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Executives

Jim W. Moore - Executive Vice President, Chief Operating Officer, Treasurer

Richard J. Vander Woude - Senior Vice President, General Counsel, Secretary

J. Bryan Baker - Chief Financial Officer, Senior Vice President

James C. Holmes - Senior Vice President, Director of Finance, Treasurer

Suzy W. Taylor - Head of Investor Relations

Analysts

[Matt O’Nee] - Stephens, Inc.

[Fred Burtner - Burtner Investments]

[Michael Southour - Benjamin Partners]

[Aaron Caddell - Havde Capital]

FirstCity Financial Corp. (FCFC) Q3 2008 Earnings Call November 10, 2008 10:00 AM ET

Operator

Welcome to the third quarter 2008 FirstCity Financial earnings conference call. My name is Jasmine and I’ll be your operator for today. At this time all participants are in a listen-only mode. We will conduct a question and answer session towards the end of the conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to your host for today, Mr. Jim Moore, Chief Operating Officer.

Jim W. Moore

My name is Jim Moore and I’m Chief Operating Officer of the company. Jim Sartain is unable to be with us this morning. Jim’s mother passed away over the weekend and I know you’ll join me in extending your sympathies to Jim and his family. I know he’s in our thoughts and prayers.

Let me introduce the people here in attendance. We have Bryan Baker, our Chief Financial Officer, Jim Holmes, our Director of Finance and Treasurer, Rick Vander Woude, our General Counsel, and Suzy Taylor, Head of Investor Relations. At this time I’d like to ask Rick Vander Woude to give us our forward-looking statement.

Richard J. Vander Woude

This conference call may include comments that are not historical facts such as projections of revenues, income or loss, future economic performance, plans or objectives of management for future operations or other forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements are dependent upon a number of uncertainties that could cause the actual results to differ materially from those implied, projected or predicted in the forward-looking statements. When any such forward-looking statement includes a statement of the assumptions underlying such forward-looking statement the company cautions that while such assumptions are believed to be reasonable and made in good faith, assumed facts almost always vary from actual results and the differences between assumed facts and actual results can be material depending upon the circumstances. Additional information concerning factors that can cause actual results to materially differ from the forward-looking statements are contained in the press release issued earlier this morning and the company’s latest Form 10K and Form 10Q and other factors discussed in the company’s filings with the Securities and Exchange Commission.

Jim W. Moore

As everyone can see, FirstCity is reporting for the quarter a loss of $1.8 million. This compares to a net income of $2.7 million in the third quarter of ’07 and also compares to a $6.5 million loss in the previous quarter. We are showing some improvement quarter-to-quarter but we still are reporting a loss.

The losses this quarter are primarily the result of $2.1 million impairments on portfolio assets globally and another contributing factor is $1.2 million of asset level expenses that are primarily the result of nonperforming assets in REO in our portfolios. In addition to those we have losses from foreign currency exchange of approximately $400,000 which predominantly took place in Europe.

While we continue to suffer in our portfolio from declining real estate values and extended [inaudible] collections as they relate to our disposition scenarios, the economy and the adverse thereof continues to impact our earnings. But once again we feel like we are making some progress and we’ll talk about this a little bit later.

In the third quarter FirstCity invested approximately $9.3 million. This was down from the second quarter total of $65.6 million. We’ll talk about this a little bit later as well but our pipeline is growing and our purchasing opportunities are expanding as well.

I also would like to announce that FirstCity completed its 1.5 million share stock repurchase program with the acquisition of a little over 439,000 shares since June 30.

At this time I’d like to turn the call over to Bryan Baker, who will share with you more details about the financial report.

J. Bryan Baker

If you look at the table on page 1, Jim kind of already described the results there for you. But if you look at the quarter of a $1.755 million loss or $0.17 a share, it was negatively impacted by impairments of $2.1 million and fx losses of $448,000. If you add those two back, we had about $800,000 of core earnings related to our platforms compared to $11.868 million loss or $1.14 for the year. Net of impairments and fx gains if you add those back, you’d come down to $2.4 million of core earnings for the year.

Obviously those results are depressed by other factors as lower collections are hitting us in the US and driving down our income from portfolio assets in the US. If you flip over to page 6 of your press release, there’s a consolidated income statement comparative. We’ll just kind of walk through that.

If you look at the total revenues quarter-to-quarter and year-to-year, they’re up slightly while the US is seeing downward pressure on its revenues as a result of the lower collections and higher costs in its partnerships related to the growing REO balances in those entities. We are seeing offsets and increases in our new businesses such as our private equity business and our additional investments in SBA loans which are offsetting some of the declines in the US portfolio income. Overall it’s flat year-to-year and quarter-to-quarter.

Then coming down to the expense section, you can see our interest expense is down slightly at a lower average debt expense primarily because we didn’t buy as much and we had cash coming in to pay down the debt. Our average cost of debt is about 8% for the quarter.

The salaries and benefits is higher year-to-year and quarter-to-quarter as a result of our new platforms and our new subsidiaries that we’re adding under our private equity business and our growth in our portfolio business in preparation for what we see as a tremendous growth opportunity in the coming months.

Provisions obviously are a lot higher year-to-year and quarter-to-quarter. Jim has talked about that in the past. We see much lower levels this quarter and we’re happy about that but as we all know this market is still maturing. We look at that every quarter and we’ll just have to see how it goes.

Property protection expense is another line item that continues to grow as our REO balances grow. We’ve basically doubled our wholly-owned REO portfolio to $30 million from the same period last year and as a result of that we have higher expense loads on those assets as we’re closing them and getting them ready to sell. As REO continues to grow, we’ll have higher expense load which also has downward pressure on our net income.

Occupancy, data processing and other is up quarter-to-quarter and year-to-year. The quarter-to-quarter analysis is basically a swing in the way we record some of our fx gains and losses. In ’07 we had about a $2.3 million swing from ’07 to ’08 and went from a gain of $1.6 million in ’07 to a loss of $800,000 in that particular account category so that’s why you see that big variance there.

Overall in summary, I think that the lower collection in the US and Europe, impairments in the US, asset expenses in the US; all those things are having downward pressure on the earnings but we’re getting some benefit from adding our new investments under our private equity business and additional loans we’re making under our SBA platform. We’re also seeing increasing downward pressure on earnings as a result of the growth in REO balances. Basically once they go into REO they’re not accruing income anymore and there’s an additional expense load.

That brings you down to the $1.8 million for the quarter and $11.9 million for the year.

With that I’ll turn it back over to Jim.

Jim W. Moore

As we mentioned earlier, we invested approximately $9.3 million in the third quarter. I think it’s important to note that most of this is in the US. This is considerably a lower volume of investment that what we accomplished in the second quarter. A lot of this has to do with the timing of what’s going on in the market place.

I’d like to share with you what our pipeline is. We have a pipeline that today sits at about $7.1 billion of which $6 billion is in the US. We’re seeing the opportunities coming from the FDIC and banks and other lenders at a much greater level than what we’ve seen in previous quarters. That $6 billion in the US compares to approximately about $700 million at our last conference call. Our pipeline and our opportunities for acquisitions have grown substantially in a roughly short period of time.

We are taking a look at all of these opportunities. We have a due diligence team that’s working very diligently during this time evaluating these portfolios and preparing bids. It’s our expectation that in the fourth quarter our acquisitions will be higher than the third quarter. Some of it still will be impacted by the timing of the bid dates and we could actually close if we were to win the bids. But we certainly expect to win our share of the bids that we’re going to be making in the fourth quarter but also in the first quarter of ’09.

In fact we believe that opportunities are really going to become greater in the ’09 period than they are in ’08. There are just more deals, we’re seeing higher margins, it’s becoming a buyer’s market whereas in the past six months it’s been more of a seller’s market, we see the FDIC continuing to fail banks and that creates more opportunities for us to acquire portfolios, we see other banks and other lenders beginning to loosen up on portfolios that they’re wanting to dispose of, so we feel very good about the market place.

We have taken some action in our operating platform in terms of increasing the people we have available to perform due diligence. Also we’ve been building up our asset management staff because as we take on more assets we’re going to need more people to service those assets and we don’t want to be caught in a position where we’re short on talent or on people as we take on the additional resources. We expect earning assets to grow in the fourth quarter and on through ’09, and we want to make sure that our platform is sufficient to handle all that additional load.

One of the things that we’re beginning to see as everyone’s aware is the TARP program, Treasury Asset Repurchase Program. It’s something that’s still in process. It hasn’t been fully defined yet. It’s still being implemented. We’re not certain of how this will shake out but one thing we’re certain of is that the impact will benefit FirstCity as a whole.

We’re seeing banks receive capital and as those banks receive capital they become more willing to shed their problem assets. We’re seeing banks turn loose of their liquidity lines to some extent. We do have borrowers that are able to access resolutions whenever the circumstances dictate that.

We’ve been very pleased that even though our overall collections have been down in the third quarter, borrowers are at least having good discussions with their bankers relative to the opportunities. What we’ve found is that if it makes sense to the banker, he will make the loan. So while it’s still a very tight credit market, I think we’re seeing some loosening of that and I think with what the government is doing and its resolution program will help the entire market as it relates to our business as well.

We’re looking forward to having the TARP program being completed or defined or redefined, however they’re going to do this. We’d just like to see what impact it’s going to have. But once again we think it will be a very positive impact on our company.

As it relates to liquidity all of our debt facilities are still in place. I know there’s been a lot of concern about H Boss since they’ve been struggling in recent days. Their merger with Lloyd’s is still pending. We believe that once that merger is finalized, and it looks like it is going to be finalized, it will stabilize their situation. If their situation stabilizes, it stabilizes ours as well. Debt facilities are still operating. They’re still open. As far as the bank is concerned, their information to us is that it’s business as usual. All of our debt covenants are in compliance. We still have a strong borrowing base and we have strong cash flows which helps that process.

Our credit facility, our debt facility, matures in November of ’10 so we still have availability basically through ’10 subject to our volume based requirements. As you can see we still have $145 million available in the facility subject to those volume based requirements.

The bank has been very supportive. Even though it’s business as usual they maintain good communications with us. We believe their liquidity’s going to be adequate and satisfactory to carry us through these periods.

Also I’d like to talk a little bit about our share repurchase program. We did complete our program here in recent days. We bought almost 480,000 shares since June 30 and that completed our program. The average price per share of those 439,000 shares was $3.87 so that took us to 1.5 million shares of which we had a total cost of $10.9 million or an average share price of $7.28. That program is now complete.

You can also look in the press release at the schedule of unrealized gross profits. You’ll see that this scheduled compared to the same time as last quarter is down slightly; however it’s still a very strong unrealized gross profit and that represents essentially the remaining collections that we expect to collect over the life of the portfolios that we have. As long as that number is as high as it is, we believe that earnings for the company will come back into play.

The only thing that’s hurting us right now is that we haven’t been able to acquire a great deal of product but we expect that trend to change here in the fourth quarter and through the first quarter of ’09. As we continue to add earning assets that unrealized gross profit will grow as will our borrowing base capacity with our vending facilities and we’re looking forward to the upcoming opportunities.

In summary, we are disappointed with the loss for the quarter but we feel like we’re making progress. Our pipeline is very strong and we will continue to bid on portfolios. We have more opportunities to bid on than we’ve had in some time.

Once again the situation that we’re looking at, the circumstances that we’re looking at are very similar to what we saw during the [inaudible] days. We’re seeing portfolios that we’ll be able to acquire at reasonable prices and healthy profit margins. The competition is tough. There are a lot of people out bidding on the portfolios but we believe we will win our fair share.

We have adequate liquidity to get us through this period. We have adequate liquidity to take advantage of the new opportunities. We continue to develop relationship with other parties who may partner with us or provide financing with us and other situations.

We’re very positive about what we see in the future. We feel like the circumstances are going our way and we just need to execute on the plans that we have. Given the people that we have in the company and the backing of H Boss we feel like execution will not be an issue.

That concludes our prepared remarks and we’d like to turn it back to the question and answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from [Matt O’Nee] - Stephens, Inc.

[Matt O’Nee] - Stephens, Inc.

In the past we’ve talked about 4Q being a seasonally good quarter with collections and new investments. Is that something that we should expect again in 4Q?

Jim W. Moore

We certainly anticipate that.

[Matt O’Nee] - Stephens, Inc.

On both collections and the new investments?

Jim W. Moore

We’re seeing I think an uptick in collection opportunities and I think over the third quarter we’re going to see a definite increase in the fourth quarter. I believe that with what we have on our plate for potential bids fourth quarter could be very good as well.

[Matt O’Nee] - Stephens, Inc.

You mentioned some numbers in your prepared remarks with the pipeline. Can you remind us what you consider the pipeline? Is it opportunities that you see or is it things you’re actually bidding on? How do you consider the pipeline?

Jim W. Moore

It includes that we’re actively bidding on and items that we’re actively at least exploring the opportunity. Of that $6 billion in the US that I gave you earlier, about $2.6 billion of that is on deals that we are actually going to bid on and the rest would be on deals that are out there and we may get to them but we’re still evaluating the opportunities. Once we get to the point to where we believe an opportunity no longer meets the criteria of something that we can pursue, we take it out of our pipeline.

[Matt O’Nee] - Stephens, Inc.

You said it was $6 billion in 3Q. Compared to what last quarter?

Jim W. Moore

I think at the last conference call it was about $700 million in the US.

J. Bryan Baker

In addition to the $6 billion in the US we have about $1.1 billion of opportunities that are lined up also in Europe and Latin America. But our focus is going to be predominantly in the US and we feel like that’s where the strongest opportunities are. With the potential profit margins that exist there that’s where we feel like we’ve got to maintain our focus.

[Matt O’Nee] - Stephens, Inc.

If provisions came down in 3Q significantly from the second quarter, is it safe to say that collections improved significantly in 3Q from 2Q?

Jim W. Moore

They didn’t improve significantly. Actually they were off a little bit in 3Q. But at the same time that lower collection figures into our impairments because if we have impairments that are scheduled to come in to a particular quarter and it doesn’t take place, they get pushed out and that increases the impairment. So in the fourth quarter if they improve, then it could be that the cash flows that we have scheduled if they take place, that will prevent possible impairments.

But impairments also include declines in underlying values so as we go through our ongoing process of getting updated appraisals and updated BPOs and market data about our underlying collateral those values where it continued to go down, it could result in further impairments. That’s an ongoing process. We update every month and make adjustments accordingly. So to say that we will not have significant impairments in the fourth quarter, I couldn’t guarantee that. We’ll just provide them and recognize them as we become aware of them.

[Matt O’Nee] - Stephens, Inc.

So in terms of the appraisals, did you have more appraisals done in the second quarter and that’s why we saw a larger provision or do you have the same amount of appraisals done every month and every quarter and that’s an ongoing process?

Jim W. Moore

It’s an ongoing process. We did have a large number that came in in the second quarter just because of timing. Essentially we try to update collateral values no less than on an annual basis so we have a regular schedule behind every asset when it is required. Sometimes additional information comes in and it’s still right on mark with where we are and sometimes it comes in and it requires an adjustment downward.

We also had a hurricane in Texas in October and we’re still dealing with that to see what impact that may have in the fourth quarter. Our initial reports indicate that we have very limited hurricane damage except in a couple situations. At the same time we don’t think it’s going to be a monumental number. In fact we may very well come out of the hurricane with very limited impact as it relates to impairments.

[Matt O’Nee] - Stephens, Inc.

From more of a macro perspective, I’m looking at FCFC four consecutive quarters of negative EPS and we’re talking about increasing leverage from your creditors. What are your creditors saying in the face of this global credit crisis when you guys want to increase your leverage with a track record of the last four quarters of being all negative EPS?

J. Bryan Baker

I don’t want to speak for our creditors but I do know that they pay less attention to our earnings in comparison to what attention they pay to our borrowing base. The way our facilities are structured they look more to that borrowing base calculation over earnings. Now we took steps earlier in the year to eliminate an EBITDA covenant that we had and we converted that to a cash flow ratio. Since we made that conversion, the cash flow ratio and the test in the documents we’ve been well within that covenant limit.

[Matt O’Nee] - Stephens, Inc.

So that cash flow would be affected by the provision from the appraisals or is that not part of the cash flows you’re talking about?

J. Bryan Baker

The impairments are essentially a noncash item so when they make that cash flow estimate it’s based on pure cash that flows in on collections on the entire portfolio and then what’s projected happened in previous periods.

Obviously if we take an impairment by lowering cash flows that impacts that borrowing base but even as we’ve done that with the impairments we’ve taken year-to-date, our borrowing base still remains strong. We’ve not had any problems with our borrowing base being inadequate to support the debt. In fact it’s well in excess of what the debt is. So as long as we’re in that situation we feel like the bank is going to understand.

We have discussions with the bank all the time. We meet with them regularly and we know that they’re obviously concerned about the economy and they expect us to be more conservative in our bids, to be more conservative in our valuations. But as long as they’re comfortable with that and our cash flows are as strong as they are and our projections are still very close to what we’re coming in at, I don’t think we’ll have any problem with the bank because once again our covenants are all in compliance and we don’t foresee that we’re going to be in any noncompliance in the near future.

[Matt O’Nee] - Stephens, Inc.

Could you remind us of the geographies of your current US investments, maybe the three or four largest states that you guys are invested in? And maybe also the geographies of some of the pipelines that you’re talking about, some of the states that have the most opportunities that you see?

Jim W. Moore

I’ll let Jim Holmes answer the question about our portfolio.

James C. Holmes

In our servicing portfolio we have a good deal of it in Texas as we over the last two or three years have invested in some M&A activity down here. We have a West Coast concentration in California, not Southern California. But also in the Southeast; it’s kind of broad because some of it’s in Florida, some of it’s in the Mid-Atlantic States. Then there’s another general grouping up in New England. Of course probably the toughest one is our investments up in the Great Lakes region, Michigan, Ohio. Again we think we’ve bought that stuff at pretty deep discounts so just managing the assets up in the Great Lakes region in particular is probably our toughest subgroup.

Jim W. Moore

As it relates to our pipeline, the assets are really all over. You do see a large concentration in Florida, Utah, California but in the portfolios that we’re looking at, we’re looking at Texas, Arkansas, Missouri, East Coast particularly in the Southeast, Alabama, Georgia, banks that are in Nevada and California that failed as well.

So we’re pretty well geographically diverse although we do see a lot of acquisitions of development loans that come out of Florida where banks had gone outside their normal market opportunities to go chase that rabbit. But we are very attune to what’s going on in those markets and if were to buy in the markets where you’re seeing a lot of these assets, we feel like it will be the right price.

Operator

Our next question comes from [Fred Burtner - Burtner Investments].

[Fred Burtner - Burtner Investments]

On Bank of Scotland are you thinking about adding a second bank so you’re not totally dependent on H Boss?

Jim W. Moore

We always explore that opportunity. We’ve had financing with Bank of America in the past. We still have banking with Bank of America. We have financing with US Bank out of Minneapolis. We’ve had some financing with some local banks here that help us out with liquidity issues from time to time. So we do feel like there are other banks that we can go to and we’re always exploring the opportunities for additional relationships. Yes, given the impact of what’s happened at Bank of Scotland we obviously are attuned about that and looking for that additional opportunity.

[Fred Burtner - Burtner Investments]

With any of those banks do you have a material line of credit at this point?

Jim W. Moore

Jim, what do we have with Bank of America today?

James C. Holmes

On outstanding senior [inaudible] of Bank of America it’s about $25 million to $30 million. What was your question Fred?

[Fred Burtner - Burtner Investments]

How large a line of credit if you have with any bank other than H Boss?

James C. Holmes

The other facilities we have aren’t technically lines of credit. They’re more term debt facilities. With US Bank it’s under $10 million, with Bank of America it’s under $30 million, and with the local banks they’re under $10 million as well.

[Fred Burtner - Burtner Investments]

With the problems of AIG what is the status of your joint venture in Mexico? Are you thinking of replacing AIG or what is happening?

Jim W. Moore

We’re sitting back waiting for AIG to tell us what direction they’re going to go. Right now it’s business as usual with AIG. They’ve not exited the market. Does that mean they’re not going to sell their position in that type of assets whether it be in Mexico or in other parts of the world? We don’t know so we’re just kind of waiting for direction from them. But right now it’s business as usual. They’re our partner and they still participate.

[Fred Burtner - Burtner Investments]

Could you discuss any opportunities the company has with any of the failed banks or banks that may be failing?

Jim W. Moore

At this point we have not. I think a lot of the banks are still waiting to see what they’re going to get out of the TARP program. There’s probably less interest today in banks seeking outside partners because they’re going to wait and see what impact TARP is going to have on their situation. But we would certainly explore that if the opportunities presented themselves.

[Fred Burtner - Burtner Investments]

Could you discuss any investments in terms of the size that you’ve closed on since September 30 in the pipeline?

Jim W. Moore

We’ve closed a couple of transactions since September 30 but they’re larger than what we closed in the third quarter. We anticipate that we’re going to be probably closing some more before year end although that’s not guaranteed. I would say that we’ve already closed on more than what we produced in the third quarter.

[Fred Burtner - Burtner Investments]

Substantially more than $10 million or just close to $10 million?

Jim W. Moore

Slightly more.

[Fred Burtner - Burtner Investments]

You also in the press release had $1.8 million of equity interest investments. What was that?

Jim W. Moore

I believe that was the Crestone opportunity, wasn’t it Jim?

James C. Holmes

It was our Wyoming opportunity, the Crestone deal, private equity fund.

Jim W. Moore

Do you want to talk about that outside with it Jim?

James C. Holmes

It was on the PRL actually. We have an investment in a French company called PRL and we acquired some additional shares in that company for about $1.6 million. Then we had two small additional investments in some other subsidiaries.

[Fred Burtner - Burtner Investments]

On the balance sheet there was a large increase in minority interest in other liabilities. Is there anything significant in that change from the June balance sheet?

Jim W. Moore

What that is primarily is we’re having to consolidate PRL and a good bit of that is related to the minority interest in PRL. Then there’s a minority interest in another German deal and another European deal. So it’s all foreign investments that we’re having to consolidate because of the accounting rules. It doesn’t have a lot of additional balance sheet impact but the minority interest is fairly large.

[Fred Burtner - Burtner Investments]

Could you discuss your opportunity on the REO assets you have either to exit them, sell them or just to work at problems in this environment?

James C. Holmes

Obviously our REO portfolio is larger than what it has been traditionally over the years and we prefer not to have the REO directly but it is a difficult environment to sell REO. We’re making every effort to sell. We are willing to look at discounted prices in order to gain more liquidity if that makes sense. The biggest issue we have on the REO is the buyers finding financing. So we are making a little noise about providing seller financing particularly if there’s an adequate down payment and the borrower’s in a position to carry the property in terms of paying taxes, insurance and that kind of thing.

But it is a struggle with our REO portfolio just because of the tight credit markets. It not only impacts getting the underlying property itself financed but buyers backed off a little bit not knowing what direction our economy’s going to go in overall. I think if we get some improvement, the buyers will return.

There are very few properties we have where we have absolutely no interest so that’s an encouraging thing. A lot of the properties we have, particularly the larger ones, have at least some interest so we’re confident that at some price we’ll be able to dispose of that REO property. However I think on some of the properties the timing may be extended but we do feel like we’ve gotten pretty close to the bottom of what those REO properties are worth.

[Fred Burtner - Burtner Investments]

To what degree do you think the credit markets are still frozen? I know they are but how unfrozen have they become?

Jim W. Moore

The small banks, community banks, regional banks appear to have more flexibility than the larger banks. It seems like the larger the bank the more it’s frozen just because of their own shell shock. But we’ve seen smaller banks and community banks are still very active. They don’t have the problems of the larger banks and they still want to put loans to work so they can increase their income.

[Fred Burtner - Burtner Investments]

The number of US employees in the last three months declined slightly yet you said earlier in the call that you have a buildup in your asset management staff. What function are you reducing staffing in?

J. Bryan Baker

That’s in the SBA platform that backed off the production staff to try to collect what we have on the books and look for new opportunities because there’s not a lot of opportunities in the market right now for those new acquisitions.

Jim W. Moore

What we encountered with our SBA platform is we had ramped up towards the end of last year what we call PDOs or production officers, people that would go out and find USBA loans to book. But what we found in ’08 is that the market is just not very strong. A lot of people have backed off of SBA lending because of the problems in the economy so we recognized in June of this year that the market for SBA loans wasn’t going to be strong enough to support the platform.

So we did go through a retrenchment of that operating facility. Our goal was to lower the overhead so that at the very worst case we’d be at a break-even point. That’s kind of where we are today. We’re just about break-even on ABL. We’ve already gone through the cuts on that staff so there was a large number of people that left there.

But we have been building our due diligence staff. We have been building our asset management staff. I just failed to recognize that the ABL cuts were larger than the building additions and the buildup is more in the last quarter.

What we are seeing though is a little bit more interest in SBA loans and we’re one of the few lenders that are still making a few loans although when we make loans we feel like it’s a very good SBA loan. But since the credit markets have gotten frozen it does push a few more borrowers our way.

[Fred Burtner - Burtner Investments]

With the tight credit markets to the degree you’ve used financial partners to acquire some large portfolios; can you discuss the availability of credit for these potential partners of yours?

Jim W. Moore

We’re being told by these potential partners that they have the funding and I guess at this point we take them at their word. But we have been approached by several parties and they’re all strong parties. No one’s mentioned any resistance because of the credit markets to invest in these types of assets. They’re actively pursuing these opportunities.

Operator

Our next question comes from [Michael Southour - Benjamin Partners].

[Michael Southour - Benjamin Partners]

Could you discuss the REO assets a little bit so we could get a little more flavor of them? What kind of properties are they? Are there several that are particularly large or are they all rather small? Geographic distribution? Property type? That kind of thing?

Jim W. Moore

It’s all across the board. We have everything from apartment houses to rent houses to golf courses, industrial buildings, churches. You name it; we have a little bit of it. Most of the REOs are not large. We did have two apartment projects, one of them which we actually got paid off. We sold it in October. It was about an $8 million payoff. But then we had another one that’s about almost $4 million in carrying costs and we’re still working on trying to find a buyer for that project.

But most of our REO assets are smaller than that and we have very few that are over $1 million. So a lot of it could be duplexes, raw land, industrial buildings, warehouses; it’s just a hodge podge of different types.

A lot of it is in the Midwest up in the Rust Belt and that’s where we’re struggling a great deal with some of these properties. But there’s also still a fair amount of property that’s in Texas.

[Michael Southour - Benjamin Partners]

Could you go over the process of booking an impairment on these things? You’re bidding on the loans at a discount so your cost is a discount to cost. Does that mean that the whole portfolio is then going to have a loss or you’re cherry-picking out specific assets that are in the portfolio that are going to have a loss? How does that work?

Jim W. Moore

Let me use this illustration and see if this helps. Let’s say we buy a portfolio and it’s got 10 assets in there. The way that we arrive at our price typically is we go through disposition strategies and assign a disposition strategy and a cash flow budget to each one of those assets. Then based upon whatever return we’re looking for in that portfolio we’ll discount those flows back at that rate to get to the purchase price.

So essentially when we buy that pool of loans it stays as a pool. In some cases you can split them up and have them as individual assets but in many cases we take them on as a pool. So we gauge the impairments based upon the overall cash flow for that pool going forward.

If something happens that changes that cash flow, it can either go up or down on a discounted basis. So if something happens where the expected collections go down, then that creates the potential for an impairment. We may end up collecting more cash in the long run or we may collect the same amount of cash but if we push it out beyond the original projection dates, then that can create an impairment.

All the while on these pools, we have to accrue under the accounting rules at the discount rate for which we bought that portfolio; the return that we estimated that portfolio. So anything that changes that cash flow scenario, if it doesn’t happen in accordance with the way it was projected, can create an impairment whether it’s a cash flow impairment or whether it’s a real value impairment because we recognize that the property of the value is not what we thought it was.

Does that help answer your question or do we need to go into more detail?

[Michael Southour - Benjamin Partners]

Some. It seems like we’re dealing with the pool as a pool and then at a certain point you deal with the individual pieces as individual pieces. It’s complicated.

J. Bryan Baker

It is complicated. One you have an asset go into REO you pull it out of the pool and you account for that separately as an individual asset. The impairment test changes at that point to net realizable value so whatever you expect to collect, if that’s greater than your book value, and then you’re okay. But if it drops, then you have impairment for that difference.

[Michael Southour - Benjamin Partners]

So that’s really where it drops out of the pool?

J. Bryan Baker

Right.

[Michael Southour - Benjamin Partners]

Then I have one last question which is kind of a philosophy question. If you think that things are going to be better as a bidder going into 2009, why would you be doing anything now?

Jim W. Moore

We think there are opportunities out there that we can bid on and make money on. When I say that we think in ’09 that the opportunities are going to be better, it doesn’t necessarily mean a better profit, it doesn’t necessarily mean a better margin or a better price; it just means there’s going to be more of it.

We think that when we see an opportunity that gives us the kind of returns that we look for and we think it’s a reasonable risk and we calculated all the caveats in there about collection strategies that we want to calculation, if we feel like it meets our criteria we want to buy it and put it on the books to make money. Part of our problem today is we need more earning assets. So if they’re out there and we can buy them at the right price, we’re going to execute.

And once again, in terms of ’09 I’m not sure that the prices will be any better in ’09 but I just think there’ll be more product to look at and to acquire.

Operator

Our next question comes from [Aaron Caddell - Havde Capital].

[Aaron Caddell - Havde Capital]

I was just wondering if you could clarify your comments on the buy-back and especially given all the opportunities you’re seeing out there, am I to understand that with the completion of the buy-back you’re thought is to kind of sit tight for now even if the stock remains below book value? Can you just give your current thoughts on that?

Jim W. Moore

That is correct. That would be our current position unless our Board of Directors makes a decision that they want to expand the buy-back program.

Operator

You have no further questions at this time. I’d like to turn the call back to Jim Moore for closing remarks.

Jim W. Moore

I want to thank everyone for participating in our conference call today.

Once again we’re a little bit disappointed in our operating results but we feel very good about the opportunities for the next several months. The buying opportunities are beginning to not overwhelm us but in a pleasing way they’re giving us lots of things to look at and to consider. We’re looking forward to the challenge of buying in this market place because we think the time is right and we think it’s going to get better in the course of the next 12 months. But once again we have to execute on that and that’s what we plan to do.

Thank you very much for participating and we look forward to talking to each of you next quarter.

Operator

Thank you for attending today’s conference. This concludes your presentation. You may now disconnect. Good day.

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Source: FirstCity Financial Corp. Q3 2008(Quarter End 9/30/08) Earnings Call Transcript
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