Table ofContents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**Form 10-Q**

 
| **(Mark One)**                                             | ** **                                                                                              |
|------------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| **x**                                                      | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**  |
|                                                       | ** **                                                                                              |
| **For the quarterly period ended September 30, 2008** |
|                                                       | ** **                                                                                              |
| **£**                                                 | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission file number 033-19694**

 

**FirstCity Financial Corporation**

(Exact name of registrant as specified in its charter)

* *

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

 

**(254) 761-2800**

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes x     No £

 

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

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

 

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

 

The number of shares of common stock, par value$.01 per share, outstanding at November 3, 2008 was 9,831,937.

 

 

 

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Table ofContents

 

**TABLEOF CONTENTS**

 
| **PART I**                    | ** **                                                                                      |
|-------------------------------|-------------------------------------------------------------------------------------------------|
| ** **                    | ** **                                                                                      | ** ** |
| **Item 1.**                   | **Financial Statements**                                                                        | **2** |
| ** **                    | **Consolidated Balance Sheets**                                                                 | **2** |
| ** **                    | **Consolidated Statements of  Operations**                                                      | **3** |
| ** **                    | **Consolidated Statements of  Stockholders’ Equity**                                       | **4** |
| ** **                    | **Consolidated Statements of  Cash Flows**                                                      | **5** |
| ** **                    | **Notes to  Consolidated Financial Statements**                                                 | **6** |
| **Item 2.**                   | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | **32** |
| **Item 3.**                   | **Quantitative  and Qualitative Disclosures About Market Risk**                                 | **45** |
| **Item 4.**                   | **Controls and  Procedures**                                                                    | **47** |
| ** **                    | ** **                                                                                      |
| **PART II OTHER INFORMATION** | **48**                                                                                          |
| ** **                    | **48**                                                                                          |
| **Item 1.**                   | **Legal Proceedings**                                                                           | **48** |
| **Item 1A.**                  | **Risk Factors**                                                                                | **48** |
| **Item 2.**                   | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                | **48** |
| **Item 3.**                   | **Defaults  Upon Senior Securities**                                                            | **48** |
| **Item 4.**                   | **Submission  of Matters to a Vote of Security Holders**                                        | **48** |
| **Item 5.**                   | **Other Information**                                                                           | **48** |
| **Item 6.**                   | **Exhibits**                                                                                    | **48** |
| **SIGNATURES**                | **53**                                                                                          |
| **Exhibit Index**             | ** **                                                                                      |

 

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Table ofContents

 

**PART I**

 

**FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements.**

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDBALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                    | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                                                                    | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                    | ** ** | ** **             | ** ** | ** **            | ** ** |
| Cash and cash equivalents                                                                                                                                                                     |       | $                      | 12,984     |                  | $          | 23,037 |   |
| Restricted cash                                                                                                                                                                               |       | 1,124                  |       | 509                   |       |
| Portfolio Assets:                                                                                                                                                                             |       |                   |       |                  |       |
| Loan portfolios, net                                                                                                                                                                          |       | 111,586                |       | 107,169               |       |
| Real estate held for sale                                                                                                                                                                     |       | 19,919                 |       | 14,832                |       |
| Real estate held for investment, net                                                                                                                                                          |       | 9,648                  |       | —                |       |
| Total Portfolio Assets                                                                                                                                                                        |       | 141,153                |       | 122,001               |       |
| Loans receivable - affiliates                                                                                                                                                                 |       | 25,733                 |       | 5,447                 |       |
| Loans receivable - SBA held for sale                                                                                                                                                          |       | 3,193                  |       | 133                   |       |
| Loans receivable - SBA held for investment, net                                                                                                                                               |       | 14,294                 |       | 14,234                |       |
| Loans receivable - other                                                                                                                                                                      |       | 14,307                 |       | 5,995                 |       |
| Equity investments                                                                                                                                                                            |       | 93,287                 |       | 87,622                |       |
| Deferred tax asset, net                                                                                                                                                                       |       | 20,101                 |       | 20,101                |       |
| Service fees receivable ($904 and $785 from  affiliates, respectively)                                                                                                                        |       | 1,040                  |       | 842                   |       |
| Servicing assets - SBA loans                                                                                                                                                                  |       | 752                    |       | 843                   |       |
| Other assets, net                                                                                                                                                                             |       | 18,962                 |       | 17,355                |       |
| Total Assets                                                                                                                                                                                  |       | $                      | 346,930    |                  | $          | 298,119 |   |
| ** **                                                                                                                                                                                    | ** ** | ** **             | ** ** | ** **            | ** ** |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                 |       |                   |       |                  |       |
| Liabilities:                                                                                                                                                                                  |       |                   |       |                  |       |
| Notes payable to banks                                                                                                                                                                        |       | $                      | 216,597    |                  | $          | 177,329 |   |
| Note payable to affiliate                                                                                                                                                                     |       | 8,658                  |       | —                |       |
| Minority interest                                                                                                                                                                             |       | 16,705                 |       | 3,209                 |       |
| Other liabilities                                                                                                                                                                             |       | 12,901                 |       | 10,758                |       |
| Total Liabilities                                                                                                                                                                             |       | 254,861                |       | 191,296               |       |
| Commitments and contingencies (Note 14)                                                                                                                                                       |       |                   |       |                  |       |
| 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: 11,331,937 and 11,326,937, respectively; shares  outstanding: 10,168,307 and 10,746,437, respectively) |       | 113                    |       | 113                   |       |
| Treasury stock, at cost: 1,163,630 shares and  580,500 shares, respectively                                                                                                                   |       | (9,792                 | )          | (5,978                | )          |
| Paid in capital                                                                                                                                                                               |       | 101,747                |       | 101,240               |       |
| Retained earnings (accumulated deficit)                                                                                                                                                       |       | (2,266                 | )          | 9,602                 |       |
| Accumulated other comprehensive income                                                                                                                                                        |       | 2,267                  |       | 1,846                 |       |
| Total Stockholders’ Equity                                                                                                                                                               |       | 92,069                 |       | 106,823               |       |
| Total Liabilities and Stockholders’ Equity                                                                                                                                               |       | $                      | 346,930    |                  | $          | 298,119 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                                                                                                                                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                                     | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                                                                                                                     | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues:                                                                                                                                                                      |       |                             |       |                            |       |   |   |   |   |
| Servicing fees ($3,530 and $2,163 from affiliates  for the three month periods, respectively, and $8,178 and $7,344 from  affiliates for the nine month periods, respectively) |       | $                                | 3,842      |                            | $          | 2,426 |   | $ | 8,748 |   | $ | 8,008 |   |
| Income from Portfolio Assets                                                                                                                                                   |       | 5,229                            |       | 5,743                           |       | 15,786 |   | 16,463 |   |
| Gain on sale of SBA loans held for sale, net                                                                                                                                   |       | 85                               |       | 34                              |       | 227 |   | 658 |   |
| Interest income from SBA loans                                                                                                                                                 |       | 368                              |       | 752                             |       | 1,210 |   | 1,666 |   |
| Interest income from loans receivable - affiliates                                                                                                                             |       | 875                              |       | 147                             |       | 1,508 |   | 413 |   |
| Interest income from loans receivable - other                                                                                                                                  |       | 541                              |       | 1,627                           |       | 1,171 |   | 3,516 |   |
| Revenue from railroad operations                                                                                                                                               |       | 810                              |       | 302                             |       | 2,474 |   | 302 |   |
| Other income                                                                                                                                                                   |       | 939                              |       | 601                             |       | 2,558 |   | 1,598 |   |
| Total revenues                                                                                                                                                                 |       | 12,689                           |       | 11,632                          |       | 33,682 |   | 32,624 |   |
| Expenses:                                                                                                                                                                      |       |                             |       |                            |       |   |   |   |   |
| Interest and fees on notes payable to banks                                                                                                                                    |       | 4,249                            |       | 4,747                           |       | 11,690 |   | 13,666 |   |
| Interest and fees on notes payable to affiliate                                                                                                                                |       | 322                              |       | —                          |       | 322 |   | — |   |
| Salaries and benefits                                                                                                                                                          |       | 5,655                            |       | 4,446                           |       | 15,982 |   | 12,303 |   |
| Provision for loan and impairment losses                                                                                                                                       |       | 1,123                            |       | (136                            | )          | 11,243 |   | 936 |   |
| Property protection                                                                                                                                                            |       | 1,307                            |       | 781                             |       | 4,661 |   | 1,950 |   |
| Occupancy, data processing and other                                                                                                                                           |       | 3,774                            |       | 1,438                           |       | 9,025 |   | 8,590 |   |
| Total expenses                                                                                                                                                                 |       | 16,430                           |       | 11,276                          |       | 52,923 |   | 37,445 |   |
| Equity in earnings of investments                                                                                                                                              |       | 2,170                            |       | 2,157                           |       | 8,018 |   | 8,315 |   |
| Gain on sale of subsidiaries and interest in equity  investments                                                                                                               |       | —                           |       | 207                             |       | — |   | 207 |   |
| Earnings (loss) from continuing operations before  income taxes and minority interest                                                                                          |       | (1,571                           | )          | 2,720                           |       | (11,223 | ) | 3,701 |   |
| Income tax benefit (expense)                                                                                                                                                   |       | 44                               |       | (153                            | )          | (245 | ) | (366 | ) |
| Minority interest                                                                                                                                                              |       | (224                             | )          | 87                              |       | (255 | ) | 210 |   |
| Earnings (loss) from continuing operations                                                                                                                                     |       | (1,751                           | )          | 2,654                           |       | (11,723 | ) | 3,545 |   |
| Discontinued operations                                                                                                                                                        |       |                             |       |                            |       |   |   |   |   |
| Loss from discontinued operations                                                                                                                                              |       | (4                               | )          | —                          |       | (145 | ) | — |   |
| Net earnings (loss)                                                                                                                                                            |       | $                                | (1,755     | )                               | $          | 2,654 |   | $ | (11,868 | ) | $ | 3,545 |   |
|                                                                                                                                                                           |       |                             |       |                            |       |   |   |   |   |
| Basic earnings (loss) per common share are as  follows:                                                                                                                        |       |                             |       |                            |       |   |   |   |   |
| Earnings (loss) from continuing operations                                                                                                                                     |       | $                                | (0.17      | )                               | $          | 0.25 |   | $ | (1.13 | ) | $ | 0.33 |   |
| Discontinued operations                                                                                                                                                        |       | $                                | —     |                            | $          | — |   | $ | (0.01 | ) | $ | — |   |
| Net earnings (loss) to common stockholders                                                                                                                                     |       | $                                | (0.17      | )                               | $          | 0.25 |   | $ | (1.14 | ) | $ | 0.33 |   |
| Weighted average common shares outstanding                                                                                                                                     |       | 10,232                           |       | 10,790                          |       | 10,391 |   | 10,789 |   |
| Diluted earnings (loss) per common share are as  follows:                                                                                                                      |       |                             |       |                            |       |   |   |   |   |
| Earnings (loss) from continuing operations                                                                                                                                     |       | $                                | (0.17      | )                               | $          | 0.23 |   | $ | (1.13 | ) | $ | 0.31 |   |
| Discontinued operations                                                                                                                                                        |       | $                                | —     |                            | $          | — |   | $ | (0.01 | ) | $ | — |   |
| Net earnings (loss) to common stockholders                                                                                                                                     |       | $                                | (0.17      | )                               | $          | 0.23 |   | $ | (1.14 | ) | $ | 0.31 |   |
| Weighted average common shares outstanding                                                                                                                                     |       | 10,232                           |       | 11,379                          |       | 10,391 |   | 11,402 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**AND COMPREHENSIVE INCOME**

**(Dollars in thousands)**

 
| ** **                                                                 | ** ** | ** **            | ** ** | ** **              | ** ** | ** **       | ** ** | ** **       | ** ** | ** **        | ** ** | **Retained**           | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|------------------|------------|------------------|------------|-------------------|------------|------------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                 | ** ** | ** **            | ** ** | ** **              | ** ** | ** **       | ** ** | ** **       | ** ** | ** **        | ** ** | **Earnings**           | ** ** | **Other**       | ** ** | **Total**  | ** ** |
| ** **                                                                 | ** ** | **Common Stock** | ** ** | **Treasury Stock** | ** ** | **Paid in** | ** ** | **(Accumulated** | ** ** | **Comprehensive** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                 | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Shares**       | ** ** | **Amount**       | ** ** | **Capital**       | ** ** | **Deficit)**           | ** ** | **Income**      | ** ** | **Equity** | ** ** |
| ** **                                                                 | ** ** | ** **            | ** ** | ** **              | ** ** | ** **       | ** ** | ** **       | ** ** | ** **        | ** ** | ** **             | ** ** | ** **      | ** ** | ** ** | ** ** |
| **Balances, December 31, 2006**                                       |       | 11,316,937            |       | $                       | 113        |             | 530,300    |             | $          | (5,571            | )          | $                      | 100,562    |            | $          | 7,417      |       | $ | 1,372 |   | $ | 103,893 |   |
| Exercise of common stock options                                           |       | 10,000                |       | —                  |       | —           |       | —           |       | 35                |       | —                 |       | —          |       | 35         |       |
| Repurchase of common stock                                                 |       | —                |       | —                  |       | 50,200           |       | (407             | )          | —            |       | —                 |       | —          |       | (407       | )          |
| Additional paid in capital arising from stock option  compensation expense |       | —                |       | —                  |       | —           |       | —           |       | 643               |       | —                 |       | —          |       | 643        |       |
| Comprehensive income:                                                      |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       |       |       |
| Net earnings for 2007                                                      |       | —                |       | —                  |       | —           |       | —           |       | —            |       | 2,185                  |       | —          |       | 2,185      |       |
| Translation adjustments                                                    |       | —                |       | —                  |       | —           |       | —           |       | —            |       | —                 |       | 474             |       | 474        |       |
| Total comprehensive income                                                 |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       | 2,659      |       |
| **Balances, December 31, 2007**                                       |       | 11,326,937            |       | $                       | 113        |             | 580,500    |             | $          | (5,978            | )          | $                      | 101,240    |            | $          | 9,602      |       | $ | 1,846 |   | $ | 106,823 |   |
| Exercise of common stock options                                           |       | 5,000                 |       | —                  |       | —           |       | —           |       | 12                |       | —                 |       | —          |       | 12         |       |
| Repurchase of common stock                                                 |       | —                |       | —                  |       | 583,130          |       | (3,814           | )          | —            |       | —                 |       | —          |       | (3,814     | )          |
| Additional paid in capital arising from stock option  compensation expense |       | —                |       | —                  |       | —           |       | —           |       | 495               |       | —                 |       | —          |       | 495        |       |
| Comprehensive income (loss):                                               |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       |       |       |
| Net loss for the first nine months of 2008                                 |       | —                |       | —                  |       | —           |       | —           |       | —            |       | (11,868                | )          | —          |       | (11,868    | )          |
| Translation adjustments                                                    |       | —                |       | —                  |       | —           |       | —           |       | —            |       | —                 |       | 421             |       | 421        |       |
| Total comprehensive loss                                                   |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       | (11,447    | )          |
| **Balances, September 30, 2008 (unaudited)**                          |       | 11,331,937            |       | $                       | 113        |             | 1,163,630  |             | $          | (9,792            | )          | $                      | 101,747    |            | $          | (2,266     | )          | $ | 2,267 |   | $ | 92,069 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                                              | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                              | ** ** | **September 30,**          | ** ** |
| ** **                                                                              | ** ** | **2008**                        | ** ** | **2007** | ** ** |
| **Cash flows from operating activities:**                                               |       |                            |       |   |   |
| Net earnings (loss)                                                                     |       | $                               | (11,868    | ) | $ | 3,545 |   |
| Adjustments to reconcile net earnings (loss) to net  cash used in operating activities: |       |                            |       |   |   |
| Net loss from discontinued operations                                                   |       | 145                             |       | — |   |
| Purchase of SBA loans held for sale                                                     |       | —                          |       | (18,355 | ) |
| Net principal payments (advances) on SBA loans held  for sale                           |       | (7,938                          | )          | (358 | ) |
| Proceeds from the sale of SBA loans held for sale,  net                                 |       | 5,310                           |       | 17,123 |   |
| Purchases of Portfolio Assets                                                           |       | (50,121                         | )          | (61,249 | ) |
| Proceeds applied to principal on Portfolio Assets                                       |       | 46,944                          |       | 60,814 |   |
| Income from Portfolio Assets                                                            |       | (15,786                         | )          | (16,463 | ) |
| Capitalized interest and costs on Portfolio Assets  and loans receivable                |       | (986                            | )          | (776 | ) |
| Provision for loan and impairment losses                                                |       | 11,243                          |       | 936 |   |
| Equity in earnings of investments                                                       |       | (8,018                          | )          | (8,315 | ) |
| Gain on sale of SBA loans held for sale, net                                            |       | (227                            | )          | (658 | ) |
| Gain on sale of subsidiaries and equity investments                                     |       | —                          |       | (207 | ) |
| Depreciation and amortization                                                           |       | 2,808                           |       | 1,956 |   |
| Net premium amortization of loans receivable                                            |       | (231                            | )          | (427 | ) |
| Stock-based compensation expense related to stock  options                              |       | 495                             |       | 408 |   |
| Increase in restricted cash                                                             |       | (615                            | )          | (172 | ) |
| Decrease (increase) in service fees receivable                                          |       | (198                            | )          | 270 |   |
| Increase in other assets                                                                |       | (1,460                          | )          | (5,359 | ) |
| Increase in other liabilities                                                           |       | 4,975                           |       | 791 |   |
| Net cash used in operating activities                                                   |       | (25,528                         | )          | (26,496 | ) |
| **Cash flows from investing activities:**                                               |       |                            |       |   |   |
| Purchases of property and equipment, net                                                |       | (1,795                          | )          | (502 | ) |
| Proceeds from sale of subsidiaries and equity  investments                              |       | —                          |       | 726 |   |
| Cash paid for business combination, net of cash  acquired                               |       | (300                            | )          | (5,629 | ) |
| Net principal collections (advances) on loans  receivable                               |       | (28,338                         | )          | 1,837 |   |
| Purchases of SBA loans held for investment                                              |       | —                          |       | (17,407 | ) |
| Net principal collections (advances) on SBA loans  held for investment                  |       | (156                            | )          | 2,303 |   |
| Contributions to Acquisition Partnerships and  Servicing and Operating Entities         |       | (3,037                          | )          | (22,352 | ) |
| Distributions from Acquisition Partnerships and  Servicing and Operating Entities       |       | 14,762                          |       | 52,291 |   |
| Net cash provided by (used in) investing activities                                     |       | (18,864                         | )          | 11,267 |   |
| **Cash flows from financing activities:**                                               |       |                            |       |   |   |
| Borrowings under note payable to affiliate                                              |       | 8,577                           |       | — |   |
| Borrowings under notes payable to banks                                                 |       | 107,525                         |       | 142,549 |   |
| Principal payments of notes payable to banks, net                                       |       | (76,658                         | )          | (110,850 | ) |
| Payments of debt issuance costs and loan fees                                           |       | (1,291                          | )          | (2,134 | ) |
| Repurchase of common stock                                                              |       | (3,814                          | )          | (82 | ) |
| Proceeds from issuance of common stock                                                  |       | 12                              |       | 35 |   |
| Net cash provided by financing activities                                               |       | 34,351                          |       | 29,518 |   |
| Net cash provided by (used in) continuing operations                                    |       | (10,041                         | )          | 14,289 |   |
| **Cash flows from discontinued operations:**                                            |       |                            |       |   |   |
| Net cash used in operating activities                                                   |       | (12                             | )          | (24 | ) |
| Net cash used in discontinued operations                                                |       | (12                             | )          | (24 | ) |
| **Net increase (decrease) in cash and cash  equivalents**                               |       | (10,053                         | )          | 14,265 |   |
| **Cash and cash equivalents, beginning of period**                                      |       | 23,037                          |       | 18,472 |   |
| **Cash and cash equivalents, end of period**                                            |       | $                               | 12,984     |   | $ | 32,737 |   |
| **Supplemental disclosure of cash flow  information:**                                  | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Cash paid during the period for:                                                        | ** ** | ** **                      | ** ** | ** ** | ** ** |
| Interest                                                                                |       | $                               | 9,607      |   | $ | 12,012 |   |
| Income taxes, net of refunds received                                                   |       | 215                             |       | 287 |   |

 

See accompanying notes to consolidated financial statements.

 

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Table ofContents

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**September 30, 2008**

**(Unaudited)**

 

**(1)  Basis of Presentation and Summary of Significant AccountingPolicies**

 

***The Company***

 

FirstCity Financial Corporation and subsidiaries (the “Company” or “FirstCity”)is a financial services company with offices throughout the United States andMexico, and a presence in France, Germany, Brazil and Chile. At September 30,2008, the Company was engaged in one principal reportable segment – PortfolioAsset acquisition and resolution. Theportfolio asset acquisition and resolution business involves acquiringportfolios of loans, real estate and other assets or similar single-assetinvestments (collectively referred to as “Portfolios” or “Portfolio Assets”).The Company generally acquires Portfolio Assets at a discount to theirlegal principal balances or appraised values,and then services and resolves the Portfolio Assets in an effort to maximizethe present value of the ultimate cash recoveries. The Company also invests inspecial situations and restructuring arrangements such as acquiring orfinancing distressed debt and businesses, originating junior- and senior-bridgeloans, and executing lower middle-market buyouts; and purchases, originates andservices U.S. Small Business Administration loans.

 

***Basis of Presentation***

 

The unaudited consolidated financial statements of FirstCity reflect, inthe opinion of management, all adjustments, consisting only of normal andrecurring adjustments, necessary to present fairly FirstCity’s consolidatedfinancial position at September 30, 2008, its results of operations forthe three and nine month periods ended September 30, 2008 and 2007 andcash flows for the nine month periods ended September 30, 2008 and 2007.Certain disclosures have been condensed or omitted from these financialstatements. Accordingly, these financial statements should be read with the consolidatedfinancial statements included in the Company’s 2007 Annual Report on Form 10-K,as amended. Certain amounts in the consolidated financial statements for prioryears have been reclassified to conform to current consolidated financialstatement presentation.

 

***Use of Estimates***

 

The preparation of financial statements inconformity with U.S. generally accepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and disclosureof contingent assets and liabilities at the date of the financial statementsand the reported amounts of revenues and expenses during the reporting period.Material estimates that are particularly susceptible to significant change inthe near-term relate to the estimation of future cash flows on Portfolio Assetsused in the calculation of income and evaluation of impairment; interest rateenvironments; valuation of the deferred tax asset; valuation of servicingassets and underlying assumptions; valuation of loans receivable (includingloans receivable held in securitization trusts); and income tax uncertainties.Actual results could differ materially from those estimates.

 

***Restricted Cash***

 

Restricted cash includes monies due onloan-related remittances received by the Company and due to third parties.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

***Portfolio Assets – Real Estate***

 

*Classification and Impairment Evaluation*

 

Real estate held for sale primarily includesreal estate acquired through loan foreclosure. The Company classifies aproperty as held for sale if (1) management commits to a plan to sell theproperty; (2) the Company actively markets the property in its currentcondition for a price that is reasonable in comparison to its fair value; and (3) managementconsiders the sale of such property within one year of the balance sheet dateto be probable. Real estate held for sale is stated at the lower of cost orfair value less estimated disposition costs. Real estate is not depreciatedwhile it is classified as held for sale. Impairment losses are recorded if aproperty’s fair value less estimated disposition costs is less than itscarrying amount. Impairment recoveries are recorded for any subsequent increasein the property’s fair value less estimated disposition costs up to the amountof cumulative losses previously recognized on the property.

 

Real estate held for investment generallyincludes acquired properties and is carried at cost less depreciation andamortization, as applicable. The Company classifies a property as held forinvestment if the property is still under development and/or management doesnot expect the property to be sold within one year of the balance sheet date.The Company periodically reviews its property held for investment forimpairment whenever events or changes in circumstances indicate the carryingamount of the asset may not be recoverable. Recoverability of property held forinvestment is measured by comparison of the carrying amount of the asset tofuture net cash flows expected to be generated by the property. If the propertyis considered impaired, the impairment to be recognized is measured by theamount by which the carrying amount of the property exceeds the fair value ofthe property. Fair value is determined by discounted cash flows or marketcomparisons.

 

*Cost Capitalization and Allocation*

 

Real estate properties acquired through, or inlieu of, loan foreclosure are initially recorded at the lower of cost (i.e. theunderlying loan’s carrying value) or estimated fair value less dispositioncosts at the date of foreclosure, establishing a new cost basis. The amount, ifany, by which the carrying value of the underlying loan exceeds the property’sfair value less estimated disposition costs at the foreclosure date is chargedas a loss against operations. The Company capitalizes costs incurred for anysubsequent expenditures that represent capital improvements and significantbetterments and replacements. Expenditures for repairs, maintenance, and otherholding costs are charged to operations as incurred.

 

Real estate properties acquired through apurchase transaction are initially recorded at the cost of the acquisition. Thecost of acquired property includes the purchase price of the property, legalfees, and certain other acquisition costs. Subsequent to acquisition, theCompany capitalizes capital improvements and expenditures related tosignificant betterments and replacements. Expenditures for repairs,maintenance, and other holding costs are charged to operations as incurred.

 

When acquiring real estate with an existingbuilding through a purchase transaction, the Company generally allocates thepurchase price between land, land improvements, building, tenant improvements,and intangible assets related to in-place leases based on their relative fair valuesin accordance with SFAS 141 and SFAS 142. The fair values of acquired land andbuildings are generally determined based on an estimated discounted future cashflow model with lease-up assumptions as if the building was vacant uponacquisition, third-party valuations, and other relevant data. The fair value ofin-place leases includes the value of net lease intangibles for above- andbelow-market rents and tenant origination costs, determined on a lease-by-leasebasis. Amounts allocated to building and improvements are depreciated overtheir estimated remaining lives. Amounts allocated to tenant improvements,in-place lease assets and other lease-related intangibles are amortized overthe remaining life of the underlying leases.

 

*Disposition of Real Estate*

 

Gains ondisposition of real estate are recognized upon sale of the underlying propertyin accordance with SFAS No. 66, *Accountingfor Sales of Real Estate*. We evaluate real estate transactions todetermine if it qualifies for gain recognition under the full accrual method.If the transaction does not meet the criteria for the full accrual method ofprofit recognition based on our assessment, we account for the sale based on anappropriate deferral method determined by the nature and extent of the buyer’sinvestment and our continuing involvement.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

***Reclassifications***

 

Certain amounts inthe consolidated financial statements for prior periods have been reclassifiedto conform to current consolidated financial statement presentation as follows:

 

·                  In all reportingperiods prior to December 31, 2007, FirstCity reported payments of debtissuance costs and loan fees in “Cash flows from operating activities” on theConsolidated Statements of Cash Flows. The Company now reports these amounts in“Cash flows from financing activities.” The total amount reclassified was $2.1million for the nine month period ended September 30, 2007.

·                  For the ninemonth period ended September 30, 2007, FirstCity reported cash received onloan-related remittances and due to third parties as “Cash and cash equivalents”on the Consolidated Balance Sheets. The Company now reports this amount as “Restrictedcash” on the Consolidated Balance Sheets and “Cash flows from operatingactivities” on the Consolidated Statements of Cash Flows. The total amountreclassified was $509,000 at December 31, 2007 on the Consolidated BalanceSheets, and $172,000 for the nine month period ended September 30, 2007 onthe Consolidated Statements of Cash Flows.

·                  For the ninemonth period ended September 30, 2007, FirstCity reported certaincapitalized interest amounts as principal payments on notes payable. TheCompany reclassified $743,000 from “Cash flows from operating activities” to “Cashflows from financing activities” on the Consolidated Statements of Cash Flowsfor the nine month period ended September 30, 2007.

 

Managementbelieves that the changes to the Consolidated Statements of Cash Flows andConsolidated Balance Sheets as described above are not material relative to theconsolidated financial statements taken as a whole. These reclassificationshave the following impact on the consolidated financial statements:

 

| ** **                                                                   | ** ** | **Nine Months Ended**      | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                   | ** ** | **September 30,**               | ** ** |
| ** **                                                                   | ** ** | **2007**                             | ** ** |
| ** **                                                                   | ** ** | **(Dollars in thousands)** | ** ** |
| Consolidated Statements of Cash Flows:                                       |       |                                 |       |
| Cash flows from operating activities (as reported)                           |       | $                                    | (27,715    | ) |
| Impact of reclassification on payments of debt issuance  costs and loan fees |       | 2,134                                |       |
| Impact of reclassification on change in restricted  cash                     |       | (172                                 | )          |
| Impact of reclassification on principal payments of  notes payable to banks  |       | (743                                 | )          |
| Cash flows from operating activities (as corrected)                          |       | $                                    | (26,496    | ) |
|                                                                         |       |                                 |       |
| Cash flows from financing activities (as reported)                           |       | $                                    | 30,909     |   |
| Impact of reclassification on payments of debt issuance  costs and loan fees |       | (2,134                               | )          |
| Impact of reclassification on principal payments of  notes payable to banks  |       | 743                                  |       |
| Cash flows from financing activities (as corrected)                          |       | $                                    | 29,518     |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

| ** **                                    | ** ** | **December 31,**                | ** ** |
|-----------------------------------------------|------------|--------------------------------------|------------|
| ** **                                    | ** ** | **2007**                             | ** ** |
| ** **                                    | ** ** | **(Dollars in thousands)** | ** ** |
| Consolidated Balance Sheets:                  |       |                                 |       |
| Cash and cash equivalents (as reported)       |       | $                                    | 23,546     |   |
| Impact of reclassification of restricted cash |       | (509                                 | )          |
| Cash and cash equivalents (as corrected)      |       | $                                    | 23,037     |   |
|                                          |       |                                 |       |
| Restricted cash (as reported)                 |       | $                                    | —     |   |
| Impact of reclassification of restricted cash |       | 509                                  |       |
| Restricted cash (as corrected)                |       | $                                    | 509        |   |

 

**(2)  Recently Issued and Recently Adopted Accounting Standards**

 

***Recently Issued Accounting Standards***

 

In May 2008,the Financial Accounting StandardsBoard (“FASB”) issued Statementof Financial Accounting Standards (“SFAS”) No. 162, *The Hierarchy of Generally Accepted Accounting Principles* (“SFAS162”), which is intended to improve financial reporting by identifying aconsistent framework or hierarchy for selecting accounting principles to be usedin preparing financial statements of nongovernmental entities that arepresented in conformity with generally accepted accounting principles (“GAAP”)in the United States (the GAAP hierarchy). SFAS 162 is effective 60 daysfollowing the Securities and Exchange Commission’s (the “SEC”) approval of thePublic Company Accounting Oversight Board amendment to AU Section 411, *The Meaning of Present Fairly in Conformity with Generally AcceptedAccounting Principles*. TheCompany does not expect the adoption of SFAS 162 will have a material impact onits consolidated financial statements or financial statement disclosures.

 

In March 2008,the FASB issued SFAS No. 161, *Disclosures about Derivative Instruments and HedgingActivities* (“SFAS 161”), an amendment to SFAS No. 133, *Accounting for Derivative Instruments and HedgingActivities*. SFAS 161 requires enhanced disclosures about derivativeinstruments and hedged items that are accounted for under SFAS No. 133 andrelated interpretations. SFAS 161 will be effective for the Company’s interimand annual financial statements for periods beginning after November 15,2008, with early adoption permitted. SFAS 161 expands the disclosurerequirements for derivatives and hedged items and has no impact on the Company’saccounts for any such instruments. The Company is currently evaluating theimpact of adopting SFAS 161 on its financial statement footnote disclosures.

 

In December 2007,the FASB issued SFAS No. 141R, *Business Combinations* (“SFAS 141R”) and SFAS No. 160, *Noncontrolling Interests in Consolidated Financial Statements – anamendment to ARB No. 51* (“SFAS 160”). SFAS 141R and SFAS 160require most identifiable assets, liabilities, non-controlling interests, andgoodwill acquired in a business combination to be recorded at “full fair value”and require non-controlling interests (previously referred to as “minorityinterests”) to be reported as a component of equity, which changes theaccounting for transactions with non-controlling interest holders. Both SFAS141R and SFAS 160 are effective for periods beginning on or after December 15,2008, and earlier adoption is prohibited. SFAS 141R will be applied to businesscombinations occurring after the effective date. SFAS 160 will be appliedprospectively to all non-controlling interests, including any that arose beforethe effective date. The Company is currently evaluating the impact of adoptingSFAS 141R and SFAS 160 on its financial condition, results of operations andfuture business acquisitions.

 

In February 2007, the FASB issued SFAS No.159,*The Fair Value Option for Financial Assets andFinancial Liabilities-Including an amendment of FASB Statement No. 115*(“SFAS159”).**SFAS 159 providesentities an opportunity to choose to measure eligible items at fair value at specifiedelection dates. Unrealized gains and losses on items for which the fair valueoption has been elected are reported in earnings at each subsequent reportingdate. The fair value option (i) may be applied instrument by instrument,with certain exceptions, (ii) is irrevocable (unless a new election dateoccurs) and (iii) is applied only to entire instruments and not toportions of instruments. Adoption of SFAS 159 is optional and, if adopted,would be effective for the Company’s 2008 fiscal year. The Company elected notto adopt SFAS 159. As such, SFAS 159 did not impact the Company’s consolidatedfinancial statements or financial statement footnote disclosures.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

***Recently Adopted Accounting Standards***

 

Effective January 1,2008, the Company adopted SFAS No. 157, *Fair ValueMeasurements* (“SFAS 157”). SFAS 157 defines fair value, establishesa framework for measuring fair value under generally accepted accountingprinciples, and enhances disclosures about fair value measurements. Fair valueis defined under SFAS 157 as the exchange price that would be received for anasset or paid to transfer a liability (exit price) in the principal or mostadvantageous market for the asset or liability in an orderly transactionbetween market participants on the measurement date.  The adoption of SFAS 157 did not have anyeffect on our financial statements at the date of adoption. For additionalinformation, refer to Note 13 of the Consolidated Financial Statements.

 

In February 2008,the FASB issued FASB Staff Position 157-2, *Effective Date of FASBStatement No. 157*, which delays the effective date of SFAS 157for non-financial assets and non-financial liabilities that are not required orpermitted to be measured at fair value on a recurring basis. The Company willbe required to apply SFAS 157, effective January 1, 2009, to non-financialassets and liabilities that qualified for the deferral.

 

In October 2008,the FASB issued FASB Staff Position 157-3, *Determining the Fair Valueof a Financial Asset When the Market for That Asset is Not Active*(“FSP 157-3”). FSP 157-3 applies to financial assets within the scope ofaccounting pronouncements that require or permit fair value measurements underSFAS 157, and clarifies the application of SFAS 157 in a market that is notactive. FSP 157-3 states that an entity should not automatically conclude thata particular transaction price is determinative of fair value. In a dislocatedmarket, judgment is required to evaluate whether individual transactions areforced liquidations or distressed sales. When relevant observable marketinformation is not available, a valuation approach that incorporatesmanagement’s judgments about the assumptions that market participants would usein pricing the asset in a current sale transaction would be acceptable. FSP157-3 is effective immediately and applies to prior periods for which financialstatements have not been issued, including interim or annual periods ending onor before September 30, 2008. Accordingly, we adopted FSP 157-3 prospectively,beginning July 1, 2008. The adoption of FSP 157-3 did not have a materialimpact on our financial results or fair value determinations.

 

**(3)  Business Acquisitions**

 

*Step Acquisition – UBN, SA*

 

On September 8, 2008, the Company, througha wholly-owned subsidiary, acquired an additional 7.75% ownership interest inUBN, SA (formerly P.R.L. Developpement, SAS) for $1.5 million. As a result ofthe additional equity purchase, the Company’s ownership interest in UBN, SA(“UBN”) increased to 53.5%, resulting in UBN becoming a consolidated subsidiaryof the Company. The transaction was accounted for as a step acquisition inaccordance with SFAS 141, and resultantly, UBN’s assets and liabilities of$23.8 million (including $1.2 million in cash) and $1.6 million, respectively,were included in the Company’s consolidated balance sheet at the date of thestep acquisition. The Company previously accounted for its investment in UBNunder the equity method of accounting, and the carrying amount of the Company’s45.75% equity interest in UBN at the time of the step acquisition approximated$10.2 million. UBN’s results of operations since September 8, 2008,approximately $38,000, are included in the Company’s consolidated statements ofoperations.

 

*Property Acquisition*

 

In June 2008, the Company, through a majority-owned subsidiary,acquired an 80% interest in 122-132 West Pierpont Avenue in Salt Lake City,Utah for an aggregate purchase price of approximately $10.3 million, includingthe assumption of $7.6 million in debt. The property consists of office andretail buildings aggregating approximately 53,000 net rentable square feet. TheCompany is in the process of obtaining valuations of certain tangible andintangible assets; thus, the allocation of the purchase price is subject torefinement.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(4)  Discontinued Operations**

 

Discontinued operations are comprised of twocomponents previously reported as the Company’s residential and commercialmortgage banking business (“Mortgage”) and the consumer lending businessconducted through the Company’s minority interest investment in Drive FinancialServices LP (“Consumer”). In the third quarter of 2008, the Company recorded noprovision related to the discontinued Mortgage operations. There was no incomeor loss from discontinued operations in the first nine months of 2007. At September 30,2008 and December 31, 2007, liabilities from discontinued Consumeroperations of $469,000 and $568,000, respectively, which consist of stateincome taxes payable, were included in other liabilities.

 

**(5)  Portfolio Assets**

 

Portfolio Assets are summarized as follows:

 

| ** **                                  | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2008**                             | ** ** | **2007**              | ** ** |
| ** **                                  | ** ** | **(Dollars in thousands)** | ** ** |
| Loan Portfolios                             | ** ** | ** **                           | ** ** | ** **            | ** ** |
| Loans Acquired Prior to 2005                | ** ** | ** **                           | ** ** | ** **            | ** ** |
| Non-performing Portfolio Assets             |       | $                                    | 3,550      |                  | $          | 4,177 |   |
| Performing Portfolio Assets (1)             |       | 68,944                               |       | 1,266                 |       |
| Loans Acquired After 2004                   | ** ** | ** **                           | ** ** | ** **            | ** ** |
| Loans acquired with credit deterioration    |       | 111,080                              |       | 97,630                |       |
| Loans acquired with no credit deterioration |       | 3,545                                |       | 3,871                 |       |
| Outstanding balance                         |       | 187,119                              |       | 106,944               |       |
| Allowance for loan losses (1)               |       | (77,084                              | )          | (1,723                | )          |
| Carrying amount of loans, net of allowance  |       | 110,035                              |       | 105,221               |       |
|                                        |       |                                 |       |                  |       |
| Real estate held for sale                   |       | 19,919                               |       | 14,832                |       |
| Real estate held for investment, net        |       | 9,648                                |       | —                |       |
| Other                                       |       | 1,551                                |       | 1,948                 |       |
| Portfolio Assets, net                       |       | $                                    | 141,153    |                  | $          | 122,001 |   |

 

----

(1)                IncludesPortfolio Assets and related allowance acquired in the step acquisition of UBN,SA in September 2008 (refer to Note 3).

 

In the first quarter of 2008, the Company discontinued using the incomerecognition model under AICPA Statement of Position 03-3, *Accounting for Certain Loans or Debt SecuritiesAcquired in a Transfer* (“SOP 03-3”) for previously-purchasednon-performing loan portfolios in Mexico. Recognition of income under SOP 03-3is dependent on management having the ability to develop reasonableexpectations as to both the timing and amount of cash flows to be collected. Inthe event management cannot develop a reasonable expectation of the timing andamount of cash flows expected to be collected, SOP 03-3 permits the use of thecost-recovery accounting model. Due to uncertainties related to the legal andeconomic environment in Mexico, management determined that it no longer has theability to develop a reasonable expectation of the timing of cash flows to becollected, and as of January 1, 2008, began accounting for its non-performingloan portfolios in Mexico under the cost-recovery accounting model – whichrequires collections received to be applied first against the recorded amountof the loan or pool. When the carrying amount of the loan or pool has beenreduced to zero, any additional amounts received are recognized as income. TheCompany evaluates at the balance sheet date if the remaining amount that isprobable of collection is less than the carrying value, and if so, recognizesimpairment. For subsequent increases in the actual cash flows or cash flowsexpected to be collected, management will reverse any existing valuationallowance for that loan or pool. At September 30,2008, the Company’s carrying amount of non-performing loans in Mexico accountedfor using the cost-recovery model in the caption “Loans Acquired After 2004 –Loans acquired with credit deterioration” in the table above approximated $14.5million. The Company acquired $8.7 million of loan portfolios in Mexico withcredit deterioration in the second quarter of 2008 that are accounted for usingthe cost-recovery accounting model under SOP 03-3.

 

In June 2008, FirstCity and another investoracquired a portfolio of non-performing loans in Mexico for $8.7 million. At September 30,2008, FirstCity accounted for this investment as a consolidated Portfolio Assetsince it has a 58.0% ownership interest

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

in the entity that holds the portfolio. Pursuant to the purchaseagreement, as amended, the other investor (42.0% ownership interest) has theoption to acquire additional interests in the investment that will allow it toown 80.0% of the entity that holds the loan portfolio by paying FirstCity anamount equal to 38.0% of the portfolio’s purchase price (and FirstCity wouldsubsequently own 20.0% of the portfolio). If the investor does not exercise itsoption by December 2008, then FirstCity and the investor will execute anadministrative services agreement that will entitle FirstCity to receive fromthe investor a one-time oversight fee in the amount of $698,000.

 

Certain Portfolio Assets are pledged to secure a$100.0 million revolving loan facility between FH Partners LLC, an indirectwholly-owned affiliate of FirstCity, and Bank of Scotland. See Note 2 to theCompany’s 2007 Annual Report on Form 10-K filed with the Securities andExchange Commission (“SEC” or “Commission”) on March 17, 2008 for adescription of this revolving credit agreement. In addition, certain PortfolioAssets are pledged to secure notes payable of certain consolidated affiliatesof FirstCity that are generally non-recourse to FirstCity or any affiliateother than the acquiring entity that incurred the debt.

 

Income from Portfolio Assets is summarized asfollows:

 

| ** **                                  | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                  | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                                  | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                  | ** ** | **(Dollars in thousands)** | ** ** |
| Loan Portfolios                             |       |                                 |       |                            |       |   |   |   |   |
| Loans Acquired Prior to 2005                |       |                                 |       |                            |       |   |   |   |   |
| Non-performing Portfolio Assets             |       | $                                    | 93         |                            | $          | 325 |   | $ | 348 |   | $ | 1,193 |   |
| Performing Portfolio Assets                 |       | 183                                  |       | 165                             |       | 326 |   | 727 |   |
| Loans Acquired After 2004                   | ** ** | ** **                           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans acquired with credit deterioration    |       | 4,454                                |       | 4,300                           |       | 12,920 |   | 12,450 |   |
| Loans acquired with no credit deterioration |       | 116                                  |       | 417                             |       | 325 |   | 1,113 |   |
| Real Estate Portfolios                      |       | 329                                  |       | 478                             |       | 1,705 |   | 806 |   |
| Other                                       |       | 54                                   |       | 58                              |       | 162 |   | 174 |   |
| Income from Portfolio Assets                |       | $                                    | 5,229      |                            | $          | 5,743 |   | $ | 15,786 |   | $ | 16,463 |   |

 

The Companyrecorded a provision for loan and impairment losses on Portfolio Assets ofapproximately $11.0 million for the nine month period ended September 30,2008, which is comprised of a $1.0 million impairment charge on real estateportfolios and a $10.0 million allowance for loan losses, net ofrecoveries.  For the nine month periodended September 30, 2007, the Company recorded a provision for loan andimpairment losses on Portfolio Assets of $757,000, which is comprised of a$93,000 impairment charge on real estate portfolios and a $664,000 allowancefor loan losses.

 

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

 

| ** **                                         | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                         | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                                         | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                         | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                                  |       | $                                    | (10,454    | )                               | $          | (1,244 | ) | $ | (1,723 | ) | $ | (333 | ) |
| Provisions                                         |       | (1,413                               | )          | (661                            | )          | (10,567 | ) | (1,686 | ) |
| Recoveries                                         |       | 341                                  |       | 908                             |       | 603 |   | 1,022 |   |
| Charge offs                                        |       | —                               |       | —                          |       | 162 |   | — |   |
| Increase due to step acquisition (refer to Note 3) | (65,557    | )                                    | —     |                            | (65,557    | ) | — |   |
| Translation adjustments                            |       | (1                                   | )          | —                          |       | (2 | ) | — |   |
| Ending Balance                                     |       | $                                    | (77,084    | )                               | $          | (997 | ) | $ | (77,084 | ) | $ | (997 | ) |

 

Changes inaccretable yield for loans acquired after 2004 with evidence of creditdeterioration are as follows:

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

| ** **                                          | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                          | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                                          | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                          | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                                   |       | $                                    | 55,184     |                            | $          | 32,241 |   | $ | 35,951 |   | $ | 32,339 |   |
| Additions                                           |       | (4,692                               | )          | 6,549                           |       | 15,521 |   | 9,785 |   |
| Accretion                                           |       | (3,824                               | )          | (3,505                          | )          | (10,558 | ) | (10,086 | ) |
| Reclassification from (to) nonaccretable difference |       | (1,652                               | )          | (327                            | )          | 5,905 |   | 4,838 |   |
| Disposals                                           |       | (1,045                               | )          | (1,005                          | )          | (3,496 | ) | (2,924 | ) |
| Translation adjustments                             |       | 58                                   |       | 22                              |       | 706 |   | 23 |   |
| Ending Balance                                      |       | $                                    | 44,029     |                            | $          | 33,975 |   | $ | 44,029 |   | $ | 33,975 |   |

 

For the three- and nine-month periods ended September 30, 2008,the Company adjusted the accretable yield schedules on certain loans to reflectthe residual excess of the expected future cash flows over their carryingvalues. The following accretable yield adjustments are included in the tabularpresentation above for the three-months ended September 30, 2008: (1) $10.2million increase to “Beginning Balance”; (2) $1.0 million increase to“Reclassification from (to) nonaccretable difference”; and (3) $6.1 milliondecrease to “Additions”. In addition, the tabular presentation above includesan $11.2 million increase to “Reclassification from (to) nonaccretabledifference” for the nine-months ended September 30, 2008. These adjustments tothe underlying accretable yield schedules did not impact the Company’sconsolidated financial condition or results of operations.

 

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

 

| ** **                                                              | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                                              | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                                                              | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                              | ** ** | **(Dollars in thousands)** | ** ** |
| Face value at acquisition                                               |       | $                                    | 10,784     |                            | $          | 27,480 |   | $ | 85,539 |   | $ | 78,030 |   |
| Cash flows expected to be collected at acquisition, net  of adjustments |       | (2,092                               | )          | 21,638                          |       | 61,193 |   | 60,465 |   |
| Basis in acquired loans at acquisition                                  |       | 2,600                                |       | 15,089                          |       | 45,672 |   | 50,680 |   |
|                                                                         |            |                                      |            |                                 |            |  |  |  |  |  |  |  |  |

 

**(6)  Loans Receivable**

 

***Loansreceivable – affiliates***

 

Loans receivable –affiliates, which are designated by management as held for investment, aresummarized as follows:

 

| ** **                    | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2008**                             | ** ** | **2007**              | ** ** |
| ** **                    | ** ** | **(Dollars in thousands)** | ** ** |
| Outstanding balance           |       | $                                    | 24,481     |                  | $          | 4,967 |   |
| Capitalized interest          |       | 1,252                                |       | 480                   |       |
| Carrying amount of loans, net |       | $                                    | 25,733     |                  | $          | 5,447 |   |

 

The summary ofactivity in loans receivable – affiliates is as follows:

 

| ** **                      | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                      | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                      | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance               |       | $                                    | 18,980     |                            | $          | 5,084 |   | $ | 5,447 |   | $ | 4,755 |   |
| Advances                        |       | 8,710                                |       | 181                             |       | 22,210 |   | 667 |   |
| Payments received               |       | (1,941                               | )          | (73                             | )          | (2,455 | ) | (447 | ) |
| Capitalized interest            |       | 581                                  |       | 89                              |       | 772 |   | 233 |   |
| Other noncash adjustments       |       | (163                                 | )          | —                          |       | (163 | ) | — |   |
| Foreign exchange gains (losses) |       | (434                                 | )          | 234                             |       | (78 | ) | 307 |   |
| Ending Balance                  |       | $                                    | 25,733     |                            | $          | 5,515 |   | $ | 25,733 |   | $ | 5,515 |   |

 

Loans receivable –affiliates represent advances to entities formed with other investors(“Acquisition Partnerships”) and other affiliated entities to acquireportfolios of performing and nonperforming commercial and consumer loans andother assets; and a senior debt financing arrangement with an

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

equity-method investee toprovide capital for business expansion. The loans are reported at theiroutstanding principal balances adjusted for unearned discounts, loanorigination fees, and the allowance for loan losses. Interest is accrued whenearned in accordance with the contractual terms of the loans. Interest is recognizedon an accrual basis at the applicable interest rate on the principal amountoutstanding. Loan origination fees and direct costs are generally amortized aslevel-yield adjustments over the respective loan terms. Unamortized net fees orcosts are recognized upon early repayment of the loans.  Loans receivable – affiliates are generallysecured by the underlying collateral that was acquired with the loan proceeds.Advances to affiliates to acquire loan portfolios are secured by the underlyingcollateral of the individual notes within the portfolios, which is generallyreal estate and foreclosed properties; whereas the advance to the affiliate forbusiness expansion purposes is secured by equipment and ownership interests.

 

Managementevaluates the need for impairment based upon the performance of the loans andvarious other factors. Impairment is evaluated by analyzing expected futurecash flows and evaluating values of the underlying loan collateral. Foradvances secured by loan portfolios, management analyzes the expected cashflows within each pool to determine that the cash flows are sufficient to repaythese notes. For the loan secured by equipment and ownership interests,management analyzes the expected future cash flows from the borrowing entity (discountedfor the loan’s risk-adjusted rate), and the values of the underlyingcollateral, to determine whether the Company expects to ultimately collect allcontractual principal and interest. The results of management’s evaluationsindicated that projected cash flows and underlying collateral are sufficient torepay the loans and no allowances for impairment are necessary. The Companyrecorded no provisions for impairment on loans receivable – affiliates for thenine months ended September 30, 2008 and 2007.

 

***Loansreceivable – SBA held for sale***

 

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

 

| ** **                    | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2008**                             | ** ** | **2007**              | ** ** |
| ** **                    | ** ** | **(Dollars in thousands)** | ** ** |
| Outstanding balance           |       | $                                    | 3,162      |                  | $          | 133 |   |
| Capitalized costs             |       | 31                                   |       | —                |       |
| Carrying amount of loans, net |       | $                                    | 3,193      |                  | $          | 133 |   |

 

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

 

| ** **                         | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                         | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                         | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                         | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                  |       | $                                    | 2,219      |                            | $          | 3,830 |   | $ | 133 |   | $ | — |   |
| Purchases of loans                 |       | —                               |       | —                          |       | — |   | 18,355 |   |
| Originations and advances of loans |       | 3,167                                |       | 227                             |       | 8,009 |   | 1,051 |   |
| Payments received                  |       | (40                                  | )          | (282                            | )          | (71 | ) | (693 | ) |
| Capitalized costs                  |       | 4                                    |       | —                          |       | 30 |   | — |   |
| Loans sold                         |       | (2,157                               | )          | (1,267                          | )          | (4,908 | ) | (15,806 | ) |
| Premium amortization, net          |       | —                               |       | (30                             | )          | — |   | (429 | ) |
| Ending Balance                     |       | $                                    | 3,193      |                            | $          | 2,478 |   | $ | 3,193 |   | $ | 2,478 |   |

 

Loans receivable – SBA held for sale represent U.S. Small BusinessAdministration (“SBA”) loans acquired by the Company in February 2007 andSBA loan originations and advances made since such time.  SBA loans held for sale represent theportions of the loans that are guaranteed by the SBA, and are reflected at thelower of aggregate cost or estimated fair value. Net unrealized losses, if any,are recognized through a valuation allowance by charges to income. The carryingvalue of SBA loans held for sale is net of premiums as well as deferredorigination fees and costs. Premiums and net origination fees and costs aredeferred and included in the basis of the loans in calculating gains and lossesupon sale. SBA loans are generally secured by the borrowing entities’ assetssuch as accounts, property and equipment, and other assets. The Companygenerally sells the guaranteed portion of each loan to a third party andretains the servicing rights. The difference between the proceeds received andthe allocated carrying value of the loans sold are

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

recognized as netgains on sales of loans.  Thenon-guaranteed portion is generally held in the portfolio and classified asheld for investment.  The Companyrecorded no write-downs of SBA loans held for sale below their cost for thenine months ended September 30, 2008 and 2007.

 

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

 

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

 

| ** **                    | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2008**                             | ** ** | **2007**              | ** ** |
| ** **                    | ** ** | **(Dollars in thousands)** | ** ** |
| Outstanding balance           |       | $                                    | 15,459     |                  | $          | 15,727 |   |
| Allowance for loan losses     |       | (25                                  | )          | (151                  | )          |
| Discounts, net                |       | (1,180                               | )          | (1,346                | )          |
| Capitalized costs             |       | 40                                   |       | 4                     |       |
| Carrying amount of loans, net |       | $                                    | 14,294     |                  | $          | 14,234 |   |

 

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

 

| ** **                         | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                         | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                         | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                         | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                  |       | $                                    | 13,692     |                            | $          | 15,480 |   | $ | 14,234 |   | $ | — |   |
| Purchases of loans                 |       | —                               |       | —                          |       | — |   | 17,406 |   |
| Originations and advances of loans |       | 1,056                                |       | 76                              |       | 2,660 |   | 351 |   |
| Payments received                  |       | (464                                 | )          | (678                            | )          | (2,535 | ) | (2,655 | ) |
| Capitalized costs                  |       | 9                                    |       | —                          |       | 36 |   | 2 |   |
| Provision for SBA loan losses, net |       | 208                                  |       | (110                            | )          | 126 |   | (179 | ) |
| Discount accretion, net            |       | 21                                   |       | 212                             |       | 166 |   | 55 |   |
| Charge offs                        |       | (228                                 | )          | —                          |       | (393 | ) | — |   |
| Ending Balance                     |       | $                                    | 14,294     |                            | $          | 14,980 |   | $ | 14,294 |   | $ | 14,980 |   |

 

Loans receivable –SBA held for investment represent SBA loans acquired by the Company in February 2007and SBA loan originations and advances made since such time. SBA loans held forinvestment are reported at their outstanding principal balances adjusted forunearned discounts, net deferred loan origination costs and the allowance forloan losses. Interest is recognized on an accrual basis at the applicableinterest rate on the principal amount outstanding. Loan origination fees anddirect costs as well as premiums and discounts are generally amortized as levelyield adjustments over the respective loan terms. Unamortized net fees or costsare recognized upon early repayment of the loans. SBA loans held for investmentare generally secured by the borrowing entities’ assets such as accounts,property and equipment, and other assets. Management evaluates the need forimpairment based upon the performance of the loans and other portfoliocharacteristics, such as industry concentrations and loan collateral, whichalso impacts management’s estimates of the impairment. Impairment is evaluatedby analyzing the expected future cash flows from the borrowing entity(discounted for the loans’ risk-adjusted rates), and the values of theunderlying collateral, to determine whether the Company expects to ultimatelycollect all contractual principal and interest. The adequacy of the allowancefor loan losses is reviewed by management on a regular basis and adjustments,if necessary, are reflected in operations during the periods in which theybecome known. Considerations in this evaluation include past and current lossexperience, risks inherent in the current portfolio, and evaluation ofcommercial and real estate collateral as well as current economic conditions.

 

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

 

Changes in theallowance for loan losses related to loans receivable – SBA held for investmentare as follows:

 

| ** **        | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|-------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **        | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **        | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **        | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance |       | $                                    | (233       | )                               | $          | (69 | ) | $ | (151 | ) | $ | — |   |
| Provisions        |       | (7                                   | )          | (110                            | )          | (243 | ) | (179 | ) |
| Recoveries        |       | 2                                    |       | —                          |       | 4 |   | — |   |
| Charge Offs       |       | 213                                  |       | —                          |       | 365 |   | — |   |
| Ending Balance    |       | $                                    | (25        | )                               | $          | (179 | ) | $ | (25 | ) | $ | (179 | ) |

 

***Loansreceivable – other***

 

Loans receivable –other, which are designated by management as held for investment, aresummarized as follows:

 

| ** **                     | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2008**                             | ** ** | **2007**              | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** ** |
| Outstanding balance            |       | $                                    | 14,073     |                  | $          | 5,502 |   |
| Discounts, net                 |       | (21                                  | )          | (24                   | )          |
| Capitalized interest and costs |       | 255                                  |       | 517                   |       |
| Carrying amount of loans, net  |       | $                                    | 14,307     |                  | $          | 5,995 |   |

 

Changes in loansreceivable – other are as follows:

 

| ** **                      | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                      | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                      | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance               |       | $                                    | 16,492     |                            | $          | 29,223 |   | $ | 5,995 |   | $ | 23,991 |   |
| Advances                        |       | 528                                  |       | —                          |       | 11,000 |   | 6,646 |   |
| Payments received               |       | (2,337                               | )          | (6,444                          | )          | (2,418 | ) | (8,703 | ) |
| Capitalized interest and costs  |       | (355                                 | )          | (2                              | )          | (262 | ) | 499 |   |
| Provision for loan impairment   |       | —                               |       | —                          |       | — |   | — |   |
| Discount accretion, net         |       | (14                                  | )          | 29                              |       | 10 |   | 148 |   |
| Foreign exchange gains (losses) |       | (7                                   | )          | 23                              |       | (18 | ) | 248 |   |
| Ending Balance                  |       | $                                    | 14,307     |                            | $          | 22,829 |   | $ | 14,307 |   | $ | 22,829 |   |

 

Loans receivable – other include loans made to non-affiliated entitiesand are secured by the borrowing entities’ assets such as accounts receivable,inventory, property and equipment, and various other assets. The loans arereported at their outstanding principal balances adjusted for unearneddiscounts, loan origination fees, and the allowance for loan losses. Interestis accrued when earned in accordance with the contractual terms of the loans.Interest is recognized on an accrual basis at the applicable interest rate onthe principal amount outstanding.  Loanorigination fees and direct costs are generally amortized as level-yield adjustmentsover the respective loan terms. Unamortized net fees or costs are recognizedupon early repayment of the loans. Management evaluates the need for impairmentbased upon the performance of the loans and various other factors. Impairmentis evaluated by analyzing the expected future cash flows from the borrowingentity (discounted for the loans’ risk-adjusted rates), and the values of theunderlying collateral, to determine whether the Company expects to ultimatelycollect all contractual principal and interest. The results of this evaluationindicated that projected cash flows and underlying collateral are sufficient torepay the loans and no allowances for impairment were necessary. The Companyrecorded no provisions for impairment on loans receivable – other for the ninemonths ended September 30, 2008 and 2007.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(7)  Equity Investments**

 

The Company has investments in AcquisitionPartnerships and their general partners and investments in servicing andoperating entities that are accounted for under the equity method ofaccounting. The condensed combined financial position and results of operationsof the Acquisition Partnerships (excluding servicing entities), which includethe domestic and foreign Acquisition Partnerships and their general partners,are summarized below:

 

**Condensed Combined Balance Sheets**

 

| ** **                                             | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **2008**                             | ** ** | **2007**              | ** ** |
| ** **                                             | ** ** | **(Dollars in thousands)** | ** ** |
| Assets                                                 |       | $                                    | 386,308    |                  | $          | 457,490 |   |
| Liabilities                                            |       | $                                    | 106,334    |                  | $          | 141,430 |   |
| Net equity                                             |       | 279,974                              |       | 316,060               |       |
|                                                   |       | $                                    | 386,308    |                  | $          | 457,490 |   |
|                                                   |       |                                 |       |                  |       |
| Equity investment in Acquisition Partnerships          |       | $                                    | 62,724     |                  | $          | 76,078 |   |
| Equity investment in servicing and operating  entities |       | 30,563                               |       | 11,544                |       |
|                                                   |       | $                                    | 93,287     |                  | $          | 87,622 |   |

 

**Condensed Combined Summary of Operations**

 

| ** **                                              | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                              | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                                              | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                              | ** ** | **(Dollars in thousands)** | ** ** |
| Income from Portfolio Assets                            |       | $                                    | 23,794     |                            | $          | 25,379 |   | $ | 74,866 |   | $ | 70,215 |   |
| Other income                                            |       | (275                                 | )          | 204                             |       | 819 |   | 926 |   |
| Revenues                                                |       | 23,519                               |       | 25,583                          |       | 75,685 |   | 71,141 |   |
| Interest expense                                        |       | 1,737                                |       | 2,588                           |       | 8,950 |   | 8,396 |   |
| Average cost (annualized)                               |       | 7.60                                 | %          | 14.47                           | %          | 9.21 | % | 13.86 | % |
| Service fees                                            |       | 6,657                                |       | 4,960                           |       | 19,819 |   | 14,593 |   |
| Provision for loan and impairment losses                |       | 3,059                                |       | 3,272                           |       | 11,805 |   | 9,936 |   |
| Other operating costs                                   |       | 6,789                                |       | 5,687                           |       | 18,207 |   | 14,018 |   |
| Foreign currency (gains) losses                         |       | (3,081                               | )          | 5,368                           |       | (11,461 | ) | 2,046 |   |
| Income tax and other taxes                              |       | (101                                 | )          | 25                              |       | 1,636 |   | (1,682 | ) |
| Expenses                                                |       | 15,060                               |       | 21,900                          |       | 48,956 |   | 47,307 |   |
| Equity in earnings of investments                       |       | (69                                  | )          | 310                             |       | 1,567 |   | 1,126 |   |
| Net earnings                                            |       | $                                    | 8,390      |                            | $          | 3,993 |   | $ | 28,296 |   | $ | 24,960 |   |
|                                                    |       |                                 |       |                            |       |   |   |   |   |
| Equity in earnings of Acquisition Partnerships          |       | $                                    | 1,582      |                            | $          | 2,084 |   | $ | 6,920 |   | $ | 7,538 |   |
| Equity in earnings of servicing and operating  entities |       | 588                                  |       | 73                              |       | 1,098 |   | 777 |   |
|                                                    |       | $                                    | 2,170      |                            | $          | 2,157 |   | $ | 8,018 |   | $ | 8,315 |   |

 

Portfolio Assets held by certain AcquisitionPartnerships are pledged to secure notes payable that are generallynon-recourse to FirstCity or any affiliate other than the partnership entitythat incurred the debt.

 

On September 8, 2008, the Company, through a wholly-ownedsubsidiary, acquired an additional 7.75% ownership interest in UBN, SA(formerly P.R.L. Developpement, SAS). As a result of the additional equitypurchase, the Company’s ownership interest in UBN, SA (“UBN”) increased to53.5%, resulting in UBN converting from an equity-method investment to aconsolidated subsidiary of the Company at September 8, 2008. The Companypreviously accounted for its investment in UBN under the equity method ofaccounting. As such, the assets, liabilities and equity of UBN are not includedin the applicable balance sheet tables above and below at September 30,2008; and its results of operations from September 9, 2008 to September 30,2008 are not included in the applicable

 

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

 

earnings tablesabove and below for the three month and nine month periods ended September 30,2008. Refer to Note 3 for additional discussion on this transaction.

 

In the first quarter of 2008, the Company discontinued using the incomerecognition model under SOP 03-3 for previously-purchased non-performing loanportfolios in Mexico (refer to Note 5 for a detailed discussion). In accordancewith SOP 03-3, the Acquisition Partnerships now account for theirnon-performing loan portfolios in Mexico under the cost-recovery model — whichrequires collections received to be applied first against the recorded amount ofthe loan or pool. At September 30,2008, the Acquisition Partnerships’ carrying amount of non-performing loans inMexico accounted for using the cost-recovery model in the caption “Assets” inthe “Condensed Combined Balance Sheets” table above approximated $153.9million. The Acquisition Partnerships did not acquire any loan portfolios inMexico with credit deterioration in the third quarter of 2008 that are withinthe scope of SOP 03-3.

 

The assets and equity of the AcquisitionPartnerships and equity investments in the Acquisition Partnerships aresummarized by geographic region below. The WAMCO Partnerships represent limitedpartnerships and limited liability companies in which the Company has a commonownership with Cargill.

 

| ** **                                   | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2008**                             | ** ** | **2007**              | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)** | ** ** |
| Assets:                                      |       |                                 |       |                  |       |
| Domestic:                                    |       |                                 |       |                  |       |
| WAMCO Partnerships                           |       | $                                    | 67,962     |                  | $          | 87,086 |   |
| Other                                        |       | 7,664                                |       | 7,758                 |       |
| Latin America                                |       | 193,248                              |       | 200,780               |       |
| Europe:                                      |       |                                 |       |                  |       |
| UBN, SA (formerly P.R.L. Developpement, SAS) |       | —                               |       | 21,794                |       |
| Other                                        |       | 117,434                              |       | 140,072               |       |
|                                         |       | $                                    | 386,308    |                  | $          | 457,490 |   |

 

| ** **                                     | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **2008**                             | ** ** | **2007**              | ** ** |
| ** **                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Equity:                                        |       |                                 |       |                  |       |
| Domestic:                                      |       |                                 |       |                  |       |
| WAMCO Partnerships                             |       | $                                    | 36,986     |                  | $          | 44,309 |   |
| Other                                          |       | 4,124                                |       | 4,237                 |       |
| Latin America                                  |       | 175,698                              |       | 168,108               |       |
| Europe:                                        |       |                                 |       |                  |       |
| UBN, SA (formerly P.R.L. Developpement, SAS)   |       | —                               |       | 19,728                |       |
| Other                                          |       | 63,166                               |       | 79,678                |       |
|                                           |       | $                                    | 279,974    |                  | $          | 316,060 |   |
| Equity investment in Acquisition Partnerships: |       |                                 |       |                  |       |
| Domestic:                                      |       |                                 |       |                  |       |
| WAMCO Partnerships                             |       | $                                    | 18,328     |                  | $          | 22,065 |   |
| Other                                          |       | 1,978                                |       | 2,064                 |       |
| Latin America                                  |       | 24,258                               |       | 21,555                |       |
| Europe:                                        |       |                                 |       |                  |       |
| UBN, SA (formerly P.R.L. Developpement, SAS)   |       | —                               |       | 9,085                 |       |
| Other                                          |       | 18,160                               |       | 21,309                |       |
|                                           |       | $                                    | 62,724     |                  | $          | 76,078 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

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

 

| ** **                                   | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                                   | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)** | ** ** |
| Revenues:                                    |       |                                 |       |                            |       |   |   |   |   |
| Domestic:                                    |       |                                 |       |                            |       |   |   |   |   |
| WAMCO Partnerships                           |       | $                                    | 2,440      |                            | $          | 5,404 |   | $ | 8,490 |   | $ | 13,776 |   |
| Other                                        |       | 133                                  |       | 196                             |       | 430 |   | 793 |   |
| Latin America                                |       | 8,769                                |       | 11,702                          |       | 32,495 |   | 31,144 |   |
| Europe:                                      |       |                                 |       |                            |       |   |   |   |   |
| UBN, SA (formerly P.R.L. Developpement, SAS) |       | 31                                   |       | 866                             |       | 1,629 |   | 1,612 |   |
| Other                                        |       | 12,146                               |       | 7,415                           |       | 32,641 |   | 23,816 |   |
|                                         |       | $                                    | 23,519     |                            | $          | 25,583 |   | $ | 75,685 |   | $ | 71,141 |   |
|                                         |       |                                 |       |                            |       |   |   |   |   |
| Net earnings:                                |       |                                 |       |                            |       |   |   |   |   |
| Domestic:                                    |       |                                 |       |                            |       |   |   |   |   |
| WAMCO Partnerships                           |       | $                                    | (184       | )                               | $          | 2,167 |   | $ | 375 |   | $ | 5,149 |   |
| Other                                        |       | (351                                 | )          | (77                             | )          | (667 | ) | 28 |   |
| Latin America                                |       | 2,485                                |       | (1,754                          | )          | 8,475 |   | 4,809 |   |
| Europe:                                      |       |                                 |       |                            |       |   |   |   |   |
| UBN, SA (formerly P.R.L. Developpement, SAS) |       | 76                                   |       | 1,048                           |       | 2,845 |   | 2,705 |   |
| Other                                        |       | 6,364                                |       | 2,609                           |       | 17,268 |   | 12,269 |   |
|                                         |       | $                                    | 8,390      |                            | $          | 3,993 |   | $ | 28,296 |   | $ | 24,960 |   |
| Equity in earnings of Acquisition            |       |                                 |       |                            |       |   |   |   |   |
| Partnerships:                                |       |                                 |       |                            |       |   |   |   |   |
| Domestic:                                    |       |                                 |       |                            |       |   |   |   |   |
| WAMCO Partnerships                           |       | $                                    | (303       | )                               | $          | 1,102 |   | $ | (11 | ) | $ | 2,445 |   |
| Other                                        |       | (145                                 | )          | (38                             | )          | (283 | ) | (17 | ) |
| Latin America                                |       | 405                                  |       | (62                             | )          | 1,509 |   | 815 |   |
| Europe:                                      |       |                                 |       |                            |       |   |   |   |   |
| UBN, SA (formerly P.R.L. Developpement, SAS) |       | 35                                   |       | 456                             |       | 1,250 |   | 1,177 |   |
| Other                                        |       | 1,590                                |       | 626                             |       | 4,455 |   | 3,118 |   |
|                                         |       | $                                    | 1,582      |                            | $          | 2,084 |   | $ | 6,920 |   | $ | 7,538 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

Combining statements of operations for the WAMCOPartnerships follow. WAMCO 30 is considered to be a significantsubsidiary of FirstCity.

 

**Three Months Ended September 30, 2008**

 
| ** **                                     | ** ** | **WAMCO**                            | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **30**                               | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| ** **                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Income from Portfolio Assets                   |       | $                                    | 1,184      |             | $          | 1,254        |       | $ | 2,438 |   |
| Other income, net                              |       | 1                                    |       | 1                |       | 2            |       |
| Revenues                                       |       | 1,185                                |       | 1,255            |       | 2,440        |       |
| Interest and fees on notes payable             |       | (345                                 | )          | (26              | )          | (371         | )          |
| Provision for loan and impairment losses       |       | (124                                 | )          | 1                |       | (123         | )          |
| Servicing fees — affiliate                |       | (120                                 | )          | (353             | )          | (473         | )          |
| General, administrative and operating expenses |       | (817                                 | )          | (840             | )          | (1,657       | )          |
| Expenses                                       |       | (1,406                               | )          | (1,218           | )          | (2,624       | )          |
| Net earnings (loss)                            |       | $                                    | (221       | )                | $          | 37           |       | $ | (184 | ) |

 

**Three Months Ended September 30, 2007**

 
| ** **                                     | ** ** | **WAMCO**                            | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **30**                               | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| ** **                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Income from Portfolio Assets                   |       | $                                    | 3,427      |             | $          | 1,923        |       | $ | 5,350 |   |
| Other income, net                              |       | 53                                   |       | 1                |       | 54           |       |
| Revenues                                       |       | 3,480                                |       | 1,924            |       | 5,404        |       |
| Interest and fees on notes payable             |       | (503                                 | )          | (108             | )          | (611         | )          |
| Provision for loan and impairment losses       |       | (748                                 | )          | 2                |       | (746         | )          |
| Servicing fees — affiliate                |       | (305                                 | )          | (198             | )          | (503         | )          |
| General, administrative and operating expenses |       | (1,174                               | )          | (203             | )          | (1,377       | )          |
| Expenses                                       |       | (2,730                               | )          | (507             | )          | (3,237       | )          |
| Net earnings                                   |       | $                                    | 750        |             | $          | 1,417        |       | $ | 2,167 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**Nine Months Ended September 30, 2008**

 
| ** **                                     | ** ** | **WAMCO**                            | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **30**                               | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| ** **                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Income from Portfolio Assets                   |       | $                                    | 4,671      |             | $          | 3,805        |       | $ | 8,476 |   |
| Other income, net                              |       | 12                                   |       | 2                |       | 14           |       |
| Revenues                                       |       | 4,683                                |       | 3,807            |       | 8,490        |       |
| Interest and fees on notes payable             |       | (1,181                               | )          | (122             | )          | (1,303       | )          |
| Provision for loan and impairment losses       |       | (1,336                               | )          | (1,703           | )          | (3,039       | )          |
| Servicing fees — affiliate                |       | (372                                 | )          | (795             | )          | (1,167       | )          |
| General, administrative and operating expenses |       | (1,600                               | )          | (1,006           | )          | (2,606       | )          |
| Expenses                                       |       | (4,489                               | )          | (3,626           | )          | (8,115       | )          |
| Net earnings                                   |       | $                                    | 194        |             | $          | 181          |       | $ | 375 |   |

 

**Nine Months Ended September 30, 2007**

 
| ** **                                     | ** ** | **WAMCO**                            | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **30**                               | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| ** **                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Income from Portfolio Assets                   |       | $                                    | 9,658      |             | $          | 3,955        |       | $ | 13,613 |   |
| Other income, net                              |       | 158                                  |       | 5                |       | 163          |       |
| Revenues                                       |       | 9,816                                |       | 3,960            |       | 13,776       |       |
| Interest and fees on notes payable             |       | (1,806                               | )          | (367             | )          | (2,173       | )          |
| Provision for loan losses                      |       | (1,235                               | )          | (474             | )          | (1,709       | )          |
| Servicing fees — affiliate                |       | (1,360                               | )          | (569             | )          | (1,929       | )          |
| General, administrative and operating expenses |       | (2,288                               | )          | (528             | )          | (2,816       | )          |
| Expenses                                       |       | (6,689                               | )          | (1,938           | )          | (8,627       | )          |
| Net earnings                                   |       | $                                    | 3,127      |             | $          | 2,022        |       | $ | 5,149 |   |

 

At September 30,2008, the Company had $32.1 million in Euro-denominated debt for the purpose ofhedging a portion of the net equity investments in Europe. In general, the typeof risk hedged relates to the foreign currency exposure of net investments inEurope caused by movements in Euro exchange rates. The Company designated thehedging relationship such that changes in the net investments being hedged areexpected to be offset by corresponding changes in the values of theEuro-denominated debt.

 

Effectiveness ofthe hedging relationship is measured and designated at the beginning of eachmonth by comparing the outstanding balance of the Euro-denominated debt to thecarrying value of the designated net equity investments. The net foreigncurrency translation gain (loss) included in accumulated other comprehensiveincome relating to the Euro-denominated debt was $1.9 million for the ninemonths ended September 30, 2008 and ($1.4) million for the same period in2007.

 

**(8)  Servicing Assets – SBA Loans**

 

In accordance with SFAS No. 156, *Accountingfor Servicing of Financial Assets*(“SFAS 156”), servicing rights purchased or resulting from thesale of loans are initially recognized at fair value at the date of acquisitionor transfer. Subsequent to the date of purchase or sale, the Company elected tomeasure the carrying value of the servicing assets by using the amortizationmethod — which amortizes the servicing assets in proportion to and over theperiod of estimated net servicing income, and evaluates servicing assets forimpairment based on fair value at each reporting date. The Company evaluatesthe possible impairment of servicing assets based on the difference between thecarrying amount and current fair value of the servicing assets. Impairment ischarged to servicing fees in the period recognized.

 

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 purchaseprice were the rights to service additional loans with an unpaid balance of$33.8 million. The Company recorded a servicing asset of $758,000 relating tothese servicing rights. Additional servicing rights have been capitalized sincethe portfolio acquisition as a result of loans sold. Servicing rights arerecognized as assets when the SBA loans are

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

sold and the rights toservice those loans are retained. The Company retains servicingresponsibilities and receives servicing fees of approximately 1%.

 

Changes in theCompany’s amortized servicing assets are as follows:

 

| ** **                                  | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                  | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                                  | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                  | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                           |       | $                                    | 841        |                            | $          | 939 |   | $ | 885 |   | $ | — |   |
| Servicing Assets capitalized                |       | 40                                   |       | 23                              |       | 94 |   | 1,032 |   |
| Servicing Assets amortized                  |       | (49                                  | )          | (53                             | )          | (147 | ) | (123 | ) |
| Ending Balance                              |       | $                                    | 832        |                            | $          | 909 |   | $ | 832 |   | $ | 909 |   |
| ** **                                  | ** ** | ** **                           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Reserve for impairment of servicing assets: | ** ** | ** **                           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Beginning Balance                           |       | $                                    | (92        | )                               | $          | (48 | ) | $ | (42 | ) | $ | — |   |
| Impairments                                 |       | (10                                  | )          | (5                              | )          | (79 | ) | (53 | ) |
| Recoveries                                  |       | 22                                   |       | 48                              |       | 41 |   | 48 |   |
| Charge Offs                                 |       | —                               |       | —                          |       | — |   | — |   |
| Ending Balance                              |       | $                                    | (80        | )                               | $          | (5 | ) | $ | (80 | ) | $ | (5 | ) |
|                                        |       |                                 |       |                            |       |   |   |   |   |
| Ending Balance (net of reserve)             |       | $                                    | 752        |                            | $          | 904 |   | $ | 752 |   | $ | 904 |   |
| ** **                                  | ** ** | ** **                           | ** ** | ** **                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fair value of amortized servicing assets:   |       |                                 |       |                            |       |   |   |   |   |
| Beginning balance                           |       | $                                    | 749        |                            | $          | 891 |   | $ | 843 |   | $ | — |   |
| Ending balance                              |       | $                                    | 752        |                            | $          | 904 |   | $ | 752 |   | $ | 904 |   |

 

The Company relies primarily on an undiscounted cash flow model toestimate the fair value of its servicing assets. The model calculates estimatedfair value of the servicing assets using predominant risk characteristics ofservicing assets such as discount rate, prepayment speed, weighted average lifeof the underlying loans, and the interest rates of the underlying loans. Theestimated fair value of servicing assets was determined using discount ratesranging from 7.00% to 11.19%, prepayment speeds of 15%, and weighted averagelives ranging from 72 to 299 months. In the event future prepayments aresignificant or impairments are incurred and future expected cash flows areinadequate to cover the unamortized servicing assets, additional amortizationor impairment charges would be recognized.

 

**(9)  Segment Reporting**

 

The Company is engaged in one reportable segment- Portfolio Asset acquisition and resolution. The following is a summary of results of operations for the PortfolioAsset acquisition and resolution segment and reconciliation to losses fromcontinuing operations for the three and nine months ended September 30,2008 and 2007.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 
| ** **                                                                         | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                                                                         | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                         | ** ** | **(Dollars in thousands)** | ** ** |
| **Portfolio Asset Acquisition and Resolution:**                                    |       |                                 |       |                            |       |   |   |   |   |
| Revenues:                                                                          |       |                                 |       |                            |       |   |   |   |   |
| Servicing fees                                                                     |       | $                                    | 3,842      |                            | $          | 2,426 |   | $ | 8,748 |   | $ | 8,008 |   |
| Income from Portfolio Assets                                                       |       | 5,229                                |       | 5,743                           |       | 15,786 |   | 16,463 |   |
| Gain on sale of SBA loans held for sale, net                                       |       | 85                                   |       | 34                              |       | 227 |   | 658 |   |
| Interest income from SBA loans                                                     |       | 368                                  |       | 752                             |       | 1,210 |   | 1,666 |   |
| Interest income from loans receivable - affiliates                                 |       | 875                                  |       | 147                             |       | 1,508 |   | 413 |   |
| Interest income from loans receivable - other                                      |       | 541                                  |       | 1,627                           |       | 1,171 |   | 3,516 |   |
| Revenue from railroad operations                                                   |       | 810                                  |       | 302                             |       | 2,474 |   | 302 |   |
| Other                                                                              |       | 851                                  |       | 461                             |       | 2,243 |   | 1,246 |   |
| Total                                                                              |       | 12,601                               |       | 11,492                          |       | 33,367 |   | 32,272 |   |
| Expenses:                                                                          |       |                                 |       |                            |       |   |   |   |   |
| Interest and fees on notes payable                                                 |       | 4,571                                |       | 4,747                           |       | 12,012 |   | 13,666 |   |
| Salaries and benefits                                                              |       | 4,607                                |       | 3,549                           |       | 12,800 |   | 9,688 |   |
| Provision for loan and impairment losses                                           |       | 1,123                                |       | (136                            | )          | 11,243 |   | 936 |   |
| Property protection                                                                |       | 1,307                                |       | 785                             |       | 4,661 |   | 1,950 |   |
| Occupancy, data processing and other                                               |       | 3,157                                |       | 332                             |       | 6,965 |   | 3,900 |   |
| Minority interest                                                                  |       | 224                                  |       | (87                             | )          | 255 |   | (210 | ) |
| Total                                                                              |       | 14,989                               |       | 9,190                           |       | 47,936 |   | 29,930 |   |
| Equity in earnings of investments                                                  |       | 2,170                                |       | 2,157                           |       | 8,018 |   | 8,315 |   |
| Gain on sale of subsidiaries and equity investments                                |       | —                               |       | 207                             |       | — |   | 207 |   |
| Operating contribution before direct taxes                                         |       | $                                    | (218       | )                               | $          | 4,666 |   | $ | (6,551 | ) | $ | 10,864 |   |
| Operating contribution, net of direct taxes                                        |       | $                                    | (510       | )                               | $          | 4,680 |   | $ | (7,131 | ) | $ | 10,863 |   |
|                                                                               |       |                                 |       |                            |       |   |   |   |   |
| **Corporate Overhead:**                                                            |       |                                 |       |                            |       |   |   |   |   |
| Salaries and benefits, occupancy, professional and  other income and expenses, net |       | 1,241                                |       | 2,026                           |       | 4,592 |   | 7,318 |   |
| Earnings (loss) from continuing operations                                         |       | $                                    | (1,751     | )                               | $          | 2,654 |   | $ | (11,723 | ) | $ | 3,545 |   |

 

Revenues and equity in earnings of investmentsfrom the Portfolio Asset acquisition and resolution segment are attributable todomestic and foreign operations as follows:

 
| ** **    | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|---------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **    | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **    | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **    | ** ** | **(Dollars in thousands)** | ** ** |
| Domestic      |       | $                                    | 8,373      |                            | $          | 9,869 |   | $ | 22,340 |   | $ | 26,218 |   |
| Latin America |       | 4,433                                |       | 2,303                           |       | 11,321 |   | 8,528 |   |
| Europe        |       | 1,955                                |       | 1,462                           |       | 7,690 |   | 5,667 |   |
| Other         |       | 10                                   |       | 15                              |       | 34 |   | 174 |   |
| Total         |       | $                                    | 14,771     |                            | $          | 13,649 |   | $ | 41,385 |   | $ | 40,587 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

Total assets for the Portfolio Asset acquisitionand resolution segment and a reconciliation to total assets are as follows:

 
| ** **                                   | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2008**                             | ** ** | **2007**              | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)** | ** ** |
| Cash and cash equivalents                    |       | $                                    | 12,984     |                  | $          | 23,037 |   |
| Restricted cash                              |       | 1,124                                |       | 509                   |       |
| Portfolio acquisition and resolution assets: |       |                                 |       |                  |       |
| Domestic                                     |       | 194,051                              |       | 163,078               |       |
| Latin America                                |       | 52,698                               |       | 33,450                |       |
| Europe                                       |       | 54,692                               |       | 46,701                |       |
| Other                                        |       | 272                                  |       | 371                   |       |
| Deferred tax asset, net                      |       | 20,101                               |       | 20,101                |       |
| Other non-earning assets, net                |       | 11,008                               |       | 10,872                |       |
| Total assets                                 |       | $                                    | 346,930    |                  | $          | 298,119 |   |

 

**(10)  Earnings (Loss) per Common Share**

 

Basic net earnings(loss) per common share calculations are based upon the weighted average numberof common shares outstanding during the period. The dilutive effect of commonshare equivalents is included in the calculation of diluted earnings (loss) pershare only when the effect of their inclusion would be dilutive. Thecalculations of basic and dilutive earnings (loss) per share were determined asfollows:

 
| ** **                                                                        | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                                                        | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                                                                        | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                        | ** ** | **(Dollars in thousands)** | ** ** |
| Earnings (loss) from continuing operations                                        |       | $                                    | (1,751     | )                               | $          | 2,654 |   | $ | (11,723 | ) | $ | 3,545 |   |
| Loss from discontinued operations                                                 |       | (4                                   | )          | —                          |       | (145 | ) | — |   |
| Net earnings (loss) available to common shareholders                              |       | $                                    | (1,755     | )                               | $          | 2,654 |   | $ | (11,868 | ) | $ | 3,545 |   |
|                                                                              |       |                                 |       |                            |       |   |   |   |   |
| Weighted average outstanding shares of common stock  (in thousands)               |       | 10,232                               |       | 10,790                          |       | 10,391 |   | 10,789 |   |
| Dilutive effect of:                                                               |       |                                 |       |                            |       |   |   |   |   |
| Warrants                                                                          |       | —                               |       | 317                             |       | — |   | 324 |   |
| Employee stock options                                                            |       | —                               |       | 272                             |       | — |   | 289 |   |
| Weighted average outstanding shares of common stock  and common stock equivalents |       | 10,232                               |       | 11,379                          |       | 10,391 |   | 11,402 |   |
|                                                                              |       |                                 |       |                            |       |   |   |   |   |
| Earnings (loss) from continuing operations per  share:                            |       |                                 |       |                            |       |   |   |   |   |
| Basic                                                                             |       | $                                    | (0.17      | )                               | $          | 0.25 |   | $ | (1.13 | ) | $ | 0.33 |   |
| Diluted                                                                           |       | $                                    | (0.17      | )                               | $          | 0.23 |   | $ | (1.13 | ) | $ | 0.31 |   |
| Loss from discontinued operations per share:                                      |       |                                 |       |                            |       |   |   |   |   |
| Basic                                                                             |       | $                                    | —     |                            | $          | — |   | $ | (0.01 | ) | $ | — |   |
| Diluted                                                                           |       | $                                    | —     |                            | $          | — |   | $ | (0.01 | ) | $ | — |   |
| Net earnings (loss) per share:                                                    |       |                                 |       |                            |       |   |   |   |   |
| Basic                                                                             |       | $                                    | (0.17      | )                               | $          | 0.25 |   | $ | (1.14 | ) | $ | 0.33 |   |
| Diluted                                                                           |       | $                                    | (0.17      | )                               | $          | 0.23 |   | $ | (1.14 | ) | $ | 0.31 |   |
|                                                                              |       |                                 |       |                            |       |   |   |   |   |
| Dilutive shares excluded from above:                                              |       |                                 |       |                            |       |   |   |   |   |
| Warrants                                                                          |       | 210                                  |       | —                          |       | 247 |   | — |   |
| Employee stock options                                                            |       | 150                                  |       | —                          |       | 190 |   | — |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(11)  Stock-Based Compensation**

 

The impact on theresults of operations of recording stock-based compensation for the three andnine month periods ended September 30, 2008 and 2007 was as follows:

 

| ** **                                         | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                         | ** ** | **September 30,**               | ** ** | **September 30,**          | ** ** |
| ** **                                         | ** ** | **2008**                             | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                         | ** ** | **(Dollars in thousands)** | ** ** |
| Amount of compensation cost recognized in expenses |       | $                                    | 73         |                            | $          | 119 |   | $ | 495 |   | $ | 408 |   |
| Tax benefit recognized in income                   |       | $                                    | —     |                            | $          | — |   | $ | — |   | $ | — |   |
| Amount capitalized as part of an asset             |       | $                                    | —     |                            | $          | — |   | $ | — |   | $ | — |   |

 

A summary of stockoption activity as of September 30, 2008 and changes during the periodthen ended is presented below:

 

| ** **                             | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **              | ** ** |
|----------------------------------------|------------|------------|------------|--------------|------------|-----------------|------------|-------------------------|------------|
| ** **                             | ** ** | ** ** | ** ** | ** **   | ** ** | **Average**     | ** ** | ** **              | ** ** |
| ** **                             | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Remaining**   | ** ** | ** **              | ** ** |
| ** **                             | ** ** | ** ** | ** ** | **Average**  | ** ** | **Contractual** | ** ** | **Aggregate**           | ** ** |
| ** **                             | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Term**        | ** ** | **Intrinsic**           | ** ** |
| ** **                             | ** ** | **Shares** | ** ** | **Price**    | ** ** | **(Years)**     | ** ** | **Value**               | ** ** |
| ** **                             | ** ** | ** ** | ** ** | ** **   | ** ** | ** **      | ** ** | **(in thousands)** | ** ** |
| Outstanding at  January 1, 2008   |       | 879,150    |       | $            | 6.67       |            |       |                    |       |   |
| Granted                                |       | 30,000     |       | 4.69         |       |            |       |                    |       |
| Exercised                              |       | (5,000     | )          | 2.43         |       |            |       |                    |       |
| Expired                                |       | (7,500     | )          | 29.69        |       |            |       |                    |       |
| Forfeited                              |       | (85,500    | )          | 8.28         |       |            |       |                    |       |
| Outstanding at September 30, 2008 |       | 811,150    |       | $            | 6.24       |            | 5.45       |                    | $          | 2,128 |   |
| Exercisable at September 30, 2008 |       | 650,075    |       | $            | 5.36       |            | 4.65       |                    | $          | 2,076 |   |

 

The totalintrinsic value of stock options exercised during the nine month periods ended September 30,2008 and 2007 was $14,000 and $47,000, respectively. As of September 30,2008, there was approximately $815,000 million of total unrecognizedcompensation cost related to unvested share-based compensation arrangementsgranted under the stock option plans. That cost is expected to be recognizedover a weighted average period of 2.4 years.

 

The fair value ofstock options granted was estimated on the date of grant using theBlack-Scholes option pricing model. Expected volatilities are based onhistorical volatility of the Company’s stock. The Company estimated theexpected term of its unvested options by taking the average of the vesting termremaining and the contractual term of the option (“simplified method”), asillustrated in SEC Staff Accounting Bulletin No. 107. The Company uses thesimplified method of estimating the expected term of the share options sincethe Company does not have sufficient historical exercise data to provide areasonable basis upon which to estimate the expected term. The expected liferepresents the period of time that options granted are expected to beoutstanding. The risk-free rate is based on the U.S. Treasury rate with amaturity date corresponding to the options’ expected life. The following tablesets forth the weighted average assumptions used to calculate the fair value ofthe stock options for each respective period:

 

| ** **                             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                             | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| Weighted average grant date fair value |       | $                                | —     |                            | $          | — |   | $ | 3.05 |   | $ | — |   |
| Volatility                             |       | 0                                | %          | 0                               | %          | 78 | % | 0 | % |
| Risk-free interest rate                |       | 0.00                             | %          | 0.00                            | %          | 3.73 | % | 0.00 | % |
| Expected life in years                 |       | 0                                |       | 0                               |       | 5 |   | 0 |   |
| Dividend yield                         |       | Zero                             |       | Zero                            |       | Zero |   | Zero |   |
|                                        |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

A summary of thestatus and changes of FirstCity’s non-vested shares as of September 30,2008, and changes during the nine months ended September 30, 2008 ispresented below:

 

| ** **                            | ** ** | ** ** | ** ** | **Weighted-**       | ** ** |
|---------------------------------------|------------|------------|------------|---------------------|------------|
| ** **                            | ** ** | ** ** | ** ** | **Average**         | ** ** |
| ** **                            | ** ** | ** ** | ** ** | **Grant-Date**      | ** ** |
| ** **                            | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
| Non-vested at January 1, 2008    |       | 240,950    |       | $                   | 6.89       |   |
| Granted                               |       | 30,000     |       | $                   | 3.05       |   |
| Vested                                |       | (88,625    | )          | $                   | 5.09       |   |
| Forfeited                             |       | (21,250    | )          | $                   | 7.61       |   |
| Non-vested at September 30, 2008 |       | 161,075    |       | $                   | 7.07       |   |

 

**(12)  Income Taxes**

 

Federal income taxes are provided at a 35% rate.The Company has substantial net operating loss carryforwards for federal incometax purposes (“NOLs”), which can be used to offset the tax liability associatedwith the Company’s pre-tax earnings until the earlier of the expiration orutilization of such NOLs. The Company accounts for the benefit of the NOLs byrecording the benefit as an asset and then establishing a valuation allowanceto value the net deferred tax asset at a level, which more likely than not,will be realized. Realization of the deferred tax asset is determined based onmanagement’s expectation of generating sufficient taxable income in a lookforward period over the next four years. The ultimate realization of theresulting net deferred tax asset is dependent upon generating sufficienttaxable income from continuing operations prior to the expiration of the netoperating loss carryforwards. Although realization is not assured, managementbelieves it is more likely than not that all of the recorded deferred taxasset, net of the allowance, will be realized. The amount of the deferred taxasset considered realizable, however, could be adjusted in the future ifestimates of future taxable income during the carryforward period change. Theability of the Company to realize the deferred tax asset is periodicallyreviewed and the valuation allowance is adjusted accordingly.

 

On October 1, 2007 the Entrepreneurial Tax of Unique Rate (referred toby its Spanish acronym, IETU or “Flat Tax”) in Mexico was published. The FlatTax law was effective on January 1, 2008 and replaces the existing asset-based tax. The FlatTax applies to a different tax base than the income tax and will be paid if theFlat Tax exceeds the income tax computed under existing law. In accordance withSFAS 109, *Accounting for Income Taxes*, the effectsof the Flat Tax should be reflected in the consolidated financial statements. TheFlat Tax has no impact on the Company’s deferred tax assets recognized as of September 30,2008.

 

Beginning with theadoption of FASB Interpretation No. 48, *Accountingfor 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 thosepositions are more likely than not of being sustained. Recognized income taxpositions are measured at the largest amount that is greater than 50% likely ofbeing realized. Changes in recognition or measurement are reflected in theperiod 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 ifsuch positions were probable of being sustained. Under FIN 48, income taxbenefits are recognized and measured based upon a two-step model: (1) atax position must be more-likely-than-not to be sustained based solely on itstechnical merits in order to be recognized; and (2) the benefit ismeasured as the largest dollar amount of that position that ismore-likely-than-not to be sustained upon settlement. The difference betweenthe benefit recognized for a position in accordance with this FIN 48 model andthe tax benefit claimed on a tax return is referred to as an unrecognized taxbenefit (“UTB”).

 

The gross amount of UTBs on uncertain tax positions as of September 30,2008 totaled $349,000, which if recognized, would impact the Company’seffective income tax rate. A reconciliation of UTBs for the first nine monthsof 2008 follows:

 

| ** **                         | ** ** | **2008**                             | ** ** |
|------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | **(Dollars in thousands)** | ** ** |
| Balance at January 1, 2008    |       | $                                    | 579        |   |
| Payments and settlements           |       | (2                                   | )          |
| Lapse of statute of limitations    |       | (228                                 | )          |
| Balance at September 30, 2008 |       | $                                    | 349        |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

Over the next twelve months, due to the expiration of the statute oflimitations related to certain UTBs, the Company anticipates that it isreasonably possible that the amount of UTBs could be reduced by approximately$50,000, which would impact the Company’s effective tax rate. The Companyrecords interest and penalties related to income tax uncertainties in theprovision for income taxes. At September 30, 2008, interest and penaltiesof $122,000 are included in “Other liabilities” as income taxes payable.

 

In a letter dated March 26, 2008, the Internal Revenue Servicenotified FirstCity of the completion of its examination on the Company’s 2004federal income tax return. The examination results were that no changes weremade to FirstCity’s original tax return as filed. FirstCity currently files taxreturns in approximately 35 states and is currently being examined in threestates for the year 2004.  Tax year 1990and subsequent years are open to federal examination, and tax year 2003 andsubsequent years are open to state examination.

 

**(13)  Fair Value**

 

Effective January 1, 2008, the Company adopted SFAS 157, whichdefines fair value, establishes a consistent framework for measuring fairvalue, and expands disclosure requirements about fair value measurements. SFAS157 defines fair value as the exchange price that would be received for anasset or paid to transfer a liability (exit price) in the principal or mostadvantageous market for the asset or liability in an orderly transactionbetween market participants on the measurement date. SFAS 157 also establishesa fair value hierarchy which describes three levels of inputs that may be usedto measure fair value:

 

·                  Level 1 – Valuations are based uponquoted prices in active exchange markets involving identical assets andliabilities.

 

·                  Level 2 – Observable inputs otherthan Level 1 prices, such as quoted prices for similar instruments in activemarkets; quoted prices and valuations for identical or similar instruments inmarkets that are not active; and model-based valuation techniques withsignificant assumptions and inputs that are observable in the market or can bederived principally from or corroborated by observable market data.

 

·                  Level 3 – Valuations are derived frommodel-based techniques that use inputs and significant assumptions that aresupported by little or no observable market data. Valuation techniques includethe use of pricing models, discounted cash flow models and similarmethodologies.

 

At September 30, 2008, the Company did not have any assets orliabilities that are measured at fair value on a recurring basis. However, theCompany is required to measure certain financial assets at fair value on anon-recurring basis in accordance with generally accepted accountingprinciples. These adjustments to fair value generally result from write-downsof individual assets as a result of impairment or application oflower-of-cost-or-fair value accounting. For assets measured at fair value on anon-recurring basis and carried at fair value on the balance sheet at September 30,2008, the following table provides the level of valuation assumptions used todetermine the fair value of the related individual assets or portfolios at quarterend:

 

| ** **                           | ** ** | ** **                                                        | ** ** | ** **             | ** ** | ** **       | ** ** | ** **       | ** ** | **Total Losses in**    | ** ** |
|--------------------------------------|------------|-------------------------------------------------------------------|------------|------------------------|------------|------------------|------------|------------------|------------|----------------------------------|------------|
| ** **                           | ** ** | **Carrying Value at September 30, 2008** | ** ** | **Quarter Ended** | ** ** |
| **(Dollars in thousands)** | ** ** | **Total**                                                         | ** ** | **Level 1**       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **September 30, 2008** | ** ** |
| Portfolio Assets - loans (1)         |       | $                                                                 | 3,639      |                   | $          | —           |       | $                | —     |                             | $          | 3,639 |   | $ | (65 | ) |
|                                      |            |                                                                   |            |                        |            |                  |            |                  |            |                                  |            |  |  |  |  |  |

 

----

| (1) | Represents the carrying value of impaired loans that  were measured for impairment using the estimated fair value of the collateral  for collateral-dependent loans. The carrying value of loans fully charged-off  is zero. |
|-----|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The carrying value and related write-downs of “Portfolio Assets – loans”in the table above are based on collateral valuations using observable andunobservable inputs, adjusted for various considerations such as marketconditions, economic and competitive environment, and other assets with similarcharacteristics (i.e. industry, geography, etc.) that, in management’s opinion,reflect elements a marketplace participant would consider. The Companyclassifies its fair value measurement techniques for Portfolio Assets as Level3 inputs for the following reasons: (1) distressed asset acquisitionsgenerally occur in inactive markets for which observable market prices are notreadily available (i.e. price quotations vary substantially over time and amongmarket-makers, and pricing information is generally not released to thepublic); and (2) the Company’s valuation techniques that aremost-significant to the fair value measurements are principally derived fromassumptions and inputs that are corroborated by little or no observable marketdata.

 

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

 

Under SFAS 157, we attempt to base our fair values on the price thatwould be received to sell an asset in an orderly transaction between marketparticipants at the measurement date. It is our policy to maximize the use ofobservable inputs, when reasonably available and without undue cost, andminimize the use of unobservable inputs when developing fair value measurementsin accordance with the fair value hierarchy in SFAS 157. Fair valuemeasurements for assets where there exists limited or no observable market dataand, therefore, are based principally on our own estimates and assumptions, areoften calculated based on collateral valuations adjusted for the economic andcompetitive environment, the characteristics of the asset, and other suchfactors. Additionally, there may be inherent weaknesses in any valuationtechnique, and changes in the underlying assumptions used, including discountrates and estimates of future cash flows, that could significantly affect theresults of current or future values.

 

**(14)  Commitments andContingencies**

 

*IndemnificationObligation Commitments*

 

On September 21,2004, FirstCity, FirstCity Consumer Corporation (“Consumer Corp.”), FirstCityFunding LP (“Funding LP”) and FirstCity Funding GP (“Funding GP”) entered intoa Securities Purchase Agreement to sell a 31% beneficial ownership interest inDrive and its general partner, Drive GP LLC, to IFA-GP, IFA-LP and MG-LP (the “2004Securities Purchase Agreement”). In the 2004 Securities Purchase Agreement,FirstCity, Consumer Corp., Funding LP and Funding GP made variousrepresentations and warranties concerning (i) their respectiveorganizations, (ii) their power and authority to enter into the 2004Securities Purchase Agreement and the transactions contemplated therein, (iii) theownership of the limited partnership interests in Drive by Funding LP, (iv) theownership of membership interests in Drive-GP by Consumer Corp., and (iv) thecapital structure of Funding LP. FirstCity, Consumer Corp., Funding LP andFunding GP also agreed to indemnify BoS (USA), IFA-GP, IFA-LP and MG-LP fromdamages resulting from a breach of any representation or warranty contained inthe 2004 Securities Purchase Agreement or otherwise made by FirstCity, ConsumerCorp. or Funding LP in connection with the transaction. The indemnityobligations under the 2004 Securities Purchase Agreement survive for a maximumperiod of five (5) years from November 1, 2004. Neither FirstCity,Consumer Corp., Funding LP, or Funding GP is required to make any payments as aresult of the indemnity provided under the 2004 Securities Purchase Agreementuntil the aggregate amount payable exceeds $25,000, and then only for theamount in excess of $25,000 in the aggregate; however certain representationsand warranties are not subject to this $25,000 threshold. Management of theCompany believes that FirstCity will not have to pay any amounts relating tothese representations and warranties.

 

On August 8,2006, an Interest Purchase and Sale Agreement was entered into by and amongBidmex Holding, LLC (“Buyer”), as buyer, and Strategic Mexican InvestmentPartners, L.P. (“SMIP”), an affiliate of the Company and Cargill FinancialServices International, Inc. (“CFSI”), (collectively, the “Sellers”), asseller, and eleven U.S. limited liability companies (“LLCs”) which invested inMexican portfolio acquisition entities (“SRLs”) and the AIG entities asadditional parties.  In the Interest Purchase and Sale Agreement, theSellers and the LLCs made various representations and warranties concerning (i) theexistence and ownership of the LLCs and the related SRLs, (ii) the assetsand liabilities of the LLCs, (iii) taxes related to periods prior to August 8,2006, and (iv) the operations of the LLCs and SRLs.  The Sellersagreed to indemnify the Buyer and AIG Entities from damages resulting from abreach of any representation or warranty contained in the Interest Purchase andSale Agreement on a several and not joint basis according to their respectiveownership 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 notbe identified to a particular LLC.  The indemnity obligation under theInterest Purchase and Sale Agreement survives for a period of the statute oflimitations for matters related to taxes, existence and authority,capitalization and good standing of the LLCs and SRLs and for a period of twoyears from August 8, 2006, the closing date with respect to all otherrepresentations and warranties.  The Sellers are not required to make anypayments as a result of the indemnity provisions of the Interest Purchase andSale Agreement until the aggregate amount payable under that agreement and theAsset Purchase Agreement exceeds $25,000; however, claims related to taxes andfraud are not subject to this $25,000 threshold.  The Interest Purchaseand Sale Agreement limits the liability of the Sellers for indemnifiable lossesunder the Interest Purchase and Sale Agreement and the Asset Purchase Agreementto the Aggregate Purchase Price (without duplication of amounts recoveredpursuant to the terms of the Asset Purchase Agreement).  FirstCity does not believe that the potentialliability would have a material adverse effect on the consolidated financialposition, results of operations or liquidity of FirstCity, its subsidiaries,its affiliates or the Acquisition Partnerships.

 

Also on August 8,2006, Bidmex Holding, LLC entered into an Agreement for the Onerous Transfer ofLoans and Litigious Rights (the “Asset Purchase Agreement”) between and amongResidencial Oeste, S. de R.L. de C.V., as seller (the “Asset Seller”), anaffiliate of CFSI and SMIP, Residencial Oeste 2, S. de R.L. de C.V., aspurchaser (the “Asset Purchaser”), and CFSI, SMIP, and Bidmex Acquisition, LLC,the parent of the Asset Purchaser, as additional parties.  The AssetPurchase Agreement provides for the sale of the loan portfolio owned by theSeller to the Purchaser for a purchase price of $10.1 million on the closingdate, which purchase price is

 

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

 

part of the AggregatePurchase Price.  In the Asset Purchase Agreement, the Asset Seller and theSellers made various representations and warranties concerning (i) theexistence and ownership of the Seller, (ii) the ownership of the loanportfolio, (iii) taxes related to periods arising prior to the closing date,and (iv) the existence of the loans comprising the loan portfolio andother matters related to the loan portfolio.  The Asset Seller agreed toindemnify the Asset Purchaser from damages resulting from a breach of anyrepresentation or warranty.  The indemnity obligation under the AssetPurchase Agreement survives for a period of the statute of limitations formatters related to existence and ownership of the Seller, ownership of theloans, and taxes for periods prior to August 8, 2006, and for a period oftwo years from August 8, 2006, with respect to all other representationsand warranties.  The Seller is not required to make any payments as aresult of the indemnity provisions of the Asset Purchase Agreement until theaggregate amount payable under that Agreement exceeds $25,000; however, claimsrelated to taxes and fraud are not subject to this $25,000 threshold.  TheInterest Purchase and Sale Agreement limits the liability of the Sellers forindemnifiable losses under the Asset Purchase Agreement to the AggregatePurchase Price. FirstCity does not believe that the potential liability wouldhave a material adverse effect on the consolidated financial position, resultsof operations or liquidity of FirstCity, its subsidiaries, its affiliates orthe Acquisition Partnerships.

 

*Commitments to Repurchase Loans*

 

In connection withthe Interest Purchase and Sale Agreement, Recuperación de Carteras Mexicanas,S. de R.L. de C.V., as optionor (“RCM”), an affiliate of SMIP and CFSI, granteda put option dated August 8, 2006 to Bidmex Holding, LLC, as optionee,related to the purchase of any loan of Solución de Activos Residenciales, S. deR.L. de C.V. or Solución de Activos Comerciales, S. de R.L. de C.V., each aMexican SRL, if any borrower of a loan owned by those entities has filed orfiles a challenge in a legal proceeding related to any such loan based on, inaddition to any other defense claims, a claim on grounds related to the MexicanSupreme Court Ruling that has put into issue the actions required for transferof loans by Mexican financial institutions after August 2003, providedthat any such challenge is asserted on or before the earlier of (i) thereversal of the Supreme Court Ruling, or (ii) February 1, 2008.  The purchase price for any loan under the putoption 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, plusany taxes paid or payable with respect to the cash flow from each loan, reducedby any cash flow received by Bidmex Holding, LLC with respect to the loan.Pursuant to the put option agreement, Bidmex Holding, LLC delivered a notice toexercise the put option on March 31, 2008 for qualifying loans with apurchase price of approximately $635,000, of which the Company’s share isapproximately $127,000.

 

Financial Security Assurance Inc. (“FSA”), in itscapacity as certificate insurer under the Pooling and Servicing Agreement,relating to the FirstCity Capital Home Equity Loan Trust 1998-2 (the “Trust”),dated as of November 1, 1998 by and among FC Capital Corp., in itscapacities as seller and master servicer, and The Bank of New York, in itscapacity as trustee, made demand on FC Capital Corp. to repurchase certainloans that were subject to repurchase due to fraud of third parties inconnection with the origination of the loans. FC Capital Corp. agreed toprovide a letter of credit in the amount of the repurchase price for the loansin lieu of being required to purchase the loans from the Trust. FirstCity hasobtained and delivered to FSA, for the benefit of FC Capital Corp., anirrevocable letter of credit in the amount of $0.5 million from the Bank ofScotland.  Pursuant to the agreement withFSA, FC Capital Corp. will have the option to purchase the loans for $0.5million prior to a call under the letter of credit.

 

*Lettersof Credit and Other Guarantees*

 

On November 5, 2007, Fondo de Inversion Privado NPL Fund One (“PIF1”),an equity investment of FirstCity Chile, Ltda., entered into a revolving lineof credit with a maximum loan amount of $15.0 million with Banco SantanderChile, S.A. The proceeds were used to acquire a loan portfolio at face valuefrom FirstCity NPL S.A. (a consolidated affiliate of FirstCity Chile, Ltda.)and to finance the purchase of other loan portfolios from non-affiliatedparties. Pursuant to terms of the credit facility, FirstCity was required toprovide a stand-by letter of credit from Bank of Scotland that would satisfythe maximum loan balance upon demand. At September 30, 2008, FirstCity hada letter of credit in the amount of $14.5 million from Bank of Scotland underthe 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 eventthat a demand is made under the $14.5 million letter of credit, FirstCity isrequired to reimburse Bank of Scotland by making payment to Bank of Scotlandfor all amounts disbursed or to be disbursed by Bank of Scotland under theletter of credit.

 

On November 29, 2006, FirstCity Mexico SA de CV, a Mexicanaffiliate of FirstCity, entered into a revolving line of credit with a maximumloan amount in Mexican pesos equivalent to $13.2 million as of September 30,2008, with Banco Santander, S.A. The proceeds were used to pay down theacquisition facility with the Bank of Scotland. Pursuant to the terms of the credit facility, FirstCity Mexico SA de CVwas required to provide a stand-by letter of credit from Bank of Scotland thatwould satisfy the loan balance upon demand.  At September 30, 2008,FirstCity had a letter of credit in the amount of $14.1 million from Bank ofScotland

 

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

 

under the terms ofFirstCity’s revolving acquisition facility with Bank of Scotland.  In theevent that a demand is made under the $14.1 million letter of credit, FirstCityis required to reimburse Bank of Scotland by making payment to Bank of Scotlandfor all amounts disbursed or to be disbursed by Bank of Scotland under theletter of credit.

 

ABL, a subsidiary ofFirstCity, has a $40.0 million revolving loan facility with Wells FargoFoothill, LLC (“WFF”), as most recently amended on July 30, 2007, for thepurpose of financing and acquiring SBA loans. The obligations under thisfacility are secured by substantially all of the assets of ABL.  At September 30,2008, the balance of this facility was $11.6 million.  In connection withthe first amendment to this facility on February 27, 2007, FirstCityprovided WFF with an unconditional guaranty, up to a maximum of $5.0 millionplus enforcement cost, of the obligations of ABL under the loan facility thatrelate to funds in the amount of $31.7 million advanced by WFF to ABL inconnection of a portfolio of SBA loans in February 2007. This guarantyarrangement remains in effect until the obligations incurred in connection withthe advance related to the acquisition of the portfolio of SBA loans are paidin full.

 

FirstCity CommercialCorp. (“FirstCity Commercial”), a wholly-owned affiliate of FirstCity, providesvarious financial institutions with guarantees of the debt obligations ofcertain Acquisition Partnerships. The underlying debt financing arrangements ofthese Acquisitions Partnerships have various maturities ranging from September 2008to February 2010, and are secured primarily by certain real estateproperties held by the Acquisition Partnerships. At September 30, 2008,FirstCity Commercial’s maximum commitments under these guaranty arrangementstotaled $1.9 million, and the total outstanding debt obligations of theseAcquisition Partnerships attributed to FirstCity Commercial’s underlyingguaranty approximated $2.3 million.

 

*EnvironmentalMatters*

 

The Company generally retains environmental consultants to conduct orupdate environmental assessments in connection with the Company’s foreclosedand acquired real estate properties. These environmental assessments have notrevealed environmental conditions that the Company believes will have amaterial adverse effect on its business, assets, financial condition, resultsof operations or liquidity, and the Company is not otherwise aware ofenvironmental conditions with respect to properties that the Company believeswould have such a material adverse effect. However, from time to time,environmental conditions at the Company’s properties have required and may inthe future require environmental testing and/or regulatory filings, as well asremedial action. Liabilitiesfor future remediation costs are recorded when environmental assessments and/orremedial efforts are probable and the costs can be reasonably estimated. Otherthan for assessments, the timing and magnitude of these accruals generally arebased on the completion of investigations or other studies or a commitment to aformal plan of action. Environmental liabilities are based on best estimates ofprobable undiscounted future costs using currently available technology andapplying current regulations, as well as our own internal policies.

 

*Limited-LifePartnerships*

 

SFAS No. 150, *Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity*(“SFAS 150”), establishes standards on how an issuer classifies and measurescertain financial instruments with characteristics of both liabilities andequity. Certain provisions of SFAS 150 would have required us to classifynon-controlling interests in consolidated limited-life subsidiaries asliabilities adjusted to their settlement values in our consolidated financialstatements. However, the FASB indefinitely deferred application of themeasurement and recognition provisions, but not the disclosure requirements, ofSFAS 150 with respect to these non-controlling interests. At September 30,2008, the estimated settlement value of non-controlling interests in theCompany’s consolidated limited-life partnerships was $1.3 million. The minorityinterest amount recognized as a liability on the consolidated balance sheetsrelated to these non-controlling interests was approximately ($348,000) at September 30,2008.

 

*Legal Proceedings*

 

There have been no material developments with regard to any mattersdisclosed under Part I, Item 3 “Legal Proceedings” in our Annual Report onForm 10-K for the fiscal year ended December 31, 2007.

 

**(15)  Other Related Party Transactions**

 

FirstCity hasfinancing and service arrangements with certain Acquisition Partnerships andother affiliated entities, and financing arrangements with certainnon-affiliated entities that are considered to be variable interest entities (“VIEs”),as defined in FASB Interpretation No. 46R, *Consolidationof Variable Interest Entities* (“FIN 46R”). However, FirstCity is notdeemed to be the primary

 

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

 

beneficiary of theseentities based on the provisions of FIN 46R. The Company could experience aloss in the event that cash flows from the VIEs or the underlying collateralare not collected as expected. At September 30, 2008, FirstCity’s maximumexposure to loss as a result of its involvement with the VIEs is $46.7 million.

 

In June 2008, FC Acquisitions SRL de CV (“FC Acquisitions”), anindirect majority-owned Mexican affiliate of FirstCity, acquired a loanportfolio in Mexico (refer to Note 5). FC Acquisitions financed the loanportfolio purchase with proceeds from an $8.7 million loan from FirstCityMexico, Inc. (“FirstCity Mexico”), an indirect wholly-owned affiliate ofFirstCity. The loan by FirstCity Mexico was repaid from the proceeds of a loanfrom MCS Trust SA de CV (“MCS Trust”) to FC Acquisitions pursuant to an $8.7million term note payable to MCS Trust. The loan by MCS Trust was funded withthe proceeds of a loan from BMX Holding II LLC (“BMX Holding II”), an affiliateof FirstCity Mexico. The accounts of MCS Trust are consolidated by BMX HoldingII, an entity that is treated as an equity-method investment by FirstCity dueto its 8.0% ownership interest in BMX Holding II. In July 2008, BMXHolding II, as the note holder, sold and assigned the note of MCS Trust to BMXHolding III LLC, an indirect majority-owned affiliate of FirstCity, for $8.7million. At September 30, 2008, this note receivable had a carrying amountof $8.7 million and was included in “Loans receivable – affiliates” on theCompany’s consolidated balance sheet. The terms and carrying amount of the noteare summarized in the “Credit Facilities” schedule included under the caption **Liquidity and Capital Resources** in Part I, Item 2. ofthis Form 10-Q.

 

The Company hascontracted with the Acquisition Partnerships and related parties as a thirdparty loan servicer. Servicing fees and due diligence fees (included in otherincome) derived from such affiliates totaled $3.5 million and $2.2 million inthe third quarters of 2008 and 2007, respectively, and $8.2 million and $7.3million in the first nine months of 2008 and 2007, respectively.

 

FirstCityServicing Corporation (“FCSC”), an indirect wholly-owned affiliate of theCompany, and MCS et Associates (“MCS”), in which FCSC is an 11.89% shareholderas of December 31, 2007, are parties to Consulting, License andConfidentiality Agreements dated June 30, 1999 pursuant to which FCSCprovides consultation services and personnel to be employed by MCS to assist indeveloping and managing due diligence and servicing systems. Pursuant to thoseagreements, MCS provides the supplied personnel with compensation, taxequalization payments, housing allowances, transportation allowance, and taxpreparation. MCS also pays consulting fees to FCSC and reimburses FCSC fortravel, hotel, airfare, and meal expenses incurred related to the provision ofthe services. In the third quarters of 2008 and 2007, FCSC received from MCSfees totaling $84,000 and $102,000, respectively, and $324,000 and $334,000 inthe first nine months of 2008 and 2007, respectively.

 

FirstCity Commercial owns 80% of FirstCity Denver Investment Corp. (“FirstCityDenver”) – a special situations platform that acquires and finances distresseddebt and companies, originates junior- and senior-bridge loans, and executeslower middle market buyouts. The other 20% interest in FirstCity Denver isowned by Crestone Capital LLC, a Colorado limited liability company that isowned by Richard W. Horrigan and Stephen C. Schmeltekopf. Mr. Horrigan,President of FirstCity Denver, and Mr. Schmeltekopf, Senior Vice Presidentof FirstCity Denver, are employees of FirstCity Denver and have employmentcontracts with FirstCity Denver.

 

**(16)  Stockholders’ Equity**

 

The Company has a stock repurchase plan, as authorized by the Board ofDirectors, that provides for the purchase of up to 1,500,000 shares of theCompany’s common stock. In the third quarter of 2008, FirstCity repurchased102,800 shares of its common stock on the open market for a total of $569,000.In October 2008, the Company completed the repurchase of 1,500,000 sharesof common stock under the plan by purchasing an additional 336,370 of itscommon stock on the open market for $1.1 million.

 

**(17)  Statements of Cash Flows**

 

In June 2008, the Company acquired a real estate property througha majority-owned subsidiary of FirstCity Denver. As part of the investment, theCompany paid approximately $2.7 million, assumed a note payable of $7.6 millionand recorded a non-cash increase to “Portfolio Assets – Real estate held forinvestment” on the Company’s consolidated balance sheet for the same amount.Refer to Note 3 for a summary of the transaction.

 

In September 2008, the Company purchased an additional equityinterest in a subsidiary for $1.5 million. The transaction was accounted for asa step acquisition under SFAS 141. Refer to Note 3 for a summary of the assetsacquired and liabilities assumed as part of the transaction.

 

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**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

 

**Overview**

 

FirstCity is a financial services company engagedin one principal reportable segment – Portfolio Asset acquisition andresolution. The Portfolio Asset acquisition and resolution business involvesacquiring portfolios of loans, real estate and other assets or similarsingle-asset investments (collectively referred to as “Portfolios” or “PortfolioAssets”). The Company generally acquires Portfolio Assets at a discountto their legal principal balances or appraised values, and then services and resolves the Portfolio Assets in an effort tomaximize the present value of the ultimate cash recoveries. FirstCity alsoinvests in special situations and restructuring arrangements such as acquiringor financing distressed debt and businesses, originating junior- and senior-bridgeloans, and executing lower middle-market buyouts; and purchases, originates andservices U.S. Small Business Administration loans.

 

During the thirdquarter of 2008, the Company recorded a net loss to common stockholders on adiluted basis of $1.8 million or $0.17 per common share. The operatingcontribution from the Portfolio Asset acquisition and resolution segmentresulted in a $0.5 million operating loss for the third quarter of 2008compared with a $4.7 million operating gain for the same period in 2007. See **Results of Operations** below for a detailed review of thethird quarter of 2008 compared to the third quarter of 2007.

 

The Company wasinvolved in acquiring $4.5 million of portfolio investments with a face valueof approximately $78.1 million in the third quarter 2008 – of which FirstCity’sinvestment share was $3.2 million. FirstCity’s global distribution of its thirdquarter 2008 investments includes $2.9 million in the United States and $0.3million in Latin America. In addition to its portfolio acquisitions in thirdquarter 2008, FirstCity invested $4.2 million in the form of SBA loanoriginations and advances; and $1.8 million in equity interest acquisitions. AtSeptember 30, 2008, FirstCity’s earning assets (Portfolio Assets, equityinvestments, loans receivable and entity-level earning assets) totaled $301.7million, and the global distribution of such earning assets (at carrying value)included $194.3 million in the United States; $54.7 million in Europe; and$52.7 million in Latin America.

 

The Company’searnings in third quarter 2008 were negatively impacted by foreign currencytransaction losses; and net impairment provisions, declining collections, andasset-level expenses related to the Company’s domestic consolidated portfoliosand partnerships:

 

*ForeignCurrency Transaction Losses*

 

The combinedimpact of foreign currency transactions from the Company’s consolidated andnon-consolidated foreign operations resulted in a $0.4 million foreign currencyexchange loss in third quarter 2008 (compared to a combined impact of $0.9million in foreign currency exchange gains in third quarter 2007). The globaldistribution of the Company’s combined foreign currency exchange loss in thirdquarter 2008 was comprised of $0.5 million of exchange losses from Europeanoperations and $0.1 million of exchange gains from Latin American operations.

 

*NetImpairment Provisions, Declining Collections and Asset-Level Expenses*

 

The Companyrecorded $2.1 million of net impairment provisions in third quarter 2008 –comprised of $1.1 million of net provisions recorded to our consolidatedportfolios, and $1.0 million as our share of net impairment provisions recordedto portfolio assets held in our partnership interests. The global distributionof the $2.1 million of net impairment provisions recorded by the Company inthird quarter 2008 includes $1.2 million in the United States, $0.3 million inEurope, and $0.6 million in Latin America. The impairment provisions in thirdquarter 2008 were attributed primarily to declines in values of loan collateraland real estate assets in our domestic portfolios, and additional delays in thetiming of collections of expected cash flows on domestic loan portfolios.Collections on the Company’s consolidated domestic portfolios decreased to$14.5 million in third quarter 2008 from $18.3 million in third quarter 2007,and aggregate collections on portfolios held in non-consolidated domesticpartnerships decreased to $13.2 million in third quarter 2008 from $14.2million in third quarter 2007. FirstCity also recorded $1.2 million ofasset-level costs (i.e. property taxes, insurance, repairs and legal costs) inthird quarter 2008 related to consolidated domestic portfolios to protect theCompany’s security interests in its loan collateral and to support foreclosedproperties until they are sold. These asset-level costs are attributedprimarily to increased levels of delinquent property tax and insurance paymentsby the borrowers and increased loan foreclosures over the past twelve months.Management believes that declines in real estate values, delayed collections,and rising asset-level costs are the resulting adverse effects from thesubprime mortgage crisis that began in the United States in 2007 (i.e. risingloan defaults and foreclosures on loan collateral because borrowers cannotrefinance their loans and/or continue to make payments, and significantdeclines in real estate values due to excess building inventories). Theimpairment provisions were identified in connection with

 

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management’s quarterly evaluationof the collectability of the Company’s Portfolio Assets. The process for evaluating and measuringimpairment is critical to our financial results, as it requires subjective andcomplex judgments, as a result of the need to make estimates about the impactof matters that are uncertain. It remains unclear what impact the illiquid markets,real estate value declines and the overall economic slowdown will ultimatelyhave on our financial results. Therefore, we cannot provide assurance that, inany particular period, we will not incur additional impairment provisions inthe future.

 

Considering thesubstantial losses reported in the financial services sector over the past yearand downward pressure on economic growth due to the subprime mortgage crisis,management remains positive on the outlook of the Company. Management believesthat current market conditions should not hinder FirstCity’s ability to expandits business, and that asset acquisition opportunities at attractive marginsare available. As mentioned above, FirstCity was involved in acquiring $4.5million of portfolio investments with a face value of approximately $78.1million in the third quarter 2008 (of which FirstCity’s investment share was$3.2 million), and the Company invested an additional $6.0 million in the formof equity interest acquisitions and loan investments. In addition, FirstCity iscurrently evaluating 29 different transactions representing approximately $7.2billion in face value of assets, although there can be no assurance thatFirstCity will be able to consummate any of these transactions on acceptableterms.

 

In addition, in light of current market conditions that createdliquidity constraints primarily as a result of the deterioration in thesubprime mortgage industry and tightening credit standards in the marketplace,management believes that current market conditions will not impact FirstCity’sability to finance its operations. Currently, FirstCity has (1) $350.0 million of credit facility commitmentsavailable to (i) finance the senior debt and equity portions of portfolioand asset purchases; (ii) finance equity investments in new ventures; and (iii) providefor the issuance of letters of credit working capital loans; and (2) a$40.0 million credit facility commitment to finance SBA loan originations andadvances.

 

The Company’sfinancial results are affected by many factors including, but not limited to,fluctuations in interest rates; fluctuations in the underlying values of loancollateral, real estate and other assets; delays and declines in cash receiptson Portfolio Assets, loans and other assets; timing and ability to liquidateassets; availability of investment and asset acquisition opportunities; and theCompany’s ability to consummate such transactions on acceptable terms. TheCompany’s business and results of operations are also affected by the availabilityof financing with terms acceptable to the Company and the Company’s access tocapital markets, including the securitization markets.

 

As a result of thesignificant period-to-period fluctuations in the revenues and earnings ofFirstCity’s Portfolio Asset acquisition and resolution business,period-to-period comparisons of the results of our continuing operations maynot be meaningful. Such variances, alone or with other factors, such asconditions in the economy or the financial services industries or otherdevelopments affecting us, may result in significant fluctuations in ourreported operations and in the trading prices of common stock.

 

Components of the results for the three and ninemonth periods ended September 30, 2008 and 2007, respectively, aredetailed below (dollars in thousands except per share data):

 

| ** **                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                      | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                      | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                      | ** ** | **(Dollars in thousands)**       | ** ** |
| Portfolio Asset Acquisition and Resolution      |       | $                                | (510       | )                               | $          | 4,680 |   | $ | (7,131 | ) | $ | 10,863 |   |
| Corporate overhead                              |       | (1,241                           | )          | (2,026                          | )          | (4,592 | ) | (7,318 | ) |
| Earnings (loss) from continuing operations      |       | (1,751                           | )          | 2,654                           |       | (11,723 | ) | 3,545 |   |
| Loss from discontinued operations, net of taxes |       | (4                               | )          | —                          |       | (145 | ) | — |   |
| Net earnings (loss) to common stockholders      |       | $                                | (1,755     | )                               | $          | 2,654 |   | $ | (11,868 | ) | $ | 3,545 |   |
| Diluted earnings (loss) per common share        |       | $                                | (0.17      | )                               | $          | 0.23 |   | $ | (1.14 | ) | $ | 0.31 |   |

 

**Results of Operations**

 

The following discussion and analysis is based onthe segment reporting information presented in Note 9 to the ConsolidatedFinancial Statements of the Company included in Item 1. of this Form 10-Q,and should be read in conjunction with the Consolidated Financial Statements(including the Notes thereto) included elsewhere in this Form 10-Q.

 

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***Third Quarter 2008 Compared to Third Quarter 2007***

 

The Company reported net losses of $1.8 millionin the third quarter 2008 compared to net earnings of $2.7 million in the thirdquarter 2007. Diluted net losses to common stockholders were $0.17 per commonshare in the third quarter of 2008 compared to $0.23 of diluted net earningsper common share in the third quarter of 2007.

 

*Portfolio Asset Acquisition and Resolution*

 

The operating contribution from the PortfolioAsset acquisition and resolution segment resulted in a $0.5 million operatingloss in the third quarter of 2008 compared to a $4.7 million operating gain inthe third quarter of 2007. FirstCity was involved in acquiring $4.5 million ofPortfolio Asset acquisitions in third quarter 2008 with an approximate facevalue of $78.1 million, compared to its involvement in acquiring $19.7 millionof Portfolio Asset acquisitions in third quarter 2007 with an approximate facevalue of $34.9 million. In third quarter 2008, FirstCity’s investment share inthe Portfolio Asset acquisitions was $3.2 million – comprised of $2.9 millionacquired through consolidated Portfolios and $0.3 million through AcquisitionPartnerships. In third quarter 2007, the Company’s investment share in thePortfolio Asset acquisitions was $16.3 million – comprised of $15.1 millionacquired through consolidated Portfolios and loan purchases and $1.2 millionthrough Acquisition Partnerships.

 

FirstCity invested an additional $6.0 million inthird quarter 2008 in the form of****SBA loanoriginations and advances, and equity interest acquisitions; compared to $6.3 million of additional investmentsin third quarter 2007 in the form of a business acquisition and SBA loanoriginations and advances.

 

*Servicing fee revenues. *Servicing fee revenues increased to $3.8 million in the third quarter of2008 from $2.4 million in the third quarter of 2007. Servicing fees fromdomestic Acquisition Partnerships totaled $1.2 million in third quarter 2008compared to $0.5 million in third quarter 2007, while servicing fees from LatinAmerican Acquisition Partnerships totaled $2.6 million in third quarter 2008compared to $1.9 million in third quarter 2007. The overall increase inservicing fees is attributed primarily to (1) recognition ofperformance-based service fees on certain domestic partnerships in thirdquarter 2008; and (2) service fees earned on new domestic and LatinAmerican arrangements that were created since third quarter 2007. Servicingfees from domestic Acquisition Partnerships are generally based on a percentageof the collections received from portfolios held by these non-consolidated domesticpartnerships; whereas servicing fees from Latin American AcquisitionPartnerships are generally based on the cost of servicing plus a profit margin.

 

*Income from Portfolio Assets*.  Incomefrom Portfolio Assets decreased to $5.2 million in the third quarter of 2008compared to $5.7 million in the third quarter of 2007. FirstCity’s averageinvestment in consolidated Portfolio Assets was $142.3 million and $118.8million for the third quarters of 2008 and 2007, respectively. However,collections from consolidated Portfolio Assets totaled $15.6 million in thirdquarter 2008 compared to $19.7 million in third quarter 2007. Refer to Note 5to the Consolidated Financial Statements included in Item 1 of this Form 10-Qfor a summary of income from Portfolio Assets.

 

*Gain on sale of SBA loans heldfor sale. *The Company recorded an $85,000 gain on the sales of SBA loans in third quarter 2008 with abasis in the loans sold of $2.2 million, compared to $34,000 of gains recordedin third quarter 2007 with a basis in the loans sold of $1.3 million. Gains onSBA loan sales reflect the Company’s participation in the SBA guaranteed loanprogram. Under the SBA 7(a) program, the SBA guarantees up to 85 percentof the principal of a qualifying loan. The Company generally sells theguaranteed portions of originated loans into the secondary market and retainsthe unguaranteed portion for investment.

 

*Interest income from SBAloans. *Interest income from SBA loans decreased to $0.4million during the third quarter of 2008 compared to $0.8 million during thethird quarter of 2007. The income decline is attributed to FirstCity’s averageinvestment in SBA loans falling to $16.9 million for third quarter 2008 from$18.3 million for third quarter 2007.

 

* Interest income from affiliates. *Interest income from affiliates increased to $0.9 million in thirdquarter 2008 compared to $0.1 million in third quarter 2007. The increasedincome is attributed to FirstCity’s average investment level in loansreceivable from affiliates rising to $22.6 million for third quarter 2008 from$5.2 million for third quarter 2007.

 

*Interest income from loansreceivable – other. * Interestincome from loans receivable – other was $0.5 million in the third quarter of2008 and $1.6 million in the third quarter of 2007. The income decline isattributed to the Company’s decreased investment level in loans tonon-affiliated entities. FirstCity’s average investment in loans receivable –other was $15.4 million and $27.7 million for the third quarters of 2008 and2007, respectively.

 

*Revenue from railroad operations*.  Revenuefrom railroad operations represents revenue generated by the Company’smajority-owned domestic railroad company that was acquired in August 2007.Third quarter 2008 includes a full quarter of railroad operations

 

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revenue ($0.8 million), whereas third quarter 2007 includes a partialquarter of revenue ($0.3 million) due to the mid-quarter acquisition.

 

*Other income*.  Otherincome for the third quarter of 2008 increased by $0.4 million in comparison tothe third quarter of 2007 primarily due to rental income recorded in thirdquarter 2008 from  the Company’s officebuilding investment (acquired in June 2008), and additional revenuegenerated by certain income-producing foreclosure properties in third quarter2008.

 

*Expenses. *Operating expenses approximated $15.0 million and $9.2 million in thethird quarters of 2008 and 2007, respectively. The following is a discussion ofthe major components of operating expenses.

 

Interest and fees on notes payable were $4.6million and $4.7 million in the third quarters of 2008 and 2007, respectively.FirstCity’s average outstanding debt increased to $231.4 million in thirdquarter 2008 from $219.3 million in the third quarter of 2007, while theaverage cost of borrowings decreased to 7.9% in 2008 compared to 8.7% in 2007.

 

Salaries and benefits increased to $4.6 millionin the third quarter of 2008 from $3.5 million in the third quarter of 2007,primarily due to additional salaries and benefits in 2008 that resulted fromthe railroad company acquisition in August 2007, and increased staffing atthe Company’s domestic and Latin American servicing platforms. The total numberof personnel within the Portfolio Asset acquisition and resolution segment was228 and 200 at September 30, 2008 and 2007, respectively.

 

Net provisions for loan and impairment losses totaled $1.1 million inthird quarter 2008 compared to a $0.1 million net recovery in third quarter2007. The increase is attributed primarily to net impairment provisions of $1.1million recorded in 2008 to the Company’s consolidated domestic portfolios. Theimpairment provisions in third quarter 2008 were attributed primarily todeclines in values of loan collateral and real estate assets in our domesticportfolios, and additional delays in the timing of collections of expected cashflows on domestic loan portfolios. Management believes that declines in realestate values and delayed collections are the resulting adverse effects fromthe subprime mortgage crisis that began in the United States in 2007 (i.e.rising loan defaults and foreclosures on loan collateral because borrowerscannot refinance their loans and/or continue to make payments and significantdeclines in real estate values due to excess building inventories). Theimpairment provisions were identified in connection with management’s regularevaluation of the collectibility of the Company’s Portfolio Assets. Management’sevaluation is inherently subjective as it requires estimates that aresusceptible to revision in future periods as more information becomesavailable.

 

Occupancy, data processing, property protection andother expenses increased to $4.5 million for the third quarter of 2008 from$1.1 million in the third quarter of 2007. The increase is primarily attributedto $0.5 million of additional property protection expenses (i.e. propertytaxes, insurance and legal) incurred in 2008 to protect FirstCity’s real estatesecurity interests in its domestic consolidated loan portfolios and supportforeclosed properties; and $0.8 million of foreign currency exchange lossesrecorded in third quarter 2008 compared to $1.6 million of gains in thirdquarter 2007.

 

*Equity in earnings ofinvestments. *Equity in earnings of investments remainedconstant at $2.2 million in the third quarter of 2008 compared to $2.2 millionin the third quarter of 2007. Equity in earnings of Acquisition Partnershipsdecreased to $1.6 million in 2008 from $2.1 million in 2007, and equity inearnings of servicing and operating entities increased by $0.5 million in 2008compared to 2007. The following is a discussion of equity in earnings from FirstCity’sAcquisition Partnerships by geographic region. Refer to Note 7 of theConsolidated Financial Statements included in Item 1 on this Form 10-Q fora summary of revenues, earnings and equity in earnings of FirstCity’s equityinvestments by region.

 

·             *Domestic*— Total revenues reported by domestic Acquisition Partnerships decreased to$2.6 million in third quarter 2008 from $5.6 million in 2007. Total net earnings reported by domesticpartnerships decreased to a $0.5 million loss in third quarter 2008 compared to$2.1 million of net earnings in third quarter 2007. The decrease intotal partnership earnings was attributed primarily to a decrease in portfolioasset holdings (i.e. earning assets) to $63.1 million in 2008 from $96.4million in 2007 and a decrease in collections to $13.2 million in third quarter2008 from $14.2 million in third quarter 2007 – which collectively resulted ina decline in income generated by these assets to $2.6 million in third quarter2008 compared to $5.5 million in third quarter 2007. The collective activitydescribed above translated to a decrease in FirstCity’s share of domesticpartnership earnings to a $0.4 million loss for third quarter 2008 from $1.1million of net earnings for third quarter 2007.

 

FirstCity’s average investment in domestic partnerships decreased to$20.7 million in third quarter 2008 from $36.1 million in 2007. As a result,FirstCity’s share of domestic partnership revenues experienced a correspondingdecrease as discussed above. Since amajority of FirstCity’s domestic portfolio acquisitions over the past two yearswere acquired through consolidated

 

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Portfolios instead of equity investments inAcquisition Partnerships, the Company expects income from consolidatedPortfolios to off-set the decline in equity in earnings from the domesticpartnerships.

 

·             *Latin America* —Total revenues reported by Latin American Acquisition Partnerships decreased to$8.8 million in third quarter 2008 from $11.7 million in third quarter 2007.However, total net earnings reported byLatin American partnerships increased to $2.5 million in third quarter 2008compared to a $1.8 million loss in third quarter 2007. The increase in totalnet earnings reported by Latin American partnerships was attributed primarilyto the following: (1) decrease in interest expense to $0.9 million inthird quarter 2008 compared to $1.9 million in third quarter 2007; and (2) increasein foreign currency exchange gains to $3.1 million in third quarter 2008compared to $5.4 million of exchange losses in third quarter 2007. The positiveimpact from these factors to total net earnings reported by Latin American partnerships was partially off-set by thefollowing: (1) decrease in collections on seasoned cost-recoveryloan portfolios to $2.4 million in third quarter 2008 compared to $6.7 millionin third quarter 2007 – resulting in a $1.6 million decrease in income relatedto these portfolios in 2008 compared to 2007; (2) decrease in interest andaccretion on performing loan portfolios to $7.6 million in third quarter 2008compared to $9.0 million in third quarter 2007; (3) increase in netimpairment provisions to $2.0 million in third quarter 2008 compared to $1.3million in third quarter 2007; and (4) increase in servicing fees expenseto $3.9 million in third quarter 2008 compared to $2.8 million in third quarter2007.  The collective activitydescribed above translated to a small increase in FirstCity’s share of netearnings in Latin American partnerships to $0.4 million for third quarter 2008from a $0.1 million loss for third quarter 2007.

 

·             *Europe*— Totalrevenues reported by European Acquisition Partnerships increased to $12.2million in third quarter 2008 from $8.3 million in third quarter 2007. Total net earnings reported by Europeanpartnerships increased to $6.4 million in third quarter 2008 compared to $3.7million in third quarter 2007. The increase in total partnershipearnings was attributed primarily to the following (1) increase incollections on seasoned cost-recovery loan portfolios to $9.1 million in thirdquarter 2008 compared to $4.1 million in third quarter 2007 – resulting in a$3.7 million increase in income related to these portfolios in 2008 compared to2007; and (2) increase in interest and accretion on performing loanportfolios to $6.0 million in third quarter 2008 compared to $5.3 million inthird quarter 2007 (attributed primarily to accretion rate increases on certainexisting portfolios since third quarter 2007). The collective activitydescribed above translated to an increase in FirstCity’s share of Europeanpartnership earnings to $1.6 million for third quarter 2008 from $1.1 millionfor third quarter 2007.

 

*Other Significant Items Affecting Operations*

 

The following items affect the Company’s overallresults of operations and are not directly related to the Portfolio Assetacquisition and resolution business discussed above.

 

*Corporate overhead. *Net corporate overhead expenses (excluding taxes) decreased to $1.6million in the third quarter of 2008 compared to $1.9 million in the thirdquarter of 2007 primarily due to a $0.5 million decrease in accounting andlegal fees.

 

*Income taxes. *Provision for income tax benefit (expense)approximated $44,000 in the third quarter of 2008 and ($153,000) in the thirdquarter of 2007. Refer to additionalinformation on income taxes disclosed in Note 12 to the Consolidated FinancialStatements included in Item 1 on this Form 10-Q.

 

***First Nine Months of 2008 Compared to First Nine Months of 2007***

 

The Company reported net losses of $11.9 millionin the first nine months of 2008 compared to net earnings of $3.5 million inthe first nine months 2007. Diluted net losses to common stockholders were$1.14 per common share in the first nine months of 2008 compared to $0.31 ofdiluted net earnings per common share in the first nine months of 2007.

 

*Portfolio Asset Acquisition and Resolution*

 

The operating contribution from the PortfolioAsset acquisition and resolution segment resulted in a $7.1 million operatingloss in the first nine months of 2008 compared to a $10.9 million operating gainin the first nine months of 2007. FirstCity was involved in acquiring $61.1million of Portfolio Asset acquisitions in the first nine months of 2008 withan approximate face value of $716.2 million, compared to its involvement inacquiring $189.9 million of Portfolio Asset acquisitions in the first ninemonths of 2007 with an approximate face value of $422.3 million. In 2008,FirstCity’s investment share in the Portfolio Asset acquisitions was $45.1million – comprised of $38.0 million acquired through consolidated Portfoliosand $7.1 million through Acquisition Partnerships. In

 

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the first nine months of 2007, FirstCity’sinvestment share in the Portfolio Assets was $111.0 million – comprised of$92.4 million acquired through consolidated Portfolios and $18.6 millionthrough Acquisition Partnerships.

 

FirstCity invested an additional$39.7 million in the first nine months of 2008 in the form of real estateinvestments, debt financing arrangements, SBA loan originations andadvances, and equity interest investments;compared to $18.3 million of such additional investments in the first ninemonths of 2007.

 

*Servicing fee revenues.*Servicing fee revenues decreased to $8.7 millionin the first nine months of 2008 from $8.0 million in the first nine months of2007. Servicing fees from domestic Acquisition Partnerships totaled $2.0million in first nine months of 2008 compared to $2.3 million in first ninemonths of 2007, while servicing fees from Latin American AcquisitionPartnerships totaled $6.7 million in first nine months of 2008 compared to $5.7million in first nine months of 2007. The overall increase in servicing fees isattributed primarily to service fees earned on new domestic and Latin Americanarrangements that were created since third quarter 2007; off-set primarily by adecline in domestic partnership collections to $30.7 million in the first ninemonths of 2008 compared to $56.7 million in 2007. Servicing fees from domesticAcquisition Partnerships are generally based on a percentage of the collectionsreceived from portfolios held by these non-consolidated domestic partnerships;whereas servicing fees from Latin American Acquisition Partnerships aregenerally based on the cost of servicing plus a profit margin.

 

*Income from Portfolio Assets*. Income from Portfolio Assets decreased to $15.8million in the first nine months of 2008 compared to $16.5 million in the firstnine months of 2007. FirstCity’s average investment in consolidated PortfolioAssets was $127.5 million and $115.7 million for the first nine months of 2008and 2007, respectively. However, collections from consolidated Portfolio Assetsdecreased to $46.5 million in the first nine months of 2008 compared to $60.8million in 2007. Refer to Note 5 to the Consolidated Financial Statementsincluded in Item 1 of this Form 10-Q for a summary of income fromPortfolio Assets.

 

*Gain onsale of SBA loans held for sale.*TheCompany recorded a $0.2 million gain on the sales of SBA loans in the first nine months of2008 with a basis in the loans sold of $5.1 million, compared to $0.7 millionof gains recorded in the first nine months of 2007 with a basis in the loanssold of $16.2 million. Gains on SBA loan sales reflect the Company’sparticipation in the SBA guaranteed loan program. Under the SBA7(a) program, the SBA guarantees up to 85 percent of the principal of aqualifying loan. The Company generally sells the guaranteed portions oforiginated loans into the secondary market and retains the unguaranteed portionfor investment.

 

*Interest income from SBAloans.*Interest incomefrom SBA loans decreased to $1.2 million during the first nine months of 2008compared to $1.7 million during the first nine months of 2007. The incomedecline is attributed to FirstCity’s average investment in SBA loans falling to$15.6 million for 2008 from $17.9 million for 2007.

 

* Interest income from affiliates.*Interest income from affiliates increased to $1.5million for the first nine months of 2008 compared to $0.4 million for thefirst nine months of 2007. The increased income is attributed to FirstCity’saverage investment in loans receivable from affiliates rising to $15.0 millionfor 2008 from $4.9 million for 2007.

 

*Interest income from loansreceivable — other.*Interestincome from loans receivable — other was $1.2 million for the first nine monthsof 2008 and $3.5 million for the first nine months of 2007. The income declineis attributed to the Company’s decreased investment level in loans tonon-affiliated entities. FirstCity’s average investment in loans receivable —other was $10.7 million and $27.1 million for the first nine months of 2008 and2007, respectively.

 

*Revenue from railroadoperations*. Revenue fromrailroad operations represents revenue generated by the Company’smajority-owned domestic railroad company that was acquired in August 2007.Revenue from railroad operations was $2.5 million for the first nine months of2008 and $0.3 million for the first nine months of 2007 (partial period sincethe railroad was acquired in August 2007).

 

*Other income*. Other income for the first nine months of 2008increased by $1.0 million in comparison to 2007 primarily due to rental incomerecorded in 2008 from the Company’s office building investment (acquired inJune 2008); (2) additional revenue generated by certainincome-producing foreclosure properties in third quarter 2008; and(3) management oversight fees attributed to new Latin American portfolioinvestments in 2008.

 

*Expenses.*Operating expenses were $47.9 million and $29.9million in the first nine months of 2008 and 2007, respectively. The followingis a discussion of the major components of operating expenses.

 

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Interest and fees on notespayable were $12.0 million and $13.7 million in the first nine months of 2008and 2007, respectively. FirstCity’s average outstanding debt decreased to$199.3 million in the first nine months of 2008 from $212.9 million in thefirst nine months of 2007, while the average cost of borrowings decreased to8.0% in 2008 compared to 8.6% in 2007.

 

Salaries and benefits increasedto $12.8 million in the first nine months of 2008 from $9.7 million in thefirst nine months of 2007, primarily due to additional salaries and benefits in2008 that resulted from the railroad company acquisition in August 2007,and increased staffing at ABL (SBA lending platform), FirstCity Crestone(special situations investment platform), and the Company’s domestic and LatinAmerican servicing platforms. The total number of personnel within thePortfolio Asset acquisition and resolution segment was 228 and 200 atSeptember 30, 2008 and 2007, respectively.

 

Net provisions for loan and impairment losses totaled$11.2 million in the first nine months of 2008 compared to $0.9 million in thefirst nine months of 2007. The increase is attributed primarily to netimpairment provisions of $10.2 million recorded in 2008 to the Company’sconsolidated domestic portfolios and loans; and $1.0 million of provisionsrecorded to domestic real estate properties. The impairment provisions in 2008were attributed primarily to declines in values of loan collateral and realestate assets in our domestic portfolios, and additional delays in the timingof collections of expected cash flows on domestic loan portfolios. Managementbelieves that declines in real estate values and delayed collections are theresulting adverse effects from the subprime mortgage crisis that began in theUnited States in 2007 (i.e. rising loan defaults and foreclosures on loancollateral because borrowers cannot refinance their loans and/or continue tomake payments and significant declines in real estate values due to excessbuilding inventories). The impairment provisions were identified in connectionwith management’s regular evaluation of the collectibility of the Company’sPortfolio Assets. Management’s evaluation is inherently subjective as itrequires estimates that are susceptible to revision in future periods as moreinformation becomes available.

 

Occupancy, data processing,property protection and other expenses increased to $11.6 million for the firstnine months of 2008 from $5.9 million in the first nine months of 2007. Theincrease is attributed primarily to (1) $2.4 million of additionalproperty protection expenses (i.e. property taxes, insurance and legal)incurred in 2008 to protect FirstCity’s real estate security interests in itsdomestic consolidated loan portfolios and support foreclosed properties;(2) $1.0 million of foreign currency exchange losses recorded in 2008compared to $1.1 million of gains in 2007; (3) additional legal,accounting and professional fees of $0.5 million recorded in 2008 compared to2007; and (4) additional foreign tax expense of $0.3 million recorded in2008 compared to 2007.

 

*Equity in earnings ofinvestments.*Equity inearnings of investments slightly decreased to $8.0 million in the first ninemonths of 2008 compared to $8.3 million in the first nine months of 2007.Equity in earnings of Acquisition Partnerships decreased to $6.9 million in2008 from $7.5 million in 2007, and equity in earnings of servicing andoperating entities increased to $1.1 million in 2008 compared to $0.8 millionin 2007. The following is a discussion of equity in earnings from FirstCity’sAcquisition Partnerships by geographic region. Refer to Note 7 of theConsolidated Financial Statements included in Item 1 on this Form 10-Q fora summary of revenues, earnings and equity in earnings of FirstCity’s equityinvestments by region.

 
|   | • | *Domestic* — Total  revenues reported by domestic Acquisition Partnerships decreased to $8.9  million in the first nine months of 2008 from $14.6 million in 2007. Total net earnings reported by domestic  partnerships decreased to a $0.3 million loss in the first nine months of  2008 compared to $5.2 million of net earnings in the first nine months of  2007. The decrease in total partnership earnings was attributed  primarily to the following: (1) decrease in portfolio asset holdings  (i.e. earning assets) to $63.1 million in 2008 from $96.4 million in 2007;  (2) decrease in collections to $30.7 million in 2008 from $56.7 million  in 2007 — which collectively resulted in a decline in income generated by these  assets to $8.9 million in 2008 compared to $14.3 million 2007; and  (3) increase in net impairment provisions to $3.0 million in 2008  compared to $1.7 million in 2007. The collective activity described above  translated to a decrease in FirstCity’s share of domestic partnership  earnings to a $0.3 million loss for 2008 from $2.4 million of net earnings  for 2007. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |   | FirstCity’s average investment in domestic  partnerships decreased to $22.2 million in the first nine months of 2008 from  $35.2 million in 2007. As a result, FirstCity’s share of domestic partnership  revenues experienced a corresponding decrease as discussed above. Since a majority of FirstCity’s domestic  portfolio acquisitions over the past two years were acquired through  consolidated Portfolios instead of equity investments in Acquisition  Partnerships, the Company expects income from consolidated Portfolios to  off-set the decline in equity in earnings from the domestic partnerships.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   | • | *Latin America* — Total revenues  reported by Latin American Acquisition Partnerships increased to $32.5  million in the first nine months of 2008 from $31.1 million in the first nine  months of 2007. Total net earnings  reported by Latin American partnerships increased to $8.5 million in the  first nine months of 2008 compared to $4.8 million in the first nine months  of 2007. The increase in total earnings reported by Latin American  partnerships was attributed primarily to the following: (1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |

 

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|   |   | increase in collections to $56.9 million in 2008  from $42.1 million in 2007 – which collectively resulted in an increase in  income generated by these assets to $32.3 million in 2008 compared to $30.6  million 2007; (2) decrease in interest expense to $4.8 million in 2008  from $5.8 million in 2007; and (3) increase in foreign currency exchange  gains to $11.5 million in 2008 compared to a $6.2 million exchange loss in  2007. The positive impact from these factors to total net earnings by Latin  American partnerships was partially off-set by the following:  (1) increase in net impairment provisions to $7.3 million in 2008  compared to $6.2 million in 2007; (2) increase in servicing fees expense  to $12.7 million in 2008 compared to $8.2 million in 2007; and  (3) increase in foreign tax expense to $1.1 million in 2008 from a  foreign tax benefit of $2.4 million in 2007.  The collective activity described above translated to an  increase in FirstCity’s share of net earnings in Latin American partnerships  to $1.5 million for the first nine months of 2008 from $0.8 million for the  first nine months of 2007.                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|   | • | *Europe*— Total revenues  reported by European Acquisition Partnerships increased to $34.3 million in  the first nine months of 2008 from $25.4 million in 2007. Total net earnings reported by European  partnerships increased to $20.1 million in the first nine months of 2008  compared to $15.0 million in the first nine months of 2007. The  increase in total earnings reported by European partnerships was attributed  primarily to (1) increase in collections on seasoned cost-recovery loan  portfolios to $20.7 million in 2008 compared to $14.1 million in 2007 —  resulting in an increase in income related to these portfolios to $14.2 in  2008 compared to $9.2 million 2007; (2) increase in interest and  accretion on performing loan portfolios to $19.5 million in 2008 compared to  $16.0 million in 2007 (attributed primarily to accretion rate increases on  certain existing portfolios since third quarter 2007); and (3) decrease  in net impairment provisions to $1.5 million in 2008 compared to $2.0 million  in 2007. The positive impact from these factors to total net earnings by  European partnerships was partially off-set by the following:  (1) increase in interest expense to $2.7 million in 2008 from $0.2  million in 2007; and (2) increase in servicing fees expense to $5.8  million in 2008 compared to $4.4 million in 2007. The collective activity  described above translated to an increase in FirstCity’s share of European  partnership earnings to $5.7 million for the first nine months of 2008 from  $4.3 million for the first nine months of 2007. |

 

*Other Significant Items AffectingOperations*

 

The following items affect theCompany’s overall results of operations and are not directly related to thePortfolio Asset acquisition and resolution business discussed above.

 

*Corporate overhead.*Net corporate overhead expenses (excluding taxes)decreased to $4.9 million in the first nine months of 2008 compared to $7.0million in the first nine months of 2007, primarily due to $2.2 million inexpenses incurred during the first nine months of 2007 relating to anindependent investigation authorized by the Company’s audit committee.

 

*Income taxes.*Provision for incometax expense approximated $0.2 million in the first nine months of 2008, and$0.4 in the first nine months of 2007. Refer to additional information on income taxes disclosed in Note 12 tothe Consolidated Financial Statements included in Item 1 on thisForm 10-Q.

 

#### **Financial Condition**

#### ** **

Significant changes inFirstCity’s financial condition during the first nine months of 2008 resultedfrom the following:

 

Consolidated assets of $346.9million at September 30, 2008 were $48.8 million higher than consolidatedassets at December 31, 2007. The increase in consolidated assets isattributed primarily to a $56.5 million net increase in Portfolio Assets, loaninvestments and equity-method investments related to FirstCity’s investmentactivities; off-set by a $10.1 million net decrease in cash to fund operations.

 

Consolidated liabilities of$254.9 million as of September 30, 2008 were $63.6 million higher thanconsolidated liabilities at December 31, 2007. Total notes payableincreased by $47.9 million primarily to finance the Company’s investmentactivities in the first nine months of 2008.

 

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

#### ** **

Aggregate acquisitions by theCompany are as follows (in thousands):

 
|                      |   | **Purchase**                         |   | **FirstCity**  |   |
|---------------------------|--------|--------------------------------------|--------|----------------|--------|
|                      |   | **Price**                            |   | **Investment** |   |
|                      |   | **(Dollars in thousands)** |   |
| First nine months of 2008 |   | $61,128                              |   | $45,124        |   |
| Total 2007                |   | 214,333                              |   | 126,714        |   |
| Total 2006                |   | 296,990                              |   | 144,048        |   |
| Total 2005                |   | 146,581                              |   | 71,405         |   |
| Total 2004                |   | 174,139                              |   | 59,762         |   |
| Total 2003                |   | 129,192                              |   | 22,944         |   |

 

**Provision for Income Taxes**

 

The Company has substantialNOLs, which can be used to offset the tax liability associated with the Company’spre-tax earnings until the earlier of the expiration or utilization of suchNOLs. The Company accounts for the benefit of the NOLs by recording the benefitas an asset and then establishing a valuation allowance to value the netdeferred tax asset at a level, which more likely than not, will be realized.Realization is determined based on management’s expectation of generatingsufficient taxable income in a look forward period over the next four years.The ultimate realization of the resulting net deferred tax asset is dependentupon generating sufficient taxable income from its continuing operations priorto expiration of the NOLs. Although realization is not assured, managementbelieves it is more likely than not that all of the recorded deferred taxasset, net of the allowance, will be realized. The amount of the deferred taxasset considered realizable, however, could be adjusted in the future ifestimates of future taxable income during the carryforward period change. Theability of the Company to realize the deferred tax asset is periodicallyreviewed and the valuation allowance is adjusted accordingly.

 

**Liquidity and Capital Resources**

 

TheCompany requires liquidity to fund its operations, working capital, payment ofdebt, repurchase of the Company’s common stock, equity for acquisition ofPortfolio Assets, investments in and advances to entities formed with otherinvestors to acquire Portfolios (“Acquisition Partnerships”) and otherinvestments. The potential sources of liquidity are funds generated fromoperations, equity distributions from the Acquisition Partnerships, interestand principal payments on subordinated intercompany debt, dividends from theCompany’s subsidiaries, borrowings from revolving lines of credit and othercredit facilities, proceeds from equity market transactions, securitization andother structured finance transactions, and other special purpose short-termborrowings.

 

*Bank ofScotland and BoS (USA), Inc.*

 

FirstCity has a $225.0 million revolving creditfacility with Bank of Scotland that matures in November 2010. Therevolving loan facility is used to finance the senior debt and equity portionof portfolio and asset purchases made by FirstCity and to provide for theissuance of letters of credit and working capital loans. The obligations ofFirstCity under this facility are guaranteed by substantially all of thewholly-owned subsidiaries of FirstCity and are secured by security interests insubstantially all of the assets of FirstCity and its wholly-owned subsidiaries.The primary terms and key covenants of the $225.0 million revolving creditfacility, as amended, are as follows:

 

•                    Themaximum outstanding amount of loans and letters of credit issued under the loanfacility that may be outstanding under the loan facility is $225.0 million;

•                    Allowsloans to be made based upon a borrowing base of (a) 70% of the net presentequity value of certain affiliates of FirstCity engaged in the asset andportfolio investment business, and (b) 40% of the equity investment ofFirstCity and its subsidiaries in certain new ventures;

•                    Theavailable interest rates under the loan facility are *LondonInterbank Offering Rate*(“LIBOR”) plus 2.00% to 2.50% per annum;

•                    Themaximum value for assets that can be included in the borrowing base from theacquisition of portfolio assets in certain countries are as follows: Mexico -$40.0 million, Brazil - $10.0 million, Chile - $25.0 million, and Argentina orUruguay - $6.0 million;

•                    Thelimit for loans that can be borrowed in Euros under the loan facility is $50.0million;

•                    Themaximum amount of letters of credit that can be issued under the loan facilityis $40.0 million;

•                    Themaximum amount of working capital loans that can be outstanding under the loanfacility is $35.0 million;

 

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•                    Theratio of indebtedness to tangible net worth should be equal to or less than 3.5to 1.00 for the last day of the fiscal quarter;

•                    Tangiblenet worth should not fall below $85.0 million; and

•                    Theratio of cumulative current recovered and projected collections to cumulativeoriginal projected collections should not be less than 0.90 to 1.00.

 

AtSeptember 30, 2008, the Company was in compliance with all materialcovenants or other requirements set forth in the credit agreements or otheragreements with Bank of Scotland.

 

On July 14, 2008, the Company and Bank ofScotland entered into an amendment to the revolving loan facility that addedfinancial covenants to the loan facility which require FirstCity and all othermembers of the consolidated group to maintain, on a consolidated basis, a ratioof net cash flow to total interest and fee expense of not less than 5.00 to1.00 for the four fiscal quarters then ended and a cash conversion rate of notless than 25% for the four fiscal quarters then ended. The amendment iseffective as of July 14, 2008, and the additional covenants are applicableto the fiscal quarters ending September 30, 2008 and thereafter.

 

FirstCityhas $32.1 million in Euro-denominated debt outstanding on the $225.0 millionrevolving credit facility with Bank of Scotland described above for the purposeof hedging a portion of the net equity investments in Europe. In general, thetype of risk hedged relates to the foreign currency exposure of net investmentsin Europe caused by movements in Euro exchange rates. The Company entered intothe hedging relationship such that changes in the net investments being hedgedare expected to be offset by corresponding changes in the values of theEuro-denominated debt. Effectiveness of the hedging relationship is measuredand designated at the beginning of each month by comparing the outstandingbalance of the Euro-denominated debt to the carrying value of the designatednet equity investments. The net foreign currency translation gain (loss)included in accumulated other comprehensive income relating to theEuro-denominated debt was $1.9 million for the nine months ended September 30,2008, and ($1.4) million for the same period in 2007.

 

FH Partners, LLC has a $100.0 million revolving loanfacility with Bank of Scotland that provides financing for Portfolio and assetpurchases by FH Partners, LLC. This revolving loan facility matures inNovember 2010, and is secured by all assets of FH Partners, LLC and aguaranty by FirstCity and certain of its wholly-owned subsidiaries. The primaryterms and key covenants of the $100.0 million revolving loan facility, asamended, are as follows:

 

•                    Allows loansto be made for the acquisition of Portfolio Assets in the United States, andprovides for loans to be used for other purposes with advance approval fromBank of Scotland;

•                    Provides thateach loan may be in an amount of up to 70% of the net present value of theassets being acquired with the proceeds of the loan;

•                    Provides thatthe aggregate outstanding balances of all loans will not exceed 65% of the netpresent value of the assets securing the loan facility;

•                    Provides thatFH Partners must maintain a ratio of cumulative current recovered and projectedcollections to cumulative original projected collections of not less than 0.90to 1.00;

•                    Provides foran interest rate of LIBOR plus 2.0%; and

•                    Provides thatall other financial covenants will mirror the key covenants of the facilitythat FirstCity has with Bank of Scotland.

 

AtSeptember 30, 2008, the Company was in compliance with all materialcovenants or other requirements set forth in the credit agreements or otheragreements with Bank of Scotland.

 

On July 14, 2008, FH Partners LLC and Bank ofScotland entered into an amendment to the revolving loan facility that addedfinancial covenants to the loan facility which require FH Partners LLC tomaintain a ratio of net cash flow to total interest and fee expense of not lessthan 7.00 to 1.00 for the four fiscal quarters then ended and a cash conversionrate of not less than 35% for the four fiscal quarters then ended. Theamendment is effective as of July 14, 2008, and the additional covenantsare applicable to the fiscal quarters ending September 30, 2008 andthereafter.

 

FirstCity has a $25.0million subordinated credit agreement with BoS (USA), Inc. (“BoS (USA)”)which may be used to finance equity investments in new ventures, equity investmentsmade in connection with portfolio and asset purchases and loans made byFirstCity and its subsidiaries to acquisition entities, provide for theissuance of letters of credit, and for working capital loans. This creditfacility matures in November 2010 and is secured by substantially all ofthe assets of FirstCity and its wholly-owned 

 

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subsidiaries and guaranteedby substantially all of FirstCity’s wholly-owned subsidiaries. The primaryterms and key covenants of this $25.0 million loan facility are as follows:

 

•                    Allows loansto be made in maximum aggregate amount of $25.0 million during the term of theloan facility;

•                    Provides forinterest rates, at FirstCity’s election, of LIBOR plus 5.0%, Bank of Scotlandbase or prime rate plus 3.0%, or a fixed rate for a period agreed to byFirstCity and BoS (USA) as agent;

•                    Allows loansto be made based upon a borrowing base of (a) 80% of the net presentequity value of certain affiliates of FirstCity engaged in the asset andportfolio investment business, and (b) 90% of the equity investment ofFirstCity and its subsidiaries in certain new ventures;

•                    Limits that themaximum value for assets that can be included in the borrowing base from theacquisition of portfolio assets in certain countries as follows (a) Mexicoup to $40.0 million, (b) Brazil up to $10.0 million, (c) Chile up to$25.0 million and (d) Argentina and Uruguay up to $6.0 million;

•                    Provides forinclusion in the borrowing base of loans made to FirstCity Denver InvestmentCorp. (a majority-owned subsidiary of FirstCity) for the purpose of investingin distressed debt, special loan originations, leveraged buyouts and otherspecial opportunities;

•                    Provides forinclusion in the borrowing base of certain loans made by FirstCity subsidiariesto non-affiliated entities that are secured by real estate; and

•                    Includesfinancial covenants that the ratio of indebtedness to tangible net worth shouldbe equal to or less than 3.5 to 1.00 for the last day of each fiscal quarter,and that the ratio of cumulative current recovered and projected collections tocumulative original projected collections should not be less than 0.90 to 1.00for each fiscal quarter.

 

AtSeptember 30, 2008, the Company was in compliance with all materialcovenants or other requirements set forth in the credit agreements or otheragreements with BoS (USA).

 

On July 14, 2008, the Company and BoS (USA)entered into an amendment to the subordinated credit agreement that addedfinancial covenants to the loan facility which require FirstCity and all othermembers of the consolidated group to maintain, on a consolidated basis, a ratioof net cash flow to total interest and fee expense of not less than 5.00 to1.00 for the four fiscal quarters then ended and a cash conversion rate of notless than 25% for the four fiscal quarters then ended. The amendment iseffective as of July 14, 2008, and the additional covenants are applicableto the fiscal quarters ending September 30, 2008 and thereafter.

 

BoS(USA) has a warrant to purchase 425,000 shares of the Company’s voting commonstock at $2.3125 per share. BoS (USA) is entitled to additional warrants in connectionwith this existing warrant for 425,000 shares under certain specific situationsto retain its ability to acquire approximately 4.86% of the Company’s votingcommon stock. The warrant expires on August 31, 2010, if it is notexercised prior to that date.

 

*BancoSantander, S.A.*

 

FirstCity Mexico SA de CV, a Mexican affiliate ofFirstCity, has a revolving line of credit with a maximum loan amount of142,240,000 Mexican pesos with Banco Santander, S.A., which was equivalent to$13.2 million U.S. dollars at September 30, 2008. The loan proceeds areused to pay down the acquisition facility with the Bank of Scotland. Pursuantto the terms of the credit facility, FirstCity Mexico SA de CV was required toprovide a stand-by letter of credit from Bank of Scotland that would satisfythe loan balance upon demand.  At September 30, 2008, FirstCity had aletter of credit in the amount of $14.1 million from Bank of Scotland under theterms of FirstCity’s revolving acquisition facility with Bank 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 Bankof Scotland for all amounts disbursed or to be disbursed by Bank of Scotlandunder the letter of credit.

 

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*Wells Fargo Foothill, LLC*

 

American BusinessLending, Inc. (“ABL”), a subsidiary of FirstCity, has a $40.0 millionrevolving loan facility with Wells Fargo Foothill, LLC (“WFF”) for the purposeof financing and acquiring SBA loans. The obligations under this facility aresecured by substantially all of the assets of ABL.  In addition, FirstCityprovided WFF with an unconditional guaranty, up to a maximum of $5.0 millionplus enforcement cost, of the obligations of ABL under the loan facility thatrelate to funds in the amount of $31.7 million advanced by WFF to ABL inconnection of a portfolio of SBA loans in February 2007. Thisguaranty arrangement remains in effect until the obligations incurred inconnection with the advance related to the acquisition of the portfolio of SBAloans are paid in full. The primary terms of the $40.0 million revolving loanfacility, as amended, are as follows:

 

•                    Allowsadvances in the maximum amount of $40.0 million (the “Maximum Credit Line”) tobe made under the facility;

•                    Provides for aborrowing base for originating loans by which (a) the sum of (1) upto 100% of the net eligible SBA guaranteed loans originated by ABL, plus(2) up to 80% of the net eligible non-guaranteed loans originated by ABL,exceeds (b) the sum of (1) any reserves for obligations of ABLrelated to the bank products, plus (2) the aggregate amount, if any, of loanreserves then established and outstanding, plus (3) the aggregate amountof any other reserves established by WFF;

•                    Provides for aborrowing base for the portfolio of SBA loans acquired in February 2007 bywhich (a) the sum of (1) up to 100% of the net eligible SBAguaranteed performing loans acquired by ABL in February 2007, (provided,that such percentage shall be reduced by 5% on November 1, 2007 and on thefirst day of each month thereafter), plus (2) up to 80% of the neteligible non-guaranteed performing loans acquired by ABL, exceeds (b) thesum of (1) any reserves with respect to acquired performing loans relatedto the bank products, plus (2) the aggregate amount, if any, of loanreserves then established and outstanding, plus (3) the aggregate amountof any other reserves established by WFF;

•                    Provides foran interest rate of LIBOR plus 2.625% or, alternatively, the greater of(x) the Wells Fargo prime rate or (y) 7.50% per annum;

•                    Provides foran unused credit line fee in an amount equal to 0.25% per annum of the averagedaily difference during the month in question (or portion thereof) between theMaximum Credit Line and the aggregate outstanding principal amount of theadvances outstanding under the facility for such month (or portion thereof);

•                    Provides inthe event of the termination of the facility by ABL for a prepayment fee of2.0% of the Maximum Credit Line if paid prior to December 14, 2008, and1.0% of the Maximum Credit Line if paid during the period beginningDecember 15, 2008 and ending December 13, 2009; and

•                    Provides for amaturity date of December 14, 2009.

#### ** **

#### **The security agreement executed byABL to secure the obligations under this credit facility grants a securityinterest to WFF in all of the assets of ABL, except the unguaranteed portionsof certain SBA-guaranteed loans, certain other assets, and the Small BusinessLending Corporation license. In addition, the loan facility contains certaindefined financial covenants including a maximum ratio of debt to equity,minimum level of tangible net worth, minimum interest coverage ratios, andasset quality ratios related to the underlying loan collateral. At September30, 2008, ABL was in compliance with all material covenants or otherrequirements set forth in the credit agreement or other agreements with WFF,except for two covenants related to loan losses and tangible net worth. At theend of each fiscal quarter, ABL’s loan losses for the twelve-month period thenending should not exceed 2.0% of the average amount of non-guaranteed loansoutstanding during the period (ABL’s loan loss measure under this condition was2.9% at September 30, 2008). In addition, at the end of each fiscal quarter,ABL is required to maintain, on a consolidated basis, tangible net worth of notless than $6.5 million (ABL’s tangible net worth approximated $6.4 million atSeptember 30, 2008). WFF has waived these requirements of the agreement as ofand for the quarter ended September 30, 2008.**

#### ** **

Excludingthe term acquisition facilities of the unconsolidated Acquisition Partnerships,as of September 30, 2008, the Company and its subsidiaries had creditfacilities providing for borrowings in an aggregate principal amount of $425million and outstanding borrowings of $225 million.

 

Managementbelieves that the existing loan facilities; related fees generated from theservicing of assets; equity distributions from existing AcquisitionPartnerships; collections from consolidated portfolios, loans and otherinvestments; sales of interests in equity investments; and sales of guaranteedportions of existing and originated SBA loans will allow the Company to meetits obligations as they come due during the next twelve months.

 

Thefollowing table summarizes the material terms of the credit facilities to whichthe Company, its major operating subsidiaries and the Acquisition Partnershipswere parties to as of October 31, 2008, and the outstanding borrowingsunder such facilities as of September 30, 2008.

 

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| ** **                                                                                                     | ** ** | **Credit  Facilities**     | ** ** | ** **             | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                                                                                     | ** ** | ** **                 | ** ** | ** **             | ** ** |
| ** **                                                                                                     | ** ** | **Funded  and**            | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                     | ** ** | **Unfunded**               | ** ** | **Outstanding**        | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                     | ** ** | **Commitment**             | ** ** | **Borrowings**         | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                     | ** ** | **Amount  as of**          | ** ** | **as of**              | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                     | ** ** | **October 31,**       | ** ** | **September 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                     | ** ** | **2008**                   | ** ** | **2008**               | ** ** | **Interest  Rate** | ** ** | **Other  Terms and Conditions** | ** ** |
| ** **                                                                                                     | ** ** | **(Dollars  in millions)** | ** ** | ** **             | ** ** | ** ** | ** ** |
| Bank of Scotland $225  million portfolioacquisition and working capital facility (1)                           |       | $                          | 225        |                   | $          | 114 |   | $84 at LIBOR+ 2.0% - 2.50%; $30 at 18-month fixed rate of 7.86% |   | Secured by equity interests and other assets of FirstCity, matures  November 2010 |   |
|                                                                                                           |       |                       |       |                   |       |   |   |   |   |
| Bank of Scotland $100  million portfolio  acquisition -  revolving credit                                 |       | 100                        |       | 55                     |       | $53 at LIBOR+ 2.0% $2 at prime |   | Secured by assets of FH Partners, L.P. and guaranteed by the Company,  matures November 2010 |   |
|                                                                                                           |       |                       |       |                   |       |   |   |   |   |
| Bank of Scotland $25  million subordinated delayed draw credit                                                 |       | 25                         |       | 7                      |       | prime plus 3% |   | Secured by security interests in assets of FirstCity and wholly-owned subsidiaries,  matures November 2010 |   |
|                                                                                                           |       |                       |       |                   |       |   |   |   |   |
| American Bank term loan for  portfolio acquisition by FC Washington                                            |       | 1                          |       | 1                      |       | Fixed 5.0% |   | Secured by assets of FC Washington and guaranteed by the Company,  matures May 2011 |   |
|                                                                                                           |       |                       |       |                   |       |   |   |   |   |
| Participation payable                                                                                          |       | 1                          |       | 1                      |       | 23.92% imputed rate |   | Participation agreement on 33% of net cash flows received on one  portfolio |   |
|                                                                                                           |       |                       |       |                   |       |   |   |   |   |
| Banco Santander line of  credit facility, denominated in Mexican pesos                                         |       | 11                         |       | 14                     |       | Rate based on 28 day Mexican index rate plus 1.5% |   | Secured by Bank of Scotland letter of credit, matures November 2008,  commitment amount 142,240,000 MXN |   |
| ** **                                                                                                     | ** ** | ** **                 | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Wells Fargo Foothill, Inc.  $40 million  revolving loan facility                                          |       | 40                         |       | 12                     |       | LIBOR+ 2.625% or greater of Wells Fargo prime or 7.5% |   | Secured by assets of American Business Lending, Inc., matures December  2009 |   |
| ** **                                                                                                     | ** ** | ** **                 | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| The First National Bank of  Central  Texas term loan for portfolio  acquisition by MPortfolio Corporation |       | 1                          |       | 1                      |       | LIBOR+ 1.75% |   | Secured by assets of MPortfolio Corporation, matures June 2010 |   |
|                                                                                                           |       |                       |       |                   |       |   |   |   |   |
| LaSalle Bank NA term loan                                                                                      |       | 3                          |       | 3                      |       | LIBOR+ 2.25% |   | Secured by assets of East Penn Railroad LLC, matures March 2011 |   |
|                                                                                                           |       |                       |       |                   |       |   |   |   |   |
| LaSalle Bank NA revolving  loan facility                                                                       |       | 1                          |       | —                 |       | option of Base Rate (greater of prime or Federal Funds Rate+ .5%) plus  margin, or LIBOR plus margin |   | Secured by assets of East Penn Railroad LLC, matures March 2011 |   |
|                                                                                                           |       |                       |       |                   |       |   |   |   |   |
| Merrill Lynch Mortgage  Trust term loan                                                                        |       | 8                          |       | 8                      |       | Fixed 6.07% |   | Secured by assets of Oregon Short Line Building LLC, matures April  2016 |   |
|                                                                                                           |       |                       |       |                   |       |   |   |   |   |
| Notes payable to banks                                                                                         |       | 416                        |       | 216                    |       |   |   |   |   |
|                                                                                                           |       |                       |       |                   |       |   |   |   |   |
| MCS Trust SA de CV term  loan                                                                                  |       | 9                          |       | 9                      |       | Fixed 20% |   | Secured by assets of FC Acquisitions, SRL de CV, matures June 2020 |   |
|                                                                                                           |       |                       |       |                   |       |   |   |   |   |
| Note payable to affiliate                                                                                      |       | 9                          |       | 9                      |       |   |   |   |   |
|                                                                                                           |       |                       |       |                   |       |   |   |   |   |
| Total                                                                                                          |       | $                          | 425        |                   | $          | 225 |   |   |   |   |   |

 

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(1)          The Bank of Scotlandfacility allows loans to be made in Euros up to a maximum amount in Euros thatis equivalent to $50.0 million. At September 30, 2008, the Company hadapproximately $32.1 million outstanding under the Euro-denominated portion ofthis facility.

 

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**Forward-Looking Statements**

 

FirstCity may from time to timemake written or oral forward-looking statements, including statements containedin FirstCity’s filings with the SEC (including this Quarterly Report onForm 10-Q and the Exhibits hereto), in its reports to stockholders and inother FirstCity communications. These statements relate to the Company’sstrategic objectives and future performance, which are not historical facts,and may be deemed to be forward-looking statements under the Private SecuritiesLitigation Reform Act of 1995, Section 27A of the Securities Act of 1933,as amended, and Section 21E of the Securities Exchange Act of 1934, asamended (“Exchange Act”). Forward-looking statements include, withoutlimitation, statements regarding our future financial position, businessstrategy, and plans and objectives of management for future operations, as wellas any statement that may project, indicate or imply future results,performance or achievements, and may contain the words “expect,” “intend,” “plan,” “anticipate,”“estimate,” “believe,” “may,” “could,” “would,” “should,” “will likely result,”“indication,” “outlook,” “projects”and similar expressions. Forward-looking statements are not guarantees offuture performance and involve certain risks, uncertainties and assumptionsthat are difficult to predict. Actual results and outcomes may differmaterially from those expressed in, or implied by, our forward-lookingstatements.

 

There are many important factorsthat could cause the Company’s actual results to differ materially from thoseindicated in the forward-looking statements. Such factors include, but are notlimited to, changes in general economic conditions in the United States andlocal economic conditions in the geographic regions and industries in which theCompany operates; foreign social and economic conditions; performance of theCompany’s subsidiaries and affiliates; availability of investments andinvestment opportunities; the Company’s ability to project future cash receiptsand develop critical assumptions and estimates underlying asset performance;increased competition in the business in which we operate; the Company’sability to consummate portfolio acquisitions and other investment transactionson acceptable terms; credit risk associated with our borrowers’ ability torepay their loans; level of nonperforming assets, charge-offs and impairmentprovisions; risks associated with foreign operations; currency exchange ratefluctuations; risks associated with start-up of new businesses and entry intonew markets; changes in the interest rate environment and market liquidity;fluctuations in residential and commercial real estate values; adversemovements and volatility in equity capital markets; the degree to which theCompany is leveraged; the Company’s continued need for financing; availabilityof the Company’s credit facilities;  abilityto obtain additional financing from the Bank of Scotland or any other lender;the impact of certain covenants in loan agreements of the Company and itssubsidiaries; risks of declining value of loans, collateral or assets; theability of the Company to utilize NOLs; liabilities resulting from litigationand regulatory investigations that might arise from continuing and discontinuedoperations, including costs, expenses, settlements and judgments; changes(legislative and otherwise) in the asset securitization industry; changes indomestic or foreign tax laws, rules and regulations as well as court,Internal Revenue Service or other governmental agencies’ interpretationsthereof; changes in accounting standards, rules and interpretations; andfactors more fully discussed and identified in the Company’s Annual Report onForm 10-K, for the year ended December 31, 2007, filed with the SECon March 17, 2008 (including those discussed under “Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations”), aswell as in other SEC filings of the Company. Many of these factors are beyondthe Company’s control. In addition, it should be noted that past financial andoperational performance of the Company is not necessarily indicative of futurefinancial and operational performance. Given these risks and uncertainties,investors should not place undue reliance on forward-looking statements. Theforward-looking statements in this Quarterly Report on Form 10-Q representbeliefs and assumptions only as of the date of this Quarterly Report onForm 10-Q. Except as required by applicable law, the Company expresslydisclaims any obligation or intention to release publicly any updates orrevisions to any forward-looking statement to reflect any change in theCompany’s expectations with regard thereto or any change in future events,conditions or circumstances on which any forward-looking statement is based.

 

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

 

**InterestRate Risk**

 

Marketrisk is the risk of loss from adverse changes in market prices and interestrates. The Company’s operations are materially impacted by net gains on salesof loans and net interest margins. The level of gains from loan sales theCompany achieves is dependent on demand for the products originated. Netinterest margins are dependent on the Company’s ability to maintain the spreador interest differential between the interest it charges the customer for loansand the interest the Company is charged for the financing of those loans. The followingdescribes each component of interest bearing assets held by the Company and howeach could be affected by changes in interest rates.

 

TheCompany invests in Portfolio Assets both directly through consolidatedsubsidiaries and indirectly through equity investments in AcquisitionPartnerships. Portfolio Assets consist of investments in pools ofnon-homogenous assets that predominantly consist of 

 

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loan and realestate assets. Earnings from these assets are based on the estimated futurecash flows from such assets and recorded when those cash flows occur. Theunderlying loans within these pools bear both fixed and variable rates. Due tothe non-performing nature and history of these loans, changes in prevailingbenchmark rates (such as the prime rate or LIBOR) generally have a nominaleffect on the ultimate future cash flow to be realized from the Portfolio Assets.

 

Loansreceivable consist primarily of loans made to affiliated entities (includingAcquisition Partnerships) and non-affiliated entities, and generally bearinterest at fixed rates. The repayment of the loans is generally dependent uponfuture cash flows of the borrowers, future cash flows of the underlyingcollateral, and distributions from affiliated entities. Since these loans arepredominantly fixed-rate financial instruments, changes in market interestrates would not have a significant impact on the collectibility of these loans.

 

SBA loans receivable were $17.5 million atSeptember 30, 2008, of which $3.2 million were related to the guaranteedportion of these loans. The guaranteed portion is backed by the full faith andcredit of the U.S. Small Business Administration, and is generally sold intothe secondary market. Virtually all of the SBA loans have variable interestrates. Assuming that the balance sheet were to remain constant and no actionswere taken to alter the existing interest rate sensitivity, a hypotheticalimmediate change in interest rates would have a minimal effect on interestincome from SBA loans for the third quarter of 2008. Although managementbelieves that this measure is indicative of our sensitivity to interest rate changes,it does not adjust for potential changes in credit quality, size andcomposition of the assets on the balance sheet, and other business developmentsthat could affect a net increase (decrease) in assets. Accordingly, noassurances can be given that actual results would not differ materially fromthe potential outcome simulated by this estimate.

 

FirstCityhad $225.3 million in debt outstanding at September 30, 2008. The Companyis exposed to interest rate risk primarily through its variable rate debt, whichtotaled $178.3 million or 79.1% of the Company’s total debt. A 50 basispoint change in interest rates would increase or decrease FirstCity’s interestexpense by approximately $1.0 million annually.

 

**ForeignCurrency Risk**

 

TheCompany currently has loans and equity investments in Europe, Latin America(i.e. Mexico, Argentina, Dominican Republic, Brazil and Chile) and Canada.

 

InEurope and in Mexico, the Company’s investments are primarily in the form ofequity and represent a significant portion of the Company’s total equityinvestments. As previously discussed, the revolving acquisition facility withBank of Scotland for $225.0 million provides that the Company may borrow up toa maximum amount in Euros that is equivalent to U.S. $50 million. At September 30,2008, the Company had U.S. $32.1 million in Euro-denominated debt for thepurpose of hedging a portion of the net equity investments in Europe. InNovember 2006, the Company acquired a line of credit facility with BancoSantander, S.A. that provides that the Company may borrow up to a currentmaximum of 142,240,000 Mexican pesos. At September 30, 2008, the Companyhad 142,240,000 in Mexican peso-denominated debt, which was equivalent to U.S.$14.0 million. Management of the Company feels that these loan agreements willhelp reduce the risk of adverse effects of currency changes on theseinvestments.

 

Asharp change in the foreign currencies related to the investments in Europe,Latin America and Canada relative to the U.S. dollar could materially adverselyaffect the financial position and results of operations of the Company. A 5%and 10% incremental depreciation of these currencies would result in anestimated decline in the valuation of the Company’s foreign investments and areindicated in the following table. These amounts are estimates; consequently,these amounts are not necessarily indicative of the actual effect of suchchanges with respect to the Company’s consolidated financial position orresults of operations.

 

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| ** ** | ** ** | ** ** | ** ** | **One U.S.  dollar  equals** | ** ** | **Estimated decline in  valuation of investments  resulting from  incremental depreciation  of foreign currency of  (dollars in thousands)** | ** ** |
|------------|------------|------------|------------|-----------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** ** | ** ** | ** ** | ** ** | ** **                        | ** ** | **5%**                                                                                                                                                                                              | ** ** | **10%** | ** ** |
|       |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Europe     |       | EUR        |       | 0.69                              |       | $                                                                                                                                                                                                   | 2,010      |   | $ | 3,846 |   |
|       |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Mexico     |       | MXN        |       | 10.79                             |       | $                                                                                                                                                                                                   | 2,414      |   | $ | 4,656 |   |
|       |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Chile      |       | CLP        |       | 550.59                            |       | $                                                                                                                                                                                                   | 235        |   | $ | 449 |   |
|       |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Brazil     |       | BRL        |       | 1.90                              |       | $                                                                                                                                                                                                   | 44         |   | $ | 84 |   |
|       |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Argentina  |       | ARS        |       | 3.13                              |       | $                                                                                                                                                                                                   | 44         |   | $ | 86 |   |

 

**Item 4. Controls andProcedures.**

 

*Disclosure Controls andProcedures*

 

The Company’s disclosurecontrols and procedures are designed to ensure that information required to bedisclosed under the Exchange Act securities laws is accumulated andcommunicated to management, including the Company’s Chief Executive Officer andChief Financial Officer.

 

As of the end of the periodcovered by this report, the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, conducted an evaluation of theeffectiveness and design of the Company’s disclosure controls and procedures(as defined in Rules 13a-15(e) and 15d-15(e) under the ExchangeAct). Based on that evaluation, the Company’s Chief Executive Officer and ChiefFinancial Officer concluded, as of the end of the period covered by thisreport, that the Company’s disclosure controls and procedures were effective,in all material respects, in recording, processing, summarizing and reportinginformation required to be disclosed by the Company, within the time periodsspecified in the SEC’s rules and forms.

 

*Internal Control OverFinancial Reporting*

 

Internalcontrol over financial reporting is defined in Rule 13a-15(f) promulgatedunder the Exchange Act as a process designed by, or under the supervision of,the company’s principal executive and principal financial officers and effectedby the company’s board of directors, management and other personnel, to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withU.S. generally accepted accounting principles (GAAP) and includes thosepolicies and procedures that:

 

•                    pertainto the maintenance of records that in reasonable detail accurately and fairlyreflect the transactions and dispositions of assets of the company;

•                    providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with GAAP, and that receiptsand expenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and

•                    providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of the company’s assets that could have amaterial effect on the financial statements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Projections of any evaluation of effectivenessto future periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 

As ofthe end of the period covered by this report, there have been no changes in theCompany’s internal control over financial reporting (as defined inRule 13a-15(f) of the Exchange Act) during the quarter to which thisreport relates that have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

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**PART II**

 

**OTHER INFORMATION**

** **

**Item 1. Legal Proceedings.**

 

There have been no materialdevelopments with regard to any matters disclosed under Part I, Item 3“Legal Proceedings” in our Annual Report on Form 10-K for the fiscal yearended December 31, 2007.

 

**Item 1A. Risk Factors.**

 

There have been no material changes to the riskfactors as previously disclosed under Item 1A in the Company’s Annual Report onForm 10-K for the year ended December 31, 2007.

 

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

 

The following summarizespurchases of common stock during the third quarter 2008:

 
| ** ** | ** ** | ** **                                       | ** ** | ** **                                   | ** ** | **Total Number**                                                                   | ** ** | **Maximum Number**                                                     | ** ** |
|------------|------------|--------------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** ** | ** ** | ** **                                       | ** ** | ** **                                   | ** ** | **of Shares Purchased**                                                       | ** ** | **of Shares that May**                                       | ** ** |
| **Month**  | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average  Price Paid  Per Share** | ** ** | **as Part of Publicly  Announced Plans  or Programs (1)** | ** ** | **Yet Be Purchased  Under the Plans  or Programs** | ** ** |
| July       |       | 17,800                                           |       | $                                            | 4.23       |                                                                                    | 17,800     |                                                                        |       |   |
| August     |       | —                                           |       | $                                            | —     |                                                                                    | —     |                                                                        |       |   |
| September  |       | 85,000                                           |       | $                                            | 5.81       |                                                                                    | 85,000     |                                                                        |       |   |
| Total      |       | 102,800                                          |       | $                                            | 5.54       |                                                                                    | 102,800    |                                                                        | 336,370    |   |

 

----

(1)  The Company has astock repurchase program that was approved by the Board of Directors inAugust 2006 for the repurchase of up to 1,000,000 shares of the Company’scommon stock in the open market or otherwise from time to time. OnFebruary 6, 2008, the Board of Directors approved the repurchase of an additional 500,000 shares (up to a totalof 1,500,000 shares) and the plan was extended to August 30, 2009.

 

**Item 3. Defaults Upon SeniorSecurities.**

 

None

 

**Item 4. Submission of Matters to a Vote of SecurityHolders.**

 

None

 

**Item 5. Other Information.**

 

On October 17, 2008, American Business Lending, Inc.(“American”), an affiliate of FirstCity, as borrower, and Wells Fargo Foothill,LLC (“Lender”), as lender, entered into a Conditional Waiver AgreementRegarding Event of Default dated effective September 30, 2008, whichwaived compliance with Section 5.11(a) of the loan agreement for thefiscal quarter ending September 30, 2008, and was conditioned uponAmerican maintaining, on a consolidated basis with American’s subsidiaries,tangible net worth of not less than $6,000,000 as of the quarter ending September 30,2008, after taking into account any dividends paid or accrued.. The Agreementprovided for the waiver of the default by American which occurred on September 30,2008, as a result of American’s failure to meet the tangible net worthrequirement of $6,500,000 under Section 5.11(a) of the loanagreement.

 

On November 10, 2008, American Business Lending, Inc., anaffiliate of FirstCity, as borrower, and Wells Fargo Foothill, LLC, as lender,entered into a Conditional Waiver Under Loan Agreement dated November 10,2008 and effective September 30, 2008, which waived compliance with Section 5.11(a) ofthe loan agreement for the fiscal quarters ending September 30, 2008 and December 31,2008, with respect to a portfolio of purchased loans, and was conditioned uponAmerican not causing or allowing, as of the fiscal quarters ending September 30,2008 and December 31, 2008, the ratio of (i) loan losses for thetwelve month period then ending, to (ii) the average amount of allnon-guaranteed notes receivable outstanding during such period, to be more thanthree percent.

 

**Item 6. Exhibits.**

 
| **Exhibit********Number** | ** ** | ** ** | ** ** | **Description  of Exhibit**                                                                                                                                                                                                                                                                                                                                                |
|---------------------------|------------|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1                       |       | —     |       | Joint Plan of  Reorganization by First City Bancorporation of Texas, Inc., Official  Committee of Equity Security Holders and J-Hawk Corporation, with the  Participation of Cargill Financial Services Corporation, Under Chapter 11 of  the United States Bankruptcy Code, Case No. 392-39474-HCA-11  (incorporated herein by reference to Exhibit 2.1 of |

 

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|   |   |   |   | the Company’s  Current Report on Form 8-K dated July 3, 1995 filed with the  Commission on July 18, 1995)                                                                                                                                                                                                                                                                                                                                                                 |
|--------|--------|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 2.2    |   | — |   | Agreement and  Plan of Merger, dated as of July 3, 1995, by and between First City  Bancorporation of Texas, Inc. and J-Hawk Corporation (incorporated  herein by reference to Exhibit 2.2 of the Company’s Current Report on  Form 8-K dated July 3, 1995 filed with the Commission on  July 18, 1995)                                                                                                                                                    |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 3.1    |   | — |   | Amended and  Restated Certificate of Incorporation of the Company (incorporated herein by  reference to Exhibit 3.1 of the Company’s Current Report on  Form 8-K dated July 3, 1995 filed with the Commission on  July 18, 1995)                                                                                                                                                                                                                                     |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 3.2    |   | — |   | Amended and  Restated Bylaws of the Company (incorporated herein by reference to  Exhibit 3.1 of the Company’s Current Report on Form 8-K dated  December 30, 2005 filed with the Commission on December 30, 2005)                                                                                                                                                                                                                                                   |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.1   |   | — |   | Revolving Credit  Agreement, dated August 26, 2005, among FH Partners, L.P., as Borrower,  and the Lenders named therein, as Lenders, and Bank of Scotland, as Agent  (incorporated herein by reference to Exhibit 10.1 of the Company’s  Form 8-K dated September 1, 2005)                                                                                                                                                                                          |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.2   |   | — |   | Guaranty  Agreement, dated August 26, 2005, executed by FirstCity Financial  Corporation, FirstCity Commercial Corporation, FirstCity Europe Corporation,  FirstCity Holdings Corporation, FirstCity International Corporation,  FirstCity Mexico, Inc., and FirstCity Servicing Corporation for the  benefit of Bank of Scotland, as agent, and lenders (incorporated herein by  reference to Exhibit 10.2 of the Company’s Form 8-K dated  September 1, 2005) |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.3   |   | — |   | Contribution and  Assumption Agreement, dated August 18, 2000, by and between Funding LP  and Drive (incorporated herein by reference to Exhibit 10.42 of the  Company’s Form 8-K dated August 25, 2000, filed with the Commission  on September 11, 2000)                                                                                                                                                                                                      |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.4   |   | — |   | Separation  Agreement and Release, dated March 31, 2004, by and between G. Stephen  Fillip, FirstCity Servicing Corporation and FirstCity Financial Corporation  (incorporated herein by reference to Exhibit 10.19 of the Company’s  Form 10-Q dated May 14, 2004).                                                                                                                                                                                                 |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.5   |   | — |   | Consultant  Agreement, dated April 1, 2004, by and between FirstCity Servicing  Corporation and G. Stephen Fillip (incorporated herein by reference to  Exhibit 10.20 of the Company’s Form 10-Q dated May 14, 2004)                                                                                                                                                                                                                                                 |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.6   |   | — |   | Securities  Purchase Agreement dated as of September 21, 2004 by and among FirstCity  Financial Corporation and certain affiliates of FirstCity and IFA Drive GP  Holdings LLC, IFA Drive LP Holdings LLC, Drive Management LP and certain  affiliates of those persons. (incorporated herein by reference to  Exhibit 10.1 of the Company’s Form 8-K dated September 27,  2004)                                                                                     |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.7   |   | — |   | Revolving Credit  Agreement, dated November 12, 2004, among FirstCity Financial  Corporation as Borrower and the Lenders named therein, as Lenders, and Bank  of Scotland, as Agent (incorporated herein by reference to Exhibit 10.12  of the Company’s Form 10-Q dated November 15, 2004)                                                                                                                                                                          |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.8   |   | — |   | 1995 Stock  Option and Award Plan (incorporated herein by reference to Exhibit A of  the Company’s Schedule 14A, Definitive Proxy Statement, dated March 27,  1996)                                                                                                                                                                                                                                                                                                            |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.9   |   | — |   | 1996 Stock  Option and Award Plan (incorporated herein by reference to Exhibit C of  the Company’s Schedule 14A, Definitive Proxy Statement, dated March 27,  1996)                                                                                                                                                                                                                                                                                                            |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.10  |   | — |   | 2004 Stock  Option and Award Plan (incorporated herein by reference to Appendix A of the  Company’s Schedule 14A, Definitive Proxy Statement, dated October 21,  2003)                                                                                                                                                                                                                                                                                                              |

 

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

 

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| 10.23  |   | — |   | Amendment  No. 9 to Revolving Credit Agreement, dated as of June 29, 2007,  among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.23 of the Company’s Form 10-Q dated  August 10, 2007)                                             |
|--------|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.24  |   | — |   | Amendment  No. 1 to Revolving Credit Agreement, dated June 29, 2007, among FH  Partners, L.P., as Borrower, and the Lenders named therein, as Lenders, and  Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.24 of the Company’s Form 10-Q dated August 10,  2007)                                                               |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.25  |   | — |   | Amendment No. 2 to Loan Agreement, dated as of  July 30, 2007, by and between American Business Lending, Inc., as  Borrower, and Wells Fargo Foothill, LLC, as lender (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  August 3, 2007)                                                                              |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.26  |   | — |   | Amendment  No. 10 to Revolving Credit Agreement, dated as of August 22, 2007,  among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  August 28, 2007)                                            |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.27  |   | — |   | Amendment  No. 3 and Consent to Revolving Credit Agreement, dated August 22,  2007, among FH Partners, L.L.C., as Borrower, and the Lenders named therein,  as Lenders, and Bank of Scotland, as Agent (incorporated herein by reference  to Exhibit 10.2 of the Company’s Form 8-K dated August 28,  2007)                                                 |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.28  |   | — |   | Subordinated  Delayed Draw Credit Agreement, dated as of September 5, 2007, among  FirstCity Financial Corporation, as Borrower, and the Lenders named therein,  as Lenders, and BoS (USA), Inc., as agent (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  September 10, 2007)                                          |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.29  |   | — |   | Letter agreement  between FirstCity Financial Corporation and Bank of Scotland extending time  period for closing of subordinate credit facility to be provided by BoS  (USA,) Inc. to October 2, 2007 (incorporated herein by reference to  Exhibit 10.2 of the Company’s Form 8-K dated September 10,  2007)                                                   |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.30  |   | — |   | Letter agreement  between FirstCity Financial Corporation and BoS (USA), Inc. extending  time period for closing of subordinate credit facility to be provided by BoS  (USA), Inc. to October 31, 2007 (incorporated herein by reference  to Exhibit 10.1 of the Company’s Form 8-K dated October 5,  2007)                                            |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.31  |   | — |   | Letter agreement  between FirstCity Financial Corporation and Bank of Scotland extending time  period for closing of subordinate credit facility to be provided by BoS  (USA), Inc. to October 31, 2007 (incorporated herein by reference  to Exhibit 10.2 of the Company’s Form 8-K dated October 5,  2007)                                                |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.32  |   | — |   | Letter agreement  between FirstCity Financial Corporation and BoS (USA), Inc. extending  time period for closing of subordinate credit facility to be provided by BoS  (USA), Inc. to November 16, 2007 (incorporated herein by reference  to Exhibit 10.1 of the Company’s Form 8-K dated November 8,  2007)                                          |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.33  |   | — |   | Letter agreement  between FirstCity Financial Corporation and Bank of Scotland which amended  the Revolving Credit Agreement to extend time period for closing of  subordinate credit facility to be provided by BoS (USA), Inc. to  November 16, 2007 (incorporated herein by reference to Exhibit 10.2  of the Company’s Form 8-K dated November 8, 2007) |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.34  |   | — |   | Amendment and  Consent No. 21 to Revolving Credit Agreement, dated as of May 8, 2008,  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  May 14, 2008)                                       |

 

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| 10.35  |   | — |   | Amendment and  Consent No. 8 to Subordinated Delayed Draw Credit Agreement, dated as of  May 8, 2008, 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 10.2 of the Company’s  Form 8-K dated May 14, 2008)     |
|--------|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.36  |   | — |   | Amendment and  Consent No. 5 to Revolving Credit Agreement, dated as of May 8,  2008, among FH Partners, LLC, as Borrower, and the Lenders named therein, as  Lenders, and Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.3 of the Company’s Form 8-K dated May 14, 2008)                                       |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.37  |   | — |   | Amendment and  Consent No. 25 to Revolving Credit Agreement, dated as of July 14,  2008, 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  July 18, 2008)                     |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.38  |   | — |   | Amendment and  Consent No. 12 to Subordinated Delayed Draw Credit Agreement, dated as  of July 14, 2008, 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 10.2 of the Company’s  Form 8-K dated July 18, 2008) |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.39  |   | — |   | Amendment and  Consent No. 6 to Revolving Credit Agreement, dated as of July 14,  2008, among FH Partners, LLC, as Borrower, and the Lenders named therein, as  Lenders, and Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.3 of the Company’s Form 8-K dated July 18, 2008)                                    |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.40* |   | — |   | Conditional  Waiver Agreement Regarding Event of Default dated effective September 30,  2008, between American Business Lending, Inc., an affiliate of FirstCity, as  borrower, and Wells Fargo Foothill, LLC, as lender.                                                                                                                                                  |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.41* |   | — |   | Conditional  Waiver Under Loan Agreement dated November 10, 2008, between American  Business Lending, Inc., an affiliate of FirstCity, as borrower, and Wells  Fargo Foothill, LLC, as lender.                                                                                                                                                                             |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 31.1*  |   | — |   | Certification of  the Chief Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                             |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 31.2*  |   | — |   | Certification of  the Chief Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                             |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 32.1*  |   | — |   | Certification of  the Chief Executive Officer pursuant to 18 U.S.C Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                           |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 32.2*  |   | — |   | Certification of  the Chief Financial Officer pursuant to 18 U.S.C Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                           |

 

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* Filed herewith.

 

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**SIGNATURES**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 
|   | FIRSTCITY FINANCIAL  CORPORATION |
|--------|----------------------------------|
|   |                             |   |
|   |                             |   |
|   | By:                              | /s/   JAMES T. SARTAIN |
|   |                             | James  T. Sartain |
|   |                             | *President  and Chief Executive* |
|   |                             | *Officer  and Director* |
|   |                             | *(Duly  authorized officer and* |
|   |                             | *Principal  Executive Officer)* |
|   |                             | * * |
|   |                             | * * |
|   | By:                              | /s/   J. BRYAN BAKER |
|   |                             | J.  Bryan Baker |
|   |                             | *Senior  Vice President and Chief* |
|   |                             | *Financial  Officer* |
|   |                             | *(Duly  authorized officer and* |
|   |                             | *Principal  Financial Officer)* |

 

Dated: November 10, 2008

 

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**Exhibit Index**

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

 

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| 10.8       |       | —     |       | 1995 Stock  Option and Award Plan (incorporated herein by reference to Exhibit A of  the Company’s Schedule 14A, Definitive Proxy Statement, dated March 27,  1996)                                                                                                                                                                                                                                                                           |
|------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.9       |       | —     |       | 1996 Stock Option  and Award Plan (incorporated herein by reference to Exhibit C of the  Company’s Schedule 14A, Definitive Proxy Statement, dated March 27,  1996)                                                                                                                                                                                                                                                                           |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.10      |       | —     |       | 2004 Stock  Option and Award Plan (incorporated herein by reference to Appendix A of the  Company’s Schedule 14A, Definitive Proxy Statement, dated October 21,  2003)                                                                                                                                                                                                                                                                             |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.11      |       | —     |       | Sixth Amendment  to Right Of First Refusal Agreement And Due Diligence Reimbursement Agreement  dated effective as of February 1, 2006 (incorporated herein by reference  to Exhibit 10.1 of the Company’s Form 8-K dated February 6,  2006)                                                                                                                                                                                        |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.12      |       | —     |       | Asset Purchase  Agreement, dated June 30, 2006, by and among FirstCity Financial  Corporation and its subsidiaries, FirstCity Business Lending Corporation and  American Business Lending, Inc.; and AMRESCO SBA Holdings, Inc. and  NCS I, LLC (incorporated herein by reference to Exhibit 10.1 of the  Company’s Form 8-K dated July 7, 2006)                                                                          |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.13      |       | —     |       | 2006 Stock  Option and Award Plan (incorporated herein by reference to Appendix A of the  Company’s Schedule 14A, Definitive Proxy Statement, dated June 26, 2006)                                                                                                                                                                                                                                                                                 |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.14      | ** ** | **—** |       | Interest  Purchase and Sale Agreement, dated August 8, 2006, by and among Bidmex  Holding, LLC, and Strategic Mexican Investment Partners, L.P. and Cargill Financial  Services International, Inc. and certain other parties (incorporated  herein by reference to Exhibit 10.14 of the Company’s Form 10-Q  dated November 9, 2006)                                                                                          |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.15      | ** ** | **—** |       | Put Option  Agreement dated August 8, 2006, by and among Bidmex Holding, LLC,  Recuperacion de Carteras Mexicanas, S. de R.L. de C.V., Bidmex 6, LLC,  Strategic Mexican Investment Partners 2, L.P. and Cargill Financial Services  International, Inc. (incorporated herein by reference to  Exhibit 10.15 of the Company’s Form 10-Q dated November 9,  2006)                                                               |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.16      | ** ** | **—** |       | Guarantee dated  August 8, 2006, executed by FirstCity Financial Corporation for the  benefit of Bidmex Holding, LLC, Residencial Oeste 2 S. de R.L. de C.V.,  National Union Fire Insurance Company of Pittsburg, P.A., American General  Life Insurance Company, and American General Life and Accident Insurance  Company (incorporated herein by reference to Exhibit 10.15 of the  Company’s Form 10-Q dated November 9, 2006) |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.17      |       | —     |       | Amendment  No. 4 to Revolving Credit Agreement, dated as of October 31, 2006,  among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated November 7,  2006)                                                                                                              |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.18      |       | —     |       | Management  Employment Contract dated November 30, 2006, between FirstCity Business  Lending Corporation, American Business Lending, Inc.**,**and Charles P. Bell, Jr.  (incorporated herein by reference to Exhibit 10.2 of the Company’s  Form 8-K dated December 7, 2006)                                                                                                                                              |
| ** ** | ** ** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.19      |       | —     |       | Management  Employment Contract dated November 30, 2006, between FirstCity Business  Lending Corporation, American Business Lending, Inc.**,**and Joe N. Smith (incorporated herein  by reference to Exhibit 10.3 of the Company’s Form 8-K dated  December 7, 2006)                                                                                                                                                           |
| ** ** | ** ** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.20      |       | —     |       | Amendment  No. 5 to Revolving Credit Agreement, dated as of December 14, 2006,  among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  December 20, 2006)                                                                                                            |
| ** ** | ** ** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.21      |       | —     |       | Loan Agreement, dated as of December 15, 2006  by and between American Business                                                                                                                                                                                                                                                                                                                                                                         |

 

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Table of Contents

 
|   |   |   |   | Lending, Inc., as Borrower, and Wells Fargo  Foothill, LLC, as lender (incorporated herein by reference to  Exhibit 10.1 of the Company’s Form 8-K dated December 28,  2006)                                                                                                                                            |
|--------|--------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.22  |   | — |   | Amendment No. 1 to Loan Agreement, dated as of  February 27, 2007, by and between American Business Lending, Inc.,  as Borrower, and Wells Fargo Foothill, LLC, as lender (incorporated herein by  reference to Exhibit 10.22 of the Company’s Form 10-K dated July 24,  2007)                                |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.23  |   | — |   | Amendment  No. 9 to Revolving Credit Agreement, dated as of June 29, 2007,  among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.23 of the Company’s Form 10-Q dated  August 10, 2007)    |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.24  |   | — |   | Amendment  No. 1 to Revolving Credit Agreement, dated June 29, 2007, among FH  Partners, L.P., as Borrower, and the Lenders named therein, as Lenders, and  Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.24 of the Company’s Form 10-Q dated August 10,  2007)                      |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.25  |   | — |   | Amendment No. 2 to Loan Agreement, dated as of  July 30, 2007, by and between American Business Lending, Inc., as  Borrower, and Wells Fargo Foothill, LLC, as lender (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  August 3, 2007)                                     |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.26  |   | — |   | Amendment  No. 10 to Revolving Credit Agreement, dated as of August 22, 2007,  among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  August 28, 2007)   |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.27  |   | — |   | Amendment  No. 3 and Consent to Revolving Credit Agreement, dated August 22,  2007, among FH Partners, L.L.C., as Borrower, and the Lenders named therein,  as Lenders, and Bank of Scotland, as Agent (incorporated herein by reference  to Exhibit 10.2 of the Company’s Form 8-K dated August 28,  2007)        |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.28  |   | — |   | Subordinated  Delayed Draw Credit Agreement, dated as of September 5, 2007, among  FirstCity Financial Corporation, as Borrower, and the Lenders named therein,  as Lenders, and BoS (USA), Inc., as agent (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  September 10, 2007) |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.29  |   | — |   | Letter agreement  between FirstCity Financial Corporation and Bank of Scotland extending time  period for closing of subordinate credit facility to be provided by BoS  (USA,) Inc. to October 2, 2007 (incorporated herein by reference to  Exhibit 10.2 of the Company’s Form 8-K dated September 10,  2007)          |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.30  |   | — |   | Letter agreement  between FirstCity Financial Corporation and BoS (USA), Inc. extending  time period for closing of subordinate credit facility to be provided by BoS  (USA), Inc. to October 31, 2007 (incorporated herein by reference  to Exhibit 10.1 of the Company’s Form 8-K dated October 5,  2007)   |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.31  |   | — |   | Letter agreement  between FirstCity Financial Corporation and Bank of Scotland extending time  period for closing of subordinate credit facility to be provided by BoS  (USA), Inc. to October 31, 2007 (incorporated herein by reference  to Exhibit 10.2 of the Company’s Form 8-K dated October 5,  2007)       |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.32  |   | — |   | Letter agreement  between FirstCity Financial Corporation and BoS (USA), Inc. extending  time period for closing of subordinate credit facility to be provided by BoS  (USA), Inc. to November 16, 2007 (incorporated herein by reference  to Exhibit 10.1 of the Company’s Form 8-K dated November 8,  2007) |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                             |
| 10.33  |   | — |   | Letter agreement  between FirstCity Financial Corporation and Bank of Scotland which                                                                                                                                                                                                                                                             |

 

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Table of Contents

 
|   |   |   |   | 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)                                                                       |
|--------|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.34  |   | — |   | Amendment and  Consent No. 21 to Revolving Credit Agreement, dated as of May 8,  2008, 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  May 14, 2008)                        |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.35  |   | — |   | Amendment and  Consent No. 8 to Subordinated Delayed Draw Credit Agreement, dated as of  May 8, 2008, 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 10.2 of the Company’s  Form 8-K dated May 14, 2008)     |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.36  |   | — |   | Amendment and  Consent No. 5 to Revolving Credit Agreement, dated as of May 8,  2008, 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 10.3 of the Company’s Form 8-K dated May 14, 2008)                                    |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.37  |   | — |   | Amendment and  Consent No. 25 to Revolving Credit Agreement, dated as of July 14,  2008, 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  July 18, 2008)                     |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.38  |   | — |   | Amendment and  Consent No. 12 to Subordinated Delayed Draw Credit Agreement, dated as  of July 14, 2008, 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 10.2 of the Company’s  Form 8-K dated July 18, 2008) |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.39  |   | — |   | Amendment and  Consent No. 6 to Revolving Credit Agreement, dated as of July 14,  2008, 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 10.3 of the Company’s Form 8-K dated July 18, 2008)                                 |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.40* |   | — |   | Conditional  Waiver Agreement Regarding Event of Default dated effective September 30,  2008, between American Business Lending, Inc., an affiliate of FirstCity, as  borrower, and Wells Fargo Foothill, LLC, as lender.                                                                                                                                                  |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.41* |   | — |   | Conditional  Waiver Under Loan Agreement dated November 10, 2008, between American  Business Lending, Inc., an affiliate of FirstCity, as borrower, and Wells  Fargo Foothill, LLC, as lender.                                                                                                                                                                             |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 31.1*  |   | — |   | Certification of  the Chief Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                             |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 31.2*  |   | — |   | Certification of  the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                                                                                             |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 32.1*  |   | — |   | Certification of  the Chief Executive Officer pursuant to 18 U.S.C Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                           |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 32.2*  |   | — |   | Certification of  the Chief Financial Officer pursuant to 18 U.S.C Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                           |

 

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