Use these links to rapidly review the documentTABLE OF CONTENTS



UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, DC 20549

Form 10-K

|(Mark One)                                                    |                                                                                         
|------------------------------------------------------------- | ----------------------------------------------------------------------------------------
|ý                                                             | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|For the fiscal year ended December 31, 2007                  
|or                                                           
|o                                                             | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|For the transition period
from                             to

Commission file number 033-19694

---

FirstCity Financial Corporation(Exact name of registrant as specified in its charter)

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

(254) 761-2800(Registrant's Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

|Title of Each Class          |  | Name of Each Exchange on Which Registered
|---------------------------- |  | -----------------------------------------
|Common Stock, par value $.01 |  | The NASDAQ Stock Market LLC              

Securities registered pursuant to Section 12(g) of the Act:
None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act.    Yes o        No ý

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act.    Yes o        No ý

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not
be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K.    o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definition of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

|Large accelerated filer o |  | Accelerated filer ý |  | Non-accelerated filer o (Do not check if a smaller reporting company) |  | Smaller reporting company o
|------------------------- |  | ------------------- |  | --------------------------------------------------------------------- |  | ---------------------------

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates, based upon the closing price of the common
stock on the Nasdaq National Market System as of June 30, 2007, was $95,343,164.

The
number of shares of common stock outstanding at March 13, 2008, was 10,481,907.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates certain information by reference to the earlier filed of (i) an amendment to this annual report on Form 10-K or
(ii) the definitive proxy statement for the 2008 Annual Meeting of Stockholders.



---





FIRSTCITY FINANCIAL CORPORATION

TABLE OF CONTENTS



|           |  |                                                                                                              |  | Page
|---------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|           |  | PART I                                                                                                       |  |     
|Item 1.    |  | Business                                                                                                     |  | 3   
|Item 1A.   |  | Risk Factors                                                                                                 |  | 13  
|Item 1B.   |  | Unresolved Staff Comments                                                                                    |  | 19  
|Item 2.    |  | Properties                                                                                                   |  | 19  
|Item 3.    |  | Legal Proceedings                                                                                            |  | 19  
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                                          |  | 22  
|           |  | PART II                                                                                                      |  |     
|Item 5.    |  | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 23  
|Item 6.    |  | Selected Financial Data                                                                                      |  | 24  
|Item 7.    |  | Management's Discussion and Analysis of Financial Condition and Results of Operations                        |  | 25  
|Item 7A.   |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 46  
|Item 8.    |  | Financial Statements and Supplementary Data                                                                  |  | 48  
|Item 9.    |  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure                         |  | 132 
|Item 9A.   |  | Controls and Procedures                                                                                      |  | 132 
|Item 9B.   |  | Other Information                                                                                            |  | 132 
|           |  | PART III                                                                                                     |  |     
|Item 10.   |  | Directors, Executive Officers and Corporate Governance                                                       |  | 133 
|Item 11.   |  | Executive Compensation                                                                                       |  | 133 
|Item 12.   |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 133 
|Item 13.   |  | Certain Relationships and Related Transactions, and Director Independence                                    |  | 133 
|Item 14.   |  | Principal Accounting Fees and Services                                                                       |  | 133 
|           |  | PART IV                                                                                                      |  |     
|Item 15.   |  | Exhibits and Financial Statement Schedules                                                                   |  | 134 
|Signatures |  | 138                                                                                                         

FORWARD LOOKING INFORMATION

Some of the statements in this report constitute forward-looking statements by words such as "believe," "expect," "anticipate," "optimistic," "intend," "plan,"
"aim," "will," "may," "should," "could," "would," "likely," "estimate," "predict," "potential," or "continue" or other similar expressions. Under "Item 1A. Risk Factors", we discuss certain
factors that affect our business and operations and factors that may cause our actual results to differ materially from these forward-looking statements. You are cautioned not to place undue reliance
on these forward-looking statements, which speak only as of the date on which they are made. We undertake no obligation to update publicly or revise any forward-looking statements.

2

Table of Contents

---





PART I

Item 1.Business.

General

FirstCity Financial Corporation (the "Company", "FirstCity," "we" or "us"), a Delaware corporation, is a financial services company headquartered in Waco, Texas
with offices throughout the United States and Mexico and a presence in Europe and South America. The Company began operating in 1986 as a specialty financial services company focused on acquiring and
resolving distressed loans and other assets purchased at a discount relative to the aggregate unpaid principal balance of the loans or the appraised value of the other assets ("Face Value"). To date
the Company has acquired, for its own account and through various affiliated partnerships, pools of assets or single assets (collectively referred to as "Portfolio Assets" or "Portfolios") with a Face
Value of approximately $10.0 billion. The Company's servicing expertise, which it has developed largely through the resolution of distressed assets, is a cornerstone of its growth strategy.
Today the Company is engaged in one reportable business segmentPortfolio Asset acquisition and resolution. See Note 8 of the Company's Consolidated Financial Statements for certain
financial information about this segment of the Company.

Securities Exchange Act Reports and Additional Information

FirstCity makes available free of charge on or through its website atwww.fcfc.com, its Annual Report on
Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other information releases including all amendments to those reports
as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission ("SEC"). Also, the SEC maintains a website that contains
reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The public can obtain any documents that the Company
files with the SEC atwww.sec.gov.

Business Strategy

The Company's core business is the acquisition, management, servicing and resolution of Portfolio Assets. Key elements of the Company's overall business strategy
include:



3

Table of Contents

---





Background

The Company began operating in the financial services business in 1986 as a purchaser of distressed assets from the Federal Deposit Insurance Corporation ("FDIC")
and the Resolution Trust Corporation ("RTC"). From its original office in Waco, Texas, with a staff of four professionals, the Company's asset acquisition and resolution business grew to become a
significant participant in an industry fueled by the problems experienced by banks and thrifts throughout the United States. In the late 1980s, the Company also began acquiring assets from healthy
financial institutions interested in eliminating nonperforming assets from their portfolios. In 1991, the Company began its relationship with certain affiliates of Cargill, Incorporated (collectively,
"Cargill")a privately-held, multi-national agricultural and financial services company. Since that time, the Company and Cargill have formed a series of Acquisition
Partnerships (as defined below) through which they have jointly acquired over $7.9 billion in Face Value of Portfolio Assets.

In
July 1995, the Company acquired by merger (the "Merger") First City Bancorporation of Texas, Inc. ("FCBOT"), a former bank holding company that had been engaged in a proceeding
under Chapter 11 of the United States Bankruptcy Code since November 1992. As a result of the Merger, the Company's common stock, $.01 par value per share ("Common Stock") became publicly held.
In addition, as a result of the Merger, the Company retained FCBOT's rights to approximately $596 million in NOLs, which the Company uses to offset taxable income generated by the Company and
its consolidated subsidiaries.

In
July 1997, the Company acquired Harbor Financial Group, Inc. and its subsidiaries (collectively referred to as "Mortgage Corp.") and expanded into related niche financial
services markets, such as mortgage conduit banking, conducted through one of its subsidiaries, FC Capital Corp. ("Capital Corp."), and consumer finance, conducted through another of its subsidiaries,
FirstCity Consumer Lending Corporation ("Consumer Corp."). In 1999, the Company formally adopted plans to
discontinue the operations of Mortgage Corp. and Capital Corp. As a result, the operations of such entities have ceased and the results of historical operations for Mortgage Corp. and Capital Corp.
have been reflected as discontinued mortgage operations.

As
a result of the liquidity constraints created by the discontinued operations of Mortgage Corp. and Capital Corp., in the third quarter of 2000, Consumer Corp. completed the sale of a
49% equity interest in its automobile finance operation to IFA Drive GP Holdings LLC ("IFA-GP") and IFA Drive LP Holdings LLC ("IFA-LP"),
wholly-owned subsidiaries of BoS(USA), Inc. ("BoS(USA)"), a wholly-owned subsidiary of Bank of Scotland, for a purchase price of $15 million cash and resulted in a gain of
$12.1 million ($4 million was deferred and recognized in the December 2002 recapitalization discussed below).

In
December 2002, FirstCity completed a recapitalization in which holders of FirstCity's redeemable preferred stock, par value $.01 per share ("New Preferred Stock"), representing 89.3%
of the shares previously outstanding, exchanged 1,092,210 shares of New Preferred Stock for 2,417,388 shares of Common Stock and $10.5 million. FirstCity also recognized the $4 million
gain (previously deferred) from the release of its guaranty of Drive Financial Services LP ("Drive") indebtedness to BoS(USA), Inc. ("BoS(USA)"). BoS(USA)'s warrant to purchase 1,975,000 shares
of non-voting Common Stock was cancelled. FirstCity also acquired the minority interest in FirstCity Holdings held by Terry R. DeWitt, G. Stephen Fillip and James C. Holmes, each of whom
were Senior Vice Presidents of FirstCity, by issuing 400,000 shares of Common Stock of the Company and a cash flow note which was settled for $310,000 in 2006 as part of the transaction with American
International Group, Inc. ("AIG"), which is discussed below.

4

Table of Contents

---



On
November 1, 2004, FirstCity and certain of its subsidiaries completed the sale of its remaining 31% beneficial ownership interest in Drive and its general partner,
Drive GP LLC, to IFA-GP, IFA-LP and Drive Management LP ("MG-LP") for a total purchase price of $108.5 million in cash, which resulted in distributions and
payments to FirstCity and Consumer Corp. in the aggregate amount of $86.8 million in cash from various sources.

On
December 30, 2004, FirstCity redeemed all of the outstanding shares of its New Preferred Stock at a total redemption price of $21.525 per share. The redemption price
represented the liquidation preference of the New Preferred Stock plus the final normal quarterly dividend of $.525 per share.

During
the third quarter of 2006, FirstCity completed a total restructure of its investments in Mexico in a transaction which aligned FirstCity with AIG. The Company received
$1.9 million in incentive service fees related to the sale of certain assets in Mexico which occurred as a result of the restructure. The details of the restructure are provided in
Note 6 to the Consolidated Financial Statements. In addition,
the Company recorded a gain on the sale of equity investments of $2.5 million. This gain consisted of: 1) one domestic equity investment resulting in a gain of $1.3 million and;
2) a partial sale of Mexico equity investments in connection with a restructure with AIG resulting in a gain of $1.2 million.

Portfolio Asset Acquisition and Resolution Business

In the Portfolio Asset acquisition and resolution business, FirstCity primarily acquires loans in groups or portfolios that have experienced deterioration of
credit quality between origination and the Company's acquisition of the loans. The amount paid for a loan reflects FirstCity's determination that it is probable the Company will be unable to collect
all amounts due according to the loan's contractual terms.

Portfolios
are either acquired for FirstCity's own account or through investment entities formed with one or more other co-investors (each such entity, an "Acquisition
Partnership"). To date, FirstCity and the Acquisition Partnerships have acquired over $10.0 billion in Face Value of assets, with FirstCity's equity investment being $660 million.



In the early 1990s large quantities of nonperforming assets were available for acquisition from the RTC and the FDIC. Since 1993, sellers of nonperforming assets
have included private sellers as well as government agencies such as the Small Business Administration. Private sellers include financial institutions, insurance companies, and other institutional
lenders, both in the United States and in various foreign countries. As a result of mergers, acquisitions and corporate downsizing efforts, other business entities frequently seek to dispose of excess
real estate or other financial assets not meeting the strategic needs of a seller. Sales of such assets improve the seller's balance sheet, reduce overhead costs, reduce staffing requirements and
avoid management and personnel distractions associated with the intensive and time-consuming task of resolving loans and disposing of real estate. Consolidations within a broad range of
industries, especially banking, have augmented the trend of financial institutions and other sellers packaging and selling asset portfolios to investors as a means of disposing of nonperforming loans
or other surplus or non-strategic assets.



FirstCity acquires and manages Portfolio Assets, which are generally purchased at a discount to Face Value by FirstCity or through Acquisition Partnerships. The
Portfolio Assets are generally nonhomogeneous assets, including loans of varying qualities that are unsecured or secured by diverse collateral types and real estate. Some of the secured Portfolio
Assets are loans for which resolution is

5

Table of Contents

---



tied
primarily to the real estate securing the loan, while others may be collateralized business loans, the resolution of which may be based either on real estate, business assets or other collateral
cash flow.

FirstCity
seeks to resolve Portfolio Assets through (i) a negotiated settlement with the borrower in which the borrower pays all or a discounted amount of the loan,
(ii) conversion of the loan into a performing asset through extensive servicing efforts followed by either a sale of the loan to a third party or retention of the loan by FirstCity or the
Acquisition Partnerships or (iii) foreclosure and sale of the collateral securing the loan.

FirstCity
has substantial experience acquiring, managing and resolving a wide variety of asset types and classes. As a result, it does not limit itself as to the types of Portfolios it
will evaluate and purchase. FirstCity's willingness to acquire Portfolio Assets is generally determined by factors including the information that is available regarding the assets in a Portfolio, the
price at which the Portfolio can be acquired and the expected net cash flows from the resolution of such assets. FirstCity and the Acquisition Partnerships have acquired Portfolio Assets in virtually
all 50 states, the Virgin Islands, Dominican Republic, Puerto Rico, Chile, France, Germany, Japan, Mexico, and Argentina. FirstCity believes that its willingness to acquire nonhomogeneous Portfolio
Assets without regard to geographic location provides it with an advantage over certain competitors that limit their activities to either a specific asset type or geographic location.

FirstCity
also seeks to capitalize on emerging opportunities in foreign countries in which the market for nonperforming loans of the type generally purchased by FirstCity is less
efficient than the market for such assets in the United States. FirstCity has equity interests in certain European servicing companies (MCS and HMCS), and in conjunction with these servicing entities
and Cargill, the Company actively pursues opportunities to purchase pools of Portfolio Assets in France, Germany and other areas of Western Europe. First City also partners with American International
Group, Inc. ("AIG"), a leading international insurance organization, to actively pursue mutual business opportunities to purchase pools of Portfolio Assets in Latin America.

The
following table presents selected data for the Portfolio Assets acquired by FirstCity:

Portfolio Assets Acquired

Year ended December 31,2007

2006

2005(Dollars in thousands)Face Value

$
514,413

$
855,633

$
330,390Total purchase price

$
214,333

$
296,990

$
146,581Total invested(1)

$
213,881

$
298,515

$
134,085FirstCity invested(2)

$
126,714

$
144,048

$
71,405Total number of Portfolio Assets


82,537


392,208


28,839




6

Table of Contents

---





Portfolio Purchases by Region

Year ended December 31,2007

2006

2005(Dollars in thousands)Purchase priceDomestic

$
121,679

$
136,596

$
93,410Europe


23,199


102,158


37,172Latin America


69,455


58,236


15,999Total

$
214,333

$
296,990

$
146,581FirstCity investedDomestic

$
108,532

$
103,467

$
58,558Europe


7,902


32,893


10,638Latin America


10,280


7,688


2,209Total

$
126,714

$
144,048

$
71,405




FirstCity develops its Portfolio Asset opportunities through a variety of sources. Since the activities or contemplated activities of expected sellers are
generally publicized in industry publications and through other similar sources, FirstCity monitors such publications and similar sources. FirstCity also maintains relationships with a variety of
parties involved as sellers or as brokers or agents for sellers. Many of the brokers and agents concentrate by asset type and have become familiar with FirstCity's acquisition criteria and
periodically approach FirstCity with identified opportunities. In addition, business referrals from other investors in Acquisition Partnerships, repeat business from previous sellers, focused
marketing by FirstCity and the nationwide presence of FirstCity are important sources of business.

FirstCity
identifies investment opportunities in foreign markets in much the same manner as in the United States. In varying degrees of volume and efficiency, the markets of Europe,
Asia, and Latin America all include sellers of nonperforming assets. In some countries, such as Mexico, the government has taken a very active role in the management and orderly disposition of these
types of assets. FirstCity's established presence in Mexico and France provides a strong base for the identification, valuation, and acquisition of assets in those countries, as well as in adjacent
markets. FirstCity continues to identify partners who have contacts within various foreign markets and or can assist in locating Portfolio Asset opportunities with FirstCity.



Prior to making an offer to acquire any Portfolio, FirstCity performs an extensive evaluation of the assets that comprise the Portfolio. If, as is often the case,
the Portfolio Assets are nonhomogeneous, FirstCity evaluates all individual assets determined to be significant to the total of the proposed purchase. If the Portfolio Assets are homogenous in nature,
a sample of the assets comprising the Portfolio may be selected for evaluation. The evaluation of individual assets generally includes analyzing the credit and collateral file or other due diligence
information supplied by the seller. Based upon such seller-provided information, FirstCity undertakes additional evaluations of the asset, that, to the extent permitted by the seller, include site
visits to, and environmental reviews of the property securing the loan or the asset proposed to be purchased. FirstCity also analyzes relevant local economic and market conditions based on information
obtained from its prior experience in the market or from other sources, such as local appraisers, real estate principals, realtors and brokers.

7

Table of Contents

---



The
evaluation includes an analysis of an asset's projected cash flow and sources of repayment, including the availability of third party guarantees. FirstCity values loans (and other
assets included in a portfolio) on the basis of its estimate of the present value of estimated cash flow to be derived in the resolution process. Once the cash flow estimates for a proposed purchase
and the financing and partnership structure, if any, are finalized, FirstCity can complete the determination of its proposed purchase price for the targeted Portfolio Assets. Purchases are subject to
purchase and sale agreements between the seller and the purchasing affiliate of FirstCity.

The
analysis and underwriting procedure in foreign markets follows the same extensive diligence philosophy as that employed by the Company domestically. Additional risks are evaluated in
foreign markets, including economic factors (inflation or deflation), currency strength, short and long-term market stability and political concerns. These risks are evaluated and priced
into the cost of the acquisition.



After a Portfolio is acquired, FirstCity assigns the Portfolio Assets to account servicing officers who are independent of the personnel that performed the due
diligence evaluation in connection with the purchase of the Portfolio. Portfolio Assets are serviced either at the Company's headquarters or in one of FirstCity's other offices. FirstCity may
establish servicing operations in locations in close proximity to significant concentrations of Portfolio Assets. Such offices are reviewed for closing after the assets in the geographic region
surrounding the office are substantially resolved. The assigned account servicing officer develops a business plan and budget for each asset based upon an independent review of the cash flow
projections developed during the investment evaluation, physical inspections of assets or collateral underlying the related loans, evaluation of local market conditions and discussions with the
relevant borrower. Budgets are periodically reviewed and revised as necessary. FirstCity employs loan-tracking software and other operational systems that are generally similar to systems
used by commercial banks, but which have been enhanced to track both the collected and the projected cash flows from Portfolio Assets.

The
Company does not recognize capitalized servicing rights related to its Portfolio Assets because servicing is not contractually separated from the underlying assets by sale or
securitization of the assets with servicing retained or separate purchase or assumption of the servicing. FirstCity services, in all material respects, the Portfolio Assets owned for its own account,
the Portfolio Assets owned by the Acquisition Partnerships and, to a very limited extent, certain Portfolio Assets owned by third parties. In connection with the Acquisition Partnerships in the United
States, FirstCity generally earns a servicing fee, which is a percentage of gross cash collections generated rather than a management fee based on the Face Value of the asset being serviced. The rate
of servicing fee charged is generally a function of the average Face Value of the assets within each pool being serviced (the larger the average Face Value of the assets in a Portfolio, the lower the
fee percentage within the prescribed range), the type of assets and the level of servicing required on each asset. For the Mexican Acquisition Partnerships, FirstCity earns a servicing fee based on
costs of servicing plus a profit margin. The Company also has certain consulting contracts with its Mexican investment entities pursuant to which the Company is entitled to additional compensation for
servicing once a specified return to the investors has been achieved. The Acquisition Partnerships in Europe and South America are serviced by various entities in which the Company maintains an equity
interest in the servicing entities. In all cases, service fees are recognized as they are earned in accordance with the servicing agreements.

8

Table of Contents

---





In connection with the Company's lending activities relative to U.S. Small Business Administration ("SBA") loan programs, the Company recognizes servicing assets
when rights are acquired or through the sale of SBA loans it originates or purchases. Generally, purchased servicing assets are capitalized at cost to acquire the rights and are carried at the lower
of cost, net of accumulated amortization, or fair value. For sales of SBA loans in which the Company retains the servicing rights, a portion of the cost or originating the loan is allocated to the
servicing right based on relative fair value. Subsequent to the date of sale, the Company accounts for the servicing assets by using the amortization method, which amortizes servicing assets in
proportion to, and over the period of, estimated net servicing income. The amortization of the servicing assets is analyzed periodically and adjusted to reflect changes in prepayment rates and other
estimates. See Note 18 of the Consolidated Financial Statements for more information on servicing rights related to SBA loans.



Portfolio Assets are either acquired for the account of a subsidiary of FirstCity or through the Acquisition Partnerships. Portfolio Assets owned directly by a
subsidiary of FirstCity may be funded with loans made by FirstCity to its subsidiaries, equity financing provided by an affiliate of Cargill, the Bank of Scotland or other third parties and secured
debt that is recourse only to the Acquisition Partnership.

Each
Acquisition Partnership is a separate legal entity, (generally a limited partnership, but may instead be a limited liability company, trust, corporation or other type of entity).
FirstCity and an investor typically form a corporation to serve as the corporate general partner of each Acquisition Partnership. Generally, for domestic Acquisition Partnerships, FirstCity and
another investor each own 50% of the general partner and a 49.5% limited partnership interest in the domestic Acquisition Partnership (the general partner owns the other 1% interest). Cargill or its
affiliates are the investor in the vast majority of the Acquisition Partnerships currently in existence. See "Relationship with Cargill." Certain institutional investors have also held limited
partnership interests in the Acquisition Partnerships and may hold interests in the related corporate general partners.

The
Acquisition Partnerships are generally financed by debt, secured only by the assets of the individual entity, and are nonrecourse to the Company, its co-investors and the
other Acquisition Partnerships. FirstCity believes that this legal structure insulates the Company and the other Acquisition Partnerships from certain potential risks, while permitting FirstCity to
share in the economic benefits of each Acquisition Partnership.

Senior
secured acquisition financing by Bank of Scotland provides the majority of the funding for the purchase of Portfolios. Senior acquisition financing is obtained at variable
interest rates with negotiated spreads to the base rates. The terms of the senior acquisition debt of the Acquisition Partnerships often allow, under certain conditions, distributions to equity
partners before the debt is repaid in full.

Prior
to maturity of the senior acquisition debt, the Acquisition Partnerships typically refinance the senior acquisition debt with long-term debt secured by the assets of
the partnership. Such long-term debt generally accrues interest at a lower rate than the senior acquisition debt, has collateral terms similar to the senior acquisition debt, and permits
distributions of excess cash flow generated by the Acquisition Partnership to the equity partners so long as the partnership is in compliance with applicable financial covenants.

In
foreign markets, FirstCity conducts analysis with respect to the establishment of ownership structures. Prior to investment, FirstCity, in conjunction with its
co-investors, performs significant due diligence and planning on the tax, licensing, and other ownership issues of the particular country. As in

9

Table of Contents

---



the
United States, each foreign Acquisition Partnership is a separate legal entity, generally formed as the equivalent of a limited liability company or a liquidating trust.



Cargill, a diversified financial services company, is generally regarded as one of the world's largest privately held corporations and has offices worldwide.
Cargill and certain of its affiliates have historically provided significant debt and equity financing to the Acquisition Partnerships. Cargill and certain of its affiliates are investors in the vast
majority of our domestic Acquisition Partnerships at December 31, 2007. While not dependent on Cargill, FirstCity believes its relationship with Cargill enhances the Company's credibility as a
purchaser of Portfolio Assets and facilitates its ability to expand into related businesses and foreign markets. FirstCity is not dependent on Cargill or its affiliates for future liquidity or
funding.



American International Group, Inc. ("AIG") is a leading international insurance organization with operations in over 130 countries and jurisdictions. AIG
and FirstCity have partnered together on
several Latin American investments. FirstCity, while not dependent on AIG, believes its relationship with AIG enhances the Company's credibility as a purchaser of Portfolio Assets and facilitates its
ability to expand into related businesses and foreign markets. AIG and FirstCity continue to pursue other mutual business opportunities in Latin America. The Company is not dependent on AIG for future
liquidity or funding.



FirstCity has had a significant relationship with Bank of Scotland and The Governor and The Company of the Bank of Scotland ("BoS-UK") and their
subsidiaries since September 1997. FirstCity and its wholly-owned subsidiaries have entered into loan agreements with Bank of Scotland and its affiliates, BoS (USA) Inc. and BoS-UK
from time to time since 1997.



Bank of Scotland provides FirstCity and its subsidiaries a loan facility under a revolving credit agreement to finance the senior debt and equity portion of
portfolio and asset purchases and working capital loans. The maximum available commitment under this revolving credit facility was $225.0 million at December 31, 2007. This facility is
secured by substantially all of the assets of FirstCity and certain of its wholly-owned subsidiaries and guaranteed by substantially all of the wholly-owned subsidiaries of FirstCity.

In
September 2007, FirstCity and BoS (USA) Inc. entered into a subordinated delayed draw credit agreement which may be used to finance equity investments in new ventures, equity
investments made in connection with portfolio and asset purchases and loans made by FirstCity and its subsidiaries to acquisition entities, provide for the issuance of letters of credit, and for
working capital loans. This credit agreement was effective on November 16, 2007 and is guaranteed by substantially all of the wholly-owned subsidiaries of FirstCity and secured by substantially
all of the assets of FirstCity and its wholly-owned subsidiaries



Since August 2005, the Bank of Scotland has provided financing to FH Partners LLC, a wholly-owned affiliate of FirstCity, to finance portfolio and asset
purchases made by FH Partners LLC. The maximum available commitment under this revolving credit facility has grown to $100.0 million at

10

Table of Contents

---



December 31,
2007 from $50.0 million at its origination in 2005. This facility is secured by all assets of FH Partners LLC and guaranteed by FirstCity and certain of its wholly-owned
subsidiaries.

Refer
to Note 2 of the Consolidated Financial Statements for additional detail and terms underlying the Company's loan facilities with the Bank of Scotland.

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



Historically, FirstCity has leveraged its expertise in asset resolution and servicing by investing in a wide variety of asset types across a broad geographic
scope. FirstCity continues to follow this investment strategy and seeks expansion opportunities into new asset classes and geographic areas when it believes it can achieve attractive risk adjusted
returns. The following items are significant elements of FirstCity's business strategy in the portfolio acquisition and resolution business:



Consumer LendingDiscontinued Operations

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

11

Table of Contents

---





Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 144,Accounting for the Impairment or Disposal of Long-Lived
Assets,the consolidated financial statements have been reclassified for all periods presented to reflect the operations, assets and liabilities of the consumer business
segment as discontinued operations. The assets and liabilities of such operations have been included in other assets and liabilities in the Consolidated Financial Statements.

Government Regulation

Certain aspects of the Company's Portfolio Asset acquisition and resolution business are subject to regulation under various foreign, federal, state and local
statutes and regulations that impose requirements and restrictions affecting, among other things, disclosures to obligors, the terms of secured transactions, collection, repossession and claims
handling procedures, multiple qualification and licensing requirements for doing business in various jurisdictions, and other trade practices.

Competition

The Portfolio Asset acquisition business is highly competitive. Some of the Company's principal competitors are substantially larger and better capitalized than
the Company. Because of these resources, these companies may be better able than the Company to acquire Portfolio Assets, to pursue new business opportunities or to survive periods of industry
consolidation. Generally, there are three aspects of the distressed asset business: due diligence, Portfolio management, and servicing. The Company is a major participant in all three areas. In
comparison, certain of its competitors (including certain securities and banking firms) have historically competed primarily as portfolio purchasers and have customarily engaged other parties to
conduct due diligence on potential Portfolio purchases and to service acquired assets, and certain other competitors (including certain banking and other firms) have historically competed primarily as
servicing companies.

The
Company believes that its ability to acquire Portfolios for its own account and through Acquisition Partnerships will be an important component of the Company's overall future
growth. Acquisitions of Portfolios are often based on competitive bidding, which involves the danger of bidding too low (which
generates no business), or bidding too high (which could result in the purchase of a Portfolio at an economically unattractive price).

Employees

The Company had 241 employees as of December 31, 2007 compared with 208 employees at December 31, 2006. The Company believes that it has been
successful in attracting quality employees and that employee relations are good.

Foreign Operations

We have investments in various Acquisition Partnerships and servicing entities in Europe and Central and South America. Revenues outside of the U.S. are a
material part of our business, and they accounted for more than 37% of our consolidated revenues and equity in earnings of investments in each year in the three-year period ended
December 31, 2007. See Note 8 to the Consolidated Financial Statements for the year ended December 31, 2007.

In
maintaining foreign operations, our business is exposed to risks inherent in such operations, including those of currency fluctuations. Information on currency exchange risk appears
in Part II, Item 7A of this Annual Report on Form 10-K, which information is incorporated herein by reference.

Financial
information about geographic areas, including net sales and assets, for the years in the period ended December 31, 2007 appears in Note 8 to the Consolidated
Financial Statements in

12

Table of Contents

---



Part II,
Item 8 of this Annual Report on Form 10-K, which information is incorporated herein by reference.

Item 1A.Risk Factors.

This
section highlights specific risks that could affect our Company and its businesses. You should carefully consider each of the following risks and all of the other information set
forth in this Annual Report on Form 10-K. Based on the information currently known to us, we believe that the following information identifies the most significant risk factors
affecting our Company. However, the risks and uncertainties our Company faces are not limited to those described below. Additional risks and uncertainties not presently known to us or that we
currently believe to be immaterial may also adversely affect our business.

If
any of the following risks and uncertainties develops into actual events or the circumstances described in the risks and uncertainties occur, these events or circumstances could have
a material adverse effect on our business, financial condition or results of operations. These events could also have a negative effect on the trading price of our securities.

We may not predict the availability of Portfolio Assets.

Long-term cycles in the general economy affect the business of acquiring and resolving Portfolio Assets. We cannot predict our future annual
acquisition volume of Portfolio Assets. Moreover, our future purchase of Portfolio Assets will depend on the availability of Portfolios offered for sale, the availability of capital and our ability to
submit successful bids to purchase Portfolio Assets. Due to the highly competitive environment of the business of acquiring Portfolio Assets in the United States, we may be required to acquire
Portfolio Assets at higher prices, which will lower our profit margins on the resolution of such Portfolios. To offset these changes in the domestic arena, we continue to develop our presence in other
markets. Under certain circumstances, we may choose not to bid for Portfolio Assets that we believe cannot be acquired at attractive prices. As a result of all the above factors, we may be materially
adversely affected by variations on our Portfolio Asset purchases, and the revenue derived from the resolution of such Portfolio Assets.

Our ability to manage risks associated with growth and entry into new businesses and foreign markets may be limited.

We have entered into new business related to the Portfolio Asset acquisition business and new foreign markets in the Portfolio Asset acquisition business. We have
also recently entered into the business of originating and servicing loans as a small business lending company through our ninety-six percent (96%) investment in American Business
Lending, Inc. ("ABL") and acquisition by ABL of unguaranteed portions of certain business loans, certain loan servicing rights and obligations including certain fees to be earned
on the portion of such loans that are guaranteed by the U.S. Small Business Administration. Additionally, we have entered into a special situations platform that will buy or finance distressed debt
and companies, originate junior and senior bridge loans, and execute lower middle market buyouts through our eighty percent (80%) investment in FirstCity Crestone. We are also expanding operations in
Latin America and Europe.

The
entry into these new businesses and foreign markets has resulted in increased demands on our personnel and systems. The development and integration of the new businesses and
operations in foreign venues requires the investment of additional capital and the continuous involvement of our senior management. We also must manage a variety of businesses and operations in
foreign venues with differing markets, customer bases, financial products, systems and managements. An inability to develop, integrate and manage our businesses and operations in foreign venues could
have a material adverse effect on our financial condition, results of operations and business prospects. Risks related to

13

Table of Contents

---



the
start up of a business or entry into a new foreign market, including the ability to implement the new business plan and strategy to generate sufficient revenues necessary to avoid losses common to
start up companies, the availability of opportunities for investment in the markets to be entered, the dependency of new businesses for liquidity and our ability to support and manage continued growth
is dependent upon, among other things, our ability to attract and retain senior management for each of our businesses, to hire, train, and manage our workforce and to continue to develop the skills
necessary for us to compete successfully in our existing and new businesses and operations in foreign venues. There can be no assurance that we will successfully meet all of these challenges.

It is likely that our actual experience will not be consistent with the assumptions underlying our Portfolio Asset performance and that the differences may be material and
adverse.

We determine the purchase price and carrying value of Portfolio Assets acquired by us by estimating expected future cash flows from such assets. We develop and
revise such estimates based on our historical experience and current market conditions, and based on the discount rates that we believe are appropriate for the assets comprising the Portfolios. In
addition, many obligors on Portfolio Assets have impaired or poor credit history, low income or other adverse credit events. We are subject to various risks associated with these borrowers, including,
but not limited to, the risk that the borrowers will not satisfy their debt service obligations and that the realizable value of the assets securing their loans will not be sufficient to repay the
borrowers' debt. If our Portfolio Asset performance differs from our assumptions and estimates, we may be materially adversely affected.

Investments in and revenues from our foreign operations are subject to the risks associated with transactions involving foreign currencies.

We have acquired, and manage and resolve, Portfolio Assets located in Europe and Latin America and are actively pursuing opportunities to purchase additional
pools of distressed assets in these locations. Foreign operations are subject to various special risks, including currency translation risks, currency exchange rate fluctuations, exchange controls and
different political, social and legal environments within such foreign markets. To the extent future financing in foreign currencies is unavailable at reasonable rates, we will be further exposed to
currency translation risks, currency exchange rate
fluctuations and exchange controls. In addition, earnings of foreign operations may be subject to foreign income taxes that reduce cash flow available to meet debt service requirements and our other
obligations, which may be payable even if we have no earnings on a consolidated basis. Fluctuation in our reported results from operations in foreign countries could materially adversely affect us.

We may be materially adversely affected by fluctuation in interest rates.

Most of our borrowings are at variable rates of interest. We will be materially impacted by fluctuations in interest rates.

In
addition, a substantial and sustained decline in interest rates may adversely impact the amount of distressed assets available for purchase by us. The value of our interest-earning
assets and liabilities may be directly affected by the level of and fluctuations in interest rates, including the valuation of any residual interests in securitizations that would be severely impacted
by increased loan prepayments resulting from declining interest rates.

Our liquidity or ability to raise capital may be limited.

The successful execution of our business strategy depends on our continued access to financing. In addition, we must also have access to liquidity to invest as
equity or subordinated debt to meet our capital needs. We rely upon access to the capital markets and the cash flow from our subsidiaries to

14

Table of Contents

---



fund
asset growth and to provide sources of liquidity. Our ability to issue and sell common equity (including securities convertible into, or exercisable or exchangeable for, common equity) is limited
as a result of the tax laws relating to the preservation of the NOLs available to us as a result of the Merger. There can be no assurance that our funding relationships with commercial banks,
investment banks and financial services companies (including the Bank of Scotland) will continue past their respective current maturity dates. If these credit facilities are not extended and we cannot
find alternative funding sources on satisfactory terms, or at all, we may be materially adversely affected. See "Liquidity and Capital Resources."

We may be materially adversely affected by the decline in value of collateral securing loans acquired for resolution.

The value of the collateral securing loans acquired for resolution, as well as real estate or other acquired distressed assets, is subject to various risks,
including uninsured damage, change in location or decline in value caused by use, age or market conditions. We may be materially adversely affected by any material decline in the value of such
collateral.

We may not have access to the estimated net operating loss carryforwards.

We believe that, as a result of the Merger, approximately $596 million of NOLs were available to us to offset future taxable income as of
December 31, 1995. Since December 31, 1995, we have generated an additional $52 million in net tax operating losses, utilized $95 million of NOLs, and had expiring NOLs of
$321 million. Accordingly, as of December 31, 2007, we believe that we have approximately $232 million of NOLs available to offset future taxable income. Out of the total
$232 million of NOLs, we estimate that we will be able to utilize $57 million, which equates to a $20 million deferred tax asset on our books and records. However, because our
position in respect of the original $596 million NOLs resulting from the Merger is based upon factual determinations and upon legal issues with respect to which there is uncertainty and because
no ruling has been obtained from the Internal Revenue Service (the "IRS") regarding the availability of the NOLs to us, there can be no assurance that the IRS will not challenge the availability of
such NOLs and, if challenged, that the IRS will not be successful in disallowing this portion of our NOLs, with the result that our $20 million deferred tax asset would be reduced or
eliminated.

The
NOLs may be carried forward to offset our future federal taxable income through the year 2021; however, the availability of some of the NOLs began to expire beginning in 2005. Our
ability to utilize such NOLs will be severely limited if there is a more than 50% ownership change at our company during a three-year testing period within the meaning of
section 382 of the Internal Revenue Code of 1986, as amended (the "Tax Code").

If
we were unable to utilize our NOLs to offset future taxable income, we would lose our ability to generate capital to support our expansion plans on a tax-advantaged basis,
to offset our pretax income and our consolidated subsidiaries' pretax income, and to have access to the cash flow that would otherwise be represented by payments of federal tax liabilities.

It is possible that our actual experience will not be consistent with the assumptions regarding recognition of deferred tax asset and that the differences may be material and
adverse.

As noted above, we have NOLs available for federal income tax purposes to offset future federal taxable income, if any, through the year 2021. A valuation
allowance is provided to reduce the deferred tax assets to a level, which, more likely than not, will be realized. Realization is determined based on our management's expectation of generating
sufficient taxable income in a look forward period over the next four years. The ultimate realization of the resulting net deferred tax asset is dependent upon generating sufficient taxable income
prior to expiration of the net operating loss carryforwards.

15

Table of Contents

---



Although
realization is not assured, management believes it is more likely than not that all of the recorded deferred tax asset, net of the allowance, will be realized. The amount of the deferred tax
asset considered realizable, however, could be adjusted in the future if estimates of future taxable income during the carryforward period change. The change in valuation allowance represents a change
in the estimate of the future taxable income during the carryforward period since the prior year-end and utilization of net operating loss carryforwards since the Merger. Our ability to
realize the deferred tax asset is periodically reviewed and the valuation allowance is adjusted accordingly. See "Discussion of Critical Accounting PoliciesDeferred Tax Asset."

We may incur significant costs relating to removal of hazardous substances or waste from real property in Portfolio Assets.

We acquire through our subsidiaries and affiliates real property in our Portfolio Asset acquisition and resolution business. There is a risk that properties
acquired by us could contain hazardous substances or waste, contaminants or pollutants. We may be required to remove such substances from the affected properties at our expense, and the cost of such
removal may substantially exceed the value of the affected properties or the loans secured by such properties. Furthermore, we may not have adequate remedies against the prior owners or other
responsible parties to recover our costs, either as a matter of law or regulation, or as a result of such prior owners' financial inability to pay such costs. We may find it difficult or impossible to
sell the affected properties either prior to or following any such removal.

We may not be able to successfully compete in the business in which we operate.

The business in which we operate is highly competitive. Some of our principal competitors are substantially larger and better capitalized than us. Because of
their resources, these companies may be better able than us to acquire Portfolio Assets, to pursue new business opportunities or to survive periods of industry consolidation. Access to and the cost of
capital are critical to our ability to compete.
Many of our competitors have superior access to capital sources and can arrange or obtain lower cost of capital, resulting in a competitive disadvantage to us with respect to such competitors.

In
addition, certain of our competitors may have higher risk tolerances or different risk assessments, which could allow these competitors to establish lower margin requirements and
pricing levels than those established by us. In the event a significant number of competitors establish pricing levels below those established by us, our ability to compete would be materially
adversely affected.

We may be adversely affected by a general deterioration in economic, general business and market conditions.

Periods
of economic slowdown or recession, or declining demand for commercial real estate or commercial or consumer loans may adversely affect our business. Periods of economic slowdown
or recession, whether general, regional or industry-related, may adversely affect the resolution of Portfolio Assets, lead to a decline in prices or demand for collateral underlying Portfolio Assets,
or increase the cost of capital invested by us and the length of time that capital is invested in a particular Portfolio. All or any one of these events could decrease the rate of return and profits
to be realized from such Portfolio and materially adversely affect our consolidated financial position, results of operations and business prospects.

We may be adversely affected by the regulated environment in which we operate.

Some aspects of our business are subject to regulation, examination and licensing under various federal, state and local statutes and regulations that impose
requirements and restrictions affecting, among other things, credit activities, maximum interest rates, finance and other charges, disclosures to

16

Table of Contents

---



obligors,
the terms of secured transactions, collection, repossession and claims handling procedures, multiple qualification and licensing requirements for doing business in various jurisdictions, and
other trade practices. We believe that we are currently in compliance in all material respects with applicable regulations, but there can be no assurance that we will be able to maintain such
compliance. Failure to comply with, or changes in, these laws or regulations, or the expansion of our business into jurisdictions that have adopted more stringent regulatory requirements than those in
which we currently conduct business, could have an adverse effect on our company by, among other things, limiting the income we may generate on existing and additional loans, limiting the states in
which we may operate or restricting our ability to realize on the collateral securing its loans. See "Item 1BusinessGovernment Regulation."

We may be adversely affected by the result of certain legal proceedings.

Periodically, our company, our subsidiaries, our affiliates and the Acquisition Partnerships are parties to or otherwise involved in legal proceedings arising in
the normal course of business.

We may be adversely affected by a termination of our relationship with Cargill.

Our relationship with Cargill is material in a number of respects. Cargill, a subsidiary of Cargill, Incorporated, a privately held, multi-national agricultural
and financial services company, has provided equity and debt financings for some of the Acquisition Partnerships. Cargill beneficially owns approximately 2.38% of our outstanding Common Stock, and a
Cargill designee, Jeffery Leu, is a member of our Board of Directors. We believe that our relationship with Cargill significantly enhances our credibility as a purchaser of Portfolio Assets and
facilitates our ability to expand into other businesses and foreign markets.

Although
our management believes that our relationship with Cargill is excellent, there can be no assurance that such relationship will continue in the future. As we have begun to
acquire more portfolios on our own or with other partners and have secured alternative sources of financing, our dependence on Cargill has diminished. There can be no assurance that such alternative
financing will
continue to be available. Any termination of such relationship could have a material adverse effect on our consolidated financial position, results of operations and business prospects.

We may be adversely affected by a termination of employment of certain key personnel.

We are dependent on the efforts of our senior executive officers, particularly James T. Sartain (President and Chief Executive Officer). We are also dependent on
several of the key members of our management who are instrumental in developing and implementing the business strategy for the Company. In addition, our borrowing facilities include key personnel
provisions. These provisions generally provide that if certain key personnel are no longer employed and suitable replacements are not found within a defined time limit, certain facilities become due
and payable. We may be adversely affected by the inability or unwillingness of one or more of these individuals to continue in his present role. There can be no assurance that any of the foregoing
individuals will continue to serve in his current capacity or for what time period such service might continue. We do not maintain key person life insurance for any of its senior executive officers.

17

Table of Contents

---





Our directors and executive officers may effectively control any vote of stockholders of our company.

Our directors and executive officers collectively beneficially own 16.36% of the Common Stock. Although there are no agreements or arrangements with respect to
voting such Common Stock among such persons, they, if acting together, may effectively be able to control any vote of our stockholders and thereby exert considerable influence over the affairs of our
company. James T. Sartain, President and Chief Executive Officer of our company, is the beneficial owner of 6.0% of the Common Stock. There can be no assurance that the interests of management or the
other entities and individuals will be aligned with our other stockholders.

Restrictions on transfer of shares may prevent certain holders of our Common Stock from transferring such stock.

Our Amended and Restated Certificate of Incorporation (the "Certificate of Incorporation") contains provisions restricting the transfer of its securities that are
designed to delay, defer or prevent a change of control of our company by deterring unsolicited tender offers or other unilateral takeover proposals and compelling negotiations with our Board of
Directors rather than non-negotiated takeover attempts even if such events may be in the best interests of our stockholders. Our Certificate of Incorporation also contains certain
provisions restricting the transfer of securities in our company that are designed to prevent ownership changes that might limit or eliminate our ability to use our NOLs resulting from the Merger.
Such restrictions may prevent certain holders of Common Stock from transferring such stock even if such holders are permitted to sell such stock without restriction under the Securities Act of 1933,
as amended, and may limit our ability to sell Common Stock to certain existing holders of Common Stock at an advantageous time or at a time when capital may be required but unavailable from any other
source.

We may be adversely affected by period to period variances.

The revenue of our company and Acquisition Partnerships is based on proceeds realized from the resolution of the Portfolio Assets, which proceeds have
historically varied significantly and likely will continue to vary significantly from period to period. Consequently, our period-to-period revenue and results of operations
have historically varied, and are likely to continue to vary, correspondingly. Such variances, alone or with other factors, such as conditions in the economy or the financial services industries or
other developments affecting us, may result in significant fluctuations in our reported operations and in the trading prices of our securities, particularly the Common Stock.

We may be adversely affected by tax, monetary and fiscal policy changes.

We originate and acquire financial assets, the value and income potential of which are subject to influence by foreign regulations, various state and federal tax,
monetary and fiscal policies in effect from time to time. The nature and direction of such policies are entirely outside our control, and we cannot predict the timing or effect of changes in such
policies. Changes in such policies could have a material adverse effect on our consolidated financial position, results of operations and business prospects.

We may be adversely affected by changes in future cash receipts.

We have in the past been able to establish with reasonable accuracy the estimated future cash receipts over the life of a purchased asset pool. Changes in
economic conditions, fluctuations in interest rates, deterioration of collateral values, and other factors described in this section could cause the estimates of future cash flows to be materially
different than actual cash receipts.

The
effects of an increase in the estimated future cash receipts would generally increase revenues from Portfolio Assets by increasing gross profit on a non-performing or
real estate pool and increasing

18

Table of Contents

---



the
effective yield on a performing or SOP 03-3 Portfolio while a decrease in future cash receipts would generally have the effect of reducing revenues by reducing gross profit on a
non-performing or real estate pool and decreasing the effective yield on a performing or SOP 03-3 Portfolio. In some cases a reduction in the total future cash receipts
by collecting those cash receipts sooner than expected could have a positive impact on our revenues from Portfolio Assets due to reduced interest expense and other carrying costs associated with the
Portfolio Assets. Although such trend is a generally positive trend, we may be adversely affected by the higher levels of interest expense and other carrying costs of the Portfolios negating any
potentially positive effects.

We may incur significant credit losses due to downward trends in the economy and in the real estate market.

We originate and underwrite loans to affiliated entities (including Acquisition Partnerships) and non-affiliated entities, and purchase and originate
SBA loans. The repayment of the loans is generally dependent upon future cash flows of the borrowers, future cash flows of the underlying collateral, and distributions made from affiliated entities.
While we evaluate all of our loans for impairment on a regular basis by reviewing the collectibility of the loans in light of various factors, worsening economic conditions increase the risk that our
borrowers will not be able to repay our loans, and worsening real estate market conditions increase the risk that the value of the properties securing certain of our loans will be insufficient to
repay amounts owing to us in the event our borrowers default on the loans.

Item 1B.Unresolved Staff Comments.

None.

Item 2.Properties.

The Company occupies approximately 56,000 square feet of office space, all of which is leased. The Company leases its current headquarters building under a
noncancellable operating lease, which expires December 31, 2011. All leases of the other offices of the Company and subsidiaries expire prior to 2015. Such office space is suitable and adequate
for the Company's current needs. The following is a list of the Company's principal physical properties leased as of December 31, 2007.

Location

Function

Business SegmentWaco, Texas

Executive Offices

Corporate/CommercialGuadalajara, Mexico

Servicing Offices

CommercialMexico City, Mexico

Servicing Offices

CommercialDallas, Texas

Servicing Offices

CommercialGreenwood Village, Colorado

Servicing Offices

Commercial


Item 3.Legal Proceedings.

FirstCity and certain of its subsidiaries and affiliates (including Acquisition Partnerships) are involved in various claims and legal proceedings arising in the
ordinary course of business. In view of the inherent difficulty of predicting the outcome of pending legal actions and proceedings, the Company cannot state with certainty the eventual outcome of any
such proceedings. Based on current knowledge, management does not believe that liabilities, if any, arising from any single ordinary course proceeding will have a material adverse effect on the
consolidated financial condition, operations, results of operations or liquidity of the Company.

19

Table of Contents

---





On January 19, 2005, Prudential Financial, Inc. ("Prudential") filed a petition in interpleader seeking to interplead 321,211 shares of Prudential
common stock and any associated dividends arising from the demutualization of Prudential in December 2000. The shares of Prudential common stock related to group annuity contracts purchased by
First-City National Bank of Houston, as trustee of the First City Bancorporation Employee Retirement Trust (the "Trust") to fund obligations to participants in the First City
Bancorporation Employee Retirement Plan (the "Plan") in connection with termination of the Plan and the Trust in 1987. FirstCity, FCLT Loans Asset Corp. ("FCLT"), an alleged assignee of the FirstCity
Liquidating Trust, JP Morgan Chase Bank, National Association ("JP Morgan"), and First-City National Bank of Houston as trustee of the Trust were made defendants in the suit as claimants
to the Prudential common stock and dividends. An agreed order dated January 27, 2005, was entered by the Court providing that the Prudential common stock be transferred to JP Morgan as record
owner and that JP Morgan sell the stock. The January 27, 2005 order also provided that the proceeds from the sale be held by JP Morgan pending resolution, by agreement or court order, of all
conflicting claims to the proceeds. JP Morgan advised that the Prudential common stock was sold on January 28, 2005 for total proceeds of approximately $17.5 million. JP Morgan also
received funds in the amount of approximately $489,000, which were dividend payments related to the Prudential common stock. JP Morgan filed a third party action naming Mr. Blair as a third
party defendant with an alleged interest in the demutualization proceeds. On October 1, 2005, the court certified a class represented by Mr. Blair.

On
March 21, 2006, FirstCity received notice that the 152nd District Court, Harris County, Texas granted FirstCity's motion for partial summary judgment. The
order granting FirstCity's motion for partial summary judgment rendered judgment in favor of FirstCity as to the ownership of the demutualization proceeds. The Court's summary judgment order also
denied the claims to ownership of the demutualization proceeds by FCLT and Mr. Blair, individually and as representative of the proposed class of employee beneficiaries. The motions submitted
to the Court prior to its order dated March 21, 2006 did not address all matters pending in the lawsuit. Mr. Blair, as class representative, filed a motion for new trial to set aside the
summary judgment in favor of FirstCity and for reconsideration of granting Mr. Blair's motion for summary judgment. FCLT filed a motion for the Court to reconsider its order granting the
partial summary judgment for FirstCity. FirstCity moved for summary judgment on
all remaining claims and for entry of a final judgment on May 12, 2006. On August 14, 2006, the Court entered an order (i) finding that FirstCity is the sole owner of the
"demutualization proceeds" being the proceeds from the sale of the 321,211 shares of Prudential Financial, Inc. stock, the dividends on such shares and all accrued interest and income arising
there from, (2) granting FirstCity's motion for summary judgment against FCLT's claims for breach of contract and tortious interference, (3) providing that JP Morgan continue to hold the
demutualization proceeds until the appellate process has been completed, (4) denying the request by FirstCity that FCLT or Mr. Blair be required to post bond or other form of security on
appeal, and (5) denying all other claims for relief. FCLT and Mr. Blair filed notices of appeal to the First or Fourteenth Court of Appeals of the State of Texas. The appeal has been
assigned to the First Court of Appeals and all parties have filed their briefs with the Court. The parties participated in Court ordered mediation on February 13, 2007 which was unsuccessful.
FirstCity cannot give any assurances as to the time period for the appeal of the final judgment or the timing of receipt or ultimate amount of proceeds to be received, if any.

In
the trial court, FCLT filed a counterclaim against FirstCity for damages related to alleged breaches of contract by FirstCity related to failure to assign the proceeds to FCLT and
FirstCity's assertion of a claim to the proceeds and a claim for tortious interference by FirstCity as a result of FirstCity's claim for the proceeds. In connection with that claim, FCLT seeks to
recover attorney's fees and other damages related to the assertion by FirstCity of an interest in the shares of Prudential

20

Table of Contents

---



common
stock. No amount has been asserted by FCLT Loans Asset Corp. and the company does not believe that its actions give rise to a claim by FCLT Loans Asset Corp. The trial court denied these claims
of FCLT in its orders resolving claims with respect to the motions for summary judgment filed by each of the parties. The appeal by FCLT seeks to overturn the summary judgment rendered against it with
respect to these claims. FirstCity believes that the claims of FCLT are without merit and that it has valid defenses to these claims.



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 LLC (formerly FH Partners, L.P.) and FirstCity Servicing Corporation, each an indirectly wholly-owned subsidiary of FirstCity, and FirstCity
Financial Corporation as defendants in a suit filed by Plaintiffs against State Bank and Cole Harmonson before the 98th Judicial District Court of Travis County, Texas. FirstCity
Financial Corporation was served with Plaintiff's Notice of Nonsuit Without Prejudice in the suit on April 25, 2007. In the First Amended Petition the Plaintiffs sought unspecified damages for
breach of contract and conversion related to alleged breaches by FH Partners LLC ("FH Partners") and FirstCity Servicing Corporation in connection with a loan agreement related to a loan from
State Bank to Plaintiffs that was purchased by FH Partners from State Bank on December 22, 2006. The Plaintiffs also raised other claims solely against the other defendants. The Plaintiffs
allege that they entered into a loan or line of credit with State Bank and that due to an error by State Bank the Plaintiffs borrowed more on the line of credit than was allowed under the borrowing
base. The Plaintiffs further allege that State Bank entered in an agreement with Plaintiffs that the default by Plaintiffs would be cured if the Plaintiffs pledged additional property to secure the
loans and that the Plaintiffs would be allowed to borrow under the line of credit. Plaintiffs allege that State Bank, and subsequently FH Partners, have refused to honor the agreement by State Bank
concerning the pledge of the additional property. On July 25, 2007, counsel for FH Partners received a Second Amended Petition in which the Plaintiffs allege that they have sustained actual
damages of $165 million as a result of the joint actions of State Bank, Cole Harmonson, FH Partners and FirstCity Servicing Corporation. The Plaintiffs assert claims against FH Partners and
FirstCity Servicing Corporation for breach of contract, conversion, civil conspiracy, tortious interference with prospective economic relationships and usury related to FH Partners and FirstCity
Servicing Corporation treating the loans that FH Partners purchased from State Bank as being in default, retaining payments delivered to the lockbox for the loan, retaining mortgage loan files that
the Plaintiffs allege were unrelated to the loan agreement, interfering with contracts and relationships of the Plaintiffs by such actions, and charging interest higher than the maximum amount allowed
under the Texas Finance Code. The Plaintiffs additionally seek recovery of statutory penalties under the Texas Finance Code and attorney's fees. The Plaintiffs have made additional claims against the
other defendants alleging promissory estoppel, fraud and business disparagement. On or about October 5, 2007, Plaintiffs' counsel suggested that his clients were considering
non-suiting their claims against FH Partners and FirstCity Servicing Corporation. Therefore, instead of counter-claiming against the Plaintiffs in the same suit for the indebtedness owed
under the loan, on October 9, 2007, FH Partners filed a separate collection suit against the Plaintiffs and guarantors Jason Herring and Kimberly Herring, now known as Kimberly McCormick.
Plaintiffs' counsel has subsequently indicated that he had misunderstood the positions of the parties, that a non-suit is not likely to occur and that he will probably seek to consolidate
the collection suit with the original action. All defendants in the collection suit have answered. Prosperity Bank, FH Partners and FirstCity Servicing Corporation filed motions for summary judgment
in the original suit based upon a General Release and Indemnity Agreement. Shortly before the hearing on the summary judgment motions, the Plaintiffs filed their third amended petition to add
Grandview Homes, Inc. as an additional plaintiff, to allege some of the previous claims against FH Partners and FirstCity Servicing Corporation as well as Prosperity Bank and to state
additional claims for negligent misrepresentation, tortious interference with property rights,

21

Table of Contents

---



fraud
in the inducement, duress, lack of consideration, unconscionability, estoppel and waiver. Since
these additional parties and claims were not addressed by the summary judgment motions, the hearings were postponed. On or about December 14, 2007, Plaintiffs filed their fourth amended
petition, which added the claim that the general release is invalid for lack of mutuality of obligation and for failure to meet the express negligence test. One deposition has been taken and
Plaintiffs have engaged in written discovery with Prosperity Bank and sent written discovery to FH Partners and FirstCity Servicing Corporation, but have suspended the deadlines to respond while the
parties are discussing settlement. FirstCity does not have sufficient information to estimate any potential liability or probability of liability, but is unaware of any factual or legal basis for
liability. If a settlement is not reached, FirstCity intends to contest the case vigorously.

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

The Company held its annual meeting of stockholders (the "Annual Meeting") on November 15, 2007. The following items for business were considered at the
Annual Meeting.

(a) Election of Directors

The following individuals were elected as directors to serve as members of the Company's Board of Directors until the Company's 2008 annual meeting of
stockholders. The number of votes cast for each nominee was as follows:

Nominee

Votes For

Votes
Against

AbstainedRichard E. Bean

9,342,737

536,570

C. Ivan Wilson

9,341,487

537,820

James T. Sartain

9,841,971

37,336

Dane Fulmer

9,842,064

37,243

Robert E. Garrison II

9,842,074

37,233

D. Michael Hunter

9,842,074

37,233

Jeffery D. Leu

9,840,824

38,483

F. Clayton Miller

9,842,074

37,233




(b) Ratification of Appointment of Auditors

A proposal to ratify the Board of Directors' appointment of KPMG LLP as the Company's independent auditors for 2007 was approved by the stockholders. The
number of votes for the proposal: 9,856,372; votes against: 20,013; abstentions: 2,922.

22

Table of Contents

---



PART II

Item 5.Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The Company's Common Stock is traded on the Nasdaq Global Select Market under the symbol FCFC. The number of holders of record of Common Stock on March 13,
2008 was approximately 725, as provided by American Stock Transfer and Trust Company, the Company's transfer agent. High and low stock prices for the Common Stock in the two years ended
December 31, 2007 and December 31, 2006 are displayed in the following table:

2007 Market Price

2006 Market PriceQuarter EndedHigh

Low

High

LowMarch 31

$
11.35

$
10.03

$
12.25

$
10.25June 30


10.30


9.00


12.05


10.35September 30


11.07


7.37


11.20


8.53December 31


10.04


7.46


11.10


9.76


The
Company has never declared or paid a dividend on the Common Stock. The Company currently intends to retain future earnings to finance its growth and development and therefore does
not anticipate that it will declare or pay any dividends on the Common Stock in the foreseeable future. Any future determination as to payment of dividends will be made at the discretion of the Board
of Directors of the Company and will depend upon the Company's operating results, financial condition, capital requirements, general business conditions and such other factors that the Board of
Directors deems relevant. Certain loan facilities to which the Company and its subsidiaries are parties contain restrictions relating to the payment of dividends and other distributions.

The
following summarizes purchases of Common Stock during the fourth quarter 2007:

Month

Total Number
of Shares
Purchased

Average
Price Paid
Per Share

Total Number
of Shares Purchased
as Part of Publicly
Announced Plans
or Programs(1)

Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans
or ProgramsOctober



$


November

1,700

$
8.18

1,700December

38,700

$
8.04

38,700Total

40,400

$
8.05

40,400

419,500




23

Table of Contents

---







Item 6.Selected Financial Data.

The following tables set forth selected consolidated financial information regarding the Company's results of operations and balance sheets. The data presented
below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" under Item 7 and with the related Consolidated Financial
Statements and Notes thereto under Item 8 of this Annual Report on Form 10-K, respectively.

Selected Financial Data

|                                                             |         | Years Ended December 31, |        
|------------------------------------------------------------ | ------- | ------------------------ | -------
|
|
|Consolidated Statement of Operations Data:                   |         |                          |        
|Revenues                                                     |         | $                        | 43,656 
|Expenses                                                     |         |                          | 51,842 
|Equity in earnings of investments                            |         |                          | 10,944 
|Gain on sale of interest in equity investments               |         |                          | 207    
|Earnings from continuing operations                          |         |                          | 2,185  
|Earnings (loss) from discontinued operations                 |         |                          |       
|Net earnings (loss)                                          |         |                          | 2,185  
|Redeemable preferred dividends                               |         |                          |       
|Net earnings (loss) to common stockholders                   |         |                          | 2,185  
|Earnings (loss) from continuing operations per common share |         |                          |        
|                                                             | Basic   |                          |        
|                                                             | Diluted |                          |        
|Net earnings (loss) per common share                        |         |                          |        
|                                                             | Basic   |                          |        
|                                                             | Diluted |                          |        
|Consolidated Balance Sheet Data:                             |         |                          |        
|Total assets                                                 |         |                          | 298,119
|Total notes payable                                          |         |                          | 177,329
|Preferred stock                                              |         |                          |       
|Total common equity                                          |         |                          | 106,823

In
December 2002, FirstCity completed a recapitalization in which holders of the New Preferred Stock exchanged 1,092,210 shares of New Preferred Stock, for 2,417,388 shares of Common
Stock and $10.5 million. During 2003, 4,400 shares of New Preferred Stock were redeemed for 8,200 shares of Common Stock, leaving 126,291 shares outstanding at December 31, 2003. On
December 30, 2004, FirstCity redeemed all of the outstanding shares of its New Preferred Stock at a total redemption price of $21.525 per share. The redemption price represented the liquidation
preference of the New Preferred Stock plus the final normal quarterly dividend of $.525 per share. In addition, FirstCity issued 400,000 shares of Common Stock as part of a transaction to acquire the
minority interest in FirstCity Holdings, Inc. from Terry R. DeWitt, G. Stephen Fillip and James C. Holmes.

In
November 2004, FirstCity completed the sale of its 31% investment in Drive. As a result, the consumer lending segment conducted through Drive was no longer considered a principal
reportable segment and is treated as a discontinued operation. The results of historical operations have been reflected as discontinued operations in accordance with SFAS No. 144, Accounting for the Impairment or Disposal
of Long-Lived Assets.

24

Table of Contents

---



Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements of the Company (including the Notes thereto)
included in Part II, Item 8 of this Annual Report on Form 10-K.

Overview

FirstCity is a financial services company engaged in the acquisition and resolution of portfolios of loans, real estate and other assets or similar single-asset
investments (collectively referred to as "Portfolio Assets"). The Portfolio Asset acquisition and resolution business involves acquiring Portfolio Assets at a discount to their legal principal balance
or appraised value, and servicing and resolving such assets in an effort to maximize the present value of the ultimate cash recoveries.

During
2007, the Company recorded net earnings to Common Stockholders on a diluted basis of $2.2 million or $0.19 per common share. The operating contribution from the Portfolio
Asset acquisition and resolution segment was $11.4 million for 2007 compared with $15.1 million for 2006. The Company was involved in $214.3 million of portfolio acquisitions in
2007of which FirstCity's
investment share was $126.7 million. FirstCity's global distribution of its 2007 investments includes $108.5 million in the United States, $7.9 million in Europe, and
$10.3 million in Latin America. In addition to its portfolio acquisitions in 2007, FirstCity invested $4.0 million in a Chilean servicing company; $5.9 million in a domestic
railroad company; and $12.1 million in the form of loans receivable to domestic and foreign entities. Earning assets (Portfolio Assets, equity investments, loans receivable and entity-level
earning assets) remained relatively level at $243.6 million in 2007 compared to $250.4 million in 2006. FirstCity's total investment level of $148.7 million in 2007 represents the
second-highest amount invested in a single year in the Company's history (the Company's highest investment level was $172.2 million in 2006).

The
Company's investments in 2007 include the purchase of $36.8 million of SBA loans and servicing assets, and another $2.2 million of SBA loan originations and advances
through its majority-owned subsidiary American Business Lending, Inc. ("ABL"). The Company believes that the ability to purchase and originate these types of loans provides the
diversity to create an attractive growth opportunity within the domestic market.

In
addition, the Company's 2007 investments include $5.6 million and $5.9 million in the form of loans receivable and a railroad business acquisition, respectively, under
its new special situations platformFirstCity Crestonewhich was formed in April 2007. This special situations platform focuses on constructive investing in restructurings,
turnarounds, businesses with robust market positions, and other special situations; and provides the Company the ability to acquire or finance distressed businesses, originate junior- and
senior-bridge loans, and execute lower middle-market buyouts.

The
Company's earnings in 2007 were negatively impacted by $6.4 million of net provisionscomprised of $2.1 million recorded to our wholly-owned portfolios and
$4.3 million as our share recorded to portfolio assets held in our partnership interests. The provisions in 2007 were necessary as a result of increased delays in the collection of certain
assets and deterioration of the domestic residential and commercial real estate market. The impairment provisions were identified in connection with management's regular evaluation of the
collectibility of the Company's Portfolio Assets and loans. Management's evaluation is inherently subjective as it requires estimates that are susceptible to revision in future periods as more
information becomes available.

Considering
the recent deterioration of credit quality experienced by many banks, management remains positive on the outlook of the Company. Management believes that the current market
conditions will not hinder FirstCity's ability to grow its business, and that acquisition opportunities at attractive margins are on the rise. FirstCity's total investment level approximated
$150.0 million in 2007, and the Company is currently evaluating 27 different transactions representing over $1.8 billion in

25

Table of Contents

---



face
value of assets, although there can be no assurance that FirstCity will be able to consummate any of these transactions on acceptable terms.

In
addition, in light of current market conditions that are creating liquidity constraints primarily as a result of the deterioration in the subprime mortgage industry and tightening
credit standards in the marketplace, management believes that the current market conditions will not impact FirstCity's ability to obtain financing for its operationsas evidenced by
recent increases totaling $125.0 million in the Company's credit facilities commitments (discussed below).

In
August 2007, FirstCity increased its borrowing capacity by $100.0 million. FirstCity secured a $50.0 million increase in its revolving credit facility commitment with
the Bank of Scotland from $175.0 million to $225.0 million; and FH Partners, LLC (a wholly-owned affiliate of FirstCity) secured a $50.0 million increase in its revolving
credit facility commitment with Bank of Scotland from $50.0 million to $100.0 million. The Company uses the credit facilities, along with other financing arrangements, to finance equity
investments and portfolio and asset purchases, and to provide for the issuance of letters of credit and working capital loans.

Effective
November 2007, FirstCity increased its borrowing capacity another $25.0 million through a subordinated credit agreement with Bank of Scotland. This arrangement provides
the Company with a $25.0 million loan facility to finance equity investments in new ventures, the senior debt and equity portion of portfolio and asset purchases, and to provide for the
issuance of letters of credit working capital loans.

The
Company's financial results are affected by many factors including levels of and fluctuations in interest rates, fluctuations in the underlying values of real estate and other
assets, the timing and ability to liquidate assets, and the availability and prices for loans and assets acquired in all of the Company's businesses. The Company's business and results of operations
are also affected by the availability of financing with terms acceptable to the Company and the Company's access to capital markets, including the securitization markets.

As
a result of the significant period-to-period fluctuations in the revenues and earnings of the Company's Portfolio Asset acquisition and resolution business,
period-to-period comparisons of the Company's results of continuing operations may not be meaningful.

Results of Independent Investigation

The Audit Committee of the Board of Directors conducted an independent investigation in 2007 ("Independent Investigation") to review whether FirstCity and its
subsidiaries received inadequate compensation, or other improprieties occurred, with respect to the sale of a loan portfolio to a third party, and FirstCity's compliance with laws applicable to its
foreign operations as a result of allegations against an officer of an affiliate of FirstCity regarding matters that occurred prior to the individual's becoming an officer of that affiliate. The Audit
Committee engaged an outside law firm to act as
independent counsel and conduct the investigation, and independent counsel worked with external forensic accountants to conduct its review.

The
Independent Investigation (completed in July 2007) found that the loan portfolio sale was initiated by other portfolio investors, who owned a majority investment in the portfolio,
and that the portfolio appeared to have been sold for the best price available at the time. The Independent Investigation found no evidence indicating that FirstCity or any officer, manager or
full-time employee personally benefited from the transactions relating to the portfolio sale. The Independent Investigation concluded that the sales price received by FirstCity and the
other portfolio investors was reasonable based upon the information that was available at the time of the sale.

The
Independent Investigation concluded that it was unable to complete its review of the issues relating to allegations against the officer of an affiliate of FirstCity due to its
inability to access certain

26

Table of Contents

---



documentation
outside FirstCity's custody and control. FirstCity has reviewed these issues, performed on-site procedures at the affiliate location and has determined that no adjustment to
FirstCity's financial statements is required in connection with this issue.

The
Independent Investigation recommended improvements designed to provide additional assurances for accurate financial reporting, particularly with respect to FirstCity's Latin American
operations, and to improve FirstCity's internal control structure. The Independent Investigation also recommended changes in FirstCity's approach to foreign business relationships. In addition, the
Independent Investigation made a number of recommendations aimed at improving FirstCity's compliance practices and procedures. FirstCity has already begun taking steps to implement the foregoing
recommendations.

FirstCity
has not identified any material adjustment to its financial statements that are required in connection with the results of the Independent Investigation. The costs associated
with the investigation approximated $2.2 million in 2007.

Results of Operations



Net earnings to Common Stockholders were $2.2 million in 2007 compared to $9.8 million in 2006. On a per share basis, diluted net earnings to Common
Stockholders were $0.19 in 2007 compared to $.83 in 2006. The Company reported earnings from continuing operations of $2.2 million in 2007 compared to $9.9 million in 2006.



The operating contribution from the Portfolio Asset acquisition and resolution business of $11.4 million in 2007 decreased from $15.1 million in
2006. FirstCity was involved in $214.3 million of Portfolio Asset acquisitions in 2007 ($106.6 million in wholly-owned portfolios and $107.7 million through Acquisition
Partnerships), compared to $297.0 million in 2006 ($91.0 million in wholly-owned portfolios and $206.0 million through Acquisition Partnerships). FirstCity's investment share in
these Portfolio Asset acquisitions (including SBA loans) was $126.7 million in 2007 compared to $144.0 million in 2006which includes investments in wholly-owned portfolios
of $104.9 million in 2007 and $82.5 million in 2006. Additional investments (loan originations and business acquisitions) backed by FirstCity totaled $22.0 million in 2007
compared to $28.2 million in 2006.

Servicing fee revenues.Servicing fee revenues decreased to $10.4 million in 2007 from $12.9 million in 2006.
Servicing fee revenues in 2006 include $1.9 million of incentive service fees resulting from the restructure of Mexican Investment Platform. This contributed to the decrease in service fees
from Latin American partnerships to $7.8 million in 2007 from $9.5 million in 2006. Service fees from domestic Acquisition Partnerships totaled $2.6 million in 2007 compared to
$3.4 million in 2006. Also contributing to the overall decrease in servicing fees is a decline in collections from loans held by domestic and Latin American Acquisition Partnerships to
$123.3 million in 2007 from $188.0 million in 2006. Since a majority of the Portfolio acquisitions over the past two years were purchased through wholly-owned Portfolios instead of
investments in Acquisition Partnerships, the Company expects income from wholly-owned Portfolio Assets to off-set the decline in servicing fee revenues (which are generated primarily from
loan portfolios held by Acquisition Partnerships).

Income from Portfolio Assets.Income from Portfolio Assets increased to $22.8 million in 2007 compared to
$11.0 million in 2006, primarily due to increased purchases of wholly-owned domestic Portfolio Assets. FirstCity's average investment in wholly-owned Portfolio Assets increased to
$117.0 million for 2007 from $62.5 million for 2006. Refer to Note 8 to the Consolidated Financial Statements for a summary of income from Portfolio Assets.

27

Table of Contents

---



Gain on sale of SBA loans held for sale.The Company recorded net gains on SBA loan sales of $0.7 million in 2007. The
Company's basis in SBA loans sold in 2007 approximated $17.8 million. Gains on SBA loan sales reflect the Company's participation in the SBA 7(a) guaranteed loan program. Under the program, SBA
guarantees up to 85 percent of the principal of a qualifying loan. The Company generally sells the guaranteed portion of the loan into the secondary market and retains the unguaranteed portion.

Interest income from SBA loans.Interest income from SBA loans was $2.1 million in 2007 as a result of the SBA
portfolio acquisition and SBA loan originations in 2007.

Interest income from affiliates.Interest income from affiliates decreased $0.6 million in 2007 from
$1.5 million in 2006 primarily due to the conversion of $21.3 million of affiliated loans to equity as part of the Company's restructure of its Mexican investments in
2006which significantly reduced the amount of affiliated loans outstanding and the corresponding interest income.

Interest income from loans receivableother.Interest income from loans receivableother increased to
$3.8 million in 2007 from $0.6 million in 2006. The income increase is attributed to the Company's increased level of investments in the form of loan originations to domestic entities in
2007primarily through FirstCity's new special situations platform (FirstCity Crestone) that was formed in April 2007. FirstCity's average investment in loans receivableother
approximated $22.0 million in 2007 and $4.8 million in 2006.

Other income.Other income increased to $2.8 million in 2007 from $1.6 million in 2006 primarily due to
$1.0 million of revenues generated from the Company's majority-owned domestic railroad company that was acquired in August 2007.

Expenses.Operating expenses were $42.7 million in 2007 compared to $26.4 in 2006. The following is a discussion of
the major components of operating expenses:

Interest
and fees on notes payable increased to $18.1 million in 2007 compared to $8.3 million in 2006. The average debt for the period increased to $212.9 million
in 2007 from $100.3 million in 2006, and the average cost of borrowing increased to 8.5% in 2007 from 8.3% in 2006. The increase in the Company's debt level is a result of increased limits on
existing credit facilities and the addition of a new loan facility the Company secured in 2007 to accommodate its growth and investment acquisitions.

Salaries
and benefits increased to $13.3 million in 2007 from $11.4 million in 2006primarily due to additional salaries and benefits of $1.6 million in
2007 attributed to ABL (new SBA lending program) and FirstCity Crestone (new special situations platform). Total personnel within the Portfolio Asset acquisition and resolution segment were 206 and
176 at December 31, 2007 and 2006, respectively.

Provisions
for loan and impairment losses totaled $2.1 million in 2007 compared to $0.3 million in 2006. The increase in loan and impairment provisions from 2006 to 2007 is
attributed to increased net provisions of $1.6 million to wholly-owned portfolios and $0.2 million of net provisions to SBA loans in 2007. See Notes 1(e), 1(f), 4 and 5 of the
Consolidated Financial Statements for a detailed discussion on FirstCity's impairment evaluation processes.

Occupancy,
data processing, property protection and other expenses increased to $9.2 million in 2007 from $6.5 million in 2006. The increase is attributed primarily to
additional operating expenses of $1.0 million from ABL and FirstCity Crestone and additional asset-level costs (i.e. property protection costs) of $2.2 million related to the
Company's wholly-owned portfolios in 2007.

Equity in earnings of investments.Equity in earnings of investments decreased slightly to $10.9 million in 2007
compared to $11.8 million in 2006. Equity in earnings of Acquisition Partnerships decreased to $9.5 million in 2007 from $10.9 million in 2006, while equity in earnings of
servicing

28

Table of Contents

---



entities
increased to $1.4 million in 2007 from $0.8 million in 2006. The following is a discussion of equity in earnings from the Company's Acquisition Partnerships by geographic
region. Refer to Note 6 of the Consolidated Financial Statements for a summary of revenues, earnings and equity in earnings of FirstCity's equity investments by region.



Gain on sale of subsidiaries and equity investments.Gain on sale of subsidiaries of $0.2 million was recorded in
2007, which consists of the sale of two Latin American subsidiaries. Gain on sale of equity investments of $2.5 million was recorded in 2006. This gain primarily consisted of the following:
(1) sale of a domestic equity investment resulting in a gain of $1.3 million; and (2) partial sale of twelve Latin American equity investments to AIG resulting in a gain of
$1.2 million in accordance with the restructuring of the Mexican Investment Platform.



The following items affect the Company's overall results of operations and are not directly allocated to the Portfolio Asset acquisition and resolution business
discussed above.

29

Table of Contents

---



Corporate interest and overhead.Net corporate overhead expenses (excluding taxes) increased to $8.7 million in 2007
from $5.2 million in 2006, primarily due to increased legal and accountings costs of $2.6 million (including $2.2 million related to the Independent Investigation authorized by
the audit committee) and director fees of $0.2 million incurred in 2007.

Income taxes.Provision for income taxes was $0.8 million in 2007 compared to $0.2 million in 2006, and taxes
in both years related primarily to state income taxes. Refer to Note 11 of the Consolidated Financial Statements for a detailed description of the Company's income tax components.



Net earnings to Common Stockholders were $9.8 million in 2006 compared to $8.2 million in 2005. On a per share basis, diluted net earnings to Common
Stockholders were $.83 in 2006 compared to $.69 in 2005. The Company reported earnings from continuing operations of $9.9 million in 2006 compared to $8.1 million in 2005. Losses from
discontinued operations were $75,000 in 2006 compared to earnings of $153,000 in 2005. Following is a discussion of the Portfolio Asset acquisition and resolution segment and other corporate overhead
as presented in Note 8 of the Consolidated Financial Statements.



The operating contribution from the Portfolio Asset acquisition and resolution business of $15.1 million in 2006 increased from $13.8 million in
2005. FirstCity purchased $297.0 million of Portfolio Assets during 2006 ($206 million through the Acquisition Partnerships) compared to $146.6 million in acquisitions in 2005.
FirstCity's investment in these acquisitions was $144.0 million and $71.4 million in 2006 and 2005, respectively. FirstCity's year-end investment in wholly-owned Portfolio
Assets was $108.7 million at December 31, 2006 compared to $49.3 million at December 31, 2005.

Servicing fee revenues.Servicing fee revenues increased by 9.8% to $12.9 million in 2006 from $11.8 million in
2005. Service fees from the Latin American partnerships (including incentive service fees) increased by $1.3 million or 16.3% as a result of a $1.9 million in incentive service fee
resulting from the restructure of the Mexican Investment Platform offset by efforts to reduce operating costs in Mexico. For the Mexican Acquisition Partnerships, FirstCity earns a servicing fee based
on costs of servicing plus a profit margin. Service fees from domestic Acquisition Partnerships decreased by $0.18 million or 5% due to a lower service fee rate produced based on the mix of
collections.

Income from Portfolio Assets.Income from Portfolio Assets increased 33.0% to $11.0 million in 2006 compared to
$8.3 million in 2005, primarily due to increased resolution of portfolio assets. FirstCity's average investment in wholly-owned domestic portfolio assets was $60.1 million and
$40.9 million during 2006 and 2005, respectively.

Interest income from affiliates.Interest income from affiliates decreased slightly to $1.5 million in 2006 from
$1.8 million in 2005.

Interest income from loans receivableother.Interest income from loans receivableother was
$0.6 million in 2006 and relates to loans originated in the latter half of 2006 which included loans to a Canadian real estate company, and two domestic real estate companies.

Other income.Other income was $1.6 million in 2006 compared to $1.7 million in 2005, primarily due to a
reduction in the estimated carrying value of loans payable to certain members of management by $0.3 million. See further discussion related to these loans in Note 2 of the Consolidated
Financial Statements.

30

Table of Contents

---



Expenses.Operating expenses were $26.4 million in 2006 compared to $21.6 in 2005. The following is a discussion of
the major components.

Interest
and fees on notes payable increased to $8.3 million in 2006 compared to $4.0 million in 2005. The average debt for the period increased to $100.3 million in
2006 from $56.4 million in 2005 and the average cost of borrowing increased to 8.3% in 2006 from 7.1% in 2005.

Salaries
and benefits decreased to $11.4 million in 2006 from $12.1 million in 2005. Total personnel within the Portfolio Asset acquisition and resolution segment were 176
and 184 at December 31, 2006 and 2005, respectively.

The
provision for loan and impairment losses was $271,000 in 2006 and $212,000 in 2005. See Note 1(e) of the Consolidated Financial Statements for a detailed discussion on
FirstCity's allowance for loan losses.

Occupancy,
data processing, property protection and other expenses increased by 23% to $6.5 million in 2006 from $5.3 million in 2005 primarily due to higher servicing and
legal and accounting fees.

Minority
interest expense was minimal from year to year.

Equity in earnings of investments.Equity in earnings of investments decreased slightly to $11.8 million in 2006
compared to $12.0 million in 2005. Equity earnings in Acquisition Partnerships decreased by 3.9% to $10.9 million in 2006 from $11.4 in 2005. Equity in earnings of servicing entities
increased by 28.9% to $0.8 million in 2006 from $.6 million in 2005. Following is a discussion of equity earnings in Acquisition Partnerships by geographic region. See Note 6 to
the Consolidated Financial Statements for a summary of revenues and earnings of the Acquisition Partnerships and equity in earnings of the Acquisition Partnerships.



31

Table of Contents

---









Gain on sale of subsidiaries and equity investments.Gain on sale of equity investments of $2.5 million was recorded
in 2006. This gain primarily consisted of: 1) one domestic equity investment resulting in a gain of $1.3 million; and 2) a partial sale of twelve Latin American equity investments
to AIG resulting in a gain of $1.2 million in accordance with the restructuring of the Mexican Investment Platform.



The following items affect the Company's overall results of operations and are not directly allocated to the Portfolio Asset acquisition and resolution business
discussed above.

Corporate interest and overhead.Net corporate overhead expenses (excluding taxes) decreased from $5.6 million in 2005
to $5.2 million in 2006, primarily due to increased management fee income from acquisition partnerships, from $0.5 million in 2005 to $0.7 million in 2006. Other expenses
increased due to recording $.4 million in stock option expense beginning 2006 in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment,offset
by decreased legal and accounting fees from $1.3 million in 2005 to $1.0 million in 2006.

Income taxes.Provision for income taxes was $173,000 in 2006 compared to $292,000 in 2005, and taxes in both years related
primarily to state income taxes. Federal income taxes are provided at a 35% rate applied to taxable income or loss and are offset by NOLs that the Company believes are available. The
tax benefit of the NOLs is recorded in the period during which the benefit is realized. The Company recorded no deferred tax provision in 2006 and 2005.

Discontinued Operations.The Company recorded a provision of $75,000 in 2006 for additional losses from discontinued mortgage
operations compared to $356,000 in 2005. At December 31, 2006, the only asset remaining from discontinued mortgage operations was an investment security resulting from the retention of a
residual interest in a securitization transaction. This security is in "run-off," and the Company is contractually obligated to service the underlying asset. The assumptions used in the
valuation model consider both industry as well as the Company's historical experience. As the security "runs off," assumptions are reviewed in light of historical evidence in revising the prospective
results of the model. These revised assumptions could potentially result in either an increase or decrease in the estimated cash receipts. An additional provision is booked based on the output of the
valuation model if deemed necessary.

In
April 2005, the Company exercised an early purchase option on the 1998-1 securitization. Loans receivable were recorded at $6.1 million in accordance with
EITF 02-9,Accounting for Changes that Result in a Transferor Regaining Control of Financial Assets Sold.The transaction did not
have an impact on the results of operations, but did result in the elimination of $.8 million of residual interest previously classified as discontinued mortgage assets.

Earnings
from discontinued consumer operations were zero in 2006 compared to $509,000 in 2005. On November 1, 2004, FirstCity completed the sale of its remaining 31% interest in
Drive and recognized a net gain of $53.3 million. In 2005, an estimated tax provision of $.6 million was reversed due to lower than anticipated state income taxes related to the sale.

32

Table of Contents

---



Portfolio Asset Acquisition and Resolution

In 2007 the Company invested $126.7 million in Portfolios acquired through Acquisition Partnerships and subsidiaries. Acquisitions by the Company over the
last five years are summarized as follows:

Purchase
Price

FirstCity
Investment(In thousands)1st Quarter

$
78,771

$
69,4552nd Quarter


91,431


25,2933rd Quarter


19,665


16,2704th Quarter


24,466


15,696Total 2007


214,333


126,714Total 2006


296,990


144,048Total 2005


146,581


71,405Total 2004


174,139


59,762Total 2003


129,192


22,944


Revenues
with respect to the Company's Portfolio Asset acquisition and resolution segment consist primarily of (i) servicing fees from Acquisition Partnerships for the servicing
activities performed related to the assets held in the Acquisition Partnerships, (ii) interest income on performing Portfolio Assets and loans receivable, and (iii) gains on disposition
of assets. The Company also records equity in earnings of affiliated Acquisition Partnerships and servicing entities.

Liquidity and Capital Resources

The Company requires liquidity to fund its operations, working capital, payment of debt, repurchase of the Company's Common Stock, equity for acquisition of
Portfolio Assets, investments in and advances to entities formed with other investors to acquire Portfolios ("Acquisition Partnerships") and other investments. The potential sources of liquidity are
funds generated from operations, equity distributions from the Acquisition Partnerships, interest and principal payments on subordinated intercompany debt, dividends from the Company's subsidiaries,
borrowings from revolving lines of credit and other credit facilities, proceeds from equity market transactions, securitization and other structured finance transactions and other special purpose
short-term borrowings.

In
August 2007, FirstCity obtained an increase from $175.0 million to $225.0 million in its revolving credit facility with Bank of Scotland that matures in November 2010.
The revolving loan facility is used to finance the senior debt and equity portion of portfolio and asset purchases made by FirstCity and to provide for the issuance of letters of credit and working
capital loans. The obligations of FirstCity under this facility are guaranteed by substantially all of the wholly-owned subsidiaries of FirstCity and are secured by security interests in substantially
all of the assets of FirstCity and its wholly-owned subsidiaries. The primary terms and key covenants of the $225.0 million revolving credit facility, as amended, are as follows:



33

Table of Contents

---





In
August 2007, FH Partners, LLC, an indirect wholly-owned affiliate of FirstCity, obtained an increase from $50.0 million to $100.0 million on its revolving loan
facility with Bank of Scotland that provides financing for Portfolio and asset purchases by FH Partners, LLC. This revolving loan facility matures in November 2010, and is secured by all assets
of FH Partners, LLC and a guaranty by FirstCity and certain of its wholly-owned subsidiaries. The primary terms and key covenants of the $100.0 million revolving loan facility, as
amended, are as follows:



On
September 5, 2007, FirstCity and BoS (USA), Inc. ("BoS (USA)") entered into a Subordinated Delayed Draw Credit Agreement (the "Subordinated Credit Agreement") which may
be used to finance equity investments in new ventures, equity investments made in connection with portfolio and asset purchases and loans made by FirstCity and its subsidiaries to acquisition
entities, provide for the issuance of letters of credit, and for working capital loans. The Subordinated Credit Agreement was effective as of November 16, 2007. The primary terms and key
covenants of this $25.0 million loan facility are as follows:



34

Table of Contents

---





The
obligations of FirstCity under the Subordinated Credit Agreement are guaranteed by substantially all of the wholly-owned subsidiaries of FirstCity and are secured by security
interests in substantially all of the assets of FirstCity and its wholly-owned subsidiaries. The Subordinated Credit Agreement provides that any failure to make a payment or acceleration of debt under
the revolving credit facility entered into between FirstCity and Bank of Scotland on November 12, 2004, is a default under the Subordinated Credit Agreement and provides for other events of
default and other provisions that are customary for a facility of this type.

At
December 31, 2007, the Company had $41.5 million in Euro-denominated debt for the purpose of hedging a portion of the net equity investments in Europe. In
general, the type of risk hedged relates to the foreign currency exposure of net investments in Europe caused by movements in Euro exchange rates. The Company entered into the hedging relationship
such that changes in the net investments being hedged are expected to be offset by corresponding changes in the values of the Euro-denominated debt. Effectiveness of the hedging
relationship is measured and designated at the beginning of each month by comparing the outstanding balance of the Euro-denominated debt to the carrying value of the designated net equity
investments. The net foreign currency translation gain (loss) included in accumulated other comprehensive income relating to the Euro-denominated debt was ($2.4) million for the year ended
December 31, 2007, ($2.5) million for 2006, and $1.3 million for 2005.

On
November 29, 2006, FirstCity Mexico SA de CV, a Mexican affiliate of FirstCity, entered into a revolving line of credit with a maximum loan amount of 148,096,800 Mexican
pesos with Banco Santander, S.A., which was equivalent to $13.5 million U.S. dollars at December 31, 2007. The proceeds were used to pay down the acquisition facility with the
Bank of Scotland. Pursuant to the terms of the credit facility, FirstCity Mexico SA de CV was required to provide a stand-by letter of credit from Bank of Scotland that would
satisfy the loan balance upon demand. At December 31, 2007, FirstCity had a letter of credit in the amount of $14.1 million from Bank of Scotland under the terms of FirstCity's revolving
acquisition facility with Bank of Scotland. In the event that a demand is made under the $14.1 million letter of credit, FirstCity is required to reimburse Bank of Scotland by making payment to
Bank of Scotland for all amounts disbursed or to be disbursed by Bank of Scotland under the letter of credit.

35

Table of Contents

---



American
Business Lending, Inc. ("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 and acquiring SBA loans. The obligations under this facility are secured by substantially all of the assets of
ABL. In connection with the first amendment to this facility on February 27, 2007, FirstCity provided WFF with an unconditional guaranty, up to a maximum of $5 million plus enforcement
cost, of the obligations of ABL under the loan facility that relate to funds in the amount of $31.7 million advanced by WFF to ABL in connection of a portfolio of SBA loans in February 2007.
This guaranty will remain in effect until the obligations incurred in connection with the
advance related to the acquisition of the portfolio of SBA loans are paid in full. The primary terms and key covenants of the $40.0 million revolving loan facility, as amended, are as follows:



The
security agreement executed by ABL to secure the obligations under the Credit Agreement grants a security interest to WFF in all of the assets of ABL except (a) the
unguaranteed portions of any SBA-guaranteed loan originated by AMRESCO SBA Holdings, Inc. ("ASBA") and transferred to ABL pursuant to the Asset Purchase Agreement dated as of
June 30, 2006, by and among NCS I, LLC and ASBA, as sellers, ABL, as the purchaser, and FirstCity Business Lending Corporation and FirstCity pursuant to which ABL acquired those SBA
loans, and any other assets transferred by ASBA to ABL pursuant to that Asset Purchase Agreement, including, the Small Business Lending Corporation license.

36

Table of Contents

---



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

Excluding
the term acquisition facilities of the unconsolidated Acquisition Partnerships, as of December 31, 2007, the Company and its subsidiaries had credit facilities providing
for borrowings in an aggregate principal amount of $408.8 million and outstanding borrowings of $177.3 million.

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

Discussion of Critical Accounting Policies

In the ordinary course of business, the Company has made a number of estimates and assumptions relating to the reporting of results of operations and financial
position in the preparation of its consolidated financial statements in conformity with accounting principles generally accepted in the United States. Actual results could differ significantly from
those estimates under different assumptions
and conditions. The Company believes that the following discussion addresses the Company's most critical accounting policies, which are those that are most important to the portrayal of the Company's
consolidated financial position and results and require management's most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that
are inherently uncertain.



On January 1, 2005, FirstCity adopted the provisions of AICPA Statement of Position 03-3,Accounting for Certain Loans
or Debt Securities Acquired in a Transfer("SOP 03-3"). SOP 03-3 addresses accounting differences between contractual cash flows and cash
flows expected to be collected from an investor's initial investment in loans acquired in a transfer if those difference are attributable, at least in part, to credit quality.
SOP 03-3 requires impaired loans be recorded at fair value and prohibits "carrying over" or the creation of valuation allowances in the initial accounting of loans acquired in a
transfer that are within the scope of SOP 03-3. Under SOP 03-3, the excess cash flows expected at purchase over the purchase price is recorded as interest income
over the life of the loan.

For
loan portfolios acquired prior to January 1, 2005, FirstCity designated such loans as non-performing Portfolio Assets or performing Portfolio Assets. Such
designation was made at the acquisition of the pool and does not change even though the actual performance of the loans may change. FirstCity accounts for all nonperforming loans acquired after 2004
in accordance with SOP 03-3. The following is a description of each classification and the related accounting policy accorded to each Portfolio type:



Non-performing Portfolio Assets consist primarily of distressed loans and loan related assets, such as foreclosed upon collateral. Accounting for
non-performing portfolios is on a pool basis as opposed to an individual asset-by-asset basis. Prior to January 1, 2005, Portfolio Assets were designated as
non-performing if a majority of all of the loans in the Portfolio were significantly under performing in accordance with the contractual terms of the underlying loan agreements at the date
of acquisition. Net gain on resolution of non-performing Portfolio Assets is recognized as income to the extent that

37

Table of Contents

---



proceeds
collected exceed a pro rata portion of allocated cost from the pool. Cost allocation is based on a proration of actual proceeds divided by total estimated proceeds of the pool. No interest
income is recognized separately on non-performing Portfolio Assets. All proceeds, of whatever type, are included in income from Portfolio Assets in determining the gain on resolution of
such assets. Accounting for non-performing Portfolios is on a pool basis as opposed to an individual asset-by-asset basis.

All
non-performing Portfolio Assets are purchased at discounts from their outstanding legal principal amount, the total of the aggregate of expected future sales prices and
the total payments to be received from obligors. Subsequent to acquisition, the adjusted cost of non-performing Portfolio Assets is evaluated for impairment on a quarterly basis. The
evaluation of impairment is determined based on the review of the estimated future cash receipts, which represents the net realizable value of the non-performing pool. Once it is
determined that there is impairment, a valuation allowance is established for any impairment identified through provisions charged to operations in the period the impairment is identified.

The
actual future proceeds of the pool could vary materially from the estimated proceeds of the pool due to changes in economic conditions, deterioration of collateral values,
deterioration in the borrower's financial condition and other conditions described in the risk factors discussed earlier in this document. In the event that the actual future proceeds of the pool
exceed the current estimates, the reported future results of the Company could be higher than anticipated and would result in a higher net gain on resolution of non-performing Portfolio
Assets. In the event that actual future proceeds of the pool are less than current estimates, the reported future results of the Company could be lower than anticipated and would result in lower net
gain on resolution of non-performing Portfolio Assets or possibly require the Company to recognize impairment in the value of the pool.



Performing Portfolio Assets consist primarily of portfolios of loans acquired at a discount from the aggregate amount of the borrowers' obligation. Prior to
January 1, 2005, performing Portfolio Assets were accounted for using the interest methodacquisition discounts for the Portfolio as a whole are accreted as an adjustment to yield
over the estimated life of the Portfolio. Performing Portfolio Assets are carried at the unpaid principal balance of the underlying loans, net of acquisition discounts and allowance for loan losses.
Significant increases in expected future cash flows may be recognized prospectively through an upward adjustment of the internal rate of return ("IRR") over a portfolio's remaining life. Any increase
to the IRR then becomes the new benchmark for impairment testing. Income on performing Portfolio Assets is accrued monthly based on each loan pool's effective IRR. Cash flows greater than the interest
accrual will reduce the carrying value of the pool. Likewise, cash flows that are less than the accrual will increase the carrying balance. The IRR is estimated and periodically recalculated based on
the timing and amount of anticipated cash flows using the Company's proprietary collection model. Gains are recognized on the performing Portfolio Assets when sufficient funds are received to fully
satisfy the obligation on loans included in the pool, either from funds from the borrower or sale of the loan. The gain recognized represents the difference between the proceeds received and the
allocated carrying value of the individual loan in the pool.

38

Table of Contents

---





The actual future cash flows of the pool could vary materially from the expected future cash flows of the pool due to changes in economic conditions, changes in collateral values,
deterioration in the borrowers financial condition, restructure or renewal of individual loans in the pool, sale of loans within the pool and other conditions described in the risk factors discussed
earlier in this document. In the event that the actual future cash flows of the pool exceed the current estimates, the reported future results of the Company could be higher than anticipated and would
result in a higher level of interest income due to greater amounts of discount accretion being included in revenue derived from the performing Portfolio Assets as well as higher gains recognized on
the sale of individual loans from a pool. In the event that actual future cash flows of the pool are less than current estimates, the reported future results of the Company could be lower than
anticipated and would result in a lower level of interest income and reduced gains from the sale of assets from a pool, lower levels of interest income as a result of lower amounts of discount
accretion being included in revenue derived from performing Portfolio Assets or possibly require the Company to recognize impairment in the value of the pool due to a decline in the present value of
the expected future cash flows.



Management's best estimate of IRR as of January 1, 2005, is the basis for subsequent impairment testing. If it is probable that all cash flows estimated at
acquisition plus any changes to expected cash flows arising from changes in estimates after acquisition would not be collected, the carrying value of a pool would be written down to maintain the then
current IRR. Prior to January 1, 2005, impairment charges would be taken to the income statement with a corresponding write-off of the receivable balance. Consequently, no allowance
for loan loss was recorded prior to January 1, 2005. The Company recorded net impairment provisions of $2,000 in 2007, $62,000 in 2006 and $132,000 in 2005.

A
pool can become fully amortized (zero carrying balance on the balance sheet) while still generating cash collections. In this case, all cash collections are recognized as revenue when
received. Additionally, the Company uses the cost recovery method when timing and amount of collections on a particular pool of accounts cannot be reasonably predicted. Under the cost recovery method,
no revenue is recognized until the Company has fully collected the cost of the Portfolio, or until such time that the Company considers the collections to be probable and estimable and begins to
recognize income based on the interest method as described above.



At acquisition, FirstCity reviews each loan to determine whether there is evidence of deterioration of credit quality since origination and if it is probable that
FirstCity will be unable to collect all amounts due according to the loan's contractual terms. If both conditions exist, FirstCity determines whether each such loan is to be accounted for individually
or whether such loans will be assembled into pools of loans based on common risk characteristics (including loan type, collateral type, geographical location, performance status and borrower
relationship).

FirstCity
considers expected prepayments, and estimates the amount and timing of undiscounted expected principal, interest, and other cash flows (expected at acquisition) for each loan
and each subsequently aggregated pool of loans. FirstCity determines the excess of the loan's or pool's scheduled contractual principal and contractual interest payments over all cash flows expected
at acquisition as an amount that should not be accreted ("nonaccretable difference"). The excess of the loan's cash flows expected to be collected at acquisition over the initial investment in the
loan or pool is accreted into interest income over the remaining life of the loan or pool ("accretable yield").

Over
the life of the loan or pool, FirstCity continues to estimate cash flows expected to be collected. FirstCity evaluates at the balance sheet date whether the present value of its
loans

39

Table of Contents

---



determined
using the effective interest rates has decreased below book value and if so, a valuation allowance is established for any impairment identified through provisions charged to operations in
the period the impairment is identified. The present value of any subsequent increase in the loan's or pool's actual cash flows or cash flows expected to be collected is used first to reverse any
existing valuation allowance for that loan or pool. Any remaining increases in the present value of cash flows expected to be collected will be used to recalculate the amount of accretable yield
recognized on a prospective basis over the pool's remaining life.

FirstCity
establishes valuation allowances for all acquired loans subject to SOP 03-3 to reflect only those losses incurred after acquisitionthat is, the
present value of cash flows
expected at acquisition that are not expected to be collected. The Company recorded net impairment provisions of $1.4 million in 2007, $132,000 in 2006, and none in 2005 on these loans.



Loans acquired without evidence of credit deterioration at acquisition for which FirstCity has the positive intent and ability to hold for the foreseeable future
are classified as held for investment and reported at their unpaid principal balance net of unamortized purchase discounts or premiums.

Interest
accrual ceases when payments become 90 days contractually past due. An allowance for loan losses is established when a loan becomes impaired. A loan is impaired when full
payment under the loan terms is not expected. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific
borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any
loan that, in management's judgment, should be charged off. Loan losses are charged against the allowance when management believes that the uncollectibility of a loan balance is confirmed. The Company
recorded net impairment provisions of $58,000 in 2007, $49,000 in 2006, and $31,000 in 2005 on these loans.



Real estate portfolios consist of real estate acquired from a variety of sellers. Such Portfolios are carried at the lower of cost or fair value less estimated
costs to sell. Costs relating to the development and improvement of real estate for its intended use are capitalized, whereas those relating to holding assets are charged to expense. Income or loss is
recognized upon the disposal of the real estate. Rental income, net of expenses, on real estate Portfolios is recognized when received. Accounting for the Portfolios is on an individual
asset-by-asset basis as opposed to a pool basis. Subsequent to acquisition, the amortized cost of real estate portfolios is evaluated for impairment on a quarterly basis. The
evaluation of impairment is determined based on the review of the estimated future cash receipts, net of costs to sell, which represents the net realizable value of the real estate portfolio.
Impairment losses are charged to operations in the period the impairment is identified. The Company recorded net impairment losses of $407,000, $28,000, and $49,000 in 2007, 2006 and 2005,
respectively.



Loans receivable consist of loans made to affiliated entities (including Acquisition Partnerships) and non-affiliated entities, and purchased and
originated SBA loans. The repayment of the loans is generally dependent upon future cash flows of the borrowers, future cash flows of the underlying collateral (i.e. loan pools), and
distributions made from affiliated entities. Interest is accrued when earned in accordance with the contractual terms of the loans. Loan origination fees and costs as well as premiums and discounts
are amortized as level-yield adjustments over the respective loan terms. Unamortized net fees or costs are recognized upon early repayment of the loans.

40

Table of Contents

---



The
Company evaluates all loans receivable for impairment on regular basis by reviewing the collectibility of the loans in light of various factors, as applicable, such as estimated
future cash receipts of the borrower or underlying collateral, historical experience, estimated value of underlying collateral, prevailing economic conditions, and industry concentrations. This
evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. A loan is considered impaired if it is probable that
the Company will not ultimately collect all principal or interest amounts contractually due. Loans that experience insignificant payment shortfalls generally are not classified as impaired. When a
loan is determined to be impaired, unpaid interest is reversed against interest income and the Company ceases to accrue interest on the note. When ultimate collectibility of the impaired note is in
doubt, all cash receipts are generally applied to reduce the principal amount of such notes until the principal has been recovered, and are recognized as interest income thereafter. Impairment losses
are charged against an allowance account through provisions charged to operations in the period impairment is identified. Loans are written-off against the allowance when all possible
means of collection have been exhausted and the potential for recovery is considered remote.



As a part of the process of preparing its consolidated financial statements, the Company is required to calculate its income taxes in each of the jurisdictions in
which it operates. This process involves calculating the Company's current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting
purposes. These differences result in deferred tax assets and liabilities. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the
financial statement carrying amounts and the tax basis of existing assets and liabilities and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The effects of future changes in tax laws or changes in tax rates are not anticipated. The measurement of deferred tax
assets, if any, is reduced by the amount of any tax benefits that, based on available evidence, are not expected to be realized.

As
a result of the Merger, the Company has substantial federal NOLs that can be used to offset the tax liability associated with the Company's pre-tax earnings until the
earlier of the expiration or utilization of such NOLs. The Company accounts for the benefit of the NOLs by recording the benefit as an asset and then establishing an allowance to value the net
deferred tax asset at a value commensurate with the Company's expectation of being able to utilize the recognized benefit in the foreseeable future. Such estimates are reevaluated on a quarterly basis
with the adjustment to the allowance recorded as an adjustment to the income tax expense generated by the quarterly operating results. Significant events that change the Company's view of its
currently estimated ability to utilize the tax benefits result in substantial changes to the estimated allowance required to value the deferred tax benefits recognized in the Company's periodic
consolidated financial statements. The Company's analysis resulted in no change in 2007, 2006 and 2005.

The
Company has a net deferred tax asset of $20.1 million in the consolidated balance sheet as of December 31, 2007, which is composed of a gross deferred tax asset of
$81.1 million net of a valuation allowance of $61.0 million. The ultimate realization of the resulting net deferred tax asset is dependent upon generating sufficient taxable income from
its continuing operations prior to expiration of the net operating loss carryforwards. Although realization is not assured, management believes it is more likely than not that all of the recorded
deferred tax asset, net of the allowance, will be realized. The amount of the deferred tax asset considered realizable, however, could be adjusted in the future if estimates of future taxable income
during the carryforward period change. The ability of the Company to realize the

41

Table of Contents

---



deferred
tax asset is periodically reviewed and the valuation allowance is adjusted accordingly. See "Item 1A. Risk Factors."



FirstCity accounts for its investments in Acquisition Partnerships and their general partners using the equity method of accounting. This accounting method
generally results in the pass-through of its pro rata share of earnings from the partnerships' activities as if it had a direct investment in the underlying Portfolio Assets held by the
partnerships. The revenues and earnings of the partnerships are determined on a basis consistent with the accounting methodology applied to Portfolio Assets as described in the preceding paragraphs.
FirstCity has ownership interests in the various partnerships that range from 2% to 50%. The Company also holds investments in servicing entities that are accounted for under the equity method.

Distributions
of cash flow from the Acquisition Partnerships are a function of the terms and covenants of the loan agreements related to the secured borrowings of the Acquisition
Partnerships. Generally, the terms of the underlying loan agreements permit some distribution of cash flow to the equity partners so long as loan to cost and loan to value relationships are in
compliance with the terms and covenants of the applicable loan agreement. Once the secured borrowings of the Acquisition Partnerships are fully paid, all cash flow in excess of operating expenses is
available for distribution to the equity partners.



Discontinued operations are comprised of two components previously reported as the Company's residential and commercial mortgage banking business and the consumer
lending business conducted through FirstCity's minority interest investment in Drive. In November 2004, FirstCity completed the sale of its interest in Drive, and as of December 31, 2004, the
Company had zero assets remaining from the discontinued consumer operations, but certain income realized from such operations.

The
only asset remaining from discontinued mortgage operations is an investment security resulting from the retention of a residual interest in a securitization transaction. This
security is in "run-off," and the Company is contractually obligated to service this asset. Prior to the fourth quarter of 2004, FirstCity classified these securities as held to maturity
and considered the estimated future gross cash receipts for such investment securities in the computation of the value of such investment securities. In the fourth quarter of 2004, FirstCity's
management elected to pursue a strategy to liquidate these assets and carry them as held for sale. Consequently, in accordance with SFAS No. 144,Accounting for the
Impairment or Disposal of Long-Lived Assets,the remaining security is recorded at the lower of their carrying value or fair value less cost to sell. The cash flows
are collected over a period of time and are valued using a discount rate of 18% and prepayment assumptions of 32% for fixed rate loans and 33% for variable rate loans. Overall loss rates are estimated
at 14% of collateral. The assumptions used in the valuation model consider both industry as well as the Company's historical experience and are reviewed quarterly in light of historical evidence in
revising the prospective results of the model. These revised assumptions could potentially result in either an increase or decrease in the estimated cash receipts. An additional provision is booked
based on the output of the valuation model if deemed necessary. The Company recorded no provisions in 2007, $75,000 in 2006 and $356,000 in 2005 for additional losses from discontinued mortgage
operations. The provision in 2005 primarily related to a decrease in the estimated future gross cash receipts on residual interests in securitizations as a result of the actual losses exceeding the
losses projected by the valuation model.

42

Table of Contents

---





The Company uses estimates to determine future cash receipts from Portfolio Assets. These estimates of future cash receipts from acquired Portfolio Asset pools
are utilized in four primary ways:





The Company uses a proprietary asset management software program to manage the Portfolio Assets it owns and services. Each asset within a pool is analyzed by an
account manager who is responsible for analyzing the characteristics of each asset within a pool. The account manager projects future cash receipts and expenses related to each asset and the sum of
which provides the total estimated future cash receipts related to a particular purchased asset pool. These estimates are routinely monitored by the Company to determine reasonableness of the
estimates provided.



The Company has in the past been able to establish with reasonable accuracy the estimated future cash receipts over the life of a purchased asset pool. Changes in
economic conditions, fluctuations in interest rates, deterioration of collateral values, and other factors described in the risk factors section could cause the estimates of future cash flows to be
materially different than actual cash receipts.

The
effects of an increase in the estimated future cash receipts would generally increase revenues from Portfolio Assets by increasing gross profit on a non-performing or
real estate pool and increasing the effective yield on a performing or SOP 03-3 portfolio while a decrease in future cash receipts would generally have the effect of reducing
revenues by reducing gross profit on a non-performing or real estate pool and creating impairment on a performing or SOP 03-3 portfolio. In some cases a reduction in the
total future cash receipts by collecting those cash receipts sooner than expected could have a positive impact on the Company's revenues from Portfolio Assets due to reduced interest expense and other
carrying costs associated with the Portfolio Assets. Likewise an increase in future cash receipts, although generally a positive trend, could have a negative impact on future revenues of the Company
if collected over a longer period, resulting in higher levels of interest expense and other carrying costs of the portfolios negating any potentially positive effects.



In addition to consolidating entities in which FirstCity has a direct or indirect controlling financial interest, FirstCity evaluates the consolidation of
entities to which common conditions of consolidation, such as voting interests and board representation, do not apply. FirstCity performs this evaluation pursuant to FASB Interpretation
No. 46R,Consolidation of Variable Interest Entities("FIN 46R"). FIN 46R provides that, in the absence of clear control through
voting interests, board representation or similar rights, a company's exposure, or variable interest, to the economic risks and potential rewards associated with its interest in the entity is the best
evidence of control.

In
connection with FIN 46R, when evaluating an entity for consolidation, FirstCity first determines whether an entity is within the scope of FIN 46R and if it is deemed to
be a variable interest entity ("VIE"). If the entity is considered to be a VIE, FirstCity determines whether it would be considered the entity's primary beneficiary. FirstCity consolidates those VIEs
for which it has determined that it is

43

Table of Contents

---



the
primary beneficiary. Generally, FirstCity will consolidate an entity not deemed either a VIE upon a determination that its ownership, direct or indirect, exceeds fifty percent of the outstanding
voting shares of an entity and/or that it has the ability to control the financial or operating policies through its voting rights, board representation or other similar rights. For entities where
FirstCity does not have a controlling interest (financial or operating), the investments in such entities are accounted for using the equity. FirstCity applies the equity method of accounting when it
has the ability to exercise significant influence over operating and financial policies of an investee in accordance with APB Opinion No. 18,The Equity Method of
Accounting for Investments in Common Stock.

Equity
earnings in most of the foreign Acquisition Partnerships are recorded on a one-month lag due to the timing of FirstCity's receipt of those financial statements.

Contractual Obligations and Commercial Commitments

The following tables present contractual cash obligations and commercial commitments of the Company as of December 31, 2007. See Notes 7, 13 and 15
of the Notes to Consolidated Financial Statements (dollars in thousands).

|                                                                                                   |  | Payment Due by Period
|-------------------------------------------------------------------------------------------------- |  | ---------------------
|
|Notes payable secured by Portfolio Assets, loans receivable and equity in Acquisition Partnerships |  | $                    
|Unsecured notes                                                                                    |  |                      
|Operating leases                                                                                   |  |                      
|Unfunded Portfolio purchase obligation                                                             |  |                      
|                                                                                                   |  |                      
|                                                                                                   |  | $                    
|                                                                                                   |  |                      

|
|

|                       |  | Amount of Commitment Expiration Period
|---------------------- |  | --------------------------------------
|
|Commercial Commitments |  | $                                     

Effect of Newly Issued Accounting Standards

In December 2007, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141R, Business
Combinations("SFAS 141R") and SFAS No. 160,Noncontrolling Interests in Consolidated Financial
Statementsan amendment to ARB No. 51("SFAS 160"). SFAS 141R and 160 require most identifiable assets, liabilities,
non-controlling interests, and goodwill acquired in a business combination to be recorded at "full fair value" and require non-controlling interests (previously referred to as
"minority interests") to be reported as a component of equity, which changes the accounting for transactions with non-controlling interest holders. Both SFAS 141R and 160 are
effective for periods beginning on or after December 15, 2008, and earlier adoption is prohibited. SFAS 141R will be applied to business combinations occurring after the effective date.
SFAS 160 will be applied prospectively to all non-controlling interests, including any that arose before the effective date. The Company is currently evaluating the impact of
adopting SFAS 141R and 160 on its financial condition and results of operations.

In
February 2007, the FASB issued SFAS No.159,The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement
No. 115("SFAS 159"). SFAS 159 permits entities to choose to measure eligible items at fair value at specified election dates. Unrealized

44

Table of Contents

---



gains
and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date. The fair value option (i) may be applied instrument by
instrument, with certain exceptions, (ii) is irrevocable (unless a new election date occurs) and (iii) is applied only to entire instruments and not to portions of instruments.
SFAS 159 is effective for the Company's 2008 fiscal year. The Company is currently evaluating the impact the adoption of SFAS 159 could have on its financial condition, results of
operations and cash flows.

In
September 2006, the FASB issued SFAS No. 157,Fair Value Measurements("SFAS 157"). SFAS No. 157 establishes a
framework for measuring fair value and expands disclosures about fair value
measurements. The changes to current practice resulting from the application of SFAS 157 relate to the definition of fair value, the methods used to measure fair value, and enhances disclosures
about fair value measurements. SFAS 157 does not require any new fair value measures. SFAS 157 is effective for the Company on January 1, 2008. SFAS 157 is required to be
applied prospectively, except for certain financial instruments. Any transition adjustment will be recognized as an adjustment to opening retained earnings in the year of adoption. In February 2008,
the FASB decided to defer SFAS 157's fair-value measurement requirements for nonfinancial assets and liabilities that are not required or permitted to be measured at fair value on a
recurring basis. The Company is currently evaluating the impact the adoption of SFAS 157 will have on its financial condition and results of operations.

Effects of Newly Adopted Accounting Standards

Effective January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, Accounting for Uncertainty in Income TaxesAn Interpretation of FASB Statement No. 109("FIN 48"). FIN 48 clarifies the
financial statement recognition and disclosure requirements for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement of Financial Accounting
Standards ("SFAS") No. 109,Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold and measurement attribute for the
financial statement recognition and derecognition of tax positions taken or expected to be taken in a tax return. Furthermore, FIN 48 provides related guidance on measurement, classification,
interest and penalties, and disclosure. See Note 11 to the Consolidated Financial Statements for the impact of adopting FIN 48 on the Company's results of operations and financial
position.

Effective
January 1, 2007, the Company adopted SFAS No. 156,Accounting for Servicing of Financial Assetsan amendment of FASB Statement
No. 140("SFAS 156"). SFAS 156 requires an entity to recognize a servicing asset or liability each time it undertakes an obligation to service a financial
asset by entering into a servicing contract in specified situations. Such servicing assets or liabilities would be initially measured at fair value, if practicable, and subsequently measured at
amortized value or fair value based upon an election of the reporting entity. SFAS 156 also specifies certain financial statement presentations and disclosures in connection with servicing
assets and liabilities. The Company elected to measure the servicing assets, subsequent to the date of sale, by using the amortization method which amortizes servicing assets in proportion to and over
the period of estimated net servicing income and assesses servicing assets for impairment based on fair value at each reporting date. The adoption of SFAS 156 by the Company on
January 1, 2007 did not have a significant impact on the Company's consolidated financial position or earnings.

On
December 31, 2006, the Company adopted SEC Staff Accounting Bulletin Topic 1N, Financial StatementsConsidering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial Statements("SAB 108"). SAB 108 provides guidance on how prior year misstatements should be
evaluated when determining the materiality of misstatements in the current year financial statements and it also addresses how to correct material misstatements. The Company's adoption of
SAB 108 resulted in an adjustment to opening retained earnings for the year ended December 31, 2006 by approximately $327 thousand, all of which relates to the Company's
investments

45

Table of Contents

---



in
certain Acquisition Partnerships accounted for under the equity method of accounting. Approximately $152 thousand reflects a correction to write-off cumulative translation
adjustments related to certain foreign investments during the periods 2002 through 2005, and approximately $106 thousand reflects a correction in a Partnership's accounting for property taxes
in 2005. The remaining $69 thousand reflects the Company's 2005 correction of accounting for equity earnings on a pro-rata basis recorded in an acquired investment subsequent to the
acquisition date. The Company reviewed the annual amount of reduced equity earnings incurred in prior periods for these corrections and considered the effects to be immaterial to prior periods both
individually and in the aggregate.

Item 7A.Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

Market risk is the risk of loss from adverse changes in market prices and interest rates. The Company's operations are materially impacted by net gains on sales
of loans and net interest margins. The level of gains from loan sales the Company achieves is dependent on demand for the products originated. Net interest margins are dependent on the Company's
ability to maintain the spread or interest differential between the interest it charges the customer for loans and the interest the Company is charged for the financing of those loans. The following
describes each component of interest bearing assets held by the Company and how each could be affected by changes in interest rates.

The
Company invests in Portfolio Assets both directly through consolidated subsidiaries and indirectly through equity investments in Acquisition Partnerships. Portfolio Assets consist of
investments in pools of non-homogenous assets that predominantly consist of loan and real estate assets. Earnings from these assets are based on the estimated future cash flows from such
assets and recorded when those cash flows occur. The underlying loans within these pools bear both fixed and variable
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 realized from the Portfolio Assets.

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

SBA
loans receivable were $14.4 million at December 31, 2007, of which $0.1 million were related to the guaranteed portion of these loans. The guaranteed portion is
backed by the full faith and credit of the U.S. Small Business Administration, and is generally sold into the secondary market. Virtually all of the SBA loans have variable interest rates. Assuming
that the balance sheet were to remain constant and no actions were taken to alter the existing interest rate sensitivity, a hypothetical immediate change in interest rates would have a minimal effect
on interest income from SBA loans for 2007. Although management believes that this measure is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit
quality, size and composition of the assets on the balance sheet, and other business developments that could affect a net increase (decrease) in assets. Accordingly, no assurances can be given that
actual results would not differ materially from the potential outcome simulated by this estimate.

FirstCity
had $177.3 million in debt outstanding at December 31, 2007. The Company is exposed to interest rate risk primarily through its variable rate debt, which totaled
$146.0 million or 82% of the Company's total debt. A 50 basis point change in interest rates would increase or decrease FirstCity's annual interest expense by approximately $0.9 million
annually.

46

Table of Contents

---



Foreign Currency Risk

The Company currently has loans 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 a significant portion of the Company's total equity investments. As previously
discussed, the revolving acquisition facility with Bank of Scotland for $225 million allows loans to be made in Euros up to a
maximum amount in Euros that is equivalent to $50 million U.S. dollars. At December 31, 2007, the Company had $41.5 million in Euro-denominated debt for the purpose of
hedging a portion of the net equity investments in Europe. In November 2006 the Company acquired a line of credit facility with Banco Santander, S.A. that allows loans to be made in Mexican
pesos up to a maximum of 148,096,800 Mexican pesos. At December 31, 2007, the Company had 148,096,800 in Mexican peso-denominated debt, which was equivalent to $13.5 million
U.S. dollars. Management of the Company feels that these loan agreements will help reduce the risk of adverse effects of currency changes on these investments.

A
sharp change in the foreign currencies related to the investments in Europe, Latin America and Canada relative to the U.S. dollar could materially adversely affect the financial
position and results of operations of the Company. A 5% and 10% incremental depreciation of these currencies would result in an estimated decline in the valuation of the Company's foreign investments
and are indicated in the following table. These amounts are estimates; consequently, these amounts are not necessarily indicative of the actual effect of such changes with respect to the Company's
consolidated financial position or results of operations.

Estimated decline in
valuation of investments
resulting from
incremental depreciation
of foreign currency of
(dollars in thousands)One U.S.
dollar
equals5%

10%Europe

EUR

0.68

$
2,104

$
4,027Mexico

MXN

10.87

$
1,918

$
3,702Argentina

ARS

3.15

$
61

$
119Dominican Republic

DOP

33.75

$
19

$
36Chile

CLP

497.70

$
159

$
303Canada

CAD

0.98

$
18

$
35


47

Table of Contents

---





Item 8.Financial Statements and Supplementary Data.

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES        CONSOLIDATED BALANCE SHEETS        (Dollars in thousands, except per share data)

|                                                                      |                                                                                                                                                                                             | December 31,
2007                          |         | December 31,
2006 |        
|--------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------- | ----------------- | -------
|ASSETS                                                                |                                                                                                                                                                                             |                                            |         |                   |        
|Cash and cash equivalents                                             |                                                                                                                                                                                             | $                                          | 23,546  |                   | $      
|Portfolio Assets, net                                                 |                                                                                                                                                                                             |                                            | 122,001 |                   |        
|Loans receivableaffiliates                                           |                                                                                                                                                                                             |                                            | 5,447   |                   |        
|Loans receivableSBA held for sale                                    |                                                                                                                                                                                             |                                            | 133     |                   |        
|Loans receivableSBA held for investment, net                         |                                                                                                                                                                                             |                                            | 14,234  |                   |        
|Loans receivableother                                                |                                                                                                                                                                                             |                                            | 5,995   |                   |        
|Equity investments                                                    |                                                                                                                                                                                             |                                            | 87,622  |                   |        
|Deferred tax asset, net                                               |                                                                                                                                                                                             |                                            | 20,101  |                   |        
|Service fees receivable ($785 and $917 from affiliates, respectively) |                                                                                                                                                                                             |                                            | 842     |                   |        
|Servicing assetsSBA loans                                            |                                                                                                                                                                                             |                                            | 843     |                   |        
|Other assets, net                                                     |                                                                                                                                                                                             |                                            | 17,355  |                   |        
|                                                                      |                                                                                                                                                                                             |                                            |         |                   |        
|                                                                      |                                                                                                                                                                                             | Total Assets                               |         | $                 | 298,119
|                                                                      |                                                                                                                                                                                             |                                            |         |                   |        
|LIABILITIES AND STOCKHOLDERS' EQUITY                                  |                                                                                                                                                                                             |                                            |         |                   |        
|Liabilities:                                                          |                                                                                                                                                                                             |                                            |         |                   |        
|                                                                      | Notes payable other                                                                                                                                                                         |                                            | $       | 177,329           |        
|                                                                      | Minority interest                                                                                                                                                                           |                                            |         | 3,209             |        
|                                                                      | Other liabilities                                                                                                                                                                           |                                            |         | 10,758            |        
|                                                                      |                                                                                                                                                                                             |                                            |         |                   |        
|                                                                      |                                                                                                                                                                                             | Total Liabilities                          |         |                   | 191,296
|Commitments and contingencies (note 15)                               |                                                                                                                                                                                             |                                            |         |                   |        
|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: 10,746,437 and 10,786,637, respectively) |                                            |         | 113               |        
|                                                                      | Treasury stock, at cost: 580,500 shares and 530,300 shares, respectively                                                                                                                    |                                            |         | (5,978            | )      
|                                                                      | Paid in capital                                                                                                                                                                             |                                            |         | 101,240           |        
|                                                                      | Retained earnings                                                                                                                                                                           |                                            |         | 9,602             |        
|                                                                      | Accumulated other comprehensive income                                                                                                                                                      |                                            |         | 1,846             |        
|                                                                      |                                                                                                                                                                                             |                                            |         |                   |        
|                                                                      |                                                                                                                                                                                             | Total Stockholders' Equity                 |         |                   | 106,823
|                                                                      |                                                                                                                                                                                             |                                            |         |                   |        
|                                                                      |                                                                                                                                                                                             | Total Liabilities and Stockholders' Equity |         | $                 | 298,119
|                                                                      |                                                                                                                                                                                             |                                            |         |                   |        

See
accompanying notes to consolidated financial statements.

48

Table of Contents

---





FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF OPERATIONS        (Dollars in thousands, except per share data)

|                                                                              |                                                                             | Year ended December 31, |       
|----------------------------------------------------------------------------- | --------------------------------------------------------------------------- | ----------------------- | ------
|
|Revenues:                                                                     |                                                                             |                         |       
|                                                                              | Servicing fees ($9,679, $12,635, and $11,463 from affiliates, respectively) |                         | $     
|                                                                              | Income from Portfolio Assets                                                |                         |       
|                                                                              | Gain on sale of SBA loans held for sale, net                                |                         |       
|                                                                              | Interest income from SBA loans                                              |                         |       
|                                                                              | Interest income from affiliates                                             |                         |       
|                                                                              | Interest income from loans receivableother                                 |                         |       
|                                                                              | Other income                                                                |                         |       
|                                                                              |                                                                             |                         |       
|                                                                              |                                                                             | Total revenues          |       
|                                                                              |                                                                             |                         |       
|Expenses:                                                                     |                                                                             |                         |       
|                                                                              | Interest and fees on notes payableother                                    |                         |       
|                                                                              | Interest and fees on notes payable to affiliates                            |                         |       
|                                                                              | Salaries and benefits                                                       |                         |       
|                                                                              | Provision for loan and impairment losses                                    |                         |       
|                                                                              | Occupancy, data processing, property protection and other                   |                         |       
|                                                                              |                                                                             |                         |       
|                                                                              |                                                                             | Total expenses          |       
|                                                                              |                                                                             |                         |       
|Equity in earnings of investments                                             |                                                                             |                         | 10,944
|Gain on sale of subsidiaries and interest in equity investments               |                                                                             |                         | 207   
|                                                                              |                                                                             |                         |       
|Earnings from continuing operations before income taxes and minority interest |                                                                             |                         | 2,965 
|                                                                              |                                                                             | Income tax expense      |       
|                                                                              |                                                                             | Minority interest       |       
|                                                                              |                                                                             |                         |       
|Earnings from continuing operations                                           |                                                                             |                         | 2,185 
|Discontinued operations                                                       |                                                                             |                         |       
|                                                                              | Loss from discontinued operations                                           |                         |       
|                                                                              | Income tax benefit                                                          |                         |       
|                                                                              |                                                                             |                         |       
|                                                                              | Net earnings (loss) from discontinued operations                            |                         |       
|                                                                              |                                                                             |                         |       
|Net earnings                                                                  |                                                                             | $                       | 2,185 
|                                                                              |                                                                             |                         |       
|Basic earnings per common share are as follows:                               |                                                                             |                         |       
|                                                                              | Earnings from continuing operations                                         |                         | $     
|                                                                              | Discontinued operations                                                     |                         | $     
|                                                                              | Net earnings to common stockholders                                         |                         | $     
|                                                                              | Weighted average common shares outstanding                                  |                         |       
|Diluted earnings per common share are as follows:                             |                                                                             |                         |       
|                                                                              | Earnings from continuing operations                                         |                         | $     
|                                                                              | Discontinued operations                                                     |                         | $     
|                                                                              | Net earnings to common stockholders                                         |                         | $     
|                                                                              | Weighted average common shares outstanding                                  |                         |       

See
accompanying notes to consolidated financial statements.

49

Table of Contents

---





FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY        AND COMPREHENSIVE INCOME        (Dollars in thousands)

|                                                                                        |                         | Common Stock |   | Treasury Stock |     |   |         | Retained
Earnings
(Accumulated
Deficit) |   | Accumulated
Other
Comprehensive
Income |   |   |        
|--------------------------------------------------------------------------------------- | ----------------------- | ------------ | - | -------------- | --- | - | ------- | --------------------------------------- | - | -------------------------------------- | - | - | -------
|
|
|Balances, December 31, 2004                                                             |                         | 11,260,687   |   | $              | 113 |   |        |                                         | $ |                                       |   | $ | 99,364 
|Exercise of common stock options                                                        |                         | 46,500       |   |                |    |   |        |                                         |   |                                       |   |   | 196    
|Additional paid in capital arising from sale of shares by investee                      |                         |             |   |                |    |   |        |                                         |   |                                       |   |   | 283    
|Comprehensive income:                                                                   |                         |              |   |                |     |   |         |                                         |   |                                        |   |   |        
|                                                                                        | Net earnings for 2005   |              |  |                |     |  |         |                                        |   |                                        |  |   |        
|                                                                                        | Translation adjustments |              |  |                |     |  |         |                                        |   |                                        |  |   |        
|                                                                                        |                         |              |   |                |     |   |         |                                         |   |                                        |   |   |        
|Total comprehensive income                                                              |                         |              |   |                |     |   |         |                                         |   |                                        |   |   |        
|                                                                                        |                         |              |   |                |     |   |         |                                         |   |                                        |   |   |        
|Balances, December 31, 2005                                                             |                         | 11,307,187   |   |                | 113 |   |        |                                         |   |                                       |   |   | 99,843 
|Cumulative effect of adjustments resulting from the adoption of SAB No. 108 (Note 1(r)) |                         |             |   |                |    |   |        |                                         |   |                                       |   |   |       
|Exercise of common stock options                                                        |                         | 9,750        |   |                |    |   |        |                                         |   |                                       |   |   | 68     
|Repurchase of common stock                                                              |                         |             |   |                |    |   | 530,300 |                                         |   | (5,571                                 | ) |   |       
|Additional paid in capital arising from stock option compensation expense               |                         |             |   |                |    |   |        |                                         |   |                                       |   |   | 651    
|Comprehensive income:                                                                   |                         |              |   |                |     |   |         |                                         |   |                                        |   |   |        
|                                                                                        | Net earnings for 2006   |              |  |                |     |  |         |                                        |   |                                        |  |   |        
|                                                                                        | Translation adjustments |              |  |                |     |  |         |                                        |   |                                        |  |   |        
|                                                                                        |                         |              |   |                |     |   |         |                                         |   |                                        |   |   |        
|Total comprehensive income                                                              |                         |              |   |                |     |   |         |                                         |   |                                        |   |   |        
|                                                                                        |                         |              |   |                |     |   |         |                                         |   |                                        |   |   |        
|Balances, December 31, 2006                                                             |                         | 11,316,937   |   | $              | 113 |   | 530,300 |                                         | $ | (5,571                                 | ) | $ | 100,562
|Exercise of common stock options                                                        |                         | 10,000       |   |                |    |   |        |                                         |   |                                       |   |   | 35     
|Repurchase of common stock                                                              |                         |             |   |                |    |   | 50,200  |                                         |   | (407                                   | ) |   |       
|Additional paid in capital arising from stock option compensation expense               |                         |             |   |                |    |   |        |                                         |   |                                       |   |   | 643    
|Comprehensive income:                                                                   |                         |              |   |                |     |   |         |                                         |   |                                        |   |   |        
|                                                                                        | Net earnings for 2007   |              |  |                |     |  |         |                                        |   |                                        |  |   |        
|                                                                                        | Translation adjustments |              |  |                |     |  |         |                                        |   |                                        |  |   |        
|                                                                                        |                         |              |   |                |     |   |         |                                         |   |                                        |   |   |        
|Total comprehensive income                                                              |                         |              |   |                |     |   |         |                                         |   |                                        |   |   |        
|                                                                                        |                         |              |   |                |     |   |         |                                         |   |                                        |   |   |        
|Balances, December 31, 2007                                                             |                         | 11,326,937   |   | $              | 113 |   | 580,500 |                                         | $ | (5,978                                 | ) | $ | 101,240
|                                                                                        |                         |              |   |                |     |   |         |                                         |   |                                        |   |   |        

See accompanying notes to consolidated financial statements.

50

Table of Contents

---





FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF CASH FLOWS        (Dollars in thousands)

|                                                              |                                                                                 | Year Ended December 31,                                                 |                                                    
|------------------------------------------------------------- | ------------------------------------------------------------------------------- | ----------------------------------------------------------------------- | ---------------------------------------------------
|
|Cash flows from operating activities (Revisedsee note 1(s)): |                                                                                 |                                                                         |                                                    
|                                                              | Net earnings                                                                    |                                                                         | $                                                  
|                                                              | Adjustments to reconcile net earnings to net cash used in operating activities: |                                                                         |                                                    
|                                                              |                                                                                 | Net (earnings) loss from discontinued operations                        |                                                    
|                                                              |                                                                                 | Purchase of SBA loans held for sale                                     |                                                    
|                                                              |                                                                                 | Net principal advances on SBA loans held for sale                       |                                                    
|                                                              |                                                                                 | Proceeds from the sale of SBA loans held for sale, net                  |                                                    
|                                                              |                                                                                 | Purchases of Portfolio Assets                                           |                                                    
|                                                              |                                                                                 | Proceeds applied to principal on Portfolio Assets                       |                                                    
|                                                              |                                                                                 | Income from Portfolio Assets                                            |                                                    
|                                                              |                                                                                 | Capitalized interest and costs on Portfolio Assets and loans receivable |                                                    
|                                                              |                                                                                 | Provision for loan and impairment losses                                |                                                    
|                                                              |                                                                                 | Equity in earnings of investments                                       |                                                    
|                                                              |                                                                                 | Gain on sale of SBA loans held for sale, net                            |                                                    
|                                                              |                                                                                 | Gain on sale of subsidiaries and equity investments                     |                                                    
|                                                              |                                                                                 | Depreciation and amortization                                           |                                                    
|                                                              |                                                                                 | Net premium amortization of loans receivable                            |                                                    
|                                                              |                                                                                 | Stock-based compensation expense related to stock options               |                                                    
|                                                              |                                                                                 | Decrease in service fees receivable                                     |                                                    
|                                                              |                                                                                 | Decrease (increase) in other assets                                     |                                                    
|                                                              |                                                                                 | Change in imputed value of debt                                         |                                                    
|                                                              |                                                                                 | Increase (decrease) in other liabilities                                |                                                    
|                                                              |                                                                                 |                                                                         |                                                    
|                                                              |                                                                                 |                                                                         | Net cash used in operating activities              
|                                                              |                                                                                 |                                                                         |                                                    
|Cash flows from investing activities (Revisedsee Note 1(s)): |                                                                                 |                                                                         |                                                    
|                                                              |                                                                                 | Purchases of property and equipment, net                                |                                                    
|                                                              |                                                                                 | Proceeds from sale of subsidiaries and equity investments               |                                                    
|                                                              |                                                                                 | Cash paid for business combination, net of cash acquired                |                                                    
|                                                              |                                                                                 | Net principal collections (advances) on loans receivable                |                                                    
|                                                              |                                                                                 | Purchases of SBA loans held for investment                              |                                                    
|                                                              |                                                                                 | Net principal collections on SBA loans held for investment              |                                                    
|                                                              |                                                                                 | Contributions to Acquisition Partnerships and Servicing Entities        |                                                    
|                                                              |                                                                                 | Distributions from Acquisition Partnerships and Servicing Entities      |                                                    
|                                                              |                                                                                 |                                                                         |                                                    
|                                                              |                                                                                 |                                                                         | Net cash provided by (used in) investing activities
|                                                              |                                                                                 |                                                                         |                                                    
|Cash flows from financing activities (Revisedsee Note 1(s)): |                                                                                 |                                                                         |                                                    
|                                                              |                                                                                 | Borrowings under notes payableother, net                               |                                                    
|                                                              |                                                                                 | Principal payments of notes payable to affiliates                       |                                                    
|                                                              |                                                                                 | Principal payments of notes payableother, net                          |                                                    
|                                                              |                                                                                 | Payments of debt issuance costs and loan fees                           |                                                    
|                                                              |                                                                                 | Repurchase of common stock                                              |                                                    
|                                                              |                                                                                 | Proceeds from issuance of common stock                                  |                                                    
|                                                              |                                                                                 |                                                                         |                                                    
|                                                              |                                                                                 |                                                                         | Net cash provided by (used in) financing activities
|                                                              |                                                                                 |                                                                         |                                                    
|                                                              |                                                                                 |                                                                         | Net cash provided by continuing operations         
|Cash flows from discontinued operations:                      |                                                                                 |                                                                         |                                                    
|                                                              |                                                                                 |                                                                         | Net cash used in operating activities              
|                                                              |                                                                                 |                                                                         | Net cash provided by investing activities          
|                                                              |                                                                                 |                                                                         |                                                    
|                                                              |                                                                                 |                                                                         | Net cash used in discontinued operations           
|                                                              |                                                                                 |                                                                         |                                                    
|Net increase in cash and cash equivalents                     |                                                                                 |                                                                         | 5,074                                              
|Cash and cash equivalents, beginning of period                |                                                                                 |                                                                         | 18,472                                             
|                                                              |                                                                                 |                                                                         |                                                    
|Cash and cash equivalents, end of period                      |                                                                                 | $                                                                       | 23,546                                             
|                                                              |                                                                                 |                                                                         |                                                    
|Supplemental disclosure of cash flow information:             |                                                                                 |                                                                         |                                                    
|                                                              | Cash paid during the period for:                                                |                                                                         |                                                    
|                                                              |                                                                                 | Interest                                                                |                                                    
|                                                              |                                                                                 | Income taxes, net of refunds received                                   |                                                    

See accompanying notes to consolidated financial statements.

51

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies



FirstCity Financial Corporation (the "Company" or "FirstCity") is a financial services company with offices throughout the United States and Mexico, and a
presence in France, Germany, Brazil, Argentina and Chile. FirstCity was formed on July 3, 1995 by the merger of J-Hawk Corporation and First City Bancorporation of
Texas, Inc. (the "Merger").

At
December 31, 2007, the Company was engaged in one principal reportable segmentPortfolio Asset acquisition and resolution. In the Portfolio Asset acquisition and
resolution business, the Company acquires and resolves portfolios of performing and nonperforming commercial and consumer loans and other assets (collectively, "Portfolio Assets" or "Portfolios"),
which are generally acquired at a discount to their legal principal balance or appraised value. Purchases may be in the form of pools of assets or single assets. The Portfolio Assets are generally
aggregated, including loans of varying qualities that are secured or unsecured by diverse collateral types and foreclosed properties. Some Portfolio Assets are loans for which resolution is tied
primarily to the real estate securing the loan, while others may be collateralized business loans, the resolution of which may be based either on real estate, business assets or other collateral cash
flow. Portfolio Assets are acquired on behalf of the Company or its wholly owned subsidiaries, and on behalf of legally independent domestic and foreign partnerships and other entities ("Acquisition
Partnerships" or "WAMCO Partnerships") in which a partially-owned affiliate of the Company is the general partner and the Company and other investors (including but not limited to Cargill) are limited
partners.

The
Company services, manages and ultimately resolves or otherwise disposes of substantially all of the assets it, its Acquisition Partnerships, or other related entities acquire. The
Company services such assets until they are collected or sold and normally does not manage assets for non-affiliated third parties.



The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Material estimates that are particularly susceptible to significant change in the near-term relate to the estimation of future collections on purchased
Portfolio Assets used in the calculation of income from Portfolio Assets; interest rate environments; valuation of the deferred tax asset; prepayment speeds and valuation of servicing assets; and
valuation of loans receivable (including loans receivable held in securitization trusts). Actual results could differ materially from those estimates.



The accompanying consolidated financial statements include the accounts of FirstCity and all of its majority owned subsidiaries (collectively, the "Company"). In
accordance with Financial Accounting Standards Board ("FASB") Interpretation No. 46(R),Consolidation of Variable Interest Entities("FIN 46R"), the Company also consolidates any variable interest entities ("VIE") of which it is the

52

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies (Continued)

primary
beneficiary, as defined. Furthermore, the Company consolidates entities not deemed to be VIEs in which it holds, directly or indirectly, more than 50% of the voting interests or where it
exercises control in accordance with ARB No. 51,Consolidated Financial Statements. All significant intercompany transactions and balances have
been eliminated in consolidation. Investments in 20% to 50% owned affiliates are accounted for on the equity method of accounting since the Company has the ability to exercise significant influence
over the operating and financial policies of those affiliates. The following is a listing of the 20% to 50% owned affiliates accounted for on the equity method of accounting and held at
December 31, 2007:

Affiliate

Percentage
OwnershipCRY Limited

20.00
%CTY Limited

20.00
%UHR Limited

20.00
%WOX Limited

20.00
%FG Portfolio Limited

22.50
%SAI Societe Auxiliaire Immobiliere

22.50
%WOD Limited

22.50
%WOL Limited

22.50
%BIDMEX 6, LLC

22.56
%NEVVS Limited

25.00
%HMCS-GEN Limited

30.00
%HMCS-SIG Limited

30.00
%CVI GVF (Lux) Securitisation S.a.r.l. acting in the name and on behalf of its Compartment, "Sprockhövel"

30.00
%CVI GVF (Lux) Securitisation S.a.r.l. acting in the name and on behalf of its Compartment, "Marktheidenfeld"

30.00
%CVI GVF (Lux) Securitisation S.a.r.l. acting in the name and on behalf of its Compartment, "Voreifel"

32.00
%HMCS-ECK Limited

32.00
%EHCTY Limited

33.00
%MinnTex Investment Partners LP

33.00
%Santiago Asset Acquisition Company One, SA

33.00
%Brazos River Partnership One, LP

33.33
%P.R.L. Developpement, SAS

45.75
%First B Realty, LP

49.00
%WAMCO XX, Ltd

49.00
%WAMCO XXIV, Ltd

49.00
%WAMCO 30, Ltd

49.47
%FirstVal 1, Ltd

49.50
%WAMCO 32, Ltd

49.50
%FCS Creamer, Ltd

49.75
%FCS Wildhorse, Ltd

49.75
%


53

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies (Continued)

FCS Wood, Ltd

49.75
%Servicios Integrales de Cobranza SA

50.00
%Calibat Fund, LLC

50.00
%FCS Creamer GP Corp

50.00
%FCS Wildhorse GP Corp

50.00
%FCS Wood GP Corp

50.00
%FirstVal 1 GP Corp

50.00
%Inversiones Crediticias SA

50.00
%MinnTex GP Corp

50.00
%WAMCO XX of Texas, Inc

50.00
%WAMCO XXIV of Texas, Inc

50.00
%WAMCO XXVII of Texas, Inc

50.00
%WAMCO 30 of Texas, Inc

50.00
%WAMCO 32 of Texas, Inc

50.00
%


Investments
in less than 20% owned affiliates are also accounted for on the equity method of accounting. FirstCity has the ability to exercise significant influence over operating and
financial policies of these entities, despite its comparatively smaller ownership percentage, due primarily to its active participation in the policy-making process as well as its involvement in the
day-to-day management activities. These partnerships are formed to share
in the risks and rewards in developing new markets as well as to pool resources. Following is a listing of the less than 20 percent owned affiliates accounted for on the equity method of
accounting and held at December 31, 2007:

Affiliate

Percentage
OwnershipTB 1 Private Financial Trust

2.09
%WAMCO XXVII, Ltd

4.07
%BMX Holding II, LLC

8.00
%Renova Financial Trust

10.00
%TR I Private Financial Trust

10.00
%WHBE Limited

10.00
%El Consorcio Recovery FirstCity BNV, SA

11.09
%MCS et Associes, SA

11.89
%Bidmex Holding, LLC

15.00
%HMCS Investment GmbH

16.30
%ResMex, LLC

19.45
%


Equity
earnings in the foreign investments, with the exception of P.R.L. Developpement, SAS, and MCS et Associes, SA, are recorded on a one-month lag due to the timing
of FirstCity's receipt of those financial statements.

54

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies (Continued)

The
Company has loans receivable from certain Acquisition Partnerships (see Note 1(f)). In situations where the Company is not required to advance additional funds to the
Acquisition Partnership and previous losses have reduced the equity investment to zero, the Company continues to report its share of equity method losses in its consolidated statements of operations
to the extent of and as an adjustment to the adjusted basis of the related loan receivable in compliance with EITF 98-13,Accounting by an Equity Method
Investor for Investee Losses When the Investor Has Loans to and Investments in Other Securities of the Investee("EITF 98-13") (See Note 5).



For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or
less to be cash equivalents. The Company has maintained balances in various operating and money market accounts in excess of federally insured limits.



FirstCity primarily acquires loans in groups or portfolios that have experienced deterioration of credit quality between origination and the Company's acquisition
of the loans. The amount paid for a loan reflects FirstCity's determination that it is probable the Company will be unable to collect all amounts due according to the loan's contractual terms.

On
January 1, 2005, FirstCity adopted the provisions of AICPA Statement of Position 03-3,Accounting for Certain Loans or Debt Securities
Acquired in a Transfer("SOP 03-3"). SOP 03-3 addresses accounting differences between contractual cash flows and cash flows expected to
be collected from an investor's initial investment in loans acquired in a transfer if those difference are attributable, at least in part, to credit quality. SOP 03-3 requires
impaired loans be recorded at fair value and prohibits "carrying over" or the creation of valuation allowances in the initial accounting of loans acquired in a transfer that are within the scope of
SOP 03-3. Under SOP 03-3, the excess cash flows expected at purchase over the purchase price is recorded as interest income over the life of the loan.

For
loan Portfolios acquired prior to January 1, 2005, FirstCity designated such loans as non-performing Portfolio Assets or performing Portfolio Assets. Such
designation was made at the acquisition of the pool and does not change even though the actual performance of the loans may change. FirstCity accounts for all non-performing loans acquired
after 2004 in
accordance with SOP 03-3. The following is a description of each classification and the related accounting policy accorded to each Portfolio type:



Non-performing Portfolio Assets consist primarily of distressed loans and loan related assets, such as foreclosed upon collateral. Prior to
January 1, 2005, Portfolio Assets were designated as non-performing if a majority of all of the loans in the Portfolio were significantly under performing in

55

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies (Continued)

accordance
with the contractual terms of the underlying loan agreements at the date of acquisition. Net gain on resolution of non-performing Portfolio Assets is recognized as income to the
extent that proceeds collected exceed a pro rata portion of allocated cost from the pool. Cost allocation is based on a proration of actual proceeds divided by total estimated proceeds of the pool. No
interest income is recognized separately on non-performing Portfolio Assets. All proceeds, of whatever type, are included in income from Portfolio Assets in determining the gain on
resolution of such assets. Accounting for non-performing Portfolios is on a pool basis as opposed to an individual asset-by-asset basis.



Performing Portfolio Assets consist primarily of Portfolios of consumer and commercial loans acquired at a discount from the aggregate amount of the borrowers'
obligation. Prior to January 1, 2005, performing Portfolio Assets were accounted for using the interest methodacquisition discounts for the Portfolio as a whole are accreted as an
adjustment to yield over the estimated life of the Portfolio. Performing Portfolio Assets are carried at the unpaid principal balance of the underlying loans, net of acquisition discounts and
allowance for loan losses. Significant increases in expected future cash flows may be recognized prospectively through an upward adjustment of the internal rate of return ("IRR") over a portfolio's
remaining life. Any increase to the IRR then becomes the new benchmark for impairment testing. Income on performing Portfolio Assets is accrued monthly based on each loan
pool's effective IRR. Cash flows greater than the interest accrual will reduce the carrying value of the pool. Likewise, cash flows that are less than the accrual will increase the carrying balance.
The IRR is estimated and periodically recalculated based on the timing and amount of anticipated cash flows using the Company's proprietary collection model. Gains are recognized on the performing
Portfolio Assets when sufficient funds are received to fully satisfy the obligation on loans included in the pool, either from funds from the borrower or sale of the loan. The gain recognized
represents the difference between the proceeds received and the allocated carrying value of the individual loan in the pool.



Management's best estimate of IRR as of January 1, 2005, is the basis for subsequent impairment testing. If it is probable that all cash flows estimated at
acquisition plus any changes to expected cash flows arising from changes in estimates after acquisition would not be collected, the carrying value of a pool would be written down to maintain the
then-current IRR. Prior to January 1, 2005, impairment charges would be taken to operations with a corresponding write-off of the receivable balance. Consequently, no
allowance for loan loss was recorded prior to January 1, 2005.

A
pool can become fully amortized (zero carrying balance on the balance sheet) while still generating cash collections. In this case, all cash collections are recognized as revenue when
received. Additionally, the Company uses the cost recovery method when timing and amount of collections on a particular pool of accounts cannot be reasonably predicted. Under the cost recovery method,
no revenue is recognized until the Company has fully collected the cost of the portfolio, or until such time that the Company considers the collections to be probable and estimable and begins to
recognize income based on the interest method as described above.

56

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies (Continued)



FirstCity considers expected prepayments, and estimates the amount and timing of undiscounted expected principal, interest, and other cash flows (expected at
acquisition) for each loan and each subsequently aggregated pool of loans. FirstCity determines the excess of the loan's or pool's scheduled contractual principal and contractual interest payments
over all cash flows expected at acquisition as an amount that should not be accreted ("nonaccretable difference"). The excess of the loan's cash flows expected to be collected at acquisition over the
initial investment in the loan or pool is accreted into interest income over the remaining life of the loan or pool ("accretable yield").

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

FirstCity
establishes valuation allowances for loans acquired with credit deterioration to reflect only those losses incurred after acquisitionthat is, the present value of
cash flows expected at acquisition that are not expected to be collected.



Loans acquired without evidence of credit deterioration at acquisition for which FirstCity has the positive intent and ability to hold for the foreseeable future
are classified as held for investment and reported at their unpaid principal balance net of unamortized purchase discounts or premiums.

Interest
accrual ceases when payments become 90 days contractually past due. An allowance for loan losses is established when a loan becomes impaired through provisions charged to
operations. A loan is impaired when full payment under the loan terms is not expected. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the
portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the
entire allowance is available for any loan that, in management's judgment, should be charged-off. Loan losses are charged against the allowance when management believes that the
uncollectibility of a loan balance is confirmed.



Real estate Portfolios consist of real estate acquired from a variety of sellers. Such Portfolios are carried at the lower of cost or fair value less estimated
costs to sell. Costs relating to the development

57

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies (Continued)

and
improvement of real estate for its intended use are capitalized, whereas those relating to holding assets are charged to expense. Income or loss is recognized upon the disposal of the real estate.
Rental income, net of expenses, on real estate Portfolios is recognized when received. Accounting for the Portfolios is on an individual asset-by-asset basis as opposed to a
pool basis. Subsequent to acquisition, the amortized cost of a real estate Portfolio is evaluated for impairment on a quarterly basis. The evaluation of impairment is determined based on the review of
the estimated future cash receipts, which represents the net realizable value of the real estate Portfolio. Impairment losses are charged to operations in the period the impairment is identified.



Loans receivable consist of loans made to affiliated entities (including Acquisition Partnerships) and non-affiliated entities, and purchased and
originated U.S. Small Business Administration ("SBA") loans. The repayment of the loans is generally dependent upon future cash flows of the borrowers, future cash flows of the underlying collateral,
and distributions made from affiliated entities. Interest is accrued when earned in accordance with the contractual terms of the loans. Loan origination fees and costs as well as premiums and
discounts are amortized as level-yield adjustments over the respective loan terms. Unamortized net fees or costs are recognized upon early repayment of the loans.

The
Company evaluates all loans receivable for impairment on regular basis by reviewing the collectibility of the loans in light of various factors, as applicable, such as estimated
future cash receipts of the borrower or underlying collateral, historical experience, estimated value of underlying collateral, prevailing economic conditions, and industry concentrations. This
evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. A loan is considered impaired if it is probable that
the Company will not ultimately collect all principal or interest amounts contractually due. Loans that experience insignificant payment shortfalls generally are not classified as impaired. When a
loan is determined to be impaired, unpaid interest is reversed against interest income and the Company ceases to accrue interest on the note. When ultimate collectibility of the impaired note is in
doubt, all cash receipts are generally applied to reduce the principal amount of such notes until the principal has been recovered, and are recognized as interest income thereafter. Impairment losses
are charged against an allowance account through provisions charged to operations in the period impairment is identified. Loans are written-off against the allowance when all possible
means of collection have been exhausted and the potential for recovery is considered remote.



Property and equipment are carried at cost, less accumulated depreciation, and are included in other assets. Depreciation is provided using the
straight-line method over the estimated useful lives of the assets.

58

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies (Continued)



Intangible assets includes (1) the excess of purchase price over fair value of assets acquired in connection with purchase transactions (goodwill);
(2) a franchise granted by the Small Business Administration to originate and service loans as a small business lending company; and (3) the purchase price of future service fee
revenues, all of which are included in other assets. Goodwill and intangible assets with indefinite useful lives are tested for impairment in accordance with the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 142,Goodwill and Other Intangible Assets.



In connection with the Company's SBA lending activities, the Company recognizes servicing assets in a purchase or through the sale of originated or purchased
loans when servicing rights are retained. Servicing assets are initially measured at fair valuepurchased servicing assets are capitalized at the cost to acquire the rights; whereas
servicing rights retained from SBA loan sales are capitalized at the origination cost allocated to the servicing rights based on relative fair value. The Company subsequently measures the servicing
assets by using the amortization method, which amortizes servicing assets in proportion to, and over the period of, estimated net servicing income. The amortization of the servicing assets is analyzed
periodically and is adjusted to reflect changes in prepayment rates and other estimates. See Note 18 for more information on servicing rights related to SBA loans.

The
Company does not recognize capitalized servicing rights related to its Portfolio Assets because servicing is not contractually separated from the underlying assets by sale or
securitization of the assets with servicing retained or separate purchase or assumption of the servicing. The Company services, in all material respects, the Portfolio Assets owned for its own
account, the Portfolio Assets owned by the Acquisition Partnerships and, to a very limited extent, certain Portfolio Assets owned by third parties. In connection with the Acquisition Partnerships in
the United States, the Company generally earns a servicing fee, which is a percentage of gross cash collections generated rather than a management fee based on the Face Value of the asset being
serviced. The rate of servicing fee charged is generally a function of the average Face Value of the assets within each pool being serviced (the larger the average Face Value of the assets in a
Portfolio, the lower the fee percentage within the prescribed range), the type of assets and the level of servicing required on each assets. For the Mexican Acquisition Partnerships, the Company earns
a servicing fee based on costs of servicing plus a profit margin. The Acquisition Partnerships in Europe and South America are serviced by various entities in which the Company maintains an equity
interest. In all cases, service fees are recognized as they are earned in accordance with the servicing agreements.



The Company has certain servicing contracts with its Mexican investment entities whereby the Company is entitled to additional compensation for servicing once a
specified return to the investors has been achieved. The Company recognizes revenue related to these contracts when the investors receive the required level of returns specified in the contracts and
the Mexican investment entity

59

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies (Continued)

receives
cash in an amount greater than the required returns. There is no guarantee that the required level of returns to the investors will be achieved or that any additional compensation to the
Company related to the contracts will be realized. The amount of these fees recognized by the Company was $2.2 million in 2006 which included $1.9 million for incentive service fees from
the sale of certain equity investments in Latin America, and $359 in 2005.

The
Mexican investment entities record an accrued expense for these contingent fees provided that these fees are probable and reasonably estimable.



Statement of Financial Accounting Standards No. 130,Reporting Comprehensive Income("SFAS 130"),
established standards for reporting and displaying comprehensive income (loss) and its components in a financial statement that is displayed with the same prominence as other financial statements.
SFAS 130 also requires the accumulated balance of other comprehensive income (loss) to be displayed separately in the equity section of the consolidated balance sheet. The Company's other
comprehensive income (loss) consists of foreign currency transactions and unrealized gains (losses) on securitization transactions.



The Company has determined that the local currency is the functional currency for its operations outside the United States (primarily Europe and Latin America).
Assets and liabilities denominated in foreign functional currencies are translated at the exchange rate as of the balance sheet date. Translation adjustments are recorded as a separate component of
stockholders' equity in accumulated other comprehensive income (loss). Revenues, costs and expenses denominated in foreign currencies
are translated at the weighted average exchange rate for the period. An analysis of the changes in the cumulative adjustments during 2007, 2006 and 2005 follows (dollars in thousands):

Balance, December 31, 2004

$
3,235Aggregate adjustment for the year resulting from translation adjustments and gains and losses on certain hedge transactions


(2,222
)Balance, December 31, 2005


1,013Aggregate adjustment for the year resulting from translation adjustments and gains and losses on certain hedge transactions


359Balance, December 31, 2006


1,372Aggregate adjustment for the year resulting from translation adjustments and gains and losses on certain hedge transactions


474Balance, December 31, 2007

$
1,846


Increases
or decreases in expected functional currency cash flows upon settlement of a foreign currency transaction are recorded as foreign currency transaction gains or losses and
included in the results of operations in the period in which the transaction is settled. Aggregate foreign currency

60

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies (Continued)

transaction
gains included in the consolidated statements of operations for 2007, 2006 and 2005 were $984, $935 and $848, respectively.

The
net foreign currency translation gain (loss) included in accumulated other comprehensive income relating to the Euro-denominated debt was ($2,365) for 2007, ($2,509) for
2006 and $1,348 for 2005.



The Company files a consolidated federal income tax return with its 80% or greater owned subsidiaries. The Company records all of the allocated federal
income tax provision of the consolidated group in the parent corporation.

Deferred
tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts and the tax basis of existing
assets and liabilities and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The effects of future changes in tax laws or changes in tax rates are not anticipated. The measurement of deferred tax
assets, if any, is reduced by the amount of any tax benefits that, based on available evidence, are not expected to be realized.

Beginning
with the adoption of FASB Interpretation No. 48,Accounting for Uncertainty in Income TaxesAn Interpretation of FASB Statement
No. 109("FIN 48") as of January 1, 2007, the Company recognizes the effect of income tax positions only if those positions are more likely than not of
being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period
in which the change in judgment occurs. Prior to the adoption of FIN 48, the Company generally recognized the effect of income tax positions only if such positions were probably of being
sustained.



Basic net earnings per common share calculations are based upon the weighted average number of common shares outstanding. Potentially dilutive common share
equivalents include warrants and employee stock options in the diluted loss per common share calculations.

61

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies (Continued)

Basic
and diluted earnings from continuing operations per share were determined as follows:

Year ended December 31,2007

2006

2005Earnings from continuing operations

$
2,185

$
9,877

$
8,078Weighted average outstanding shares of common stock (in thousands)


10,786


11,125


11,285Dilutive effect of:Warrants


322


335


342Employee stock options


284


299


385Weighted average outstanding shares of common stock and common stock equivalents


11,392


11,759


12,012Earnings from continuing operations per share:Basic

$
0.20

$
0.89

$
0.72Diluted

$
0.19

$
0.84

$
0.68




The Company assesses the impairment of long-lived assets and certain identifiable intangibles whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of
the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured
by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to
sell.



FirstCity adopted Statement of Financial Accounting Standards No. 123 (revised 2004),Share-Based Payment("SFAS 123R"), using the modified prospective transition method beginning January 1, 2006. Accordingly, during 2006, the Company recorded stock-based compensation expense for awards
granted prior to, but not yet vested as of January 1, 2006, as if the fair value method required for pro forma disclosure under SFAS 123,Accounting for
Stock-Based Compensation, were in effect for expense recognition purposes, adjusted for estimated forfeitures. For these awards, the Company recognized compensation expense
using the straight-line amortization method. For stock-based awards granted after January 1, 2006, the Company uses the Black-Scholes valuation model to recognize compensation
expense based on the estimated grant date fair value method using a straight-line amortization method. As SFAS 123R requires that stock-based compensation expense be based on awards
that are ultimately expected to vest, stock-based compensation for 2007 has been reduced for estimated forfeitures. When estimating forfeitures, FirstCity considers voluntary termination behaviors as
well as trends of actual option forfeitures.

62

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies (Continued)



In December 2007, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141R, Business
Combinations("SFAS 141R") and SFAS No. 160,Noncontrolling Interests in Consolidated Financial
Statementsan amendment to ARB No. 51("SFAS 160"). SFAS 141R and 160 require most identifiable assets, liabilities,
non-controlling interests, and goodwill acquired in a business combination to be recorded at "full fair value" and require non-controlling interests (previously referred to as
"minority interests") to be reported as a component of equity, which changes the accounting for transactions with non-controlling interest holders. Both SFAS 141R and 160 are
effective for periods beginning on or after December 15, 2008, and earlier adoption is prohibited. SFAS 141R will be applied to business combinations occurring after the effective date.
SFAS 160 will be applied prospectively to all non-controlling interests, including any that arose before the effective date. The Company is currently evaluating the impact of
adopting SFAS 141R and 160 on its financial condition and results of operations.

In
February 2007, the FASB issued SFAS No.159,The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement
No. 115("SFAS 159"). SFAS 159 permits entities to choose to measure eligible items at fair value at specified election dates. Unrealized gains and losses
on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date. The fair value option (i) may be applied instrument by instrument, with
certain exceptions, (ii) is irrevocable (unless a new election date occurs) and (iii) is applied only to entire instruments and not to portions of instruments. SFAS 159 is
effective for the Company's 2008 fiscal year. The Company is currently evaluating the impact the adoption of SFAS 159 could have on its financial condition, results of operations and cash
flows.

In
September 2006, the FASB issued SFAS No. 157,Fair Value Measurements("SFAS 157"). SFAS No. 157 establishes a
framework for measuring fair value and expands disclosures about fair value measurements. The changes to current practice resulting from the application of SFAS 157 relate to the definition of
fair value, the methods used to measure fair value, and enhances disclosures about fair
value measurements. SFAS 157 does not require any new fair value measures. SFAS 157 is effective for the Company on January 1, 2008. SFAS 157 is required to be applied
prospectively, except for certain financial instruments. Any transition adjustment will be recognized as an adjustment to opening retained earnings in the year of adoption. In February 2008, the FASB
decided to defer SFAS 157's fair-value measurement requirements for nonfinancial assets and liabilities that are not required or permitted to be measured at fair value on a
recurring basis. The Company is currently evaluating the impact the adoption of SFAS 157 will have on its financial condition and results of operations.



Effective January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement No. 109("FIN 48"). FIN 48 clarifies the
financial statement recognition and disclosure requirements for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement of Financial Accounting
Standards ("SFAS") No. 109,Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold and measurement

63

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies (Continued)

attribute
for the financial statement recognition and derecognition of tax positions taken or expected to be taken in a tax return. Furthermore, FIN 48 provides related guidance on measurement,
classification, interest and penalties, and disclosure. See Note 11 for the impact of adopting FIN 48 on the Company's results of operations and financial position.

Effective
January 1, 2007, the Company adopted SFAS No. 156,Accounting for Servicing of Financial Assetsan amendment of FASB Statement
No. 140("SFAS 156"). SFAS 156 requires an entity to recognize a servicing asset or liability each time it undertakes an obligation to service a financial
asset by entering into a servicing contract in specified situations. Such servicing assets or liabilities would be initially measured at fair value, if practicable, and subsequently measured at
amortized value or fair value based upon an election of the reporting entity. SFAS 156 also specifies certain financial statement presentations and disclosures in connection with servicing
assets and liabilities. The Company elected to measure the servicing assets, subsequent to the date of sale, by using the amortization method which amortizes servicing assets in proportion to and over
the period of estimated net servicing income and assesses servicing assets for impairment based on fair value at each reporting date. The adoption of SFAS 156 by the Company on
January 1, 2007 did not have a significant impact on the Company's consolidated financial position or earnings.

On
December 31, 2006, the Company adopted SEC Staff Accounting Bulletin Topic 1N, Financial StatementsConsidering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial Statements("SAB 108"). SAB 108 provides guidance on how prior year misstatements should be
evaluated when determining the materiality of misstatements in the
current year financial statements and it also addresses how to correct material misstatements. The Company's adoption of SAB 108 resulted in an adjustment to opening retained earnings for the
year ended December 31, 2006 by approximately $327 thousand, all of which relates to the Company's investments in certain Acquisition Partnerships accounted for under the equity method
of accounting. Approximately $152 thousand reflects a correction to write-off cumulative translation adjustments related to certain foreign investments during the periods 2002
through 2005, and approximately $106 thousand reflects a correction in a Partnership's accounting for property taxes in 2005. The remaining $69 thousand reflects the Company's 2005
correction of accounting for equity earnings on a pro-rata basis recorded in an acquired investment subsequent to the acquisition date. The Company reviewed the annual amount of reduced
equity earnings incurred in prior periods for these corrections and considered the effects to be immaterial to prior periods both individually and in the aggregate.



Certain amounts in the consolidated financial statements for prior years have been reclassified to conform with the current consolidated financial statement
presentation. In 2006, the Company reclassified gain on resolution of Portfolio Assets and loan interest income as income from Portfolio Assets. These items were reported separately in prior periods.

In
all reporting prior to December 31, 2006, FirstCity reported net principal collections (advances) on loans receivable in cash flows from operating activities on the
Consolidated Statements of Cash Flows. The Company is now reporting these items in cash flows from investing activities. Prior year amounts reported on the Consolidated Statements of Cash Flows have
been adjusted to conform to this

64

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

1. Summary of Significant Accounting Policies (Continued)

treatment
which is required under generally accepted accounting principles. The total amount thus reclassified was $1.7 million for the year ended December 31, 2005. Management believes
that the changes in the Consolidated Statement of Cash Flows for the year ended December 31, 2005 are not significant relative to the financial statements taken as a whole.

In
all reporting prior to December 31, 2007, FirstCity reported payments of debt issuance costs and loan fees in cash flows from operating activities on the Consolidated
Statements of Cash Flows. The Company is now reporting these items in cash flows from financing activities. Prior year amounts reported on the Consolidated Statements of Cash Flows have been adjusted
to conform to this treatment which is required under generally accepted accounting principles. The total amount thus reclassified was $1.3 million for the year ended December 31, 2005
and $1.7 million for the year ended December 31, 2006. Management believes that the changes in the Consolidated Statement of Cash Flows for the years ended December 31, 2005 and
2006 are not significant relative to the financial statements taken as a whole.

These
reclassifications have the following impact on the financial statements:

Year Ended December 31,2006

2005Statement of Cash Flows:Cash flows from operating activities (as reported)

$
(65,030
)
$
(13,892
)Impact of reclassification on net principal collections (advances) on loans receivable





(1,717
)Impact of reclassification on payments of debt issuance costs and loan fees


1,723


1,357Cash flows from operating activities (as corrected)

$
(63,307
)
$
(14,252
)Cash flows from investing activities (as reported)

$
(19,623
)
$
(16,443
)Impact of reclassification on net principal collections (advances) on loans receivable





1,717Cash flows from investing activities (as corrected)

$
(19,623
)
$
(14,726
)Cash flows from financing activities (as reported)

$
90,244

$
40,661Impact of reclassification on payments of debt issuance costs and loan fees


(1,723
)

(1,357
)Cash flows from financing activities (as corrected)

$
88,521

$
39,304


2. Restructure, Liquidity and Capital Resources



Generally, the Company requires liquidity to fund its operations, working capital, payment of debt, equity for acquisition of Portfolio Assets, investments in and
advances to entities formed to acquire

65

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

2. Restructure, Liquidity and Capital Resources (Continued)

Portfolios
("Acquisition Partnerships"), retirement of and dividends on preferred stock, and other investments. The potential sources of liquidity are funds generated from operations, equity
distributions from the Acquisition Partnerships, interest and principal payments on subordinated intercompany debt, dividends from the Company's subsidiaries, borrowings from revolving lines of credit
and other credit facilities, proceeds from equity market transactions, securitization and other structured finance transactions and other special purpose short-term borrowings.

In
December 2002, FirstCity completed a recapitalization in which holders of the New Preferred Stock exchanged 1,092,210 shares of New Preferred Stock, for 2,417,388 shares of Common
Stock and $10.5 million. During 2003, 4,400 shares of New Preferred Stock were redeemed for 8,200 shares of Common Stock, leaving 126,291 shares outstanding at December 31, 2003. On
December 30, 2004, FirstCity redeemed all of the outstanding shares of its New Preferred Stock at a total redemption price of $21.525 per share. The redemption price represented the liquidation
preference of the New Preferred Stock plus the final normal quarterly dividend of $.525 per share. In addition, FirstCity issued 400,000 shares of Common Stock and a note payable, to be periodically
redeemed by the Company for an aggregate of up to $3.2 million out of certain cash collections from servicing income from Portfolios in Mexico, as part of a transaction to acquire the minority
interest in FirstCity Holdings, Inc. from Terry R. DeWitt, G. Stephen Fillip and James C. Holmes, each of whom were Senior Vice Presidents of FirstCity. In 2006, this cash flow note was settled
for $310 as part of a transaction involving American International Group, Inc. ("AIG"), which is more fully discussed below and in Note 6.

As
a part of the recapitalization, BoS(USA), Inc. ("BoS(USA)") provided a non-recourse loan in the amount of $16 million to FirstCity which was used to pay the
cash portion of the exchange offer to the holders of the New Preferred Stock, to pay expenses of the exchange offer and recapitalization, and to reduce FirstCity's debt to the Bank of Scotland. In
connection with the $16 million loan, FirstCity was obligated to pay an arrangement fee to BoS(USA) equal to 20% of all amounts received by FirstCity in excess of $16 million from any
sale or other disposition of FirstCity's 20% interest in Drive and all dividends and other distributions paid by Drive or its general partner on FirstCity's 20% interest in Drive. This arrangement was
settled as part of the Drive Sale discussed below.

On
November 1, 2004, FirstCity completed the sale of the Company's 31% beneficial ownership interest in Drive and its general partner, Drive GP LLC, which resulted
in net proceeds of $86.8 million. A portion of the proceeds were used to pay off debt. As a result of the sale, FirstCity owed the Bank of Scotland an arrangement fee of $8.0 million
relating to the $16.0 million loan to FirstCity discussed above. This fee was paid in January 2005.

During
the period from December 1998 to March 2005, FirstCity Mexico, Inc. and Strategic Mexican Investment Partners, L.P. ("SMIP"), each affiliates of FirstCity and
Cargill Financial Services International, Inc. ("CFSI") and, in some instances, other investors, acquired 12 residential and commercial non-performing loan portfolios from financial
institutions in Mexico (the "Mexican Portfolios"). Each portfolio was acquired by a Mexican limited liability company (each a "Mexican SRL") that was owned by a Delaware limited
liability company formed by each investor group. On August 8, 2006, SMIP and National Union Fire Insurance Company of Pittsburgh, Pa., American General Life Insurance Company and American
General Life and Accident Insurance Company, affiliates of AIG Global Asset Management Holdings Corp. (collectively the "AIG Entities") formed

66

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

2. Restructure, Liquidity and Capital Resources (Continued)

Bidmex
Holding, LLP for the purpose of acquiring the Mexican Portfolios by purchasing the interests of Cargill and SMIP in eleven of the Mexican limited liability companies (the "LLCs") and
purchasing the loan portfolio of one of the Mexican limited liability companies (the "Purchased Portfolio") for an aggregate purchase price of $119.3 million U.S. Dollars as of that date (the
"Aggregate Purchase Price"). SMIP acquired 15% of the membership interests in Bidmex Holding, LLC. A 9% interest acquired by SMIP is of equivalent standing to membership interests held by the
AIG affiliates representing 85% of the membership interests. The remaining 6% membership interest acquired by SMIP is subordinate to the other owners of interests in Bidmex Holding, LLC, who
will receive the return of and a return on their contribution equivalent to an 9% internal rate of return with respect to their interests prior to SMIP receiving the return of and a return on its
capital contribution equivalent to a 9% internal rate of return with respect to its 6% interest.

Also
on August 8, 2006, an Interest Purchase and Sale Agreement was entered into by and among Bidmex Holding, LLC ("Buyer"), as buyer, and SMIP and CFSI (collectively, the
"Sellers"), as seller, and eleven of the LLCs and the AIG entities as additional parties. In the Interest Purchase and Sale Agreement, the Sellers and the LLCs made various
representations and warranties concerning (i) the existence and ownership of the LLCs and the related Mexican SRLs, (ii) the assets and liabilities of the LLCs,
(iii) taxes related to periods prior to August 8, 2006, and (iv) the operations of the LLCs and
SRLs. The Sellers agreed to indemnify the Buyer and AIG Entities from damages resulting from a breach of any representation or warranty contained in the Interest Purchase and Sale Agreement on a
several and not joint basis according to their respective ownership percentages in each LLC as to any matter related to a particular LLC, or on the basis of 80% to CFSI and 20% to SMIP
as to any matter that could not be identified to a particular LLC. The indemnity obligation under the Interest Purchase and Sale Agreement survives for a period of the statute of limitations
for matters related to taxes, existence and authority, capitalization and good standing of the LLCs and SRLs and for a period of two years from August 8, 2006, the closing date with
respect to all other representations and warranties. The Sellers are not required to make any payments as a result of the indemnity provisions of the Interest Purchase and Sale Agreement until the
aggregate amount payable under that agreement and the Asset Purchase Agreement exceeds $250; however, claims related to taxes and fraud are not subject to this $250 threshold. The Interest Purchase
and Sale Agreement limits the liability of the Sellers for indemnifiable losses under the Interest Purchase and Sale Agreement and the Asset Purchase Agreement to the Aggregate Purchase Price (without
duplication of amounts recovered pursuant to the terms of the Asset Purchase Agreement).

Also
on August 8, 2006, Bidmex Holding, LLC entered into an Agreement for the Onerous Transfer of Loans and Litigious Rights (the "Asset Purchase Agreement") between and
among Residencial Oeste, S. de R.L. de C.V., as seller (the "Asset Seller"), an affiliate of CFSI and SMIP, Residencial Oeste 2, S. de R.L. de C.V., as purchaser (the "Asset Purchaser"), and CFSI,
SMIP, and Bidmex Acquisition, LLC, the parent of the Asset Purchaser, as additional parties. The Asset Purchase Agreement provides for the sale of the loan portfolio owned by the Seller to the
Purchaser for a purchase price of $10.1 million U.S. dollars on the closing date, which purchase price is part of the Aggregate Purchase Price. In the Asset Purchase Agreement, the Asset Seller
and the Sellers made various representations and warranties concerning (i) the existence and ownership of the Seller, (ii) the ownership of the loan portfolio, (iii) taxes related
to periods arising prior to the closing date, and

67

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

2. Restructure, Liquidity and Capital Resources (Continued)

(iv) the
existence of the loans comprising the loan portfolio and other matters related to the loan portfolio. The Asset Seller agreed to indemnify the Asset Purchaser from damages resulting
from a breach of any representation or warranty. The indemnity obligation under the Asset Purchase Agreement survives for a period of the statute of limitations for matters related to existence and
ownership of the Seller, ownership of the loans, and taxes for periods prior to August 8, 2006, and for a period of two years from August 8, 2006, with respect to all other
representations and warranties. The Seller is not required to make any payments as a result of the indemnity provisions of the Asset Purchase Agreement until the aggregate amount payable under that
Agreement exceeds $25; however, claims related to taxes and fraud are not subject to this $25 threshold. The Interest Purchase and Sale Agreement limits the liability of the Sellers for indemnifiable
losses under the Asset Purchase Agreement to the Aggregate Purchase Price.

In
connection with the 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,
granted a put option dated August 8, 2006 to Bidmex Holding, LLC, as optionee, pursuant to 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 put option to Bidmex Holding, LLC related to the purchase of any loan of Solución de 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 by those entities has filed or files a challenge in a
legal proceeding related to any such loan based on, in addition to any other defense claims, a claim on
grounds related to the Mexican Supreme Court Ruling that has put into issue the actions required for transfer of loans by Mexican financial institutions after August 2003, provided that any such
challenge is asserted on or before the earlier of (i) the reversal of the Supreme Court Ruling, or (ii) February 1, 2008. The purchase price for any loan under the put option is
to be the allocated purchase price set by the parties for the loan, plus certain expenses related to the transfer and collection of the loan, plus any taxes paid or payable with respect to the cash
flow from each loan, reduced by any cash flow received by Bidmex Holding, LLC with respect to the loan.

Also
in connection with the Interest Purchase and Sale Agreement, FirstCity entered executed a Guaranty dated as of August 8, 2006, in favor of Bidmex Holding, LLC, Asset
Purchaser, and the AIG Entities, pursuant to which FirstCity guaranteed that FirstCity would cause and enable SMIP to perform its obligations under the Interest Purchase and Sale Agreement and Asset
Purchase Agreement, that SMIP would perform and fulfill its obligations under those agreements and also that the payments provided for in those agreements would be promptly paid when due. FirstCity's
obligations under the Guaranty are subject to any beneficiary obtaining judgment against SMIP regarding the performance of any obligation for which such beneficiary is seeking FirstCity's guaranty.



FirstCity has a $225.0 million revolving acquisition facility with Bank of Scotland that matures in November 2010. The revolving loan facility is
used to finance the senior debt and equity portion of portfolio and asset purchases made by FirstCity and to provide for the issuance of letters of credit and working capital loans. The obligations of
FirstCity under this facility are guaranteed by substantially all of the wholly-owned subsidiaries of FirstCity and are secured by security interests in substantially all of

68

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

2. Restructure, Liquidity and Capital Resources (Continued)

the
assets of FirstCity and its wholly-owned subsidiaries. The primary terms and key covenants of the $225.0 million revolving credit facility, as amended, are as follows:



FH
Partners, LLC, an indirect wholly-owned affiliate of FirstCity, has a $100.0 million revolving loan facility with Bank of Scotland that provides financing for Portfolio and
asset purchases by FH Partners, LLC. This revolving loan facility matures in November 2010, and is secured by all assets of FH Partners,
LLC and a guaranty by FirstCity and certain of its wholly-owned subsidiaries. The primary terms and key covenants of the $100.0 million revolving loan facility, as amended, are as follows:



69

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

2. Restructure, Liquidity and Capital Resources (Continued)



Effective
November 2007, FirstCity and BoS (USA), Inc. ("BoS (USA)") entered into a Subordinated Delayed Draw Credit Agreement (the "Subordinated Credit Agreement") which may be
used to finance equity investments in new ventures, equity investments made in connection with portfolio and asset purchases and loans made by FirstCity and its subsidiaries to acquisition entities,
provide for the issuance of letters of credit, and for working capital loans. The obligations of FirstCity under the Subordinated Credit Agreement are guaranteed by substantially all of the
wholly-owned subsidiaries of FirstCity and are secured by security interests in substantially all of the assets of FirstCity and its wholly-owned subsidiaries. The Subordinated Credit Agreement
provides that any failure to make a payment or acceleration of debt under the revolving credit facility entered into between FirstCity and Bank of Scotland on November 12, 2004, is a default
under the Subordinated Credit Agreement and provides for other events of default and other provisions that are customary for a facility of this type. The primary terms and key covenants of this
$25.0 million loan facility are as follows:



70

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

2. Restructure, Liquidity and Capital Resources (Continued)



At
December 31, 2007, the Company had $41.5 million in Euro-denominated debt with Bank of Scotland for the purpose of hedging a portion of the net equity
investments in Europe. In general, the type of risk hedged relates to the foreign currency exposure of net investments in Europe caused by movements in Euro exchange rates. The Company entered into
the hedging relationship such that changes in the net investments being hedged are expected to be offset by corresponding changes in the values of the Euro-denominated debt. Effectiveness
of the hedging relationship is measured and designated at the beginning of each month by comparing the outstanding balance of the Euro-denominated debt to the carrying value of the
designated net equity investments. The net foreign currency translation gain (loss) included in accumulated other comprehensive income relating to the Euro-denominated debt was ($2.4)
million for the year ended December 31, 2007, ($2.5) million for 2006, and $1.3 million for 2005.

In
November 2006, FirstCity Mexico SA de CV, a Mexican affiliate of FirstCity, entered into a revolving line of credit with a maximum loan amount of 148,096,800 Mexican pesos with
Banco Santander, S.A., which was equivalent to $13.5 million U.S. dollars at December 31, 2007. The proceeds were used to pay down the acquisition facility with the Bank of
Scotland. Pursuant to the terms of the credit facility, FirstCity Mexico SA de CV was required to provide a stand-by letter of credit from Bank of Scotland that would satisfy the
loan balance upon demand. At December 31, 2007, FirstCity had a letter of credit in the amount of $14.1 million from Bank of Scotland under the terms of FirstCity's revolving acquisition
facility with Bank of Scotland. In the event that a demand is made under the $14.1 million letter of credit, FirstCity is required to reimburse Bank of Scotland by making payment to Bank of
Scotland for all amounts disbursed or to be disbursed by Bank of Scotland under the letter of credit.

American
Business Lending, Inc. ("ABL"), a subsidiary of FirstCity, has a $40.0 million revolving loan facility with Wells Fargo Foothill, LLC
("WFF"), as most recently amended in July 2007, for the purpose of financing and acquiring SBA loans. The obligations under this facility are secured by substantially all of the assets of ABL. In
connection with this loan facility, FirstCity provided WFF with an unconditional guaranty, up to a maximum of $5 million plus enforcement cost, of the obligations of ABL under the loan facility
that relate to funds in the amount of $31.7 million advanced by WFF to ABL in connection of a portfolio of SBA loans in February 2007. This guaranty remains in effect until the obligations
incurred in connection with the advance related to the acquisition of the portfolio of SBA loans are paid in full. The primary terms and key covenants of the $40.0 million revolving loan
facility, as amended, are as follows:



71

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

2. Restructure, Liquidity and Capital Resources (Continued)



The
security agreement executed by ABL to secure the obligations under its $40.0 million credit facility grants a security interest to WFF in all of the assets of ABL except
(a) the unguaranteed portions of any SBA-guaranteed loan originated by AMRESCO SBA Holdings, Inc. ("ASBA") and transferred to ABL pursuant to the Asset Purchase Agreement
dated as of June 30, 2006, by and among NCS I, LLC and ASBA, as sellers, ABL, as the purchaser, and FirstCity Business Lending Corporation and FirstCity pursuant to which ABL acquired
those SBA loans, and any other assets transferred by ASBA to ABL pursuant to that Asset Purchase Agreement, including, the Small Business Lending Corporation license.

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

Management
believes that the existing loan facilities, the related fees generated from the servicing of assets, equity distributions from existing Acquisition Partnerships and
wholly-owned portfolios, sales

72

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

2. Restructure, Liquidity and Capital Resources (Continued)

of
interests in equity investments, and origination and sales of guaranteed portions of SBA 7(a) loans, will allow the Company to meet its obligations as they come due during the next twelve months.

3. Discontinued Operations

Discontinued operations are comprised of two components previously reported as the Company's residential and commercial mortgage banking business ("Mortgage") and
the consumer lending business conducted through the Company's minority interest investment in Drive ("Consumer"). Earnings (loss) from discontinued operations is summarized as follows:

Year ended December 31,2007

2006

2005Mortgage

$


$
(75
)
$
(356
)Consumer








509Net earnings (loss) from discontinued operations

$


$
(75
)
$
153




Assets remaining from discontinued mortgage operations are investment securities resulting from the retention of a residual interest in a securitization
transaction. These securities are in "run-off," and the Company is contractually obligated to service these assets. Prior to the fourth quarter of 2004, FirstCity classified these
securities as held to maturity and considered the estimated future gross cash receipts for such investment securities in the computation of the value of such investment securities. In the fourth
quarter of 2004, FirstCity's management elected to pursue a strategy to liquidate these assets and carry them as held for sale. Consequently, in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets("SFAS 144"), the securities are recorded at the lower of their
carrying value or fair value less cost to sell.

In
April 2005, the Company exercised an early purchase option on the 1998-1 securitization. Loans receivable were recorded at $6.1 million in accordance with
EITF 02-9,Accounting for Changes That Result in a Transferor Regaining Control of Financial Assets Sold.FirstCity evaluated each
loan at the acquisition date to determine whether there was evidence of credit deterioration since origination. At December 31, 2007, the acquired loans are included in Portfolio Assets in the
consolidated balance sheet and classified as either "loans acquired with credit deterioration" or "loans acquired without credit deterioration." See Note 1(e) for a description of the
accounting policy for these loans. As of December 31, 2007 only one investment security remained from discontinued mortgage operations. Discontinued mortgage assets of $133 at
December 31, 2007 are included in other assets.

The
assumptions used in the valuation model consider both industry as well as the Company's historical experience and are reviewed quarterly in light of historical evidence in revising
the prospective results of the model. These revised assumptions could potentially result in either an increase or decrease in the estimated cash receipts. An additional provision is booked based on
the output of the valuation model if deemed necessary. The Company recorded provisions of $75 in 2006

73

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

3. Discontinued Operations (Continued)

and
$356 in 2005 for additional losses from discontinued mortgage operations. No provisions for additional losses were recorded in 2007.



In September 2004, FirstCity sold its 31% beneficial ownership interest in Drive Financial Services LP ("Drive") for a total purchase price of
$108.5 million in cash, resulting in distributions and payments to
FirstCity in the aggregate amount of $86.8 million in cash, from various sources. The sale was completed in November 2004, and net cash proceeds from these transactions were primarily used to
pay off debt.

Pursuant
to SFAS No. 144, the consolidated financial statements present the operations, assets and liabilities of the consumer business segment as discontinued operations. There
were no consumer assets held for sale as of December 31, 2007 and 2006. The liabilities of such operations have been included in other liabilities on the consolidated balance sheets and
consisted of state taxes payable as of December 31, 2007 and 2006 of $568 and $114, respectively.

The
net earnings from discontinued consumer operations are classified on the consolidated statements as a component of "Earnings from discontinued operations." Summarized results of
discontinued consumer operations are as follows:

Year ended December 31,2007

2006

2005Other expenses

$


$


$
(121
)Income taxes








630Earnings from discontinued consumer operations

$


$


$
509


4. Portfolio Assets

Portfolio Assets are pledged to secure notes payable that are non-recourse to FirstCity or any affiliate other than the entity that incurred the debt.
See Note 2 for a description of the Revolving Credit agreement between FH Partners, LLC and Bank of Scotland, which is guaranteed by FirstCity and the primary wholly-owned subsidiaries
of FirstCity.

74

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

4. Portfolio Assets (Continued)

Portfolio Assets are summarized as follows:

December 31,
2007

December 31,
2006Loan PortfoliosLoans Acquired Prior to 2005Non-performing Portfolio Assets

$
4,177

$
6,163Performing Portfolio Assets


1,266


5,166Loans Acquired After 2004Loans acquired with credit deterioration


97,630


84,550Loans acquired with no credit deterioration


3,871


6,473Outstanding balance


106,944


102,352Allowance for loan losses


(1,723
)

(333
)Carrying amount of loans, net of allowance


105,221


102,019Real Estate Portfolios


14,832


4,574Other


1,948


2,103Portfolio Assets, net

$
122,001

$
108,696


Income
from Portfolio Assets is summarized as follows:

Year ended December 31,2007

2006

2005Loan PortfoliosLoans Acquired Prior to 2005Non-performing Portfolio Assets

$
1,780

$
2,962

$
4,407Performing Portfolio Assets


1,113


1,483


2,122Loans Acquired After 2004Loans acquired with credit deterioration


17,289


4,578


1,091Loans acquired with no credit deterioration


1,233


396


354Real Estate Portfolios


1,108


1,325


197Other


231


243


91Income from Portfolio Assets

$
22,754

$
10,987

$
8,262


During
2007, the Company recorded provisions for loan and impairment losses, net of recoveries, by a charge to income of $1,879which is comprised of impairment charges on
real estate portfolios of $407 and $1,472 to allowance for loan losses. During 2006, the Company recorded provisions for loan and impairment losses, net of recoveries, by a charge to income of
$271which is comprised of impairment charges on real estate portfolios of $28 and $243 to allowance for loan losses.

75

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

4. Portfolio Assets (Continued)

The
changes in the allowance for loan losses are as follows:

Year ended December 31,2007

2006

2005Beginning Balance

$
(333
)
$
(163
)
$
Provisions


(2,385
)

(363
)

(462
)Recoveries


913


120


299Charge Offs


82


73


Ending Balance

$
(1,723
)
$
(333
)
$
(163
)


Changes
in accretable yield at December 31, 2007 on loans acquired after 2004 with evidence of credit deterioration were as follows:

Year ended December 31,2007

2006

2005Beginning Balance

$
32,339

$
3,765

$
Additions


26,327


33,210


6,101Accretion


(13,665
)

(4,025
)

(711
)Reclassification from (to) nonaccretable difference


(4,030
)

(109
)

(1,039
)Disposals


(5,102
)

(553
)

(586
)Translation adjustments


82


51


Ending Balance

$
35,951

$
32,339

$
3,765


Loans
acquired during each period for which it was probable at acquisition that all contractually required payments would not be collected are as follows:

Year ended December 31,2007

2006

2005Face value at acquisition

$
148,529

$
300,481

$
25,656Cash flows expected to be collected at acquisition


91,237


119,122


26,088Basis in acquired loans at acquisition


64,910


85,912


19,987


76

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

5. Loans Receivable



Loans receivableaffiliates, which are designated by management as held for investment, are summarized as follows:

Year ended December 31,2007

2006Outstanding balance

$
4,967

$
4,598Capitalized costs


480


157Carrying amount of loans, net

$
5,447

$
4,755


The
summary of activity in loans receivableaffiliates is as follows:

Year ended December 31,2007

2006

2005Beginning Balance

$
4,755

$
19,606

$
21,255Advances


893


12,132


1,790Payments received


(968
)

(1,757
)

(3,507
)Capitalized costs


323


530


239Other noncash adjustments





(26,015
)

(97
)Foreign exchange gains (losses)


444


259


(74
)Ending Balance

$
5,447

$
4,755

$
19,606


Loans
receivableaffiliates represent advances to Acquisition Partnerships and other affiliated entities to acquire portfolios of performing and nonperforming commercial and
consumer loans and other assets. The loans are reported at their outstanding principal balances adjusted for net deferred loan origination and other capitalized costs and the allowance for loan
losses. Interest is recognized on an accrual basis at the applicable interest rate on the principal amount outstanding. Loans receivable from affiliates are generally secured by the underlying
collateral of the individual notes within the portfolios that were acquired with the loan proceeds, which is generally real estate and foreclosed properties. The loans are evaluated for impairment by
analyzing the expected future cash flows from the underlying assets within each pool to determine that the cash flows are sufficient to
repay these notes. The Company applies the asset valuation methodology consistently in all venues and uses the same proprietary asset management system to evaluate impairment on all asset pools. The
results of this evaluation indicated that cash flows from the pools will be sufficient to repay the loans. The Company recorded no provisions for impairment on loans receivableaffiliates
in 2007, 2006 and 2005.

In
August 2006, FirstCity completed a restructuring of its investments in Mexico in a transaction with American International Group, Inc. ("AIG"). As a result, FirstCity
eliminated substantially all of its loans receivable approximately $21.3 million from its Mexico acquisition partnerships. Equity method losses were recorded to reduce the loans receivable from
certain Mexican partnerships, in compliance with EITF 98-13,Accounting by an Equity Method Investor for Investee Losses When the

77

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

5. Loans Receivable (Continued)

Investor Has Loans to and Investments in Other Securities of the Investee, and EITF 99-10,Percentage Used to Determine the Amount of
Equity Method Losses. Equity method losses were zero for 2007 and 2006, and $.1 million for 2005.



Loans receivableSBA held for sale are summarized as follows:

Year ended December 31,2007

2006Outstanding balance

$
133

$
Premiums





Carrying amount of loans, net

$
133

$



Changes
in loans receivableSBA held for sale are as follows:

Year ended December 31,2007

2006

2005Beginning Balance

$


$


$
Purchases of loans


18,355





Originations and advances of loans


1,661





Payments received


(1,655
)




Loans sold


(17,276
)




Premium amortization, net


(488
)




Transferred to held for investment


(464
)




Ending Balance

$
133

$


$



Loans
receivableSBA held for sale represent SBA loans acquired by the Company in February 2007 (see Note 18) and SBA loan originations and advances made since such
time. SBA loans held for sale represent the guaranteed portions of the loans, and are reflected at the lower of aggregate cost or estimated fair value. Net unrealized losses, if any, are recognized
through a valuation allowance by charges to income. The carrying value of SBA loans held for sale is net of premiums as well as deferred origination fees and costs. Premiums and net origination fees
and costs are deferred and included in the basis of the loans in calculating gains and losses upon sale. The Company generally sells the guaranteed portion of each loan to a third party and retains
the servicing rights. The difference between the proceeds received and the allocated carrying value of the loans sold are recognized as net gains on sales of loans. The non-guaranteed
portion is generally held in the portfolio and classified as held for investment. The Company recorded no write-downs of SBA loans held for sale below their cost in 2007.

78

Table of Contents

---





FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

5. Loans Receivable (Continued)



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

Year ended December 31,2007

2006Outstanding balance

$
15,727

$
Allowance for loan losses


(151
)

Discounts, net


(1,346
)

Capitalized origination costs


4


Carrying amount of loans, net

$
14,234

$



Changes
in loans receivableSBA held for investment are as follows:

Year ended December 31,2007

2006

2005Beginning Balance

$


$


$
Purchases of loans


17,407





Originations and advances of loans


554





Payments received


(4,167
)




Capitalized origination costs


4





Provision for SBA loan losses


(151
)




Discount accretion, net


155





Charge offs


(32
)




Transferred from held for sale


464





Ending Balance

$
14,234

$


$



Loans
receivableSBA held for investment represent SBA loans acquired by the Company in February 2007 (see Note 18) and SBA loan originations and advances made since
such time. SBA loans held for investment are reported at their outstanding principal balances adjusted for unearned discounts, net deferred loan origination costs and the allowance for loan losses.
Interest is recognized on an accrual basis at the applicable interest rate on the principal amount outstanding. Loan origination fees and direct costs as well as premiums and discounts are amortized
as level yield adjustments over the respective loan terms. Unamortized net fees or costs are recognized upon early repayment of the loans. SBA loans held for investment are generally secured by the
borrowing entities' assets such as accounts, property and equipment, and other assets. The loans are evaluated for impairment based upon performance of the loans and other portfolio characteristics,
such as industry concentrations and loan collateral, which also impacts management's estimates of the impairment. The adequacy of the allowance for loan losses is reviewed by management on a regular
basis and adjustments, if necessary, are reflected in operations during the periods in which they become known. Considerations in this evaluation include past and current loss experience, risks
inherent in the current

79

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

5. Loans Receivable (Continued)

portfolio,
and evaluation of commercial and real estate collateral as well as current economic conditions.

Changes
in the allowance for loan losses on loans receivableSBA held for investment are as follows:

Year ended December 31,2007

2006

2005Beginning Balance

$


$


$
Provisions


(182
)




Recoveries








Charge Offs


31





Ending Balance

$
(151
)
$


$





Loans receivableother, which are designated by management as held for investment, are summarized as follows:

Year ended December 31,2007

2006Outstanding balance

$
5,502

$
24,152Discounts, net


(24
)

(161
)Capitalized costs


517


Carrying amount of loans, net

$
5,995

$
23,991


Changes
in loans receivableother are as follows:

Year ended December 31,2007

2006

2005Beginning Balance

$
23,991

$


$
Advances


9,246


18,298


Payments received


(28,175
)




Capitalized costs


518





Other noncash adjustments





5,737


Discount accretion, net


163


63


Foreign exchange gains (losses)


252


(107
)

Ending Balance

$
5,995

$
23,991

$



80

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

5. Loans Receivable (Continued)

Loans
receivableother include loans made to non-affiliated entities and are secured by the borrowing entities' assets such as accounts receivable, inventory,
property and equipment, and other assets. Interest is accrued when earned in accordance with the contractual terms of the loans. The loans are reported at their outstanding principal balances adjusted
for unearned discounts, loan origination fees, and the allowance for loan losses. Interest is recognized on an accrual basis at the applicable interest rate on the principal amount outstanding. Loan
origination fees and direct costs are amortized as level-yield adjustments over the respective loan terms. Unamortized net fees or costs are recognized upon early repayment of the loans. Management
evaluates these loans for impairment by analyzing the expected future cash flows from the borrowing entity and the values of the underlying collateral to determine whether the Company expects to
ultimately collect all contractual principal and interest. The results of this evaluation indicated that projected cash flows and underlying collateral are sufficient to repay the loans and no
allowances for impairment were necessary. The Company recorded no provisions for impairment on loans receivableother in 2007 and 2006.

6. Equity Investments

The Company has investments in Acquisition Partnerships and their general partners that are accounted for under the equity method of accounting. The Company also
has investments in servicing entities that are accounted for on the equity method.

The
condensed combined financial position and results of operations of the Acquisition Partnerships (excluding servicing entities), which include the domestic and foreign Acquisition
Partnerships and their general partners, are summarized as follows:

Condensed Combined Balance Sheets

December 31,2007

2006Assets

$
440,395

$
457,173Liabilities

$
141,430

$
100,973Net equity


298,965


356,200$
440,395

$
457,173Equity investments in Acquisition Partnerships

$
76,078

$
105,852Equity investments in servicing entities


11,544


6,505$
87,622

$
112,357


81

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

6. Equity Investments (Continued)

Condensed Combined Summary of Operations

Year ended December 31,2007

2006

2005Income from Portfolio Assets

$
96,475

$
86,732

$
82,320Other income


1,103


2,171


899Revenues


97,578


88,903


83,219Interest expense


11,413


13,624


15,063Average cost (annualized)


12.46
%

6.49
%

4.86
%Service fees


21,185


18,225


19,390Provision for loan and impairment losses


16,798


857


8,888Other operating costs


20,250


17,573


24,802Foreign currency (gains) losses


(689
)

10,502


(16,861
)Income taxes


(1,837
)

5,217


471Expenses


67,120


65,998


51,753Net earnings

$
30,458

$
22,905

$
31,466Equity in earnings of Acquisition Partnerships

$
9,542

$
10,927

$
11,370Equity in earnings of servicing entities


1,402


829


643$
10,944

$
11,756

$
12,013


The
assets and equity (deficit) of the Acquisition Partnerships and equity investments in those entities are summarized by geographic region below. The WAMCO Partnerships represent
domestic

82

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

6. Equity Investments (Continued)

Texas
limited partnerships and limited liability companies in which the Company has a common ownership with Cargill.

December 31,2007

2006Assets:Domestic:WAMCO Partnerships

$
87,086

$
116,634Other


7,758


4,277Latin America


200,780


167,407Europe:P.R.L. Developpement, SAS


21,794


19,684Other


122,977


149,171$
440,395

$
457,173Equity (deficit):Domestic:WAMCO Partnerships

$
44,309

$
69,579Other


4,237


2,676Latin America


168,108


126,402Europe:P.R.L. Developpement, SAS


19,728


13,797Other


62,583


143,746$
298,965

$
356,200Equity investment in Acquisition Partnerships:Domestic:WAMCO Partnerships

$
22,065

$
34,203Other


2,064


1,691Latin America


21,555


18,640Europe:P.R.L. Developpement, SAS


9,085


6,002Other


21,309


45,316$
76,078

$
105,852


83

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

6. Equity Investments (Continued)

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

Year ended December 31,2007

2006

2005Revenues:Domestic:WAMCO Partnerships

$
17,954

$
26,136

$
30,770Other


974


1,843


5,714Latin America


42,832


37,652


23,359Europe:P.R.L. Developpement, SAS


2,756


2,302


2,176Other


33,062


20,970


21,200$
97,578

$
88,903

$
83,219Net earnings (loss):Domestic:WAMCO Partnerships

$
4,643

$
13,332

$
14,850Other


(19
)

493


4,501Latin America


7,029


(6,868
)

(3,687
)Europe:P.R.L. Developpement, SAS


4,071


3,612


2,832Other


14,734


12,336


12,970$
30,458

$
22,905

$
31,466Equity in earnings (loss) of AcquisitionPartnerships:Domestic:WAMCO Partnerships

$
2,343

$
6,431

$
6,403Other


(59
)

71


1,638Latin America


1,310


(189
)

(227
)Europe:P.R.L. Developpement, SAS


1,845


1,571


1,097Other


4,103


3,043


2,459$
9,542

$
10,927

$
11,370


At
December 31, 2007, the Company had $41.5 million in Euro-denominated debt for the purpose of hedging a portion of the net equity investments in Europe. In
general, the type of risk hedged relates to the foreign currency exposure of net investments in Europe caused by movements in Euro exchange rates. The Company designated the hedging relationship such
that changes in the net investments being hedged are expected to be offset by corresponding changes in the values of the Euro-denominated debt.

84

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

6. Equity Investments (Continued)

Effectiveness
of the hedging relationship is measured and designated at the beginning of each month by comparing the outstanding balance of the Euro-denominated debt to the
carrying value of the designated net equity investments. The net foreign currency translation gain (loss) included in accumulated other comprehensive income relating to the
Euro-denominated debt was ($2,365) for 2007, ($2,509) for 2006 and $1,348 for 2005.

During
the third quarter of 2006, FirstCity completed a total restructure of its investments in Mexico in a transaction which aligned FirstCity with American International
Group, Inc. FirstCity received a payment of $1.9 million of incentive service fees and recorded a gain on sale of $1.2 million from the sale of certain assets by Cargill Financial
Services International, Inc. and FirstCity affiliates as a result of this restructure. The net impact for the third quarter from this transaction was $2.2 million net of expenses and
intercompany eliminations. Subsequent to this transaction, Bidmex Holding LLC now owns 100% of the related Mexican investments, and FirstCity has a 9% senior and 6% subordinated equity
investment in Bidmex Holding LLC. The Company will evaluate the subordinated investment for impairment quarterly.

During
the first quarter of 2005, FirstCity invested $2.0 million to increase its ownership percentage in MCS et Associes, S.A. ("MCS"), a French servicing company, from
10.00% to 11.89% and in PRL Developpement, SAS, a French Acquisition Partnership, from 33.50% to 43.50%. P.R.L. Developpement, SAS ("PRL") increased its ownership percentage in MCS from
14.72% to 19.63% in 2005. These additional investments provided a combined direct and indirect ownership interest in MCS of 20.87%. In 2005, MCS sold its investment in Common Stock of FirstCity
resulting in a gain of $1.5 million. FirstCity accounted for its proportionate interest in this gain as an increase in the Company's carrying amount of its investment in MCS of
$0.3 million and an increase in additional paid-in capital.

85

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

7. Notes Payable

Notes payable consisted of the following:

December 31,2007

2006Notes payableother:Senior Credit Facility, secured and with recourse to the Company:US Dollar denominatedLIBOR-indexed (4.865% at December 31, 2007) plus 2.0% to 2.5%, due November 2010

$
31,260

$
55,905US Dollar denominatedfixed rate at 7.86%, due November 2010


30,000


Eurocurrency denominatedLIBOR-indexed (4.437% at December 31, 2007) plus 2.0% to 2.5%, due November 2010


41,510


48,335Prime (8.25% at December 31, 2007) plus .5%, due November 2010





10,035Subordinated Credit Facility of $25 million, secured and with recourse to the Companyoption of LIBOR plus 5%, or prime plus 3%, or fixed rate, due November 2010





Acquisition facility secured by assets of FH Partners, LLC and guaranteed by the Company, LIBOR-indexed (5.1025% at December 31, 2007) plus 2.00%, due November 2010


48,199


50,000Term loan secured by assets of FC Washington, L.P. and guaranteed by the Company, fixed rate at 5.625%, due 2008


1,337


2,580Revolving line of credit secured by Bank of Scotland letter of credit, renewable every 30 days, rate based on monthly Chilean index rate plus .0625% per month





6,518Line of credit secured by Bank of Scotland letter of credit, rate based on 28 day Mexican index rate plus 1.5%, due November 2008


13,544


13,408Revolving loan facility secured by assets of American Business Lending, Inc., LIBOR plus 2.625% (7.225% at December 31, 2007), or the greater of Wells Fargo prime or 7.5%, due December 2009


7,594


Term loan secured by assets of MPortfolio Corporation, LIBOR-indexed (4.9962% at December 31, 2007), plus 1.75%, due June 2010


3,100


Other: Secured borrowing


785


1,030Total notes payableother

$
177,329

$
187,811


Refer to Note 2 for a description of terms related to the Company's Senior Credit Facility at December 31, 2007 and other matters
concerning the Company's liquidity.

Under
terms of certain borrowings, the Company and its subsidiaries are required to maintain certain tangible net worth levels and debt to equity and debt service coverage ratios. The
terms also restrict future levels of debt. At December 31, 2007, the Company was in compliance with the aforementioned covenants. The aggregate maturities of Notes payable for the five years
ending December 31, 2012 are as follows: $14,934 in 2008, $8,242 in 2009, $154,071 in 2010, $3 in 2011, $3 in 2012, and $76 thereafter.

86

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

8. Segment Reporting

The Company is engaged in one reportable segmentPortfolio Asset acquisition and resolution. The Portfolio Asset acquisition and resolution business
involves acquiring Portfolio Assets at a discount to Face Value and servicing and resolving such Portfolios in an effort to maximize the present value of the ultimate cash recoveries. The following is
a summary of results of operations for the Portfolio Asset acquisition and resolution segment and reconciliation to earnings from continuing operations.

Year ended December 31,2007

2006

2005Portfolio Asset Acquisition and Resolution:Revenues:Servicing fees

$
10,390

$
12,906

$
11,754Income from Portfolio Assets


22,754


10,987


8,262Gain on sale of SBA loans held for sale, net


723





Interest income from SBA loans


2,140





Interest income from affiliates


560


1,498


1,838Interest income from loans receivableother


3,822


576


Other income


2,828


1,555


1,737Total


43,217


27,522


23,591Expenses:Interest and fees on notes payable


18,060


8,311


4,002Salaries and benefits


13,324


11,428


12,065Provision for loan and impairment losses


2,061


271


212Occupancy, data processing, property protection and other


9,221


6,529


5,284Minority interest


(1
)

(97
)

53Total


42,665


26,442


21,616Equity in earnings of investments


10,944


11,756


12,013Gain on sale of subsidiaries and equity investments


207


2,459


Operating contribution before direct taxes

$
11,703

$
15,295

$
13,988Operating contribution, net of direct taxes

$
11,432

$
15,104

$
13,780Corporate Overhead:Salaries and benefits, occupancy, professional and other income and expenses, net


9,247


5,227


5,702Earnings from continuing operations

$
2,185

$
9,877

$
8,078


87

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

8. Segment Reporting (Continued)

Revenues
and equity in earnings of investments from the Portfolio Asset acquisition and resolution segment attributable to domestic and foreign operations are summarized as follows:

Year ended December 31,2007

2006

2005Domestic

$
33,850

$
22,063

$
20,707Latin America


12,068


11,191


10,508Europe


8,055


5,913


4,389Other


188


111


Total

$
54,161

$
39,278

$
35,604


Total
assets for each of the segments and a reconciliation to total assets are as follows:

December 31,
2007

December 31,
2006Cash

$
23,546

$
18,472Portfolio acquisition and resolution assets:Domestic


163,078


158,147Latin America


33,450


28,883Europe


46,701


61,062Other


371


2,272Deferred tax asset, net


20,101


20,101Other non-earning assets, net


10,872


8,726Total assets

$
298,119

$
297,663


The
average investment in Portfolio Assets and loans receivable and related income from those investments are as follows:

Year Ended December 31,2007

2006

2005Average investment in Portfolio Assets and loans receivable:Domestic

$
147,545

$
66,381

$
42,567Latin America


7,952


12,479


18,068Europe


4,431


2,475


652Other


1,255


703


Total

$
161,183

$
82,038

$
61,287


88

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

8. Segment Reporting (Continued)

Income from Portfolio Assets and loans receivable:Domestic

$
27,452

$
11,392

$
8,506Latin America


1,990


1,377


1,559Europe


369


181


35Other


188


111


Total

$
29,999

$
13,061

$
10,100


9. Preferred Stock and Stockholders' Equity

On July 17, 1998, the Company filed a shelf registration statement with the Securities and Exchange Commission, which allows the Company to issue up to
$250 million in debt and equity securities from time to time in the future. The registration statement became effective July 28, 1998. As of December 31, 2007, there have been no
securities issued under this registration statement.

In
connection with the recapitalization discussed in Note 2, 400,000 shares of the Company's Common Stock were issued to purchase a minority interest.

BoS(USA)
is entitled to additional warrants in connection with its existing warrant for 425,000 shares to retain its ability to acquire approximately 4.86% of the Company's Common Stock.

The
holders of shares of the Company's Common Stock are entitled to one vote for each share on all matters submitted to a vote of Common Stockholders. In order to preserve certain tax
benefits available to the Company, transactions involving stockholders holding or proposing to acquire more than 4.75% of outstanding common shares are prohibited unless the prior approval of the
Board of Directors is obtained.

The
Board of Directors of the Company may designate the relative rights and preferences of the optional preferred stock when and if issued. Such rights and preferences can include
liquidation
preferences, redemption rights, voting rights and dividends and shares can be issued in multiple series with different rights and preferences. The Company has no current plans for the issuance of an
additional series of optional preferred stock.

On
August 14, 2006, FirstCity announced that the Board of Directors authorized a stock repurchase plan providing for the purchase of up to 1,000,000 shares of the Company's Common
Stock, with purchases to be made over a period of twelve months. In 2007 and 2006, FirstCity repurchased 50,200 and 530,300 shares, respectively, of the Company's Common Stock on the open market for a
total of $407 and $5.6 million, respectively. On February 6, 2008, the Board of Directors amended the stock repurchase plan to provide for the repurchase of an additional 500,000 shares
(up to a total of 1,500,000 shares) and the plan was extended to August 30, 2009. Subsequent to December 31, 2007, the Company repurchased an additional 264,530 shares of its Common
Stock on the open market for $2.1 million.

89

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

10. Stock Based Compensation

The Company has stock option and award plans for the benefit of key individuals, including its directors, officers and key employees. The plans are administered
by a committee of the Board of Directors and provide for the grant of up to a total of 800,000 shares (net of shares cancelled and forfeited) of Common Stock. The Company previously had a 1995 Stock
Option and Award Plan, and a 1996 Stock Option and Award Plan, which provided for a grant of up to 700,000 shares. Both plans expired in 2005 pursuant to their terms, with existing options remaining
in accordance with the terms of each grant. Stock option awards are granted with an exercise price equal to the market price of FirstCity's shares at the date of grant; those stock option awards
generally vest 25% each year from the date of grant and have 10-year contractual terms. Certain stock options issued to non-employee directors were exercisable immediately.

FirstCity
adopted SFAS 123R using the modified prospective transition method beginning January 1, 2006. Accordingly, during 2006, the Company recorded stock-based
compensation expense for awards granted prior to, but not yet vested as of January 1, 2006, as if the fair value method required for pro forma disclosure under SFAS 123 were in effect
for expense recognition purposes, adjusted for estimated forfeitures. For these awards, FirstCity recognized compensation expense using the straight-line amortization method. For
stock-based awards granted after January 1, 2006, the Company recognizes compensation expense based on the estimated grant date fair value method using the Black-Scholes valuation model. For
these awards, FirstCity recognizes compensation expense using a straight-line amortization method. As SFAS 123R requires that stock-based compensation expense be based on awards
that are ultimately expected to vest, stock-based compensation for 2007 has been reduced for estimated forfeitures. When estimating forfeitures, FirstCity considers voluntary termination behaviors as
well as trends of actual option forfeitures. The impact on the results of operations of recording stock-based compensation for 2007, 2006 and 2005 was as follows:

Year ended December 31,2007

2006

2005Amount of compensation cost recognized in income

$
643

$
651

$
Tax benefit recognized in income

$


$


$
Amount capitalized as part of an asset

$


$


$



SFAS 123R
requires cash flows resulting from excess tax benefits to be classified as a part of cash flows from financing activities. Excess tax benefits are realized tax benefits
from tax deductions for exercised options in excess of the deferred tax asset attributable to stock compensation costs for such options. Cash received from options exercised during 2007, 2006 and 2005
was $35, $68 and $196, respectively.

The
fair value of stock options granted was estimated on the date of grant using the Black-Scholes option pricing model. Expected volatilities are based on historical volatility of the
Company's stock. The Company estimated the expected term of its unvested options by taking the average of the vesting term remaining and the contractual term of the option ("simplified method"), as
illustrated in SEC Staff Accounting Bulletin No. 107. The Company uses the simplified method of estimating the expected term of the share options since the Company does not have sufficient
historical exercise data to provide a reasonable basis upon which to estimate the expected term due to limited instances of key employees

90

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

10. Stock Based Compensation (Continued)

and
directors exercising their options. The expected life represents the period of time that options granted are expected to be outstanding. The risk-free rate is based on the U.S.
Treasury rate with a maturity date corresponding to the options' expected life. The following table sets forth the weighted average assumptions used to calculate the fair value of the stock options
for 2007, 2006 and 2005.

Year ended December 31,2007

2006

2005Weighted average grant date fair value

$
6.71

$
6.71

$
9.95Volatility


78
%

82
%

84
%Risk-free interest rate


3.96%-4.48
%

4.88
%

4.50
%Expected life in years


5-6.25


5


10Dividend yield


Zero


Zero


Zero


Stock
option activity during the years indicated is as follows:

Shares

Weighted
Average
Exercise
Price

Weighted
Average
Remaining
Contractual
Term
(Years)

Aggregate
Intrinsic
ValueOutstanding at December 31, 2004

762,000

$
7.26Granted

122,650


11.62Exercised

(46,500
)

4.22Expired

(67,300
)

20.00Forfeited

(15,000
)

7.25Outstanding at December 31, 2005

755,850

$
7.02Granted

35,000


9.84Exercised

(9,750
)

6.93Expired




Forfeited

(2,000
)

27.25Outstanding at December 31, 2006

779,100

$
7.10Granted

181,500


9.50Exercised

(10,000
)

3.48Expired

(37,950
)

27.25Forfeited

(33,500
)

9.66Outstanding at December 31, 2007

879,150

$
6.67

6.09

$
4,083Exercisable at December 31, 2005

502,325

$
6.20Exercisable at December 31, 2006

582,363

$
6.51Exercisable at December 31, 2007

638,200

$
5.61

5.09

$
3,668


91

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

10. Stock Based Compensation (Continued)

The
total intrinsic value of stock options exercised during 2007, 2006 and 2005 was $56, $36 and $377, respectively. As of December 31, 2007, there was approximately
$1.4 million of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the stock option plans. That cost is expected to be recognized over
a weighted average period of 2.3 years.

A
summary of the status and changes of FirstCity's nonvested shares as of December 31, 2007, and changes during 2007 is presented below:

Shares

Weighted-
Average
Grant-Date
Fair ValueNonvested at January 1, 2007

196,737

$
6.67Granted

181,500

$
6.71Vested

(104,662
)
$
6.14Forfeited

(32,625
)
$
6.98Nonvested at December 31, 2007

240,950

$
6.89


Prior
to the adoption of SFAS 123R, FirstCity provided the disclosures required under SFAS No. 123, as amended by SFAS No. 148,Accounting
for Stock-Based CompensationTransition and Disclosures. Employee stock-based compensation expense recognized under SFAS 123R was not reflected in the
results of operations for 2005 for employee stock option awards, as all options were granted with an exercise price equal to the market value of the underlying Common Stock on the date of grant.
Forfeitures of awards were recognized as they occurred. Previously reported amounts have not been restated.

The
pro forma information for 2005 was as follows:

Year ended
December 31, 2005Net earnings to common stockholders, as reported

$
8,231Less: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects


(666
)Pro forma net earnings to common stockholders

$
7,565Net earnings per common share:Basicas reported

$
0.73Basicpro forma

$
0.67Dilutedas reported

$
0.69Dilutedpro forma

$
0.63


92

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

11. Income Taxes

Income tax expense from continuing operations consists of:

Year Ended December 31,2007

2006

2005Federal and state current expense

$
(852
)
$
(186
)
$
(250
)Federal deferred expense








Foreign current expense


71


(113
)

(42
)Foreign deferred expense





126


Total

$
(781
)
$
(173
)
$
(292
)


The
actual income tax expense attributable to earnings from continuing operations differs from the expected tax expense (computed by applying the federal corporate tax rate of 35% to
earnings from continuing operations before income taxes, minority interest and accounting change) as follows:

Year Ended December 31,2007

2006

2005Computed expected tax expense

$
(1,038
)
$
(3,484
)
$
(2,948
)Reduction in income taxes resulting from:Change in valuation allowance


1,038


3,484


2,948Alternative minimum tax and state and foreign income tax


(781
)

(173
)

(292
)$
(781
)
$
(173
)
$
(292
)


The
tax effects of temporary differences that give rise to significant portions of the deferred tax assets at December 31, 2007 and 2006 are as follows:

December 31,2007

2006Deferred tax assets (liabilities):Investments in Acquisition Partnerships, principally due to differences in basis for tax and financial reporting purposes

$
3,732

$
(347
)Intangibles, principally due to differences in amortization


326


281Tax basis in fixed assets less than book


(16
)

(76
)Foreign non-repatriated earnings


(3,028
)

(2,398
)Other


2,090


(9,010
)Federal net operating loss carryforwards


78,028


130,528Net gross deferred tax assets


81,132


118,978Valuation allowance


(61,031
)

(98,877
)Net deferred tax assets

$
20,101

$
20,101


93

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

11. Income Taxes (Continued)

The
Company has net operating loss carryforwards for federal income tax purposes of approximately $544 million from continuing operations and $9 million from discontinued
operations at December 31, 2007, less expired net operating losses of $321 millionleaving $232 million available to offset future federal taxable income, if any,
through the year 2021. A valuation allowance is provided to reduce the deferred tax assets to a level which, more likely than not, will be realized. During 2007, 2006 and 2005, the Company adjusted
the previously established valuation allowance by $37.8 million, $65.6 million and $16.3 million, respectively. The adjustments in 2007 and 2006 to the valuation
allowance included decreases of $36.8 million and $62.1 million, respectively, due to expired net operating losses.

Realization
of the deferred tax asset is determined based on management's expectation of generating sufficient taxable income in a look forward period over the next four years. The
ultimate realization of the resulting net deferred tax asset is dependent upon generating sufficient taxable income from its continuing operations prior to expiration of the net operating loss
carryforwards. Although realization is not assured, management believes it is more likely than not that all of the recorded deferred tax asset, net of the allowance, will be realized. The amount of
the deferred tax asset considered realizable, however, could be adjusted in the future if estimates of future taxable income during the carryforward period change. The ability of the Company to
realize the deferred tax asset is periodically reviewed and the valuation allowance is adjusted accordingly.

On
October 1, 2007 the Entrepreneurial Tax of Unique Rate (referred to by its Spanish acronym, IETU or "Flat Tax") in Mexico was published. The Flat Tax law was effective on
January 1, 2008 and replaces the existing asset-based tax. The Flat Tax applies to a different tax base than the income tax and will be paid if the Flat Tax exceeds the income tax computed
under existing law. In accordance with SFAS 109,Accounting for Income Taxes, the effects of the Flat Tax should be reflected in the consolidated
financial statements. The Flat Tax has no impact on the Company's deferred tax assets recognized as of December 31, 2007.

The
Company adopted the provisions of FIN 48 on January 1, 2007. Under FIN 48, income tax benefits are recognized and measured based upon a two-step
model: (1) a tax position must be more-likely-than-not to be sustained based solely on its technical merits in order to be recognized; and (2) the
benefit is measured as the largest dollar amount of that position that is more-likely-than-not to be sustained upon settlement. The difference between the benefit
recognized for a position in accordance with this FIN 48 model and the tax benefit claimed on a tax return is referred to as an unrecognized tax benefit ("UTB").

94

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

11. Income Taxes (Continued)

The gross amount of unrecognized tax benefits on uncertain tax positions as of December 31, 2007 totaled $579, which if recognized, would impact the
Company's effective income tax rate. A reconciliation of unrecognized tax benefits for 2007 follows:

2007Balance at January 1, 2007

$
110Additions based on tax positions of prior years


544Payments and settlements


(75
)Balance at December 31, 2007

$
579


As
of December 31, 2007, management is not aware of any tax positions for which it was reasonably possible that a change in the amount of unrecognized tax benefits during the next
twelve months would significantly impact the Company's effective income tax rate. Interest and penalties related to income tax uncertainties of $167 are included in the provision for income taxes and
income taxes payable.

The
Internal Revenue Service is currently in the process of examining FirstCity's federal income tax return for 2004. In addition, FirstCity currently files tax returns in approximately
35 states and is currently being examined in four states for the year 2004. Tax year 1992 and subsequent years are open to federal examination, and tax year 2003 and subsequent years are open to state
examination.

12. Employee Benefit Plan

The Company has a defined contribution 401(k) employee profit sharing plan pursuant to which the Company matches employee contributions at a stated percentage of
employee contributions to a defined maximum. The Company's contributions to the 401(k) plan were $149 in 2007, $138 in 2006 and $134 in 2005.

13. Leases

The Company leases its current headquarters under a noncancellable operating lease. The lease calls for monthly payments of $12 through its expiration in December
2011. Rental expense under this lease was $144 for 2007, and $122 for 2006 and $120 for 2005. The Company also leases office space and equipment under operating leases expiring in various years prior
to 2015. Rental expense under these leases for 2007, 2006 and 2005 was $704, $588 and $545, respectively. As of December 31, 2007, the future minimum lease payments under all noncancellable
operating leases are: $620 in 2008, $472 in 2009, $405 in 2010, $384 in 2011, $240 in 2012, and $441 thereafter.

14. Other Related Party Transactions

FirstCity has financing and service arrangements with certain Acquisition Partnerships and financing arrangements with non-affiliated entities that
are considered to be variable interest entities ("VIEs"). However, FirstCity is not determined to be the primary beneficiary of these entities. The Company could experience a loss in the event that
cash flows from the VIEs or the underlying

95

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

14. Other Related Party Transactions (Continued)

collateral
are not collected as expected. At December 31, 2007, the Company's maximum exposure to loss as a result of its involvement with the VIEs is $35.3 million.

The
Company has contracted with the Acquisition Partnerships and related parties as a third party loan servicer. Servicing fees totaling $9.7 million, $12.6 million and
$11.5 million, for 2007, 2006 and 2005, respectively, and due diligence fees (included in other income) were derived from such affiliates.

FirstCity
Servicing Corporation and MCS, in which FirstCity Servicing Corporation is an 11.89% shareholder as of December 31, 2007, are parties to Consulting, License and
Confidentiality Agreements dated June 30, 1999 pursuant to which FirstCity Servicing Corporation provides consultation services and personnel to be employed by MCS to assist in developing and
managing due diligence and servicing systems. Pursuant to those agreements, MCS agrees to provide the supplied personnel with compensation, tax equalization payments, housing allowances,
transportation allowance, tax preparation and MCS pays consulting fees to FirstCity Servicing Corporation and reimburses FirstCity Servicing Corporation for travel, hotel, airfare, and meal expenses
paid by it related to the provision of the services. EuroTex Partners, Ltd., a subsidiary of FirstCity Commercial Corporation, purchased real and personal property used as a personal residence
of the supplied employee in Paris, France for a purchase price of $2.2 million. FirstCity recorded $443, $344 and $364 in 2007, 2006 and 2005, respectively, from MCS as fees included in other
income.

In
February 2007, the Company, through its majority-owned subsidiary ABL, acquired a portfolio of SBA loans and servicing assets from Prosperity Bank for $36.8 million. FirstCity
Directors, Robert E. Garrison II and D. Michael Hunter also serve as Directors of Prosperity Bank.

In
April 2007, FirstCity entered into a special situations platform that will buy or finance distressed debt and companies, originate junior and senior bridge loans, and execute lower
middle market buyouts through its 80% investment in FirstCity Denver Investment Corp. The other 20% interest in FirstCity Denver Investment Corp. is owned by Crestone Capital LLC, a Colorado
limited liability company that is owned by Richard W. Horrigan and Stephen C. Schmeltekopf. Mr. Horrigan, President of FirstCity Denver Investment Corp., and Mr. Schmeltekopf, Senior
Vice President of FirstCity Denver Investment Corp., are employees of FirstCity Denver Investment Corp. and have employment contracts with FirstCity Denver Investment Corp. Stephen Schmeltekopf is the
brother of Andrew Schmeltekopf, Senior Vice President of FirstCity Servicing.

15. Commitments and Contingencies



FirstCity and certain of its subsidiaries and affiliates (including Acquisition Partnerships) are involved in various claims and legal proceedings arising in the
ordinary course of business. In view of the inherent difficulty of predicting the outcome of pending legal actions and proceedings, the Company cannot state with any certainty the eventual outcome of
any such proceedings. Based on current knowledge, management does not believe that liabilities, if any, arising from any single ordinary course proceeding will have a material adverse effect on the
consolidated financial condition, operations, results of operations or liquidity of the Company.

96

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

15. Commitments and Contingencies (Continued)



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 LLC (formerly FH Partners, L.P.) and FirstCity Servicing Corporation, each an indirectly wholly-owned subsidiary of FirstCity, and FirstCity
Financial Corporation as defendants in a suit filed by Plaintiffs against State Bank and Cole Harmonson before the 98th Judicial District Court of Travis County, Texas. FirstCity
Financial Corporation was served with Plaintiff's Notice of Nonsuit Without Prejudice in the suit on April 25, 2007. In the First Amended Petition the Plaintiffs sought unspecified damages for
breach of contract and conversion related to alleged breaches by FH Partners LLC ("FH Partners") and FirstCity Servicing Corporation in connection with a loan agreement related to a loan from
State Bank to Plaintiffs that was purchased by FH Partners from State Bank on December 22, 2006. The Plaintiffs also raised other claims solely against the other defendants. The Plaintiffs
allege that they entered into a loan or line of credit with State Bank and that due to an error by State Bank the Plaintiffs borrowed more on the line of credit than was allowed under the borrowing
base. The Plaintiffs further allege that State Bank entered in an agreement with Plaintiffs that the default by Plaintiffs would be cured if the Plaintiffs pledged additional property to secure the
loans and that the Plaintiffs would be allowed to borrow under the line of credit. Plaintiffs allege that State Bank, and subsequently FH Partners, have refused to honor the agreement by State Bank
concerning the pledge of the additional property. On July 25, 2007, counsel for FH Partners received a Second Amended Petition in which the Plaintiffs allege that they have sustained actual
damages of $165 million as a result of the joint actions of State Bank, Cole Harmonson, FH Partners and FirstCity Servicing Corporation. The Plaintiffs assert claims against FH Partners and
FirstCity Servicing Corporation for breach of contract, conversion, civil conspiracy, tortious interference with prospective economic relationships and usury related to FH Partners and FirstCity
Servicing Corporation treating the loans that FH Partners purchased from State Bank as being in default, retaining payments delivered to the lockbox for the loan, retaining mortgage loan files that
the Plaintiffs allege were unrelated to the loan agreement, interfering with contracts and relationships of the Plaintiffs by such actions, and charging interest higher than the maximum amount allowed
under the Texas Finance Code. The Plaintiffs additionally seek recovery of statutory penalties under the Texas Finance Code and attorney's fees. The Plaintiffs have made additional claims against the
other defendants alleging promissory estoppel, fraud and business disparagement. On or about October 5, 2007, Plaintiffs' counsel suggested that his clients were considering
non-suiting their claims against FH Partners and FirstCity Servicing Corporation. Therefore, instead of counter-claiming against the Plaintiffs in the same suit for the indebtedness owed
under the loan, on October 9, 2007, FH Partners filed a separate collection suit against the Plaintiffs and guarantors Jason Herring and Kimberly Herring, now known as Kimberly McCormick.
Plaintiffs' counsel has subsequently indicated that he had misunderstood the positions of the parties, that a non-suit is not likely to occur and that he will probably seek to consolidate
the collection suit with the original action. All defendants in the collection suit have answered. Prosperity Bank, FH Partners and FirstCity Servicing Corporation filed motions for summary judgment
in the original suit based upon a General Release and Indemnity Agreement. Shortly before the hearing on the summary judgment motions, the Plaintiffs filed their third amended petition to add
Grandview Homes, Inc. as an additional plaintiff, to allege some of the previous claims against FH Partners and FirstCity Servicing Corporation as well as Prosperity Bank and

97

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

15. Commitments and Contingencies (Continued)

to
state additional claims for negligent misrepresentation, tortious interference with property rights, fraud in the inducement, duress, lack of consideration, unconscionability, estoppel and waiver.
Since
these additional parties and claims were not addressed by the summary judgment motions, the hearings were postponed. On or about December 14, 2007, Plaintiffs filed their fourth amended
petition, which added the claim that the general release is invalid for lack of mutuality of obligation and for failure to meet the express negligence test. One deposition has been taken and
Plaintiffs have engaged in written discovery with Prosperity Bank and sent written discovery to FH Partners and FirstCity Servicing Corporation, but have suspended the deadlines to respond while the
parties are discussing settlement. FirstCity does not have sufficient information to estimate any potential liability or probability of liability, but is unaware of any factual or legal basis for
liability. If a settlement is not reached, FirstCity intends to contest the case vigorously.



On January 19, 2005, Prudential Financial, Inc. ("Prudential") filed a petition in interpleader seeking to interplead 321,211 shares of Prudential
common stock and any associated dividends arising from the demutualization of Prudential in December 2000. The shares of Prudential common stock related to group annuity contracts purchased by
First-City National Bank of Houston, as trustee of the First City Bancorporation Employee Retirement Trust (the "Trust") to fund obligations to participants in the First City
Bancorporation Employee Retirement Plan (the "Plan") in connection with termination of the Plan and the Trust in 1987. FirstCity, FCLT Loans Asset Corp. ("FCLT"), an alleged assignee of the FirstCity
Liquidating Trust, JP Morgan Chase Bank, National Association ("JP Morgan"), and First-City National Bank of Houston as trustee of the Trust were made defendants in the suit as claimants
to the Prudential common stock and dividends. An agreed order dated January 27, 2005, was entered by the Court providing that the Prudential common stock be transferred to JP Morgan as record
owner and that JP Morgan sell the stock. The January 27, 2005 order also provided that the proceeds from the sale be held by JP Morgan pending resolution, by agreement or court order, of all
conflicting claims to the proceeds. JP Morgan advised that the Prudential common stock was sold on January 28, 2005 for total proceeds of approximately $17.5 million. JP Morgan also
received funds in the amount of approximately $489,000, which were dividend payments related to the Prudential common stock. JP Morgan filed a third party action naming Mr. Blair as a third
party defendant with an alleged interest in the demutualization proceeds. On October 1, 2005, the court certified a class represented by Mr. Blair.

On
March 21, 2006, FirstCity received notice that the 152nd District Court, Harris County, Texas granted FirstCity's motion for partial summary judgment. The
order granting FirstCity's motion for partial summary judgment rendered judgment in favor of FirstCity as to the ownership of the demutualization proceeds. The Court's summary judgment order also
denied the claims to ownership of the demutualization proceeds by FCLT and Mr. Blair, individually and as representative of the proposed class of employee beneficiaries. The motions submitted
to the Court prior to its order dated March 21, 2006 did not address all matters pending in the lawsuit. Mr. Blair, as class representative, filed a motion for new trial to set aside the
summary judgment in favor of FirstCity and for reconsideration of granting Mr. Blair's motion for summary judgment. FCLT filed a motion for the

98

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

15. Commitments and Contingencies (Continued)

Court
to reconsider its order granting the partial summary judgment for FirstCity. FirstCity moved for summary judgment on all remaining claims and for entry of a final judgment on May 12,
2006. On August 14, 2006, the Court entered an order (i) finding that FirstCity is the sole owner of the "demutualization proceeds" being the proceeds from the sale of the 321,211 shares
of Prudential Financial, Inc. stock, the dividends on such shares and all accrued interest and income arising there from, (2) granting FirstCity's motion for summary judgment against
FCLT's claims for breach of contract and tortious interference, (3) providing that JP Morgan continue to hold the demutualization proceeds until the appellate process has been completed,
(4) denying the request by FirstCity that FCLT or Mr. Blair be required to post bond or other form of security on appeal, and (5) denying all other claims for relief. FCLT and
Mr. Blair filed notices of appeal to the First or Fourteenth Court of Appeals of the State of Texas. The appeal has been assigned to the First Court of Appeals and all parties have filed their
briefs with the Court. The parties participated in Court ordered mediation on February 13, 2007 which was unsuccessful. FirstCity cannot give any assurances as to the time period for the appeal
of the final judgment or the timing of receipt or ultimate amount of proceeds to be received, if any.

In
the trial court, FCLT filed a counterclaim against FirstCity claims for damages related to alleged breaches of contract by FirstCity related to failure to assign the proceeds to FCLT
and FirstCity's assertion of a claim to the proceeds and a claim for tortious interference by FirstCity as a result of FirstCity's claim for the proceeds. In connection with that claim, FCLT seeks to
recover attorney's fees and other damages related to the assertion by FirstCity of an interest in the shares of Prudential common stock. No amount has been asserted by FCLT Loans Asset Corp. and the
company does not believe that its actions give rise to a claim by FCLT Loans Asset Corp. The trial court denied these claims of FCLT in its orders resolving claims with respect to the motions for
summary judgment filed by each of the parties. The appeal by FCLT seeks to overturn the summary judgment rendered against it with respect to these claims. FirstCity believes that the claims of FCLT
are without merit and that it has valid defenses to these claims.



On September 21, 2004, FirstCity, FirstCity Consumer Corporation ("Consumer Corp."), FirstCity Funding LP ("Funding LP") and FirstCity
Funding GP ("Funding GP") entered into the a Securities Purchase Agreement to sell a 31% beneficial ownership interest in Drive and its general partner, Drive GP LLC, to
IFA-GP, IFA-LP and MG-LP (the "2004 Securities Purchase Agreement"). In the 2004 Securities Purchase Agreement, FirstCity, Consumer Corp., Funding LP and
Funding GP made various representations and warranties concerning (i) their respective organizations, (ii) their power and authority to enter into the 2004 Securities Purchase
Agreement and the transactions contemplated therein, (iii) the ownership of the limited partnership interests in Drive by Funding LP, (iv) the ownership of membership interests in
Drive-GP by Consumer Corp., and (iv) the capital structure of Funding LP. FirstCity, Consumer Corp., Funding LP and Funding GP also agreed to indemnify BoS
(USA), IFA-GP, IFA-LP and MG-LP from damages resulting from a breach of any representation or warranty contained in the 2004 Securities Purchase Agreement or
otherwise made by FirstCity, Consumer Corp. or Funding LP in connection with the transaction. The indemnity obligations under

99

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

15. Commitments and Contingencies (Continued)

the
2004 Securities Purchase Agreement survive for a maximum period of five (5) years from November 1, 2004. Neither FirstCity, Consumer Corp., Funding LP, or Funding GP is
required to make any payments as a result of the indemnity provided under the 2004 Securities Purchase Agreement until the aggregate amount payable exceeds $0.25 million, and then only for the
amount in excess of $0.25 million in the aggregate; however certain representations and warranties are not subject to this $0.25 million threshold. Management of the Company believes
that FirstCity will not have to pay any amounts relating to these representations and warranties.

On
August 8, 2006, an Interest Purchase and Sale Agreement was entered into by and among Bidmex Holding, LLC ("Buyer"), as buyer, and Strategic Mexican Investment
Partners, L.P. ("SMIP"), an affiliate of the Company and Cargill Financial Services International, Inc. ("CFSI"), (collectively, the "Sellers"), as seller, and eleven U.S. limited
liability companies ("LLCs") which invested in Mexican portfolio acquisition entities ("SRLs") and the AIG entities as additional parties. In the Interest Purchase and Sale Agreement, the Sellers and
the LLCs made various representations and warranties concerning (i) the existence and ownership of the LLCs and the related SRLs, (ii) the assets and liabilities of
the LLCs, (iii) taxes related to periods prior to August 8, 2006, and (iv) the operations of the LLCs and SRLs. The Sellers agreed to indemnify the Buyer and AIG
Entities from damages resulting from a breach of any representation or warranty contained in the Interest Purchase and Sale Agreement on a several and not joint basis according to their respective
ownership percentages in each LLC as to any matter related to a particular LLC, or on the basis of 80% to CFSI and 20% to SMIP as to any matter that could not be identified to a
particular LLC. The indemnity obligation under the Interest Purchase and Sale Agreement survives for a period of the statute of limitations for matters related to taxes, existence and
authority, capitalization and good standing of the LLCs and SRLs and for a period of two years from August 8, 2006, the closing date with respect to all other representations and
warranties. The Sellers are not required to make any payments as a result of the indemnity provisions of the Interest Purchase and Sale Agreement until the aggregate amount payable under that
agreement and the Asset Purchase Agreement exceeds $0.25 million; however, claims related to taxes and fraud are not subject to this $0.25 million threshold. The Interest Purchase and
Sale Agreement limits the liability
of the Sellers for indemnifiable losses under the Interest Purchase and Sale Agreement and the Asset Purchase Agreement to the Aggregate Purchase Price (without duplication of amounts recovered
pursuant to the terms of the Asset Purchase Agreement). FirstCity does not believe that the potential liability would have a material adverse effect on the consolidated financial position, 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 Loans and Litigious Rights (the "Asset Purchase Agreement") between and
among Residencial Oeste, S. de R.L. de C.V., as seller (the "Asset Seller"), an affiliate of CFSI and SMIP, Residencial Oeste 2, S. de R.L. de C.V., as purchaser (the "Asset Purchaser"), and CFSI,
SMIP, and Bidmex Acquisition, LLC, the parent of the Asset Purchaser, as additional parties. The Asset Purchase Agreement provides for the sale of the loan portfolio owned by the Seller to the
Purchaser for a purchase price of $10.1 million on the closing date, which purchase price is part of the Aggregate Purchase Price. In the Asset Purchase Agreement, the Asset Seller and the
Sellers made various

100

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

15. Commitments and Contingencies (Continued)

representations
and warranties concerning (i) the existence and ownership of the Seller, (ii) the ownership of the loan portfolio, (iii) taxes related to periods arising prior to
the closing date, and (iv) the existence of the loans comprising the loan portfolio and other matters related to the loan portfolio. The Asset Seller agreed to indemnify the Asset Purchaser
from damages resulting from a breach of any representation or warranty. The indemnity obligation under the Asset Purchase Agreement survives for a period of the statute of limitations for matters
related to existence and ownership of the Seller, ownership of the loans, and taxes for periods prior to August 8, 2006, and for a period of two years from August 8, 2006, with respect
to all other representations and warranties. The Seller is not required to make any payments as a result of the indemnity provisions of the Asset Purchase Agreement until the aggregate amount payable
under that Agreement exceeds $25; however, claims related to taxes and fraud are not subject to this $25 threshold. The Interest Purchase and Sale Agreement limits the liability of the Sellers for
indemnifiable losses under the Asset Purchase Agreement to the Aggregate Purchase Price. FirstCity does not believe that the potential liability would have a material adverse effect on the
consolidated financial position, results of operations or liquidity of FirstCity, its subsidiaries, its affiliates or the Acquisition Partnerships.



In connection with the 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, granted a put option dated August 8, 2006 to Bidmex Holding, LLC, as optionee, pursuant to 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 put option to Bidmex Holding, LLC related to the purchase of any loan of Solución
de 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 by those entities has filed or
files a challenge in a legal proceeding related to any such loan based on, in addition to any other defense claims, a claim on grounds related to the Mexican Supreme Court Ruling that has put
into issue the actions required for transfer of loans by Mexican financial institutions after August 2003, provided that any such challenge
is asserted on or before the earlier of (i) the reversal of the Supreme Court Ruling, or (ii) February 1, 2008. The purchase price for any loan under the put option is to be the
allocated purchase price set by the parties for the loan, plus certain expenses related to the transfer and collection of the loan, plus any taxes paid or payable with respect to the cash flow from
each loan, reduced by any cash flow received by Bidmex Holding, LLC with respect to the loan. Pursuant to the put option agreement, Bidmex Holding, LLC must deliver to RCM and other
parties a written notice of its intent to exercise the put option as to any qualifying loan on or before April 1, 2008.

Financial
Security Assurance Inc. ("FSA"), in its capacity 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 capacities as seller and master servicer, and The Bank of New York, in its capacity as
trustee, made demand on FC Capital Corp. to repurchase certain loans that were subject to repurchase due to fraud of third parties in connection with the origination of the loans. FC Capital Corp.
agreed to provide a letter of credit in the amount of the repurchase price for the loans in lieu of being required to purchase the loans from

101

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

15. Commitments and Contingencies (Continued)

the
Trust. FirstCity has obtained and delivered to FSA, for the benefit of FC Capital Corp., an irrevocable letter of credit in the amount of $0.5 million from the Bank of Scotland. Pursuant to
the agreement with FSA, FC Capital Corp. will have the option to purchase the loans for $0.5 million prior to a call under the letter of credit.



On November 5, 2007, Fondo de Inversion Privado NPL Fund One ("PIF1"), an equity investment of FirstCity Chile, Ltda., entered into a revolving line
of credit with a maximum loan amount of $15.0 million with Banco Santander Chile, S.A. The proceeds were used to acquire a loan portfolio at face value from FirstCity NPL S.A. (a
consolidated affiliate of FirstCity Chile, Ltda.) and to finance the purchase of other loan portfolios from non-affiliated parties. Pursuant to terms of the credit facility,
FirstCity was required to provide a stand-by letter of credit from Bank of Scotland that would satisfy the maximum loan balance upon demand. At December 31, 2007, FirstCity had a
letter of credit in the amount of $15.0 million from Bank of Scotland under the terms of FirstCity's revolving acquisition facility with Bank of Scotland, with Banco Santander
Chile, S.A. as the letter of credit beneficiary. In the event that a demand is made under the $15.0 million letter of credit, FirstCity is required to reimburse Bank of Scotland by
making payment to Bank of Scotland for all amounts disbursed or to be disbursed by Bank of Scotland under the letter of credit.

On
November 29, 2006, FirstCity Mexico SA de CV, a Mexican affiliate of FirstCity, entered into a revolving line of credit with a maximum loan amount in Mexican pesos
equivalent to $13.5 million with Banco Santander, S.A. The proceeds were used to pay down the acquisition facility with the Bank of Scotland. Pursuant to the terms of the credit
facility, FirstCity Mexico SA de CV was required to
provide a stand-by letter of credit from Bank of Scotland that would satisfy the loan balance upon demand. At December 31, 2007, FirstCity had a letter of credit in the amount of
$14.1 million from Bank of Scotland under the terms of FirstCity's revolving acquisition facility with Bank of Scotland. In the event that a demand is made under the $14.1 million letter
of credit, FirstCity is required to reimburse Bank of Scotland by making payment to Bank of Scotland for all amounts disbursed or to be disbursed 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 and acquiring SBA loans. The obligations under this facility are secured by substantially all of the assets of ABL. At December 31, 2007, the balance of this facility
was $7.6 million. In connection with the first amendment to this facility on February 27, 2007, FirstCity provided WFF with an unconditional guaranty, up to a maximum of
$5 million plus enforcement cost, of the obligations of ABL under the loan facility that relate to funds in the amount of $31.7 advanced by WFF to ABL in connection of a portfolio of SBA loans
in February 2007. This guaranty will remain in effect until the obligations incurred in connection with the advance related to the acquisition of the portfolio of SBA loans are paid in full.

102

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

15. Commitments and Contingencies (Continued)



FirstCity has minority interests in various limited-life partnerships with a net carrying value of ($271) at December 31, 2007. The estimated
amount that would be paid to the minority interest holder if the instruments were to be settled at December 31, 2007 is $1.3 million.

16. Financial Instruments

SFAS No. 107,Disclosures about Fair Value of Financial Instruments,requires that the Company disclose
estimated fair values of its financial instruments. The fair value estimates as of December 31, 2007 and
2006 were based on pertinent information that was available to management as of the respective dates. Although management is not aware of any factors that would significantly affect the estimated fair
value amounts, such amounts have not been revalued for purposes of these financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the
amounts presented.

The
following describes the methods and assumptions used by the Company in estimating fair values.



The carrying amount of cash and cash equivalents approximated fair value at December 31, 2007 and 2006.



The Portfolio Assets and loans receivable are carried at the lower of cost or estimated fair value. Estimated fair values of Portfolio Assets and
fixed-rate loans receivable are calculated by discounting projected cash flows on an asset-by-asset basis using estimated market discount rates that reflect the
credit and interest rate risks inherent in the assets. For variable-rate loans receivable that generally re-price when market rates change and with no significant change in
credit risk, fair values are based on carrying values. The carrying values of Portfolio Assets and loans receivable was $147.8 million and $137.4 million, respectively, at
December 31, 2007 and 2006. The estimated fair values of Portfolio Assets and loans receivable was approximately $164.1 million and $149.6 million, respectively, at
December 31, 2007 and 2006.



The Company relies primarily on a combination of a discounted cash flow model of future net servicing income and analysis of current market data to estimate the
fair value of its servicing assets. The key assumptions used to calculate estimated fair value of the servicing assets include prepayment speeds and a market discount rate. The fair value estimate
excludes the value of the servicing rights for loans sold in which the servicing rights have not been capitalized.

103

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

16. Financial Instruments (Continued)



Through December 31, 2003, residual interests in securitizations included in discontinued mortgage operations were carried at estimated future gross cash
receipts. The estimated fair value was calculated using various assumptions regarding prepayment speeds and credit losses. Beginning in December 2004, the residual interests are carried at fair value.
The carrying value of the residual interests was $0.2 million and $0.1 million at December 31, 2007 and 2006, respectively.



Management believes that the repayment terms for similar rate financial instruments with similar credit risks and the stated interest rates at December 31,
2007 and 2006 approximate the market terms for similar credit instruments. Accordingly, the carrying amount of notes payable is believed to approximate fair value.

17. Business Acquisitions

In August 2007, the Company acquired through one of its consolidated subsidiaries 100% of the ownership interests of East Penn Railroad LLC ("East Penn")
for $5.9 million in cash. East Penn owns and operates a short line freight railroad in the Northeastern United States. The acquisition has been accounted for as a purchase business combination.
The results of East Penn's operations since the acquisition date have been included in the consolidated financial statements. The following table summarizes the calculation of estimated fair value of
the assets acquired and liabilities assumed at the date of acquisition.

Cash

$
274Property and equipment


7,365Other assets


645Total assets acquired


8,284Deferred grant income


1,929Other liabilities


382Total liabilities assumed


2,311Net assets acquired

$
5,973


At
December 31, 2007, the Company's consolidated balance sheet includes $8.2 million of property, equipment and other assets in "Other assets, net" and $2.5 million
of deferred grant income and other liabilities in "Other liabilities" related to East Penn's accounts.

18. Servicing AssetsSBA Loans

In February 2007, the Company, through its subsidiary American Business Lending, Inc. ("ABL"), acquired a portfolio of SBA loans for
$36.8 million. Included in the purchase price were the rights to

104

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

18. Servicing AssetsSBA Loans (Continued)

service
additional loans with an unpaid balance of $33.8 million. The Company recorded a servicing asset of $758 relating to these servicing rights. Additional servicing rights have been
capitalized since the portfolio acquisition as a result of loans sold. Servicing rights are recognized as assets when the SBA loans are sold and the rights to service those loans are retained. The
Company retains servicing responsibilities and receives servicing fees of approximately 1%.

Servicing
assets are initially measured at fair value at the date of sale. Subsequent to the sale, the Company accounts for servicing assets by using the amortization method, which
amortizes servicing assets in proportion to and over the period of estimated net servicing income. The Company periodically evaluates the possible impairment of servicing assets based on the
difference between the carrying amount and current fair value of the servicing assets.

Changes
in the Company's amortized servicing assets are as follows:

Year ended December 31,2007

2006

2005Beginning Balance

$


$


$
Servicing Assets capitalized


1,058





Servicing Assets amortized


(173
)




Ending Balance

$
885

$


$
Reserve for impairment of servicing assets:Beginning Balance

$


$


$
Impairments


(93
)




Recoveries


51





Charge Offs








Ending Balance

$
(42
)
$


$
Ending Balance (net of reserve)

$
843

$


$
Fair value of amortized servicing assets:Beginning balance

$


$


$
Ending balance

$
843

$


$



The
Company relies primarily on a discounted cash flow model to estimate the fair value of its servicing assets. The model calculates estimated fair value of the servicing assets using
predominant risk characteristics of servicing assets such as discount rate, prepayment speed, weighted average life of the
loans sold and the interest rate. The estimated fair value of servicing assets was determined using discount rates ranging from 9.75% to 11.19%, prepayment speeds of 15%, and weighted average lives
ranging from 75 to 299 months. In the event future prepayments are significant or impairments are incurred and future expected cash flows are inadequate to cover the unamortized servicing
assets, additional amortization or impairment charges would be recognized.

105

Table of Contents

---



FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006 and 2005

(Dollars in thousands, except per share data)

19. Selected Quarterly Financial Data (Unaudited)

The following are summarized quarterly financial data for the years ended December 31, 2007 and 2006:

|                                                             |  | 2007 |        | 2006
|------------------------------------------------------------ |  | ---- | ------ | ----
|
|
|
|Revenues                                                     |  | $    | 9,721  |     
|Expenses                                                     |  |      | 12,503 |     
|Equity in earnings of investments                            |  |      | 1,826  |     
|Gain on sale of subsidiaries and equity investments          |  |      |       |     
|Earnings (loss) from continuing operations                   |  |      | (915   | )   
|Loss from discontinued operations                            |  |      |       |     
|Net earnings (loss) to common stockholders                   |  |      | (915   | )   
|Earnings (loss) from continuing operations per common share |  |      |        |     
|Basic                                                        |  | $    | (0.08  | )   
|Diluted                                                      |  | $    | (0.08  | )   

106

Table of Contents

---





REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Board of Directors and Stockholders
FirstCity Financial Corporation:

We
have audited the accompanying consolidated balance sheets of FirstCity Financial Corporation and subsidiaries as of December 31, 2007 and 2006, and the related consolidated
statements of operations, stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2007. These consolidated
financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FirstCity Financial Corporation and
subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31,
2007, in conformity with U.S. generally accepted accounting principles.

As
discussed in note 1 to the consolidated financial statements, as of January 1, 2007, the Company adopted the provisions of Financial Accounting Standards Board
Interpretation No. 48,Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement No. 109, and the
provisions of Statement of Financial Accounting Standards No. 156,Accounting for Servicing of Financial Assetsan amendment of FASB Statement
No. 140. As discussed in note 1 to the consolidated financial statements, as of January 1, 2006 the Company adopted the provisions of Statement of
Financial Accounting Standards No. 123(R),Share-Based Payment, and as of December 31, 2006, the Company adopted the Securities and
Exchange Commission Staff Accounting Bulletin No. 108,Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial
Statements.

We
also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), FirstCity Financial Corporation's internal control over financial
reporting as of December 31, 2007, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), and our report dated March 17, 2008, expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.

KPMG LLP

Dallas,
Texas
March 17, 2008

107

Table of Contents

---



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Board of Directors and Stockholders
FirstCity Financial Corporation:

We
have audited FirstCity Financial Corporation's internal control over financial reporting as of December 31, 2007, based on criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). FirstCity Financial Corporation's management is responsible for
maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's
Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

We
conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our
audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A
company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In
our opinion FirstCity Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on criteria
established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We
also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of FirstCity Financial
Corporation and subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of operations,
stockholders' equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2007, and our report dated March 17, 2008,
expressed an unqualified opinion on those consolidated financial statements.

KPMG LLP

Dallas,
Texas
March 17, 2008

108

Table of Contents

---





WAMCO PARTNERSHIPS        COMBINED FINANCIAL STATEMENTS  December 31, 2007, 2006 and 2005  (With Report of Independent Registered Public Accounting Firm)

109

Table of Contents

---





REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The
Partners
WAMCO Partnerships:

We
have audited the accompanying combined balance sheets of the WAMCO Partnerships as of December 31, 2007 and 2006, and the related combined statements of operations, changes in
partners' capital, and cash flows for each of the years in the three-year period ended December 31, 2007. These combined financial statements are the responsibility of the
Partnerships' management. Our responsibility is to express an opinion on these combined financial statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the combined financial statements referred to above present fairly, in all material respects, the financial position of the WAMCO Partnerships as of December 31,
2007 and 2006, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007, in conformity with U.S. generally
accepted accounting principles.

As
discussed in note 2 to the combined financial statements, as of December 31, 2006, the Company adopted the Securities and Exchange Commission Staff Accounting Bulletin
No. 108,Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in the Current Year Financial Statements.

KPMG LLP

Dallas,
Texas
March 17, 2008

110

Table of Contents

---





WAMCO PARTNERSHIPS        COMBINED BALANCE SHEETS        December 31, 2007 and 2006

|                                                                                             |                   | 2007 |        | 2006  
|-------------------------------------------------------------------------------------------- | ----------------- | ---- | ------ | ------
|
|ASSETS                                                                                       |                   |      |        |       
|Cash                                                                                         |                   | $    | 5,946  |       
|Portfolio Assets, net                                                                        |                   |      | 80,325 |       
|Other assets, net                                                                            |                   |      | 815    |       
|                                                                                             |                   |      |        |       
|                                                                                             |                   | $    | 87,086 |       
|                                                                                             |                   |      |        |       
|LIABILITIES AND PARTNERS' CAPITAL                                                            |                   |      |        |       
|Notes payable                                                                                |                   | $    | 40,525 |       
|Other liabilities (including $1,481 and $1,799 to affiliates in 2007 and 2006, respectively) |                   |      | 2,252  |       
|                                                                                             |                   |      |        |       
|                                                                                             | Total liabilities |      |        | 42,777
|Partners' capital                                                                            |                   |      | 44,309 |       
|                                                                                             |                   |      |        |       
|                                                                                             |                   | $    | 87,086 |       
|                                                                                             |                   |      |        |       

See
accompanying notes to combined financial statements.

111

Table of Contents

---





WAMCO PARTNERSHIPS        COMBINED STATEMENTS OF OPERATIONS        Years Ended December 31, 2007, 2006 and 2005

|                                               |  | 2007 |         | 2006 |   | 2005    |  
|---------------------------------------------- |  | ---- | ------- | ---- | - | ------- | -
|
|Income from Portfolio Assets                   |  | $    | 17,764  |      | $ | 24,577  |  
|Other income, net                              |  |      | 190     |      |   | 1,559   |  
|                                               |  |      |         |      |   |         |  
|Revenues                                       |  |      | 17,954  |      |   | 26,136  |  
|                                               |  |      |         |      |   |         |  
|Interest and fees on notesaffiliate           |  |      |        |      |   | (467    | )
|Interest and fees on notes payableother       |  |      | (2,782  | )    |   | (3,409  | )
|Provision for loan and impairment losses       |  |      | (4,883  | )    |   | (1,803  | )
|Servicing feesaffiliate                       |  |      | (2,314  | )    |   | (3,659  | )
|General, administrative and operating expenses |  |      | (3,332  | )    |   | (3,466  | )
|                                               |  |      |         |      |   |         |  
|Expenses                                       |  |      | (13,311 | )    |   | (12,804 | )
|                                               |  |      |         |      |   |         |  
|Net earnings                                   |  | $    | 4,643   |      | $ | 13,332  |  
|                                               |  |      |         |      |   |         |  

See
accompanying notes to combined financial statements.

112

Table of Contents

---





WAMCO PARTNERSHIPS        COMBINED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL        Years Ended December 31, 2007, 2006 and 2005

|                                                                                        |                             | Class A Equity |   | Class B Equity |   |   |     |   |     |      |  
|--------------------------------------------------------------------------------------- | --------------------------- | -------------- | - | -------------- | - | - | --- | - | --- | ---- | -
|
|
|Balance at December 31, 2004                                                            |                             | $              |  |                | $ |  |     | $ | 789 |      | $
|                                                                                        | Contributions               |                |   |               |   |   |    |   |     |     |  
|                                                                                        | Distributions               |                |   | (1             | ) |   | (43 | ) |     | (789 | )
|                                                                                        | Comprehensive income:       |                |   |                |   |   |     |   |     |      |  
|                                                                                        | Net earnings                |                |   | 1              |   |   | 43  |   |     |     |  
|                                                                                        |                             |                |   |                |   |   |     |   |     |      |  
|                                                                                        | Total comprehensive income  |                |   | 1              |   |   | 43  |   |     |     |  
|                                                                                        |                             |                |   |                |   |   |     |   |     |      |  
|Balance at December 31, 2005                                                            |                             |                |  |                |   |  |     |   |    |      |  
|Cumulative effect of adjustments resulting from the adoption of SAB No. 108 (Note 2(f)) |                             |                |  |                |   |  |     |   |    |      |  
|                                                                                        | Contributions               |                |   |               |   |   |    |   |     |     |  
|                                                                                        | Distributions               |                |   |               |   |   |    |   |     |     |  
|                                                                                        | Change in combined entities |                |   |               |   |   |    |   |     |     |  
|                                                                                        | Comprehensive income:       |                |   |                |   |   |     |   |     |      |  
|                                                                                        | Net earnings                |                |   |               |   |   |    |   |     |     |  
|                                                                                        |                             |                |   |                |   |   |     |   |     |      |  
|                                                                                        | Total comprehensive income  |                |   |               |   |   |    |   |     |     |  
|                                                                                        |                             |                |   |                |   |   |     |   |     |      |  
|Balance at December 31, 2006                                                            |                             |                |  |                |   |  |     |   |    |      |  
|                                                                                        | Contributions               |                |   |               |   |   |    |   |     |     |  
|                                                                                        | Distributions               |                |   |               |   |   |    |   |     |     |  
|                                                                                        | Comprehensive income:       |                |   |                |   |   |     |   |     |      |  
|                                                                                        | Net earnings                |                |   |               |   |   |    |   |     |     |  
|                                                                                        |                             |                |   |                |   |   |     |   |     |      |  
|                                                                                        | Total comprehensive income  |                |   |               |   |   |    |   |     |     |  
|                                                                                        |                             |                |   |                |   |   |     |   |     |      |  
|Balance at December 31, 2007                                                            |                             | $              |  |                | $ |  |     | $ |    |      | $
|                                                                                        |                             |                |   |                |   |   |     |   |     |      |  

See
accompanying notes to combined financial statements.

113

Table of Contents

---





WAMCO PARTNERSHIPS        COMBINED STATEMENTS OF CASH FLOWS        Years Ended December 31, 2007, 2006 and 2005

|                                      |                                                                                     | 2007                                                              |                                           | 2006  |         | 2005    |       
|------------------------------------- | ----------------------------------------------------------------------------------- | ----------------------------------------------------------------- | ----------------------------------------- | ----- | ------- | ------- | ------
|
|Cash flows from operating activities: |                                                                                     |                                                                   |                                           |       |         |         |       
|                                      | Net earnings                                                                        |                                                                   | $                                         | 4,643 |         | $       | 13,332
|                                      | Adjustments to reconcile net earnings to net cash provided by operating activities: |                                                                   |                                           |       |         |         |       
|                                      |                                                                                     | Amortization of loan origination and commitment fees              |                                           |       | 207     |         |       
|                                      |                                                                                     | Amortization of deferred profit sharing                           |                                           |       |        |         |       
|                                      |                                                                                     | Provision for loan and impairment losses                          |                                           |       | 4,883   |         |       
|                                      |                                                                                     | Income from Portfolio Assets                                      |                                           |       | (17,764 | )       |       
|                                      |                                                                                     | Purchase of Portfolio Assets                                      |                                           |       | (20,434 | )       |       
|                                      |                                                                                     | Advances net of receipts on Portfolio Asset lines of credit       |                                           |       | (4,502  | )       |       
|                                      |                                                                                     | Capitalized costs and interest on Portfolio Assets                |                                           |       | (275    | )       |       
|                                      |                                                                                     | Proceeds applied to principal on Portfolio Assets                 |                                           |       | 65,508  |         |       
|                                      |                                                                                     | Excess of distribution over cost from partnership carried at cost |                                           |       |        |         |       
|                                      |                                                                                     | (Increase) decrease in deferred profit sharing                    |                                           |       |        |         |       
|                                      |                                                                                     | (Increase) decrease in other assets                               |                                           |       | (138    | )       |       
|                                      |                                                                                     | Increase (decrease) in deferred compensation                      |                                           |       |        |         |       
|                                      |                                                                                     | Deferred compensation and profit sharing paid                     |                                           |       |        |         |       
|                                      |                                                                                     | Increase (decrease) in other liabilities                          |                                           |       | (664    | )       |       
|                                      |                                                                                     |                                                                   |                                           |       |         |         |       
|                                      |                                                                                     |                                                                   | Net cash provided by operating activities |       |         | 31,464  |       
|                                      |                                                                                     |                                                                   |                                           |       |         |         |       
|Cash flows from investing activities: |                                                                                     |                                                                   |                                           |       |         |         |       
|                                      |                                                                                     | Distributions from partnership                                    |                                           |       |        |         |       
|                                      |                                                                                     | Change in combined entities                                       |                                           |       |        |         |       
|                                      |                                                                                     |                                                                   |                                           |       |         |         |       
|                                      |                                                                                     |                                                                   | Net cash provided by investing activities |       |         |        |       
|                                      |                                                                                     |                                                                   |                                           |       |         |         |       
|Cash flows from financing activities: |                                                                                     |                                                                   |                                           |       |         |         |       
|                                      |                                                                                     | Borrowing of debtaffiliate                                       |                                           |       |        |         |       
|                                      |                                                                                     | Borrowing of debt                                                 |                                           |       | 38,500  |         |       
|                                      |                                                                                     | Repayment of debtaffiliate                                       |                                           |       |        |         |       
|                                      |                                                                                     | Repayment of debt                                                 |                                           |       | (42,114 | )       |       
|                                      |                                                                                     | Capital contributions                                             |                                           |       | 20,433  |         |       
|                                      |                                                                                     | Capital distributions                                             |                                           |       | (50,346 | )       |       
|                                      |                                                                                     |                                                                   |                                           |       |         |         |       
|                                      |                                                                                     |                                                                   | Net cash used in financing activities     |       |         | (33,527 | )     
|                                      |                                                                                     |                                                                   |                                           |       |         |         |       
|Net decrease in cash                  |                                                                                     |                                                                   | (2,063                                    | )     |         | (4,838  | )     
|Cash at beginning of year             |                                                                                     |                                                                   | 8,009                                     |       |         | 12,847  |       
|                                      |                                                                                     |                                                                   |                                           |       |         |         |       
|Cash at end of year                   |                                                                                     | $                                                                 | 5,946                                     |       | $       | 8,009   |       
|                                      |                                                                                     |                                                                   |                                           |       |         |         |       

Supplemental
disclosure of cash flow information:



See
accompanying notes to combined financial statements.

114

Table of Contents

---





WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS

December 31, 2007, 2006, and 2005

(Dollars in thousands)

1. Organization and Partnership Agreements

The combined financial statements represent domestic Texas limited partnerships and limited liability companies ("Acquisition Partnerships" or "Partnerships") and
include the accounts of WAMCO III, Ltd. ("WAMCO III"); WAMCO XX, Ltd. ("WAMCO XX") (formerly WAMCO IX, Ltd. ("WAMCO IX")); WAMCO
XXIV, Ltd. ("WAMCO XXIV"); WAMCO XXV, Ltd. ("WAMCO XXV"); WAMCO XXVI, Ltd.; WAMCO XXVII, Ltd.; WAMCO XXVIII, Ltd.
("WAMCO XXVIII"); WAMCO XXIX, Ltd.; WAMCO 30, Ltd. ("WAMCO 30"); WAMCO 31, Ltd. ("WAMCO 31"); WAMCO 32, Ltd.
("WAMCO 32"); WAMCO 33, Ltd. ("WAMCO 33"); WAMCO 34, Ltd. ("WAMCO 34"); WAMCO 35, Ltd. ("WAMCO 35");
FirstVal 1, Ltd. ("FirstVal"), SOWAMCO XXIX, Ltd. ("SOWAMCO XXIX"); Calibat Fund, LLC; First B Realty, Ltd.; FirstStreet Investments LLC
("FirstStreet"); and FC Properties, Ltd. ("FC Properties"). FirstCity Financial Corporation or its subsidiaries, FirstCity Commercial Corporation and FirstCity Holdings Corporation
(together "FirstCity"), share limited partnership interests and participate as general partners in common with Cargill Financial Services, Inc. in all of the Partnerships. WAMCO 30 is
considered to be a significant subsidiary of FirstCity. The WAMCO 30 partnership recorded initial activity during 2002.

The
Partnerships were formed to acquire, hold and dispose of Portfolio Assets acquired from the Federal Deposit Insurance Corporation, Resolution Trust Corporation and other
nongovernmental agency sellers, pursuant to certain purchase agreements or assignments of such purchase agreements. In accordance with the purchase agreements, the Partnerships retain certain rights
of return regarding the assets related to defective title, past due real estate taxes, environmental contamination, structural damage and other limited legal representations and warranties.

Generally,
the partnership agreements of the Partnerships provide for certain preferences as to the distribution of cash flows. Proceeds from disposition of and payments received on the
Portfolio Assets are allocated based on the partnership and other agreements which ordinarily provide for the payment of interest and mandatory principal installments on outstanding debt before
payment of intercompany servicing fees and return of capital and restricted distributions to partners.

In
2005, 2006 and 2007, several WAMCO Partnerships merged with and into other existing WAMCO Partnerships under common ownership. The results of these mergers did not affect the
ownership structure and did not significantly impact the Partnerships' combined financial condition and results of operations. Refer to Note 7 for a description of the mergers.

2. Summary of Significant Accounting Policies



The Partnerships acquire and resolve portfolios of performing and nonperforming commercial and consumer loans and other assets (collectively, "Portfolio Assets"
or "Portfolios"), which are generally acquired at a discount to their legal principal balance. Purchases may be in the form of pools of assets or single assets. The Portfolio Assets are generally
non-homogeneous assets, including loans of varying qualities that are secured by diverse collateral types and foreclosed properties. Some Portfolio Assets are loans for which resolution is
tied primarily to the real estate securing the loan, while others may be collateralized business loans, the resolution of which may be based either on business or real estate or other collateral cash
flow. Portfolio Assets are acquired on behalf of Acquisition Partnerships in which a corporate general partner, FirstCity and other investors are limited partners.

115

Table of Contents

---



WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

2. Summary of Significant Accounting Policies (Continued)

On
January 1, 2005, FirstCity adopted the provisions of AICPA Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer
("SOP 03-3"). SOP 03-3 addresses accounting differences between contractual cash flows and cash flows expected to be collected from an investor's initial
investment in loans acquired in a transfer if those difference are attributable, at least in part, to credit quality. SOP 03-3 requires impaired loans be recorded at fair value and
prohibits "carrying over" or the creation of valuation allowances in the initial accounting of loans acquired in a transfer that are within the scope of SOP 03-3. Under
SOP 03-3, the excess cash flows expected at purchase over the purchase price is recorded as interest income over the life of the loan.

For
loan Portfolios acquired prior to January 1, 2005, FirstCity designated such loans as non-performing Portfolio Assets or performing Portfolio Assets. Such
designation was made at the acquisition of the pool and does not change even though the actual performance of the loans may change. FirstCity accounts for all non-performing loans acquired
after 2004 in accordance with SOP 03-3. The following is a description of each classification and the related accounting policy accorded to each Portfolio type:



Non-performing Portfolio Assets consist primarily of distressed loans and loan related assets, such as foreclosed upon collateral. Prior to
January 1, 2005, Portfolio Assets were designated as non-performing unless a majority of all of the loans in the Portfolio was being repaid in accordance with the contractual terms
of the underlying loan agreements at date of acquisition. Such Portfolios were acquired on the basis of an evaluation by the Partnerships of the timing and amount of cash flow expected to be derived
from borrower payments or other resolution of the underlying collateral securing the loan.

All
non-performing Portfolio Assets were purchased at substantial discounts from their outstanding legal principal amount, the total of the aggregate of expected future sales
prices and the total payments to be received from obligors. Subsequent to acquisition, the adjusted cost of non-performing Portfolio Assets is evaluated for impairment on a quarterly
basis. A valuation allowance is established for any impairment identified through provisions charged to earnings in the period the impairment is identified. Net impairment provisions recorded on
non-performing Portfolio Assets were $500, $1,221, and $307 for 2007, 2006 and 2005, respectively.

Accounting
for Portfolios is on a pool basis as opposed to an individual asset-by-asset basis.



Performing Portfolio Assets consist primarily of Portfolios of consumer and commercial loans acquired at a discount from the aggregate amount of the borrowers'
obligation. Prior to January 1, 2005, Portfolios were classified as performing if a majority of all of the loans in the Portfolio is being

116

Table of Contents

---



WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

2. Summary of Significant Accounting Policies (Continued)

repaid
in accordance with the contractual terms of the underlying loan agreements at date of acquisition.

Performing
Portfolio Assets are carried at the unpaid principal balance of the underlying loans, net of acquisition discounts. Interest is accrued when earned in accordance with the
contractual terms of the loans. The accrual of interest is discontinued once a Portfolio becomes impaired. Acquisition discounts for the Portfolio as a whole are accreted as an adjustment to yield
over the estimated life of the Portfolio. Accounting for these Portfolios is on a pool basis as opposed to an individual asset-by-asset basis.

Gains
are recognized on the performing Portfolio Assets when sufficient funds are received to fully satisfy the obligation on loans included in the pool, either from funds from the
borrower or sale of the loan. The gain recognized represents the difference between the proceeds received and the allocated carrying value of the individual loan in the pool.

Impairment
on each Portfolio is measured based on the present value of the expected future cash flows in the aggregate discounted at the loans' risk adjusted rates, which approximates
the effective interest rates, or the fair value of the collateral, less estimated selling costs, if any loans are collateral dependent and foreclosure is probable. Net impairment provisions recorded
on performing Portfolio Assets were $749, $83, and $654 for 2007, 2006 and 2005, respectively.



Management's best estimate of the Portfolio's internal rate of return ("IRR") as of January 1, 2005, is the basis for subsequent impairment testing. If it
is probable that all cash flows estimated at acquisition plus any changes to expected cash flows arising from changes in estimates after acquisition would not be collected, the carrying value of a
pool would be written down to maintain the then current IRR. Prior to January 1, 2005, impairment charges would be taken to operations with a corresponding
write-off of the receivable balance. Consequently, no allowance for loan loss was recorded prior to January 1, 2005.

A
pool can become fully amortized (zero carrying balance on the balance sheet) while still generating cash collections. In this case, all cash collections are recognized as revenue when
received. Additionally, the Partnerships use the cost recovery method when timing and amount of collections on a particular pool of accounts cannot be reasonably predicted. Under the cost recovery
method, no revenue is recognized until the Partnerships have fully collected the cost of the portfolio, or until such time that the Partnerships consider the collections to be probable and estimable
and begin to recognize income based on the interest method as described above.



The Partnerships consider expected prepayments, and estimates the amount and timing of undiscounted expected principal, interest, and other cash flows (expected
at acquisition) for each loan and each subsequently aggregated pool of loans. The Partnerships determine the excess of the loan's or

117

Table of Contents

---



WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

2. Summary of Significant Accounting Policies (Continued)

pool's
scheduled contractual principal and contractual interest payments over all cash flows expected at acquisition as an amount that should not be accreted (nonaccretable difference). The excess of
the loan's cash flows expected to be collected at acquisition over the initial investment in the loan or pool is accreted into interest income over the remaining life of the loan or pool (accretable
yield).

Over
the life of the loan or pool, the Partnerships continue to estimate cash flows expected to be collected. The Partnerships evaluate at the balance sheet date whether the present
value of its loans determined using the effective interest rates has decreased below book value and if so, a valuation allowance is established for any impairment identified through provisions charged
to operations in the period the impairment is identified. The present value of any subsequent increase in the loan's or pool's actual cash flows or cash flows expected to be collected is used first to
reverse any existing valuation allowance for that loan or pool. Any remaining increases in the present value of cash flows expected to be collected will be used to recalculate the amount of accretable
yield recognized on a prospective basis over the pool's remaining life.

The
Partnerships establish valuation allowances for all acquired loans subject to SOP 03-3 to reflect only those losses incurred after acquisitionthat is,
the present value of cash flows expected at acquisition that are not expected to be collected. The Partnerships recorded net impairment provisions of $3,478 in 2007, $396 in 2006 and $62 in 2005 on
these loans.



Loans acquired without evidence of credit deterioration at acquisition for which the Partnerships have the positive intent and ability to hold for the foreseeable
future are classified as held for investment and reported at their unpaid principal balance net of unamortized purchase discounts or premiums.

Interest
accrual ceases when payments become 90 days contractually past due. An allowance for loan losses is established when a loan becomes impaired. A loan is impaired when full
payment under the loan terms is not expected. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific
borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any
loan that, in management's judgment, should be charged off. Loan losses are charged against the allowance when management believes that the uncollectibility of a loan balance is confirmed.



Real estate portfolios consist of real estate acquired from a variety of sellers. Such Portfolios are carried at the lower of cost or fair value less estimated
costs to sell. Costs relating to the development and improvement of real estate for its intended use are capitalized, whereas those relating to holding assets are charged to expense. Income or loss is
recognized upon the disposal of the real estate. Rental income, net of expenses, on real estate Portfolios is recognized when received. Accounting for the Portfolios is on an individual
asset-by-asset basis as opposed to a pool basis. Subsequent to acquisition, the amortized cost of a real estate Portfolio is evaluated for impairment on a quarterly basis. The

118

Table of Contents

---



WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

2. Summary of Significant Accounting Policies (Continued)

evaluation
of impairment is determined based on the review of the estimated future cash receipts, net of costs to sell, which represents the net realizable value of the real estate Portfolio.
Impairment losses are charged to operations in the period the impairment is identified. The Company recorded net impairment losses on real estate of $156, $103, and $0 as of December 31, 2007,
2006 and 2005, respectively.

Assets
are foreclosed when necessary through an arrangement with an affiliated entity whereby title to the foreclosed asset is held by the affiliated entity and a note receivable from
the affiliate is held by the Partnerships. For financial statement presentation, the affiliated entity note receivable created by the arrangement is included in Portfolio Assets and is recorded at the
lower of allocated cost or fair value less estimated cost to sell the underlying asset.



Under current Federal laws, partnerships are not subject to income taxes; therefore, no provision has been made for such taxes in the accompanying combined
financial statements. For tax purposes, income or loss is included in the individual tax returns of the partners.



The preparation of combined financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and
assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the combined financial statements and the reported amounts of revenues and expenses during the
reporting period. Material estimates that are particularly susceptible to significant change in the near-term relate to the estimation of future collections on Portfolio Assets used in the
calculation of income from Portfolio Assets and estimation of interest rate environments. Actual results could differ from those estimates.



Certain amounts in the consolidated financial statements for prior years have been reclassified to conform with current consolidated financial statement
presentation. In 2006, the Company reclassified gain on resolution of Portfolio Assets and loan interest income as income from Portfolio Assets. These items were reported separately in prior periods.



Change in combined entities reflects the reduction in equity and cash due to the reduction of number of entities included in the combined and combining statements
for 2006.



On December 31, 2006, the Partnerships adopted SEC Staff Accounting Bulletin Topic 1N, Financial StatementsConsidering
the Effects of Prior Year Misstatements when Quantifying Misstatements

119

Table of Contents

---



WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

2. Summary of Significant Accounting Policies (Continued)

in Current Year Financial Statements("SAB 108"). SAB 108 provides guidance on how prior year misstatements should be evaluated when determining the materiality
of misstatements in the current year financial statements and it also addresses how to correct material misstatements. The Partnerships adoption of SAB 108 resulted in an adjustment to opening
retained earnings for the year ended December 31, 2006 by approximately $212 thousand, all of which relates to a correction in WAMCO 33's accounting for property taxes paid in 2005. The
Partnerships reviewed the annual amount of earnings incurred in prior periods for this correction and considered the effect to be immaterial to prior periods both individually and in the aggregate.

3. Combining Financial Statements

WAMCO 30 is considered to be a significant subsidiary of FirstCity. The WAMCO 30 partnership recorded initial activity during 2002. The following tables
summarize the combining balance sheets of the WAMCO Partnerships as of December 31, 2007 and 2006, and the related combining statements of operations, changes in partners' capital, and cash
flows for each of the years in the three-year period ended December 31, 2007.

Combining Balance Sheets    December 31, 2007

WAMCO 30

Other Partnerships

CombinedASSETSCash

$
4,976

$
970

$
5,946Portfolio Assets, net


39,720


40,605


80,325Other assets, net


757


58


815$
45,453

$
41,633

$
87,086LIABILITIES AND PARTNERS' CAPITALNotes payable


35,925

$
4,600

$
40,525Other liabilities


1,998


254


2,252Total liabilities


37,923


4,854


42,777Partners' capital


7,530


36,779


44,309$
45,453

$
41,633

$
87,086Other liabilities owed to affiliates included in above balances

$
1,458

$
23

$
1,481


120

Table of Contents

---



WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

3. Combining Financial Statements (Continued)

Combining Balance Sheets    December 31, 2006

WAMCO 30

Other Partnerships

CombinedASSETSCash

$
6,497

$
1,512

$
8,009Portfolio Assets, net


80,126


28,089


108,215Other assets, net


337


73


410$
86,960

$
29,674

$
116,634LIABILITIES AND PARTNERS' CAPITALNotes payable


36,523

$
7,616


44,139Other liabilities


2,798


118


2,916Total liabilities


39,321


7,734


47,055Partners' capital


47,639


21,940


69,579$
86,960

$
29,674

$
116,634Other liabilities owed to affiliates included in above balances

$
1,805

$
(6
)
$
1,799


Combining Statements of Operations    Year Ended December 31, 2007

WAMCO 30

Other Partnerships

CombinedIncome from Portfolio Assets

$
12,505

$
5,259

$
17,764Other income, net


184


6


190Revenues


12,689


5,265


17,954Interest and fees expenseother


(2,328
)

(454
)

(2,782
)Provision for loan and impairment losses


(2,370
)

(2,513
)

(4,883
)Service feesaffiliate


(1,639
)

(675
)

(2,314
)General, administrative and operating expenses


(2,520
)

(812
)

(3,332
)Expenses


(8,857
)

(4,454
)

(13,311
)Net earnings

$
3,832

$
811

$
4,643


121

Table of Contents

---



WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

3. Combining Financial Statements (Continued)

Combining Statements of Operations  Year Ended December 31, 2006

WAMCO 30

Other Partnerships

CombinedIncome from Portfolio Assets

$
18,054

$
6,523

$
24,577Other income, net


264


1,295


1,559Revenues


18,318


7,818


26,136Interest and fees expenseaffiliate


(38
)

(429
)

(467
)Interest and fees expenseother


(3,215
)

(194
)

(3,409
)Provision for loan and impairment losses


(470
)

(1,333
)

(1,803
)Service feesaffiliate


(2,902
)

(757
)

(3,659
)General, administrative and operating expenses


(1,553
)

(1,913
)

(3,466
)Expenses


(8,178
)

(4,626
)

(12,804
)Net earnings

$
10,140

$
3,192

$
13,332


Combining Statements of Operations  Year Ended December 31, 2005

|                                               |              | WAMCO 30 |        | Other Partnerships |   | Combined |      
|---------------------------------------------- | ------------ | -------- | ------ | ------------------ | - | -------- | -----
|Income from Portfolio Assets                   |              | $        | 16,823 |                    | $ | 13,841   |      
|Other income, net                              |              |          | 55     |                    |   | 51       |      
|                                               |              |          |        |                    |   |          |      
|Revenues                                       |              |          | 16,878 |                    |   | 13,892   |      
|                                               |              |          |        |                    |   |          |      
|Interest and fees expenseaffiliate            |              |          | (1,165 | )                  |   | (600     | )    
|Interest and fees expenseother                |              |          | (2,371 | )                  |   |         |      
|Provision for loan and impairment losses       |              |          | (822   | )                  |   | (202     | )    
|Service feesaffiliate                         |              |          | (2,246 | )                  |   | (1,145   | )    
|General, administrative and operating expenses |              |          | (1,701 | )                  |   | (5,668   | )    
|                                               |              |          |        |                    |   |          |      
|Expenses                                       |              |          | (8,305 | )                  |   | (7,615   | )    
|                                               |              |          |        |                    |   |          |      
|                                               | Net earnings |          | $      | 8,573              |   | $        | 6,277
|                                               |              |          |        |                    |   |          |      

122

Table of Contents

---





WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

3. Combining Financial Statements (Continued)

Combining Statements of Changes in Partners' Capital  Years Ended December 31, 2007, 2006 and 2005

|                             |                                                                                         | WAMCO 30 |        | Other Partnerships |   | Combined |        
|---------------------------- | --------------------------------------------------------------------------------------- | -------- | ------ | ------------------ | - | -------- | -------
|Balance at December 31, 2004 |                                                                                         | $        | 46,189 |                    | $ | 35,044   |        
|                             | Contributions                                                                           |          |        | 51,797             |   |          |       
|                             | Distributions                                                                           |          |        | (18,962            | ) |          | (17,589
|                             | Net earnings                                                                            |          |        | 8,573              |   |          | 6,277  
|                             |                                                                                         |          |        |                    |   |          |        
|                             | Total comprehensive income                                                              |          |        | 8,573              |   |          | 6,277  
|                             |                                                                                         |          |        |                    |   |          |        
|Balance at December 31, 2005 |                                                                                         |          | 87,597 |                    |   | 23,732   |        
|                             |                                                                                         |          |        |                    |   |          |        
|                             | Cumulative effect of adjustments resulting from the adoption of SAB No. 108 (Note 2(f)) |          |        | (212               | ) |          |       
|                             | Contributions                                                                           |          |        | 40,948             |   |          | 14,364 
|                             | Distributions                                                                           |          |        | (90,834            | ) |          | (13,162
|                             | Change in combined entities                                                             |          |        |                   |   |          | (6,186 
|                             | Net earnings                                                                            |          |        | 10,140             |   |          | 3,192  
|                             |                                                                                         |          |        |                    |   |          |        
|                             | Total comprehensive income                                                              |          |        | 10,140             |   |          | 3,192  
|                             |                                                                                         |          |        |                    |   |          |        
|Balance at December 31, 2006 |                                                                                         |          | 47,639 |                    |   | 21,940   |        
|                             |                                                                                         |          |        |                    |   |          |        
|                             | Contributions                                                                           |          |        |                   |   |          | 20,433 
|                             | Distributions                                                                           |          |        | (43,941            | ) |          | (6,405 
|                             | Net earnings                                                                            |          |        | 3,832              |   |          | 811    
|                             |                                                                                         |          |        |                    |   |          |        
|                             | Total comprehensive income                                                              |          |        | 3,832              |   |          | 811    
|                             |                                                                                         |          |        |                    |   |          |        
|Balance at December 31, 2007 |                                                                                         | $        | 7,530  |                    | $ | 36,779   |        
|                             |                                                                                         |          |        |                    |   |          |        

123

Table of Contents

---





WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

3. Combining Financial Statements (Continued)

Combining Statements of Cash Flows  Year Ended December 31, 2007

|                                                 |                                                                                               | WAMCO 30                                                    |                                                     | Other Partnerships |         | Combined |    
|------------------------------------------------ | --------------------------------------------------------------------------------------------- | ----------------------------------------------------------- | --------------------------------------------------- | ------------------ | ------- | -------- | ---
|Cash flows from operating activities:            |                                                                                               |                                                             |                                                     |                    |         |          |    
|                                                 | Net earnings                                                                                  |                                                             | $                                                   | 3,832              |         | $        | 811
|                                                 | Adjustments to reconcile net earnings to net cash provided by (used in) operating activities: |                                                             |                                                     |                    |         |          |    
|                                                 |                                                                                               | Amortization of loan origination and commitment fees        |                                                     |                    | 192     |          |    
|                                                 |                                                                                               | Provision for loan and impairment losses                    |                                                     |                    | 2,370   |          |    
|                                                 |                                                                                               | Income from Portfolio Assets                                |                                                     |                    | (12,505 | )        |    
|                                                 |                                                                                               | Purchase of Portfolio Assets                                |                                                     |                    |        |          |    
|                                                 |                                                                                               | Advances net of receipts on Portfolio Asset lines of credit |                                                     |                    | (4,502  | )        |    
|                                                 |                                                                                               | Capitalized costs and interest on Portfolio Assets          |                                                     |                    | (164    | )        |    
|                                                 |                                                                                               | Proceeds applied to principal on Portfolio Assets           |                                                     |                    | 54,733  |          |    
|                                                 |                                                                                               | Increase in other assets                                    |                                                     |                    | (138    | )        |    
|                                                 |                                                                                               | Increase (decrease) in other liabilities                    |                                                     |                    | (800    | )        |    
|                                                 |                                                                                               |                                                             |                                                     |                    |         |          |    
|                                                 |                                                                                               |                                                             | Net cash provided by (used in) operating activities |                    |         | 43,018   |    
|                                                 |                                                                                               |                                                             |                                                     |                    |         |          |    
|Cash flows from financing activities:            |                                                                                               |                                                             |                                                     |                    |         |          |    
|                                                 |                                                                                               | Borrowing of debt                                           |                                                     |                    | 38,500  |          |    
|                                                 |                                                                                               | Repayment of debt                                           |                                                     |                    | (39,098 | )        |    
|                                                 |                                                                                               | Capital contributions                                       |                                                     |                    |        |          |    
|                                                 |                                                                                               | Capital distributions                                       |                                                     |                    | (43,941 | )        |    
|                                                 |                                                                                               |                                                             |                                                     |                    |         |          |    
|                                                 |                                                                                               |                                                             | Net cash provided by (used in) financing activities |                    |         | (44,539  | )  
|                                                 |                                                                                               |                                                             |                                                     |                    |         |          |    
|Net decrease in cash                             |                                                                                               |                                                             | (1,521                                              | )                  |         | (542     | )  
|Cash at beginning of year                        |                                                                                               |                                                             | 6,497                                               |                    |         | 1,512    |    
|                                                 |                                                                                               |                                                             |                                                     |                    |         |          |    
|Cash at end of year                              |                                                                                               | $                                                           | 4,976                                               |                    | $       | 970      |    
|                                                 |                                                                                               |                                                             |                                                     |                    |         |          |    
|Supplemental disclosure of cash flow information |                                                                                               |                                                             |                                                     |                    |         |          |    
|                                                 | Approximate cash paid for interest                                                            |                                                             | $                                                   | 2,141              |         | $        | 448

124

Table of Contents

---





WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

3. Combining Financial Statements (Continued)

Combining Statements of Cash Flows  Year Ended December 31, 2006

|                                                 |                                                                                               | WAMCO 30                                                          |                                                     | Other Partnerships |         | Combined |        
|------------------------------------------------ | --------------------------------------------------------------------------------------------- | ----------------------------------------------------------------- | --------------------------------------------------- | ------------------ | ------- | -------- | -------
|Cash flows from operating activities:            |                                                                                               |                                                                   |                                                     |                    |         |          |        
|                                                 | Net earnings                                                                                  |                                                                   | $                                                   | 10,140             |         | $        | 3,192  
|                                                 | Adjustments to reconcile net earnings to net cash provided by (used in) operating activities: |                                                                   |                                                     |                    |         |          |        
|                                                 |                                                                                               | Amortization of loan origination and commitment fees              |                                                     |                    | 262     |          |        
|                                                 |                                                                                               | Amortization of deferred profit sharing                           |                                                     |                    |        |          |        
|                                                 |                                                                                               | Provision for loan and impairment losses                          |                                                     |                    | 470     |          |        
|                                                 |                                                                                               | Income from Portfolio Assets                                      |                                                     |                    | (18,054 | )        |        
|                                                 |                                                                                               | Purchase of Portfolio Assets                                      |                                                     |                    | (42,307 | )        |        
|                                                 |                                                                                               | Advances net of receipts on Portfolio Asset lines of credit       |                                                     |                    | (9,565  | )        |        
|                                                 |                                                                                               | Capitalized costs and interest on Portfolio Assets                |                                                     |                    | (623    | )        |        
|                                                 |                                                                                               | Proceeds applied to principal on Portfolio Assets                 |                                                     |                    | 100,887 |          |        
|                                                 |                                                                                               | Excess of distribution over cost from partnership carried at cost |                                                     |                    |        |          |        
|                                                 |                                                                                               | Decrease in deferred profit sharing                               |                                                     |                    |        |          |        
|                                                 |                                                                                               | Increase in other assets                                          |                                                     |                    | (376    | )        |        
|                                                 |                                                                                               | Decrease in deferred compensation                                 |                                                     |                    |        |          |        
|                                                 |                                                                                               | Deferred compensation and profit sharing paid                     |                                                     |                    |        |          |        
|                                                 |                                                                                               | Increase (decrease) in other liabilities                          |                                                     |                    | 485     |          |        
|                                                 |                                                                                               |                                                                   |                                                     |                    |         |          |        
|                                                 |                                                                                               |                                                                   | Net cash provided by operating activities           |                    |         | 41,319   |        
|                                                 |                                                                                               |                                                                   |                                                     |                    |         |          |        
|Cash flows from investing activities:            |                                                                                               |                                                                   |                                                     |                    |         |          |        
|                                                 | Distributions from partnership                                                                |                                                                   |                                                     |                   |         |          | 2,570  
|                                                 | Change in combined entities                                                                   |                                                                   |                                                     |                   |         |          | (1,126 
|                                                 |                                                                                               |                                                                   |                                                     |                    |         |          |        
|                                                 |                                                                                               |                                                                   | Net cash provided by investing activities           |                    |         |         |        
|                                                 |                                                                                               |                                                                   |                                                     |                    |         |          |        
|Cash flows from financing activities:            |                                                                                               |                                                                   |                                                     |                    |         |          |        
|                                                 | Borrowing of debtaffiliate                                                                   |                                                                   |                                                     | 27                 |         |          |       
|                                                 | Borrowing of debt                                                                             |                                                                   |                                                     | 38,500             |         |          | 8,000  
|                                                 | Repayment of debtaffiliate                                                                   |                                                                   |                                                     | (2,088             | )       |          | (5,805 
|                                                 | Repayment of debt                                                                             |                                                                   |                                                     | (31,619            | )       |          | (384   
|                                                 | Capital contributions                                                                         |                                                                   |                                                     | 40,949             |         |          | 14,363 
|                                                 | Capital distributions                                                                         |                                                                   |                                                     | (90,833            | )       |          | (13,163
|                                                 |                                                                                               |                                                                   |                                                     |                    |         |          |        
|                                                 |                                                                                               |                                                                   | Net cash provided by (used in) financing activities |                    |         | (45,064  | )      
|                                                 |                                                                                               |                                                                   |                                                     |                    |         |          |        
|Net decrease in cash                             |                                                                                               |                                                                   | (3,745                                              | )                  |         | (1,093   | )      
|Cash at beginning of year                        |                                                                                               |                                                                   | 10,242                                              |                    |         | 2,605    |        
|                                                 |                                                                                               |                                                                   |                                                     |                    |         |          |        
|Cash at end of year                              |                                                                                               | $                                                                 | 6,497                                               |                    | $       | 1,512    |        
|                                                 |                                                                                               |                                                                   |                                                     |                    |         |          |        
|Supplemental disclosure of cash flow information |                                                                                               |                                                                   |                                                     |                    |         |          |        
|                                                 | Approximate cash paid for interest                                                            |                                                                   | $                                                   | 2,937              |         | $        | 583    

125

Table of Contents

---





WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

3. Combining Financial Statements (Continued)

Combining Statements of Cash Flows  Year Ended December 31, 2005

|                                                 |                                                                                     | WAMCO 30                                                    |                                                     | Other Partnerships |         | Combined |        
|------------------------------------------------ | ----------------------------------------------------------------------------------- | ----------------------------------------------------------- | --------------------------------------------------- | ------------------ | ------- | -------- | -------
|Cash flows from operating activities:            |                                                                                     |                                                             |                                                     |                    |         |          |        
|                                                 | Net earnings                                                                        |                                                             | $                                                   | 8,573              |         | $        | 6,277  
|                                                 | Adjustments to reconcile net earnings to net cash provided by operating activities: |                                                             |                                                     |                    |         |          |        
|                                                 |                                                                                     | Amortization of loan origination and commitment fees        |                                                     |                    | 358     |          |        
|                                                 |                                                                                     | Amortization of deferred profit sharing                     |                                                     |                    |        |          |        
|                                                 |                                                                                     | Provision for loan and impairment losses                    |                                                     |                    | 822     |          |        
|                                                 |                                                                                     | Income from Portfolio Assets                                |                                                     |                    | (16,823 | )        |        
|                                                 |                                                                                     | Purchase of Portfolio Assets                                |                                                     |                    | (60,551 | )        |        
|                                                 |                                                                                     | Advances net of receipts on Portfolio Asset lines of credit |                                                     |                    | (2,185  | )        |        
|                                                 |                                                                                     | Capitalized costs and interest on Portfolio Assets          |                                                     |                    | (994    | )        |        
|                                                 |                                                                                     | Proceeds applied to principal on Portfolio Assets           |                                                     |                    | 72,306  |          |        
|                                                 |                                                                                     | Increase in deferred profit sharing                         |                                                     |                    |        |          |        
|                                                 |                                                                                     | (Increase) decrease in other assets                         |                                                     |                    | (160    | )        |        
|                                                 |                                                                                     | Increase in deferred compensation                           |                                                     |                    |        |          |        
|                                                 |                                                                                     | Deferred compensation and profit sharing paid               |                                                     |                    |        |          |        
|                                                 |                                                                                     | Increase (decrease) in other liabilities                    |                                                     |                    | 332     |          |        
|                                                 |                                                                                     |                                                             |                                                     |                    |         |          |        
|                                                 |                                                                                     |                                                             | Net cash provided by operating activities           |                    |         | 1,678    |        
|                                                 |                                                                                     |                                                             |                                                     |                    |         |          |        
|Cash flows from financing activities:            |                                                                                     |                                                             |                                                     |                    |         |          |        
|                                                 | Borrowing of debtaffiliate                                                         |                                                             |                                                     | 9,056              |         |          |       
|                                                 | Borrowing of debt                                                                   |                                                             |                                                     | 29,100             |         |          |       
|                                                 | Repayment of debtaffiliate                                                         |                                                             |                                                     | (37,966            | )       |          | (769   
|                                                 | Repayment of debt                                                                   |                                                             |                                                     | (32,263            | )       |          |       
|                                                 | Capital contributions                                                               |                                                             |                                                     | 51,797             |         |          |       
|                                                 | Capital distributions                                                               |                                                             |                                                     | (18,962            | )       |          | (17,589
|                                                 |                                                                                     |                                                             |                                                     |                    |         |          |        
|                                                 |                                                                                     |                                                             | Net cash provided by (used in) financing activities |                    |         | 762      |        
|                                                 |                                                                                     |                                                             |                                                     |                    |         |          |        
|Net increase (decrease) in cash                  |                                                                                     |                                                             | 2,440                                               |                    |         | (3,328   | )      
|Cash at beginning of year                        |                                                                                     |                                                             | 7,802                                               |                    |         | 5,933    |        
|                                                 |                                                                                     |                                                             |                                                     |                    |         |          |        
|Cash at end of year                              |                                                                                     | $                                                           | 10,242                                              |                    | $       | 2,605    |        
|                                                 |                                                                                     |                                                             |                                                     |                    |         |          |        
|Supplemental disclosure of cash flow information |                                                                                     |                                                             |                                                     |                    |         |          |        
|                                                 | Approximate cash paid for interest                                                  |                                                             | $                                                   | 3,191              |         | $        | 601    

126

Table of Contents

---



WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

4. Portfolio Assets

Portfolio Assets are summarized as follows:

December 31, 2007WAMCO
30

Other
Partnerships

CombinedLoan PortfoliosLoans Acquired Prior to 2005Non-performing Portfolio Assets

$
11,707

$
1,515

$
13,222Performing Portfolio Assets


7,593


8,225


15,818Loans Acquired After 2004Loans acquired with credit deterioration


22,484


30,184


52,668Loans acquired with no credit deterioration


300





300Outstanding balance


42,084


39,924


82,008Allowance for loan losses


(3,433
)

(2,207
)

(5,640
)Carrying amount of loans, net of allowance


38,651


37,717


76,368Real Estate Portfolios, net of allowance


1,069


2,888


3,957Portfolio Assets, net

$
39,720

$
40,605

$
80,325


|
|

December 31, 2006WAMCO 30

Other Partnerships

CombinedLoan PortfoliosLoans Acquired Prior to 2005Non-performing Portfolio Assets

$
19,311

$
3,074

$
22,385Performing Portfolio Assets


11,096


10,723


21,819Loans Acquired After 2004Loans acquired with credit deterioration


49,126


10,949


60,075Loans acquired with no credit deterioration


1,765





1,765Outstanding balance


81,298


24,746


106,044Allowance for loan losses


(1,172
)

(326
)

(1,498
)Carrying amount of loans, net of allowance


80,126


24,420


104,546Real Estate Portfolios, net of allowance





3,669


3,669Portfolio Assets, net

$
80,126

$
28,089

$
108,215


Portfolio
Assets are pledged to secure non-recourse notes payable.

5. Deferred Profit Sharing and Deferred Compensation

In connection with the formation of FC Properties, an agreement was entered into which provided for potential payments to the project manager based on a
percentage of total estimated sales. An equal

127

Table of Contents

---



WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

5. Deferred Profit Sharing and Deferred Compensation (Continued)

amount
of deferred profit participation and deferred compensation is recorded based on such estimates with the deferred profit participation being amortized into expense in proportion to actual sales
realized. No profit participation was paid until the limited partners recognized a 20% return on their investment. This return threshold was met in 2001. As a result of the disposition of FC
Properties in 2006, this obligation is no longer presented as of December 31, 2006. At December 31, 2005, the estimated liability for this profit participation was $14,539, and was
reported as deferred compensation in the accompanying combined balance sheets. Additionally, amortization of $596 and $4,088 was recognized during 2006 and 2005, respectively, and has been included in
general, administrative and operating expenses in the accompanying combined statements of operations.

The
achievement of the 20% return on investment resulted in payments of $396 and $4,365 in deferred profit sharing and commissions in 2006, and 2005, respectively.

6. Notes Payable

Notes payable at December 31, 2007 and 2006 consist of the following:

2007

2006London Interbank Offering Rate (LIBOR) (4.6% at December 31, 2007) based:WAMCO 30 (LIBOR plus 1.65%)

$
35,925

$
WAMCO 30 (LIBOR plus 2.0%)





28,146WAMCO 30 (LIBOR plus 2.35%)





3,818WAMCO 30 (LIBOR plus 2.5%)





4,559Other Partnerships (LIBOR plus 1.75%)


4,600


7,616$
40,525

$
44,139


In
November 2007, $20.9 million of notes payable from WAMCO 30, WAMCO 31 and WAMCO 34 were renewed into a new note payable with WAMCO 30 in connection with a merger involving
these entities. Refer to Note 7 for a description of the merger.

Collateralized
loans are typically payable based on proceeds from disposition of and payments received on the Portfolio Assets.

128

Table of Contents

---



WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

6. Notes Payable (Continued)

Contractual
maturities (excluding principal and interest payments payable from proceeds from dispositions of and payments received on the Portfolio Assets) of notes payable are as
follows:

WAMCO 30

Other Partnerships

CombinedYear Ending December 31:2008

$


$


$
2009








2010


35,925


4,600


40,5252011








$
35,925

$
4,600

$
40,525


The
loan agreements and master note purchase agreements, under which notes payable were incurred, contain various covenants including limitations on other indebtedness, maintenance of
service agreements and restrictions on use of proceeds from disposition of and payments received on the Portfolio Assets. As of December 31, 2007, the Partnerships were in compliance with the
aforementioned covenants.

In
connection with notes payable, the Partnerships incurred origination and commitment fees. These fees are amortized over the stated maturity of the related notes and are included in
interest and fees on notes payable. At December 31, 2007 and 2006, approximately $372 and $382, respectively, of origination and commitment fees are included in other assets, net.

7. Transactions with Affiliates

Under the terms of the various servicing agreements between the Partnerships and FirstCity, FirstCity receives a servicing fee based on proceeds from resolution
of the Portfolio Assets for processing transactions on the Portfolio Assets and for conducting settlement, collection and other resolution activities. Service fees to affiliates of approximately
$2,314, $3,659, and $3,391 are reported on the accompanying combined statements of operations in 2007, 2006 and 2005, respectively.

In
November 2007, WAMCO 31, WAMCO 33, WAMCO 34, and WAMCO 35 merged with and into WAMCO 30 with WAMCO 30 being the surviving entity. In connection with the merger, WAMCO 30 entered into
a $38.5 million note payable and used $21.0 million of the loan proceeds to pay-off then-existing notes payable ($20.9 million principal and
$0.1 million interest) for WAMCO 30, WAMCO 31 and WAMCO 34. WAMCO 33 and WAMCO 35 did not have any notes payable outstanding at the time of the merger.

During
2006, WAMCO XXV and WAMCO XXVIII merged with and into WAMCO 30 with WAMCO 30 being the surviving entity. Also during 2006, WAMCO IX was renamed as WAMCO XX, and WAMCO XXX was
renamed as WAMCO 30. In August 2006, FirstCity disposed of its ownership interest in FC Properties.

During
2005, WAMCO III merged into WAMCO IX with WAMCO IX being the surviving entity. The partnership agreement for WAMCO III provided for Class A and Class B Equity
partners. The

129

Table of Contents

---



WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

7. Transactions with Affiliates (Continued)

Class A
Equity partners were WAMCO III of Texas, Inc., FirstCity Commercial Corporation and CFSC Capital Corp. II, and the Class B Equity partner was CFSC Capital Corp. II. The
Class B Equity limited partner was allocated 20 percent net income or loss, excluding equity earnings in FirstStreet, recognized by the partnership prior to allocation of net income or
loss to the Class A Equity partners. Net earnings in FirstStreet were allocated to the Class A Equity partners in proportion to their respective ownership percentages. Net income or loss
was credited or charged to the Class A Equity partners' capital accounts in proportion to their respective capital account balances after the 20% allocation to the Class B Equity limited
partner. Distributions were allocated using the same methodology as net income or loss. The Class B Equity limited partner was not required to make capital contributions. During 2005, WAMCO III
was dissolved and had zero equity at December 31, 2005.

8. Fair Value of Financial Instruments

SFAS No. 107,Disclosures about Fair Value of Financial Instruments, requires that the Company disclose
estimated fair values of its financial instruments. The fair value estimates as of December 31, 2007 and 2006 were based on pertinent information that was available to management as of the
respective dates. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been revalued for purposes of these financial
statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented.

The
following describes the methods and assumptions used by the Company in estimating fair values.



The carrying amount of cash and other liabilities approximates fair value at December 31, 2007 and 2006 due to the short-term nature of such
accounts.



Portfolio Assets are carried at the lower of cost or estimated fair value. The estimated fair value is calculated by discounting projected cash flows on an
asset-by-asset basis using estimated market discount rates that reflect the credit and interest rate risk inherent in the assets. The carrying value of Portfolio Assets was
$80,325 and $108,215 at December 31, 2007 and 2006, respectively. The estimated fair value of the Portfolio Assets was approximately $82,985 and $119,952 at December 31, 2007 and 2006,
respectively.



Management believes that for similar financial instruments with comparable credit risks, the stated interest rates at December 31, 2007 and 2006
approximate market rates. Accordingly, the carrying amount of notes payable is believed to approximate fair value. In addition, the majority of the partnerships' debt is at variable rates of interest.

130

Table of Contents

---



WAMCO PARTNERSHIPS

NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)

December 31, 2007, 2006, and 2005

(Dollars in thousands)

9. Commitments and Contingencies

The Partnerships are involved in various legal proceedings in the ordinary course of business. In the opinion of management, the resolution of such matters will
not have a material adverse impact on the combined financial position, results of operations or liquidity of the Partnerships.

10. Interest Rate Swap

WAMCO XXVIII was involved with an interest rate swap contract that matured in December 2005. WAMCO XXVII entered into the swap contract in 2001 in order to manage
a portion of the interest rate risk associated with its long-term debt. Under the swap agreement, WAMCO
XXVIII paid fixed and floating-rate interest and received floating-rate interest at specified periodic intervals based on an agreed upon notional amount. Income or expense
associated with these periodic payments was recorded on an accrual basis. WAMCO XXVIII recorded $133 of net swap expense associated with these periodic payments for the year ended December 31,
2005. Net swap expense is included in interest and fees expenseaffiliate in the accompanying combined statements of operations.

WAMCO
XXVIII did not meet the criteria necessary to categorize its swap agreement as a hedging activity under the provisions of FASB No. 133,Accounting
for Derivative Instruments and Hedging Activities;therefore, change in fair value of the interest rate swap was reported in general, administrative and operating expenses and
was $129 during 2005.

131

Table of Contents

---





Item 9.Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

Not
applicable.

Item 9A.Controls and Procedures.

The Company's management, including the Company's principal executive officer and principal financial officer, has evaluated the effectiveness of the Company's
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this
Annual Report on Form 10-K. Based upon that evaluation, the Company's principal executive officer and principal financial officer have concluded that the disclosure controls and
procedures were effective as of the end of the period covered by this Annual Report on Form 10-K.

There
were no changes in the Company's internal control over financial reporting that occurred during the Company's last fiscal quarter that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial reporting.

KPMG LLP,
the Company's independent registered public accounting firm, has audited our consolidated financial statements included with this report and has audited our internal
control over financial reporting as of December 31, 2007. The report of KPMG LLP, which expresses an unqualified opinion
on our internal control over financial reporting, is included in Part II, Item 8 of this Annual Report on Form 10-K.

Management's Annual Report on Internal Control Over Financial Reporting

The management of FirstCity Financial Corporation is responsible for establishing and maintaining adequate internal control over financial reporting for the
Company. With the participation of the Chief Executive Officer and the Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial
reporting based on the framework and criteria established inInternal ControlIntegrated Framework, issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this evaluation, our management has concluded that our internal control over financial reporting was effective as of December 31, 2007.

Item 9B.Other Information.

WAMCO 30, Ltd. and P.R.L. Developpement, SAS ("PRL") are considered to be significant subsidiaries of the Company under SEC
Rule 3-09 under Regulation S-X ("Rule 3-09"). Rule 3-09 requires the Company to file separate company financial statements
for its significant subsidiaries that are not consolidated with the Company's accounts. As such, separate company financial statements of WAMCO 30, Ltd. are presented in the WAMCO Partnerships
combined financial statements as of December 31, 2007, 2006 and 2005 that are included in the Company's 2007 Annual ReportFinancial Statements and Analysis. However, separate
company financial statements for PRL are not included in this Annual Report. In accordance with Rule 3-09 for foreign equity method investments, Company management expects to file
by amendment to this Annual Report any required financial statements with respect to PRL on or before June 30, 2008.

132

Table of Contents

---





PART III

Item 10.Directors, Executive Officers and Corporate Governance.

The information required by Item 10 of Form 10-K is hereby incorporated by reference from the earlier filed of (i) an amendment
to this annual report on Form 10-K or (ii) the Company's definitive proxy statement for the 2008 Annual Meeting of Stockholders, which will be filed within 120 days
after the Company's year end for the year covered by this report.

Item 11.Executive Compensation.

The information required by Item 11 of Form 10-K is hereby incorporated by reference from the earlier filed of (i) an amendment
to this annual report on Form 10-K or (ii) the Company's definitive proxy statement for the 2008 Annual Meeting of Stockholders, which will be filed within 120 days
after the Company's year end for the year covered by this report.

Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The
information required by Item 12 of Form 10-K is hereby incorporated by reference from the earlier filed of (i) an amendment to this annual report on
Form 10-K or (ii) the Company's definitive proxy statement for the 2008 Annual Meeting of Stockholders, which will be filed within 120 days after the Company's year
end for the year covered by this report.

Item 13.Certain Relationships and Related Transactions, and Director Independence.

The
information required by Item 13 of Form 10-K is hereby incorporated by reference from the earlier filed of (i) an amendment to this annual report on
Form 10-K or (ii) the Company's definitive proxy statement for the 2008 Annual Meeting of Stockholders, which will be filed within 120 days after the Company's year
end for the year covered by this report.

Item 14.Principal Accounting Fees and Services.

The information required by Item 14 of Form 10-K is hereby incorporated by reference from the earlier filed of (i) an amendment
to this annual report on Form 10-K or (ii) the Company's definitive proxy statement for the 2008 Annual Meeting of Stockholders, which will be filed within 120 days
after the Company's year end for the year covered by this report.

133

Table of Contents

---





PART IV

Item 15.Exhibits and Financial Statement Schedules.



The
consolidated financial statements of FirstCity and the combined financial statements of the WAMCO Partnerships (Acquisition Partnerships) are incorporated herein by reference to
Item 8, "Financial Statements and Supplementary Data," of this Annual Report on Form 10-K.



Financial
statement schedules have been omitted because the information is either not required, not applicable, or is included in Item 8, "Financial Statements and Supplementary
Data."



|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           |  |  |  | Contribution and Assumption Agreement by and between Funding LP and Drive dated as of August 18, 2000. (incorporated herein by reference to Exhibit 10.42 of the Company's Form 8-K dated August 25, 2000, filed with the
Commission on September 11, 2000).                                                                                                                                                                                                   
|10.2           |  |  |  | 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).                                                                                                                                                                                               
|10.3           |  |  |  | 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).                                                                                                                                                                                                                                             
|10.4           |  |  |  | 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)                                                                                     

134

Table of Contents

---



|10.5  |  |  |  | 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)                                                                                                                                                                   
|----- |  | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.6  |  |  |  | 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)                                                                                                                                                                                                                                                                                          
|10.7  |  |  |  | 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)                                                                                                                                                                                                                                                                                          
|10.8  |  |  |  | 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)                                                                                                                                                                                                                                                                                       
|10.9  |  |  |  | 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).                                                                                                                                                                                  
|10.10 |  |  |  | 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).
|10.11 |  |  |  | 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)                             

135

Table of Contents

---



|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)        

136

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)
|21.1* |  |  |  | Subsidiaries of the Registrant                                                                                                                                                                                                                                                                                                                        
|23.1* |  |  |  | Consent of KPMG LLP.                                                                                                                                                                                                                                                                                                                                  
|23.2* |  |  |  | Consent of KPMG LLP.                                                                                                                                                                                                                                                                                                                                  
|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 Annual Report on Form 10-K for the
year ended December 31, 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 Annual Report on Form 10-K for the year
ended December 31, 2007.                                                                                  

---

137

Table of Contents

---





SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

| |  | FIRSTCITY FINANCIAL CORPORATION
| |  | -------------------------------
| |  | By:                            

March 17,
2008

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on
the dates indicated.

|Signature                               |  | Title                                                                           |  | Date          
|--------------------------------------- |  | ------------------------------------------------------------------------------- |  | --------------
|                                        |  |                                                                                 |  |               
|/s/RICHARD E. BEANRichard E. Bean       |  | Chairman of the Board and Director                                              |  | March 17, 2008
|/s/JAMES T. SARTAINJames T. Sartain     |  | President, Chief Executive Officer and Director (Principal Executive Officer)   |  | March 17, 2008
|/s/J. BRYAN BAKERJ. Bryan Baker         |  | Senior Vice President and Chief Financial Officer (Principal Financial Officer) |  | March 17, 2008
|/s/C. IVAN WILSONC. Ivan Wilson         |  | Vice Chairman of the Board and Director                                         |  | March 17, 2008
|/s/DANE FULMERDane Fulmer               |  | Director                                                                        |  | March 17, 2008
|/s/ROBERT E. GARRISONRobert E. Garrison |  | Director                                                                        |  | March 17, 2008
|/s/D. MICHAEL HUNTERD. Michael Hunter   |  | Director                                                                        |  | March 17, 2008
|/s/JEFFERY D. LEUJeffery D. Leu         |  | Director                                                                        |  | March 17, 2008
|/s/F. CLAY MILLERF. Clay Miller         |  | Director                                                                        |  | March 17, 2008

138

Table of Contents

---