Table ofContents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**Form 10-Q**

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

 

**Commission file number 033-19694**

 

**FirstCity Financial Corporation**

(Exact name of registrant as specified in its charter)

* *

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

 

**(254) 761-2800**

(Registrant’s telephone number, including area code)

 

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

 

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

 

| Large accelerated filer  o | Accelerated filer x | Non-accelerated filer o                         | Smaller reporting  company o |
|----------------------------|--------------------------|-------------------------------------------------|-----------------------------------|
|                       |                     | (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 August 4, 2008 was 10,248,307.

 

 

 

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Table of Contents

 

**TABLEOF CONTENTS**

 

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

 

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Table ofContents

 

**PART I**

 

**FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements.**

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDBALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                    | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                                                                    | ** ** | **(Unaudited)**   | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                    | ** ** | ** **        | ** ** | ** **            | ** ** |
| Cash and cash equivalents                                                                                                                                                                     |       | $                 | 12,316     |                  | $          | 23,037 |   |
| Restricted cash                                                                                                                                                                               |       |              | 1,190      |                  |       | 509 |   |
| Portfolio Assets, net                                                                                                                                                                         |       | 147,840           |       | 122,001               |       |
| Loans receivable - affiliates                                                                                                                                                                 |       | 18,980            |       | 5,447                 |       |
| Loans receivable - SBA held for sale                                                                                                                                                          |       | 2,219             |       | 133                   |       |
| Loans receivable - SBA held for investment, net                                                                                                                                               |       | 13,692            |       | 14,234                |       |
| Loans receivable - other                                                                                                                                                                      |       | 16,492            |       | 5,995                 |       |
| Equity investments                                                                                                                                                                            |       | 87,624            |       | 87,622                |       |
| Deferred tax asset, net                                                                                                                                                                       |       | 20,101            |       | 20,101                |       |
| Service fees receivable ($596 and $785 from  affiliates, respectively)                                                                                                                        |       | 711               |       | 842                   |       |
| Servicing assets - SBA loans                                                                                                                                                                  |       | 749               |       | 843                   |       |
| Other assets, net                                                                                                                                                                             |       | 26,709            |       | 17,355                |       |
| Total Assets                                                                                                                                                                                  |       | $                 | 348,623    |                  | $          | 298,119 |   |
| ** **                                                                                                                                                                                    | ** ** | ** **        | ** ** | ** **            | ** ** |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                 |       |              |       |                  |       |
| Liabilities:                                                                                                                                                                                  |       |              |       |                  |       |
| Notes payable to banks                                                                                                                                                                        |       | $                 | 230,585    |                  | $          | 177,329 |   |
| Note payable to affiliate                                                                                                                                                                     |       | 8,658             |       | —                |       |
| Minority interest                                                                                                                                                                             |       | 3,066             |       | 3,209                 |       |
| Other liabilities                                                                                                                                                                             |       | 12,122            |       | 10,758                |       |
| Total Liabilities                                                                                                                                                                             |       | 254,431           |       | 191,296               |       |
| Commitments and contingencies (note 13)                                                                                                                                                       |       |              |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                    |       |              |       |                  |       |
| Optional preferred stock (par value $.01 per share;  98,000,000 shares authorized; no shares issued or outstanding)                                                                           |       | —            |       | —                |       |
| Common stock (par value $.01 per share; 100,000,000  shares authorized; shares issued: 11,326,937 and 11,326,937, respectively; shares  outstanding: 10,266,107 and 10,746,437, respectively) |       | 113               |       | 113                   |       |
| Treasury stock, at cost: 1,060,830 shares and  580,500 shares, respectively                                                                                                                   |       | (9,223            | )          | (5,978                | )          |
| Paid in capital                                                                                                                                                                               |       | 101,662           |       | 101,240               |       |
| Retained earnings (accumulated deficit)                                                                                                                                                       |       | (511              | )          | 9,602                 |       |
| Accumulated other comprehensive income                                                                                                                                                        |       | 2,151             |       | 1,846                 |       |
| Total Stockholders’ Equity                                                                                                                                                               |       | 94,192            |       | 106,823               |       |
| Total Liabilities and Stockholders’ Equity                                                                                                                                               |       | $                 | 348,623    |                  | $          | 298,119 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                                                                                                                                                    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                                                    | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                                                                                                                    | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues:                                                                                                                                                                     |       |                             |       |                           |       |   |   |   |   |
| Servicing fees ($2,484 and $2,728 from affiliates  for the three month periods, respectively, and $4,648 and $5,181 from  affiliates for the six month periods, respectively) |       | $                                | 2,706      |                           | $          | 2,977 |   | $ | 4,906 |   | $ | 5,582 |   |
| Income from Portfolio Assets                                                                                                                                                  |       | 5,622                            |       | 5,685                          |       | 10,557 |   | 10,720 |   |
| Gain on sale of SBA loans held for sale, net                                                                                                                                  |       | 133                              |       | 343                            |       | 142 |   | 624 |   |
| Interest income from SBA loans                                                                                                                                                |       | 366                              |       | 606                            |       | 842 |   | 914 |   |
| Interest income from affiliates                                                                                                                                               |       | 483                              |       | 140                            |       | 633 |   | 266 |   |
| Interest income from loans receivable - other                                                                                                                                 |       | 355                              |       | 982                            |       | 630 |   | 1,889 |   |
| Revenue from controlled affiliate                                                                                                                                             |       | 859                              |       | —                         |       | 1,664 |   | — |   |
| Other income                                                                                                                                                                  |       | 965                              |       | 538                            |       | 1,619 |   | 997 |   |
| Total revenues                                                                                                                                                                |       | 11,489                           |       | 11,271                         |       | 20,993 |   | 20,992 |   |
| Expenses:                                                                                                                                                                     |       |                             |       |                           |       |   |   |   |   |
| Interest and fees on notes payable                                                                                                                                            |       | 3,758                            |       | 4,668                          |       | 7,441 |   | 8,919 |   |
| Salaries and benefits                                                                                                                                                         |       | 5,297                            |       | 3,864                          |       | 10,327 |   | 7,857 |   |
| Provision for loan and impairment losses                                                                                                                                      |       | 7,090                            |       | 746                            |       | 10,120 |   | 1,072 |   |
| Occupancy, data processing, property protection and  other                                                                                                                    |       | 4,680                            |       | 4,388                          |       | 8,605 |   | 8,321 |   |
| Total expenses                                                                                                                                                                |       | 20,825                           |       | 13,666                         |       | 36,493 |   | 26,169 |   |
| Equity in earnings of  investments                                                                                                                                            |       | 3,008                            |       | 4,332                          |       | 5,848 |   | 6,158 |   |
| Earnings (loss) from continuing operations before  income taxes and minority interest                                                                                         |       | (6,328                           | )          | 1,937                          |       | (9,652 | ) | 981 |   |
| Income tax expense                                                                                                                                                            |       | (98                              | )          | (146                           | )          | (289 | ) | (213 | ) |
| Minority interest                                                                                                                                                             |       | (53                              | )          | 15                             |       | (31 | ) | 123 |   |
| Earnings (loss) from  continuing operations                                                                                                                                   |       | (6,479                           | )          | 1,806                          |       | (9,972 | ) | 891 |   |
| Discontinued operations                                                                                                                                                       |       |                             |       |                           |       |   |   |   |   |
| Loss from discontinued operations                                                                                                                                             |       | (50                              | )          | —                         |       | (141 | ) | — |   |
| Net earnings (loss)                                                                                                                                                           |       | $                                | (6,529     | )                              | $          | 1,806 |   | $ | (10,113 | ) | $ | 891 |   |
| Basic earnings (loss)  per common share are as follows:                                                                                                                       |       |                             |       |                           |       |   |   |   |   |
| Earnings (loss) from continuing operations                                                                                                                                    |       | $                                | (0.63      | )                              | $          | 0.17 |   | $ | (0.96 | ) | $ | 0.08 |   |
| Discontinued operations                                                                                                                                                       |       | $                                | —     |                           | $          | — |   | $ | (0.01 | ) | $ | — |   |
| Net earnings (loss) to common stockholders                                                                                                                                    |       | $                                | (0.63      | )                              | $          | 0.17 |   | $ | (0.97 | ) | $ | 0.08 |   |
| Weighted average common shares outstanding                                                                                                                                    |       | 10,357                           |       | 10,789                         |       | 10,471 |   | 10,789 |   |
| Diluted earnings (loss)  per common share are as follows:                                                                                                                     |       |                             |       |                           |       |   |   |   |   |
| Earnings (loss) from continuing operations                                                                                                                                    |       | $                                | (0.63      | )                              | $          | 0.16 |   | $ | (0.96 | ) | $ | 0.08 |   |
| Discontinued operations                                                                                                                                                       |       | $                                | —     |                           | $          | — |   | $ | (0.01 | ) | $ | — |   |
| Net earnings (loss) to common stockholders                                                                                                                                    |       | $                                | (0.63      | )                              | $          | 0.16 |   | $ | (0.97 | ) | $ | 0.08 |   |
| Weighted average common shares outstanding                                                                                                                                    |       | 10,357                           |       | 11,397                         |       | 10,471 |   | 11,414 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION ANDSUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**AND COMPREHENSIVE INCOME**

**(Dollars in thousands)**

 
| ** **                                                                 | ** ** | ** **            | ** ** | ** **              | ** ** | ** **       | ** ** | ** **       | ** ** | ** **        | ** ** | **Retained**           | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|------------------|------------|------------------|------------|-------------------|------------|------------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                 | ** ** | ** **            | ** ** | ** **              | ** ** | ** **       | ** ** | ** **       | ** ** | ** **        | ** ** | **Earnings**           | ** ** | **Other**       | ** ** | **Total**  | ** ** |
| ** **                                                                 | ** ** | **Common Stock** | ** ** | **Treasury Stock** | ** ** | **Paid in** | ** ** | **(Accumulated** | ** ** | **Comprehensive** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                 | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Shares**       | ** ** | **Amount**       | ** ** | **Capital**       | ** ** | **Deficit)**           | ** ** | **Income**      | ** ** | **Equity** | ** ** |
| ** **                                                                 | ** ** | ** **            | ** ** | ** **              | ** ** | ** **       | ** ** | ** **       | ** ** | ** **        | ** ** | ** **             | ** ** | ** **      | ** ** | ** ** | ** ** |
| **Balances, December 31, 2006**                                       |       | 11,316,937            |       | $                       | 113        |             | 530,300    |             | $          | (5,571            | )          | $                      | 100,562    |            | $          | 7,417      |       | $ | 1,372 |   | $ | 103,893 |   |
| Exercise of common stock options                                           |       | 10,000                |       | —                  |       | —           |       | —           |       | 35                |       | —                 |       | —          |       | 35         |       |
| Repurchase of common stock                                                 |       | —                |       | —                  |       | 50,200           |       | (407             | )          | —            |       | —                 |       | —          |       | (407       | )          |
| Additional paid in capital arising from stock option  compensation expense |       | —                |       | —                  |       | —           |       | —           |       | 643               |       | —                 |       | —          |       | 643        |       |
| Comprehensive income:                                                      |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       |       |       |
| Net earnings for 2007                                                      |       | —                |       | —                  |       | —           |       | —           |       | —            |       | 2,185                  |       | —          |       | 2,185      |       |
| Translation adjustments                                                    |       | —                |       | —                  |       | —           |       | —           |       | —            |       | —                 |       | 474             |       | 474        |       |
| Total comprehensive income                                                 |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       | 2,659      |       |
| **Balances, December 31, 2007**                                       |       | 11,326,937            |       | $                       | 113        |             | 580,500    |             | $          | (5,978            | )          | $                      | 101,240    |            | $          | 9,602      |       | $ | 1,846 |   | $ | 106,823 |   |
| Repurchase of common stock                                                 |       | —                |       | —                  |       | 480,330          |       | (3,245           | )          | —            |       | —                 |       | —          |       | (3,245     | )          |
| Additional paid in capital arising from stock option  compensation expense |       | —                |       | —                  |       | —           |       | —           |       | 422               |       | —                 |       | —          |       | 422        |       |
| Comprehensive income (loss):                                               |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       |       |       |
| Net loss for the first six months of 2008                                  |       | —                |       | —                  |       | —           |       | —           |       | —            |       | (10,113                | )          | —          |       | (10,113    | )          |
| Translation adjustments                                                    |       | —                |       | —                  |       | —           |       | —           |       | —            |       | —                 |       | 305             |       | 305        |       |
| Total comprehensive loss                                                   |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       | (9,808     | )          |
| **Balances, June 30, 2008 (unaudited)**                               |       | 11,326,937            |       | $                       | 113        |             | 1,060,830  |             | $          | (9,223            | )          | $                      | 101,662    |            | $          | (511       | )          | $ | 2,151 |   | $ | 94,192 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                                              | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                              | ** ** | **June 30,**              | ** ** |
| ** **                                                                              | ** ** | **2008**                       | ** ** | **2007** | ** ** |
| Cash flows from operating activities:                                                   |       |                           |       |   |   |
| Net earnings (loss)                                                                     |       | $                              | (10,113    | ) | $ | 891 |   |
| Adjustments to reconcile net earnings (loss) to net  cash used in operating activities: |       |                           |       |   |   |
| Net loss from discontinued operations                                                   |       | 141                            |       | — |   |
| Purchase of SBA loans held for sale                                                     |       | —                         |       | (18,355 | ) |
| Net principal payments (advances) on SBA loans held  for sale                           |       | (4,811                         | )          | (413 | ) |
| Proceeds from the sale of SBA loans held for sale,  net                                 |       | 2,993                          |       | 15,772 |   |
| Purchases of Portfolio Assets                                                           |       | (47,345                        | )          | (45,273 | ) |
| Proceeds applied to principal on Portfolio Assets                                       |       | 30,924                         |       | 41,116 |   |
| Income from Portfolio Assets                                                            |       | (10,557                        | )          | (10,720 | ) |
| Capitalized interest and costs on Portfolio Assets  and loans receivable                |       | (982                           | )          | (685 | ) |
| Provision for loan and impairment losses                                                |       | 10,120                         |       | 1,072 |   |
| Equity in earnings of investments                                                       |       | (5,848                         | )          | (6,158 | ) |
| Gain on sale of SBA loans held for sale, net                                            |       | (142                           | )          | (624 | ) |
| Depreciation and amortization                                                           |       | 1,834                          |       | 1,365 |   |
| Net premium amortization of loans receivable                                            |       | (199                           | )          | (164 | ) |
| Stock-based compensation expense related to stock  options                              |       | 422                            |       | 289 |   |
| Increase in restricted cash                                                             |       | (681                           | )          | (500 | ) |
| Decrease (increase) in service fees receivable                                          |       | 131                            |       | (375 | ) |
| Increase in other assets                                                                |       | (9,103                         | )          | (2,227 | ) |
| Increase in other liabilities                                                           |       | 1,568                          |       | 2,328 |   |
| Net cash used in operating activities                                                   |       | (41,648                        | )          | (22,661 | ) |
| Cash flows from investing activities:                                                   |       |                           |       |   |   |
| Purchases of property and equipment, net                                                |       | (1,220                         | )          | (422 | ) |
| Net principal collections (advances) on loans  receivable                               |       | (23,377                        | )          | (4,499 | ) |
| Purchases of SBA loans held for investment                                              |       | —                         |       | (17,406 | ) |
| Net principal collections (advances) on SBA loans  held for investment                  |       | 445                            |       | 1,700 |   |
| Contributions to Acquisition Partnerships and  Servicing and Operating Entities         |       | (2,491                         | )          | (21,146 | ) |
| Distributions from Acquisition Partnerships and  Servicing and Operating Entities       |       | 11,052                         |       | 25,205 |   |
| Net cash used in investing activities                                                   |       | (15,591                        | )          | (16,568 | ) |
| Cash flows from financing activities:                                                   |       |                           |       |   |   |
| Borrowings under note payable to affiliate                                              |       | 8,658                          |       | — |   |
| Borrowings under notes payable to banks                                                 |       | 93,807                         |       | 116,973 |   |
| Principal payments of notes payable to banks, net                                       |       | (51,773                        | )          | (77,689 | ) |
| Payments of debt issuance costs and loan fees                                           |       | (921                           | )          | (647 | ) |
| Repurchase of common stock                                                              |       | (3,245                         | )          | — |   |
| Proceeds from issuance of common stock                                                  |       | —                         |       | 18 |   |
| Net cash provided by financing activities                                               |       | 46,526                         |       | 38,655 |   |
| Net cash used in continuing operations                                                  |       | (10,713                        | )          | (574 | ) |
| Cash flows from discontinued operations:                                                |       |                           |       |   |   |
| Net cash used in operating activities                                                   |       | (8                             | )          | (18 | ) |
| Net cash used in discontinued operations                                                |       | (8                             | )          | (18 | ) |
| Net decrease in cash and cash equivalents                                               |       | (10,721                        | )          | (592 | ) |
| Cash and cash equivalents, beginning of period                                          |       | 23,037                         |       | 18,472 |   |
| Cash and cash equivalents, end of period                                                |       | $                              | 12,316     |   | $ | 17,880 |   |
| Supplemental disclosure of cash flow information:                                       | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Cash paid during the period for:                                                        | ** ** | ** **                     | ** ** | ** ** | ** ** |
| Interest                                                                                |       | $                              | 6,154      |   | $ | 7,741 |   |
| Income taxes, net of refunds received                                                   |       | 179                            |       | 48 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**June 30, 2008**

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

**(Unaudited)**

 

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

 

***The Company***

 

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

 

***Basis of Presentation***

 

The unaudited consolidated financial statements of FirstCity reflect, inthe opinion of management, all adjustments, consisting only of normal andrecurring adjustments, necessary to present fairly FirstCity’s consolidated financialposition at June 30, 2008, its results of operations for the three and sixmonth periods ended June 30, 2008 and 2007 and cash flows for the sixmonth periods ended June 30, 2008 and 2007.  Certain disclosures have been condensed oromitted from these financial statements. Accordingly, these financialstatements should be read with the consolidated financial statements includedin the Company’s 2007 Annual Report on Form 10-K, as amended. Certainamounts in the consolidated financial statements for prior years have beenreclassified to conform to current consolidated financial statementpresentation.

 

***Use of Estimates***

 

The preparation of financial statements inconformity with U.S. generally accepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Material estimates that are particularly susceptible tosignificant change in the near-term relate to the estimation of futurecollections on Portfolio Assets used in the calculation of income andevaluation of impairment for Portfolios; interest rate environments; valuationof the deferred tax asset; prepayment speeds and valuation of servicing assets;valuation of loans receivable (including loans receivable held insecuritization trusts); and income tax uncertainties. Actual results coulddiffer materially from those estimates.

 

***Restricted Cash***

*** ***

Restrictedcash includes monies due on loan-related remittances received by the Companyand due to third parties.

 

***Reclassifications***

 

Certain amounts inthe consolidated financial statements for prior periods have been reclassifiedto conform to current consolidated financial statement presentation. In allreporting periods prior to December 31, 2007, FirstCity reported payments ofdebt issuance costs and loan fees in cash flows from operating activities onthe Consolidated Statements of Cash Flows. The Company is now reporting theseitems in cash flows from financing activities. Prior period amounts reported onthe Consolidated Statements of Cash Flows have been adjusted to conform to thistreatment which is required under U.S. generally accepted accountingprinciples. The total amount reclassified was $647 for the six month periodended June 30, 2007. In addition, for the six-month period ended December 31,2007, FirstCity reported cash received on loan-related remittances and due tothird parties as cash and cash equivalents on the Consolidated Balance Sheets.The Company is now reporting this amount as restricted cash on the ConsolidatedBalance Sheets and cash flows from operating activities on the Consolidated Statementsof Cash Flows. The total amount reclassified was $509 at December 31, 2007 onthe Consolidated Balance Sheets, and $500 for the six-month period ended June30, 2007 on the Consolidated Statements of Cash Flows. Management believes thatthese changes to the Consolidated Statements of Cash Flows and ConsolidatedBalance Sheets as described above are immaterial relative to the consolidatedfinancial statements taken as a whole. These reclassifications have thefollowing impact on the consolidated financial statements:

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands,except per share data) – (continued)**

 
| ** **                                                                   | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                   | ** ** | **June 30,**              | ** ** |
| ** **                                                                   | ** ** | **2007**                       | ** ** |
| Consolidated Statements of Cash Flows:                                       |       |                           |       |
| Cash flows from operating activities (as reported)                           |       | $                              | (22,808    | ) |
| Impact of reclassification on payments of debt issuance  costs and loan fees |       | 647                            |       |
| Impact of reclassification on change in restricted  cash                     |       | (500                           | )          |
| Cash flows from operating activities (as corrected)                          |       | $                              | (22,661    | ) |
|                                                                         |       |                           |       |
| Cash flows from financing activities (as reported)                           |       | $                              | 39,302     |   |
| Impact of reclassification on payments of debt issuance  costs and loan fees |       | (647                           | )          |
| Cash flows from financing activities (as corrected)                          |       | $                              | 38,655     |   |

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

 

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

 

***Recently Issued Accounting Standards***

 

In March 2008, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards(“SFAS”) No. 161, *Disclosures aboutDerivative Instruments and Hedging Activities* (“SFAS 161”), anamendment to SFAS No. 133, *Accounting forDerivative Instruments and Hedging Activities*. SFAS 161 requiresenhanced disclosures about derivative instruments and hedged items that areaccounted for under SFAS No. 133 and related interpretations. SFAS 161 will beeffective for the Company’s interim and annual financial statements for periodsbeginning after November 15, 2008, with early adoption permitted. SFAS 161expands the disclosure requirements for derivatives and hedged items and has noimpact on the Company’s accounts for any such instruments. The Company iscurrently evaluating the impact of adopting SFAS 161 on its financial statementdisclosures.

 

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

 

In February 2007, the FASB issued SFAS No.159,*The Fair Value Option for Financial Assets andFinancial Liabilities-Including an amendment of FASB Statement No. 115*(“SFAS159”).**SFAS 159 providesentities an opportunity to choose to measure eligible items at fair value atspecified election dates. Unrealized gains and losses on items for which thefair value option has been elected are reported in earnings at each subsequentreporting date. The fair value option (i) may be applied instrument byinstrument, with certain exceptions, (ii) is irrevocable (unless a newelection date occurs) and (iii) is applied only to entire instruments andnot to portions of instruments. Adoption of SFAS 159 is optional and, ifadopted, would be effective for the Company’s 2008 fiscal year. The Companyelected not to adopt SFAS 159. As such, SFAS 159 did not impact the Company’sfinancial condition, results of operations and cash flows, or financialstatement footnote disclosures.

 

***Recently Adopted Accounting Standards***

 

Effective January 1,2008, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 157,*Fair Value Measurements* (“SFAS 157”).SFAS 157 defines fair value, establishes a framework for measuring fair valueunder generally accepted accounting principles, and enhances disclosures aboutfair value measurements. Fair value is defined under SFAS 157 as the exchangeprice that would be received for an asset or paid to transfer a liability (exitprice) in the principal or most advantageous market for the asset or liabilityin an orderly transaction between market participants on the measurementdate.  The adoption of SFAS 157 did nothave any effect on our financial statements at the date of adoption. Foradditional information, refer to Note 12 of the Consolidated FinancialStatements.

 

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

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

**(3) Discontinued Operations**

 

Discontinued operations are comprised of twocomponents previously reported as the Company’s residential and commercialmortgage banking business (“Mortgage”) and the consumer lending businessconducted through the Company’s minority interest investment in Drive FinancialServices LP (“Consumer”). In the second quarter of 2008, the Company recorded aprovision of $46 related to the discontinued Mortgage operations. There was noincome or loss from discontinued operations in the first six months of 2007. AtJune 30, 2008 and December 31, 2007, liabilities from discontinuedConsumer operations of $688 and $568, respectively, which consist of stateincome taxes payable, were included in other liabilities.

 

**(4)  Portfolio Assets**

 

Portfolio Assets are summarized as follows:

 
| ** **                                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Loan Portfolios                             | ** ** | ** **        | ** ** | ** **            | ** ** |
| Loans Acquired Prior to 2005                | ** ** | ** **        | ** ** | ** **            | ** ** |
| Non-performing Portfolio Assets             |       | $                 | 3,686      |                  | $          | 4,177 |   |
| Performing Portfolio Assets                 |       | 915               |       | 1,266                 |       |
| Loans Acquired After 2004                   | ** ** | ** **        | ** ** | ** **            | ** ** |
| Loans acquired with credit deterioration    |       | 117,699           |       | 97,630                |       |
| Loans acquired with no credit deterioration |       | 4,124             |       | 3,871                 |       |
| Outstanding balance                         |       | 126,424           |       | 106,944               |       |
| Allowance for loan losses                   |       | (10,454           | )          | (1,723                | )          |
| Carrying amount of loans, net of allowance  |       | 115,970           |       | 105,221               |       |
|                                        |       |              |       |                  |       |
| Real Estate Portfolios                      |       | 29,958            |       | 14,832                |       |
| Other                                       |       | 1,912             |       | 1,948                 |       |
| Portfolio Assets, net                       |       | $                 | 147,840    |                  | $          | 122,001 |   |

 

In the first quarter of 2008, the Company discontinued using the incomerecognition model under AICPA Statement of Position 03-3, *Accounting for Certain Loans or Debt SecuritiesAcquired in a Transfer* (“SOP 03-3”) for previously-purchasednon-performing loan portfolios in Mexico. Recognition of income under SOP 03-3is dependent on management having the ability to develop reasonableexpectations as to both the timing and amount of cash flows to be collected. Inthe event management cannot develop a reasonable expectation of the timing andamount of cash flows expected to be collected, SOP 03-3 permits the use of thecost-recovery accounting model. Due to uncertainties related to the legal andeconomic environment in Mexico, management determined that it no longer has theability to develop a reasonable expectation of the timing of cash flows to becollected, and as of January 1, 2008, began accounting for itsnon-performing loan portfolios in Mexico under the cost-recovery accountingmodel – which requires collections received to be applied first against therecorded amount of the loan or pool. When the carrying amount of the loan orpool has been reduced to zero, any additional amounts received are recognizedas income. The Company evaluates at the balance sheet date if the remainingamount that is probable of collection is less than the carrying value, and ifso, recognizes impairment. For subsequent increases in the actual cash flows orcash flows expected to be collected, management will reverse any existingvaluation allowance for that loan or pool. AtJune 30, 2008, the Company’s carrying amount of non-performing loans inMexico accounted for using the cost-recovery model in the caption “LoansAcquired After 2004 – Loans acquired with credit deterioration” in the tableabove approximated $14.9 million. The Company acquired $8.7 million of loanportfolios in Mexico with credit deterioration in the second quarter of 2008that are accounted for using the cost-recovery accounting model under SOP 03-3.

 

On June 20, 2008, FirstCity and anotherinvestor acquired a portfolio of non-performing loans in Mexico for $8.7million. FirstCity accounted for the investment as a consolidated PortfolioAsset at June 30, 2008 since it has a 58.0% ownership interest in theportfolio. Per terms of the purchase agreement, the other investor (42.0%ownership interest) has the option to acquire additional interests in the loanportfolio so that it would own 80.0% by paying FirstCity an amount equal to38.0% of the portfolio’s purchase price (and FirstCity would subsequently own20.0% of the portfolio). If the investor does not exercise its option withinsixty-two days from the portfolio purchase date, then FirstCity and theinvestor will execute a servicing agreement that will entitle FirstCity toreceive from the investor an oversight fee in the amount of $698.

 

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

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

Income from Portfolio Assets is summarized asfollows:

 
| ** **                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                  | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                  | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Loan Portfolios                             |       |                             |       |                           |       |   |   |   |   |
| Loans Acquired Prior to 2005                |       |                             |       |                           |       |   |   |   |   |
| Non-performing Portfolio Assets             |       | $                                | 75         |                           | $          | 126 |   | $ | 255 |   | $ | 868 |   |
| Performing Portfolio Assets                 |       | 37                               |       | 213                            |       | 143 |   | 562 |   |
| Loans Acquired After 2004                   | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans acquired with credit deterioration    |       | 4,913                            |       | 5,084                          |       | 8,466 |   | 8,150 |   |
| Loans acquired with no credit deterioration |       | 97                               |       | 204                            |       | 209 |   | 696 |   |
| Real Estate Portfolios                      |       | 447                              |       | —                         |       | 1,376 |   | 328 |   |
| Other                                       |       | 53                               |       | 58                             |       | 108 |   | 116 |   |
| Income from Portfolio Assets                |       | $                                | 5,622      |                           | $          | 5,685 |   | $ | 10,557 |   | $ | 10,720 |   |

 

The Companyrecorded a provision for loan and impairment losses on Portfolio Assets ofapproximately $9,886 for the six month period ended June 30, 2008, whichis comprised of a $994 impairment charge on real estate portfolios and an$8,892 allowance for loan losses, net of recoveries.  For the six month period ended June 30,2007, the Company recorded a provision for loan and impairment losses onPortfolio Assets of $1,003, which is comprised of a $92 impairment charge onreal estate portfolios and a $911 allowance for loan losses.

 

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

 
| ** **              | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **              | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **              | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Beginning Balance       |       | $                                | (4,273     | )                              | $          | (567 | ) | $ | (1,723 | ) | $ | (333 | ) |
| Provisions              |       | (6,287                           | )          | (791                           | )          | (9,154 | ) | (1,025 | ) |
| Recoveries              |       | 107                              |       | 114                            |       | 262 |   | 114 |   |
| Charge Offs             |       | —                           |       | —                         |       | 162 |   | — |   |
| Translation adjustments |       | (1                               | )          | —                         |       | (1 | ) | — |   |
| Ending Balance          |       | $                                | (10,454    | )                              | $          | (1,244 | ) | $ | (10,454 | ) | $ | (1,244 | ) |

 

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

 
| ** **                                          | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                          | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                          | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Beginning Balance                                   |       | $                                | 31,318     |                           | $          | 35,670 |   | $ | 35,951 |   | $ | 32,339 |   |
| Additions                                           |       | 16,898                           |       | 1,967                          |       | 20,213 |   | 3,236 |   |
| Accretion                                           |       | (3,476                           | )          | (3,867                         | )          | (6,734 | ) | (6,581 | ) |
| Reclassification from (to) nonaccretable difference |       | 1,210                            |       | —                         |       | (2,628 | ) | 5,165 |   |
| Disposals                                           |       | (1,257                           | )          | (1,567                         | )          | (2,451 | ) | (1,919 | ) |
| Translation adjustments                             |       | 306                              |       | 38                             |       | 648 |   | 1 |   |
| Ending Balance                                      |       | $                                | 44,999     |                           | $          | 32,241 |   | $ | 44,999 |   | $ | 32,241 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

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

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                         | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                         | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Face value at acquisition                          |       | $                                | 64,903     |                           | $          | 15,653 |   | $ | 74,755 |   | $ | 50,550 |   |
| Cash flows expected to be collected at acquisition |       | 53,150                           |       | 8,705                          |       | 63,285 |   | 38,827 |   |
| Basis in acquired loans at acquisition             |       | 36,252                           |       | 6,738                          |       | 43,072 |   | 35,591 |   |
|                                                    |            |                                  |            |                                |            |  |  |  |  |  |  |  |  |

 

**(5)  Loans Receivable**

 

***Loansreceivable – affiliates***

 

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

 
| ** **                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Outstanding balance           |       | $                 | 18,310     |                  | $          | 4,967 |   |
| Capitalized interest          |       | 670               |       | 480                   |       |
| Carrying amount of loans, net |       | $                 | 18,980     |                  | $          | 5,447 |   |

 

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

 
| ** **             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **             | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **             | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Beginning Balance      |       | $                                | 5,403      |                           | $          | 4,876 |   | $ | 5,447 |   | $ | 4,755 |   |
| Advances               |       | 13,500                           |       | 136                            |       | 13,500 |   | 486 |   |
| Payments received      |       | (46                              | )          | (52                            | )          | (514 | ) | (374 | ) |
| Capitalized interest   |       | 95                               |       | 79                             |       | 191 |   | 144 |   |
| Foreign exchange gains |       | 28                               |       | 45                             |       | 356 |   | 73 |   |
| Ending Balance         |       | $                                | 18,980     |                           | $          | 5,084 |   | $ | 18,980 |   | $ | 5,084 |   |

 

Loans receivable –affiliates represent advances to Acquisition Partnerships and other affiliatedentities to acquire portfolios of performing and nonperforming commercial andconsumer loans and other assets; and a senior debt financing arrangement withan affiliated entity to provide capital for business expansion. The loans arereported at their outstanding principal balances adjusted for unearneddiscounts, loan origination fees, and the allowance for loan losses. Interestis accrued when earned in accordance with the contractual terms of the loans.Interest is recognized on an accrual basis at the applicable interest rate onthe principal amount outstanding. Loan origination fees and direct costs areamortized as level-yield adjustments over the respective loan terms.Unamortized net fees or costs are recognized upon early repayment of theloans.  Loans receivable – affiliates aregenerally secured by the underlying collateral that was acquired with the loanproceeds. Advances to affiliates to acquire loan portfolios are secured by theunderlying collateral of the individual notes within the portfolios, which isgenerally real estate and foreclosed properties; whereas the advance to theaffiliate for business expansion purposes is secured by equipment and ownershipinterests.

 

Loans receivable –affiliates are evaluated for impairment by analyzing expected future cash flowsand evaluating values of the underlying loan collateral. For advances securedby loan portfolios, management analyzes the expected cash flows within eachpool to determine that the cash flows are sufficient to repay these notes. Forthe loan secured by equipment and ownership interests, management analyzes theexpected future cash flows from the borrowing entity (discounted for the loan’srisk-adjusted rate), and the values of the underlying collateral, to determinewhether the Company expects to ultimately collect all contractual principal andinterest. The results of management’s evaluations indicated that projected cashflows 

 

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** **

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

 

and underlying collateralare sufficient to repay the loans and no allowances for impairment arenecessary. The Company recorded no provisions for impairment on loansreceivable – affiliates for the six months ended June 30, 2008 and 2007.

 

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

 

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

 
| ** **                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Outstanding balance           |       | $                 | 2,191      |                  | $          | 133 |   |
| Capitalized costs             |       | 28                |       | —                |       |
| Carrying amount of loans, net |       | $                 | 2,219      |                  | $          | 133 |   |

 

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

 
| ** **                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                         | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                         | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Beginning Balance                  |       | $                                | 1,055      |                           | $          | 11,484 |   | $ | 133 |   | $ | — |   |
| Purchases of loans                 |       | —                           |       | —                         |       | — |   | 18,355 |   |
| Originations and advances of loans |       | 3,752                            |       | 760                            |       | 4,842 |   | 824 |   |
| Payments received                  |       | (29                              | )          | (224                           | )          | (31 | ) | (411 | ) |
| Capitalized costs                  |       | 7                                |       | —                         |       | 26 |   | — |   |
| Loans sold                         |       | (2,566                           | )          | (7,979                         | )          | (2,751 | ) | (14,539 | ) |
| Premium amortization, net          |       | —                           |       | (211                           | )          | — |   | (399 | ) |
| Ending Balance                     |       | $                                | 2,219      |                           | $          | 3,830 |   | $ | 2,219 |   | $ | 3,830 |   |

 

Loans receivable – SBA held for sale represent U.S. Small BusinessAdministration (“SBA”) loans acquired by the Company in February 2007 andSBA loan originations and advances made since such time.  SBA loans held for sale represent theportions of the loans that are guaranteed by the SBA, and are reflected at thelower of aggregate cost or estimated fair value. Net unrealized losses, if any,are recognized through a valuation allowance by charges to income. The carryingvalue of SBA loans held for sale is net of premiums as well as deferredorigination fees and costs. Premiums and net origination fees and costs aredeferred and included in the basis of the loans in calculating gains and lossesupon sale. SBA loans are generally secured by the borrowing entities’ assetssuch as accounts, property and equipment, and other assets. The Companygenerally sells the guaranteed portion of each loan to a third party andretains the servicing rights. The difference between the proceeds received andthe allocated carrying value of the loans sold are recognized as net gains onsales of loans.  The non-guaranteedportion is generally held in the portfolio and classified as held forinvestment.  The Company recorded nowrite-downs of SBA loans held for sale below their cost for the six monthsended June 30, 2008 and 2007.

 

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

 

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

 
| ** **                    | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Outstanding balance           |       | $                 | 15,095     |                  | $          | 15,727 |   |
| Allowance for loan losses     |       | (233              | )          | (151                  | )          |
| Discounts, net                |       | (1,201            | )          | (1,346                | )          |
| Capitalized costs             |       | 31                |       | 4                     |       |
| Carrying amount of loans, net |       | $                 | 13,692     |                  | $          | 14,234 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

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

 
| ** **                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                         | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                         | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Beginning Balance                  |       | $                                | 12,988     |                           | $          | 16,538 |   | $ | 14,234 |   | $ | — |   |
| Purchases of loans                 |       | —                           |       | —                         |       | — |   | 17,406 |   |
| Originations and advances of loans |       | 1,241                            |       | 253                            |       | 1,604 |   | 275 |   |
| Payments received                  |       | (457                             | )          | (1,152                         | )          | (2,071 | ) | (1,977 | ) |
| Capitalized costs                  |       | 20                               |       | 2                              |       | 27 |   | 2 |   |
| Provision for SBA loan losses, net |       | (110                             | )          | (69                            | )          | (82 | ) | (69 | ) |
| Discount accretion, net            |       | 10                               |       | (92                            | )          | 145 |   | (157 | ) |
| Charge offs                        |       | —                           |       | —                         |       | (165 | ) | — |   |
| Ending Balance                     |       | $                                | 13,692     |                           | $          | 15,480 |   | $ | 13,692 |   | $ | 15,480 |   |

 

Loans receivable –SBA held for investment represent SBA loans acquired by the Company in February 2007and SBA loan originations and advances made since such time. SBA loans held forinvestment are reported at their outstanding principal balances adjusted forunearned discounts, net deferred loan origination costs and the allowance forloan losses. Interest is recognized on an accrual basis at the applicableinterest rate on the principal amount outstanding. Loan origination fees anddirect costs as well as premiums and discounts are amortized as level yieldadjustments over the respective loan terms. Unamortized net fees or costs arerecognized upon early repayment of the loans. SBA loans held for investment aregenerally secured by the borrowing entities’ assets such as accounts, propertyand equipment, and other assets. The loans are evaluated for impairment basedupon performance of the loans and other portfolio characteristics, such asindustry concentrations and loan collateral, which also impacts management’sestimates of the impairment. The adequacy of the allowance for loan losses isreviewed by management on a regular basis and adjustments, if necessary, arereflected in operations during the periods in which they become known.Considerations in this evaluation include past and current loss experience,risks inherent in the current portfolio, and evaluation of commercial and realestate collateral as well as current economic conditions.

 

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

 
| ** **        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **        | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **        | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Beginning Balance |       | $                                | (123       | )                              | $          | — |   | $ | (151 | ) | $ | — |   |
| Provisions        |       | (110                             | )          | (69                            | )          | (234 | ) | (69 | ) |
| Recoveries        |       | —                           |       | —                         |       | 2 |   | — |   |
| Charge Offs       |       | —                           |       | —                         |       | 150 |   | — |   |
| Ending Balance    |       | $                                | (233       | )                              | $          | (69 | ) | $ | (233 | ) | $ | (69 | ) |

 

***Loansreceivable – other***

 

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

 
| ** **                     | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Outstanding balance            |       | $                 | 16,389     |                  | $          | 5,502 |   |
| Discounts, net                 |       | (508              | )          | (24                   | )          |
| Capitalized interest and costs |       | 611               |       | 517                   |       |
| Carrying amount of loans, net  |       | $                 | 16,492     |                  | $          | 5,995 |   |

 

Changes in loansreceivable – other are as follows:

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 
| ** **                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                      | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                      | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Beginning Balance               |       | $                                | 5,965      |                           | $          | 27,956 |   | $ | 5,995 |   | $ | 23,991 |   |
| Advances                        |       | 10,480                           |       | 3,000                          |       | 10,472 |   | 6,646 |   |
| Payments received               |       | (58                              | )          | (2,259                         | )          | (81 | ) | (2,259 | ) |
| Capitalized interest and costs  |       | 84                               |       | 267                            |       | 93 |   | 501 |   |
| Discount accretion, net         |       | 18                               |       | 58                             |       | 24 |   | 119 |   |
| Foreign exchange gains (losses) |       | 3                                |       | 201                            |       | (11 | ) | 225 |   |
| Ending Balance                  |       | $                                | 16,492     |                           | $          | 29,223 |   | $ | 16,492 |   | $ | 29,223 |   |

 

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

 

**(6)  Equity Investments**

 

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

** **

**Condensed Combined Balance Sheets**

** **
| ** **                                             | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Assets                                                 |       | $                 | 464,024    |                  | $          | 457,490 |   |
| Liabilities                                            |       | $                 | 147,117    |                  | $          | 141,430 |   |
| Net equity                                             |       | 316,907           |       | 316,060               |       |
|                                                   |       | $                 | 464,024    |                  | $          | 457,490 |   |
|                                                   |       |              |       |                  |       |
| Equity investment in Acquisition Partnerships          |       | $                 | 76,133     |                  | $          | 76,078 |   |
| Equity investment in servicing and operating  entities |       | 11,491            |       | 11,544                |       |
|                                                   |       | $                 | 87,624     |                  | $          | 87,622 |   |

 

Portfolio Assets held by certain AcquisitionPartnerships are pledged to secure notes payable that are generally non-recourse to FirstCity or any affiliate otherthan the partnership entity thatincurred the debt.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

**Condensed Combined Summary ofOperations**

 
| ** **                                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                             | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                             | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Income from Portfolio Assets                           |       | $                                | 26,781     |                           | $          | 22,096 |   | $ | 51,072 |   | $ | 44,836 |   |
| Other income                                           |       | 765                              |       | 174                            |       | 1,094 |   | 722 |   |
| Revenues                                               |       | 27,546                           |       | 22,270                         |       | 52,166 |   | 45,558 |   |
| Interest expense                                       |       | 5,337                            |       | 2,801                          |       | 7,213 |   | 5,808 |   |
| Average cost (annualized)                              |       | 14.29                            | %          | 13.79                          | %          | 9.79 | % | 13.00 | % |
| Service fees                                           |       | 8,214                            |       | 4,912                          |       | 13,162 |   | 9,633 |   |
| Provision for loan and impairment losses               |       | 3,388                            |       | 103                            |       | 8,746 |   | 6,664 |   |
| Other operating costs                                  |       | 5,602                            |       | 4,164                          |       | 11,418 |   | 8,332 |   |
| Foreign currency (gains) losses                        |       | (5,435                           | )          | (3,587                         | )          | (8,380 | ) | (3,322 | ) |
| Income tax and other taxes                             |       | 705                              |       | (1,742                         | )          | 1,737 |   | (1,708 | ) |
| Expenses                                               |       | 17,811                           |       | 6,651                          |       | 33,896 |   | 25,407 |   |
| Equity in earnings of investments                      |       | 859                              |       | 759                            |       | 1,636 |   | 816 |   |
| Net earnings                                           |       | $                                | 10,594     |                           | $          | 16,378 |   | $ | 19,906 |   | $ | 20,967 |   |
|                                                   |       |                             |       |                           |       |   |   |   |   |
| Equity in earnings of Acquisition Partnerships         |       | $                                | 3,017      |                           | $          | 3,673 |   | $ | 5,338 |   | $ | 5,454 |   |
| Equity in earnings of servicing and operating entities |       | (9                               | )          | 659                            |       | 510 |   | 704 |   |
|                                                   |       | $                                | 3,008      |                           | $          | 4,332 |   | $ | 5,848 |   | $ | 6,158 |   |

 

In the first quarter of 2008, the Company discontinued using the incomerecognition model under SOP 03-3 for previously-purchased non-performing loanportfolios in Mexico (refer to Note 4 for a detailed discussion). In accordancewith SOP 03-3, the Acquisition Partnerships now account for theirnon-performing loan portfolios in Mexico under the cost-recovery model – whichrequires collections received to be applied first against the recorded amountof the loan or pool. At June 30, 2008,the Acquisition Partnerships’ carrying amount of non-performing loans in Mexicoaccounted for using the cost-recovery model in the caption “Assets” in the “CondensedCombined Balance Sheets” table above approximated $156.5 million. TheAcquisition Partnerships did not acquire any loan portfolios in Mexico withcredit deterioration in the second quarter of 2008 that are within the scope ofSOP 03-3.

 

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

 
| ** **                | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Assets:                   |       |              |       |                  |       |
| Domestic:                 |       |              |       |                  |       |
| WAMCO Partnerships        |       | $                 | 70,465     |                  | $          | 87,086 |   |
| Other                     |       | 7,789             |       | 7,758                 |       |
| Latin America             |       | 228,975           |       | 200,780               |       |
| Europe:                   |       |              |       |                  |       |
| P.R.L. Developpement, SAS |       | 25,645            |       | 21,794                |       |
| Other                     |       | 131,150           |       | 140,072               |       |
|                      |       | $                 | 464,024    |                  | $          | 457,490 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 
| ** **                                     | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| Equity:                                        |       |              |       |                  |       |
| Domestic:                                      |       |              |       |                  |       |
| WAMCO Partnerships                             |       | $                 | 38,258     |                  | $          | 44,309 |   |
| Other                                          |       | 4,320             |       | 4,237                 |       |
| Latin America                                  |       | 178,236           |       | 168,108               |       |
| Europe:                                        |       |              |       |                  |       |
| P.R.L. Developpement, SAS                      |       | 24,034            |       | 19,728                |       |
| Other                                          |       | 72,059            |       | 79,678                |       |
|                                           |       | $                 | 316,907    |                  | $          | 316,060 |   |
| Equity investment in Acquisition Partnerships: |       |              |       |                  |       |
| Domestic:                                      |       |              |       |                  |       |
| WAMCO Partnerships                             |       | $                 | 19,134     |                  | $          | 22,065 |   |
| Other                                          |       | 2,074             |       | 2,064                 |       |
| Latin America                                  |       | 24,032            |       | 21,555                |       |
| Europe:                                        |       |              |       |                  |       |
| P.R.L. Developpement, SAS                      |       | 10,995            |       | 9,085                 |       |
| Other                                          |       | 19,898            |       | 21,309                |       |
|                                           |       | $                 | 76,133     |                  | $          | 76,078 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

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

 
| ** **                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                        | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                        | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Revenues:                         |       |                             |       |                           |       |   |   |   |   |
| Domestic:                         |       |                             |       |                           |       |   |   |   |   |
| WAMCO Partnerships                |       | $                                | 3,129      |                           | $          | 4,020 |   | $ | 6,050 |   | $ | 8,372 |   |
| Other                             |       | 103                              |       | 352                            |       | 297 |   | 597 |   |
| Latin America                     |       | 12,495                           |       | 10,130                         |       | 23,726 |   | 19,442 |   |
| Europe:                           |       |                             |       |                           |       |   |   |   |   |
| P.R.L. Developpement, SAS         |       | 1,301                            |       | 242                            |       | 1,598 |   | 746 |   |
| Other                             |       | 10,518                           |       | 7,526                          |       | 20,495 |   | 16,401 |   |
|                              |       | $                                | 27,546     |                           | $          | 22,270 |   | $ | 52,166 |   | $ | 45,558 |   |
|                              |       |                             |       |                           |       |   |   |   |   |
| Net earnings:                     |       |                             |       |                           |       |   |   |   |   |
| Domestic:                         |       |                             |       |                           |       |   |   |   |   |
| WAMCO Partnerships                |       | $                                | (235       | )                              | $          | 2,383 |   | $ | 559 |   | $ | 2,982 |   |
| Other                             |       | (75                              | )          | 125                            |       | (316 | ) | 105 |   |
| Latin America                     |       | 3,007                            |       | 8,201                          |       | 5,990 |   | 6,563 |   |
| Europe:                           |       |                             |       |                           |       |   |   |   |   |
| P.R.L. Developpement, SAS         |       | 1,591                            |       | 1,145                          |       | 2,769 |   | 1,657 |   |
| Other                             |       | 6,306                            |       | 4,524                          |       | 10,904 |   | 9,660 |   |
|                              |       | $                                | 10,594     |                           | $          | 16,378 |   | $ | 19,906 |   | $ | 20,967 |   |
| Equity in earnings of Acquisition |       |                             |       |                           |       |   |   |   |   |
| Partnerships:                     |       |                             |       |                           |       |   |   |   |   |
| Domestic:                         |       |                             |       |                           |       |   |   |   |   |
| WAMCO Partnerships                |       | $                                | (88        | )                              | $          | 1,074 |   | $ | 292 |   | $ | 1,343 |   |
| Other                             |       | (24                              | )          | 39                             |       | (138 | ) | 21 |   |
| Latin America                     |       | 735                              |       | 887                            |       | 1,104 |   | 877 |   |
| Europe:                           |       |                             |       |                           |       |   |   |   |   |
| P.R.L. Developpement, SAS         |       | 728                              |       | 498                            |       | 1,215 |   | 721 |   |
| Other                             |       | 1,666                            |       | 1,175                          |       | 2,865 |   | 2,492 |   |
|                              |       | $                                | 3,017      |                           | $          | 3,673 |   | $ | 5,338 |   | $ | 5,454 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

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

** **

**Three Months Ended June 30,2008**

 
| ** **                                     | ** ** | **WAMCO** | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|-----------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **30**    | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Income from Portfolio Assets                   |       | $         | 1,944      |             | $          | 1,183        |       | $ | 3,127 |   |
| Other income, net                              |       | 2         |       | —           |       | 2            |       |
| Revenues                                       |       | 1,946     |       | 1,183            |       | 3,129        |       |
| Interest and fees on notes payable             |       | (363      | )          | (38              | )          | (401         | )          |
| Provision for loan and impairment losses       |       | (989      | )          | (1,304           | )          | (2,293       | )          |
| Servicing fees — affiliate                |       | (138      | )          | (132             | )          | (270         | )          |
| General, administrative and operating expenses |       | (310      | )          | (90              | )          | (400         | )          |
| Expenses                                       |       | (1,800    | )          | (1,564           | )          | (3,364       | )          |
| Net earnings (loss)                            |       | $         | 146        |             | $          | (381         | )          | $ | (235 | ) |

 

**ThreeMonths Ended June 30, 2007**

 
| ** **                                     | ** ** | **WAMCO** | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|-----------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **30**    | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Income from Portfolio Assets                   |       | $         | 2,937      |             | $          | 1,019        |       | $ | 3,956 |   |
| Other income, net                              |       | 62        |       | 2                |       | 64           |       |
| Revenues                                       |       | 2,999     |       | 1,021            |       | 4,020        |       |
| Interest and fees on notes payable             |       | (603      | )          | (127             | )          | (730         | )          |
| Provision for loan and impairment losses       |       | 577       |       | (61              | )          | 516          |       |
| Servicing fees — affiliate                |       | (711      | )          | (159             | )          | (870         | )          |
| General, administrative and operating expenses |       | (428      | )          | (125             | )          | (553         | )          |
| Expenses                                       |       | (1,165    | )          | (472             | )          | (1,637       | )          |
| Net earnings                                   |       | $         | 1,834      |             | $          | 549          |       | $ | 2,383 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

**Six Months Ended June 30, 2008**

 
| ** **                                     | ** ** | **WAMCO** | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|-----------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **30**    | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Income from Portfolio Assets                   |       | $         | 3,487      |             | $          | 2,551        |       | $ | 6,038 |   |
| Other income, net                              |       | 11        |       | 1                |       | 12           |       |
| Revenues                                       |       | 3,498     |       | 2,552            |       | 6,050        |       |
| Interest and fees on notes payable             |       | (836      | )          | (96              | )          | (932         | )          |
| Provision for loan and impairment losses       |       | (1,212    | )          | (1,704           | )          | (2,916       | )          |
| Servicing fees — affiliate                |       | (252      | )          | (442             | )          | (694         | )          |
| General, administrative and operating expenses |       | (783      | )          | (166             | )          | (949         | )          |
| Expenses                                       |       | (3,083    | )          | (2,408           | )          | (5,491       | )          |
| Net earnings                                   |       | $         | 415        |             | $          | 144          |       | $ | 559 |   |

 

**Six Months Ended June 30, 2007**

 
| ** **                                     | ** ** | **WAMCO** | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|-----------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **30**    | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Income from Portfolio Assets                   |       | $         | 6,231      |             | $          | 2,032        |       | $ | 8,263 |   |
| Other income, net                              |       | 105       |       | 4                |       | 109          |       |
| Revenues                                       |       | 6,336     |       | 2,036            |       | 8,372        |       |
| Interest and fees on notes payable             |       | (1,303    | )          | (259             | )          | (1,562       | )          |
| Provision for loan losses                      |       | (487      | )          | (476             | )          | (963         | )          |
| Servicing fees — affiliate                |       | (1,055    | )          | (371             | )          | (1,426       | )          |
| General, administrative and operating expenses |       | (1,114    | )          | (325             | )          | (1,439       | )          |
| Expenses                                       |       | (3,959    | )          | (1,431           | )          | (5,390       | )          |
| Net earnings                                   |       | $         | 2,377      |             | $          | 605          |       | $ | 2,982 |   |

 

At June 30,2008, the Company had $37.2 million in Euro-denominated debt for the purpose ofhedging a portion of the net equity investments in Europe. In general, the typeof risk hedged relates to the foreign currency exposure of net investments inEurope caused by movements in Euro exchange rates. The Company designated thehedging relationship such that changes in the net investments being hedged areexpected to be offset by corresponding changes in the values of theEuro-denominated debt.

 

Effectiveness ofthe hedging relationship is measured and designated at the beginning of eachmonth by comparing the outstanding balance of the Euro-denominated debt to thecarrying value of the designated net equity investments. The net foreigncurrency translation gain (loss) included in accumulated other comprehensiveincome relating to the Euro-denominated debt was ($1.5) million for the sixmonths ended June 30, 2008 and $156 for the same period in 2007.

 

**(7)  Servicing Assets — SBA Loans**

 

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

 

In February 2007,the Company, through its subsidiary American Business Lending, Inc. (“ABL”),acquired a portfolio of SBA loans for $36.8 million. Included in the purchaseprice were the rights to service additional loans with an unpaid balance of$33.8 million. The Company recorded a servicing asset of $758 relating to theseservicing rights. Additional servicing rights have been capitalized since theportfolio acquisition as a result of loans sold. Servicing rights arerecognized as assets when the SBA loans are sold and the rights to servicethose loans are retained. The Company retains servicing responsibilities andreceives servicing fees of approximately 1%.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

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

 
| ** **                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                  | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                  | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Beginning Balance                           |       | $                                | 839        |                           | $          | 854 |   | $ | 885 |   | $ | — |   |
| Servicing Assets capitalized                |       | 52                               |       | 140                            |       | 54 |   | 1,009 |   |
| Servicing Assets amortized                  |       | (50                              | )          | (55                            | )          | (98 | ) | (70 | ) |
| Ending Balance                              |       | $                                | 841        |                           | $          | 939 |   | $ | 841 |   | $ | 939 |   |
| ** **                                  | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Reserve for impairment of servicing assets: | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Beginning Balance                           |       | $                                | (110       | )                              | $          | (39 | ) | $ | (42 | ) | $ | — |   |
| Impairments                                 |       | (1                               | )          | (9                             | )          | (69 | ) | (48 | ) |
| Recoveries                                  |       | 19                               |       | —                         |       | 19 |   | — |   |
| Charge Offs                                 |       | —                           |       | —                         |       | — |   | — |   |
| Ending Balance                              |       | $                                | (92        | )                              | $          | (48 | ) | $ | (92 | ) | $ | (48 | ) |
|                                        |       |                             |       |                           |       |   |   |   |   |
| Ending Balance (net of reserve)             |       | $                                | 749        |                           | $          | 891 |   | $ | 749 |   | $ | 891 |   |
| ** **                                  | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fair value of amortized servicing assets:   |       |                             |       |                           |       |   |   |   |   |
| Beginning balance                           |       | $                                | 729        |                           | $          | 815 |   | $ | 843 |   | $ | — |   |
| Ending balance                              |       | 749                              |       | 891                            |       | 749 |   | 891 |   |

 

The Company relies primarily on an undiscounted cash flow model toestimate the fair value of its servicing assets. The model calculates estimatedfair value of the servicing assets using predominant risk characteristics ofservicing assets such as discount rate, prepayment speed, weighted average lifeof the underlying loans, and the interest rates of the underlying loans. Theestimated fair value of servicing assets was determined using discount ratesranging from 7.50% to 11.19%, prepayment speeds of 15%, and weighted averagelives ranging from 75 to 299 months. In the event future prepayments aresignificant or impairments are incurred and future expected cash flows areinadequate to cover the unamortized servicing assets, additional amortizationor impairment charges would be recognized.

 

**(8)  Segment Reporting**

 

The Company is engaged in one reportable segment- Portfolio Asset acquisition and resolution. The following is a summary of results of operations for the PortfolioAsset acquisition and resolution segment and reconciliation to losses fromcontinuing operations for the three and six months ended June 30, 2008 and2007.

 

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** **

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

 
| ** **                                                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                         | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                         | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Portfolio Asset Acquisition and Resolution:**                                    |       |                             |       |                           |       |   |   |   |   |
| Revenues:                                                                          |       |                             |       |                           |       |   |   |   |   |
| Servicing fees                                                                     |       | $                                | 2,706      |                           | $          | 2,977 |   | $ | 4,906 |   | $ | 5,582 |   |
| Income from Portfolio Assets                                                       |       | 5,622                            |       | 5,685                          |       | 10,557 |   | 10,720 |   |
| Gain on sale of SBA loans held for sale, net                                       |       | 133                              |       | 343                            |       | 142 |   | 624 |   |
| Interest income from SBA loans                                                     |       | 366                              |       | 606                            |       | 842 |   | 914 |   |
| Interest income from affiliates                                                    |       | 483                              |       | 140                            |       | 633 |   | 266 |   |
| Interest income from loans receivable - other                                      |       | 355                              |       | 982                            |       | 630 |   | 1,889 |   |
| Revenue from controlled affiliate                                                  |       | 859                              |       | —                         |       | 1,664 |   | — |   |
| Other                                                                              |       | 921                              |       | 455                            |       | 1,392 |   | 785 |   |
| Total                                                                              |       | 11,445                           |       | 11,188                         |       | 20,766 |   | 20,780 |   |
| Expenses:                                                                          |       |                             |       |                           |       |   |   |   |   |
| Interest and fees on notes payable                                                 |       | 3,758                            |       | 4,668                          |       | 7,441 |   | 8,919 |   |
| Salaries and benefits                                                              |       | 4,232                            |       | 3,025                          |       | 8,193 |   | 6,139 |   |
| Provision for loan and impairment losses                                           |       | 7,090                            |       | 746                            |       | 10,120 |   | 1,072 |   |
| Occupancy, data processing, property protection and  other                         |       | 3,930                            |       | 2,741                          |       | 7,162 |   | 4,733 |   |
| Minority interest                                                                  |       | 53                               |       | (15                            | )          | 31 |   | (123 | ) |
| Total                                                                              |       | 19,063                           |       | 11,165                         |       | 32,947 |   | 20,740 |   |
| Equity in earnings of investments                                                  |       | 3,008                            |       | 4,332                          |       | 5,848 |   | 6,158 |   |
| Operating contribution before direct taxes                                         |       | $                                | (4,610     | )                              | $          | 4,355 |   | $ | (6,333 | ) | $ | 6,198 |   |
| Operating contribution, net of direct taxes                                        |       | $                                | (4,821     | )                              | $          | 4,313 |   | $ | (6,621 | ) | $ | 6,183 |   |
|                                                                               |       |                             |       |                           |       |   |   |   |   |
| **Corporate Overhead:**                                                            |       |                             |       |                           |       |   |   |   |   |
| Salaries and benefits, occupancy, professional and  other income and expenses, net |       | 1,658                            |       | 2,507                          |       | 3,351 |   | 5,292 |   |
| Earnings (loss) from continuing operations                                         |       | $                                | (6,479     | )                              | $          | 1,806 |   | $ | (9,972 | ) | $ | 891 |   |

 

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

 
| ** **    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **    | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **    | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Domestic      |       | $                                | 7,249      |                           | $          | 9,382 |   | $ | 13,967 |   | $ | 16,349 |   |
| Latin America |       | 3,853                            |       | 3,693                          |       | 6,888 |   | 6,225 |   |
| Europe        |       | 3,340                            |       | 2,375                          |       | 5,735 |   | 4,205 |   |
| Other         |       | 11                               |       | 70                             |       | 24 |   | 159 |   |
| Total         |       | $                                | 14,453     |                           | $          | 15,520 |   | $ | 26,614 |   | $ | 26,938 |   |

 

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** **

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

 

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

 
| ** **                                   | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| ** **                                   | ** ** | ** **        | ** ** | ** **            | ** ** |
| Cash and cash equivalents                    |       | $                 | 12,316     |                  | $          | 23,037 |   |
| Restricted cash                              |       |              | 1,190      |                  |       | 509 |   |
| Portfolio acquisition and resolution assets: |       |              |       |                  |       |
| Domestic                                     |       | 204,234           |       | 163,078               |       |
| Latin America                                |       | 44,809            |       | 33,450                |       |
| Europe                                       |       | 46,941            |       | 46,701                |       |
| Other                                        |       | 282               |       | 371                   |       |
| Deferred tax asset, net                      |       | 20,101            |       | 20,101                |       |
| Other non-earning assets, net                |       | 18,750            |       | 10,872                |       |
| Total assets                                 |       | $                 | 348,623    |                  | $          | 298,119 |   |

 

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

 

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

 
| ** **                                                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                        | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                                        | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                        | ** ** | ** **                       | ** ** | ** **                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Earnings (loss) from continuing operations                                        |       | $                                | (6,479     | )                              | $          | 1,806 |   | $ | (9,972 | ) | $ | 891 |   |
| Loss from discontinued operations                                                 |       | (50                              | )          | —                         |       | (141 | ) | — |   |
| Net earnings (loss) available to common shareholders                              |       | $                                | (6,529     | )                              | $          | 1,806 |   | $ | (10,113 | ) | $ | 891 |   |
|                                                                              |       |                             |       |                           |       |   |   |   |   |
| Weighted average outstanding shares of common stock  (in thousands)               |       | 10,357                           |       | 10,789                         |       | 10,471 |   | 10,789 |   |
| Dilutive effect of:                                                               |       |                             |       |                           |       |   |   |   |   |
| Warrants                                                                          |       | —                           |       | 323                            |       | — |   | 328 |   |
| Employee stock options                                                            |       | —                           |       | 285                            |       | — |   | 297 |   |
| Weighted average outstanding shares of common stock  and common stock equivalents |       | 10,357                           |       | 11,397                         |       | 10,471 |   | 11,414 |   |
|                                                                              |       |                             |       |                           |       |   |   |   |   |
| Earnings (loss) from continuing operations per  share:                            |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                             |       | $                                | (0.63      | )                              | $          | 0.17 |   | $ | (0.96 | ) | $ | 0.08 |   |
| Diluted                                                                           |       | $                                | (0.63      | )                              | $          | 0.16 |   | $ | (0.96 | ) | $ | 0.08 |   |
| Loss from discontinued operations per share:                                      |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                             |       | $                                | —     |                           | $          | — |   | $ | (0.01 | ) | $ | — |   |
| Diluted                                                                           |       | $                                | —     |                           | $          | — |   | $ | (0.01 | ) | $ | — |   |
| Net earnings (loss) per share:                                                    |       |                             |       |                           |       |   |   |   |   |
| Basic                                                                             |       | $                                | (0.63      | )                              | $          | 0.17 |   | $ | (0.97 | ) | $ | 0.08 |   |
| Diluted                                                                           |       | $                                | (0.63      | )                              | $          | 0.16 |   | $ | (0.97 | ) | $ | 0.08 |   |
|                                                                              |       |                             |       |                           |       |   |   |   |   |
| Dilutive shares excluded from above:                                              |       |                             |       |                           |       |   |   |   |   |
| Warrants                                                                          |       | 231                              |       | —                         |       | 265 |   | — |   |
| Employee stock options                                                            |       | 174                              |       | —                         |       | 210 |   | — |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(10)  Stock-Based Compensation**

** **

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

 
| ** **                                         | ** ** | **Three Months Ended** | ** **   | **Six Months Ended** | ** ** |
|----------------------------------------------------|------------|------------------------|--------------|----------------------|------------|
| ** **                                         | ** ** | **June 30,**      | ** **   | **June 30,**    | ** ** |
| ** **                                         | ** ** | **2008**               | ** **   | **2007**             | ** ** | **2008** | ** ** | **2007** | ** ** |
| Amount of compensation cost recognized in expenses |       | $                      |  197    |                 | $          |  109 |   | $ |  422 |   | $ |  289 |   |
| Tax benefit recognized in income                   |       | $                      |  — |                 | $          |  — |   | $ |  — |   | $ |  — |   |
| Amount capitalized as part of an asset             |       | $                      |  — |                 | $          |  — |   | $ |  — |   | $ |  — |   |

 

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

 

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

 

A summary of stockoption activity as of June 30, 2008 and changes during the period thenended is presented below:

** **
| ** **                          | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|-------------------------------------|------------|------------|------------|--------------|------------|-----------------|------------|---------------|------------|
| ** **                          | ** ** | ** ** | ** ** | ** **   | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Remaining**   | ** ** | ** **    | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Average**  | ** ** | **Contractual** | ** ** | **Aggregate** | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Term**        | ** ** | **Intrinsic** | ** ** |
| ** **                          | ** ** | **Shares** | ** ** | **Price**    | ** ** | **(Years)**     | ** ** | **Value**     | ** ** |
| Outstanding at January 1, 2008 |       | 879,150    |       | $            | 6.67       |            |       |          |       |   |
| Granted                             |       | 30,000     |       | 4.69         |       |            |       |          |       |
| Exercised                           |       | —     |       | —       |       |            |       |          |       |
| Expired                             |       | (7,500     | )          | 29.69        |       |            |       |          |       |
| Forfeited                           |       | (32,500    | )          | 6.78         |       |            |       |          |       |
| Outstanding at June 30, 2008   |       | 869,150    |       | $            | 6.40       |            | 5.77       |          | $          | 2,178 |   |
| Exercisable at June 30, 2008   |       | 673,075    |       | $            | 5.46       |            | 4.86       |          | $          | 2,100 |   |

** **

The total intrinsicvalue of stock options exercised during the six month periods ended June 30,2008 and 2007 was $-0- and $9, respectively. As of June 30, 2008, therewas approximately $1.0 million of total unrecognized compensation cost relatedto unvested share-based compensation arrangements granted under the stockoption plans.  That cost is expected tobe recognized over a weighted average period of 2.3 years.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

A summary of thestatus and changes of FirstCity’s nonvested shares as of June 30, 2008,and changes during the six months ended June 30, 2008 is presented below:

 

| ** **                        | ** ** | ** ** | ** ** | **Weighted-**  | ** ** |
|-----------------------------------|------------|------------|------------|----------------|------------|
| ** **                        | ** ** | ** ** | ** ** | **Average**    | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Grant-Date** | ** ** |
| ** **                        | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
| Nonvested at January 1, 2008 |       | 240,950    |       | $              | 6.89       |   |
| Granted                           |       | 30,000     |       | $              | 3.05       |   |
| Vested                            |       | (73,625    | )          | $              | 5.28       |   |
| Forfeited                         |       | (1,250     | )          | $              | 5.26       |   |
| Nonvested at June 30, 2008   |       | 196,075    |       | $              | 6.92       |   |

 

**(11)  Income Taxes**

** **

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

 

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

 

Beginning with theadoption of FASB Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes – An Interpretation of FASB Statement No. 109* (“FIN 48”) as of January 1,2007, the Company recognizes the effect of income tax positions only if thosepositions are more likely than not of being sustained. Recognized income taxpositions are measured at the largest amount that is greater than 50% likely ofbeing realized. Changes in recognition or measurement are reflected in theperiod in which the change in judgment occurs. Prior to the adoption of FIN 48,the Company generally recognized the effect of income tax positions only ifsuch positions were probable of being sustained. Under FIN 48, income taxbenefits are recognized and measured based upon a two-step model: (1) atax position must be more-likely-than-not to be sustained based solely on itstechnical merits in order to be recognized; and (2) the benefit ismeasured as the largest dollar amount of that position that ismore-likely-than-not to be sustained upon settlement. The difference betweenthe benefit recognized for a position in accordance with this FIN 48 model andthe tax benefit claimed on a tax return is referred to as an unrecognized taxbenefit (“UTB”).

 

The gross amount of UTBs on uncertain tax positions as of June 30,2008 totaled $577, which if recognized, would impact the Company’s effectiveincome tax rate. A reconciliation of UTBs for the first six months of 2008follows:

 

| ** **                                                    | ** ** | **2008** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|
| Balance at January 1, 2008                               |       | $        | 579        |   |
| Additions based on tax positions related to the  current year |       | —   |       |
| Payments and settlements                                      |       | (2       | )          |
| Balance at June 30, 2008                                 |       | $        | 577        |   |

 

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

 

Over the next twelve months, due to the expiration of the statute oflimitations related to certain UTBs, the Company anticipates that it isreasonably possibly that the amount of UTBs could be reduced by approximately$228, which would impact the Company’s effective tax rate. The Company recordsinterest and penalties related to income tax uncertainties in the provision forincome taxes. At June 30, 2008, interest and penalties of $178 areincluded in “Other liabilities” as income taxes payable.

 

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

 

**(12)  Fair Value**

** **

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

 

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

 

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

 

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

 

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

 

| ** **                        | ** ** | ** **                               | ** ** | ** **        | ** ** | ** **  | ** ** | ** **  | ** ** | **Total Losses in**    | ** ** |
|-----------------------------------|------------|------------------------------------------|------------|-------------------|------------|-------------|------------|-------------|------------|------------------------|------------|
| ** **                        | ** ** | **Carrying Value at June 30, 2008** | ** ** | **Quarter Ended** | ** ** |
| **(Dollars in thousands)**        | ** ** | **Total**                                | ** ** | **Level 1**       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **June 30, 2008** | ** ** |
| Portfolio Assets - loans (1)      |       | $                                        | 6,225      |              | $          | —      |       | $           | —     |                   | $          | 6,225 |   | $ | (2,114 | ) |
| SBA loans held for investment (1) |       | 169                                      |       | —            |       | —      |       | 169         |       | (110                   | )          |
| Servicing assets - SBA loans      |       | 8                                        |       | —            |       | —      |       | 8           |       | (1                     | )          |
|                              |       |                                     |       |              |       |        |       |        |       | $                      | (2,225     | ) |
|                                   |            |                                          |            |                   |            |             |            |             |            |                        |            |  |  |  |  |  |

 

----

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

 

The carrying value and related write-downs of “Portfolio Assets – loans”and “SBA loans held for investment” in the table above are based on collateralvaluations using multiple valuation approaches that are derived from observableand unobservable inputs, adjusted for various considerations such as marketconditions, economic and competitive environment, and other assets with similarcharacteristics (i.e. industry, geography, etc.) that, in management’s opinion,reflect elements a marketplace participant would consider. The Companyclassifies its fair value measurement techniques for Portfolio Assets and SBAloans as Level 3 inputs for the following reasons: (1) distressed assetacquisitions generally occur in inactive markets for which observable marketprices are not

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

readily available(i.e. price quotations vary substantially over time and among market-makers,and pricing information is generally not released to the public); and (2) theCompany’s valuation techniques that are most-significant to the fair valuemeasurements are principally derived from assumptions and inputs that arecorroborated by little or no observable market data.

 

The carrying value and related write-downs of “Servicing assets – SBAloans” in the table above are based on fair value measurements derived from theCompany’s discounted cash flow model. This model estimates fair value of theservicing assets using predominant risk characteristics of servicing assetssuch as discount rate, prepayment speed, weighted average life of theunderlying loans, and the interest rates of the underlying loans. The Companyclassifies its fair value measurement techniques for servicing assets as Level3 inputs since the Company’s valuation techniques that are most-significant tothe fair value measurements are derived from internally-developed models thatare driven by assumptions and inputs that are corroborated by little or noobservable market data.

 

Under SFAS 157, we attempt to base our fair values on the price thatwould be received to sell an asset in an orderly transaction between marketparticipants at the measurement date. It is our policy to maximize the use ofobservable inputs, when reasonably available and without undue cost, andminimize the use of unobservable inputs when developing fair value measurementsin accordance with the fair value hierarchy in SFAS 157. Fair valuemeasurements for assets where there exists limited or no observable market dataand, therefore, are based principally on our own estimates and assumptions, areoften calculated based on current pricing policy, the economic and competitiveenvironment, the characteristics of the asset, and other such factors. Additionally,there may be inherent weaknesses in any model-driven valuation technique, andchanges in the underlying assumptions used, including discount rates andestimates of future cash flows, that could significantly affect the results ofcurrent or future values.

 

**(13)  Commitments andContingencies**

** **

*IndemnificationObligation Commitments*

* *

On September 21,2004, FirstCity, FirstCity Consumer Corporation (“Consumer Corp.”), FirstCityFunding LP (“Funding LP”) and FirstCity Funding GP (“Funding GP”) entered intothe a Securities Purchase Agreement to sell a 31% beneficial ownership interestin Drive and its general partner, Drive GP LLC, to IFA-GP, IFA-LP and MG-LP(the “2004 Securities Purchase Agreement”). In the 2004 Securities PurchaseAgreement, FirstCity, Consumer Corp., Funding LP and Funding GP made variousrepresentations and warranties concerning (i) their respectiveorganizations, (ii) their power and authority to enter into the 2004Securities Purchase Agreement and the transactions contemplated therein, (iii) theownership of the limited partnership interests in Drive by Funding LP, (iv) theownership of membership interests in Drive-GP by Consumer Corp., and (iv) thecapital structure of Funding LP. FirstCity, Consumer Corp., Funding LP andFunding GP also agreed to indemnify BoS (USA), IFA-GP, IFA-LP and MG-LP fromdamages resulting from a breach of any representation or warranty contained inthe 2004 Securities Purchase Agreement or otherwise made by FirstCity, ConsumerCorp. or Funding LP in connection with the transaction. The indemnityobligations under the 2004 Securities Purchase Agreement survive for a maximumperiod of five (5) years from November 1, 2004. Neither FirstCity,Consumer Corp., Funding LP, or Funding GP is required to make any payments as aresult of the indemnity provided under the 2004 Securities Purchase Agreementuntil the aggregate amount payable exceeds $0.25 million, and then only for theamount in excess of $0.25 million in the aggregate; however certainrepresentations and warranties are not subject to this $0.25 million threshold.Management of the Company believes that FirstCity will not have to pay anyamounts relating to these representations and warranties.

 

On August 8,2006, an Interest Purchase and Sale Agreement was entered into by and amongBidmex Holding, LLC (“Buyer”), as buyer, and Strategic Mexican InvestmentPartners, L.P. (“SMIP”), an affiliate of the Company and Cargill FinancialServices International, Inc. (“CFSI”), (collectively, the “Sellers”), asseller, and eleven U.S. limited liability companies (“LLCs”) which invested inMexican portfolio acquisition entities (“SRLs”) and the AIG entities asadditional parties.  In the Interest Purchase and Sale Agreement, theSellers and the LLCs made various representations and warranties concerning (i) theexistence and ownership of the LLCs and the related SRLs, (ii) the assetsand liabilities of the LLCs, (iii) taxes related to periods prior to August 8,2006, and (iv) the operations of the LLCs and SRLs.  The Sellersagreed to indemnify the Buyer and AIG Entities from damages resulting from abreach of any representation or warranty contained in the Interest Purchase andSale Agreement on a several and not joint basis according to their respectiveownership percentages in each LLC as to any matter related to a particular LLC,or on the basis of 80% to CFSI and 20% to SMIP as to any matter that could notbe identified to a particular LLC.  The indemnity obligation under theInterest Purchase and Sale Agreement survives for a period of the statute oflimitations for matters related to taxes, existence and authority,capitalization and good standing of the LLCs and SRLs and for a period of twoyears from August 8, 2006, the closing date with respect to all other representationsand warranties.  The Sellers are not required to make any payments as aresult of the indemnity provisions of the Interest Purchase and Sale Agreementuntil the aggregate amount payable under that agreement and the Asset PurchaseAgreement exceeds $0.25 million; however, claims related to taxes and fraud arenot subject to this $0.25 million

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

threshold.  TheInterest Purchase and Sale Agreement limits the liability of the Sellers forindemnifiable losses under the Interest Purchase and Sale Agreement and theAsset Purchase Agreement to the Aggregate Purchase Price (without duplicationof amounts recovered pursuant to the terms of the Asset PurchaseAgreement).  FirstCity does not believethat the potential liability would have a material adverse effect on theconsolidated financial position, results of operations or liquidity ofFirstCity, its subsidiaries, its affiliates or the Acquisition Partnerships.

 

Also on August 8,2006, Bidmex Holding, LLC entered into an Agreement for the Onerous Transfer ofLoans and Litigious Rights (the “Asset Purchase Agreement”) between and amongResidencial Oeste, S. de R.L. de C.V., as seller (the “Asset Seller”), anaffiliate of CFSI and SMIP, Residencial Oeste 2, S. de R.L. de C.V., aspurchaser (the “Asset Purchaser”), and CFSI, SMIP, and Bidmex Acquisition, LLC,the parent of the Asset Purchaser, as additional parties.  The AssetPurchase Agreement provides for the sale of the loan portfolio owned by theSeller to the Purchaser for a purchase price of $10.1 million on the closingdate, which purchase price is 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 Agreementsurvives for a period of the statute of limitations for matters related toexistence and ownership of the Seller, ownership of the loans, and taxes forperiods prior to August 8, 2006, and for a period of two years from August 8,2006, with respect to all other representations and warranties.  TheSeller is not required to make any payments as a result of the indemnityprovisions of the Asset Purchase Agreement until the aggregate amount payableunder that Agreement exceeds $25; however, claims related to taxes and fraudare not subject to this $25 threshold.  The Interest Purchase and SaleAgreement limits the liability of the Sellers for indemnifiable losses underthe Asset Purchase Agreement to the Aggregate Purchase Price. FirstCity doesnot believe that the potential liability would have a material adverse effecton the consolidated financial position, results of operations or liquidity ofFirstCity, its subsidiaries, its affiliates or the Acquisition Partnerships.

 

*Commitments to Repurchase Loans*

* *

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

 

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

 

*Lettersof Credit and Other Guarantees*

* *

On November 5, 2007, Fondo de Inversion Privado NPL Fund One (“PIF1”),an equity investment of FirstCity Chile, Ltda., entered into a revolving lineof credit with a maximum loan amount of $15.0 million with Banco SantanderChile, S.A. The proceeds were used to acquire a loan portfolio at face valuefrom FirstCity NPL S.A. (a consolidated affiliate of FirstCity Chile, Ltda.)and to finance the purchase of other loan portfolios from non-affiliatedparties. Pursuant to terms of the credit facility, FirstCity was required

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

to provide astand-by letter of credit from Bank of Scotland that would satisfy the maximumloan balance upon demand. At June 30, 2008, FirstCity had a letter ofcredit in the amount of $16.5 million from Bank of Scotland under the terms ofFirstCity’s revolving acquisition facility with Bank of Scotland, with BancoSantander Chile, S.A. as the letter of credit beneficiary. In the event that ademand is made under the $16.5 million letter of credit, FirstCity is requiredto reimburse 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 revolving line of credit with a maximumloan amount in Mexican pesos equivalent to $13.8 million as of June 30,2008, with Banco Santander, S.A. The proceeds were used to pay down theacquisition facility with the Bank of Scotland. Pursuant to the terms of the credit facility, FirstCity Mexico SA de CVwas required to provide a stand-by letter of credit from Bank of Scotland thatwould satisfy the loan balance upon demand.  At June 30, 2008,FirstCity had a letter of credit in the amount of $14.1 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 $14.1million letter of credit, FirstCity is required to reimburse Bank of Scotlandby making payment to Bank of Scotland for all amounts disbursed or to bedisbursed by Bank of Scotland under the letter of credit.

 

ABL, a subsidiary ofFirstCity, has a $40.0 million revolving loan facility with Wells FargoFoothill, LLC (“WFF”), as most recently amended on July 30, 2007, for thepurpose of financing and acquiring SBA loans. The obligations under thisfacility are secured by substantially all of the assets of ABL.  At June 30,2008, the balance of this facility was $9.7 million.  In connection withthe first amendment to this facility on February 27, 2007, FirstCityprovided WFF with an unconditional guaranty, up to a maximum of $5.0 millionplus enforcement cost, of the obligations of ABL under the loan facility thatrelate to funds in the amount of $31.7 advanced by WFF to ABL in connection ofa portfolio of SBA loans in February 2007. This guaranty arrangementremains in effect until the obligations incurred in connection with the advancerelated to the acquisition of the portfolio of SBA loans are paid in full.

 

FirstCity CommercialCorp. (“FirstCity Commercial”), a wholly-owned affiliate of FirstCity, providesvarious financial institutions with guarantees of the debt obligations ofcertain Acquisition Partnerships. The underlying debt financing arrangements ofthese Acquisitions Partnerships have various maturities ranging from September 2008to February 2010, and are secured primarily by certain real estate held bythe Acquisition Partnerships. At June 30, 2008, FirstCity Commercial’smaximum commitments under these guaranty arrangements totaled $2.5 million, andthe total outstanding obligations of these Acquisition Partnerships attributedto FirstCity Commercial’s guaranty approximated $2.1 million.

 

*Legal Proceedings*

* *

The following information supplements and amendsour discussion set forth under Part I, Item 3 “Legal Proceedings” in ourAnnual Report on Form 10-K for the fiscal year ended December 31,2007.

 

Wave TecLitigation

 

Superior Funding, Inc., Wave Tec Pools, Inc. and Nations PoolSupply, Inc. (collectively “Plaintiffs”) filed a Fifth Amended Petitionadding additional parties related to Prosperity Bank on or about May 12,2008, but asserting no new claims against FirstCity Servicing Corporation or FHPartners LLC, indirect wholly-owned subsidiaries of FirstCity.  Plaintiffs also sent extensive requests forproduction of documents and terminated the prior agreement to suspend discoveryand responses have been filed by FH Partners LLC.  FirstCity Servicing Corporation and FHPartners LLC intend to contest the cases vigorously.

 

*OtherContingent Commitments*

* *

FirstCity hasminority interests in various limited-life partnerships with a net carryingvalue of ($321) at June 30, 2008. The estimated amount that would be paidto the minority interest holder if the instruments were to be settled at June 30,2008 is $1.3 million.

 

**(14)  Other Related PartyTransactions**

 

FirstCity hasfinancing and service arrangements with certain Acquisition Partnerships andother affiliated entities, and financing arrangements with certainnon-affiliated entities that are considered to be variable interest entities (“VIEs”),as defined in FASB Interpretation No. 46R, *Consolidationof Variable Interest Entities* (“FIN 46R”). However, FirstCity is notdeemed to be the primary beneficiary of these entities based on the provisionsof FIN 46R. The Company could experience a loss in the event that cash flows

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

from the VIEs or theunderlying collateral are not collected as expected. At June 30, 2008,FirstCity’s maximum exposure to loss as a result of its involvement with theVIEs is $49.7 million.

 

In June 2008, FCAcquisitions SRL de CV (“FC Acquisitions”), an indirect majority-owned Mexicanaffiliate of FirstCity, acquired a loan portfolio in Mexico (refer to Note 4).FC Acquisitions financed the loan portfolio purchase with a term note payableof $8.7 million to MCS Trust SA de CV (“MCS Trust”). The accounts of MCS Trustare consolidated by BMX Holding II, LLC (“BMX Holding II”) – an entity that istreated as an equity-method investment by FirstCity due to its 8.0% ownershipinterest in BMX Holding II. The terms of the note are summarized in the “CreditFacilities” schedule included under the caption **Liquidity and Capital Resources** in Part I, Item 2. of this Form 10-Q. In connection with thistransaction, FirstCity Mexico, Inc., an indirect wholly-owned affiliate ofFirstCity, advanced $8.7 million to BMX Holding II. At June 30, 2008, thisreceivable of $8.7 million was included in “Other assets” on the Company’sconsolidated balance sheet.

 

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 $2.5 million and $2.7 million inthe second quarters of 2008 and 2007, respectively, and $4.6 million and $5.2million in the first six months of 2008 and 2007, respectively.

 

FirstCityServicing Corporation (“FCSC”), an indirect wholly-owned affiliate of theCompany, and MCS et Associates (“MCS”), in which FCSC is an 11.89% shareholderas of December 31, 2007, are parties to Consulting, License andConfidentiality Agreements dated June 30, 1999 pursuant to which FCSCprovides consultation services and personnel to be employed by MCS to assist indeveloping and managing due diligence and servicing systems. Pursuant to thoseagreements, MCS provides the supplied personnel with compensation, taxequalization payments, housing allowances, transportation allowance, and taxpreparation. MCS also pays consulting fees to FCSC and reimburses FCSC fortravel, hotel, airfare, and meal expenses incurred related to the provision ofthe services. In the second quarters of 2008 and 2007, FCSC received from MCSfees totaling $127 and $101, respectively, and $240 and $232 in the first sixmonths of 2008 and 2007, respectively.

 

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

 

**(15)  Stockholders’ Equity**

 

The Company has a stock repurchase plan, as authorized by the Board ofDirectors, that provides for the purchase of up to 1,500,000 shares of theCompany’s common stock. The stock repurchase plan expires on August 30,2009. In the second quarter of 2008, FirstCity repurchased 215,800 shares ofthe Company’s common stock on the open market for a total of $1.1 million.

 

**(16)  Statements of Cash Flows**

** **

In the second quarter of 2008, the Company acquired a real estateinvestment property through a majority-owned subsidiary of FirstCity Denver. Aspart of the investment, the Company assumed a note payable of $7.6 million, andrecorded a non-cash increase to Portfolio Assets for the same amount.

 

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

 

**Overview**

 

FirstCity is a financial services company engagedin one principal reportable segment – Portfolio Asset acquisition andresolution. The Portfolio Asset acquisition and resolution business involvesacquiring portfolios of loans, real estate and other assets or similarsingle-asset investments (collectively referred to as “Portfolios” or “PortfolioAssets”). The Company generally acquires Portfolio Assets at a discountto their legal principal balances or appraised values, and then services and resolves the Portfolio Assets in an effort tomaximize the present value of the ultimate cash recoveries. FirstCity also hasa special situations platform that focuses on constructive investments inrestructurings, turnarounds, businesses with robust market positions, and otherspecial situations. This special situations platform gives FirstCity theability to acquire or finance distressed businesses, originate junior- andsenior-bridge loans, and executelower middle-market buyouts.

 

During the secondquarter of 2008, the Company recorded a net loss to common stockholders on adiluted basis of $6.5 million or $0.63 per common share. The operatingcontribution from the Portfolio Asset acquisition and resolution segmentresulted in a $4.8 million operating loss for the second quarter of 2008compared with a $4.3 million operating gain for the same period in 2007. See **Results of Operations** below for a more detailed review ofthe second quarter of 2008 compared to the second quarter of 2007.

 

The Company wasinvolved in acquiring $36.7 million of portfolio investments with a face valueof approximately $92.1 million in the second quarter 2008 – of which FirstCity’sinvestment share was $33.4 million. FirstCity’s global distribution of itssecond quarter 2008 investments includes $28.4 million in the United States and$5.0 million in Latin America. In addition to its portfolio acquisitions insecond quarter 2008, FirstCity invested $23.9 million in the form of seniordebt financing arrangements with domestic entities; $5.0 million for SBA loanoriginations and advances; and $3.3 million on investment property. At June 30,2008, FirstCity’s earning assets (Portfolio Assets, equity investments, loansreceivable and entity-level earning assets) totaled $296.3 million, and theglobal distribution of such earning assets (at carrying value) included $204.5million in United States; $47.0 million in Europe; and $44.8 million in LatinAmerica.

 

The Company’searnings in second quarter 2008 were negatively impacted by $8.5 million of netimpairment provisions – comprised of $7.1 million of net provisions recorded toour consolidated portfolios, and $1.4 million as our share of net impairmentprovisions recorded to portfolio assets held in our partnership interests. Theglobal distribution of the $8.5 million of net impairment provisions recordedby the Company in second quarter 2008 includes $8.2 million in the UnitedStates, ($0.2) million in Europe, and $0.5 million in Latin America. Theimpairment provisions in second quarter 2008 were attributed primarily todeclines in values of loan collateral and real estate assets in our domesticportfolios, and additional delays in the timing of collections of expected cashflows on domestic loan portfolios. Management believes that declines in realestate values and delayed collections are the resulting adverse effects fromthe subprime mortgage crisis that began in the United States in 2007. Economicuncertainties and substantial losses incurred by lending institutions haveresulted in “tightened credit standards” and “restrained lending”; and excesssupplies of building inventories have caused significant declines in realestate values. These events, in turn, triggered the following obstacles that hindereconomic growth and stability: (1) increased defaults and foreclosures onloan collateral because borrowers cannot refinance their loans and/or continueto make payments; (2) adverse effects on businesses due to a decline inconsumer spending; and (3) decreased investment by businesses due to theirinability to obtain low-cost loans to finance their operations and/or growth.The impairment provisions were identified in connection with management’sregular evaluation of the collectibility of the Company’s Portfolio Assets.Management’s evaluation is inherently subjective as it requires estimates thatare susceptible to revision in future periods as more information becomesavailable.

 

Considering thesubstantial losses reported in the financial services sector over the past yearand downward pressure on economic growth due to the subprime mortgage crisis, managementremains positive on the outlook of the Company. Management believes thatcurrent market conditions should not hinder FirstCity’s ability to expand itsbusiness, and that asset acquisition opportunities at attractive margins areavailable. As mentioned above, FirstCity was involved in acquiring $36.7million of portfolio investments with a face value of approximately $92.1million in the second quarter 2008 (of which FirstCity’s investment share was$33.4 million), and the Company invested an additional $32.2 million in theform of debt financing arrangements and real estate investments. In addition,FirstCity is currently evaluating 26 different transactions representing over $2.7billion in face value of assets, although there can be no assurance thatFirstCity will be able to consummate any of these transactions on acceptableterms.

 

In addition, in light of current market conditions that createdliquidity constraints primarily as a result of the deterioration in thesubprime mortgage industry and tightening credit standards in the marketplace,management believes that current market conditions will not impact FirstCity’sability to finance its operations. Currently, FirstCity has $350.0 million of credit facility 

 

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commitments available to (i) finance the senior debt and equityportions of portfolio and asset purchases; (ii) finance equity investmentsin new ventures; and (iii) provide for the issuance of letters of creditworking capital loans; and a $40.0 million credit facility commitment tofinance SBA loan originations and advances.

 

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

 

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

 

Components of the results for the three and sixmonth periods ended June 30, 2008 and 2007, respectively, are detailedbelow (dollars in thousands except per share data):

 
| ** **                                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                 | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                 | ** ** | **2008**                         | ** ** | **2007**                       | ** ** | **2008** | ** ** | **2007** | ** ** |
| Portfolio Asset Acquisition and Resolution |       | $                                | (4,821     | )                              | $          | 4,313 |   | $ | (6,621 | ) | $ | 6,183 |   |
| Corporate overhead                         |       | (1,658                           | )          | (2,507                         | )          | (3,351 | ) | (5,292 | ) |
| Earnings (loss) from continuing operations |       | (6,479                           | )          | 1,806                          |       | (9,972 | ) | 891 |   |
| Loss from discontinued operations          |       | (50                              | )          | —                         |       | (141 | ) | — |   |
| Net earnings (loss) to common stockholders |       | $                                | (6,529     | )                              | $          | 1,806 |   | $ | (10,113 | ) | $ | 891 |   |
| Diluted earnings (loss) per common share   |       | $                                | (0.63      | )                              | $          | 0.16 |   | $ | (0.97 | ) | $ | 0.08 |   |

 

**Results of Operations**

 

The following discussion and analysis is based onthe segment reporting information presented in Note 8 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.

 

***Second Quarter 2008 Compared to Second Quarter 2007***

 

The Company reported net losses of $6.5 millionin the second quarter 2008 compared to net earnings of $1.8 million in thesecond quarter 2007. On a per share basis, diluted net losses to commonstockholders were $0.63 in the second quarter of 2008 compared to $0.16 dilutednet earnings in the second quarter of 2007.

 

*Portfolio Asset Acquisition and Resolution*

 

The operating contribution from the PortfolioAsset acquisition and resolution segment resulted in a $4.8 million operatingloss in the second quarter of 2008 compared to a $4.3 million operating gain inthe second quarter of 2007. FirstCity was involved in acquiring $36.7 millionof Portfolio Asset acquisitions in second quarter 2008 with an approximate facevalue of $92.1 million, compared to its involvement in acquiring $91.4 millionof Portfolio Asset acquisitions in second quarter 2007 with an approximate facevalue of $213.5 million. In second quarter 2008, FirstCity’s investment sharein the Portfolio Asset acquisitions was $33.4 million – all of which wereacquired through consolidated Portfolios. In second quarter 2007, the Company’sinvestment share in the Portfolio Asset acquisitions was $25.2 million –comprised of $11.7 million acquired through consolidated Portfolios and loanpurchases and $13.5 million through Acquisition Partnerships.

 

FirstCity invested an additional $32.2 million inthe form of debt financing arrangements and real estate investments in secondquarter 2008 compared to $4.2 million in second quarter 2007.

 

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*Servicing fee revenues. *Servicing fee revenues decreased to $2.7 million in the second quarter of2008 from $3.0 million in the second quarter of 2007. Servicing fees fromdomestic Acquisition Partnerships totaled $0.4 million in second quarter 2008compared to $1.1 million in second quarter 2007, while servicing fees fromLatin American Acquisition Partnerships totaled $2.3 million in second quarter2008 compared to $1.9 million in second quarter 2007. Contributing to theoverall decrease in servicing fees is a decline in collections from loans heldby domestic Acquisition Partnerships to $6.4 million in 2008 from $25.3 millionin 2007. Servicing fees from domestic Acquisition Partnerships generallyfluctuate depending on the timing and amount of collections received fromportfolios held by these non-consolidated domestic partnerships – whichgenerally are charged servicing fees based on the amount of collections. Sincea majority of the domestic Portfolio Asset acquisitions over the past two yearswere purchased through consolidated Portfolios instead of investments indomestic Acquisition Partnerships, the Company expects income from consolidatedPortfolio Assets to off-set the decline in servicing fee revenues.

 

*Income from Portfolio Assets*.  Incomefrom Portfolio Assets remained constant at $5.6 million in the second quarterof 2008 compared to $5.7 million in the second quarter of 2007. FirstCity’saverage investment in consolidated Portfolio Assets was $124.1 million and$121.9 million for the second quarters of 2008 and 2007, respectively. Refer toNote 4 to the Consolidated Financial Statements included in Item 1 of this Form 10-Qfor a summary of income from Portfolio Assets.

 

*Gain on sale of SBA loans heldfor sale. *The Company recorded a $0.1 million gain on the sales of SBA loans in second quarter 2008 witha basis in the loans sold of $2.6 million, compared to $0.3 million of gainsrecorded in second quarter 2007 with a basis in the loans sold of $8.2 million.Gains on SBA loan sales reflect the Company’s participation in the SBAguaranteed loan program. Under the SBA 7(a) program, the SBA guarantees upto 85 percent of the principal of a qualifying loan. The Company generallysells the guaranteed portions of originated loans into the secondary market andretains the unguaranteed portion for investment.

 

*Interest income from SBAloans. *Interest income from SBA loans decreased to $0.4million during the second quarter of 2008 compared to $0.6 million during thesecond quarter of 2007. The income decline is attributed to FirstCity’s averageinvestment in SBA loans falling to $15.5 million for second quarter 2008 from$22.0 million for second quarter 2007.

 

* Interest income from affiliates. *Interest income from affiliates increased to $0.5 million in secondquarter 2008 compared to $0.1 million in second quarter 2007. The increasedincome is attributed to FirstCity’s average investment in loans receivable –affiliate rising to $15.5 million for second quarter 2008 from $5.0 million forsecond quarter 2007.

 

*Interest income from loansreceivable – other. * Interestincome from loans receivable – other was $0.4 million in the second quarter of2008 and $1.0 million in the second quarter of 2007. The income decline isattributed to the Company’s decreased investment level in loans tonon-affiliated entities. FirstCity’s average investment in loans receivable –other was $11.1 million and $28.3 million for the second quarters of 2008 and2007, respectively.

 

*Revenue from controlled affiliate*.  Revenuefrom controlled affiliate for the second quarter 2008 is comprised of $0.9million of revenues recorded by the Company’s majority-owned domestic railroad companythat was acquired in August 2007.

 

*Other income*.  Otherincome for the second quarter of 2008 increased by $0.4 million in comparisonto the second quarter of 2007 primarily due to a $0.1 million increase inreimbursements of due diligence costs, which vary from period to period, and a$0.1 million increase in partnership management fees.

 

*Expenses. *Operating expenses were $19.1 million and $11.2 million in the secondquarters of 2008 and 2007, respectively. The following is a discussion of themajor components of operating expenses.

 

Interest and fees on notes payable were $3.8million and $4.7 million in the second quarters of 2008 and 2007, respectively.FirstCity’s average outstanding debt decreased to $197.6 million in secondquarter 2008 from $224.8 million in the second quarter of 2007, while theaverage cost of borrowings decreased to 7.6% in 2008 compared to 8.3% in 2007.

 

Salaries and benefits increased to $4.2 millionin the second quarter of 2008 from $3.0 million in the second quarter of 2007,primarily due to additional salaries and benefits in 2008 resulting fromincreased staffing at ABL (SBA lending platform), FirstCity Crestone (specialsituations investment platform) and various other consolidated entities.****The total number of personnel within the Portfolio Assetacquisition and resolution segment were 228 and 185 at June 30, 2008 and2007, respectively.

 

Net provisions for loan and impairment losses totaled $7.1 million insecond quarter 2008 compared to $0.7 million in second quarter 2007. Theincrease is attributed primarily to net impairment provisions of $7.0 millionrecorded in 2008 to the Company’s 

 

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consolidateddomestic portfolios. The impairment provisions in second quarter 2008 wereattributed primarily to declines in values of loan collateral and real estateassets in our domestic portfolios, and additional delays in the timing of collectionsof expected cash flows on domestic loan portfolios. Declines in real estatevalues and delayed collections are the resulting adverse effects from thesubprime mortgage crisis that began in the United States in 2007. Theimpairment provisions were identified in connection with management’s regularevaluation of the collectibility of the Company’s Portfolio Assets. Management’sevaluation is inherently subjective as it requires estimates that aresusceptible to revision in future periods as more information becomesavailable.

 

Occupancy, data processing, property protectionand other expenses increased to $3.9 million for the second quarter of 2008from $2.7 million in the second quarter of 2007. The increase is primarilyattributed to $0.7 million of additional property protection expenses (i.e.property taxes, insurance and legal) incurred in 2008 to protect FirstCity’sreal estate security interests in its consolidated domestic and Latin Americanportfolios; and $0.3 million of additional foreign currency exchange losses andforeign tax expenses in second quarter 2008 compared to second quarter 2007.

 

*Equity in earnings ofinvestments. *Equity in earnings of investments decreased to$3.0 million in the second quarter of 2008 compared to $4.3 million in thesecond quarter of 2007. Equity in earnings of Acquisition Partnershipsdecreased to $3.0 million in 2008 from $3.7 million in 2007, and equity inearnings of servicing and operating entities decreased by $0.7 million in 2008compared to 2007. The following is a discussion of equity in earnings fromFirstCity’s Acquisition Partnerships by geographic region. Refer to Note 6 ofthe Consolidated Financial Statements included in Item 1 on this Form 10-Qfor a summary of revenues, earnings and equity in earnings of FirstCity’sequity investments by region.

 

·             *Domestic*—Total revenues reported by Domestic Acquisition Partnerships decreased to $3.2million in second quarter 2008 from $4.4 million in 2007. Total net earnings reported by domesticpartnerships decreased to a $0.3 million loss in second quarter 2008 comparedto $2.5 million of net earnings in second quarter 2007. The decrease intotal partnership earnings was attributed primarily to the following: (1) decreasein portfolio asset holdings (i.e. earning assets) to $73.4 million in 2008 from$102.3 million in 2007; (2) decrease in collections on cost-recovery loanportfolios and payoffs on performing loan portfolios to $4.4 million in secondquarter 2008 compared to $11.9 million in second quarter 2007 – resulting in a$1.0 million decrease in income related to these portfolios in 2008 compared to2007; and (3) increase in net provision expense to $2.3 million in secondquarter 2008 from net impairment recoveries of $0.5 million in second quarter2007. The collective activity described above translated to a decrease inFirstCity’s share of domestic partnership earnings to a $0.1 million loss forsecond quarter 2008 from $1.1 million of net earnings for second quarter 2007.

 

FirstCity’s average investment in domestic partnerships decreased to$21.8 million in second quarter 2008 from $34.2 million in 2007. As a result,FirstCity’s share of domestic partnership revenues experienced a correspondingdecrease as discussed above. Since amajority of FirstCity’s domestic portfolio acquisitions over the past two yearswere acquired through consolidated Portfolios instead of equity investments inAcquisition Partnerships, the Company expects income from consolidatedPortfolios to off-set the decline in equity in earnings from the domesticpartnerships.

 

·             *Latin America* —Total revenues reported by Latin American Acquisition Partnerships increased to$12.5 million in second quarter 2008 from $10.1 million in second quarter 2007.However, total net earnings reported byLatin American partnerships decreased to $3.0 million in second quarter 2008compared to $8.2 million in second quarter 2007. The increase in total revenuesreported by Latin American partnerships was attributed primarily to thefollowing: (1) increase in portfolio asset holdings (i.e. earning assets)to $214.1 million in 2008 from $206.0 million in 2007; (2) increasein collections on cost-recovery loan portfolios to $11.4 million in secondquarter 2008 compared to $6.3 million in second quarter 2007 – resulting in a$2.4 million increase in income related to these portfolios in 2008 compared to2007; and (3) increase in foreigncurrency exchange gains to $5.4 million in second quarter 2008 compared to $3.6million in second quarter 2007. The positive impact to total revenues reportedby Latin American partnerships was off-set by the following: (1) increasein net provision expense to $1.6 million in second quarter 2008 from $0.6million in second quarter 2007; (2) $1.6 million increase in interestexpense in second quarter 2008 compared to second quarter 2007; (3) $1.3million increase in property protection expense in second quarter 2008 comparedto second quarter 2007; (4) $3.3 million increase in servicing fee expensein second quarter 2008 compared to second quarter 2007; and (5) $2.2million increase in income tax expense in second quarter 2008 compared tosecond quarter 2007. The collective activity described above translatedto a small decrease in FirstCity’s share of net earnings in Latin Americanpartnerships to $0.7 million for second quarter 2008 from $0.9 million forsecond quarter 2007.

 

·             *Europe*— Totalrevenues reported by European Acquisition Partnerships increased to $11.8million in second quarter 2008 from $7.8 million in 2007. Total net earnings reported by Europeanpartnerships increased to $7.9 million in second quarter 2008 compared to $5.7million in second quarter 2007. The increase in total partnershipearnings was attributed primarily to 

 

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the following: (1) increase in collections on cost-recovery loanportfolios to $5.8 million in second quarter 2008 compared to $4.6 million insecond quarter 2007 – resulting in a $1.1 million increase in income related tothese portfolios in 2008 compared to 2007; (2) $2.3 million increase inportfolio interest income in second quarter 2008 compared to second quarter2007 (attributed primarily to $12.7 million of loan portfolio acquisitions and accretionrate increases on certain existing portfolios since June 2007); and (3) $0.5million decrease in net provision expense in second quarter 2008 compared tosecond quarter 2007. The positive impact tonet earnings reported by European partnerships was off-set by a $1.3 millionincrease in interest expense in second quarter 2008 compared to second quarter2007; and a $0.6 million increase in servicing fee expense in second quarter2008 compared to second quarter 2007. The collective activity describedabove translated to an increase in FirstCity’s share of European partnershipearnings to $2.4 million for second quarter 2008 from $1.7 million for secondquarter 2007.

 

*Other Significant Items Affecting Operations*

 

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

 

*Corporate overhead. *Net corporate overhead expenses (excluding taxes) decreased to $1.8million in the second quarter of 2008 compared to $2.4 million in the secondquarter of 2007, primarily due to $0.8 million in expenses incurred during thesecond quarter of 2007 relating to an independent investigation authorized bythe Company’s audit committee.

 

*Income taxes. *Provision for income tax expense approximated$0.1 million in the second quarter of 2008 and the second quarter of 2007. Refer to additional information disclosed in Note11 to the Consolidated Financial Statements included in Item 1 on this Form 10-Q.

 

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

 

The Company reported net losses of $10.1 millionin the first six months of 2008 compared to net earnings of $0.9 million in thefirst six months 2007. On a per share basis, diluted net losses to commonstockholders were $0.97 in the first six months of 2008 compared to $0.08diluted net earnings in the first six months of 2007.

 

*Portfolio Asset Acquisition and Resolution*

 

The operating contribution from the PortfolioAsset acquisition and resolution segment resulted in a $6.6 million operatingloss in the first six months of 2008 compared to a $6.2 million operating gainin the first six months of 2007. FirstCity was involved in acquiring $56.6million of Portfolio Asset acquisitions in the first six months of 2008 with anapproximate face value of $638.1 million, compared to its involvement inacquiring $170.2 million of Portfolio Asset acquisitions in the first sixmonths of 2007 with an approximate face value of $387.4 million. In 2008,FirstCity’s investment share in the Portfolio Asset acquisitions was $41.9million – comprised of $40.1 million acquired through consolidated Portfoliosand $1.8 million through Acquisition Partnerships. In the first six months of2007, FirstCity’s investment share in the Portfolio Assets was $94.7 million –comprised of $77.3 million acquired through consolidated Portfolios and $17.4million through Acquisition Partnerships.

 

FirstCity invested an additional $33.7 million inthe form of debt financing arrangements and real estate investments in thefirst six months of 2008 compared to $12.0 million in the first six months of2007.

 

*Servicing fee revenues. *Servicing fee revenues decreased to $4.9 million in the first six monthsof 2008 from $5.6 million in the first six months of 2007. Servicing fees fromdomestic Acquisition Partnerships totaled $0.8 million in first six months of2008 compared to $1.7 million in first six months of 2007, while servicing feesfrom Latin American Acquisition Partnerships totaled $4.1 million in first sixmonths of 2008 compared to $3.9 million in first six months of 2007.Contributing to the overall decrease in servicing fees is a decline incollections from loans held by domestic Acquisition Partnerships to $17.6million in 2008 from $42.5 million in 2007. Servicing fees from domesticAcquisition Partnerships generally fluctuate depending on the timing and amountof collections received from portfolios held by these non-consolidated domesticpartnerships – which generally are charged servicing fees based on the amountof collections. Since a majority of the domestic Portfolio Asset acquisitionsover the past two years were purchased through consolidated Portfolios insteadof investments in domestic Acquisition Partnerships, the Company expects incomefrom consolidated Portfolio Assets to off-set the decline in servicing feerevenues.

 

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*Income from Portfolio Assets*.  Incomefrom Portfolio Assets remained constant at $10.6 million in the first sixmonths of 2008 compared to $10.7 million in the first six months of 2007.FirstCity’s average investment in consolidated Portfolio Assets was $121.9million and $114.9 million for the first six months of 2008 and 2007,respectively. Refer to Note 4 to the Consolidated Financial Statements includedin Item 1 of this Form 10-Q for a summary of income from Portfolio Assets.

 

*Gain on sale of SBA loans heldfor sale. *The Company recorded a $0.1 million gain on the sales of SBA loans in the first six months of2008 with a basis in the loans sold of $2.8 million, compared to $0.6 millionof gains recorded in the first six months of 2007 with a basis in the loans soldof $14.9 million. Gains on SBA loan sales reflect the Company’s participationin the SBA guaranteed loan program. Under the SBA 7(a) program, the SBAguarantees up to 85 percent of the principal of a qualifying loan. The Companygenerally sells the guaranteed portions of originated loans into the secondarymarket and retains the unguaranteed portion for investment.

 

*Interest income from SBAloans. *Interest income from SBA loans decreased slightlyto $0.8 million during the first six months of 2008 compared to $0.9 millionduring the first six months of 2007. The income decline is attributed toFirstCity’s average investment in SBA loans falling to $14.9 million for 2008from $17.8 million for 2007.

 

* Interest income from affiliates. *Interest income from affiliates increased to $0.6 million for the firstsix months of 2008 compared to $0.3 million for the first six months of 2007.The increased income is attributed to FirstCity’s average investment in loansreceivable – affiliate rising to $11.2 million for 2008 from $4.8 million for2007.

 

*Interest income from loansreceivable – other. * Interestincome from loans receivable – other was $0.6 million for the first six monthsof 2008 and $1.9 million for the first six months of 2007. The income declineis attributed to the Company’s decreased investment level in loans tonon-affiliated entities. FirstCity’s average investment in loans receivable –other was $8.9 million and $27.1 million for the first six months of 2008 and2007, respectively.

 

*Revenue from controlled affiliate*.  Revenuefrom controlled affiliate for the first six months of 2008 is comprised of $1.7million of revenues recorded by the Company’s majority-owned domestic railroadcompany that was acquired in August 2007.

 

*Other income*.  Otherincome for the first six months of 2008 increased by $0.6 million in comparisonto 2007 primarily due to a $0.1 million increase in reimbursements of duediligence costs, which vary from period to period, and a $0.2 million increasein partnership management fees.

 

*Expenses. *Operating expenses were $32.9 million and $20.7 million in the first sixmonths of 2008 and 2007, respectively. The following is a discussion of themajor components of operating expenses.

 

Interest and fees on notes payable were $7.4 millionand $8.9 million in the first six months of 2008 and 2007, respectively.FirstCity’s average outstanding debt decreased to $186.3 million in the firstsix months of 2008 from $211.4 million in the first six months of 2007, whilethe average cost of borrowings decreased to 8.0% in 2008 compared to 8.4% in2007.

 

Salaries and benefits increased to $8.2 millionin the first six months of 2008 from $6.1 million in the first six months of2007, primarily due to additional salaries and benefits in 2008 resulting fromincreased staffing at ABL (SBA lending platform), FirstCity Crestone (specialsituations investment platform) and various other consolidated entities.****The total number of personnel within the Portfolio Assetacquisition and resolution segment were 228 and 185 at June 30, 2008 and2007, respectively.

 

Net provisions for loan and impairment losses totaled $10.1 million inthe first six months of 2008 compared to $1.1 million in the first six monthsof 2007. The increase is attributed primarily to net impairment provisions of$9.8 million recorded in 2008 to the Company’s consolidated domesticportfolios. The impairment provisions in the first six months of 2008 wereattributed primarily to declines in values of loan collateral and real estateassets in our domestic portfolios, and additional delays in the timing ofcollections of expected cash flows on domestic loan portfolios. Declines inreal estate values and delayed collections are the resulting adverse effectsfrom the subprime mortgage crisis that began in the United States in 2007. Theimpairment provisions were identified in connection with management’s regularevaluation of the collectibility of the Company’s Portfolio Assets. Management’sevaluation is inherently subjective as it requires estimates that aresusceptible to revision in future periods as more information becomesavailable.

 

Occupancy, data processing, property protectionand other expenses increased to $7.2 million for the first six months of 2008from $4.7 million in the first six months of 2007. The increase is primarilyattributed to $2.2 million of additional property protection 

 

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expenses (i.e. property taxes, insurance and legal) incurred in 2008 toprotect FirstCity’s real estate security interests in its consolidated domesticand Latin American portfolios.

 

*Equity in earnings ofinvestments. *Equity in earnings of investments decreased to$5.8 million in the first six months of 2008 compared to $6.2 million in thefirst six months of 2007. Equity in earnings of Acquisition Partnershipsdecreased to $5.3 million in 2008 from $5.5 million in 2007, and equity inearnings of servicing and operating entities increased by $0.2 million in 2008compared to 2007. The following is a discussion of equity in earnings fromFirstCity’s Acquisition Partnerships by geographic region. Refer to Note 6 ofthe Consolidated Financial Statements included in Item 1 on this Form 10-Qfor a summary of revenues, earnings and equity in earnings of FirstCity’sequity investments by region.

 

·             *Domestic*— Total revenues reported by Domestic Acquisition Partnerships decreased to$6.3 million in the first six months of 2008 from $9.0 million in 2007. Total net earnings reported by domesticpartnerships decreased to $0.2 million in the first six months of 2008 comparedto $3.1 million in the first six months of 2007. The decrease in totalpartnership earnings was attributed primarily to the following: (1) decreasein portfolio asset holdings (i.e. earning assets) to $73.4 million in 2008 from$102.3 million in 2007; (2) decrease in collections on cost-recovery loanportfolios and payoffs on performing loan portfolios to $12.6 million in thefirst six months of 2008 compared to $20.8 million in the first six months of2007 – resulting in a $2.2 million decrease in income related to theseportfolios in 2008 compared to 2007; and (3) increase in net provisionexpense to $2.9 million in the first six months of 2008 compared to $1.0million in the first six months of 2007. The collective activity describedabove translated to a decrease in FirstCity’s share of net earnings in domesticpartnerships to $0.2 million for the first six months of 2008 from $1.4 millionfor the first six months of 2007.

 

FirstCity’s average investment in domestic partnerships decreased to$22.9 million in the first six months of 2008 from $35.1 million in 2007. As aresult, FirstCity’s share of domestic partnership revenues experienced acorresponding decrease as discussed above. Sincea majority of FirstCity’s domestic portfolio acquisitions over the past twoyears were acquired through consolidated Portfolios instead of equityinvestments in Acquisition Partnerships, the Company expects income fromconsolidated Portfolios to off-set the decline in equity in earnings from thedomestic partnerships.

 

 ·          *Latin America* —Total revenues reported by Latin American Acquisition Partnerships increased to$23.7 million in the first six months of 2008 from $19.4 million in the firstsix months of 2007. However, total netearnings reported by Latin American partnerships decreased to $6.0 million inthe first six months of 2008 compared to $6.6 million in the first six monthsof 2007. The increase in total revenues reported by Latin American partnershipswas attributed primarily to the following: (1) increase in portfolio assetholdings (i.e. earning assets) to $214.1 million in 2008 from $206.0 million in2007 (which contributed to a $4.6 million increase in interest income in 2008compared to 2007); and (2) increase in foreign currency exchange gains to$8.4 million in the first six months of 2008 compared to $3.3 million in thefirst six months of 2007. The positive impact to total revenues reported byLatin American partnerships was off-set by the following: (1) $0.7 millionincrease in property protection expense in the first six months of 2008compared to the first six months of 2007; (2) $3.4 million increase inservicing fee expense in the first six months of 2008 compared to first sixmonths of 2007; and (3) $3.3 million increase in income tax expense in thefirst six months of 2008 compared to the first six months of 2007. Thecollective activity described above translated to a slight increase inFirstCity’s share of net earnings in Latin American partnerships to $1.1million for the first six months of 2008 from $0.9 million for the first sixmonths of 2007.

 

·             *Europe*— Totalrevenues reported by European Acquisition Partnerships increased to $22.1million in the first six months of 2008 from $17.1 million in 2007. Total net earnings reported by Europeanpartnerships increased to $13.7 million in the first six months of 2008compared to $11.3 million in the first six months of 2007. The increasein total partnership earnings was attributed primarily to (1) increased incollections on cost-recovery loan portfolios to $11.7 million in the first sixmonths of 2008 compared to $10.0 million in the first six months of 2007 –resulting in a $1.4 million increase in income related to these portfolios in2008 compared to 2007; and (2) increased interest income earned on otherportfolios to $13.5 million in the first six months of 2008 compared to $10.7million in the first six months of 2007 (attributed primarily to $12.7 millionof loan portfolio acquisitions and accretion rate increases on certain existingportfolios since June 2007). Thepositive impact to net earnings reported by European partnerships was off-setby a $2.1 million increase in interest expense in the first six months of 2008compared to the first six months of 2007; and a $0.8 million increase inservicing fee expense in the first six months of 2008 compared to the first sixmonths of 2007. The collective activity described above translated to anincrease in FirstCity’s share of European partnership earnings to $4.1 millionfor the first six months of 2008 from $3.2 million for the first six months of2007.

 

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*Other Significant Items Affecting Operations*

 

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

 

*Corporate overhead. *Net corporate overhead expenses (excluding taxes) decreased to $3.3million in the first six months of 2008 compared to $5.1 million in the firstsix months of 2007, primarily due to $2.0 million in expenses incurred duringthe first six months of 2007 relating to an independent investigationauthorized by the Company’s audit committee.

 

*Income taxes. *Provision for income tax expense approximated$0.3 million in the first six months of 2008, and $0.2 in the first six monthsof 2007. Refer to additionalinformation disclosed in Note 11 to the Consolidated Financial Statementsincluded in Item 1 on this Form 10-Q.

 

#### **Financial Condition**

 

Significant changes in FirstCity’s financialcondition during the first six months of 2008 resulted from the following:

 

Consolidated assets of $348.6 million at June 30,2008 were $50.5 million higher than consolidated assets at December 31, 2007.The increase in consolidated assets is primarily attributed to a $60.0 millionnet increase in Portfolio Assets, loan investments and other receivablesrelated to FirstCity’s investment activities; off-set by a $10.0 milliondecrease in cash to fund operations.

 

Consolidated liabilities of $254.4 million as of June 30,2008 were $63.1 million higher than consolidated liabilities at December 31,2007. Total notes payable increased by $61.9 million primarily to finance theCompany’s investment activities in the first six months of 2008.

 

#### **Portfolio Asset Acquisition and Resolution**

 

Aggregate acquisitions by the Company are asfollows (in thousands):

 

| ** **               | ** ** | **Purchase** | ** ** | **FirstCity**  | ** ** |
|--------------------------|------------|--------------|------------|----------------|------------|
| ** **               | ** ** | **Price**    | ** ** | **Investment** | ** ** |
| First six months of 2008 |       | $            | 56,640     |           | $          | 41,883 |   |
| Total 2007               |       | 214,333      |       | 126,714        |       |
| Total 2006               |       | 296,990      |       | 144,048        |       |
| Total 2005               |       | 146,581      |       | 71,405         |       |
| Total 2004               |       | 174,139      |       | 59,762         |       |
| Total 2003               |       | 129,192      |       | 22,944         |       |
|                          |            |              |            |                |            |  |  |

 

**Provision for Income Taxes**

 

The Company has substantial NOLs, which can beused to offset the tax liability associated with the Company’s pre-tax earningsuntil the earlier of the expiration or utilization of such NOLs. The Companyaccounts for the benefit of the NOLs by recording the benefit as an asset andthen establishing a valuation allowance to value the net deferred tax asset ata level, which more likely than not, will be realized. Realization isdetermined based on management’s expectation of generating sufficient taxableincome in a look forward period over the next four years. The ultimate realizationof the resulting net deferred tax asset is dependent upon generating sufficienttaxable income from its continuing operations prior to expiration of the NOLs.Although realization is not assured, management believes it is more likely thannot that all of the recorded deferred tax asset, net of the allowance, will berealized. The amount of the deferred tax asset considered realizable, however,could be adjusted in the future if estimates of future taxable income duringthe carryforward period change. The ability of the Company to realize thedeferred tax asset is periodically reviewed and the valuation allowance isadjusted accordingly.

 

**Liquidity and Capital Resources**

 

The Companyrequires liquidity to fund its operations, working capital, payment of debt,repurchase of the Company’s common stock, equity for acquisition of PortfolioAssets, investments in and advances to entities formed with other investors toacquire Portfolios (“Acquisition Partnerships”) and other investments. Thepotential sources of liquidity are funds generated from operations, 

 

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equity distributions fromthe Acquisition Partnerships, interest and principal payments on subordinatedintercompany debt, dividends from the Company’s subsidiaries, borrowings fromrevolving lines of credit and other credit facilities, proceeds from equitymarket transactions, securitization and other structured finance transactions,and other special purpose short-term borrowings.

 

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

 

FirstCity has a $225.0 million revolving credit facility with Bank ofScotland that matures in November 2010. The revolving loan facility isused to finance the senior debt and equity portion of portfolio and assetpurchases made by FirstCity and to provide for the issuance of letters ofcredit and working capital loans. The obligations of FirstCity under thisfacility are guaranteed by substantially all of the wholly-owned subsidiariesof FirstCity and are secured by security interests in substantially all of theassets of FirstCity and its wholly-owned subsidiaries. The primary terms andkey covenants of the $225.0 million revolving credit facility, as amended, areas follows:

 

·                  The maximum outstanding amount ofloans and letters of credit issued under the loan facility that may beoutstanding under the loan facility is $225.0 million;

·                  Allows loans to be made based upon aborrowing base of (a) 70% of the net present equity value of certainaffiliates of FirstCity engaged in the asset and portfolio investment business,and (b) 40% of the equity investment of FirstCity and its subsidiaries incertain new ventures;

·                  The available interest rates underthe loan facility are London Interbank Offered Rate (“LIBOR”) plus 2.00% to2.50% per annum;

·                  The maximum value for assets that canbe included in the borrowing base from the acquisition of portfolio assets incertain countries are as follows: Mexico - $40.0 million, Brazil - $10.0 million,Chile - $25.0 million, and Argentina or Uruguay - $6.0 million;

·                  The limit for loans that can beborrowed in Euros under the loan facility is $50.0 million;

·                  The maximum amount of letters ofcredit that can be issued under the loan facility is $40.0 million;

·                  The maximum amount of working capitalloans that can be outstanding under the loan facility is $35.0 million;

·                  The ratio of indebtedness to tangiblenet worth should be equal to or less than 3.5 to 1.00 for the last day of thefiscal quarter;

·                  Tangible net worth should not fallbelow $85.0 million; and

·                  The ratio of cumulative current recoveredand projected collections to cumulative original projected collections shouldnot be less than 0.90 to 1.00.

 

At June 30,2008, the Company was in compliance with all material covenants or otherrequirements set forth in the credit agreements or other agreements with Bankof Scotland.

 

On July 14, 2008, the Company and Bank of Scotland entered into anamendment to the revolving loan facility that added financial covenants to theloan facility which require FirstCity and all other members of the consolidatedgroup to maintain, on a consolidated basis, a ratio of net cash flow to totalinterest and fee expense of not less than 5.00 to 1.00 for the four fiscalquarters then ended and a cash conversion rate of not less than 25% for thefour fiscal quarters then ended. The amendment is effective as of July 14,2008, and the additional covenants will be applicable to the fiscal quartersending September 30, 2008 and thereafter.

 

FirstCity has$37.2 million in Euro-denominated debt outstanding on the $225.0 millionrevolving credit facility with Bank of Scotland described above for the purposeof hedging a portion of the net equity investments in Europe. In general, thetype of risk hedged relates to the foreign currency exposure of net investmentsin Europe caused by movements in Euro exchange rates. The Company entered intothe hedging relationship such that changes in the net investments being hedgedare expected to be offset by corresponding changes in the values of theEuro-denominated debt. Effectiveness of the hedging relationship is measuredand designated at the beginning of each month by comparing the outstandingbalance of the Euro-denominated debt to the carrying value of the designatednet equity investments. The net foreign currency translation gain (loss)included in accumulated other comprehensive income relating to theEuro-denominated debt was ($1.5) million for the six months ended June 30,2008, and $156,000 for the same period in 2007.

 

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

 

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·                  Allows loans to be made for theacquisition of Portfolio Assets in the United States, and provides for loans tobe used for other purposes with advance approval from Bank of Scotland;

·                  Provides that each loan may be in anamount of up to 70% of the net present value of the assets being acquired withthe proceeds of the loan;

·                  Provides that the aggregateoutstanding balances of all loans will not exceed 65% of the net present valueof the assets securing the loan facility;

·                  Provides that FH Partners mustmaintain a ratio of cumulative current recovered and projected collections to cumulativeoriginal projected collections of not less than 0.90 to 1.00;

·                  Provides for an interest rate ofLIBOR plus 2.0%; and

·                  Provides that all other financialcovenants will mirror the key covenants of the facility that FirstCity has withBank of Scotland.

 

At June 30,2008, the Company was in compliance with all material covenants or otherrequirements set forth in the credit agreements or other agreements with Bankof Scotland.

 

On July 14, 2008, FH Partners LLC and Bank of Scotland enteredinto an amendment to the revolving loan facility that added financial covenantsto the loan facility which require FH Partners LLC to maintain a ratio of netcash flow to total interest and fee expense of not less than 7.00 to 1.00 forthe four fiscal quarters then ended and a cash conversion rate of not less than35% for the four fiscal quarters then ended. The amendment is effective as of July 14,2008, and the additional covenants will be applicable to the fiscal quartersending September 30, 2008 and thereafter.

 

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

 

·                  Allows loans tobe made in maximum aggregate amount of $25.0 million during the term of theloan facility;

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

·                  Allows loans tobe made based upon a borrowing base of (a) 80% of the net present equityvalue of certain affiliates of FirstCity engaged in the asset and portfolioinvestment business, and (b) 90% of the equity investment of FirstCity andits subsidiaries in certain new ventures;

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

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

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

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

 

At June 30,2008, the Company was in compliance with all material covenants or otherrequirements set forth in the credit agreements or other agreements with BoS(USA).

 

On July 14, 2008, the Company and BoS (USA) entered into anamendment to the subordinated credit agreement that added financial covenantsto the loan facility which require FirstCity and all other members of theconsolidated group to maintain, on a consolidated basis, a ratio of net cashflow to total interest and fee expense of not less than 5.00 to 1.00 for thefour fiscal quarters then ended and a cash conversion rate of not less than 25%for the four fiscal quarters then ended. The amendment is effective as of July 14,2008, and the additional covenants will be applicable to the fiscal quartersending September 30, 2008 and thereafter.

 

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BoS (USA) has awarrant to purchase 425,000 shares of the Company’s voting common stock at$2.3125 per share. BoS (USA) is entitled to additional warrants in connectionwith this existing warrant for 425,000 shares under certain specific situationsto retain its ability to acquire approximately 4.86% of the Company’s votingcommon stock.  The warrant expires on August 31,2010, if it is not exercised prior to that date.

 

*BancoSantander, S.A.*

 

FirstCity Mexico SA de CV, a Mexican affiliate of FirstCity, has arevolving line of credit with a maximum loan amount of 142,240,000 Mexicanpesos with Banco Santander, S.A., which was equivalent to $13.8 million U.S.dollars at June 30, 2008.  The loanproceeds are used to pay down the acquisition facility with the Bank ofScotland. Pursuant to the terms of the credit facility, FirstCity Mexico SA deCV was required to provide a stand-by letter of credit from Bank of Scotlandthat would satisfy the loan balance upon demand.  At June 30, 2008,FirstCity had a letter of credit in the amount of $14.1 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 $14.1million letter of credit, FirstCity is required to reimburse Bank of Scotlandby making payment to Bank of Scotland for all amounts disbursed or to bedisbursed by Bank of Scotland under the letter of credit.

 

*Wells Fargo Foothill, LLC*

 

American Business Lending, Inc.(“ABL”), a subsidiary of FirstCity, has a $40.0 million revolving loan facilitywith Wells Fargo Foothill, LLC (“WFF”) for the purpose of financing andacquiring SBA loans. The obligations under this facility are secured bysubstantially all of the assets of ABL.  In addition, FirstCity providedWFF with an unconditional guaranty, up to a maximum of $5 million plusenforcement cost, of the obligations of ABL under the loan facility that relateto funds in the amount of $31.7 million advanced by WFF to ABL in connection ofa portfolio of SBA loans in February 2007. This guaranty arrangementremains in effect until the obligations incurred in connection with the advancerelated to the acquisition of the portfolio of SBA loans are paid in full. Theprimary terms and key covenants of the $40.0 million revolving loan facility,as amended, are as follows:

 

·                  Allows advancesin the maximum amount of $40.0 million (the “Maximum Credit Line”) to be madeunder the facility;

·                  Provides for aborrowing base for originating loans by which (a) the sum of (1) upto 100% of the net eligible SBA guaranteed loans originated by ABL, plus (2) upto 80% of the net eligible non-guaranteed loans originated by ABL, exceeds (b) thesum of (1) any reserves for obligations of ABL related to the bankproducts, plus (2) the aggregate amount, if any, of loan reserves thenestablished and outstanding, plus (3) the aggregate amount of any otherreserves established by WFF;

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

·                  Provides for aninterest rate of LIBOR plus 2.625% or, alternatively, the greater of (x) theWells Fargo prime rate or (y) 7.50% per annum;

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

·                  Provides in theevent of the termination of the facility by ABL for a prepayment fee of 2.0% ofthe Maximum Credit Line if paid prior to December 14, 2008, and 1.0% ofthe Maximum Credit Line if paid during the period beginning December 15,2008 and ending December 13, 2009; and

·                  Provides for amaturity date of December 14, 2009.

 

#### **The security agreement executed by ABL to secure theobligations under this credit facility grants a security interest to WFF in allof the assets of ABL, except the unguaranteed portions of certainSBA-guaranteed loans, certain other assets, and the Small Business LendingCorporation license. At June 30, 2008, ABL was in compliance with allmaterial covenants or other requirements set forth in the credit agreement orother agreements with WFF.**

 

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Excluding the termacquisition facilities of the unconsolidated Acquisition Partnerships, as of June 30,2008, the Company and its subsidiaries had credit facilities providing forborrowings in an aggregate principal amount of $429 million and outstandingborrowings of $239 million.

 

Managementbelieves that the existing loan facilities; related fees generated from theservicing of assets; equity distributions from existing AcquisitionPartnerships; collections from consolidated portfolios, loans and otherinvestments; sales of interests in equity investments; and sales of guaranteedportions of existing and originated SBA 7(a) loans will allow the Companyto meet its obligations as they come due during the next twelve months.

 

The followingtable summarizes the material terms of the credit facilities to which theCompany, its major operating subsidiaries and the Acquisition Partnerships wereparties to as of July 31, 2008, and the outstanding borrowings under suchfacilities as of June 30, 2008.

 

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| ** **                                                                                              | ** ** | **Credit  Facilities**     | ** ** | ** **        | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|-------------------|------------|
| ** **                                                                                              | ** ** | **Funded  and**            | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                              | ** ** | **Unfunded**               | ** ** | **Outstanding**   | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                              | ** ** | **Commitment**             | ** ** | **Borrowings**    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                              | ** ** | **Amount  as of**          | ** ** | **as of**         | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                              | ** ** | **July 31,**          | ** ** | **June 30,** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                              | ** ** | **2008**                   | ** ** | **2008**          | ** ** | **Interest  Rate** | ** ** | **Other  Terms and Conditions** | ** ** |
| ** **                                                                                              | ** ** | **(Dollars  in millions)** | ** ** | ** **        | ** ** | ** ** | ** ** |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| Bank of Scotland $225 million portfolio acquisition  and working capital facility (1)                   |       | $                          | 225        |              | $          | 122 |   | $92  at LIBOR + 2.0% - 2.50%; $30 at 18-month fixed rate of 7.86% |   | Secured  by equity interests and other assets of FirstCity, matures November 2010 |   |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| Bank of Scotland $100 million portfolio acquisition  - revolving credit                                 |       | 100                        |       | 62                |       | LIBOR  + 2.0% |   | Secured  by assets of FH Partners, L.P. and guaranteed by the Company, matures  November 2010 |   |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| Bank of Scotland $25 million subordinated delayed  draw credit                                          |       | 25                         |       | 7                 |       | prime  plus 3% |   | Secured  by security interests in assets of FirstCity and wholly-owned subsidiaries,  matures November 2010 |   |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| American Bank term loan for portfolio acquisition  by FC Washington                                     |       | 1                          |       | 1                 |       | Fixed  5.0% |   | Secured  by assets of FC Washington and guaranteed by the Company, matures  May 2011 |   |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| Participation payable                                                                                   |       | 1                          |       | 1                 |       | 24.49%  imputed rate |   | Participation  agreement on 33% of net cash flows received on one portfolio |   |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| Banco Santander line of credit facility                                                                 |       | 14                         |       | 14                |       | Rate  based on 28 day Mexican index rate plus 1.5% |   | Secured  by Bank of Scotland letter of credit, matures November 2008 |   |
| ** **                                                                                              | ** ** | ** **                 | ** ** | ** **        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Wells Fargo Foothill, Inc. $40 million  revolving loan facility                                    |       | 40                         |       | 10                |       | LIBOR  + 2.625% or greater of Wells Fargo prime or 7.5% |   | Secured  by assets of American Business Lending, Inc., matures December 2009 |   |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| The First National Bank of Central Texas term loan  for portfolio acquisition by MPortfolio Corporation |       | 1                          |       | 1                 |       | LIBOR  + 1.75% |   | Secured  by assets of MPortfolio Corporation, matures June 2010 |   |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| LaSalle Bank NA term loan                                                                               |       | 4                          |       | 4                 |       | LIBOR  + 2.25% |   | Secured  by assets of East Penn Railroad LLC, matures March 2011 |   |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| LaSalle Bank NA revolving loan facility                                                                 |       | 1                          |       | —            |       | option  of Base Rate (greater of prime or Federal Funds Rate + .5%) plus margin, or  LIBOR plus margin |   | Secured  by assets of East Penn Railroad LLC, matures March 2011 |   |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| Merrill Lynch Mortgage Trust term loan                                                                  |       | 8                          |       | 8                 |       | Fixed  6.07% |   | Secured  by assets of Oregon Short Line Building LLC, matures April 2016 |   |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| Notes payable to banks                                                                                  |       | 420                        |       | 230               |       |   |   |   |   |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| MCS Trust SA de CV term loan                                                                            |       | 9                          |       | 9                 |       | Fixed  20% |   | Secured  by assets of FC Acquisitions, SRL de CV, matures June 2020 |   |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| Note payable to affiliate                                                                               |       | 9                          |       | 9                 |       |   |   |   |   |
|                                                                                                    |       |                       |       |              |       |   |   |   |   |
| Total                                                                                                   |       | $                          | 429        |              | $          | 239 |   |   |   |   |   |

 

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(1)          TheBank of Scotland facility allows loans to be made in Euros up to a maximumamount in Euros that is equivalent to $50.0 million. At June 30, 2008, theCompany had approximately $37.2 million outstanding under the Euro-denominatedportion of this facility.

 

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**Forward-Looking Statements**

 

Certain statements contained in this QuarterlyReport on Form 10-Q are incorporated by reference from time to time,including, but not limited to, statements relating to the Company’s strategicobjectives and future performance, which are not historical facts, may bedeemed to be forward-looking statements under the Private Securities LitigationReform Act of 1995, Section 27A of the Securities Act of 1933, as amended,and Section 21E of the Securities Exchange Act of 1934, as amended (“ExchangeAct”). Forward-looking statements include, without limitation, statementsregarding our future financial position, business strategy, and plans andobjectives of management for future operations, as well as any statement thatmay project, indicate or imply future results, performance or achievements, andmay contain the words “expect,” “intend,” “plan,” “anticipate,” “estimate,” “believe,”“may,” “could,” “will be,” “will continue,” “will likely result,” “indication”  and similar expressions. Forward-lookingstatements are not guarantees of future performance and involve certain risks,uncertainties and assumptions that are difficult to predict. Actual results andoutcomes may differ materially from those expressed in, or implied by, ourforward-looking statements.

 

There are many important factors that could causethe Company’s actual results to differ materially from those indicated in theforward-looking statements. Such factors include, but are not limited to,changes in general economic conditions and economic conditions in thegeographic regions and industries in which the Company operates; foreign socialand economic conditions; performance of the Company’s subsidiaries andaffiliates; the availability of investments and investment opportunities;assumptions underlying asset performance; the level of nonperforming assets,charge-offs and impairment provisions; risks associated with foreign operations;currency exchange rate fluctuations; risks associated with start up of newbusinesses and entry into new markets; changes in the interest rate environmentand market liquidity; fluctuations in residential and commercial real estatevalues; adverse movements and volatility in equity capital markets; the degreeto which the Company is leveraged; the Company’s continued need for financing;availability of the Company’s credit facilities;  ability to obtain additional financing from the Bank of Scotland or anyother lender; the impact of certain covenants in loan agreements of the Companyand its subsidiaries; risks of declining value of loans, collateral or assets;the ability of the Company to utilize NOLs; liabilities resulting fromlitigation and regulatory investigations that might arise from continuing anddiscontinued operations, including costs, expenses, settlements and judgments;changes (legislative and otherwise) in the asset securitization industry;changes in domestic or foreign tax laws, rules and regulations as well ascourt, Internal Revenue Service or other governmental agencies’ interpretationsthereof; changes in accounting standards, rules and interpretations; andfactors more fully discussed and identified in the Company’s Annual Report on Form 10-K,for the year ended December 31, 2007, filed with the SEC on March 17,2008 (including those discussed under “Item 7. Management’s Discussion andAnalysis of Financial Condition and Results of Operations”), as well as inother SEC filings of the Company. Many of these factors are beyond the Company’scontrol. In addition, it should be noted that past financial and operationalperformance of the Company is not necessarily indicative of future financialand operational performance. Given these risks and uncertainties, investorsshould not place undue reliance on forward-looking statements. Theforward-looking statements in this Quarterly Report on Form 10-Q representbeliefs and assumptions only as of the date of this Quarterly Report on Form 10-Q.Except as required by applicable law, the Company expressly disclaims anyobligation or intention to release publicly any updates or revisions to anyforward-looking statement to reflect any change in the Company’s expectationswith regard thereto or any change in future events, conditions or circumstanceson which any forward-looking statement is based.

 

**Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk.**

 

**Interest Rate Risk**

 

Market risk is therisk of loss from adverse changes in market prices and interest rates. TheCompany’s operations are materially impacted by net gains on sales of loans andnet interest margins. The level of gains from loan sales the Company achievesis dependent on demand for the products originated. Net interest margins aredependent on the Company’s ability to maintain the spread or interestdifferential between the interest it charges the customer for loans and theinterest the Company is charged for the financing of those loans. The followingdescribes each component of interest bearing assets held by the Company and howeach could be affected by changes in interest rates.

 

The Companyinvests in Portfolio Assets both directly through consolidated subsidiaries andindirectly through equity investments in Acquisition Partnerships. PortfolioAssets consist of investments in pools of non-homogenous assets thatpredominantly consist of loan and real estate assets. Earnings from theseassets are based on the estimated future cash flows from such assets andrecorded when those cash flows occur. The underlying loans within these poolsbear both fixed and variable rates. Due to the non-performing nature andhistory of these loans, changes in prevailing benchmark rates (such as theprime rate or LIBOR) generally have a nominal effect on the ultimate futurecash flow to be realized from the Portfolio Assets.

 

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Loans receivableconsist primarily of loans made to affiliated entities (including AcquisitionPartnerships) and non-affiliated entities, and generally bear interest at fixedrates. The repayment of the loans is generally dependent upon future cash flowsof the borrowers, future cash flows of the underlying collateral, anddistributions from affiliated entities. Since these loans are predominantlyfixed-rate financial instruments, changes in market interest rates would nothave a significant impact on the collectibility of these loans.

 

SBA loans receivable were $15.9 million at June 30, 2008, of which$2.2 million were related to the guaranteed portion of these loans.  The guaranteed portion is backed by the fullfaith and credit of the U.S. Small Business Administration, and is generallysold into the secondary market. Virtually all of the SBA loans have variable interest rates.  Assuming that the balance sheet were toremain constant and no actions were taken to alter the existing interest ratesensitivity, a hypothetical immediate change in interest rates would have aminimal effect on interest income from SBA loans for the second quarter of2008. Although management believes that this measure is indicative of oursensitivity to interest rate changes, it does not adjust for potential changesin credit quality, size and composition of the assets on the balance sheet, andother business developments that could affect a net increase (decrease) inassets. Accordingly, no assurances can be given that actual results would notdiffer materially from the potential outcome simulated by this estimate.

 

FirstCity had$239.2 million in debt outstanding at June 30, 2008. The Company isexposed to interest rate risk primarily through its variable rate debt, whichtotaled $192.0 million or 80.3% of the Company’s total debt. A 50 basispoint change in interest rates would increase or decrease FirstCity’s interestexpense by approximately $1.1 million annually.

 

**Foreign Currency Risk**

 

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

 

In Europe and inMexico, the Company’s investments are primarily in the form of equity andrepresent a significant portion of the Company’s total equity investments. Aspreviously discussed, the revolving acquisition facility with Bank of Scotlandfor $225.0 million provides that the Company may borrow up to a maximum amountin Euros that is equivalent to U.S. $50.0 million.  At June 30, 2008, the Company had  U.S. $37.2 million in Euro-denominated debtfor the purpose of hedging a portion of the net equity investments inEurope.  In November 2006, theCompany acquired a line of credit facility with Banco Santander, S.A. that providesthat the Company may borrow up to a current maximum of 142,240,000 Mexicanpesos. At June 30, 2008, the Company had 142,240,000 in Mexicanpeso-denominated debt, which was equivalent to U.S. $13.8 million.  Management of the Company feels that theseloan agreements will help reduce the risk of adverse effects of currencychanges on these investments.

 

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

 

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| ** **         | ** ** | ** ** | ** ** | **One U.S.  dollar  equals** | ** ** | **Estimated decline in  valuation of investments  resulting from  incremental depreciation  of foreign currency of  (dollars in thousands)** | ** ** |
|--------------------|------------|------------|------------|-----------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **         | ** ** | ** ** | ** ** | ** **                        | ** ** | **5%**                                                                                                                                                                                              | ** ** | **10%** | ** ** |
|               |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Europe             |       | EUR        |       | 0.63                              |       | $                                                                                                                                                                                                   | 2,130      |   | $ | 4,076 |   |
|               |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Mexico             |       | MXN        |       | 10.28                             |       | $                                                                                                                                                                                                   | 1,914      |   | $ | 3,692 |   |
|               |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Argentina          |       | ARS        |       | 3.02                              |       | $                                                                                                                                                                                                   | 52         |   | $ | 101 |   |
|               |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Dominican Republic |       | DOP        |       | 34.86                             |       | $                                                                                                                                                                                                   | 15         |   | $ | 28 |   |
|               |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Chile              |       | CLP        |       | 513.20                            |       | $                                                                                                                                                                                                   | 262        |   | $ | 500 |   |
|               |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Canada             |       | CAD        |       | 1.01                              |       | $                                                                                                                                                                                                   | 14         |   | $ | 27 |   |
|               |       |       |       |                              |       |                                                                                                                                                                                                |       |   |   |
| Brazil             |       | BRL        |       | 1.61                              |       | $                                                                                                                                                                                                   | 41         |   | $ | 78 |   |

 

**Item 4.  Controls and Procedures.**

 

*Disclosure Controls andProcedures*

 

The Company’s disclosure controls and proceduresare designed to ensure that information required to be disclosed under theExchange Act securities laws is accumulated and communicated to management,including the Company’s Chief Executive Officer and Chief Financial Officer.

 

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

 

*Internal Control Over FinancialReporting*

 

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

 

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

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

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

 

Because of itsinherent limitations, internal control over financial reporting may not preventor detect misstatements. Projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 

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

 

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**PART II**

 

**OTHERINFORMATION**

** **

**Item 1.  Legal Proceedings.**

 

The following information supplements and amendsour discussion set forth under Part I, Item 3 “Legal Proceedings” in ourAnnual Report on Form 10-K for the fiscal year ended December 31,2007.

 

*Wave Tec Pools, Inc. Litigation*

 

Superior Funding, Inc., Wave Tec Pools, Inc. and Nations PoolSupply, Inc. (collectively “Plaintiffs”) filed a Fifth Amended Petitionadding additional parties related to Prosperity Bank on or about May 12,2008, but asserting no new claims against FirstCity Servicing Corporation or FHPartners LLC, indirect wholly-owned subsidiaries of FirstCity.  Plaintiffs also sent extensive requests forproduction of documents and terminated the prior agreement to suspend discoveryand responses have been filed by FH Partners LLC.  FirstCity Servicing Corporation and FHPartners LLC intend to contest the cases vigorously.

 

**Item 1A.  Risk Factors.**

 

There have been nomaterial changes to the risk factors as previously disclosed under Item 1A inthe Company’s Annual Report on Form 10-K for the year ended December 31,2007.

 

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

 

The following summarizes purchases of commonstock during the second quarter 2008:

 
| ** ** | ** ** | ** **                                       | ** ** | ** **                                   | ** ** | **Total Number**                                                                   | ** ** | **Maximum Number**                                                     | ** ** |
|------------|------------|--------------------------------------------------|------------|----------------------------------------------|------------|-----------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|
| ** ** | ** ** | ** **                                       | ** ** | ** **                                   | ** ** | **of Shares Purchased**                                                       | ** ** | **of Shares that May**                                       | ** ** |
| **Month**  | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average  Price Paid  Per Share** | ** ** | **as Part of Publicly  Announced Plans  or Programs (1)** | ** ** | **Yet Be Purchased  Under the Plans  or Programs** | ** ** |
| April      |       | 121,300                                          |       | $                                            | 5.73       |                                                                                    | 121,300    |                                                                        |       |   |
| May        |       | 2,900                                            |       | $                                            | 4.53       |                                                                                    | 2,900      |                                                                        |       |   |
| June       |       | 91,600                                           |       | $                                            | 4.36       |                                                                                    | 91,600     |                                                                        |       |   |
| Total      |       | 215,800                                          |       | $                                            | 5.13       |                                                                                    | 215,800    |                                                                        | 439,170    |   |

 

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(1)  The Company has a stock repurchaseprogram that was approved by the Board of Directors in August 2006 for therepurchase of up to 1,000,000 shares of the Company’s common stock in the openmarket or otherwise from time to time. On February 6, 2008, the Boardof Directors approved the repurchase of anadditional 500,000 shares (up to a total of 1,500,000 shares) and the plan wasextended to August 30, 2009.

 

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

 

None

 

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

 

The Company heldits annual meeting of stockholders (the “Annual Meeting”) on June 16,2008. The following items for business were considered at the Annual Meeting.

 

**(a) Electionof Directors**

 

The followingindividuals were elected as directors to serve as members of the Company’sBoard of Directors until the Company’s 2009 annual meeting of stockholders. Thenumber of votes cast for each nominee was as follows:

 

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| ** **            | ** ** | ** **         | ** ** | **Votes**    | ** ** |
|-----------------------|------------|--------------------|------------|--------------|------------|
| **Nominee**           | ** ** | **Votes For** | ** ** | **Withheld** | ** ** |
| Richard E. Bean       |       | 9,854,945          |       | 154,472      |       |
| C. Ivan Wilson        |       | 9,321,558          |       | 687,859      |       |
| James T. Sartain      |       | 9,854,918          |       | 154,499      |       |
| Dane Fulmer           |       | 9,852,435          |       | 156,982      |       |
| Robert E. Garrison II |       | 9,854,945          |       | 154,472      |       |
| D. Michael Hunter     |       | 9,854,945          |       | 154,472      |       |
| F. Clayton Miller     |       | 7,623,776          |       | 2,385,641    |       |

 

**(b) Ratificationof Appointment of Auditors**

 

A proposal to ratify the Board of Directors’ appointment of KPMG LLP asthe Company’s independent auditors for 2008 was approved by the stockholders.The number of votes for the proposal: 9,900,525; votes against: 94,938;abstentions: 13,953.

 

**Item 5.  OtherInformation.**

 

None

 

**Item 6.  Exhibits.**

 
| **Exhibit********Number** | ** ** | ** ** | ** ** | **Description  of Exhibit**                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|---------------------------|------------|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1                       |       | —     |       | Joint Plan of  Reorganization by First City Bancorporation of Texas, Inc., Official  Committee of Equity Security Holders and J-Hawk Corporation, with the  Participation of Cargill Financial Services Corporation, Under Chapter 11 of  the United States Bankruptcy Code, Case No. 392-39474-HCA-11  (incorporated herein by reference to Exhibit 2.1 of the Company’s  Current Report on Form 8-K dated July 3, 1995 filed with the  Commission on July 18, 1995) |
|                      |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 2.2                       |       | —     |       | Agreement and Plan of  Merger, dated as of July 3, 1995, by and between First City  Bancorporation of Texas, Inc. and J-Hawk Corporation (incorporated  herein by reference to Exhibit 2.2 of the Company’s Current Report on  Form 8-K dated July 3, 1995 filed with the Commission on  July 18, 1995)                                                                                                                                                               |
|                      |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.1                       |       | —     |       | Amended and Restated  Certificate of Incorporation of the Company (incorporated herein by reference  to Exhibit 3.1 of the Company’s Current Report on Form 8-K dated  July 3, 1995 filed with the Commission on July 18, 1995)                                                                                                                                                                                                                                                 |
|                      |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 3.2                       |       | —     |       | Amended and Restated  Bylaws of the Company (incorporated herein by reference to Exhibit 3.1  of the Company’s Current Report on Form 8-K dated December 30, 2005  filed with the Commission on December 30, 2005)                                                                                                                                                                                                                                                              |
|                      |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.1                      |       | —     |       | Revolving Credit  Agreement, dated August 26, 2005, among FH Partners, L.P., as Borrower,  and the Lenders named therein, as Lenders, and Bank of Scotland, as Agent  (incorporated herein by reference to Exhibit 10.1 of the Company’s  Form 8-K dated September 1, 2005)                                                                                                                                                                                                     |
|                      |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.2                      |       | —     |       | Guaranty Agreement,  dated August 26, 2005, executed by FirstCity Financial Corporation,  FirstCity Commercial Corporation, FirstCity Europe Corporation, FirstCity Holdings  Corporation, FirstCity International Corporation, FirstCity  Mexico, Inc., and FirstCity Servicing Corporation for the benefit of  Bank of Scotland, as agent, and lenders (incorporated herein by reference to  Exhibit 10.2 of the Company’s Form 8-K dated September 1,  2005)            |
|                      |       |       |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.3                      |       | —     |       | Contribution and  Assumption Agreement, dated August 18, 2000, by and between Funding LP  and Drive (incorporated herein by reference to Exhibit 10.42 of the  Company’s Form 8-K dated August 25, 2000, filed with the Commission  on September 11, 2000)                                                                                                                                                                                                                 |

 

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| 10.4   |       | — |   | Separation Agreement  and Release, dated March 31, 2004, by and between G. Stephen Fillip,  FirstCity Servicing Corporation and FirstCity Financial Corporation  (incorporated herein by reference to Exhibit 10.19 of the Company’s  Form 10-Q dated May 14, 2004).                                                                                                                                                                |
|--------|------------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |       |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.5   |       | — |   | Consultant Agreement,  dated April 1, 2004, by and between FirstCity Servicing Corporation and  G. Stephen Fillip (incorporated herein by reference to Exhibit 10.20 of  the Company’s Form 10-Q dated May 14, 2004)                                                                                                                                                                                                                |
|   |       |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.6   |       | — |   | Securities Purchase  Agreement dated as of September 21, 2004 by and among FirstCity Financial  Corporation and certain affiliates of FirstCity and IFA Drive GP Holdings  LLC, IFA Drive LP Holdings LLC, Drive Management LP and certain affiliates of  those persons. (incorporated herein by reference to Exhibit 10.1 of the  Company’s Form 8-K dated September 27, 2004)                                                     |
|   |       |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.7   |       | — |   | Revolving Credit  Agreement, dated November 12, 2004, among FirstCity Financial  Corporation as Borrower and the Lenders named therein, as Lenders, and Bank  of Scotland, as Agent (incorporated herein by reference to Exhibit 10.12  of the Company’s Form 10-Q dated November 15, 2004)                                                                                                                                         |
|   |       |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.8   |       | — |   | 1995 Stock Option and  Award Plan (incorporated herein by reference to Exhibit A of the  Company’s Schedule 14A, Definitive Proxy Statement, dated March 27,  1996)                                                                                                                                                                                                                                                                           |
|   |       |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.9   |       | — |   | 1996 Stock Option and  Award Plan (incorporated herein by reference to Exhibit C of the  Company’s Schedule 14A, Definitive Proxy Statement, dated March 27,  1996)                                                                                                                                                                                                                                                                           |
|   |       |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.10  |       | — |   | 2004 Stock Option and  Award Plan (incorporated herein by reference to Appendix A of the Company’s  Schedule 14A, Definitive Proxy Statement, dated October 21, 2003)                                                                                                                                                                                                                                                                              |
|   |       |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.11  |       | — |   | Sixth Amendment to  Right Of First Refusal Agreement And Due Diligence Reimbursement Agreement  dated effective as of February 1, 2006 (incorporated herein by reference  to Exhibit 10.1 of the Company’s Form 8-K dated February 6,  2006)                                                                                                                                                                                        |
|   |       |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.12  |       | — |   | Asset Purchase  Agreement, dated June 30, 2006, by and among FirstCity Financial  Corporation and its subsidiaries, FirstCity Business Lending Corporation and  American Business Lending, Inc.; and AMRESCO SBA Holdings, Inc. and  NCS I, LLC (incorporated herein by reference to Exhibit 10.1 of the  Company’s Form 8-K dated July 7, 2006)                                                                          |
|   |       |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.13  |       | — |   | 2006 Stock Option and  Award Plan (incorporated herein by reference to Appendix A of the Company’s  Schedule 14A, Definitive Proxy Statement, dated June 26, 2006)                                                                                                                                                                                                                                                                                 |
|   |       |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.14  | ** ** | — |   | Interest Purchase and  Sale Agreement, dated August 8, 2006, by and among Bidmex Holding, LLC,  and Strategic Mexican Investment Partners, L.P. and Cargill Financial  Services International, Inc. and certain other parties (incorporated  herein by reference to Exhibit 10.14 of the Company’s Form 10-Q  dated November 9, 2006)                                                                                          |
|   |       |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.15  | ** ** | — |   | Put Option Agreement  dated August 8, 2006, by and among Bidmex Holding, LLC, Recuperacion de  Carteras Mexicanas, S. de R.L. de C.V., Bidmex 6, LLC, Strategic Mexican  Investment Partners 2, L.P. and Cargill Financial Services  International, Inc. (incorporated herein by reference to  Exhibit 10.15 of the Company’s Form 10-Q dated November 9,  2006)                                                               |
|   |       |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.16  | ** ** | — |   | Guarantee dated  August 8, 2006, executed by FirstCity Financial Corporation for the  benefit of Bidmex Holding, LLC, Residencial Oeste 2 S. de R.L. de C.V.,  National Union Fire Insurance Company of Pittsburg, P.A., American General  Life Insurance Company, and American General Life and Accident Insurance  Company (incorporated herein by reference to Exhibit 10.15 of the  Company’s Form 10-Q dated November 9, 2006) |

 

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| 10.17      |       | —     |       | Amendment No. 4 to  Revolving Credit Agreement, dated as of October 31, 2006, among  FirstCity Financial Corporation as Borrower and the Lenders named therein, as  Lenders, and Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.1 of the Company’s Form 8-K dated November 7, 2006)    |
|------------|------------|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                              |
| 10.18      |       | —     |       | Management Employment  Contract dated November 30, 2006, between FirstCity Business Lending  Corporation, American Business Lending, Inc.**,**and Charles P. Bell, Jr. (incorporated herein by  reference to Exhibit 10.2 of the Company’s Form 8-K dated  December 7, 2006)                                   |
| ** ** | ** ** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                        |
| 10.19      |       | —     |       | Management Employment  Contract dated November 30, 2006, between FirstCity Business Lending  Corporation, American Business Lending, Inc.**,**and Joe N. Smith (incorporated herein by reference to  Exhibit 10.3 of the Company’s Form 8-K dated December 7, 2006)                                                 |
| ** ** | ** ** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                        |
| 10.20      |       | —     |       | Amendment No. 5 to  Revolving Credit Agreement, dated as of December 14, 2006, among  FirstCity Financial Corporation as Borrower and the Lenders named therein, as  Lenders, and Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.1 of the Company’s Form 8-K dated December 20,  2006) |
| ** ** | ** ** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                        |
| 10.21      |       | —     |       | Loan Agreement,  dated as of December 15, 2006 by and between American Business  Lending, Inc., as Borrower, and Wells Fargo Foothill, LLC, as lender  (incorporated herein by reference to Exhibit 10.1 of the Company’s  Form 8-K dated December 28, 2006)                                                        |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                              |
| 10.22      |       | —     |       | Amendment  No. 1 to Loan Agreement, dated as of February 27, 2007, by and  between American Business Lending, Inc., as Borrower, and Wells Fargo  Foothill, LLC, as lender (incorporated herein by reference to  Exhibit 10.22 of the Company’s Form 10-K dated July 24, 2007)                                 |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                              |
| 10.23      |       | —     |       | Amendment No. 9 to  Revolving Credit Agreement, dated as of June 29, 2007, among FirstCity  Financial Corporation as Borrower and the Lenders named therein, as Lenders,  and Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.23 of the Company’s Form 10-Q dated August 10,  2007)     |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                              |
| 10.24      |       | —     |       | Amendment No. 1 to  Revolving Credit Agreement, dated June 29, 2007, among FH Partners,  L.P., as Borrower, and the Lenders named therein, as Lenders, and Bank of  Scotland, as Agent (incorporated herein by reference to Exhibit 10.24 of  the Company’s Form 10-Q dated August 10, 2007)                        |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                              |
| 10.25      |       | —     |       | Amendment  No. 2 to Loan Agreement, dated as of July 30, 2007, by and between  American Business Lending, Inc., as Borrower, and Wells Fargo Foothill,  LLC, as lender (incorporated herein by reference to Exhibit 10.1 of the  Company’s Form 8-K dated August 3, 2007)                                      |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                              |
| 10.26      |       | —     |       | Amendment No. 10  to Revolving Credit Agreement, dated as of August 22, 2007, among  FirstCity Financial Corporation as Borrower and the Lenders named therein, as  Lenders, and Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.1 of the Company’s Form 8-K dated August 28, 2007)     |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                              |
| 10.27      |       | —     |       | Amendment No. 3  and Consent to Revolving Credit Agreement, dated August 22, 2007, among  FH Partners, L.L.C., as Borrower, and the Lenders named therein, as Lenders,  and Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.2 of the Company’s Form 8-K dated August 28, 2007)          |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                              |
| 10.28      |       | —     |       | Subordinated Delayed  Draw Credit Agreement, dated as of September 5, 2007, among FirstCity  Financial Corporation, as Borrower, and the Lenders named therein, as  Lenders, and BoS (USA), Inc., as agent (incorporated herein by reference  to Exhibit 10.1 of the Company’s Form 8-K dated September 10,  2007)  |
|       |       |       |       |                                                                                                                                                                                                                                                                                                                                              |
| 10.29      |       | —     |       | Letter agreement  between FirstCity Financial Corporation and Bank of Scotland                                                                                                                                                                                                                                                                    |

 

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|   |   |   |   | extending time period  for closing of subordinate credit facility to be provided by BoS (USA,) Inc.  to October 2, 2007 (incorporated herein by reference to  Exhibit 10.2 of the Company’s Form 8-K dated September 10,  2007)                                                                                                                                  |
|--------|--------|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.30  |   | — |   | Letter agreement  between FirstCity Financial Corporation and BoS (USA), Inc. extending  time period for closing of subordinate credit facility to be provided by BoS  (USA), Inc. to October 31, 2007 (incorporated herein by reference  to Exhibit 10.1 of the Company’s Form 8-K dated October 5,  2007)                                            |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.31  |   | — |   | Letter agreement  between FirstCity Financial Corporation and Bank of Scotland extending time  period for closing of subordinate credit facility to be provided by BoS  (USA), Inc. to October 31, 2007 (incorporated herein by reference  to Exhibit 10.2 of the Company’s Form 8-K dated October 5,  2007)                                                |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.32  |   | — |   | Letter agreement  between FirstCity Financial Corporation and BoS (USA), Inc. extending  time period for closing of subordinate credit facility to be provided by BoS  (USA), Inc. to November 16, 2007 (incorporated herein by reference  to Exhibit 10.1 of the Company’s Form 8-K dated November 8,  2007)                                          |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.33  |   | — |   | Letter agreement  between FirstCity Financial Corporation and Bank of Scotland which amended  the Revolving Credit Agreement to extend time period for closing of  subordinate credit facility to be provided by BoS (USA), Inc. to  November 16, 2007 (incorporated herein by reference to Exhibit 10.2  of the Company’s Form 8-K dated November 8, 2007) |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.34  |   | — |   | Amendment and Consent  No. 21 to Revolving Credit Agreement, dated as of May 8, 2008,  among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  May 14, 2008)                                       |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.35  |   | — |   | Amendment and Consent  No. 8 to Subordinated Delayed Draw Credit Agreement, dated as of  May 8, 2008, among FirstCity Financial Corporation as Borrower and the  Lenders named therein, as Lenders, and BoS (USA), Inc., as Agent  (incorporated herein by reference to Exhibit 10.2 of the Company’s  Form 8-K dated May 14, 2008)                    |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.36  |   | — |   | Amendment and Consent  No. 5 to Revolving Credit Agreement, dated as of May 8, 2008, among  FH Partners, LLC, as Borrower, and the Lenders named therein, as Lenders, and  Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.3 of the Company’s Form 8-K dated May 14, 2008)                                                      |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.37  |   | — |   | Amendment and Consent  No. 25 to Revolving Credit Agreement, dated as of July 14, 2008,  among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  July 18, 2008)                                    |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.38  |   | — |   | Amendment and Consent  No. 12 to Subordinated Delayed Draw Credit Agreement, dated as of  July 14, 2008, among FirstCity Financial Corporation as Borrower and the  Lenders named therein, as Lenders, and BoS (USA), Inc., as Agent  (incorporated herein by reference to Exhibit 10.2 of the Company’s  Form 8-K dated July 18, 2008)                |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 10.39  |   | — |   | Amendment and Consent  No. 6 to Revolving Credit Agreement, dated as of July 14, 2008, among  FH Partners, LLC, as Borrower, and the Lenders named therein, as Lenders, and  Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.3 of the Company’s Form 8-K dated July 18, 2008)                                                   |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                                      |
| 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.                                                                                                                                                                                                                                                                            |

 

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| 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. |

 

----

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

 

Dated:  August 11, 2008

 

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**Exhibit Index**

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

 

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

 

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

 

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|   |   |   |   | amended the Revolving  Credit Agreement to extend time period for closing of subordinate credit  facility to be provided by BoS (USA), Inc. to November 16, 2007  (incorporated herein by reference to Exhibit 10.2 of the Company’s  Form 8-K dated November 8, 2007)                                                                       |
|--------|--------|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.34  |   | — |   | Amendment and Consent  No. 21 to Revolving Credit Agreement, dated as of May 8, 2008,  among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  May 14, 2008)                        |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.35  |   | — |   | Amendment and Consent  No. 8 to Subordinated Delayed Draw Credit Agreement, dated as of  May 8, 2008, among FirstCity Financial Corporation as Borrower and the  Lenders named therein, as Lenders, and BoS (USA), Inc., as Agent  (incorporated herein by reference to Exhibit 10.2 of the Company’s  Form 8-K dated May 14, 2008)     |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.36  |   | — |   | Amendment and Consent  No. 5 to Revolving Credit Agreement, dated as of May 8, 2008, among  FH Partners, L.L.C., as Borrower, and the Lenders named therein, as Lenders,  and Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.3 of the Company’s Form 8-K dated May 14, 2008)                                    |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.37  |   | — |   | Amendment and Consent  No. 25 to Revolving Credit Agreement, dated as of July 14, 2008,  among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  July 18, 2008)                     |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.38  |   | — |   | Amendment and Consent  No. 12 to Subordinated Delayed Draw Credit Agreement, dated as of  July 14, 2008, among FirstCity Financial Corporation as Borrower and the  Lenders named therein, as Lenders, and BoS (USA), Inc., as Agent  (incorporated herein by reference to Exhibit 10.2 of the Company’s  Form 8-K dated July 18, 2008) |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 10.39  |   | — |   | Amendment and Consent  No. 6 to Revolving Credit Agreement, dated as of July 14, 2008,  among FH Partners, L.L.C., as Borrower, and the Lenders named therein, as  Lenders, and Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.3 of the Company’s Form 8-K dated July 18, 2008)                                 |
|   |   |   |   |                                                                                                                                                                                                                                                                                                                                                                       |
| 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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