**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**Form 10-Q**

** **

**(Mark One)**

**x**      **QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934**

** **

**Forthe quarterly period ended March 31, 2010**

** **

**o**         **TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 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   Noo

 

Indicate by check mark whether the registrant has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes o   Noo

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer, or asmaller reporting company. See the definitions of “large accelerated filer,” “acceleratedfiler” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.(Check one.)

 

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

 

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

 

The number of shares of common stock, par value$.01 per share, outstanding at May 9, 2010 was 10,008,824.

 

 

 

----

 

 

 

**TABLE OF CONTENTS**

 
| **PART I**                     | ** **                                                                                      |
|-------------------------------------|-------------------------------------------------------------------------------------------------|
| ** **                          | ** **                                                                                      | ** ** |
| **Item 1.**                         | **Financial  Statements**                                                                       | **2** |
| ** **                          | **Consolidated  Balance Sheets**                                                                | **2** |
| ** **                          | **Consolidated  Statements of Operations**                                                      | **3** |
| ** **                          | **Consolidated  Statements of Comprehensive Income**                                            | **4** |
| ** **                          | **Consolidated  Statements of Stockholders’ Equity**                                       | **5** |
| ** **                          | **Consolidated  Statements of Cash Flows**                                                      | **6** |
| ** **                          | **Notes to Consolidated Financial Statements**                                                  | **7** |
| **Item 2.**                         | **Management’s Discussion and Analysis of Financial  Condition and Results of Operations** | **37** |
| **Item 3.**                         | **Quantitative  and Qualitative Disclosures About Market Risk**                                 | **52** |
| **Item 4.**                         | **Controls and  Procedures**                                                                    | **52** |
| ** **                          | ** **                                                                                      | ** ** |
| **PART II  OTHER INFORMATION** | **53**                                                                                          |
| ** **                          | ** **                                                                                      | ** ** |
| **Item  1.**                        | **Legal  Proceedings**                                                                          | **53** |
| **Item 1A.**                        | **Risk Factors**                                                                                | **53** |
| **Item 2.**                         | **Unregistered Sales of Equity Securities and Use of  Proceeds**                                | **53** |
| **Item 3.**                         | **Defaults Upon Senior Securities**                                                             | **53** |
| **Item 4.**                         | **Submission of Matters to a Vote of Security Holders**                                         | **53** |
| **Item  5.**                        | **Other  Information**                                                                          | **53** |
| **Item 6.**                         | **Exhibits**                                                                                    | **54** |
| **SIGNATURES**                      | **55**                                                                                          |

 

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**PART I**

 

**FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDBALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                     | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| ** **                                                                                                                                                                                     | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                     | ** ** | ** **         | ** ** | ** **            | ** ** |
| Cash and cash equivalents                                                                                                                                                                      |       | $                  | 58,469     |                  | $          | 80,368 |   |
| Restricted cash                                                                                                                                                                                |       | 1,742              |       | 1,364                 |       |
| Portfolio Assets:                                                                                                                                                                              |       |               |       |                  |       |
| Loan portfolios, net of  allowance for loan losses of $59,853 and $65,825, respectively                                                                                                        |       | 204,776            |       | 197,946               |       |
| Real estate held for sale                                                                                                                                                                      |       | 22,096             |       | 17,051                |       |
| Real estate held for  investment, net                                                                                                                                                          |       | 9,252              |       | 9,387                 |       |
| Total Portfolio Assets                                                                                                                                                                         |       | 236,124            |       | 224,384               |       |
| Loans receivable:                                                                                                                                                                              |       |               |       |                  |       |
| Loans receivable -  affiliates, net of allowance for loan losses of $67                                                                                                                        |       | 23,816             |       | 26,122                |       |
| Loans receivable - SBA held  for sale                                                                                                                                                          |       | 4,895              |       | 821                   |       |
| Loans receivable - SBA held  for investment, net of allowance for loan losses of $246 and $490,  respectively                                                                                  |       | 15,156             |       | 15,445                |       |
| Loans receivable - other,  net of allowance for loan losses of $516 and $-0-, respectively                                                                                                     |       | 12,878             |       | 10,233                |       |
| Total loans receivable, net                                                                                                                                                                    |       | 56,745             |       | 52,621                |       |
| Investment security  available for sale                                                                                                                                                        |       | 1,530              |       | 1,836                 |       |
| Equity investments                                                                                                                                                                             |       | 62,731             |       | 71,491                |       |
| Service fees receivable  ($630 and $809 from affiliates, respectively)                                                                                                                         |       | 711                |       | 850                   |       |
| Servicing assets - SBA  loans                                                                                                                                                                  |       | 889                |       | 1,056                 |       |
| Other assets, net                                                                                                                                                                              |       | 34,531             |       | 31,104                |       |
| Total Assets (1)                                                                                                                                                                               |       | $                  | 453,472    |                  | $          | 465,074 |   |
|                                                                                                                                                                                           | ** ** | ** **         | ** ** | ** **            | ** ** |
| **LIABILITIES  AND EQUITY**                                                                                                                                                                    |       |               |       |                  |       |
| Liabilities:                                                                                                                                                                                   |       |               |       |                  |       |
| Notes payable to banks                                                                                                                                                                         |       | $                  | 302,402    |                  | $          | 305,888 |   |
| Note payable to affiliate                                                                                                                                                                      |       | 7,838              |       | 7,838                 |       |
| Other liabilities                                                                                                                                                                              |       | 26,474             |       | 26,077                |       |
| Total Liabilities (2)                                                                                                                                                                          |       | 336,714            |       | 339,803               |       |
| Commitments and  contingencies (Note 17)                                                                                                                                                       |       |               |       |                  |       |
| 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: 11,508,824 and  11,483,824, respectively ; shares outstanding: 10,008,824 and 9,983,824,  respectively) |       | 115                |       | 115                   |       |
| Treasury stock, at cost:  1,500,000 shares                                                                                                                                                     |       | (10,923            | )          | (10,923               | )          |
| Paid in capital                                                                                                                                                                                |       | 103,824            |       | 103,326               |       |
| Accumulated deficit                                                                                                                                                                            |       | (18,228            | )          | (18,329               | )          |
| Accumulated other  comprehensive income                                                                                                                                                        |       | 1,110              |       | 3,460                 |       |
| FirstCity Stockholders’  Equity                                                                                                                                                           |       | 75,898             |       | 77,649                |       |
| Noncontrolling interests                                                                                                                                                                       |       | 40,860             |       | 47,622                |       |
| Total Equity                                                                                                                                                                                   |       | 116,758            |       | 125,271               |       |
| Total Liabilities and  Equity                                                                                                                                                                  |       | $                  | 453,472    |                  | $          | 465,074 |   |

 

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(1)   Our consolidated assets at March 31, 2010include the following assets of certain variable interest entities (VIEs) thatcan only be used to settle the liabilities of those VIEs: Cash and cashequivalents, $5.9 million; Portfolio Assets, $44.8 million; Other assets, $8.7million; and Total assets, $59.4 million.

 

(2)   Our consolidated liabilities at March 31,2010 include $6.9 million of VIE liabilities (included in other liabilities)for which VIE creditors do not have recourse to FirstCity.

 

See accompanying notes to consolidated financial statements.

 

2

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS(Unaudited)**

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

 
| ** **                                                        | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                        | ** ** | **March 31,**     | ** ** |
| ** **                                                        | ** ** | **2010**               | ** ** | **2009** | ** ** |
| **Revenues:**                                                     | ** ** | ** **             | ** ** | ** ** | ** ** |
| ***Finance and Servicing:***                                      |       |                   |       |   |   |
| Servicing fees ($1,895 and  $2,127 from affiliates, respectively) |       | $                      | 2,003      |   | $ | 2,392 |   |
| Income from Portfolio  Assets                                     |       | 11,463                 |       | 9,043 |   |
| Interest income from SBA  loans                                   |       | 268                    |       | 346 |   |
| Interest income from loans  receivable - affiliates               |       | 954                    |       | 923 |   |
| Interest income from loans  receivable - other                    |       | 132                    |       | 429 |   |
| Other income                                                      |       | 1,131                  |       | 880 |   |
|                                                              |       | 15,951                 |       | 14,013 |   |
| ***Manufacturing:***                                              |       |                   |       |   |   |
| Sales revenues                                                    |       | 4,359                  |       | — |   |
| ***Railroad:***                                                   |       |                   |       |   |   |
| Operating revenues                                                |       | 1,265                  |       | 747 |   |
| Other income                                                      |       | —                 |       | 921 |   |
|                                                              |       | 1,265                  |       | 1,668 |   |
| Total revenues                                                    |       | 21,575                 |       | 15,681 |   |
|                                                              |       |                   |       |   |   |
| **Costs and  expenses:**                                          |       |                   |       |   |   |
| ***Finance and Servicing:***                                      |       |                   |       |   |   |
| Interest and fees on notes  payable to banks                      |       | 3,042                  |       | 3,009 |   |
| Interest and fees on notes  payable to affiliate                  |       | 392                    |       | 433 |   |
| Salaries and benefits                                             |       | 5,071                  |       | 4,810 |   |
| Provision for loan and  impairment losses                         |       | 1,702                  |       | 1,106 |   |
| Asset-level expenses                                              |       | 1,621                  |       | 1,237 |   |
| Other                                                             |       | 3,196                  |       | 3,047 |   |
|                                                              |       | 15,024                 |       | 13,642 |   |
| ***Manufacturing:***                                              |       |                   |       |   |   |
| Cost of sales and operating  expenses                             |       | 4,836                  |       | — |   |
| ***Railroad:***                                                   |       |                   |       |   |   |
| Cost of revenues and  operating expenses                          |       | 568                    |       | 456 |   |
| Interest and fees on notes  payable to bank                       |       | 38                     |       | 35 |   |
|                                                              |       | 606                    |       | 491 |   |
| Total costs and expenses                                          |       | 20,466                 |       | 14,133 |   |
| **Earnings  before other revenue and income taxes**               |       | 1,109                  |       | 1,548 |   |
| Equity in earnings (loss)  of unconsolidated subsidiaries         |       | 2,229                  |       | (146 | ) |
| Gain on business  combinations                                    |       | 891                    |       | — |   |
| Earnings before income  taxes                                     |       | 4,229                  |       | 1,402 |   |
| Income tax expense (benefit)                                      |       | (486                   | )          | 410 |   |
| Net earnings                                                      |       | 4,715                  |       | 992 |   |
| Less: Net income  attributable to noncontrolling interests        |       | 4,614                  |       | 348 |   |
| Net earnings attributable  to FirstCity                           |       | $                      | 101        |   | $ | 644 |   |
|                                                              |       |                   |       |   |   |
| Basic earnings per share                                          |       | $                      | 0.01       |   | $ | 0.07 |   |
| Diluted earnings per share                                        |       | $                      | 0.01       |   | $ | 0.07 |   |

 

See accompanying notes to consolidated financial statements.

 

3

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOME (Unaudited)**

**(Dollars in thousands)**

 
| ** **                                                                  | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                  | ** ** | **March 31,**     | ** ** |
| ** **                                                                  | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Net earnings                                                                |       | $                      | 4,715      |   | $ | 992 |   |
| Other comprehensive income  (loss):                                         |       |                   |       |   |   |
| Net unrealized loss on  security available for sale                         |       | (1,020                 | )          | (7 | ) |
| Foreign currency  translation adjustments                                   |       | (2,657                 | )          | 329 |   |
| Total other comprehensive  income (loss)                                    |       | (3,677                 | )          | 322 |   |
| Total comprehensive income                                                  |       | 1,038                  |       | 1,314 |   |
| Less comprehensive (income)  loss attributable to noncontrolling interests: |       |                   |       |   |   |
| Net income                                                                  |       | (4,614                 | )          | (348 | ) |
| Net unrealized loss on  security available for sale                         |       | 277                    |       | — |   |
| Foreign currency  translation adjustments                                   |       | 1,050                  |       | 755 |   |
| Comprehensive income (loss)  attributable to FirstCity                      |       | $                      | (2,249     | ) | $ | 1,721 |   |

 

See accompanying notes to consolidated financial statements.

 

4

----

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY (Unaudited)**

**(Dollars in thousands)**

 
| ** **                                                      | ** ** | **FirstCity Stockholders** | ** ** | ** **   | ** ** | ** **  | ** ** |
|-----------------------------------------------------------------|------------|----------------------------|------------|--------------|------------|-------------|------------|
| ** **                                                      | ** ** | ** **                 | ** ** | ** **   | ** ** | ** **  | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | ** **                 | ** ** | ** **   | ** ** | ** **  | ** ** | ** ** | ** ** | **Other** | ** ** | **Non-** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **Common**                 | ** ** | **Treasury** | ** ** | **Paid in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | **controlling** | ** ** | **Total** | ** ** |
| ** **                                                      | ** ** | **Stock**                  | ** ** | **Stock**    | ** ** | **Capital** | ** ** | **Deficit** | ** ** | **Income (Loss)** | ** ** | **Interests** | ** ** | **Equity** | ** ** |
| ** **                                                      | ** ** | ** **                 | ** ** | ** **   | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Balances,  December 31, 2008**                           |       | $                          | 113        |         | $          | (10,923     | )          | $ | 101,875 |   | $ | (37,073 | ) | $ | (3,726 | ) | $ | 15,609 |   | $ | 65,875 |   |
| Net earnings                                                    |       | —                     |       | —       |       | —      |       | 644 |   | — |   | 348 |   | 992 |   |
| Change in net unrealized  gain on securities available for sale |       | —                     |       | —       |       | —      |       | — |   | (7 | ) | — |   | (7 | ) |
| Foreign currency  translation adjustments                       |       | —                     |       | —       |       | —      |       | — |   | 1,084 |   | (755 | ) | 329 |   |
| Stock-based compensation  expense                               |       | —                     |       | —       |       | 105         |       | — |   | — |   | — |   | 105 |   |
| Investments in  majority-owned entities                         |       | —                     |       | —       |       | —      |       | — |   | — |   | 5,743 |   | 5,743 |   |
| Distributions to  noncontrolling interests                      |       | —                     |       | —       |       | —      |       | — |   | — |   | (31 | ) | (31 | ) |
| **Balances,  March 31, 2009**                              |       | $                          | 113        |         | $          | (10,923     | )          | $ | 101,980 |   | $ | (36,429 | ) | $ | (2,649 | ) | $ | 20,914 |   | $ | 73,006 |   |
| ** **                                                      |       |                       |       |         |       |        |       |   |   |   |   |   |   |   |   |
| **Balances,  December 31, 2009**                           |       | $                          | 115        |         | $          | (10,923     | )          | $ | 103,326 |   | $ | (18,329 | ) | $ | 3,460 |   | $ | 47,622 |   | $ | 125,271 |   |
| Net earnings                                                    |       | —                     |       | —       |       | —      |       | 101 |   | — |   | 4,614 |   | 4,715 |   |
| Change in net unrealized  gain on securities available for sale |       | —                     |       | —       |       | —      |       | — |   | (743 | ) | (277 | ) | (1,020 | ) |
| Foreign currency  translation adjustments                       |       | —                     |       | —       |       | —      |       | — |   | (1,607 | ) | (1,050 | ) | (2,657 | ) |
| Exercise of common stock  options                               |       | —                     |       | —       |       | 50          |       | — |   | — |   | — |   | 50 |   |
| Stock-based compensation  expense                               |       | —                     |       | —       |       | 158         |       | — |   | — |   | — |   | 158 |   |
| Purchases of subsidiary  shares in noncontrolling interests     |       | —                     |       | —       |       | —      |       | — |   | — |   | (40 | ) | (40 | ) |
| Other activity                                                  |       | —                     |       | —       |       | 290         |       | — |   | — |   | (290 | ) | — |   |
| Investments in  majority-owned entities                         |       | —                     |       | —       |       | —      |       | — |   | — |   | 3,262 |   | 3,262 |   |
| Distributions to  noncontrolling interests                      |       | —                     |       | —       |       | —      |       | — |   | — |   | (12,981 | ) | (12,981 | ) |
| **Balances,  March 31, 2010**                              |       | $                          | 115        |         | $          | (10,923     | )          | $ | 103,824 |   | $ | (18,228 | ) | $ | 1,110 |   | $ | 40,860 |   | $ | 116,758 |   |

 

See accompanying notes to consolidated financial statements.

 

5

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS (Unaudited)**

**(Dollars in thousands)**

 
| ** **                                                                       | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                       | ** ** | **March 31,**     | ** ** |
| ** **                                                                       | ** ** | **2010**               | ** ** | **2009** | ** ** |
|                                                                             | ** ** | ** **             | ** ** | **See  Note 1** | ** ** |
| **Cash flows  from operating activities:**                                       |       |                   |       |   |   |
| Net earnings                                                                     |       | $                      | 4,715      |   | $ | 992 |   |
| Adjustments to reconcile  net earnings to net cash used in operating activities: |       |                   |       |   |   |
| Net principal advances on  SBA loans held for sale                               |       | (4,022                 | )          | (4,738 | ) |
| Proceeds applied to income  from Portfolio Assets                                |       | 1,904                  |       | 4,898 |   |
| Income from Portfolio  Assets                                                    |       | (11,463                | )          | (9,043 | ) |
| Capitalized interest and  costs on Portfolio Assets and loans receivable         |       | (179                   | )          | (191 | ) |
| Provision for loan and  impairment losses                                        |       | 1,702                  |       | 1,106 |   |
| Foreign currency  transaction losses, net                                        |       | 526                    |       | 566 |   |
| Equity in (earnings) loss  of unconsolidated subsidiaries                        |       | (2,229                 | )          | 146 |   |
| Gain on sale of railroad  property                                               |       | —                 |       | (920 | ) |
| Gain on business  combinations                                                   |       | (891                   | )          | — |   |
| Depreciation and  amortization                                                   |       | 1,140                  |       | 988 |   |
| Net premium amortization of  loans receivable                                    |       | (86                    | )          | (48 | ) |
| Stock-based compensation  expense                                                |       | 158                    |       | 105 |   |
| Increase in restricted cash                                                      |       | (378                   | )          | (60 | ) |
| Decrease (increase) in  service fees receivable                                  |       | 139                    |       | (284 | ) |
| Decrease (increase) in  other assets                                             |       | 716                    |       | (582 | ) |
| Deferred income tax benefit                                                      |       | (740                   | )          | — |   |
| Increase (decrease) in  other liabilities                                        |       | (2,077                 | )          | 281 |   |
| Net cash used in operating  activities                                           |       | (11,065                | )          | (6,784 | ) |
| **Cash flows  from investing activities:**                                       |       |                   |       |   |   |
| Purchases of property and  equipment, net                                        |       | (195                   | )          | (331 | ) |
| Proceeds from sale of  railroad property                                         |       | —                 |       | 1,350 |   |
| Cash paid for business  combination, net of cash acquired                        |       | (3,009                 | )          | — |   |
| Net principal advances on  loans receivable                                      |       | (1,075                 | )          | (881 | ) |
| Net principal payments  (advances) on SBA loans held for investment              |       | 333                    |       | (1,242 | ) |
| Net principal paydowns on  investment security available for sale                |       | 648                    |       | 965 |   |
| Purchases of Portfolio  Assets                                                   |       | (21,572                | )          | (70,324 | ) |
| Proceeds applied to  principal on Portfolio Assets                               |       | 35,136                 |       | 25,555 |   |
| Contributions to  unconsolidated subsidiaries                                    |       | (89                    | )          | (450 | ) |
| Distributions from  unconsolidated subsidiaries                                  |       | 2,924                  |       | 1,800 |   |
| Net cash provided by (used  in) investing activities                             |       | 13,101                 |       | (43,558 | ) |
| **Cash flows  from financing activities:**                                       |       |                   |       |   |   |
| Borrowings under notes  payable to banks                                         |       | 22,474                 |       | 75,488 |   |
| Principal payments of notes  payable to banks, net                               |       | (38,001                | )          | (30,263 | ) |
| Payments of debt issuance  costs and loan fees                                   |       | (935                   | )          | (332 | ) |
| Proceeds from secured  borrowings                                                |       | 2,277                  |       | — |   |
| Contributions from  noncontrolling interests                                     |       | 3,262                  |       | 5,743 |   |
| Distributions to  noncontrolling interests                                       |       | (12,981                | )          | (31 | ) |
| Cash paid for subsidiary  shares in noncontrolling interests                     |       | (40                    | )          | — |   |
| Proceeds from issuance of  common stock                                          |       | 50                     |       | — |   |
| Net cash provided by (used  in) financing activities                             |       | (23,894                | )          | 50,605 |   |
| **Effect of  exchange rate changes on cash and cash equivalents**                |       | (41                    | )          | (461 | ) |
| **Net  decrease in cash and cash equivalents**                                   |       | (21,899                | )          | (198 | ) |
| **Cash and  cash equivalents, beginning of period**                              |       | 80,368                 |       | 19,103 |   |
| **Cash and  cash equivalents, end of period**                                    |       | $                      | 58,469     |   | $ | 18,905 |   |
| **Supplemental  disclosure of cash flow information:**                           | ** ** | ** **             | ** ** | ** ** | ** ** |
| Cash paid during the period  for:                                                | ** ** | ** **             | ** ** | ** ** | ** ** |
| Interest                                                                         |       | $                      | 2,327      |   | $ | 2,330 |   |
| Income taxes, net of refunds                                                     |       | (87                    | )          | 45 |   |

 

See accompanying notes to consolidated financial statements.

 

6

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (Unaudited)**

 

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

 

***Nature of Operations***

 

FirstCityFinancial Corporation, a Delaware corporation, is a financial services companyheadquartered in Waco, Texas with offices throughout the United States andMexico and a presence in Europe and South America. When we refer to “FirstCity,”“the Company,” “we,” “our” or “us” in this Quarterly Report on Form 10-Q,we mean FirstCity Financial Corporation and subsidiaries (consolidated).

 

The Company engages in two major business segments —Portfolio Asset Acquisition and Resolution and Special Situations Platform. ThePortfolio Asset Acquisition and Resolution business has been the Company’s corebusiness segment since it commenced operations in 1986. In the Portfolio AssetAcquisition and Resolution business, the Company acquires portfolios ofperforming and non-performing loans and other assets (collectively, “PortfolioAssets” or “Portfolios”), generally at a discount to their legal principalbalances or appraised values, and services and resolves such Portfolio Assetsin an effort to maximize the present value of the ultimate cash recoveries.FirstCity acquires the Portfolio Assets for its own account or throughinvestment entities formed with one or more other co-investors (each suchentity, an “Acquisition Partnership”). The Company engages in its SpecialSituations Platform business through its majority ownership in an investmentcompany that was formed in April 2007. Through its Special SituationsPlatform, the Company provides investment capital to privately-heldmiddle-market companies through flexible capital structuring arrangements togenerate an attractive risk-adjusted return. These capital investmentsprimarily take the form of senior and junior financing arrangements, but alsoinclude direct equity investments, common equity warrants, distressed debttransactions, and leveraged buyouts. Refer to Note 16 for additionalinformation on the Company’s major business segments.

 

***Basis of Presentation***

 

The accompanyingunaudited consolidated financial statements in this Form 10-Q wereprepared in accordance with U.S. generally accepted accounting principles (“GAAP”)for interim information and with instructions to Form 10-Q and Article 10of Regulation S-X. Accordingly, the consolidated financial statements do notinclude all of the information and footnote disclosures required by GAAP forcomplete consolidated financial statements. In the opinion of management, theaccompanying consolidated financial statements include all adjustments,consisting only of normal recurring adjustments, necessary for a fairpresentation of the Company’s financial position and results of operations. Theinterim results of operations disclosed herein are not necessarily indicativeof the results that may be expected for a full year or any future period.Certain amounts in the consolidated financial statements and disclosures forprior periods were reclassified to conform to the current period presentation.These interim consolidated financial statements should be read in conjunctionwith the Company’s consolidated financial statements and footnotes theretoincluded in our annual report on Form 10-K for the year ended December 31,2009, as amended (“2009 Form 10-K”).

 

The consolidated financial statements in this Form 10-Qinclude the accounts of FirstCity, its wholly-owned and majority-ownedsubsidiaries, and certain variable interest entities (“VIEs”). All significantintercompany transactions and balances have been eliminated in consolidation.We consolidate all VIEs where we are the primary beneficiary as prescribed bythe Financial Accounting Standards Board’s (the “FASB”) accounting guidance onthe consolidation of VIEs. The primary beneficiary of a VIE is the party thathas the power to direct the activities that most-significantly impact theeconomic performance of the entity and the obligation to absorb losses or theright to receive benefits that could potentially be significant to the entity.Refer to Note 14 for more information.

 

The Company does not consolidate equity investments in20%- to 50%-owned entities that are not VIEs where the Company does not have aneffective controlling interest, or equity investments in 20%- to 50%-ownedentities that are VIEs where the Company is not the primary beneficiary.Rather, such investments are accounted for under the equity method ofaccounting since the Company has the ability to exercise significant influenceover the investees’ operating and financial policies. The Company also accountsfor its unconsolidated equity investments in less than 20%-owned entities underthe equity method of accounting. FirstCity has the ability to exercisesignificant influence over the operating and financial policies of theseentities, despite its comparatively smaller ownership percentage, due primarilyto its active participation in the policy-making process as well as itsinvolvement in the daily management activities.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

***Correction of an Error in Previously Issued Consolidated Statements ofCash Flows***

 

The Company determined that ithas incorrectly reported certain amounts related to Portfolio Asset activitiesas “Cash flows from operating activities” in the consolidated statements ofcash flows for all reporting periods prior to September 30, 2009. Uponsubsequent review, the Company determined that applicable Portfolio Assettransactions, primarily purchases and principal collections, should be reportedas “Cash flows from investing activities.” In this Form 10-Q, for reasonsdescribed below, the Company is revising its consolidated statement of cashflows for the prior reporting period so that applicable Portfolio Assettransactions are reported as “Cash flows from investing activities” instead of “Cashflows from operating activities.” All financial information contained in this Form 10-Qgives effect to these revisions. The revisions did not result in a change tothe Company’s previously-reported revenues, expenses, net earnings (loss), cashand cash equivalents, or stockholders’ equity.

 

Company management consideredall of the relevant quantitative and qualitative factors related to thecorrection of the error under Securities and Exchange Commission (“SEC”)guidance on considering the effects of prior period misstatements whenquantifying misstatements in the current period financial statements, anddetermined that the impact on previously-issued financial statements was notmaterial. Therefore, the Company is revising the prior period consolidatedstatement of cash flows for the immaterial error in this Form 10-Q and isnot amending previously-filed reports.

 

The following tables reconcilethe Company’s consolidated statement of cash flows from the previously-reportedresults to the revised results for the three-month period ended March 31,2009:

 
| ** **                                                               | ** ** | **Three Months Ended**     | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                               | ** ** | **March 31,**         | ** ** |
| ** **                                                               | ** ** | **2009**                   | ** ** |
| ** **                                                               | ** ** | **(Dollars in thousands)** | ** ** |
| Consolidated Statements of  Cash Flows:                                  |       |                       |       |
| Cash flows from operating  activities (as reported)                      |       | $                          | (51,553    | ) |
| Impact of revision on  purchases of Portfolio Assets                     |       | 70,324                     |       |
| Impact of revision on  proceeds applied to principal on Portfolio Assets |       | (25,555                    | )          |
| Cash flows from operating  activities (as revised)                       |       | $                          | (6,784     | ) |
|                                                                     |       |                       |       |
| Cash flows from investing  activities (as reported)                      |       | $                          | 1,211      |   |
| Impact of revision on  purchases of Portfolio Assets                     |       | $                          | (70,324    | ) |
| Impact of revision on  proceeds applied to principal on Portfolio Assets |       | 25,555                     |       |
| Cash flows from investing  activities (as revised)                       |       | $                          | (43,558    | ) |

 

***Out-of-PeriodAdjustments***

 

During the three monthsended March 31, 2010, upon the determination that deferred tax itemsrelated to our foreign jurisdictions had been misstated by $1.5 million asof December 31, 2009, the Company recorded a $1.0 million adjustment todeferred tax benefit and a $0.5 million adjustment to equity in earningsof unconsolidated subsidiaries in order to properly state the net deferred taxasset. The adjustment was not material to our consolidated financial statementsfor the quarterly period ended March 31, 2010 or the year endedDecember 31, 2009.

 

Also, during thethree months ended March 31, 2010, the Company recorded certain loanimpairments that included $1.2 million in impairments that should havebeen recorded during the year ended December 31, 2009. The out-of-periodadjustments were not material to our consolidated financial statements for thequarterly period ended March 31, 2010 or the year ended December31, 2009.

 

***Use of Estimates***

 

The preparation of financial statements in conformitywith GAAP requires management to make estimates and assumptions that affect thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the consolidated financial statements and thereported amounts of revenues and expenses during the reporting period. Estimatesthat are particularly susceptible to significant change in the near-term relateto the estimation of future collections on Portfolio Assets used in thecalculation of income from Portfolio Assets; valuation of deferred tax assetsand assumptions used in the calculation of income taxes; valuation of servicingassets, investment securities, loans receivable (including loans receivableheld in securitization trusts), and real estate; valuation of assets,liabilities, non-controlling interests and contingencies attributable tobusiness combinations; guarantee obligations and indemnifications; and legalcontingencies. These estimates and assumptions are based on management’s bestestimates and judgment. Management evaluates its estimates and assumptions onan ongoing basis using historical experience and other factors, including thecurrent economic environment. We adjust such estimates and assumptions whenfacts and circumstances dictate. Illiquid credit markets, along with volatilefinancial, real estate and foreign currency markets, have combined to increasethe uncertainty inherent in such estimates and assumptions. As future eventsand their effects cannot be determined with precision, actual results coulddiffer significantly from these estimates. Changes in these estimates resultingfrom continuing changes in the economic environment will be reflected in thefinancial statements in future periods.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

***PortfolioAssets***

 

The Companyinvests in Portfolio Assets and services and resolves such Portfolio Assets inan effort to maximize the present value of the ultimate cash recoveries. ThePortfolio Assets are generally non-homogeneous assets, including loans ofvarying qualities that are secured by diverse collateral types and real estate.Some Portfolio Assets are loans for which resolution is tied primarily to thereal estate securing the loan, while others may be collateralized businessloans, the resolution of which may be based on the cash flows of the businessor the underlying collateral.

 

The following is adescription of the classifications and related accounting policies for theCompany’s significant classes of Portfolio Assets:

 

Purchased Credit-Impaired Loans

 

The Companyaccounts for acquired loans and loan portfolios with evidence of creditdeterioration since origination (“Purchased Credit-Impaired Loans”) at fairvalue on the acquisition date. The amounts paid for Purchased Credit-ImpairedLoans reflect the Company’s determination that the loans have experienceddeterioration in credit quality since origination and that it is probable theCompany will be unable to collect all amounts due according to the contractualterms of the underlying loans. At acquisition, the Company reviews eachindividual loan to determine whetherthere is evidence of deterioration of credit quality since origination and ifit is probable that the Company will be unable to collect all amounts dueaccording to the loan’s contractual terms. If both conditions exist, theCompany determines whether each such loan is to be accounted for individuallyor whether such loans will be assembled into static pools based on common riskcharacteristics (primarily loan type and collateral). Static pools ofindividual loan accounts may be established and accounted for as a singleeconomic unit for the recognition of income, principal payments and lossprovision. Once a static loan pool is established, individual accounts aregenerally not added to or removed from the pool (unless the Company sells,forecloses or writes-off the loan). At acquisition, the Company determines theexcess of the scheduled contractual payments over all cash flows expected to becollected for the loan or loan pool as an amount that should not be accreted (“nonaccretabledifference”). The excess of the cash flows from the loan or loan pool expectedto be collected at acquisition over the initial investment (“accretable difference”) is recognizedas interest income over the remaining life of the loan or loan pool on alevel-yield basis (“accretable yield”). The discount (i.e. the differencebetween the cost of each loan or loan pool and the related aggregatecontractual receivable balance) is not recorded because the Company does notexpect to fully collect each contractual receivable balance. As a result, theseloans and loan pools are recorded at cost (which approximates fair value) atthe time of acquisition.

 

The Companyaccounts for Purchased Credit-Impaired Loans using either the interest methodor a non-accrual method (through application of the cost-recovery or cash basismethod of accounting). Application of the interest method is dependent onmanagement’s ability to develop a reasonable expectation as to both the timingand amount of cash flows expected to be collected. In the event the Companycannot develop or establish a reasonable expectation as to both the timing andamount of cash flows expected to be collected, the Company uses thecost-recovery or cash basis method of accounting.

 

*Interestmethod of accounting*.  Under the interest method, an effectiveinterest rate, or internal rate of return (“IRR”), is applied to the cost basisof the loan or loan pool. The excess of the contractual cash flows overexpected cash flows cannot be recognized as an adjustment of income or expenseor on the balance sheet. The IRR that is calculated when the loan is purchasedremains constant as the basis for subsequent impairment testing (performed atleast quarterly) and income recognition. Subsequent decreases in projected cashflows do not change the IRR, but are recognized as an impairment of the costbasis of the loan or loan pool (to maintain the then-current IRR), and are reflectedin the consolidated statements of operations through provisions charged tooperations, with a corresponding valuation allowance offsetting the loan orloan pool in the consolidated balance sheets. FirstCity establishes valuationallowances for loans and loan pools acquired with credit deterioration toreflect only those losses incurred after acquisition — that is, the cash flowsexpected at acquisition that are no longer expected to be collected.Significant increases in actual or expected future cash flows are used first toreverse any existing valuation allowance for that loan or loan pool, and anyremaining increase may be recognized prospectively through an upward adjustmentof the IRR over the remaining life of the loan or loan pool. Any increase tothe IRR then becomes the new benchmark for impairment testing and incomerecognition. Income from loans and loan pools accounted for under the interestmethod is accrued based on the IRR of each loan or loan pool applied to therespective adjusted cost basis. Gross collections in excess of the interestaccrual and impairments will reduce the carrying value of the loan or loanpool, while gross collections less than the interest accrual will increase thecarrying value. The IRR is calculated based on the timing and amount ofanticipated cash flows using the Company’s proprietary collection models.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

*Cost-recoverymethod of accounting. *If the amount and timing of future cashcollections on a loan are not reasonably estimable, the Company accounts forsuch asset on the cost-recovery method. Under the cost-recovery method, noincome is recognized until the Company has fully collected the cost of theloan, or until such time as the Company considers the timing and amount ofcollections to be reasonably estimable and begins to recognize income based onthe interest method as described above. At least quarterly, the Companyperforms an evaluation to determine if the remaining amount that is probable ofcollection is less than the carrying value of the loan or loan pool, and if so,recognizes impairment through provisions charged to operations. The cost-recoveryaccounting model is permitted by FASB’s accounting guidance applicable toPurchased Credit-Impaired Loans. The carrying value of PurchasedCredit-Impaired Loans accounted for under the cost-recovery method approximated$85.0 million (including $17.3 million of loans pending management’spost-purchase evaluation) at March 31, 2010, and $96.3 million (including$12.7 million of loans pending management’s post-purchase evaluation) at December 31,2009.

 

*Cashbasis method of accounting.*  If only theamount of future cash collections on a loan is reasonably estimable, theCompany accounts for such asset on an individual loan basis under the cashbasis method of accounting. Under the cash basis method, no income isrecognized unless collections are received during the period, or until suchtime as the Company considers the timing of collections to be reasonablyestimable and begins to recognize income based on the interest method asdescribed above. Income is recognized for the difference between the collectionsand a pro-rata portion of cost on a loan. Cost allocation is based on aproration of actual collections divided by total projected collections on theloan. Significant increases in future cash flows may be recognizedprospectively as income over the remaining life of the loan through increasedamounts allocated to income when collections are subsequently received.Subsequent decreases in projected cash flows are recognized as impairment ofthe loan’s cost basis to maintain a constant cost allocation based on initialprojections. The cash basis method accounting model is permitted by FASB’saccounting guidance applicable to Purchased Credit-Impaired Loans. Managementimplemented the cash basis method of accounting for such eligible loans in 2009as a result of increased uncertainty in the timing of future collections(attributable primarily to the borrowers’ inability to obtain financing torefinance the loans). The carrying value of Purchased Credit-Impaired Loansaccounted for under the cash basis method approximated $82.6 million and $42.1million at March 31, 2010 and December 31, 2009, respectively.

 

UBN Loan Portfolio

 

In September 2008,the Company, through a wholly-owned subsidiary, acquired an additionalownership interest in UBN, SA (“UBN”) in a transaction that was accounted foras a step acquisition under FASB’s business combination accounting guidance. Asa result of the transaction, UBN became a consolidated subsidiary of theCompany. As such, FirstCity added UBN’s loan portfolio to its consolidatedbalance sheet in September 2008. On the date of the acquisition, theamount of the loans and allowance for loan losses related to UBN’s loanportfolio approximated $69.1 million (including $67.3 million of non-performingloans) and $66.6 million, respectively.

 

The allowance forloan losses on the UBN loan portfolio represents management’s estimate ofcredit losses inherent in the loan portfolio at the balance sheet date.Management establishes an allowance for loan losses through a provision chargedto operations when a loan is determined to be impaired. A loan is considered tobe impaired when, based on current information and events, it is probable theCompany will not be able to collect all amounts due according to thecontractual terms of the loan agreement. Loans are charged-off against theallowance when all possible means of collection have been exhausted and theremaining balance due is deemed uncollectible. At least quarterly, managementevaluates the need for an allowance on an individual-loan basis for the UBNloan portfolio by considering information about specific borrower situations,legal collection proceedings, estimated collateral values, general economicconditions, and other factors. This evaluation is inherently subjective as itrequires estimates that are susceptible to significant revisions as moreinformation becomes available.

 

Real Estate

 

Portfolio Assetsconsisting of real estate include properties that were purchased from a varietyof sellers or acquired through loan foreclosure. Rental income, net ofexpenses, is generally recognized when received. The Company accounts for itsreal estate properties on an individual-asset basis as opposed to a pool basis.The following is a description of the classifications and related accountingpolicies for the Company’s various classes of real estate Portfolio Assets:

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

*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, and charged to operations in the period the impairment isidentified.

 

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 undiscounted cash flows expected to be generated by the property. Ifthe property is considered impaired, the impairment to be recognized ismeasured by the amount by which the carrying amount of the property exceeds itsfair value. 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,if any, 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. 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, including costs related to thedevelopment and improvement of the property for its intended use. Expendituresfor repairs, maintenance, and other holding costs are charged to operations asincurred.

 

*Disposition of Real Estate*

 

Gainson disposition of real estate are recognized upon the sale of the underlyingproperty if the transaction qualifies for gain recognition under the fullaccrual method, as prescribed by the FASB’s accounting guidance on real estatesales transactions. If the transaction does not meet the criteria for the fullaccrual method of profit recognition based on our assessment, we account forthe sale based on an appropriate deferral method determined by the nature andextent of the buyer’s investment and our continuing involvement.

 

***Loans Receivable***

 

The portion ofU.S. Small Business Administration (“SBA”) loans that are guaranteed by the SBAare classified by management as loans held for sale. These loans are recordedat the lower of aggregate cost or estimated fair value. The fair value of SBA loansheld for sale is based primarily on what secondary markets are currentlyoffering for loans with similar characteristics, or the contractual price forloan sales already consummated but which cannot be recognized as accountingsales until the expiration of a recourse period. Net unrealized losses, if any,are recognized through a valuation allowance through a charge to income. Thecarrying value of SBA loans held for sale is net of premiums as well asdeferred origination fees and costs. Premiums and net origination fees andcosts are deferred and included in the basis of the loans in calculating gainsand losses upon sale. SBA loans are generally secured by the borrowing entities’assets such as accounts receivable, property and equipment, and other businessassets. The Company generally sells the guaranteed portion of each loan to athird-party investor and retains the servicing rights. The non-guaranteedportion of SBA loans is classified as held for investment. As described in Note2, effective January 1, 2010, the Company adopted new accounting guidancethat requires SBA loan transactions subject to the SBA’s 90-day premiumrecourse provision to be accounted for initially as secured borrowings ratherthan asset sales. Once the premium recourse provision has elapsed, thetransaction will be recorded as a sale and the resulting net gain on salerecorded — which is based on the difference between the proceeds received andthe allocated carrying value of the loan sold.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

Loans receivableconsisting of loans made to affiliated entities (including AcquisitionPartnerships and other equity-method investees) and non-affiliated entities,and the non-guaranteed portion of SBA loans, are classified by management asheld for investment. These loans are reported at their outstanding principalbalances net of any unearned income, charge-offs, unamortized deferred fees andcosts on originated loans, and unamortized premiums or discounts on purchasedloans. Loan origination fees and costs, as well as purchase premiums anddiscounts, are amortized as level-yield adjustments over the respective loanterms. Unamortized net fees, costs, premiums or discounts are recognized uponearly repayment or sale of the loan. Repayment of the loans is generallydependent upon future cash flows of the borrowers, future cash flows of theunderlying collateral, and distributions made from affiliated entities.Interest is accrued when earned in accordance with the contractual terms of theloans. Interest is recognized on an accrual basis at the applicable interestrate on the principal amount outstanding.

 

The Companyevaluates the need for impairment on loans receivable held for investment on anindividual-loan basis at least quarterly by reviewing the collectibility of theloans in light of various factors, as applicable, such as estimated future cashreceipts of the borrower or underlying collateral, historical experience,estimated value of underlying collateral, prevailing economic conditions, andindustry concentrations. This evaluation is inherently subjective as itrequires estimates that are susceptible to significant revision as moreinformation becomes available. We consider a loan to be impaired when, based oncurrent information and events, we determine it is probable that we will not beable to collect all amounts due according to the loan’s contractual terms(including scheduled interest payments). When management identifies a loan asimpaired, we measure the impairment based on discounted future cash flows,except when the source of repayment is the operation or liquidation of thecollateral. In these cases, we use the current fair value of the collateral,less estimated selling costs, instead of discounted cash flows. When a loan isdetermined to be impaired, we cease to accrue interest on the note and interestpreviously accrued but not collected becomes part of our recorded investment inthe loan and is collectively reviewed for impairment. When ultimatecollectibility of the impaired note is in doubt, all collections are applied toreduce the principal amount of such notes until the principal has beenrecovered, and collections thereafter are recognized as interest income. Wereturn a loan to accrual status when we determine that the collectibility ofprincipal and interest is reasonably assured. Impairment losses are chargedagainst an allowance account through provisions charged to operations in theperiod impairment is identified. Loans are written-off against the allowancewhen all possible means of collection have been exhausted and the potential forrecovery is considered remote.

 

***RevenueRecognition — Consolidated Subsidiaries (Special Situations Platform)***

 

The Company’sconsolidated manufacturing subsidiary, which is engaged principally in thedesign, production and sale of wireless transmission equipment and softwaresolutions, recognizes revenue derived from the sale of equipment upon shipmentof the product. Revenue associated with software solutions is recognizedratably over the period of the underlying agreements.

 

The Company’sconsolidated railroad subsidiary, which interchanges rail cars with connectingcarriers and provides rail freight services for on-line customers, recognizesfreight revenue at the time the shipment is either delivered to or receivedfrom the connecting carrier at the point of interchange. Industrial switchingand other service revenues are recognized as such services are provided.

 

**(2)  New Accounting Guidance**

 

Consolidation ofVariable Interest Entities (“VIEs”)

 

Effective January 1, 2010, the Company adoptedthe FASB’s accounting guidance on the consolidation of VIEs (issued in June 2009).This new guidance eliminates the exemption for QSPEs; revises previous guidanceby replacing thequantitative-based risks and rewards calculation for determining whichenterprise, if any, has a controlling financial interest in a VIE with aqualitative approach focused on identifying which enterprise has both the powerto direct the activities of the VIE that most-significantly impacts the entity’seconomic performance and has the obligation to absorb losses or the right toreceive benefits that could be significant to the entity; requiresreconsideration of whether an entity is a VIE when any changes in facts andcircumstances occur such that the holders of the equity investment at risk, asa group, lose the power from voting rights or similar rights of thoseinvestments to direct the activities of the entity that most significantlyimpact the entity’s economic performance; and requires ongoing assessments ofwhether an enterprise is the primary beneficiary of a VIE and additionaldisclosures about an enterprise’s involvement in VIEs. The adoption ofthis guidance did not have a material impact on our consolidated financialstatements. Refer to Note 14 for additional information about the Company’sinvolvement with VIEs.

 

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Transfers of Financial Assets

 

Effective January 1, 2010, the Company adoptedthe FASB’s guidance on accounting for transfers of financial assets (issued in June 2009).This guidance amends previous guidance which, among other changes, eliminates the concept of a QSPE, changesthe requirements for de-recognizing financial assets, defines the term “participatinginterest” to establish specific conditions for reporting a transfer of aportion of a financial asset as a sale, and requires additional disclosures.The recognition and measurement provisions are effective for transfersoccurring on or after January 1, 2010. The new accounting guidance delaysthe Company’s recognition of the sale of guaranteed portions of SBA loans untilexpiration of the 90-day premium recourse provision, and requires suchtransactions to be accounted for initially as a secured borrowing. As such, theCompany did not recognize any gains related to SBA loan sales for thethree-month period ended March 31, 2010. Once the premium recourseprovision has elapsed, the transaction will be recorded as a sale with theguaranteed portion of the SBA loan and the secured borrowing removed from thebalance sheet and the resulting gain on sale recorded. Refer to Notes 1 and 5for additional information.

 

Fair Value

 

In January 2010, the FASB issued newaccounting guidance that amends existing guidance for fair value disclosures.This guidance requires separate disclosures of significant transfers of itemsin and out of Levels 1 and 2 in the fair value hierarchy and the reasons forthe transfers; requires disclosure of purchases, sales, issuances andsettlements activity on a gross (rather than net) basis relative in the Level 3reconciliation of fair value measurements for assets and liabilities measuredat fair value on a recurring basis; and clarifies, among other things, thatfair value measurement disclosures should be provided for each class of assetsand liabilities, and that disclosures of inputs and valuation techniques shouldbe provided for both recurring and non-recurring Level 2 and Level 3 fair valuemeasurements. We adopted this new guidance for the quarterly period ended March 31,2010, except for the requirement to provide Level 3 activity of purchases,sales, issuances and settlements on a gross basis, which is effective beginningthe first quarter of 2011. Since this guidance is disclosure-only in nature,our adoption of the guidance did not significantly impact the Company’sconsolidated financial statements. Refer to Note 13 for additional information.

 

Subsequent Events

 

In March 2010, the FASB issued guidance thatamends existing guidance (issued in May 2009) that established the generalstandards of accounting and disclosure for subsequent events. Among otherthings, the new guidance eliminates the requirement for SEC filers, as definedin the guidance, to disclose the date through which subsequent events have beenevaluated. That change is effective immediately. SEC filers continue to berequired to evaluate subsequent events through the date the financialstatements are issued. Although the new guidance eliminates the requirement forSEC filers to disclose the date through which subsequent events have beenevaluated, it does not prohibit SEC filers from disclosing such date. The newguidance also clarifies the requirement to disclose the date through whichsubsequent events have been evaluated in reissued financial statements to applyonly to such statements that have been restated to correct an error or to applyU.S. GAAP retrospectively. The adoption of this guidance did not have amaterial impact on our consolidated financial statements.

 

Loan Modificationsand Loan Pool Accounting

 

In April 2010, the FASB issued guidance thatclarifies the accounting for loan modifications when the loan is part of a poolthat is accounted for as a single asset. The new guidance provides thatmodifications of loans that are accounted for within a pool do not result inthe removal of those loans from the pool even if the modification of thoseloans would otherwise be considered a troubled debt restructuring. An entitywill continue to be required to consider whether the pool of assets in whichthe loan is included is impaired if expected cash flows for the pool change.This guidance does not affect the accounting for loans that are not accountedfor within pools. Loans accounted for individually continue to be subject tothe troubled debt restructuring accounting provisions. The new guidance alsoallows entities to make a one-time election to terminate accounting for loansin a pool, which may be made on a pool-by-pool basis, upon adoption of this newguidance. This guidance is effective for interim and annual periods ended afterJuly 15, 2010, and early adoption is permitted. We are currentlyevaluating the impact this guidance will have on our consolidated financialstatements.

 

**(3)  Business Acquisitions**

 

On March 31, 2010, the Company acquired anadditional 50% ownership interest in three domestic Acquisition Partnerships(WAMCO 24, WAMCO 30 and First B Realty) for $4.4 million. As a result of thistransaction, the Company’s ownership interest in each of these entitiesincreased to 100% and the Company obtained control of such entities, resultingin these Acquisition Partnerships becoming consolidated subsidiaries of theCompany. The transaction was accounted for as a business combination, andaccordingly, all of the assets and liabilities of these AcquisitionPartnerships were measured at fair value on the acquisition date and includedin the Company’s consolidated balance sheet. The following table reflects thefair value of the Acquisition Partnerships’ assets and liabilities that wereincluded in the Company’s consolidated balance sheet on the acquisition date(in thousands):

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

**Recognized amounts of identified assets acquiredand liabilities assumed (at fair value):**

 
| Cash                    |   | $      | 1,427  |   |
|-------------------------|--------|--------|--------|--------|
| Portfolio Assets        |   | 21,765 |   |
| Other assets            |   | 82     |   |
| Total assets            |   | $      | 23,274 |   |
|                    |   |   |   |
| Notes payable to  banks |   | $      | 13,811 |   |
| Other  liabilities      |   | 235    |   |
| Total liabilities       |   | $      | 14,046 |   |

 

Pursuant to accounting provisions applicable tobusiness combinations, the Company’s carrying value of its previously-heldequity-method investments in these Acquisition Partnerships was re-measured tofair value at the acquisition date. The fair value of the Company’spreviously-held equity interests exceeded the aggregate carrying value of $3.7million by approximately $0.9 million. As such, the Company recognized a $0.9million gain attributable to the re-measurement of its previously-held equityinterests on the acquisition date (included in “Gain on business combinations”in the Company’s consolidated statement of operations for the three-monthperiod ended March 31, 2010).

 

**(4)  Portfolio Assets**

 

Portfolio Assets are summarizedas follows:

 
| ** **                       | ** ** | **March 31, 2010**    | ** ** |
|----------------------------------|------------|----------------------------|------------|
| ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| ** **                       | ** ** | **Outstanding**            | ** ** | **Allowance for** | ** ** | **Outstanding** | ** ** |
| ** **                       | ** ** | **Balance**                | ** ** | **Loan Losses** | ** ** | **Balance, net** | ** ** |
| Loan Portfolios:                 |       |                       |       |   |   |   |   |
| Purchased Credit-Impaired  Loans |       | $                          | 201,756    |   | $ | 6,265 |   | $ | 195,491 |   |
| Purchased performing loans       |       | 2,951                      |       | 4 |   | 2,947 |   |
| UBN:                             |       |                       |       |   |   |   |   |
| Non-performing loans             |       | 55,495                     |       | 53,296 |   | 2,199 |   |
| Performing loans                 |       | 1,115                      |       | — |   | 1,115 |   |
| Other                            |       | 3,312                      |       | 288 |   | 3,024 |   |
| Total                            |       | $                          | 264,629    |   | $ | 59,853 |   | $ | 204,776 |   |

 
| ** **                       | ** ** | **December 31, 2009** | ** ** |
|----------------------------------|------------|----------------------------|------------|
| ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| ** **                       | ** ** | **Outstanding**            | ** ** | **Allowance for** | ** ** | **Outstanding** | ** ** |
| ** **                       | ** ** | **Balance**                | ** ** | **Loan Losses** | ** ** | **Balance, net** | ** ** |
| Loan Portfolios:                 |       |                       |       |   |   |   |   |
| Purchased Credit-Impaired  Loans |       | $                          | 192,920    |   | $ | 6,927 |   | $ | 185,993 |   |
| Purchased performing loans       |       | 3,986                      |       | 25 |   | 3,961 |   |
| UBN:                             |       |                       |       |   |   |   |   |
| Non-performing loans             |       | 60,929                     |       | 58,624 |   | 2,305 |   |
| Performing loans                 |       | 1,555                      |       | — |   | 1,555 |   |
| Other                            |       | 4,381                      |       | 249 |   | 4,132 |   |
| Total                            |       | $                          | 263,771    |   | $ | 65,825 |   | $ | 197,946 |   |

 

14

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 
| ** **                                | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                                | ** ** | **(Dollars in thousands)** | ** ** |
| Real Estate Portfolios:                   | ** ** | ** **                 | ** ** | ** **            | ** ** |
| Real estate held for sale                 |       | $                          | 22,096     |                  | $          | 17,051 |   |
| Real estate held for  investment, net (1) |       | 9,252                      |       | 9,387                 |       |
| Total                                     |       | $                          | 31,348     |                  | $          | 26,438 |   |

 

----

(1)          Includes lease-related intangiblebalances (net) of approximately $0.8 million at March 31, 2010 and December 31,2009.

 

Income from Portfolio Assets issummarized as follows:

 
| ** **                       | ** ** | **Three Months Ended**     | ** ** |
|----------------------------------|------------|----------------------------|------------|
| ** **                       | ** ** | **March 31,**         | ** ** |
| ** **                       | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| Loan Portfolios:                 | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Purchased Credit-Impaired  Loans |       | $                          | 10,024     |   | $ | 8,723 |   |
| Purchased performing loans       |       | 60                         |       | 79 |   |
| UBN                              |       | 544                        |       | 233 |   |
| Other                            |       | 289                        |       | 188 |   |
| Real Estate Portfolios           |       | 546                        |       | (180 | ) |
| Income from Portfolio  Assets    |       | $                          | 11,463     |   | $ | 9,043 |   |

 

For thethree-month period ended March 31, 2010, the Company recorded provisionsfor loan and impairment losses, net of recoveries, by a charge to income of$1.0 million — which is composed of a $1.0 million provision for loan losses,net of recoveries. For the three-month period ended March 31, 2009, theCompany recorded a provision for loan and impairment losses on Portfolio Assetsof $1.1 million — which is composed of a $0.2 million impairment charge on realestate portfolios and a $0.9 million provision for loan losses, net ofrecoveries.

 

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

 
| ** **              | ** ** | **Three Months Ended**     | ** ** |
|-------------------------|------------|----------------------------|------------|
| ** **              | ** ** | **March 31,**         | ** ** |
| ** **              | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **              | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance       |       | $                          | (65,825    | ) | $ | (76,365 | ) |
| Provisions              |       | (1,212                     | )          | (1,241 | ) |
| Recoveries              |       | 163                        |       | 312 |   |
| Charge-offs             |       | 1,683                      |       | 1,427 |   |
| Translation adjustments |       | 5,338                      |       | 3,945 |   |
| Ending Balance          |       | $                          | (59,853    | ) | $ | (71,922 | ) |

 

Accretable yieldrepresents the amount of income the Company can expect to generate over theremaining life of its existing Purchased Credit-Impaired Loans based onestimated future cash flows as of March 31, 2010 and December 31,2009. Reclassifications from nonaccretable difference to accretable yieldprimarily result from the Company’s increase in its estimates of future cashflows. Reclassifications to nonaccretable difference from accretable yieldprimarily results from the Company’s decrease in its estimates of future cashflows. Changes in accretable yield related to the Company’s PurchasedCredit-Impaired Loans for the three-month periods ended March 31, 2010 and2009 are as follows:

 

15

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 
| ** **                                      | ** ** | **Three Months Ended**     | ** ** |
|-------------------------------------------------|------------|----------------------------|------------|
| ** **                                      | ** ** | **March 31,**         | ** ** |
| ** **                                      | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                                      | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                               |       | $                          | 12,923     |   | $ | 58,114 |   |
| Additions                                       |       | —                     |       | 10,931 |   |
| Accretion                                       |       | (1,904                     | )          | (4,898 | ) |
| Reclassification from  nonaccretable difference |       | 351                        |       | 2,481 |   |
| Disposals                                       |       | (859                       | )          | (3,812 | ) |
| Transfer to non-accrual                         |       | (154                       | )          | (4,632 | ) |
| Translation adjustments                         |       | (181                       | )          | (1,544 | ) |
| Ending Balance                                  |       | $                          | 10,176     |   | $ | 56,640 |   |

 

Acquisitions ofPurchased Credit-Impaired Loans for the three-month periods ended March 31,2010 and 2009, respectively, are summarized in the table below:

 
| ** **                                                              | ** ** | **Three Months Ended**     | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                              | ** ** | **March 31,**         | ** ** |
| ** **                                                              | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                                                              | ** ** | **(Dollars in thousands)** | ** ** |
| Face value at acquisition                                               |       | $                          | 34,537     |   | $ | 140,772 |   |
| Cash flows expected to be  collected at acquisition, net of adjustments |       | 28,799                     |       | 81,122 |   |
| Basis in acquired loans at  acquisition                                 |       | 18,114                     |       | 70,191 |   |
|                                                                         |            |                            |            |  |  |  |  |

 

**(5)  Loans Receivable**

 

The following is a composition of the Company’s loansreceivable by loan type and region:

 
| ** **                                                              | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                                              | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                                                              | ** ** | **(Dollars in thousands)** | ** ** |
| Domestic:                                                               |       |                       |       |                  |       |
| Commercial and industrial:                                              |       |                       |       |                  |       |
| Affiliates, net of  allowance for loan losses of $67                    |       | $                          | 11,654     |                  | $          | 13,177 |   |
| SBA, net of allowance for  loan losses of $246 and $490, respectively   |       | 20,051                     |       | 16,266                |       |
| Other                                                                   |       | 5,115                      |       | 1,402                 |       |
| Real estate:                                                            |       |                       |       |                  |       |
| Other, net of allowance for  loan losses of $516 and $-0-, respectively |       | 7,763                      |       | 8,831                 |       |
|                                                                    |       |                       |       |                  |       |
| Foreign - commercial and  industrial:                                   |       |                       |       |                  |       |
| Affiliates                                                              |       | 12,162                     |       | 12,945                |       |
|                                                                    |       |                       |       |                  |       |
| Total loans, net                                                        |       | $                          | 56,745     |                  | $          | 52,621 |   |

 

***Loansreceivable — affiliates***

 

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

 

16

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 
| ** **                     | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** ** |
| Outstanding balance            |       | $                          | 22,380     |                  | $          | 24,757 |   |
| Allowance for loan losses      |       | (67                        | )          | (67                   | )          |
| Discounts, net                 |       | (215                       | )          | (237                  | )          |
| Capitalized interest           |       | 1,718                      |       | 1,669                 |       |
| Carrying amount of loans,  net |       | $                          | 23,816     |                  | $          | 26,122 |   |

 

A summary ofactivity in loans receivable — affiliates follows:

 
| ** **              | ** ** | **Three Months Ended**     | ** ** |
|-------------------------|------------|----------------------------|------------|
| ** **              | ** ** | **March 31,**         | ** ** |
| ** **              | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **              | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance       |       | $                          | 26,122     |   | $ | 27,080 |   |
| Advances                |       | 150                        |       | 2,300 |   |
| Payments received       |       | (2,230                     | )          | (1,277 | ) |
| Capitalized interest    |       | 49                         |       | 81 |   |
| Discount accretion, net |       | 22                         |       | — |   |
| Foreign exchange losses |       | (297                       | )          | (357 | ) |
| Ending Balance          |       | $                          | 23,816     |   | $ | 27,827 |   |

 

Loans receivable — affiliates represent (1) advancesto Acquisition Partnerships and other affiliates to acquire portfolios ofperforming and non-performing commercial and consumer loans and other assets;and (2) senior debt financing arrangements with equity-method investees toprovide capital for business expansion and operations. Loans receivable —affiliates are generally secured by the underlying collateral that was acquiredwith the loan proceeds. Advances to affiliates to acquire loan portfolios aresecured by the underlying collateral of the individual notes within theportfolios (which is generally real estate), whereas advances to affiliates forcapital investments and working capital are generally secured by businessassets (i.e. accounts receivable, inventory and equipment). The Company recorded no provisions forimpairment on loans receivable — affiliates for the three months ended March 31,2010 and 2009.

 

***Loansreceivable — SBA held for sale***

 

Loansreceivable — SBA held for sale are summarized as follows:

 
| ** **                      | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)** | ** ** |
| Outstanding balance             |       | $                          | 4,844      |                  | $          | 821 |   |
| Capitalized costs, net of  fees |       | 51                         |       | —                |       |
| Carrying amount of loans,  net  |       | $                          | 4,895      |                  | $          | 821 |   |

 

17

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

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

 
| ** **                          | ** ** | **Three Months Ended**     | ** ** |
|-------------------------------------|------------|----------------------------|------------|
| ** **                          | ** ** | **March 31,**         | ** ** |
| ** **                          | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                   |       | $                          | 821        |   | $ | 4,901 |   |
| Originations and advances  of loans |       | 4,029                      |       | 4,813 |   |
| Payments received                   |       | (7                         | )          | (75 | ) |
| Capitalized costs                   |       | 52                         |       | 81 |   |
| Ending Balance                      |       | $                          | 4,895      |   | $ | 9,720 |   |

 

Loans receivable — SBA held for sale represent theportions of SBA loans acquired and originated by the Company that areguaranteed by the SBA. These loans are secured by the borrowing entities’assets such as accounts, property, equipment and other business assets. TheCompany recorded no write-downs of SBA loans held for sale below their cost forthe three months ended March 31, 2010 and 2009.

 

At March 31, 2010, SBA loans held for saleinclude $2.1 million in guaranteed portions of SBA loans sold and subject to a90-day premium recourse provision. In accordance with FASB’s accountingguidance on transfers of financial assets (issued in June 2009) thatbecame effective in the first quarter of 2010, an off-setting secured borrowinghas been recorded and is included in “Other liabilities” in the Company’sconsolidated balance sheet. Once the premium recourse provision has elapsed,the transaction will be recorded as a sale with the guaranteed portion of theSBA loan and the secured borrowing removed from the balance sheet and theresulting gain on sale recorded. Refer to Note 2 for additional information.

 

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

 

Loans receivable — SBA held for investment aresummarized as follows:

 
| ** **                     | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** ** |
| Outstanding balance            |       | $                          | 16,427     |                  | $          | 17,072 |   |
| Allowance for loan losses      |       | (246                       | )          | (490                  | )          |
| Discounts, net                 |       | (1,137                     | )          | (1,245                | )          |
| Capitalized costs              |       | 112                        |       | 108                   |       |
| Carrying amount of loans,  net |       | $                          | 15,156     |                  | $          | 15,445 |   |

 

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

 
| ** **                           | ** ** | **Three Months Ended**     | ** ** |
|--------------------------------------|------------|----------------------------|------------|
| ** **                           | ** ** | **March 31,**         | ** ** |
| ** **                           | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                           | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                    |       | $                          | 15,445     |   | $ | 14,405 |   |
| Originations and advances  of loans  |       | 478                        |       | 1,604 |   |
| Payments received                    |       | (817                       | )          | (388 | ) |
| Capitalized costs                    |       | 3                          |       | 26 |   |
| Change in allowance for  loan losses |       | 244                        |       | (15 | ) |
| Discount accretion, net              |       | 57                         |       | 41 |   |
| Charge-offs                          |       | (254                       | )          | — |   |
| Ending Balance                       |       | $                          | 15,156     |   | $ | 15,673 |   |

 

Loans receivable — SBA held for investment representthe non-guaranteed portions of SBA loans purchased and originated by theCompany. These loans are secured by the borrowing entities’ assets such as accounts,property, equipment and other business assets. The Company recorded netimpairment provisions to SBA loans held for investment of $10,000 and $15,000for the three-month periods ended March 31, 2010 and 2009, respectively.

 

18

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

Changesin the allowance for loan losses related to loans receivable — SBA held forinvestment are as follows:

 
| ** **        | ** ** | **Three Months Ended**     | ** ** |
|-------------------|------------|----------------------------|------------|
| ** **        | ** ** | **March 31,**         | ** ** |
| ** **        | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **        | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance |       | $                          | (490       | ) | $ | (34 | ) |
| Provisions        |       | (82                        | )          | (21 | ) |
| Recoveries        |       | 72                         |       | 6 |   |
| Charge-offs       |       | 254                        |       | — |   |
| Ending Balance    |       | $                          | (246       | ) | $ | (49 | ) |

 

At March 31,2010, the Company’s recorded investment in impaired and non-accrual loansreceivable — SBA held for investment totaled $0.3 million. The average recordedinvestment in these impaired and non-accrual loans approximated $0.3 millionfor the three-month period ended March 31, 2010. At March 31, 2010,the Company had $0.1 million of valuation allowances specifically related tothese loans.

 

***Loansreceivable — other***

 

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

 
| ** **                      | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)** | ** ** |
| Outstanding balance             |       | $                          | 13,148     |                  | $          | 9,992 |   |
| Allowance for loan losses       |       | (516                       | )          | —                |       |
| Discounts, net                  |       | —                     |       | (7                    | )          |
| Capitalized interest and  costs |       | 246                        |       | 248                   |       |
| Carrying amount of loans,  net  |       | $                          | 12,878     |                  | $          | 10,233 |   |

 

Changes in loansreceivable — other are as follows:

 
| ** **                           | ** ** | **Three Months Ended**     | ** ** |
|--------------------------------------|------------|----------------------------|------------|
| ** **                           | ** ** | **March 31,**         | ** ** |
| ** **                           | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                           | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                    |       | $                          | 10,233     |   | $ | 13,533 |   |
| Advances                             |       | 5,178                      |       | 1,987 |   |
| Payments received                    |       | (2,022                     | )          | (2,129 | ) |
| Capitalized interest and costs       |       | (2                         | )          | 18 |   |
| Change in allowance for  loan losses |       | (516                       | )          | — |   |
| Discount accretion, net              |       | 7                          |       | 7 |   |
| Foreign exchange losses              |       | —                     |       | (5 | ) |
| Ending Balance                       |       | $                          | 12,878     |   | $ | 13,411 |   |

 

Loans receivable — other include loans made tonon-affiliated entities and are secured by the borrowing entities’ assets suchas accounts receivable, inventory, property and equipment, and various otherassets. The Company recorded impairment provisions on loans receivable — otherof approximately $0.5 million for the three-month period ended March 31,2010. The Company recorded no provisions for impairment for the three-monthperiod ended March 31, 2009.

 

19

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

Changes in the allowance for loan losses related toloans receivable — other are as follows:

 
| ** **        | ** ** | **Three Months Ended**     | ** ** |
|-------------------|------------|----------------------------|------------|
| ** **        | ** ** | **March 31,**         | ** ** |
| ** **        | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **        | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance |       | $                          | —     |   | $ | — |   |
| Provisions        |       | (516                       | )          | — |   |
| Charge-offs       |       | —                     |       | — |   |
| Ending Balance    |       | $                          | (516       | ) | $ | — |   |

 

At March 31, 2010, the Company’s recorded investment in impairedand non-accrual loans receivable — other totaled $8.3 million. The averagerecorded investment in these impaired and non-accrual loans approximated $8.3million for the three-month period ended March 31, 2010. At March 31,2010, the Company had $0.5 million of valuation allowances specifically relatedto these loans.

 

**(6)  Equity Investments**

 

The Company has equity investments in Acquisition Partnerships andtheir general partners, and equityinvestments in various servicing and operating entities, that areaccounted for under the equity-method of accounting. The condensed combinedfinancial position and results of operations of the Acquisition Partnerships(which include the domestic and foreign Acquisition Partnerships and theirgeneral partners) and the servicing and operating entities (collectively, the “EquityInvestees”), are summarized as follows:

 

**Condensed Combined Balance Sheets**

 
| ** **                                             | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                                             | ** ** | **(Dollars in thousands)** | ** ** |
| **Acquisition  Partnerships:**                         | ** ** | ** **                 | ** ** | ** **            | ** ** |
| Assets                                                 |       | $                          | 229,857    |                  | $          | 282,999 |   |
| Liabilities                                            |       | $                          | 69,502     |                  | $          | 97,135 |   |
| Net equity                                             |       | 160,355                    |       | 185,864               |       |
|                                                   |       | $                          | 229,857    |                  | $          | 282,999 |   |
| **Servicing  and operating entities:**                 |       |                       |       |                  |       |
| Assets                                                 |       | $                          | 137,236    |                  | $          | 134,384 |   |
| Liabilities                                            |       | $                          | 80,673     |                  | $          | 79,375 |   |
| Net equity                                             |       | 56,563                     |       | 55,009                |       |
|                                                   |       | $                          | 137,236    |                  | $          | 134,384 |   |
| **Total:**                                             |       |                       |       |                  |       |
| Assets                                                 |       | $                          | 367,093    |                  | $          | 417,383 |   |
| Liabilities                                            |       | $                          | 150,175    |                  | $          | 176,510 |   |
| Net equity                                             |       | 216,918                    |       | 240,873               |       |
|                                                   |       | $                          | 367,093    |                  | $          | 417,383 |   |
|                                                   |       |                       |       |                  |       |
| Equity investment in  Acquisition Partnerships         |       | $                          | 32,843     |                  | $          | 41,029 |   |
| Equity investment in  servicing and operating entities |       | 29,888                     |       | 30,462                |       |
|                                                   |       | $                          | 62,731     |                  | $          | 71,491 |   |

 

20

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

**Condensed Combined Summary of Operations**

 
| ** **                                              | ** ** | **Three Months Ended**     | ** ** |
|---------------------------------------------------------|------------|----------------------------|------------|
| ** **                                              | ** ** | **March 31,**         | ** ** |
| ** **                                              | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                                              | ** ** | **(Dollars in thousands)** | ** ** |
| **Acquisition  Partnerships:**                          | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Revenues                                                |       | $                          | 7,118      |   | $ | 10,410 |   |
| Expenses                                                |       | 10,175                     |       | 19,881 |   |
| Net loss                                                |       | $                          | (3,057     | ) | $ | (9,471 | ) |
|                                                    |       |                       |       |   |   |
| **Servicing  and operating entities:**                  |       |                       |       |   |   |
| Revenues                                                |       | $                          | 26,212     |   | $ | 20,728 |   |
| Costs and expenses                                      |       | 17,969                     |       | 18,983 |   |
| Net earnings                                            |       | $                          | 8,243      |   | $ | 1,745 |   |
|                                                    |       |                       |       |   |   |
| Equity in loss of  Acquisition Partnerships             |       | $                          | (608       | ) | $ | (891 | ) |
| Equity in earnings of  servicing and operating entities |       | 2,837                      |       | 745 |   |
|                                                    |       | $                          | 2,229      |   | $ | (146 | ) |

 

In March 2010, the Company acquired an additional 50% ownershipinterest in three domestic Acquisition Partnerships (refer to Note 3). As aresult of this transaction, the Company’s ownership interest in each of theseentities increased to 100%, resulting in these Acquisition Partnershipsconverting from equity-method investments to consolidated subsidiaries of theCompany at acquisition.

 

At March 31, 2010 and December 31, 2009, the AcquisitionPartnerships’ total carrying value of loans accounted for under non-accrualmethods of accounting (i.e. cost-recovery or cash basis method) approximated$164.4 million and $180.0 million, respectively.

 

The combinedassets and equity of the Equity Investees, and the Company’s carrying value ofits equity investments in the Equity Investees, are summarized by geographicregion below.

 
| ** **                                | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                                | ** ** | **(Dollars in thousands)** | ** ** |
| Combined assets of the  Equity Investees: |       |                       |       |                  |       |
| Domestic:                                 |       |                       |       |                  |       |
| Acquisition Partnerships                  |       | $                          | 29,357     |                  | $          | 58,190 |   |
| Operating entities                        |       | 40,986                     |       | 31,481                |       |
| Latin America:                            |       |                       |       |                  |       |
| Acquisition Partnerships                  |       | 133,594                    |       | 139,214               |       |
| Servicing entities                        |       | 10,798                     |       | 13,328                |       |
| Europe:                                   |       |                       |       |                  |       |
| Acquisition Partnerships                  |       | 66,906                     |       | 85,595                |       |
| Servicing entities                        |       | 85,452                     |       | 89,575                |       |
|                                      |       | $                          | 367,093    |                  | $          | 417,383 |   |

 

21

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (Unaudited)**

 
| ** **                                                                        | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                                                        | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                                                                        | ** ** | **(Dollars in thousands)** | ** ** |
| Combined equity of the  Equity Investees:                                         |       |                       |       |                  |       |
| Domestic:                                                                         |       |                       |       |                  |       |
| Acquisition Partnerships                                                          |       | $                          | 26,090     |                  | $          | 36,696 |   |
| Operating entities                                                                |       | 8,343                      |       | 5,574                 |       |
| Latin America:                                                                    |       |                       |       |                  |       |
| Acquisition Partnerships                                                          |       | 112,485                    |       | 115,768               |       |
| Servicing entities                                                                |       | (852                       | )          | 427                   |       |
| Europe:                                                                           |       |                       |       |                  |       |
| Acquisition Partnerships                                                          |       | 21,780                     |       | 33,400                |       |
| Servicing entities                                                                |       | 49,072                     |       | 49,008                |       |
|                                                                              |       | $                          | 216,918    |                  | $          | 240,873 |   |
|                                                                              |       |                       |       |                  |       |
| Company’s carrying value of  its equity investments in the Equity Investees: |       |                       |       |                  |       |
| Domestic:                                                                         |       |                       |       |                  |       |
| Acquisition Partnerships                                                          |       | $                          | 8,904      |                  | $          | 13,575 |   |
| Operating entities                                                                |       | 2,913                      |       | 1,659                 |       |
| Latin America:                                                                    |       |                       |       |                  |       |
| Acquisition Partnerships                                                          |       | 17,225                     |       | 17,532                |       |
| Servicing entities                                                                |       | 1,907                      |       | 2,677                 |       |
| Europe:                                                                           |       |                       |       |                  |       |
| Acquisition Partnerships                                                          |       | 6,714                      |       | 9,922                 |       |
| Servicing entities                                                                |       | 25,068                     |       | 26,126                |       |
|                                                                              |       | $                          | 62,731     |                  | $          | 71,491 |   |

 

Revenues and earnings (losses) of the EquityInvestees, and the Company’s share of equity in earnings (losses) of thoseentities, are summarized by geographic region below. The tables below includeindividual entities and combined entities under common management that areconsidered to be significant subsidiaries of FirstCity at March 31, 2010.

 
| ** **                                             | ** ** | **Three Months Ended**     | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|
| ** **                                             | ** ** | **March 31,**         | ** ** |
| ** **                                             | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                                             | ** ** | **(Dollars in thousands)** | ** ** |
| Revenues of the Equity  Investees:                     |       |                       |       |   |   |
| Domestic:                                              |       |                       |       |   |   |
| Agrifirst Lending LLC                                  |       | $                          | 1,247      |   | $ | — |   |
| Other Acquisition  Partnerships                        |       | 581                        |       | 1,639 |   |
| CAPP Resources, LLC  (operating entity)                |       | 3,129                      |       | 7,855 |   |
| Prime Steaks V LLC  (operating entity)                 |       | 354                        |       | — |   |
| Teton Buildings LLC  (operating entity)                |       | 2,062                      |       | 1,146 |   |
| Formation Brands LLC  (operating entity)               |       | 2,380                      |       | — |   |
| Other operating entities                               |       | 2,138                      |       | — |   |
| Latin America:                                         |       |                       |       |   |   |
| Combined AIG Partnerships  (Acquisition Partnerships)  |       | 2,694                      |       | 2,273 |   |
| Other Acquisition  Partnerships                        |       | 703                        |       | 253 |   |
| Servicios Integrales de Cobranza SA (servicing entity) |       | 2,164                      |       | 2,289 |   |
| Europe:                                                |       |                       |       |   |   |
| Combined HMCS Partnerships  (Acquisition Partnerships) |       | 309                        |       | 1,994 |   |
| Other Acquisition Partnerships                         |       | 1,583                      |       | 4,251 |   |
| MCS et Associes (servicing  entity)                    |       | 13,003                     |       | 8,162 |   |
| Other servicing entities                               |       | 983                        |       | 1,276 |   |
| ** **                                             |       | $                          | 33,330     |   | $ | 31,138 |   |

 

22

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (Unaudited)**

 
| ** **                                                         | ** ** | **Three Months Ended**     | ** ** |
|--------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                         | ** ** | **March 31,**         | ** ** |
| ** **                                                         | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                                                         | ** ** | **(Dollars in thousands)** | ** ** |
| Net earnings (loss) of the  Equity Investees:                      |       |                       |       |   |   |
| Domestic:                                                          |       |                       |       |   |   |
| Agrifirst Lending LLC                                              |       | $                          | 1,122      |   | $ | — |   |
| Other Acquisition  Partnerships                                    |       | (357                       | )          | 104 |   |
| CAPP Resources, LLC  (operating entity)                            |       | 2,326                      |       | 2,105 |   |
| Prime Steaks V LLC  (operating entity)                             |       | (172                       | )          | — |   |
| Teton Buildings LLC  (operating entity)                            |       | 1,258                      |       | (126 | ) |
| Formation Brands LLC  (operating entity)                           |       | (703                       | )          | — |   |
| Other operating entities                                           |       | 43                         |       | — |   |
| Latin America:                                                     |       |                       |       |   |   |
| Combined AIG Partnerships  (Acquisition Partnerships)              |       | (948                       | )          | (11,905 | ) |
| Other Acquisition  Partnerships                                    |       | (885                       | )          | (468 | ) |
| Servicios Integrales de Cobranza SA (servicing entity)             |       | (1,265                     | )          | (526 | ) |
| Europe:                                                            |       |                       |       |   |   |
| Combined HMCS Partnerships  (Acquisition Partnerships)             |       | (2,017                     | )          | 1,176 |   |
| Other Acquisition  Partnerships                                    |       | 28                         |       | 1,622 |   |
| MCS et Associes (servicing  entity)                                |       | 6,907                      |       | 273 |   |
| Other servicing entities                                           |       | (151                       | )          | 19 |   |
|                                                               |       | $                          | 5,186      |   | $ | (7,726 | ) |
|                                                               |       |                       |       |   |   |
| Company’s equity in  earnings (loss) of the Equity Investees: |       |                       |       |   |   |
| Agrifirst Lending LLC                                              |       | $                          | 224        |   | $ | — |   |
| Other Acquisition  Partnerships                                    |       | (92                        | )          | 1 |   |
| CAPP Resources, LLC  (operating entity)                            |       | 919                        |       | 832 |   |
| Prime Steaks V LLC  (operating entity)                             |       | (69                        | )          | — |   |
| Teton Buildings LLC  (operating entity)                            |       | 597                        |       | 6 |   |
| Formation Brands LLC  (operating entity)                           |       | (427                       | )          | — |   |
| Other operating entities                                           |       | 26                         |       | 1 |   |
| Latin America:                                                     |       |                       |       |   |   |
| AIG Partnerships  (Acquisition Partnerships)                       |       | (165                       | )          | (1,624 | ) |
| Other Acquisition  Partnerships                                    |       | 45                         |       | (20 | ) |
| Servicios Integrales de Cobranza SA (servicing entity)             |       | (632                       | )          | (263 | ) |
| Europe:                                                            |       |                       |       |   |   |
| HMCS Partnerships  (Acquisition Partnerships)                      |       | (614                       | )          | 362 |   |
| Other Acquisition  Partnerships                                    |       | (6                         | )          | 390 |   |
| MCS et Associes (servicing  entity)                                |       | 2,448                      |       | 166 |   |
| Other servicing entities                                           |       | (25                        | )          | 3 |   |
|                                                               |       | $                          | 2,229      |   | $ | (146 | ) |

 

At March 31, 2010,the Company had $21.2 million in Euro-denominated debt for the purpose ofhedging a portion of the Company’s net equity investments in Europe. Refer to Note 9 for additional information.

 

**(7)  Servicing Assets — SBALoans**

 

The Companyrecognizes servicing assets through the sale of originated SBA loans when therights to service those loans are retained. Servicing rights resulting from thesale of loans are initially recognized at fair value at the date of transfer.The Company subsequently measures the carrying value of the servicing assets byusing the amortization method, which amortizes the servicing assets inproportion to and over the period of estimated net servicing income, andevaluates servicing assets for impairment based on fair value at each reportingdate. The Company evaluates the possible impairment of servicing assets basedon the difference between the carrying amount and current fair value of theservicing assets. Impairment is charged to servicing fees in the periodrecognized.

 

23

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (Unaudited)**

 

Changes in the Company’s amortized servicing assetsare as follows:

 
| ** **                                   | ** ** | **Three Months Ended**     | ** ** |
|----------------------------------------------|------------|----------------------------|------------|
| ** **                                   | ** ** | **March 31,**         | ** ** |
| ** **                                   | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                            |       | $                          | 1,115      |   | $ | 785 |   |
| Servicing Assets  capitalized                |       | —                     |       | — |   |
| Servicing Assets amortized                   |       | (155                       | )          | (46 | ) |
| Ending Balance                               |       | $                          | 960        |   | $ | 739 |   |
| ** **                                   | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Reserve for impairment of  servicing assets: | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Beginning Balance                            |       | $                          | (59        | ) | $ | (63 | ) |
| Impairments                                  |       | (12                        | )          | — |   |
| Recoveries                                   |       | —                     |       | 19 |   |
| Ending Balance                               |       | $                          | (71        | ) | $ | (44 | ) |
|                                         |       |                       |       |   |   |
| Ending Balance (net of  reserve)             |       | $                          | 889        |   | $ | 695 |   |
| ** **                                   | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Fair value of amortized  servicing assets:   |       |                       |       |   |   |
| Beginning balance                            |       | $                          | 1,162      |   | $ | 722 |   |
| Ending balance                               |       | $                          | 985        |   | $ | 695 |   |

 

The Company relies primarily on a discounted cash flow model toestimate the fair value of its servicing assets. This model calculatesestimated fair value of the servicing assets using significant assumptionsincluding a discount rate of 12.0% and prepayment speeds of 14.0% to 15.0%(depending on certain characteristics of the related loans).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.

 

**(8)  Accumulated OtherComprehensive Income**

 

Accumulated other comprehensiveincome is composed of the following as of March 31, 2010 and December 31,2009:

 
| ** **                                                 | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                                 | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                                                 | ** ** | **(Dollars in thousands)** | ** ** |
| Cumulative foreign currency  translation adjustments       |       | $                          | (651       | )                     | $          | 956 |   |
| Net unrealized gains on  securities available for sale (1) |       | 1,761                      |       | 2,504                 |       |
| Total accumulated other  comprehensive income (loss)       |       | $                          | 1,110      |                  | $          | 3,460 |   |

 

----

(1)         Includes $0.3 million and$1.4 million at March 31, 2010 and December 31, 2009,respectively, attributable to FirstCity’s proportionate share of net unrealizedgains recorded by an investee accounted for under the equity-method ofaccounting.

 

**(9)  Foreign CurrencyExchange Risk Management**

 

We useEuro-denominated debt as a non-derivative financial instrument to partiallyoff-set the Company’s business exposure to foreign currency exchange riskattributable to our net investments in Europe. Our focus is to manage theeconomic risks associated with our European subsidiaries, which are the foreigncurrency exchange risks that will ultimately be realized when we exchange onecurrency for another. To help protect the Company’s net investment in certainof its European subsidiary operations from adverse changes in foreign currencyexchange rates, we denominate a portion of our debt in the same functionalcurrency used by the European subsidiaries. At March 31, 2010, the Companycarried $21.2 million in Euro-denominated debt and designated the debt as anon-derivative hedge of its net investment in certain European subsidiaries.The Company designated the hedging relationship such that changes in the netinvestments being hedged are expected to be naturally off-set by correspondingchanges in the value of the Euro-denominated debt. We consider our investmentsin European subsidiaries to be denominated in a relatively stable currency andof a long-term nature.

 

24

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (Unaudited)**

 

The effectiveportion of the net foreign investment hedge is reported in accumulated othercomprehensive income (loss) as part of the cumulative translation adjustment.Any ineffective portion of the net foreign investment hedge is recognized inearnings as other income (expense) during the period of change. Effectivenessof the 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.

 

At March 31,2010 and December 31, 2009, the carrying value and line item caption ofthe Company’s non-derivative instrument was reported on the consolidatedbalance sheets as follows (in thousands):

 
| **Non-Derivative**       | ** ** | ** **             | ** ** | ** **              | ** ** | ** **                 | ** ** |
|--------------------------|------------|------------------------|------------|-------------------------|------------|----------------------------|------------|
| **Instrument in**        | ** ** | ** **             | ** ** | ** **              | ** ** | ** **                 | ** ** |
| **Net Investment**       | ** ** | **Balance Sheet**      | ** ** | **Carrying Value at:**  | ** ** |
| **Hedging Relationship** | ** ** | **Location**           | ** ** | **March 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|                     |       |                   |       |                    |       |                       |       |
| Euro-denominated debt    |       | Notes payable to banks |       | $                       | 21,181     |                       | $          | 24,824 |   |
|                          |            |                        |            |                         |            |                            |            |  |  |

 

The effect of the non-derivative instrument qualifyingand designated as a hedging instrument in net foreign investment hedges on theconsolidated financial statements for the three-month periods ended March 31,2010 and 2009 was as follows (in thousands):

 
| ** **               | ** ** | ** **                | ** ** | ** **                  | ** ** | ** **                   | ** ** | **Amount of Gain (Loss)** | ** ** |
|--------------------------|------------|---------------------------|------------|-----------------------------|------------|------------------------------|------------|---------------------------|------------|
| ** **               | ** ** | ** **                | ** ** | ** **                  | ** ** | ** **                   | ** ** | **Recognized in Income**  | ** ** |
| ** **               | ** ** | **Amount of Gain (Loss)** | ** ** | ** **                  | ** ** | **(Ineffective Portion and** | ** ** |
| **Non-Derivative**       | ** ** | **Recognized in AOCI**    | ** ** | **Location of Gain (Loss)** | ** ** | **Amount Excluded from**     | ** ** |
| **Instrument in**        | ** ** | **(Effective Portion)**   | ** ** | **Reclassified from**       | ** ** | **Effectiveness Testing)**   | ** ** |
| **Net Investment**       | ** ** | **Three  Months Ended:**  | ** ** | **AOCI  into Income**       | ** ** | **Three  Months Ended:**     | ** ** |
| **Hedging Relationship** | ** ** | **March 31,  2010**  | ** ** | **March 31,  2009**    | ** ** | **(Effective  Portion)**     | ** ** | **March 31,  2010**  | ** ** | **March 31,  2009** | ** ** |
|                     |       |                      |       |                        |       |                         |       |                      |       |   |   |
| Euro-denominated debt    |       | $                         | 1,542      |                        | $          | 2,012                        |       | Other income (expense)    |       | $ | — |   | $ | — |   |
|                          |            |                           |            |                             |            |                              |            |                           |            |  |  |  |  |  |  |

 

**(10)  Income Taxes**

 

We are subject to income taxes in both the United States and thenon-U.S. jurisdictions in which we operate. Income tax expense (benefit)for the three-month periods ended March 31, 2010 and 2009 is composed ofthe following components:

 
| ** **                                     | ** ** | **Three Months Ended**     | ** ** |
|------------------------------------------------|------------|----------------------------|------------|
| ** **                                     | ** ** | **March 31,**         | ** ** |
| ** **                                     | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                                     | ** ** | **(Dollars in thousands)** | ** ** |
| ** **                                     | ** ** | ** **                 | ** ** | ** ** | ** ** |
| State current income tax expense               |       | $                          | 302        |   | $ | 197 |   |
| Foreign current income tax  expense            |       | 21                         |       | 198 |   |
| Foreign deferred income tax  expense (benefit) |       | (809                       | )          | 15 |   |
| Total                                          |       | $                          | (486       | ) | $ | 410 |   |

 

The Companyrecognizes deferred tax assets and liabilities in both the U.S. and foreignjurisdictions based on the future tax consequences attributable to temporarydifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases, and for net operating loss andtax credit carryforwards. The Company’s deferred tax assets, net of valuationallowances, totaled $0.7 million at March 31, 2010 (included in “Otherassets” in our consolidated balance sheet) and $-0- at December 31, 2009. Theincrease in the net deferred tax assets during the quarter ended March 31,2010 relates to our ability to recognize foreign tax benefits associated withU.S. GAAP adjustments to a consolidated foreign subsidiary’s local financialstatements, combined with the timing of federal income tax payments made by theforeign subsidiary in its local jurisdiction. The recognition of these foreigntax benefits is not dependent upon future taxable income in the subsidiary’sforeign jurisdiction, but rather upon reversal of the U.S. GAAP adjustments infuture periods.

 

25

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (Unaudited)**

 

The Company alsohas a substantial amount of domestic deferred tax assets attributable primarilyto net operating loss and capital loss carryforwards for U.S. federal incometax purposes, and differences between the carrying amounts and the tax bases ofAcquisition Partnership investments. At March 31, 2010 and December 31,2009, the Company established a full valuation allowance for its U.S. deferredtax assets due to the lack of sufficient objective evidence regarding therealization of these assets in the foreseeable future. We will continue toevaluate the deferred tax asset valuation allowance balances in all of ourU.S. and foreign subsidiaries throughout 2010 to determine the appropriatelevel of valuation allowances.

 

**(11)  Stock-Based Compensation**

 

Accounting for stock-based compensation requires thatthe cost resulting from all stock-based payments be recognized in the financialstatements based on the grant-date fair value of the award. The Company’sstock-based compensation expense consists of stock options and restricted stockawards (2010 only). We recognized stock-based compensation cost ofapproximately $0.2 million and $0.1 million for the three-month periods ended March 31,2010 and 2009.

 

*Stock Options*

 

A summary of the Company’s stock options and relatedactivity as of and for the three months ended March 31, 2010 is presentedbelow:

 
| ** **                                   | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **          | ** ** |
|----------------------------------------------|------------|------------|------------|--------------|------------|-----------------|------------|---------------------|------------|
| ** **                                   | ** ** | ** ** | ** ** | ** **   | ** ** | **Average**     | ** ** | ** **          | ** ** |
| ** **                                   | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Remaining**   | ** ** | ** **          | ** ** |
| ** **                                   | ** ** | ** ** | ** ** | **Average**  | ** ** | **Contractual** | ** ** | **Aggregate**       | ** ** |
| ** **                                   | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Term**        | ** ** | **Intrinsic**       | ** ** |
| ** **                                   | ** ** | **Shares** | ** ** | **Price**    | ** ** | **(Years)**     | ** ** | **Value**           | ** ** |
| ** **                                   | ** ** | ** ** | ** ** | ** **   | ** ** | ** **      | ** ** | **(in  thousands)** | ** ** |
| Options outstanding at January 1,  2010 |       | 921,400    |       | $            | 7.10       |            |       |                |       |   |
| Granted                                      |       | —     |       | —       |       |            |       |                |       |
| Exercised                                    |       | (25,000    | )          | 2.00         |       |            |       |                |       |
| Expired                                      |       | —     |       | —       |       |            |       |                |       |
| Forfeited                                    |       | —     |       | —       |       |            |       |                |       |
| Options outstanding at March 31,  2010  |       | 896,400    |       | $            | 7.24       |            | 6.13       |                | $          | 719 |   |
| Options exercisable at March 31,  2010  |       | 576,900    |       | $            | 7.17       |            | 4.50       |                | $          | 700 |   |

 

The totalintrinsic value of stock options exercised during the three-month period ended March 31,2010 was $0.1 million. As of March 31, 2010, there was approximately $1.4million of total unrecognized compensation cost related to unvested stockoptions. That cost is expected to be recognized over a weighted average periodof 1.5 years.

 

*RestrictedStock Awards*

 

In February 2010,the Company granted 28,890 restricted stock awards that vest in one installmenton the first anniversary of the date of grant. The grant-date fair value ofeach award was $5.97 — which was based on the grant-date fair value of ourcommon stock. Holders of the restricted stock awards have voting rights, andvesting of the grants is based on their continued service. Sales of therestricted stock are prohibited until the awards vest. At March 31, 2010,the Company had 28,890 of outstanding, unvested restricted stock awards withtotal unrecognized compensation cost of $0.1 million to be recognized over aweighted average period of 0.4 years.

 

26

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

**(12)  Net Earnings per CommonShare**

 

Earnings per share(“EPS”) is presented for both basic EPS and diluted EPS. We compute basic EPSby dividing net earnings available to common stockholders by theweighted-average number of common shares outstanding during the year. DilutedEPS is computed by dividing net earnings available to common stockholders bythe weighted-average number of common shares outstanding during the year, plusthe dilutive effect of common stock equivalents such as stock options andwarrants. We exclude these common stock equivalents from the computation ofdiluted EPS when the effect of inclusion would be anti-dilutive.

 

Basic and dilutednet earnings per common share were computed as follows:

 
| ** **                                                                        | ** ** | **Three Months Ended**                             | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                        | ** ** | **March 31,**                                 | ** ** |
| ** **                                                                        | ** ** | **2010**                                           | ** ** | **2009** | ** ** |
| ** **                                                                        | ** ** | **(Dollars in thousands,  except per share data)** | ** ** |
| ** **                                                                        | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Net earnings                                                                      |       | $                                                  | 4,715      |   | $ | 992 |   |
| Less: net income  attributable to the noncontrolling interest                     |       | 4,614                                              |       | 348 |   |
| Net earnings attributable  to FirstCity                                           |       | $                                                  | 101        |   | $ | 644 |   |
|                                                                              |       |                                               |       |   |   |
| Weighted average  outstanding shares of common stock (in thousands)               |       | 9,992                                              |       | 9,832 |   |
| Dilutive effect of stock  options                                                 |       | 101                                                |       | 1 |   |
| Weighted average  outstanding shares of common stock and common stock equivalents |       | 10,093                                             |       | 9,833 |   |
|                                                                              |       |                                               |       |   |   |
| Net earnings per share:                                                           |       |                                               |       |   |   |
| Basic                                                                             |       | $                                                  | 0.01       |   | $ | 0.07 |   |
| Diluted                                                                           |       | $                                                  | 0.01       |   | $ | 0.07 |   |

 

**(13)  Fair Value**

 

Fair ValueMeasurements

 

The fair value of an asset or liability is the price that would bereceived to sell that asset or paid to transfer that liability in an orderlytransaction occurring in the principal market (or most advantageous market inthe absence of a principal market) for such asset or liability. In estimatingfair value, the Company utilizes valuation techniques that are consistent withthe market approach, the income approach and/or the cost approach. Suchvaluation techniques are consistently applied. Inputs to valuation techniquesinclude the assumptions that market participants would use in pricing an assetor liability. The accounting guidance on fair value measurements establishes afair value hierarchy that prioritizes the inputs to valuation techniques tomeasure fair value. The hierarchy gives the highest priority to unadjusted quotedprices in active markets for identical assets or liabilities (Level 1measurements) and the lowest priority to measurements involving significantunobservable inputs (Level 3 measurements). The three levels of the fair valuehierarchy are described below:

 

·                  Level 1 — Valuations are based upon quoted prices (unadjusted) inactive exchange markets involving identical assets and liabilities that theCompany has the ability to access at the measurement date.

 

·                  Level 2 — Observable inputs other than Level 1 prices, such as quotedprices for similar instruments in active markets; quoted prices and valuationsfor identical or similar instruments in markets that are not active; andmodel-based valuation techniques with significant assumptions and inputs that areobservable in the market or can be derived principally from or corroborated byobservable market data.

 

·                  Level 3 — Valuations are derived from model-based techniques that useinputs and significant assumptions that are supported by little or noobservable market data. Valuation techniques include the use of pricing models,discounted cash flow models and similar methodologies.

 

27

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

The level of fair value hierarchy within which a fair value measurementin its entirety falls is based on the lowest level input that ismost-significant to the fair value measurement in its entirety.

 

*Asset Measured at Fair Value on a Recurring Basis*

 

At March 31, 2010, the only financial or non-financial item thatthe Company measured at fair value on a recurring basis was its investmentsecurity available for sale (represents a beneficial interest attributable toloans sold through a securitization transaction). The Company measures fairvalue for this investment security using a discounted cash flow model based onassumptions and inputs that are corroborated by little or no observable marketdata (Level 3 measurement). The Company uses this measurement technique becausepricing information and market-participant assumptions for purchased beneficialinterests in similar securitization transactions are not readily accessible andfrequently released to the public. At March 31, 2010 and December 31,2009, the carrying value of this investment security (at fair value)approximated $1.5 million and $1.8 million, respectively. The table belowsummarizes the changes to this Level 3 asset measured at fair value on arecurring basis for the three-month periods ended March 31, 2010 and 2009,respectively:

 
| ** **                                            | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------|------------|------------------------|------------|
| ** **                                            | ** ** | **March 31,**     | ** ** |
| **(Dollars in thousands)**                            | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Balance, beginning of  period                         |       | $                      | 1,836      |   | $ | 5,251 |   |
| Total net gains (losses)  for the period included in: |       |                   |       |   |   |
| Net income (loss)                                     |       | —                 |       | — |   |
| Other comprehensive income  (loss)                    |       | 342                    |       | (7 | ) |
| Purchases, sales, issuances  and settlements          |       | (648                   | )          | (965 | ) |
| Net transfers into Level 3                            |       | —                 |       | — |   |
| Balance, end of period                                |       | $                      | 1,530      |   | $ | 4,279 |   |

 

There were no transfers of assets or liabilities recorded at fair valueon a recurring basis into or out of Level 3 fair value measurements during thethree-month periods ended March 31, 2010 and 2009.

 

*Assets Measured at Fair Value on a Non-RecurringBasis*

 

The Company may be required, from time to time, to measure certainfinancial and non-financial assets at fair value on a non-recurring basis.These adjustments to fair value generally result from write-downs of financialand non-financial 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 that were still on the Company’s consolidated balance sheetat March 31, 2010 and December 31, 2009, the following table providesthe fair value hierarchy and the carrying value of the related individualassets at each respective period end:

 
| ** **                    | ** ** | **Carrying Value at March 31, 2010** | ** ** |
|-------------------------------|------------|-------------------------------------------|------------|
| **(Dollars in thousands)**    | ** ** | **Level 1**                               | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Portfolio Assets - loans  (1) |       | $                                         | —     |   | $ | — |   | $ | 5,098 |   | $ | 5,098 |   |
|                               |            |                                           |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                      | ** ** | **Carrying Value at December 31, 2009** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------|------------|
| **(Dollars in thousands)**                      | ** ** | **Level 1**                                  | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Portfolio Assets - loans  (1)                   |       | $                                            | —     |   | $ | — |   | $ | 12,460 |   | $ | 12,460 |   |
| Loans receivable - SBA held  for investment (1) |       | —                                       |       | — |   | 829 |   | 829 |   |
| Real estate held for sale  (2)                  |       | —                                       |       | 7,231 |   | — |   | 7,231 |   |
|                                                 |            |                                              |            |  |  |  |  |  |  |  |  |  |  |

 

----

(1)   Represents the carrying value of impairedloans that were measured for impairment using the estimated fair value of thecollateral for collateral-dependent loans.

(2)   Represents the carrying value offoreclosed real estate properties that were impaired and measured at fair valuesubsequent to their initial classification as foreclosed assets.

 

28

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

The following table presents the decrease in value of certain assetsheld at the respective period end that were measured at fair value on anon-recurring basis for which a fair value adjustment was included in theCompany’s results of operations during the respective period:

 
| ** **                     | ** ** | **Three Months Ended** | ** ** |
|--------------------------------|------------|------------------------|------------|
| ** **                     | ** ** | **March 31,**     | ** ** |
| **(Dollars in thousands)**     | ** ** | **2010**               | ** ** | **2009** | ** ** |
| Portfolio Assets - loans  (1)  |       | $                      | (958       | ) | $ | (505 | ) |
| Real estate held for sale  (2) |       | —                 |       | (163 | ) |
| Total                          |       | $                      | (958       | ) | $ | (668 | ) |

 

----

(1)   Represents write-downs of loans based onthe estimated fair value of the collateral for collateral-dependent loans.

(2)   Represents losses on foreclosed realestate properties that were measured at fair value subsequent to their initialclassification as foreclosed assets.

 

The fair values of “Portfolio Assets — loans” and “SBA loans held forinvestment,” as measured on a non-recurring basis, are based on collateralvaluations using observable and unobservable inputs, adjusted for variousconsiderations such as market conditions, economic and competitive environment,and other assets with similar characteristics (i.e. type, location, etc.) that,in management’s opinion, reflect elements a market participant would consider.The Company classifies its fair value measurement techniques for these assetsas Level 3 inputs for the following reasons: (1) distressed assettransactions generally occur in inactive markets for which observable marketprices are not readily available (i.e. price quotations vary substantially overtime and among market-makers, and pricing information is generally not releasedto the public); 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.

 

The fair value of “Real estate held for sale,” as measured on anon-recurring basis, is generally based on collateral valuations usingobservable inputs.

 

We attempt to base our fair values on the price that would be receivedto sell an asset in an orderly transaction between market participants at themeasurement date. It is our policy to maximize the use of observable inputs,when reasonably available and without undue cost, and minimize the use ofunobservable inputs when developing fair value measurements in accordance withthe fair value hierarchy. Fair value measurements for assets where there existslimited or no observable market data and, therefore, are based principally onour own estimates and assumptions, are often calculated based on collateralvaluations adjusted for the economic and competitive environment, the characteristicsof the asset, and other such factors. Additionally, there may be inherentweaknesses in any valuation technique, and changes in the underlyingassumptions used, including discount rates and estimates of future cash flows,that could significantly affect the results of current or future values.

 

Estimated Fair Values of Financial Instruments NotRecorded at Fair Value in their Entirety on a Recurring Basis

 

In addition to themethods and assumptions we use to measure the fair value of financial instrumentsas discussed in the section above, we used the following methods andassumptions to estimate the fair value of our financial instruments that arenot recorded at fair value in their entirety on a recurring basis in theCompany’s consolidated balance sheets. The fair value estimates were based onpertinent information that was available to management as of the respectivedates. The fair value estimates have not been revalued for purposes of thesefinancial statements since those dates and, therefore, current estimates offair value may differ significantly from the amounts presented. The amountsprovided herein are estimates of the exchange price that would be received tosell an asset or paid to transfer a liability in an orderly transaction (i.e.not a forced transaction, such as liquidation or distressed sale). Becauseactive markets do not exist for a significant portion of the Company’sfinancial instruments, management used present value techniques and othervaluation models to estimate the fair values of its financial instruments.These valuation methods require considerable judgment, and the resultingestimates of fair value can be significantly affected by the assumptions madeand methods used. Accordingly, the estimates provided herein do not necessarilyindicate amounts which could be realized in a current exchange. The Companybelieves the imprecision of an estimate could be significant.

 

***Cash and Cash Equivalents: ***Thecarrying amount of cash and cash equivalents approximated fair value at March 31,2010 and December 31, 2009.

 

29

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

***LoansReceivable Held-for-Sale: ***Loans held-for-sale (primarily SBA loansheld-for-sale) are carried on the Company’s consolidated balance sheet at thelower of cost or fair value. The fair value of loans held-for-sale is generallybased on what secondary markets are currently offering for loans with similarcharacteristics, or prices of the Company’s SBA loan transactions that werepreviously consummated and pending sales accounting treatment. At March 31,2010 and December 31, 2009, the carrying amount of loans held-for-saleapproximated $4.9 million and $0.8 million, respectively, and the estimatedfair values approximated $5.3 million and $0.9 million, respectively.

 

***Loan Portfolio Assets and Loans Receivable: ***Estimatedfair values of loan Portfolio Assets and fixed-rate loans receivable aregenerally determined using a discounted cash flow model, adjusted by an amountfor estimated losses, that employs market discount rates and other adjustmentsthat would be expected to be made by a market participant. The estimated fairvalue for variable-rate loans that re-price frequently is based on carryingvalues adjusted for estimated credit losses and other adjustments that would beexpected to be made by a market participant. The estimated fair value forimpaired loans is generally based on collateral valuations using observable andunobservable inputs, adjusted for various considerations that would beexpected to be made by a market participant; or discounted cash flowmodels that employ market discount rates and other adjustments that would be expected tobe made by a market participant. Management’s estimates and assumptionsregarding credit risk, cash flows and discount rates are judgmentallydetermined using available market and specific borrower information. At March 31,2010 and December 31, 2009, the carrying amounts of Portfolio Assets —loans and loans receivable (including accrued interest) approximated $260.3million and $253.0 million, respectively, and the estimated fair valuesapproximated $360.8 million and $371.1 million, respectively.

 

***Servicing Assets: ***The fair value of servicing assets isbased on a combination of a discounted cash flow model of future net servicingincome and analysis of current market data to estimate the fair value of ourservicing assets. The key assumptions used to calculate estimated fair value ofthe servicing assets include prepayment speeds and discount rate. The fairvalue estimate excludes the value of servicing rights for loans sold with90-day premium recourse provisions in which the servicing rights have not beencapitalized. See Note 7 for the carrying amount and estimated fair values ofservicing assets as of March 31, 2010 and December 31, 2009.

 

***Notes Payable: ***Management believes the interest rates and terms onits debt obligations approximate the rates and terms currently offered by otherlenders for similar debt instruments of comparable terms. As such, managementbelieves that the carrying amount of notes payable approximates fair value at March 31,2010 and December 31, 2009.

 

***Note Payable to Affiliate: ***Estimated fair value ofthe Company’s note payable to affiliate (including related interest payable) isbased on the present value of future projected cash flows using a discount ratethat reflects the risks inherent in those cash flows. At March 31, 2010 and December 31,2009, thecarrying amount of the note and interest payable to affiliate was $10.7 millionand $10.3 million, respectively, and the estimated fair values approximated$7.2 million and $6.5 million, respectively.

 

**(14)****  Variable InterestEntities**

 

In the normal course of business, the Company entersinto various types of on- and off-balance sheet transactions with entities thatinvolve variable interests. Variable interests are generally defined ascontractual, ownership or other economic interests in an entity that changewith fluctuations in the entity’s net asset value. If certain characteristicsare present in these transactions, the entity is subject to a variableinterests consolidation analysis, and consolidation is based on variableinterests, and not solely on ownership of the entity’s outstanding votingstock. In making the determination as to whether an entity is considered to bea variable interest entity (“VIE”), we first perform a qualitative analysis,which requires certain subjective decisions regarding our assessments,including, but not limited to, the design of the entity, the variability thatthe entity was designed to create and pass along to its interest holders, therights of the parties, and the purpose of the arrangement. If we cannotconclude after a qualitative analysis whether an entity is a VIE, we perform aquantitative analysis.

 

If an entity isdetermined to be a VIE, we determine if our variable interest causes us to beconsidered the primary beneficiary. We are the primary beneficiary and arerequired to consolidate the entity if we have the power to direct theactivities of the VIE that most-significantly impact the entity’s economicperformance and we have the obligation to absorb losses or the right to receivereturns that could be significant to the entity. The assessment of the partythat has the power to direct the activities of the VIE may require significantmanagement judgment when more than one party has power, or more than one partyis involved in the design of the VIE but no party has the power to direct theongoing activities that could be significant. We are required to continuallyassess whether we are the primary beneficiary and, therefore, may consolidate aVIE through the duration of our involvement.

 

The followingprovides a summary for which the Company has entered into significanttransactions with different types of VIEs:

 

AcquisitionPartnership VIEs —The Company is involved with Acquisition Partnerships that were formed with oneor more investors to invest in Portfolio Assets. These Acquisition Partnershipsare typically financed through debt and/or equity provided by the investors(including FirstCity). Certain of these Acquisition Partnerships are VIEsbecause generally they do not have sufficient equity to finance theiractivities without additional subordinated financial support, or the investorsdo not have the ability to make significant decisions about the AcquisitionPartnership’s activities. The voting interests for all but two of theAcquisition Partnership VIEs are either wholly-owned or majority-owned bynon-affiliated investors, and the Company determined that it was not theprimary beneficiary of these minority-owned Acquisition Partnership VIEs.However, the Company is deemed to be the primary beneficiary for twoAcquisition Partnership VIEs in which the Company owns a majority votinginterest. The investors and third-party creditors, including FirstCity,generally have recourse only to the extent of the assets held by theAcquisition Partnership VIEs. Certain third-party creditors have recourse to bothFirstCity and the non-affiliated investors where we jointly provide a guarantyto the Acquisition Partnership VIE. The Company does not generally providefinancial support to any Acquisition Partnership VIE beyond that which iscontractually required.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

Operating EntityVIEs — TheCompany has significant variable interests with various commercial enterpriseentities (attributable primarily to certain equity and debt investments made byFirstCity Denver — our Special Situations Platform business). FirstCityprovided financing in the form of debt and/or equity to help finance theactivities of the Operating Entity VIEs. These Operating Entities are VIEsbecause generally they do not have sufficient equity to finance theiractivities without additional subordinated financial support. The voting interestsfor all but one of the Operating Entity VIEs are either wholly-owned ormajority-owned by non-affiliated investors, and the Company determined that itwas not the primary beneficiary of these minority-owned Operating Entity VIEs. However,the Company is deemed to be the primary beneficiary for one Operating EntityVIE in which the Company owns a majority voting interest. The investors andcreditors, including FirstCity, generally have recourse only to the extent ofthe assets held by the Operating Entity VIEs. The Company does not generallyprovide financial support to any Operating Entity VIE beyond that which iscontractually required.

 

The followingtable displays the carrying amount and classification of assets and liabilitiesof consolidated VIEs that are included in the Company’s consolidated balancesheet as of March 31, 2010. We record third-party ownership in theseconsolidated VIEs in “Noncontrolling interests” in our consolidated balancesheet.

 
| ** **                              | ** ** | **Acquisition**            | ** ** | **Operating**  | ** ** |
|-----------------------------------------|------------|----------------------------|------------|----------------|------------|
| ** **                              | ** ** | **Partnership VIEs**       | ** ** | **Entity VIE** | ** ** |
| ** **                              | ** ** | **(Dollars in thousands)** | ** ** |
| Cash                                    |       | $                          | 4,664      |           | $          | 1,267 |   |
| Portfolio Assets, net                   |       | 44,777                     |       | —         |       |
| Other assets                            |       | 18                         |       | 8,650          |       |
| Total assets of  consolidated VIEs      |       | $                          | 49,459     |           | $          | 9,917 |   |
|                                    |       |                       |       |           |       |
| Total liabilities of  consolidated VIEs |       | $                          | 318        |           | $          | 6,557 |   |

 

The followingtable summarizes the carrying amounts of the assets included in the Company’sconsolidated balance sheet and the maximum loss exposure as of March 31,2010 related to the Company’s variable interests in unconsolidated VIEs.

 
| ** **                    | ** ** | **Assets on FirstCity’s** | ** ** | **FirstCity’s** | ** ** |
|-------------------------------|------------|--------------------------------|------------|----------------------|------------|
| ** **                    | ** ** | **Consolidated Balance Sheet** | ** ** | **Maximum**          | ** ** |
| ** **                    | ** ** | **Loans**                      | ** ** | **Equity**           | ** ** | **Exposure** | ** ** |
| **Type of VIE**               | ** ** | **Receivable**                 | ** ** | **Investment**       | ** ** | **to Loss (1)** | ** ** |
| ** **                    | ** ** | **(Dollars in thousands)**     | ** ** |
| Acquisition Partnership  VIEs |       | $                              | 2,041      |                 | $          | 2,874 |   | $ | 5,994 |   |
| Operating Entity VIEs         |       | 11,083                         |       | 187                  |       | 11,270 |   |
| Total                         |       | $                              | 13,124     |                 | $          | 3,061 |   | $ | 17,264 |   |

 

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(1)          Includes maximum exposure to loss attributable toFirstCity’s debt guarantees provided for certain Acquisition Partnership VIEs.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

**(15)  Other Related Party Transactions**

 

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 $1.9 million and $2.1 million forthe three month periods ended March 31, 2010 and 2009, respectively.

 

FirstCityServicing Corporation (“FCSC”), a wholly-owned subsidiary of FirstCity, and MCSet Associates (“MCS”), an equity-method investee of FirstCity in which FCSC hasan 11.89% ownership interest, are parties to certain agreements in which FCSCprovides consultation services and personnel to be employed by MCS to assist indeveloping and managing due diligence and servicing systems. Under theseagreements, MCS provides the supplied personnel with compensation, taxequalization payments, housing allowances, transportation allowance, and taxpreparation services. MCS also pays consulting fees to FCSC and reimburses FCSCfor travel, hotel, airfare, and meal expenses incurred related to the provisionof the services. FirstCity recorded fees from MCS of $105,000 and $98,000during the three month periods ended March 31, 2010 and 2009,respectively.

 

Through a seriesof related-party transactions in 2008, FC Acquisitions SRL de CV (“FCAcquisitions”), a majority-owned Mexican subsidiary of FirstCity, acquired aloan portfolio in Mexico. The final funding for this transaction resulted in anote payable to MCS Trust SA de CV (“MCS Trust”) by FC Acquisitions, and a notereceivable from MCS Trust held by BMX Holding III LLC (“BMX Holding III”), amajority-owned subsidiary of FirstCity. The accounts of MCS Trust areconsolidated by BMX Holding II, a FirstCity equity-method investee in which ithas an 8.0% ownership interest. At March 31, 2010 and December 31,2009, the note receivable held by BMX Holding III had a carrying amount of $7.8million (included in “Loans receivable — affiliates” on the Company’sconsolidated balance sheet), and accrued interest of $2.9 million and $2.5million, respectively (included in “Other assets, net” on the Company’sconsolidated balance sheet). At March 31, 2010 and December 31, 2009,the note payable to MCS Trust had a carrying amount of $7.8 million (reportedas “Notes payable to affiliate” on the Company’s consolidated balance sheet),and accrued interest of $2.9 million and $2.5 million, respectively (includedin “Other liabilities” on the Company’s consolidated balance sheet). Should thenote payable be forgiven at some future date, the corresponding note receivablewould be forgiven as well.

 

**(16)  Segment Reporting**

 

At March 31,2010 and 2009, the Company was engaged in two major business segments — PortfolioAsset Acquisition and Resolution business and Special Situations Platformbusiness.

 

In the PortfolioAsset Acquisition and Resolution business, the Company acquires and resolvesPortfolio Assets, which are generally acquired at a discount to their legalprincipal balance or appraised value. Purchases may be in the form of pools ofassets or individual assets. The Portfolio Assets are generally aggregated,including loans of varying qualities that are secured or unsecured by diversecollateral types and real estate. Some Portfolio Assets are loans for whichresolution is linked primarily to the real estate securing the loan, whileothers may be collateralized business loans for which resolution may be basedeither on real estate, business assets or other collateral cash flow. PortfolioAssets are acquired on behalf of the Company or its consolidated subsidiaries,and on behalf of domestic and foreign Acquisition Partnerships in which apartially-owned affiliate of the Company is the general partner and the Companyand other investors are limited partners. The Company services, manages andultimately resolves or otherwise disposes of substantially all Portfolio Assetsacquired by the Company, its Acquisition Partnerships, or other relatedentities. The Company services such assets until they are collected or sold.

 

The Companyengages in its Special Situations Platform business through its majorityownership interest in FirstCity Denver Investment Corp. — which was formed in April 2007.Through its Special Situations Platform business, the Company providesinvestment capital to privately-held middle-market companies through flexiblecapital structuring arrangements. The nature of the capital investmentsprimarily takes the form of senior and junior financing arrangements, but alsoincludes direct equity investments, common equity warrants, distressed debttransactions, and leveraged buyouts. FirstCity Denver’s primary investmentobjective is to generate both current income and capital appreciation throughdebt and equity investments, and to generally structure the investments to berepaid or exited in 24 to 60 months.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

Operating segment revenues andprofitability, and a reconciliation to net earnings for the three months ended March 31,2010 and 2009, are as follows:

 
| ** **                                                | ** ** | **Three Months Ended**     | ** ** |
|-----------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                | ** ** | **March 31,**         | ** ** |
| ** **                                                | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                                                | ** ** | **(Dollars in thousands)** | ** ** |
| **Portfolio  Asset Acquisition and Resolution:**          |       |                       |       |   |   |
| Total revenues                                            |       | $                          | 14,722     |   | $ | 13,297 |   |
| Operating contribution, net  of direct taxes              |       | $                          | 1,093      |   | $ | 916 |   |
| ** **                                                | ** ** | ** **                 | ** ** | ** ** | ** ** |
| **Special  Situations Platform:**                         |       |                       |       |   |   |
| Total revenues                                            |       | $                          | 6,810      |   | $ | 2,338 |   |
| Operating contribution, net  of direct taxes              |       | $                          | 715        |   | $ | 1,337 |   |
|                                                      |       |                       |       |   |   |
| Total operating  contribution, net of direct taxes        |       | $                          | 1,808      |   | $ | 2,253 |   |
| ** **                                                | ** ** | ** **                 | ** ** | ** ** | ** ** |
| **Corporate  Overhead:**                                  | ** ** | ** **                 | ** ** | ** ** | ** ** |
| Salaries and benefits and  other income and expenses, net |       | 1,706                      |       | 1,621 |   |
| Income tax expense  (benefit)                             |       | 1                          |       | (12 | ) |
| Net earnings attributable  to FirstCity                   |       | $                          | 101        |   | $ | 644 |   |

 

Revenues and equity in earnings of investments fromthe Special Situations Platform segment are all attributable to domesticoperations. Revenues and equity in earningsof unconsolidated equity-method investments from the Portfolio AssetAcquisition and Resolution segment are attributable to domestic and foreignoperations as follows:

 
| ** **    | ** ** | **Three Months Ended**     | ** ** |
|---------------|------------|----------------------------|------------|
| ** **    | ** ** | **March 31,**         | ** ** |
| ** **    | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **    | ** ** | **(Dollars in thousands)** | ** ** |
| Domestic      |       | $                          | 8,381      |   | $ | 9,733 |   |
| Latin America |       | 1,785                      |       | 919 |   |
| Europe        |       | 5,739                      |       | 1,652 |   |
| Other         |       | —                     |       | 8 |   |
| Total         |       | $                          | 15,905     |   | $ | 12,312 |   |

 

Total assets for each of thesegments and a reconciliation to total assets follows:

 
| ** **                                    | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                                    | ** ** | **(Dollars in thousands)** | ** ** |
| Cash and cash equivalents                     |       | $                          | 58,469     |                  | $          | 80,368 |   |
| Restricted cash                               |       | 1,742                      |       | 1,364                 |       |
| Portfolio acquisition and  resolution assets: |       |                       |       |                  |       |
| Domestic                                      |       | 238,693                    |       | 225,406               |       |
| Latin America                                 |       | 40,433                     |       | 41,248                |       |
| Europe                                        |       | 49,826                     |       | 57,888                |       |
| Special situations platform  assets           |       | 45,389                     |       | 41,688                |       |
| Other non-earning assets,  net                |       | 18,920                     |       | 17,112                |       |
| Total assets                                  |       | $                          | 453,472    |                  | $          | 465,074 |   |

 

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** **

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

**(17)  Commitments and Contingencies**

 

*Legal Proceedings*

 

There have been no material developments regarding any mattersdisclosed under Part I, Item 3 “Legal Proceedings” in our 2009 Form 10-K.

 

*Indemnification Obligation Commitments*

 

On August 8,2006, an Interest Purchase and Sale Agreement (“IP&S Agreement”) wasentered into by and among Bidmex Holding LLC (“Bidmex Holding”), as buyer, andStrategic Mexican Investment Partners L.P. (“SMIP”), a wholly-owned subsidiaryof FirstCity, and Cargill Financial Services International Inc. (“CFSI”),(collectively, the “Sellers”), as seller, and eleven U.S. limited liabilitycompanies (“LLCs”) which invested in Mexican portfolio acquisition entities (“SRLs”)and the AIG entities as additional parties.  In the IP&S Agreement,the Sellers and the LLCs made various representations and warranties concerning(i) the existence and ownership of the LLCs and the related SRLs, (ii) theassets and liabilities of the LLCs, (iii) taxes related to periods priorto August 8, 2006, and (iv) the operations of the LLCs and SRLs. TheSellers agreed to indemnify Bidmex Holding and AIG Entities from damagesresulting from a breach of any representation or warranty contained in theIP&S Agreement on a several and not joint basis according to theirrespective ownership percentages in each LLC as to any matter related to aparticular LLC, or on the basis of 80% to CFSI and 20% to SMIP as to any matterthat could not be identified to a particular LLC. The indemnity obligationunder the IP&S 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. The Sellers are notrequired to make any payments as a result of the indemnity provisions of theIP&S Agreement until the aggregate amount payable under that agreement andthe Asset Purchase Agreement (defined below) exceeds $250,000; however, claimsrelated to taxes and fraud are not subject to this $250,000 threshold. TheIP&S Agreement limits the liability of the Sellers for indemnifiable lossesto the Aggregate Purchase Price (defined below) (without duplication of amountsrecovered pursuant to the terms of the Asset Purchase Agreement). At this time,management does not believe that this potential obligation will have a materialadverse impact on the Company’s consolidated results of operations, financialposition or liquidity.

 

Also on August 8,2006, Bidmex Holding 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 Asset PurchaseAgreement provided for the sale of the loan portfolio owned by the Asset Sellerto the Asset Purchaser for a purchase price of $10.1 million on the closingdate, which purchase price is part of the Aggregate Purchase Price.  Inthe Asset Purchase Agreement, the Asset Seller and the Sellers made variousrepresentations and warranties concerning (i) the existence and ownershipof the Seller, (ii) the ownership of the loan portfolio, (iii) taxesrelated to periods arising prior to the closing date, and (iv) theexistence of the loans comprising the loan portfolio and other matters relatedto the loan portfolio. The Asset Seller agreed to indemnify the AssetPurchaser from damages resulting from a breach of any representation orwarranty. The indemnity obligation under the Asset Purchase Agreement survivesfor a period of the statute of limitations for matters related to existence andownership of the Seller, ownership of the loans, and taxes for periods prior toAugust 8, 2006. 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. TheIP&S Agreement limits the liability of the Sellers for indemnifiable lossesunder the Asset Purchase Agreement to the Aggregate Purchase Price. At thistime, management does not believe that this potential obligation will have amaterial adverse impact on the Company’s consolidated results of operations, financialposition or liquidity.

 

*Subordinated Equity Investment*

 

During the period from December 1998 to March 2005, FirstCityMexico Inc. and SMIP, each wholly-owned subsidiaries of FirstCity, and CargillFinancial Services International Inc. (“CFSI”) and, in some instances, otherinvestors, acquired 12 residential and commercial non-performing loanportfolios from financial institutions in Mexico (the “Mexican Portfolios”). Eachportfolio was acquired by a Mexican limited liability company (each a “MexicanSRL”) that was owned by a Delaware limited liability company formed by eachinvestor group.  On August 8, 2006, SMIP and National Union FireInsurance Company of Pittsburgh, Pa., American General Life Insurance Companyand American General Life and Accident Insurance Company, affiliates of AIGGlobal Asset Management Holdings Corp. (collectively the “AIG Entities”) formedBidmex Holding for the purpose of acquiring the Mexican Portfolios bypurchasing the interests of Cargill and SMIP in eleven of the Mexican limitedliability companies (the “LLCs”) and purchasing the loan portfolio of one ofthe Mexican limited liability companies (the “Purchased Portfolio”) for anaggregate purchase price of U.S. $119.3 million as of that date (the “AggregatePurchase Price”). SMIP acquired 15% of the membership interests in BidmexHolding. A 9% interest acquired by SMIP is of equivalent standing tomembership interests held by the AIG affiliates representing 85% of themembership interests. The remaining 6% membership interest acquired bySMIP is subordinate to the other owners of interests in Bidmex Holding, whowill receive the return of and a return on their contribution equivalent to an9% internal rate of return with respect to their interests prior to SMIPreceiving the return of and a return on its capital contribution equivalent toa 9% internal rate of return with respect to its 6% interest. At March 31,2010, the carrying value of SMIP’s membership interests in Bidmex Holding thatis included in the Company’s consolidated balance sheet approximated $11.7million ($5.3 million for the 9% membership interest and $6.4 million for the6% membership interest).

 

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** **

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

*Letters of Credit and Other Guarantees*

 

Fondo de Inversion Privado NPL Fund One (“PIF1”), an equity-methodinvestment of FirstCity, has a credit facility with Banco Santander Chile, S.A.with an unpaid principal balance of $9.6 million at March 31, 2010. PIF1uses the credit facility to finance the purchases of loan portfolios. Pursuantto terms of the credit facility, FirstCity was required to provide a stand-byletter of credit from Bank of Scotland that would satisfy the current loanbalance upon demand. At March 31, 2010, FirstCity had a letter of creditin the amount of $10.25 million from Bank of Scotland under the terms ofFirstCity’s revolving acquisition facility with Bank of Scotland, with Banco SantanderChile, S.A. as the letter of credit beneficiary. In the event that a demand ismade under the $10.25 million letter of credit, FirstCity would be required toreimburse Bank of Scotland by making payment to Bank of Scotland for allamounts disbursed or to be disbursed by Bank of Scotland under the letter ofcredit.

 

On November 29, 2006, FirstCity Mexico SA de CV, a Mexicanaffiliate of FirstCity, entered into a loan agreement with Banco Santander,S.A. that allows loans to be made in Mexican pesos. At March 31, 2010, theCompany had 142,240,000 in Mexican peso-denominated debt, which was equivalentto $11.4 million U.S. dollars. 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 March 31, 2010,FirstCity had a letter of credit in the amount of $12.6 million from Bank ofScotland under the terms of FirstCity’s revolving acquisition facility withBank of Scotland.  In the event that a demand is made under the $12.6million letter of credit, FirstCity is required to reimburse Bank of Scotlandby making payment to Bank of Scotland for all amounts disbursed or to bedisbursed by Bank of Scotland under the letter of credit.

 

American Business Lending, Inc. (“ABL”), a wholly-owned subsidiary ofFirstCity, has a $25.0 million revolving loan facility with Wells Fargo CapitalFinance (“WFCF”). The obligations under this facility are secured bysubstantially all of the assets of ABL, and FirstCity provides WFCF with anunconditional guaranty on ABL’s obligations under the loan facility up to amaximum of $5.0 million plus enforcement cost. At March 31, 2010, thebalance of this loan facility was $12.6 million.

 

FirstCity Commercial Corp. (“FirstCity Commercial”), a wholly-ownedsubsidiary of FirstCity, provides guarantees to various financial institutionsrelated to their financing of the investments and operations of certainAcquisition Partnerships. The underlying financing arrangements of theseAcquisitions Partnerships have various maturities ranging from July 2010to September 2012, and are secured primarily by certain real estateproperties held by the Acquisition Partnerships. At March 31, 2010, thetotal unpaid debt obligations of these Acquisition Partnerships attributed toFirstCity Commercial’s underlying guaranty approximated $1.5 million.

 

*Environmental Matters*

 

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. Liabilities for future remediation costs arerecorded when environmental assessments and/or remedial efforts are probableand the costs can be reasonably estimated. Other than for assessments, thetiming and magnitude of these accruals generally are based on the completion ofinvestigations or other studies or a commitment to a formal plan of action.

 

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** **

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)**

 

*Limited-LifeSubsidiaries*

 

At March 31, 2010, the estimated settlement value of the Company’snon-controlling interests in consolidated limited-life subsidiariesapproximated $2.5 million. The Company’s carrying value of the non-controllinginterests recognized on the consolidated balance sheet related to theselimited-life subsidiaries approximated $0.9 million at March 31, 2010.

 

*Income Taxes*

 

We are subject to income taxes in both the United States and thenon-U.S. jurisdictions in which we operate. Certain of our entities areunder examination by the relevant taxing authorities for various tax years. Weregularly assess the potential outcome of current and future examinations ineach of the taxing jurisdictions when determining the adequacy of the provisionfor income taxes. We have only recorded financial statement benefits for taxpositions which we believe reflect the “more-likely-than-not” criteriaincorporated in the FASB’s authoritative guidance on accounting for uncertaintyin income taxes, and we have established income tax reserves in accordance withthis authoritative guidance where necessary. Once a financial statement benefitfor a tax position is recorded or a tax reserve is established, we adjust itonly when there is more information available or when an event occursnecessitating a change. While we believe that the amount of the recordedfinancial statement benefits and tax reserves reflect the more-likely-than-notcriteria, it is possible that the ultimate outcome of current or futureexaminations may result in a reduction to the tax benefits previously recordedon the financial statements or may exceed the current income tax reserves inamounts that could be material.

 

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

 

**Overview**

 

FirstCity is afinancial services company that engages in two major business segments —Portfolio Asset Acquisition and Resolution and Special Situations Platform. ThePortfolio Asset Acquisition and Resolution business has been the Company’s corebusiness segment since it commenced operations in 1986. In the Portfolio AssetAcquisition and Resolution business, the Company acquires portfolios ofperforming and non-performing loans and other assets (collectively, “PortfolioAssets” or “Portfolios”), generally at a discount to their legal principalbalances or appraised values, and services and resolves such Portfolio Assetsin an effort to maximize the present value of the ultimate cash recoveries.Through its Special Situations Platform, the Company provides investmentcapital to privately-held middle-market companies through flexible capitalstructuring arrangements to generate an attractive risk-adjusted return. Thesecapital investments primarily take the form of senior and junior financingarrangements, but also include direct equity investments, common equitywarrants, distressed debt transactions, and leveraged buyouts.

 

FirstCityrecorded net earnings of $0.1 million, or $0.01 per common share diluted, forthe first quarter of 2010 (“Q1 2010”), compared to $0.6 million, or $0.07 percommon share diluted, for the first quarter of 2009 (“Q1 2009”). Components ofFirstCity’s results of operations for Q1 2010 and Q1 2009 are detailed below(dollars in thousands, except per share data):

 
| ** **                                  | ** ** | **Three Months Ended**     | ** ** |
|---------------------------------------------|------------|----------------------------|------------|
| ** **                                  | ** ** | **March 31,**         | ** ** |
| ** **                                  | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                                  | ** ** | **(Dollars in thousands)** | ** ** |
| Portfolio Asset Acquisition  and Resolution |       | $                          | 1,093      |   | $ | 916 |   |
| Special Situations Platform                 |       | 715                        |       | 1,337 |   |
| Operating contribution                      |       | 1,808                      |       | 2,253 |   |
| Corporate overhead                          |       | (1,707                     | )          | (1,609 | ) |
| Net earnings attributable  to FirstCity     |       | $                          | 101        |   | $ | 644 |   |
| Diluted earnings per common  share          |       | $                          | 0.01       |   | $ | 0.07 |   |

 

Referto **Results of Operations** below for adetailed review of the Company’s operations for Q1 2010 compared to Q1 2009.

 

In Q1 2010, theCompany was involved in acquiring $18.1 million of domestic Portfolio Assetinvestments with a face value of approximately $34.5 million — of whichFirstCity’s investment share was $14.6 million. In addition to its PortfolioAsset acquisitions in Q1 2010, FirstCity invested $4.5 million in the form ofSBA loan originations and advances; and $4.8 million in the form of debtinvestments under its Special Situations Platform (“FirstCity Denver”); $4.4million of equity investments in domestic portfolio companies; and $0.1 millionof other equity investments.  Subsequentto Q1 2010, FirstCity has invested $5.3 million in domestic portfolio assetacquisitions and invested another $0.9 million in the form of debt and equityinvestments.

 

At March 31,2010, the carrying value of FirstCity’s earning assets (primarily PortfolioAssets, equity investments, loans receivable, and entity-level earning assets)approximated $374.3 million — compared to $366.2 million at December 31,2009 and $346.2 million a year ago. The global distribution of FirstCity’searning assets (at carrying value) at March 31, 2010 included $284.1million in the United States; $49.8 million in Europe; and $40.4 million inLatin America.

 

*NetImpairment Provisions*

 

The Companyincurred $2.9 million of net impairment provisions in Q1 2010 compared to $1.7million of net impairment provisions in Q1 2009. Our net impairment provisionsin Q1 2010 were composed of $1.7 million of net provisions recorded to our consolidatedloans and portfolios, and $1.2 million as our share of net impairmentprovisions recorded to loans and portfolios held in our unconsolidatedAcquisition Partnerships. The global distribution of the $2.9 million netimpairment provisions recorded by the Company in Q1 2010 includes $1.7 millionin the United States, $0.7 million in Latin America, and $0.5 million inEurope. These impairment provisions were attributed primarily to declines invalues of loan collateral and real estate assets in our domestic loans andportfolios, and changes in future cash flow estimates from our foreign loansand portfolios. The impairment provisions were identified in connection withmanagement’s quarterly evaluation of the collectibility of the Company’s PortfolioAssets and loans receivable. Theprocess for evaluating and measuring impairment is critical to our financialresults, as it requires subjective and complex judgments due to the need tomake estimates about the impact of matters that are uncertain. This processalso requires estimates that are susceptible to significant revision as moreinformation becomes available. It remains unclear what impact the illiquidmarkets, real estate value declines and the overall economic slowdown willultimately have on our financial results. These conditions could adverselyimpact our business if borrowers cannot refinance their loans and/or continueto make payments — which in turn could lead to rising loan defaults andforeclosures on loan collateral. Therefore, we cannot provide assurance that,in any particular future period, we will not incur additional impairmentprovisions.

 

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*ForeignCurrency Transaction Gains*

 

The combinedimpact of foreign currency transactions from the Company’s consolidated andunconsolidated foreign operations resulted in a $0.5 million foreign currencyexchange loss in Q1 2010 (compared to a combined impact of $1.8 million inforeign currency transaction losses in Q1 2009). The Company’s combined foreigncurrency exchange loss in Q1 2010 was attributable primarily to our Europeanoperations. It remains unclear whatimpact that weakened global economic conditions will have on our financialholdings and investments from our European and Latin American operations. Assuch, we cannot provide assurance that, in any particular future period, wewill not incur foreign currency transaction losses.

 

*Management’s Outlook*

 

Despitesubstantial losses reported in the financial services sector over the past twoyears and continued weaknesses in U.S. and global economies and financialmarkets, management remains positive on the outlook of the Company. Managementbelieves that current market conditions should not hinder FirstCity’s abilityto expand its business, and that distressed asset acquisition and middle-markettransaction opportunities at attractive prices and returns are available. Asmentioned above, FirstCity’s investment level for Q1 2010 totaled $28.4million, and subsequent to March 31, 2010, the Company invested anadditional $6.2 million in domestic portfolio acquisitions and otherinvestments.

 

As reported in ourMarch 30, 2010 news release and in our 2009 Form 10-K filed with theSEC on the same date, Bank of Scotland extended the maturity dates of ourexisting loan facilities to April 1, 2011, and we have been negotiating aterm loan that allows for repayment toBank of Scotland over time as cash flows from the underlying assets securingthe loan facilities are realized. FirstCity has since obtained preliminaryapproval from Bank of Scotland on a $270.0 million term loan subject to finaldocumentation and closing. The primary terms of this pending, preliminary cashflow note facility follows:

 

·                  Scheduledamortization of $270.0 million over 3 years ($45.0 million in the first year,$80.0 million in the second year, $80.0 million in the first nine months of thethird year, and $65.0 million at maturity), with interest at LIBOR + 3.5%(LIBOR floor of 1.0%);

·                  Repayment willbe supported by the Company’s future cash flows, assets and equity investmentswhich are currently pledged to Bank of Scotland;

·                  FirstCity’sexisting loan facilities with Bank of Scotland will be capped (i.e. Bank ofScotland will have no further obligation to fund the existing loan facilities);

·                  FirstCity willreceive a monthly, unencumbered cash leak-through of 20% of the repayment cashflows, up to $25.0 million, after (a) payment to Bank of Scotland ofinterest and fees; and (b) payment of a scheduled overhead allowance ($1.5million per month for the first year, $1.03 million per month for the secondyear, and $0.7 million per month for the third year);

·                  FirstCity willprovide a limited guaranty in the amount of $75.0 million; and

·                  FirstCity willbe required to maintain a minimum net worth (to be defined) of $60.0 million.

 

As part of the pending agreement, FirstCity expects tohave in excess of $40.0 million in unencumbered cash at closing, which combinedwith the unencumbered cash leak-through of up to $25.0 million described above,will potentially provide the Company in excess of $65.0 million in unencumberedcash to fund future investments and operations.

 

We are cognizant of the distressed condition of the U.S. financialmarkets that currently presents challenges for businesses in accessingliquidity and capital. FirstCity continues to negotiate with other partiesto obtain additional financing and to make investments in acquisitionpartnerships. Therecan be no assurances that FirstCity will close on this pending cash flow notewith Bank of Scotland for its loan facilities on terms that are acceptable tothe Company, or that FirstCity will be ableto obtain alternative sources of funding and investment capital on acceptableterms, if at all.

 

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**Results of Operations**

 

The following discussion and analysis is based onthe segment reporting information presented in Note 16 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.

 

As a result of significant period-to-period fluctuations in ourrevenues and earnings, period-to-period comparisons of the results of ouroperations may not be meaningful. The Company’s financial results are impactedby many factors including, but not limited to, general economic conditions;fluctuations in interest rates and foreign currency exchange rates;fluctuations in the underlying values of real estate and other assets; thetiming and ability to collect and liquidate assets; increased competition fromother market players in the industries in which we operate; and theavailability, prices and terms for Portfolio Assets, middle-market transactionsand other investments in all of the Company’s businesses. The Company’sbusiness and results of operations are also impacted by the availability offinancing with terms acceptable to the Company, and our access to capital markets.Such factors, individually or combined with other factors, may result insignificant fluctuations in our reported operations and in the trading price ofour common stock.

 

***Q1 2010 Compared to Q1 2009***

 

Net earnings to common stockholders totaled $0.1 million in Q1 2010compared to net earnings of $0.6 million in Q1 2009. On a per share basis,diluted net earnings to common stockholders were $0.01 in Q1 2010 compared to$0.07 in Q1 2009.

 

*Portfolio Asset Acquisition andResolution*

 

The operating contribution from the PortfolioAsset Acquisition and Resolution segment resulted in a $1.1 million operatinggain in Q1 2010 compared to a $0.9 million operating gain for the same periodin 2009. FirstCitywas involved in acquiring $18.1 million of Portfolio Assets in Q1 2010 with anapproximate Face Value of $34.5 million, compared to its involvement inacquiring $70.2 million of Portfolio Assets in Q1 2009 with an approximate FaceValue of $140.8 million. In Q1 2010, FirstCity’s investment share in PortfolioAsset acquisitions was $14.6 million — with all such investments acquiredthrough consolidated Portfolios. In Q1 2009, FirstCity’s investment share inPortfolio Asset acquisitions was $64.9 million — with all such investmentsacquired through consolidated Portfolios. In Q1 2010, FirstCity invested anadditional $9.0 million in the form of SBA loan originations and advances,direct equity investments, and other loan investments — compared to $6.4million of such additional investments in Q1 2009.

 

The following is a summary of the results ofoperations for the Company’s Portfolio Asset Acquisition and Resolutionbusiness segment for the three-month periods ended March 31, 2010 and2009:

 

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| ** **                                                    | ** ** | **Three Months Ended**     | ** ** |
|---------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                    | ** ** | **March 31,**         | ** ** |
| ** **                                                    | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                                                    | ** ** | **(Dollars in thousands)** | ** ** |
| **Portfolio  Asset Acquisition and Resolution:**              |       |                       |       |   |   |
| Revenues:                                                     |       |                       |       |   |   |
| Servicing fees                                                |       | $                          | 2,003      |   | $ | 2,392 |   |
| Income from Portfolio  Assets                                 |       | 11,463                     |       | 9,043 |   |
| Interest income from SBA  loans                               |       | 268                        |       | 346 |   |
| Interest income from loans  receivable - affiliates           |       | 477                        |       | 536 |   |
| Interest income from loans  receivable - other                |       | —                     |       | 207 |   |
| Other income                                                  |       | 511                        |       | 773 |   |
| Total revenues                                                |       | 14,722                     |       | 13,297 |   |
| Expenses:                                                     |       |                       |       |   |   |
| Interest and fees on notes  payable                           |       | 3,321                      |       | 3,324 |   |
| Salaries and benefits                                         |       | 3,847                      |       | 3,569 |   |
| Provision for loan and  impairment losses                     |       | 1,101                      |       | 1,106 |   |
| Asset-level expenses                                          |       | 1,495                      |       | 1,106 |   |
| Other                                                         |       | 2,117                      |       | 2,113 |   |
| Total expenses                                                |       | 11,881                     |       | 11,218 |   |
| Equity in net earnings  (loss) of unconsolidated subsidiaries |       | 1,183                      |       | (985 | ) |
| Gain on business  combinations                                |       | 891                        |       | — |   |
| Net (income) loss  attributable to noncontrolling interests   |       | (4,476                     | )          | 83 |   |
| Operating contribution  (loss) before direct taxes            |       | $                          | 439        |   | $ | 1,177 |   |
| Operating contribution, net  of direct taxes                  |       | $                          | 1,093      |   | $ | 916 |   |

 

*Servicing fee revenues. *Servicing fee revenues decreasedto $2.0 million in Q1 2010 from $2.4 million in Q1 2009.

 

Servicing fees from domestic AcquisitionPartnerships totaled $0.3 million in Q1 2010 compared to $0.7 million in Q12009, while servicing fees from Latin American Acquisition Partnerships totaled$1.7 million in both Q1 2010 and Q1 2009. Servicing fees from domesticAcquisition Partnerships are generally based on a percentage of the collectionsreceived from Portfolio Assets held by these unconsolidated partnerships;whereas servicing fees from Latin American Acquisition Partnerships aregenerally based on the cost of servicing plus a profit margin. The decline inservicing fees from domestic Acquisition Partnerships for Q1 2010 in comparisonto Q1 2009 was attributable to the recognition of performance-based servicefees on certain domestic partnerships achieving performance thresholds in Q12009 (no such performance-based service fees were recognized in Q1 2010).

 

*Income from Portfolio Assets*.  Income from Portfolio Assets increased to$11.5 million in Q1 2010 compared to $9.0 million in Q1 2009. FirstCity’saverage investment in consolidated Portfolio Assets increased significantly to$211.5 million for Q1 2010 from $157.8 million for Q1 2009. The large increasein income from Portfolio Assets is attributed primarily to an increase inconsolidated collections to $37.0 million in Q1 2010 compared to $30.5 millionin Q1 2009 (due to FirstCity’s increased holdings in consolidated PortfolioAssets). Refer to Note 4 of the consolidated financial statements included inItem 1 of this Form 10-Q for a summary of income from Portfolio Assets.

 

*Interest income from SBAloans. *Interest income from SBA loansdecreased slightly to $268,000 for Q1 2010 from $346,000 for Q1 2009. Theinterest income decline is attributed primarily to a decline in FirstCity’saverage investment level in SBA loans to $17.5 million for Q1 2010 compared to$22.7 million for Q1 2009.

 

*Interest income from loansreceivable — affiliates. *Interest incomefrom loans receivable — affiliates decreased slightly to $477,000 in Q1 2010compared to $536,000 for Q1 2009. The interest income decline is attributed toa decline in FirstCity’s average investment level in loans receivable —affiliates to $12.6 million for Q1 2010 compared to $14.5 million for Q1 2009.

 

*Interest income from loansreceivable — other. * Interest income from loans receivable — otherdecreased by $0.2 million for Q1 2010 compared to Q1 2009. The decline ininterest income in Q1 2010 compared to Q1 2009 is attributable to FirstCity’sincreased holdings in Q1 2010 of such loans accounted for under the costrecovery method of accounting (i.e. non-accrual method). FirstCity’s averageinvestment in loans receivable — other was $5.5 million in Q1 2010 (all ofwhich were accounted for under the cost recovery method during the entireperiod). FirstCity’s average investment in loans receivable — other was $7.5million in Q1 2009 (all of which were income-accruing loans).

 

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*Other income*.  Other income for Q1 2010 decreased to $0.5million compared to $0.8 million for Q1 2009 primarily due to $0.2 million ofadditional interest income recorded in Q1 2009 compared to Q1 2010 on theCompany’s available-for-sale investment security.

 

*Expenses. *Operating expenses approximated$11.9 million and $11.2 million in Q1 2010 and Q1 2009, respectively. Thefollowing is a discussion of the major components of operating expenses.

 

Interest expense and fees on notes payabletotaled $3.3 million for both Q1 2010 and Q1 2009. FirstCity’s averageoutstanding debt increased to $291.4 million in Q1 2010 from $259.2 million inQ1 2009 — primarily to finance its increased investment activity and to provideworking capital to support future growth. However, the Company’s average costof borrowings decreased to 4.6% in Q1 2010 compared to 5.1% in Q1 2009 due to adecline in market interest rates.

 

Salaries and benefits totaled $3.8 million and$3.6 million in Q1 2010 and Q1 2009, respectively. The total number ofpersonnel within the Portfolio Asset Acquisition and Resolution segment was 211and 210 at March 31, 2010 and 2009, respectively.

 

Net provisions for loan and impairment losses on our consolidatedPortfolio Assets and loans receivable totaled $1.1 million in both Q1 2010 andQ1 2009. The $1.1 million of net impairment provisions in Q1 2010 wereattributed primarily to declines in values of loan collateral and real estateassets in our domestic loans and Portfolios, which was responsible for $1.0million of the Company’s consolidated net provisions recorded in Q1 2010. Theimpairment provisions were identified in connection with management’s quarterlyevaluation of the collectibility of the Company’s Portfolio Assets and loansreceivable. The process for evaluatingand measuring impairment is critical to our financial results, as it requiressubjective and complex judgments due to the need to make estimates about theimpact of matters that are uncertain. This process also requires estimates thatare susceptible to significant revision as more information becomes available.It remains unclear what impact the illiquid markets, real estate value declinesand the overall economic slowdown will ultimately have on our financialresults. Therefore, we cannot provide assurance that, in any particular future period,we will not incur additional impairment provisions.

 

Asset-level expenses, which generally representcosts incurred by FirstCity to manage consolidated Portfolio Assets, supportforeclosed properties and to protect its security interests in loan collateral,increased to $1.5 million in Q1 2010 compared to $1.1 millionfor Q1 2009. The increase isattributed primarily to the Company’s increased holdings in consolidatedPortfolio Assets (the Company’s average investment in consolidated PortfolioAssets totaled $211.5 million for Q1 2010 compared to $157.8 million for Q12009).

 

Other costs and expenses remained level at $2.1million for both Q1 2010 and Q1 2009.

 

*Equity in earnings ofunconsolidated subsidiaries. *Equity in earningsof unconsolidated subsidiaries (Acquisition Partnership and servicing entities)increased to $1.2 million in earnings for Q1 2010 compared to $1.0 million inlosses for Q1 2009. Equity in losses of our unconsolidated AcquisitionPartnerships was $0.6 million in Q1 2010 compared to $0.9 million in Q1 2009,whereas equity in earnings of our unconsolidated servicing entities increased to$1.8 million of earnings in Q1 2010 compared to $0.1 million of losses in Q12009. The following is a discussion of equity in earnings from FirstCity’sAcquisition Partnerships (by geographic region) and servicing entities. Referto Note 6 of the consolidated financial statements included in Item 1 of this Form 10-Qfor a summary of revenues, earnings and equity in earnings of FirstCity’sequity-method investments by region.

 

·             *Domestic* — Total revenues reported by domestic AcquisitionPartnerships increased to $1.8 million in Q1 2010 compared to $1.6 million inQ1 2009. Total net earnings reported bydomestic partnerships increased to $0.8 million in earnings for Q1 2010 comparedto $0.1 million in earnings for Q1 2009. The increase in total revenuesand net earnings in Q1 2010 compared to Q1 2009 was attributable primarily toan increase in collections to $5.3 million in Q1 2010 from $4.4 million in Q12009. In addition, asset-level expenses decreased by $0.3 million in Q1 2010compared to Q1 2009 primarily as a result of a decrease in Portfolio Assetholdings by the domestic Acquisition Partnerships over the past year (seeparagraph below). The collective activity described above translated to anincrease in FirstCity’s share of domestic partnership earnings to $132,000 inQ1 2010 compared to $1,000 in Q1 2009.

 

FirstCity’s average investment in domestic Acquisition Partnershipsdecreased to $12.2 million for Q1 2010 from $14.8 million for Q1 2009. Since a majority of FirstCity’s domesticportfolio acquisitions over the past two years were acquired through consolidatedPortfolios instead of equity-method investments in Acquisition Partnerships,the Company expects income from consolidated Portfolio Assets to grow whileequity in earnings from the domestic partnerships is expected to decrease.

 

41

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·         *Latin America* — Total revenues reported by Latin American Acquisition Partnershipsincreased to $3.4 million in Q1 2010 from $2.5 million in Q1 2009. Total netlosses reported by Latin American partnerships decreased significantly to $1.8 million in Q1 2010 compared to $12.4 millionin Q1 2009. Total collections from Latin American partnerships remained flat at$6.2 million in Q1 2010 compared to $6.1 million in Q1 2009. The significantchange in net losses reported by the Latin American partnerships in Q1 2010 andQ1 2009 was due primarily to foreign currency exchange gains of $0.8 millionrecorded by these partnerships in Q1 2010 compared to $11.1 million of foreigncurrency exchange losses recorded in Q1 2009 — an $11.9 million favorableswing. The significant fluctuation in the foreign currency exchange amountsreported by the Latin American partnerships was due to the strengthening of theMexican peso against the U.S. dollar in Q1 2010 compared to Q1 2009. Thepositive impact resulting from the foreign currency exchange transactionsdescribed above was off-set partially by $2.0 million of additional netimpairment provisions recorded in Q1 2010 compared to Q1 2009. Thecollective activity described above translated to a favorable decline inFirstCity’s share of losses in Latin American partnerships to $0.1 million inlosses for Q1 2010 compared to $1.6 million in losses for Q1 2009.  FirstCity’s average investment in LatinAmerican Acquisition Partnerships remained relatively flat at $17.4 million forQ1 2010 compared to $17.7 million for Q1 2009.

 

·             *Europe*—****Total revenues reported by European AcquisitionPartnerships decreased to $1.9 million in Q1 2010 from $6.2 million in Q1 2009.In addition, total net earnings reported by the European partnerships decreasedto $2.0 million in losses in Q1 2010 from $2.8 million in earnings for Q1 2009.The decrease in total partnership net earnings reported by Europeanpartnerships was attributed primarily to (1) decrease in collections to$7.9 million in Q1 2010 compared to $9.1 million in Q1 2009; and (2) increasein net impairment provisions to $1.5 million in Q1 2010 from $0.9 million in Q12009. In addition, contributing to the decline in European partnership revenueswas the decrease in Portfolio Asset holdings by these Acquisition Partnershipsover the past two years (see paragraph below). The collective activitydescribed above translated to a decrease in FirstCity’s share of Europeanpartnership earnings to $0.6 million in losses for Q1 2010 from $0.8 million inearnings for Q1 2009.

 

FirstCity’s average investment in European Acquisition Partnershipsdecreased to $8.1 million for Q1 2010 from $13.0 million for Q1 2009 — whichcontributed to a decline in FirstCity’s share of European partnership revenuesas discussed above. Since a majority ofFirstCity’s portfolio acquisitions over the past two years were acquiredthrough consolidated Portfolios instead of equity investments in AcquisitionPartnerships, and in light of FirstCity’s step-acquisition transactions andresulting consolidations of UBN (former unconsolidated European AcquisitionPartnership) in September 2008 and sixteen French entities (formerunconsolidated European Acquisition Partnerships) in May 2009, the Companyexpects income from consolidated Portfolio Assets to offset the decline inEuropean partnerships revenues.

 

·             *Servicing Entities*—****Total revenuesreported by our foreign unconsolidated servicing entities increased to $16.1million in Q1 2010 from $11.7 million in Q1 2009, and total net earningsreported by these entities improved to $5.5 million of net earnings in Q1 2010from $0.2 million of net losses in Q1 2009. The increase in servicing entityrevenue and our reported net earnings in the underlying entities was attributedprimarily to (1) additional investment income of $4.5 million recorded inQ1 2010 compared to Q1 2009; and (2) a $2.8 million decrease in income taxprovisions in Q1 2010 compared to Q1 2009 as a result of our ability torecognize foreign tax benefits associated with U.S. GAAP adjustments to anunconsolidated foreign servicing entity’s local financial statements, combinedwith the timing of federal income tax payments made by the foreign servicing inits local jurisdiction. The collective activity described above translated toan increase in FirstCity’s share of earnings from our servicing entities to$1.8 million in earnings for Q1 2010 from $0.1 million in losses for Q1 2009.

 

*Gain on business combinations.*  In Q1 2010, the Company recorded a $0.9million gain attributable to a step acquisition transaction in which theCompany acquired a controlling financial interest in three domestic AcquisitionPartnerships. The Company owned a noncontrolling equity interest in theseentities prior to the transaction. Pursuant to business combination accountingstandards, the Company’s previously-held noncontrolling interests in theseentities were re-measured to fair value on the acquisition date) — whichresulted in the Company’s recognition of the $0.9 million gain. Refer to Note 3of the consolidated financial statements included in Item 1 of this Form 10-Qfor additional information on this transaction.

 

*Net income attributable tononcontrolling interests. *The amount of netincome attributable to noncontrolling interests increased to $4.5 million forQ1 2010 from a net loss of $0.1 million for Q1 2009. The increase is attributedprimarily to a rise in net earnings from co-investments in Portfolio Assetswith other investors through consolidated Acquisition Partnerships since Q12009. The Company’s carrying value of noncontrolling interests on itsconsolidated balance sheets attributed to consolidated AcquisitionPartnerships, which represents the equity in these consolidated subsidiariesnot attributable to FirstCity, increased to $39.6 million at March 31,2010 from $19.8 million at March 31, 2009.

 

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***Special Situations PlatformBusiness Segment***

 

The operating contribution from the Special Situations Platformbusiness segment (“FirstCity Denver”) totaled $0.7 million in Q1 2010 comparedto $1.3 million in Q1 2009. In Q1 2010, FirstCity Denver provided $4.8 millionof investment capital to privately-held middle-market companies in the form ofdebt, compared to $2.4 million of investment capital provided to such companiesin the form of debt in Q1 2009. Since its inception in April 2007,FirstCity Denver has been involved in middle-market transactions with totalinvestment values in excess of $75.9 million, and has provided $48.6 million ofinvestment capital in connection with these investments.

 

The following is a summary of the results ofoperations for the Company’s Special Situations Platform business segment for the three months ended March 31, 2010 and2009:

 
| ** **                                             | ** ** | **Three Months Ended**     | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|
| ** **                                             | ** ** | **March 31,**         | ** ** |
| ** **                                             | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                                             | ** ** | **(Dollars in thousands)** | ** ** |
| **Special  Situations Platform:**                      |       |                       |       |   |   |
| Revenues:                                              |       |                       |       |   |   |
| Interest income from loans  receivable                 |       | $                          | 609        |   | $ | 608 |   |
| Operating revenue from  railroad operations            |       | 1,265                      |       | 747 |   |
| Operating revenue from  manufacturing operations       |       | 4,359                      |       | — |   |
| Other income                                           |       | 577                        |       | 983 |   |
| Total revenues                                         |       | 6,810                      |       | 2,338 |   |
| Expenses - Railroad  Operations:                       |       |                       |       |   |   |
| Interest and fees on notes  payable                    |       | 38                         |       | 35 |   |
| Salaries and benefits                                  |       | 277                        |       | 244 |   |
| Other                                                  |       | 291                        |       | 212 |   |
| Total railroad expenses                                |       | 606                        |       | 491 |   |
| Expenses - Manufacturing  Operations:                  |       |                       |       |   |   |
| Salaries and benefits                                  |       | 1,207                      |       | — |   |
| Cost of sales                                          |       | 2,543                      |       | — |   |
| Other                                                  |       | 1,086                      |       | — |   |
| Total manufacturing  expenses                          |       | 4,836                      |       | — |   |
| Expenses - Other:                                      |       |                       |       |   |   |
| Interest and fees on notes  payable                    |       | 113                        |       | 115 |   |
| Salaries and benefits                                  |       | 297                        |       | 192 |   |
| Provision for loan and  impairment losses              |       | 601                        |       | — |   |
| Other                                                  |       | 383                        |       | 450 |   |
| Total other expenses                                   |       | 1,394                      |       | 757 |   |
| Total expenses                                         |       | 6,836                      |       | 1,248 |   |
| Equity in net earnings of  unconsolidated subsidiaries |       | 1,046                      |       | 839 |   |
| Net income attributable to  noncontrolling interests   |       | (138                       | )          | (431 | ) |
| Operating contribution before  taxes                   |       | $                          | 882        |   | $ | 1,498 |   |
| Operating contribution, net  of direct taxes           |       | $                          | 715        |   | $ | 1,337 |   |

 

*Interest income from loansreceivable. * Interest income from loans receivable in the first quarter of 2010 remained constant in comparison to the sameperiod in 2009. FirstCity Denver’s average investment in loans receivable was$18.6 million for Q1 2010 — including $2.9 million accounted for under the costrecovery method. For Q1 2009, FirstCity Denver’s average investment in loansreceivable was $18.3 million.

 

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*Revenue and expenses from railroad operations*.  Revenue and expenses from railroad operationsrepresents the results of operations recorded by FirstCity Denver’smajority-owned railroad companies (engaged primarily in interchanging rail cars withconnecting carriers and providing rail freight services for on-line customers).Revenue from railroad operations increasedby $0.5 million in Q1 2010 comparedto Q1 2009 due to an increase in rail car movement services performed in Q12010. Total Q1 2010 expenses attributable to the railroad operationsremained relatively constant in comparison to Q1 2009.

 

*Revenue and expenses frommanufacturing operations*.  Revenueand expenses from manufacturing operations represents the results of operationsrecorded by FirstCity Denver’s majority-owned manufacturing company (engaged principally in the design,production and sale of wireless transmission equipment and software solutions) that it acquired in December 2009. The company’ssales in Q1 2010 were composed of $2.3 million related to equipment and $2.0million related to software solutions. In Q1 2010, 25% of the company’s saleswere made to international customers.

 

*Other income*.  Other income in Q1 2010 decreased by $0.4 millionin comparison to Q1 2009 primarily due to $0.9 million of gains recognized byFirstCity’s railroad operations in Q1 2009 in connection with property andequipment sales.

 

*Expenses — Other. *Other expenseincreased by $0.6 million in Q1 2010 compared to Q1 2009 primarily due to $0.6million of additional net impairment provisions recorded in Q1 2010 on amiddle-market company debt investment. The impairment provision was identified in connectionwith management’s regular evaluation of the collectibility of FirstCity Denver’sloan investments. The process forevaluating and measuring impairment is critical to our financial results, as itrequires subjective and complex judgments due to the need to make estimatesabout the impact of matters that are uncertain; and estimates that aresusceptible to significant revision as more information becomes available.

 

*Equity in net earnings ofunconsolidated subsidiaries. *Equity in netearnings of unconsolidated subsidiaries totaled $1.0 million in Q1 2010 and $0.8 million in Q1 2009 — which is composed primarily of FirstCityDenver’s equity earnings in its equity-method investments in a coal mineoperation and multiple manufacturing concerns. In Q1 2010, FirstCity Denver’sshare of net earnings in unconsolidated subsidiaries was composed primarily of$0.9 million in earnings from the coal mine operation and $0.2 million inearnings from manufacturing entities. Equity in net earnings for Q1 2009 wasattributable to earnings from the coal mine operation.

 

#### **FinancialCondition**

#### ** **

Significant changes in FirstCity’s financialcondition during the first three months of 2010 resulted from the following:

 

Consolidated assets of $453.5 million at March 31,2010 were $11.6 million lower than consolidated assets at December 31, 2009.The decrease in consolidated assets was attributed primarily to an $8.8 milliondecrease in equity-method investments during Q1 2010 (primarily due to cashdistributions, downward foreign currency translation adjustments, and FirstCity’sstep acquisition of three domestic Acquisition Partnerships that resulted inthe consolidation of such entities) and a $21.9 million decrease in cash (referto the consolidated statement of cash flows in Item 1 of this Form 10-Qfor additional information on cash changes). These asset decreases were off-setpartially by a $15.9 million increase in FirstCity’s Portfolio Assets and loansreceivable as a result of FirstCity’s investment activity in Q1 2010.

 

Consolidated liabilities of $336.7 million as of March 31,2010 were $3.1 million lower than consolidated liabilities at December 31,2009. During Q1 2010, the Company’s notes payable decreased by $15.5 million asa result of principal payments (net of borrowings). This decrease was off-setpartially by a $13.8 million increase in notes payable as a result of FirstCity’sstep acquisition of three domestic Acquisition Partnerships in Q1 2010 thatresulted in the consolidation of such entities, including their notes payable(Refer to Note 3 of the consolidated financial statements included in Item 1 ofthis Form 10-Q for additional information on this transaction).

 

FirstCity’s reported amount of noncontrollinginterests (included as a component of equity) decreased by $6.8 million since December 31,2009 primarily due to distributions to noncontrolling interests in Q1 2010,off-set partially by net earnings attributable to noncontrolling interests andinvestments in majority-owned entities in Q1 2010 (refer to the consolidatedstatement of stockholders’ equity in Item 1 of this Form 10-Q foradditional information).

 

#### **PortfolioAsset Acquisitions — Portfolio Asset Acquisition and Resolution BusinessSegment**

#### ** **

Revenues with respect to the Company’s Portfolio AssetAcquisition and Resolution business segment consist primarily of (i) incomefrom Portfolio Assets and loans receivable; (ii) gains on the dispositionand settlement of Portfolio Assets and other assets; and (iii) servicingfees from Acquisition Partnerships for the performance of servicing activitiesrelated to the assets held in unconsolidated Acquisition Partnerships. TheCompany also records equity in earnings of unconsolidated AcquisitionPartnerships and servicing entities accounted for under the equity-method ofaccounting.

 

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Portfolio Asset acquisitions bythe Company for Q1 2010 and the last five full fiscal years are as follows:

 
| ** **                 | ** ** | **Purchase**               | ** ** | **FirstCity**  | ** ** |
|----------------------------|------------|----------------------------|------------|----------------|------------|
| ** **                 | ** ** | **Price**                  | ** ** | **Investment** | ** ** |
| ** **                 | ** ** | **(Dollars in thousands)** | ** ** |
| First three months of 2010 |       | $                          | 18,114     |           | $          | 14,605 |   |
| Total 2009                 |       | 200,590                    |       | 147,654        |       |
| Total 2008                 |       | 89,314                     |       | 72,307         |       |
| Total 2007                 |       | 214,333                    |       | 126,714        |       |
| Total 2006                 |       | 296,990                    |       | 144,048        |       |
| Total 2005                 |       | 146,581                    |       | 71,405         |       |
|                            |            |                            |            |                |            |  |  |

 

Subsequent to March 31,2010, FirstCity has acquired $5.3 million of consolidated Portfolio Assets witha Face Value of approximately $15.3 million.

 

The table belowprovides a summary of our Loan Portfolio Assets as of March 31, 2010 and December 31,2009. Our Purchased Credit-Impaired Loans are categorized based on the commonrisk characteristics that management generally uses for pooling purposes (whenmanagement elects to pool groups of purchased loans).

 
| ** **                       | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| **Loan and  Loan Pool Type**     | ** ** | ** **                 | ** ** | ** **            | ** ** |
| Purchased Credit-Impaired  Loans |       |                       |       |                  |       |
| Domestic:                        |       |                       |       |                  |       |
| Commercial real estate           |       | $                          | 150,542    |                  | $          | 138,485 |   |
| Business assets                  |       | 22,326                     |       | 26,983                |       |
| Other                            |       | 7,700                      |       | 3,906                 |       |
| Latin America                    |       | 10,533                     |       | 10,545                |       |
| Europe                           |       | 10,655                     |       | 13,001                |       |
| UBN loan portfolio:              |       |                       |       |                  |       |
| Non-performing loans             |       | 55,495                     |       | 60,929                |       |
| Performing loans                 |       | 1,115                      |       | 1,555                 |       |
| Other                            |       | 6,263                      |       | 8,367                 |       |
| Outstanding balance              |       | 264,629                    |       | 263,771               |       |
| Allowance for loan losses        |       | (59,853                    | )          | (65,825               | )          |
| Carrying amount, net             |       | $                          | 204,776    |                  | $          | 197,946 |   |

 

The followingtable provides a summary of the changes in the allowance for loan lossesrelated to our Loan Portfolio Assets:

 
| ** **                               | ** ** | **Purchased Credit-Impaired Loans** | ** ** | **Other**    | ** ** | ** ** | ** ** |
|------------------------------------------|------------|-------------------------------------|------------|--------------|------------|------------|------------|
| ** **                               | ** ** | **Domestic**                        | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                               | ** ** | **Commercial**                      | ** ** | **Business** | ** ** | ** ** | ** ** | **Latin** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(dollars in thousands)**               | ** ** | **Real Estate**                     | ** ** | **Assets**   | ** ** | **Other**  | ** ** | **America** | ** ** | **Europe** | ** ** | **UBN** | ** ** | **Other** | ** ** | **Total** | ** ** |
| Beginning Balance,  January 1, 2010 |       | $                                   | 5,914      |         | $          | 394        |       | $ | 390 |   | $ | 100 |   | $ | 128 |   | $ | 58,624 |   | $ | 275 |   | $ | 65,825 |   |
| Provisions                               |       | 878                                 |       | 10           |       | 8          |       | 61 |   | 204 |   | — |   | 51 |   | 1,212 |   |
| Recoveries                               |       | (7                                  | )          | —       |       | —     |       | — |   | — |   | (155 | ) | (1 | ) | (163 | ) |
| Charge offs                              |       | (1,794                              | )          | (11          | )          | —     |       | — |   | — |   | 155 |   | (33 | ) | (1,683 | ) |
| Translation adjustments                  |       | —                              |       | —       |       | —     |       | 2 |   | (13 | ) | (5,327 | ) | — |   | (5,338 | ) |
| Ending Balance,  March 31, 2010     |       | $                                   | 4,991      |         | $          | 393        |       | $ | 398 |   | $ | 163 |   | $ | 319 |   | $ | 53,297 |   | $ | 292 |   | $ | 59,853 |   |

 

Due touncertainties related primarily to estimating the timing and/or amount ofcollections on Purchased Credit-Impaired Loans as a result of the currenteconomic environment, the Company’s levels of such loans and loan poolsaccounted for on a non-accrual method of accounting (cost-recovery or cashbasis) increased to $167.6 million at March 31, 2010 from $138.4 millionat December 31, 2009. Under U.S. GAAP, the interest method (i.e. accrualmethod) of accounting is not appropriate if management does not have theability to develop a reasonable expectation of both the timing and amount offuture cash flows to be collected. Refer to Note 1 of the consolidated financial statements included in Item 1 of this Form 10-Qfor additional information and accounting policies related to our PurchasedCredit-Impaired Loans. The following tables provide a summary of theCompany’s Purchased Credit-Impaired Loans by income-recognition method as of March 31,2010 and December 31, 2009 (dollars in thousands):

 

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| ** **    | ** ** | **March 31,  2010**   | ** ** |
|---------------|------------|----------------------------|------------|
| ** **    | ** ** | **Income-Accruing  Loans** | ** ** | **Non-Accrual  Loans** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **    | ** ** | **Purchased**              | ** ** | ** ** | ** ** | **Purchased  Credit-** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **    | ** ** | **Credit-**                | ** ** | ** ** | ** ** | **Impaired  Loans** | ** ** | **Other** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **    | ** ** | **Impaired**               | ** ** | ** ** | ** ** | ** ** | ** ** | **Cost  recovery** | ** ** | ** ** | ** ** | **Cost  recovery** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **    | ** ** | **Loans**                  | ** ** | **Other** | ** ** | **Cash  basis** | ** ** | **basis** | ** ** | **Cash  basis** | ** ** | **basis** | ** ** | **Real  Estate** | ** ** | **Total** | ** ** |
| United States |       | $                          | 23,199     |   | $ | 4,227 |   | $ | 76,965 |   | $ | 74,622 |   | $ | 1,744 |   | $ | — |   | $ | 31,348 |   | $ | 212,105 |   |
|          |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| France        |       | —                     |       | 1,115 |   | 5,610 |   | 7 |   | — |   | 2,199 |   | — |   | 8,931 |   |
|          |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Germany       |       | 4,718                      |       | — |   | — |   | — |   | — |   | — |   | — |   | 4,718 |   |
|          |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Mexico        |       | —                     |       | — |   | — |   | 10,370 |   | — |   | — |   | — |   | 10,370 |   |
|          |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total**     |       | $                          | 27,917     |   | $ | 5,342 |   | $ | 82,575 |   | $ | 84,999 |   | $ | 1,744 |   | $ | 2,199 |   | $ | 31,348 |   | $ | 236,124 |   |

 
| ** **    | ** ** | **December 31, 2009** | ** ** |
|---------------|------------|----------------------------|------------|
| ** **    | ** ** | **Income-Accruing Loans**  | ** ** | **Non-Accrual Loans** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **    | ** ** | **Purchased**              | ** ** | ** ** | ** ** | **Purchased Credit-** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **    | ** ** | **Credit-**                | ** ** | ** ** | ** ** | **Impaired Loans** | ** ** | **Other** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **    | ** ** | **Impaired**               | ** ** | ** ** | ** ** | ** ** | ** ** | **Cost recovery** | ** ** | ** ** | ** ** | **Cost recovery** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **    | ** ** | **Loans**                  | ** ** | **Other** | ** ** | **Cash basis** | ** ** | **basis** | ** ** | **Cash basis** | ** ** | **basis** | ** ** | **Real Estate** | ** ** | **Total** | ** ** |
| United States |       | $                          | 42,385     |   | $ | 5,323 |   | $ | 42,125 |   | $ | 78,165 |   | $ | 2,770 |   | $ | — |   | $ | 26,438 |   | $ | 197,206 |   |
|          |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| France        |       | —                     |       | 1,555 |   | — |   | 7,648 |   | — |   | 2,305 |   | — |   | 11,508 |   |
|          |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Germany       |       | 5,225                      |       | — |   | — |   | — |   | — |   | — |   | — |   | 5,225 |   |
|          |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Mexico        |       | —                     |       | — |   | — |   | 10,445 |   | — |   | — |   | — |   | 10,445 |   |
|          |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total**     |       | $                          | 47,610     |   | $ | 6,878 |   | $ | 42,125 |   | $ | 96,258 |   | $ | 2,770 |   | $ | 2,305 |   | $ | 26,438 |   | $ | 224,384 |   |

 

**Middle-MarketCompany Capital Investments — Special Situations Platform Business Segment**

 

Revenues with respect to the Company’s SpecialSituations Platform business segment consist primarily of (i) interest andfee income from loan investments; (ii) revenues from majority-ownedoperating entities; and (iii) equity in earnings of unconsolidatedinvestments accounted for under the equity-method of accounting.

 

Investments by FirstCity Denver since its inception inApril 2007 are summarized below:

** **
| ** **                 | ** ** | **Total**      | ** ** | **FirstCity Denver’s Investment** | ** ** |
|----------------------------|------------|----------------|------------|----------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **Investment** | ** ** | **Debt**                               | ** ** | **Equity** | ** ** | **Total** | ** ** |
| First three months of 2010 |       | $              | 4,790      |                                   | $          | 4,750 |   | $ | 40 |   | $ | 4,790 |   |
| Total 2009                 |       | 20,058         |       | 12,023                                 |       | 392 |   | 12,415 |   |
| Total 2008                 |       | 28,750         |       | 16,650                                 |       | 3,256 |   | 19,906 |   |
| Total 2007                 |       | 22,314         |       | 5,630                                  |       | 5,900 |   | 11,530 |   |
|                            |            |                |            |                                        |            |  |  |  |  |  |  |  |  |

 

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**Provision for Income Taxes**

 

The Company has substantial net operating loss carryforwards (“NOLs”)for U.S. federal income tax purposes whichcan be used to off-set the tax liability associated with the Company’s pre-taxearnings until the earlier of the expiration or utilization of such NOLs. TheCompany accounts for the benefit of these NOLs, and other income tax items inboth the U.S. and the non-U.S. jurisdictions in which we operate,  under the asset and liability method.Deferred tax assets and liabilities are recognized based on the future taxconsequences attributable to temporary differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective tax bases and operating loss and tax credit carryforwards. Deferredtax assets and liabilities are measured using enacted tax rates expected toapply to taxable income in the years in which those temporary differences areexpected to be recovered or settled. We reduce the carrying amounts of deferredtax assets by a valuation allowance if, based on the available evidence, it ismore likely than not that such assets will not be realized. Accordingly, theneed to establish valuation allowances for deferred tax assets is assessedperiodically by the Company based on the more-likely-than-not realizationthreshold criterion. In the assessment, appropriate consideration is given toall positive and negative evidence related to the realization of the deferredtax assets. This assessment considers, among other factors, the nature,frequency and severity of current and cumulative losses, forecasts of futureprofitability, excess of appreciated asset value over the tax basis of netassets, the duration of statutory carryforward periods, the Company’sexperience with utilizing available operating loss and tax creditcarryforwards, and tax planning strategies. In making such assessments,significant weight is given to evidence that can be objectively verified. At March 31,2010, the Company carried a full valuation allowance for its U.S. deferred taxassets due to the lack of sufficient objective evidence regarding therealization of these assets in the foreseeable future. We will continue toevaluate the deferred tax asset valuation allowance balances in all of ourU.S. and foreign subsidiaries throughout 2010 to determine the appropriatelevel of valuation allowances.

 

**Liquidity and Capital Resources**

 

***Overview***

 

The Companyrequires liquidity to fund its operations, Portfolio Asset acquisitions,investments in and advances to Acquisition Partnerships, capital investments inprivately-held middle-market companies, other investments, repayments of bankborrowings and other debt, and working capital to support our growth.Historically, our primary sources of liquidity have been funds generated fromoperations (primarily loan collections and service fees), equity distributionsfrom the Acquisition Partnerships and other subsidiaries, interest andprincipal payments on subordinated intercompany debt, dividends from theCompany’s subsidiaries, borrowings from credit facilities with externallenders, and other special-purpose short-term borrowings.

 

Cash generatedfrom our operations and investments is dependent primarily upon our ability tocollect on our consolidated Portfolio Assets (and Portfolio Assets in ourAcquisition Partnerships) and loan investments. Many factors, including generaleconomic conditions, are essential to our ability to generate cash flows.Fluctuations in our collections, investment income, credit availability, andadverse changes in other factors, could have a negative impact on our abilityto generate sufficient cash flows to support our business. Despite recentcredit market conditions, we have continued to have access to liquidity in bothour Portfolio Asset Acquisition and Resolution and Special Situations Platformbusiness segments through our credit facility commitments with our externallenders.

 

On and effective March 26,2010, Bank of Scotland extended the maturity dates of our existing loanfacilities to April 1, 2011, and as reported in our March 30, 2010news release and in our 2009 Form 10-K filed with the SEC on the samedate, we have been negotiating a term loan that allows for repayment to Bank of Scotland over time as cash flowsfrom the underlying assets securing the loan facilities are realized. FirstCityhas since obtained preliminary approval from Bank of Scotland on a $270.0million term loan subject to final documentation and closing. The primary termsof this pending, preliminary cash flow note facility follows:

 

·                  Scheduledamortization of $270.0 million over 3 years ($45.0 million in the first year,$80.0 million in the second year, $80.0 million in the first nine months of thethird year, and $65.0 million at maturity), with interest at LIBOR + 3.5%(LIBOR floor of 1.0%);

·                  Repayment willbe supported by the Company’s future cash flows, assets and equity investmentswhich are currently pledged to Bank of Scotland;

·                  FirstCity’sexisting loan facilities with Bank of Scotland will be capped (i.e. Bank ofScotland will have no further obligation to fund the existing loan facilities);

·                  FirstCity willreceive a monthly, unencumbered cash leak-through of 20% of the repayment cashflows, up to $25.0 million, after (a) payment to Bank of Scotland ofinterest and fees; and (b) payment of a scheduled overhead allowance ($1.5million per month for the first year, $1.03 million per month for the secondyear, and $0.7 million per month for the third year);

·                  FirstCity willprovide a limited guaranty in the amount of $75.0 million; and

·                  FirstCity willbe required to maintain a minimum net worth (to be defined) of $60.0 million.

 

As part of the pending agreement, FirstCity expects tohave in excess of $40.0 million in unencumbered cash at closing, which combinedwith the unencumbered cash leak-through of up to $25.0 million described above,will potentially provide the Company in excess of $65.0 million in unencumberedcash to fund future investments and operations.

 

47

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FirstCity is cognizant of the distressed condition of the U.S. financialmarkets that currently presents challenges for businesses in accessingliquidity and capital. As such, FirstCity continues to negotiatewith other parties to obtain additional financing and to make investments in acquisitionpartnerships. Therecan be no assurances that FirstCity will close on this pending cash flow notewith Bank of Scotland for its loan facilities on terms that are acceptable tothe Company, or that FirstCity will be ableto obtain alternative sources of funding and investment capital on acceptableterms, if at all.

 

***Consolidated Statements of CashFlows***

 

The following is an analysis of the cash flows relatedto FirstCity’s consolidated operations for the three-month periods ended March 31,2010 and 2009:

 

Our operatingactivities used cash of $11.1 million and $6.8 million for the three-monthperiods ended March 31, 2010 and 2009, respectively. For the three months endedMarch 31, 2010, net cash used in operations was attributable primarily to$4.0 million of net principal advances on SBA loans held for sale; $11.5million of non-cash deductions for income accretion and gains on PortfolioAssets; and a $2.2 million non-cash deduction for equity earnings fromequity-method investments — off-set partially by $4.7 million of net earnings;$1.9 million of proceeds applied to income from Portfolio Assets; and $2.8million of non-cash add-backs related to depreciation, amortization, andprovisions for loan and impairment losses. Net cash used in operations for thethree-month period ended March 31, 2009 was attributable primarily to $4.7million of net principal advances on SBA loans held for sale, and $9.0 millionof non-cash deductions for income accretion and gains on Portfolio Assets —off-set partially by $1.0 million of net earnings; $4.9 million of proceedsapplied to income from Portfolio Assets; and $2.1 million of non-cash add-backsrelated to depreciation, amortization, and provisions for loan and impairmentlosses. The remaining changes in the periods were due primarily to net changesin other accounts related to our operating activities.

 

Our investingactivities provided cash of $13.1 million and used cash of $43.6 million forthe three-month periods ended March 31, 2010 and 2009, respectively. Forthe three months ended March 31, 2010, net cash provided by investingactivities was attributable primarily to $13.6 million of principal collectionson Portfolio Assets (net of purchases), and $2.9 million of distributions fromequity-method investments — off-set partially by $3.0 million paid for businesscombinations (net of cash acquired), and $0.7 million of net advances andoriginations for loan investments. Net cash used in investing activities forthe three-month period ended March 31, 2009 was attributable primarily toPortfolio Assets purchases of $44.8 million (net of principal collections), and$2.1 million of net advances and originations for loan investments — off-setpartially by $1.8 million of distributions from equity-method investments, and$1.4 million of proceeds from property and equipment sales. The remainingchanges in the periods were due primarily to net changes in other accountsrelated to our investing activities.

 

Our financingactivities used cash of $23.9 million and provided cash of $50.6 million forthe three-month periods ended March 31, 2010 and 2009, respectively. Forthe three months ended March 31, 2010, net cash used in financingactivities was attributable primarily to $16.5 million of net principalpayments and fees on notes payable, and $13.0 million of cash distributions tononcontrolling interests — off-set partially by $3.3 million of contributionsfrom noncontrolling interests primarily to acquire Portfolio Assets throughconsolidated subsidiaries, and $2.3 million of proceeds from secured borrowingsrelated to SBA loan sale transactions. Net cash provided by financingactivities for the three-month period ended March 31, 2009 wasattributable primarily to $44.8 million of net borrowings to finance ourPortfolio Asset acquisitions and other investments, and $5.7 million ofcontributions from noncontrolling interests primarily to acquire PortfolioAssets through consolidated subsidiaries. The remaining changes in the periodswere due primarily to net changes in other accounts related to our financingactivities.

 

Cash paid forinterest expense approximated $2.3 million for each of the three-month periodsended March 31, 2010 and 2009. Substantially all of our interest expensewas paid on our credit facilities and other borrowings. FirstCity’s average outstanding debt increased to $302.2 million for thefirst three months of 2010 from $270.1 million for the first three months of2009, while the average cost of borrowings decreased to 4.6% in 2010 comparedto 5.2% in 2009. The increase in the Company’s debt level since March 31,2009 is a result of increased net borrowings to finance the Company’s growthand investment transactions.

 

48

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***Statementsof Cash Flows — Consolidated Railroad and Manufacturing Operations***

 

The cash flowsrelated to FirstCity’s majority-owned railroad and manufacturing subsidiarieswere not material to the Company’s consolidated cash flows for Q1 2010 or Q12009, as applicable.

 

***CreditFacilities***

 

FirstCity has$350.0 million of credit facility commitments (subject to borrowing baserequirements of the respective credit facilities) with Bank of Scotland andBoS(USA) (collectively, “Bank of Scotland”) available to finance its portfolioand asset purchases, capital investments in new ventures, and to provide forworking capital to support our growth. These credit facilities are available toFirstCity through their maturity in April 2011 (as amended — see below).As discussed above, FirstCity obtained preliminary approval from Bank ofScotland to combine the debt under these credit facilities and convert the debtinto a $270.0 million three-year term loan (subject to final documentation and closing). There can be no assurancesthat FirstCity can obtain an extension or renewal of these loan facilities onterms that are acceptable to it or agree upon the terms for an extension ofthese loan facilities.

 

On and effective March 26,2010, FirstCity entered into amendments to its existing loan facilities withBank of Scotland that extended the maturity dates of the debt outstanding underthese loan agreements to April 1, 2011. The credit amendments did notchange the other primary terms and covenants of these loan facilities.

 

The following is asummary of FirstCity’s primary external lending facilities that it uses toprovide liquidity for equity and loan investments, Portfolio Assetacquisitions, Acquisition Partnership investments, capital investments, andworking capital.

 

*$225.0 Million Revolving Loan Facility — Bank ofScotland*

 

FirstCity has a $225.0 million revolving acquisitionfacility with Bank of Scotland that matures on April 1, 2011 (as amended).The revolving loan facility is used to finance the senior debt and equityportion of Portfolio 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 secured by substantially all of the assets ofFirstCity and its consolidated subsidiaries and guaranteed by substantially allof FirstCity’s consolidated subsidiaries. The primary terms and key covenantsof this loan facility are described in our 2009 Form 10-K. At March 31,2010, the Company was in compliance with all covenants or other requirementsset forth in the credit agreement or other agreements with Bank of Scotland.

 

FirstCity has$21.2 million in Euro-denominated debt on this revolving loan facility for thepurpose of hedging a portion of the Company’s net equity investments in Europe.Refer to Note 9 to our consolidatedfinancial statements included in Item 1 of this Form 10-Q for additionalinformation.

 

*$100.0 Million Revolving LoanFacility — Bank of Scotland*

 

FH Partners has a $100.0 million revolving loanfacility with Bank of Scotland that provides financing for Portfolio Assetpurchases by FH Partners. This revolving loan facility matures on April 1,2011 (as amended), and is secured by all assets of FH Partners and a guarantyby FirstCity and certain of its consolidated subsidiaries. The primary termsand key covenants of this loan facility are described in our 2009 Form 10-K.At March 31, 2010, FH Partners was in compliance with all covenants orother requirements set forth in the credit agreement or other agreements withBank of Scotland.

 

49

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*$25.0 Million Subordinated CreditAgreement — BoS(USA)*

 

FirstCityhas a $25.0 million subordinated credit agreement with BoS(USA), which may beused to finance equity investments in new ventures, equity investments made inconnection with Portfolio Asset purchases and loans made by FirstCity and itssubsidiaries to acquisition entities, provide for the issuance of letters ofcredit, and for working capital loans. This credit facility matures on April 1,2011 (as amended), and is secured by substantially all of the assets ofFirstCity and its consolidated subsidiaries and guaranteed by substantially allof FirstCity’s consolidated subsidiaries. The primary terms and key covenantsof this loan facility are described in our 2009 Form 10-K. At March 31,2010, the Company was in compliance with all covenants or other requirementsset forth in the credit agreement or other agreements with Bank of Scotland.

 

*BancoSantander, S.A.*

 

FirstCity MexicoSA de CV, a Mexican affiliate of FirstCity, has a term note with BancoSantander, S.A. with an unpaid principal balance of 142,240,000 Mexican pesosat March 31, 2010, which was equivalent to $11.4 million U.S. dollars onthat date. The loan proceeds are used to pay down the acquisition facility withthe Bank of Scotland. Pursuant to the terms of the credit facility, FirstCityMexico SA de CV was required to provide a stand-by letter of credit from Bankof Scotland that would satisfy the loan balance upon demand. At March 31,2010, FirstCity had a letter of credit in the amount of $12.6 million from Bankof Scotland under the terms of FirstCity’s revolving acquisition facility withBank of Scotland. In the event that a demand is made under the $12.6million letter of credit, FirstCity would be required to reimburse Bank ofScotland by making payment to Bank of Scotland for all amounts disbursed or tobe disbursed by Bank of Scotland under the letter of credit.

 

*Wells Fargo Foothill, LLC*

 

At March 31,2010, ABL had a $25.0 million revolving loan facility with Wells Fargo CapitalFinance (“WFCF”) for the purpose of financing and acquiring SBA loans. Thiscredit facility matures in January 2012 and is secured by substantiallyall of the assets of ABL. In addition, FirstCity provides WFCF with anunconditional guaranty for all of ABL’s obligations up to a maximum of $5.0million plus enforcement costs. The primary terms and key covenants of thisloan facility are described in our 2009 Form 10-K. At March 31, 2010,ABL was in compliance with all covenants or other requirements set forth in thecredit agreement or other agreements with WFCF.

 

The followingtable summarizes the material terms of the credit facilities of FirstCity andits consolidated subsidiaries and the outstanding borrowings under suchfacilities as of March 31, 2010 and December 31, 2009.

 

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| ** **                                              | ** ** | ** **                                                                                       | ** ** | ** **                                                                                                                                                                                          | ** ** | **Outstanding**            | ** ** | **Outstanding**       | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                              | ** ** | ** **                                                                                       | ** ** | ** **                                                                                                                                                                                          | ** ** | **Borrowings**             | ** ** | **Borrowings**        | ** ** |
| ** **                                              | ** ** | ** **                                                                                       | ** ** | ** **                                                                                                                                                                                          | ** ** | **as of**                  | ** ** | **as of**             | ** ** |
| ** **                                              | ** ** | ** **                                                                                       | ** ** | ** **                                                                                                                                                                                          | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
| ** **                                              | ** ** | **Interest Rate**                                                                                | ** ** | **Other Terms and Conditions**                                                                                                                                                                      | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                                              | ** ** | ** **                                                                                       | ** ** | ** **                                                                                                                                                                                          | ** ** | **(Dollars in thousands)** | ** ** |
| **Notes  payable to banks:**                            |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| Bank of Scotland $225  million revolving loan facility: |       |                                                                                             |       | Secured by substantially all assets of FirstCity and certain  subsidiaries and guaranteed by substantially all of FirstCity’s consolidated  subsidiaries, matures April 2011 (as amended) |       | $                          | 152,486    |                  | $          | 157,500 |   |
| US Dollar denominated                                   |       | LIBOR-indexed (0.24619% at  March 31, 2010) plus 2.5%                                       |       |                                                                                                                                                                                                |       |                       |       |                  |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| Euro currency denominated                               |       | LIBOR-indexed (.36688% at  March 31, 2010) plus 2.5%                                        |       |                                                                                                                                                                                                |       | 21,181                     |       | 24,824                |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| Bank of Scotland $100  million revolving loan facility  |       | LIBOR-indexed (.2300% at  March 31, 2010) plus 2.0%                                         |       | Secured by all assets of FH Partners and guaranteed by FirstCity and  certain of its consolidated subsidiaries, matures April 2011 (as  amended)                                               |       | 50,848                     |       | 58,506                |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| BoS(USA) $25 million  subordinated credit agreement     |       | LIBOR + 5.0%                                                                                     |       | Secured by substantially all assets of FirstCity and certain  subsidiaries and guaranteed by substantially all of FirstCity’s consolidated  subsidiaries, matures April 2011 (as amended) |       | 25,000                     |       | 25,000                |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| WFCF $25 million revolving  loan facility               |       | Alternate interest rates  based on Wells Fargo base rate plus margin, LIBOR plus margin, or 7.5% |       | Secured by assets of ABL and guaranteed by FirstCity up to $5.0  million, matures January 2012                                                                                                 |       | 12,577                     |       | 10,694                |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| Banco Santander term loan  denominated in Mexican pesos |       | 28-day Mexican index rate (TIIE) plus 2.0%                                                       |       | Secured by Bank of Scotland letter of credit, matures  November 2010, commitment amount 142.2 million MXN                                                                                      |       | 11,066                     |       | 10,986                |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| Bank of America term loan                               |       | Greater of (prime or federal  funds rate plus 0.5%) plus margin, or LIBOR plus margin            |       | Secured by assets of FirstCity’s consolidated railroad subsidiaries,  matures March 2011                                                                                                  |       | 2,982                      |       | 3,086                 |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| Bank of America $1 million  revolving loan facility     |       | Greater of (prime or federal  funds rate + 0.5%) plus margin, or LIBOR plus margin               |       | Secured by assets of FirstCity’s consolidated railroad subsidiaries,  matures March 2011                                                                                                  |       | 395                        |       | 395                   |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| Bank of America loan                                    |       | LIBOR plus 1.65%                                                                                 |       | Secured by all assets of Wamco 30, Ltd.                                                                                                                                                             |       | 13,176                     |       | —                |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| Merrill Lynch Mortgage Trust  term loan                 |       | 6.07% fixed                                                                                      |       | Secured by assets of Oregon Short Line Building, matures  April 2016                                                                                                                           |       | 7,424                      |       | 7,452                 |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| B.E.S.V. term loan                                      |       | 1-month Eurobor + 3.5%                                                                           |       | Secured by UBN’s beneficial interests in certain portfolio entities,  matures May 2011                                                                                                    |       | 3,086                      |       | 5,433                 |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| American Bank term loan                                 |       | 5.0% fixed                                                                                       |       | Secured by assets of FC Washington and guaranteed by FirstCity,  matures May 2011                                                                                                              |       | 444                        |       | 493                   |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| U.S. Bank loan                                          |       | LIBOR plus 1.75%                                                                                 |       | Secured by all assets of Wamco XXIV, Ltd.                                                                                                                                                           |       | 636                        |       | —                |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| Participations payable                                  |       | 8.52% - 22.15% imputed rates                                                                     |       | Participation agreements on 10% - 33% of net cash flows received on  portfolios                                                                                                                     |       | 1,101                      |       | 1,519                 |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       | 302,402                    |       | 305,888               |       |
| **Note  payable to affiliate:**                         |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| MCS Trust SA de CV term loan                            |       | 20.0% fixed                                                                                      |       | Secured by assets of FC Acquisitions, SRL de CV, matures  June 2020                                                                                                                            |       | 7,838                      |       | 7,838                 |       |
|                                                    |       |                                                                                             |       |                                                                                                                                                                                                |       |                       |       |                  |       |
| **Total notes  payable**                                |       |                                                                                             |       |                                                                                                                                                                                                |       | $                          | 310,240    |                  | $          | 313,726 |   |

 

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**Cautionary Statement Regarding Forward-Looking Statements**

 

This QuarterlyReport on Form 10-Q includes forward-looking statements as defined in thePrivate Securities Litigation Reform Act of 1995. In addition, we may makeother written and oral communications from time to time that contain suchstatements. All statements, other than statements of historical fact, areforward-looking statements, including statements regarding our expectedfinancial position, future financial performance, overall trends, liquidity andcapital needs, and other statements of expectations, beliefs, future plans andstrategies, anticipated events or trends, and similar expressions concerningmatters that are not historical facts. In this context, words such as “anticipates,”“believes,” “expects,” “estimates,” “plans,” “intends,” “could,” “should,” “will,”“may” and similar words or expressions are intended to identify forward-lookingstatements and are not historical facts.

 

Theseforward-looking statements involve risks, uncertainties and assumptions that,if they never materialize or prove incorrect, could cause our results to differmaterially from those expressed or implied by such forward-looking statements.For a discussion on the risks, uncertainties and assumptions that affect ourbusiness, operating results and financial condition, you should carefullyreview the “CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS”qualification and Item 7. “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” included in our 2009 Form 10-K, andItem 2. “Management’s Discussion and Analysis of Financial Condition andResults of Operations” of this Form 10-Q.

 

We are alsosubject to other risks detailed herein or detailed from time-to-time in ourfilings with the SEC. The listed risks referenced above are not intended to beexhaustive and the order in which the risks appear is not intended as anindication of their relative weight or importance. We operate in continuallychanging business environments, and new risk factors emerge from time to time.We cannot predict these new risk factors, nor can we assess the impact, if any,of these new risk factors on our business or the extent to which any factor, orcombination of factors, may cause actual results to differ materially fromthose projected in any forward-looking statements.

 

You are cautionedthat our forward-looking statements could be wrong in light of these and otherrisks, uncertainties and assumptions, which change over time. Actual results,developments and outcomes may differ materially from those expressed in, orimplied by, our forward-looking statements. The forward-looking statementsspeak only as of the date the statement is made, and we have no obligation topublicly update or revise our forward-looking statements to reflect facts,circumstances, assumptions or events that occur after the date theforward-looking statements are made.

 

**Item 3.  Quantitative and Qualitative Disclosures AboutMarket Risk.**

 

As a “smallerreporting company” as defined by Item 10 of Regulation S-K, the Company is notrequired to provide information required by this Item.

 

**Item 4.  Controls and Procedures.**

 

*Evaluation of Disclosure Controlsand Procedures*

 

The Company’s management evaluated, with the participation of ourprincipal executive officer and principal financial officer, or personsperforming similar functions, the effectiveness of our disclosure controls andprocedures, as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as of the end of the period covered bythis report. Based on this evaluation, our principal executive officer andprincipal financial officer have concluded that, as of the end of the periodcovered by this report, our disclosure controls and procedures were effectiveto ensure that information we are required to disclose in the reports that wefile or submit under the Securities Exchange Act of 1934, as amended, isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms relating to FirstCity, including ourconsolidated subsidiaries, and was accumulated and communicated to the Company’smanagement, including the principal executive officer and principal financialofficer, or persons performing similar functions, as appropriate to allowtimely decisions regarding required disclosure.

 

*Changes in Internal Controls*

 

Inconnection with the evaluation required by paragraph (d) of Rule 13a-15under the Exchange Act, there was no change identified in our internal controlover financial reporting that occurred during the last fiscal quarter that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

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**PART II**

 

**OTHER INFORMATION**

** **

**Item 1.  Legal Proceedings.**

 

There have been no material developments regarding any mattersdisclosed under Part I, Item 3 “Legal Proceedings” in our 2009 Form 10-K.

 

**Item 1A.  Risk Factors.**

 

As a “smaller reporting company” as defined by Item 10of Regulation S-K, the Company is not required to provide information requiredby this Item.

 

**Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds.**

 

None.

 

**Item 3.  Defaults Upon Senior Securities.**

 

None.

 

**Item 4.  Reserved.**

 

**Item 5.  OtherInformation.**

 

FirstCity has scheduled its 2010 Annual Meeting of Stockholders (the “2010Annual Meeting”) for Thursday, August 19, 2010,at the Company’s principal executive offices located at 6400 Imperial Drive,Waco, Texas 76712.  It is contemplatedthat the record date for stockholders eligible to vote at the 2010 AnnualMeeting will be July 8, 2010. Information related tothe record date and other information related to the 2010 Annual Meeting willbe disclosed in the Company’s proxy materials for the 2010 AnnualMeeting.

 

Advanced Notice Deadline forRule 14a-8Stockholder Proposals

 

The 2010 Annual Meeting date represents a change of more than 30 daysfrom the anniversary of the Company’s 2009 Annual Meeting of Stockholders. As aresult, pursuant to Rule 14a-8 under the Securities Exchange Act of 1934,as amended, the Company has set a deadline for the receipt of any stockholderproposals submitted pursuant to Rule 14a-8 for inclusion in the Company’sproxy materials for the 2010 Annual Meeting. The new deadline for thesubmission of the stockholder proposals is the close of business on June 11, 2010. Such proposals should be addressed as follows:FirstCity Financial Corporation, P.O. Box 8216, Waco, Texas 76714,Attention: Secretary. The Company recommends that such proposals be sent bycertified mail, return receipt requested. Rule 14a-8 proposals will alsoneed to comply with Rule 14a-8 and other applicable law, or otherwise may byomitted from the Company’s proxy statement.

 

Advance Notice Deadline forDirector Nominations and Other Shareholder Proposals

 

In accordance with the Company’s bylaws, for director nominations orshareholder proposals to be brought before the 2010 Annual Meeting, other than Rule 14a-8proposals described above, written notice must be delivered no later than theclose of business on June 11, 2010. Such nominations or proposals shouldbe addressed as follows: FirstCity Financial Corporation, P.O. Box 8216,Waco, Texas 76714, Attention: Secretary. Such notices must also comply with therequirements of the Company’s bylaws, The NASDAQ Stock Market and otherapplicable law, and may not be presented at the 2010 Annual Meeting otherwise.

 

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**Item 6.  Exhibits.**

*** ***
| **Exhibit********Number** | ** ** | ** ** | ** ** | **Description  of Exhibit**                                                                                                                                     |
|---------------------------|------------|------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                      |       |       |       |                                                                                                                                                            |
| 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 of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                     | FIRSTCITY  FINANCIAL CORPORATION |
|--------------------------|----------------------------------|
| Dated: May 17, 2010 |                             |   |
|                     |                             |   |
|                     |                             |   |
|                     | 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)* |

 

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