Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**Form 10-Q**

 

**(Mark One)**

 
| **x**                                                      | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|------------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| ** **                                                 | ** **                                                                                              |
| **For the quarterly period ended September 30, 2009** |
| ** **                                                 | ** **                                                                                              |
| **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 has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes o  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 the 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 o          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                   |   | Smaller reporting  company x |
| (Do not check if a  smaller reporting company) |   |                              |

 

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

 

The number of shares of common stock, par value$.01 per share, outstanding at November 9, 2009 was 9,870,937.

 

 

 

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Table of Contents

 

**TABLE OF CONTENTS**

 
| **PART I**                     | ** **                                                                                      |
|-------------------------------------|-------------------------------------------------------------------------------------------------|
| ** **                          | ** **                                                                                      | ** ** |
| **Item 1.**                         | **Financial Statements**                                                                        | **1** |
| ** **                          | **Consolidated Balance Sheets**                                                                 | **1** |
| ** **                          | **Consolidated Statements of Operations**                                                       | **2** |
| ** **                          | **Consolidated  Statements of Stockholders’ Equity**                                       | **3** |
| ** **                          | **Consolidated Statements of Cash Flows**                                                       | **4** |
| ** **                          | **Notes to Consolidated Financial Statements**                                                  | **5** |
| **Item 2.**                         | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | **39** |
| **Item 3.**                         | **Quantitative  and Qualitative Disclosures About Market Risk**                                 | **58** |
| **Item 4.**                         | **Controls and Procedures**                                                                     | **59** |
| ** **                          | ** **                                                                                      | ** ** |
| **PART II  OTHER INFORMATION** | **61**                                                                                          |
| ** **                          | ** **                                                                                      | ** ** |
| **Item 1.**                         | **Legal Proceedings**                                                                           | **61** |
| **Item 1A.**                        | **Risk Factors**                                                                                | **61** |
| **Item 2.**                         | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                | **61** |
| **Item 3.**                         | **Defaults  Upon Senior Securities**                                                            | **61** |
| **Item 4.**                         | **Submission  of Matters to a Vote of Security Holders**                                        | **61** |
| **Item 5.**                         | **Other Information**                                                                           | **61** |
| **Item 6.**                         | **Exhibits**                                                                                    | **62** |
| **SIGNATURES**                      | **63**                                                                                          |

 

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Table of Contents

 

**PART I**

 

**FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements**

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

** **

**CONSOLIDATEDBALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                    | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                                                    | ** ** | **(Unaudited)**        | ** ** | **(See Note 2)**      | ** ** |
| **ASSETS**                                                                                                                                                                                    | ** ** | ** **             | ** ** | ** **            | ** ** |
| Cash and cash equivalents                                                                                                                                                                     |       | $                      | 32,992     |                  | $          | 19,103 |   |
| Restricted cash                                                                                                                                                                               |       | 1,039                  |       | 1,217                 |       |
| Portfolio Assets:                                                                                                                                                                             |       |                   |       |                  |       |
| Loan portfolios, net of  allowance for loan losses of $62,288 and $76,365, respectively                                                                                                       |       | 220,125                |       | 121,137               |       |
| Real estate held for sale                                                                                                                                                                     |       | 16,639                 |       | 17,484                |       |
| Real estate held for  investment, net                                                                                                                                                         |       | 9,514                  |       | 9,592                 |       |
| Total Portfolio Assets                                                                                                                                                                        |       | 246,278                |       | 148,213               |       |
| Loans receivable:                                                                                                                                                                             |       |                   |       |                  |       |
| Loans receivable -  affiliates                                                                                                                                                                |       | 31,211                 |       | 27,080                |       |
| Loans receivable - SBA held  for sale                                                                                                                                                         |       | 1,583                  |       | 4,901                 |       |
| Loans receivable - SBA held  for investment, net of allowance for loan losses of $441 and $34,  respectively                                                                                  |       | 15,662                 |       | 14,405                |       |
| Loans receivable - other,  net of allowance for loan losses of $-0- and $581, respectively                                                                                                    |       | 10,883                 |       | 13,533                |       |
| Total loans receivable                                                                                                                                                                        |       | 59,339                 |       | 59,919                |       |
| Investment security  available for sale                                                                                                                                                       |       | 1,755                  |       | 5,251                 |       |
| Equity investments                                                                                                                                                                            |       | 73,036                 |       | 72,987                |       |
| Service fees receivable  ($794 and $553 from affiliates, respectively)                                                                                                                        |       | 860                    |       | 626                   |       |
| Servicing assets - SBA  loans                                                                                                                                                                 |       | 985                    |       | 722                   |       |
| Other assets, net                                                                                                                                                                             |       | 21,803                 |       | 20,899                |       |
| Total Assets                                                                                                                                                                                  |       | $                      | 438,087    |                  | $          | 328,937 |   |
| ** **                                                                                                                                                                                    | ** ** | ** **             | ** ** | ** **            | ** ** |
| **LIABILITIES  AND EQUITY**                                                                                                                                                                   |       |                   |       |                  |       |
| Liabilities:                                                                                                                                                                                  |       |                   |       |                  |       |
| Notes payable to banks                                                                                                                                                                        |       | $                      | 294,805    |                  | $          | 242,889 |   |
| Note payable to affiliate                                                                                                                                                                     |       | 8,058                  |       | 8,658                 |       |
| Other liabilities                                                                                                                                                                             |       | 17,764                 |       | 11,515                |       |
| Total Liabilities                                                                                                                                                                             |       | 320,627                |       | 263,062               |       |
| Commitments and  contingencies (Note 18)                                                                                                                                                      |       |                   |       |                  |       |
| 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: 11,368,937 and  11,331,937, respectively ; shares outstanding: 9,868,937 and 9,831,937,  respectively) |       | 113                    |       | 113                   |       |
| Treasury stock, at cost:  1,500,000 shares                                                                                                                                                    |       | (10,923                | )          | (10,923               | )          |
| Paid in capital                                                                                                                                                                               |       | 103,067                |       | 101,875               |       |
| Accumulated deficit                                                                                                                                                                           |       | (26,683                | )          | (37,073               | )          |
| Accumulated other  comprehensive loss                                                                                                                                                         |       | (459                   | )          | (3,726                | )          |
| FirstCity Stockholders’  Equity                                                                                                                                                          |       | 65,115                 |       | 50,266                |       |
| Noncontrolling interests                                                                                                                                                                      |       | 52,345                 |       | 15,609                |       |
| Total Equity                                                                                                                                                                                  |       | 117,460                |       | 65,875                |       |
| Total Liabilities and  Equity                                                                                                                                                                 |       | $                      | 438,087    |                  | $          | 328,937 |   |

 

See accompanying notes to consolidated financial statements.

 

1

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                                                                                                                                                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                                                                                                                           | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenues:                                                                                                                                                                            |       |                   |       |                   |       |   |   |   |   |
| Servicing fees ($2,019 and  $3,530 from affiliates for the three month periods, respectively, and $6,282  and $8,178 from affiliates for the nine month periods, respectively)  |       | $                      | 2,222      |                   | $          | 3,842 |   | $ | 7,017 |   | $ | 8,748 |   |
| Income from Portfolio  Assets                                                                                                                                                        |       | 12,134                 |       | 5,229                  |       | 35,254 |   | 15,786 |   |
| Gain on sale of SBA loans  held for sale, net                                                                                                                                        |       | 301                    |       | 85                     |       | 911 |   | 227 |   |
| Interest income from SBA  loans                                                                                                                                                      |       | 299                    |       | 368                    |       | 940 |   | 1,210 |   |
| Interest income from loans  receivable - affiliates                                                                                                                                  |       | 1,078                  |       | 875                    |       | 2,940 |   | 1,508 |   |
| Interest income from loans  receivable - other                                                                                                                                       |       | 99                     |       | 541                    |       | 892 |   | 1,171 |   |
| Revenue from railroad  operations                                                                                                                                                    |       | 776                    |       | 810                    |       | 2,228 |   | 2,446 |   |
| Other income                                                                                                                                                                         |       | 1,822                  |       | 939                    |       | 4,891 |   | 2,586 |   |
| Total revenues                                                                                                                                                                       |       | 18,731                 |       | 12,689                 |       | 55,073 |   | 33,682 |   |
| Expenses:                                                                                                                                                                            |       |                   |       |                   |       |   |   |   |   |
| Interest and fees on notes  payable to banks                                                                                                                                         |       | 3,072                  |       | 4,249                  |       | 9,261 |   | 11,690 |   |
| Interest and fees on notes  payable to affiliate                                                                                                                                     |       | 428                    |       | 322                    |       | 1,305 |   | 322 |   |
| Salaries and benefits                                                                                                                                                                |       | 5,300                  |       | 5,655                  |       | 16,386 |   | 15,982 |   |
| Provision for loan and  impairment losses                                                                                                                                            |       | 425                    |       | 1,123                  |       | 2,208 |   | 11,243 |   |
| Asset-level expenses                                                                                                                                                                 |       | 1,992                  |       | 1,105                  |       | 4,646 |   | 4,093 |   |
| Occupancy, data processing  and other                                                                                                                                                |       | 3,093                  |       | 3,980                  |       | 8,681 |   | 9,738 |   |
| Total expenses                                                                                                                                                                       |       | 14,310                 |       | 16,434                 |       | 42,487 |   | 53,068 |   |
| Equity in net earnings of  subsidiaries                                                                                                                                              |       | 421                    |       | 2,170                  |       | 1,473 |   | 8,018 |   |
| Gain on step acquisition                                                                                                                                                             |       | —                 |       | —                 |       | 1,455 |   | — |   |
| Earnings (loss) before  income taxes                                                                                                                                                 |       | 4,842                  |       | (1,575                 | )          | 15,514 |   | (11,368 | ) |
| Income tax benefit  (expense)                                                                                                                                                        |       | (1,254                 | )          | 44                     |       | (1,957 | ) | (245 | ) |
| Net earnings (loss)                                                                                                                                                                  |       | 3,588                  |       | (1,531                 | )          | 13,557 |   | (11,613 | ) |
| Less: Net income attributable  to noncontrolling interests  (See Note 2)                                                                                                             |       | 1,588                  |       | 224                    |       | 3,167 |   | 255 |   |
| Net earnings (loss)  attributable to FirstCity                                                                                                                                       |       | $                      | 2,000      |                   | $          | (1,755 | ) | $ | 10,390 |   | $ | (11,868 | ) |
|                                                                                                                                                                                 |       |                   |       |                   |       |   |   |   |   |
| Basic earnings (loss) per  share                                                                                                                                                     |       | $                      | 0.20       |                   | $          | (0.17 | ) | $ | 1.06 |   | $ | (1.14 | ) |
| Diluted earnings (loss) per  share                                                                                                                                                   |       | $                      | 0.19       |                   | $          | (0.17 | ) | $ | 1.02 |   | $ | (1.14 | ) |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**AND COMPREHENSIVE INCOME (LOSS)**

**(Dollars in thousands)**

 
| ** **                                                      | ** ** | **FirstCity  Stockholders** | ** ** | ** **   | ** ** | ** **   | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------|------------|--------------|------------|--------------|------------|
| ** **                                                      | ** ** | ** **                  | ** ** | ** **   | ** ** | ** **   | ** ** | **Retained** | ** ** | **Accumulated** | ** ** | **Non-** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | ** **                  | ** ** | ** **   | ** ** | ** **   | ** ** | **Earnings** | ** ** | **Other** | ** ** | **controlling** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **Common**                  | ** ** | **Treasury** | ** ** | **Paid  in** | ** ** | **(Accumulated** | ** ** | **Comprehensive** | ** ** | **Interests** | ** ** | **Total** | ** ** |
| ** **                                                      | ** ** | **Stock**                   | ** ** | **Stock**    | ** ** | **Capital**  | ** ** | **Deficit)** | ** ** | **Income  (Loss)** | ** ** | **(See  Note 2)** | ** ** | **Equity** | ** ** |
| ** **                                                      | ** ** | ** **                  | ** ** | ** **   | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Balances, December 31, 2007**                            |       | $                           | 113        |         | $          | (5,978       | )          | $ | 101,240 |   | $ | 9,602 |   | $ | 1,846 |   | $ | 3,209 |   | $ | 110,032 |   |
| Exercise of common stock options                                |       | —                      |       | —       |       | 12           |       | — |   | — |   | — |   | 12 |   |
| Repurchase of common stock                                      |       | —                      |       | (3,814       | )          | —       |       | — |   | — |   | — |   | (3,814 | ) |
| Stock option compensation expense                               |       | —                      |       | —       |       | 495          |       | — |   | — |   | — |   | 495 |   |
| Investment in majority-owned entities                           |       | —                      |       | —       |       | —       |       | — |   | — |   | 14,559 |   | 14,559 |   |
| Distributions to noncontrolling interests                       |       | —                      |       | —       |       | —       |       | — |   | — |   | (1,043 | ) | (1,043 | ) |
| Other activity                                                  |       | —                      |       | —       |       | —       |       | — |   | — |   | 10 |   | 10 |   |
| Comprehensive loss:                                             |       |                        |       |         |       |         |       |   |   |   |   |   |   |   |   |
| Net loss                                                        |       | —                      |       | —       |       | —       |       | (11,868 | ) | — |   | 255 |   | (11,613 | ) |
| Foreign currency translation adjustments                        |       | —                      |       | —       |       | —       |       | — |   | 421 |   | (285 | ) | 136 |   |
| Total comprehensive loss                                        |       |                        |       |         |       |         |       |   |   |   |   |   |   | (11,477 | ) |
| **Balances, September 30, 2008**                           |       | $                           | 113        |         | $          | (9,792       | )          | $ | 101,747 |   | $ | (2,266 | ) | $ | 2,267 |   | $ | 16,705 |   | $ | 108,774 |   |
|                                                            |       |                        |       |         |       |         |       |   |   |   |   |   |   |   |   |
|                                                            |       |                        |       |         |       |         |       |   |   |   |   |   |   |   |   |
|                                                            |       |                        |       |         |       |         |       |   |   |   |   |   |   |   |   |
| **Balances, December 31, 2008**                            |       | $                           | 113        |         | $          | (10,923      | )          | $ | 101,875 |   | $ | (37,073 | ) | $ | (3,726 | ) | $ | 15,609 |   | $ | 65,875 |   |
| Exercise of common stock options                                |       | —                      |       | —       |       | 113          |       | — |   | — |   | — |   | 113 |   |
| Stock option compensation expense                               |       | —                      |       | —       |       | 438          |       | — |   | — |   | — |   | 438 |   |
| Purchases of subsidiary shares in noncontrolling  interests     |       | —                      |       | —       |       | 641          |       | — |   | — |   | (3,458 | ) | (2,817 | ) |
| Investments in majority-owned entities                          |       | —                      |       | —       |       | —       |       | — |   | — |   | 46,306 |   | 46,306 |   |
| Distributions to noncontrolling interests                       |       | —                      |       | —       |       | —       |       | — |   | — |   | (9,961 | ) | (9,961 | ) |
| Comprehensive income:                                           |       |                        |       |         |       |         |       |   |   |   |   |   |   |   |   |
| Net earnings                                                    |       | —                      |       | —       |       | —       |       | 10,390 |   | — |   | 3,167 |   | 13,557 |   |
| Change in net unrealized gain on securities available  for sale |       | —                      |       | —       |       | —       |       | — |   | 1,310 |   | 326 |   | 1,636 |   |
| Foreign currency translation adjustments                        |       | —                      |       | —       |       | —       |       | — |   | 1,957 |   | 356 |   | 2,313 |   |
| Total comprehensive income                                      |       |                        |       |         |       |         |       |   |   |   |   |   |   | 17,506 |   |
| **Balances, September 30, 2009  (unaudited)**              |       | $                           | 113        |         | $          | (10,923      | )          | $ | 103,067 |   | $ | (26,683 | ) | $ | (459 | ) | $ | 52,345 |   | $ | 117,460 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                                              | ** ** | **Nine Months Ended**   | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                              | ** ** | **September 30,**  | ** ** |
| ** **                                                                              | ** ** | **2009**                | ** ** | **2008** | ** ** |
| ** **                                                                              | ** ** | **(See Notes 1 and 2)** | ** ** |
| **Cash flows  from operating activities:**                                              |       |                    |       |   |   |
| Net earnings (loss)                                                                     |       | $                       | 13,557     |   | $ | (11,613 | ) |
| Adjustments to reconcile  net earnings (loss) to net cash used in operating activities: |       |                    |       |   |   |
| Net principal advances on  SBA loans held for sale                                      |       | (13,491                 | )          | (7,938 | ) |
| Proceeds from sales of SBA  loans held for sale, net                                    |       | 18,155                  |       | 5,310 |   |
| Proceeds applied to income  from Portfolio Assets                                       |       | 15,324                  |       | 11,371 |   |
| Income from Portfolio  Assets                                                           |       | (35,254                 | )          | (15,786 | ) |
| Capitalized interest and  costs on Portfolio Assets and loans receivable                |       | (955                    | )          | (986 | ) |
| Provision for loan and  impairment losses                                               |       | 2,208                   |       | 11,243 |   |
| Foreign currency  transaction (gains) losses, net                                       |       | (441                    | )          | 1,003 |   |
| Equity in net earnings of  non-consolidated subsidiaries                                |       | (1,473                  | )          | (8,018 | ) |
| Gain on sale of SBA loans  held for sale, net                                           |       | (911                    | )          | (227 | ) |
| Gain on sale of railroad  property                                                      |       | (920                    | )          | — |   |
| Gain on step acquisition                                                                |       | (1,455                  | )          | — |   |
| Depreciation and  amortization                                                          |       | 3,007                   |       | 2,808 |   |
| Net premium amortization of  loans receivable                                           |       | (96                     | )          | (231 | ) |
| Stock option compensation  expense                                                      |       | 438                     |       | 495 |   |
| Decrease (increase) in  restricted cash                                                 |       | 178                     |       | (615 | ) |
| Increase in service fees  receivable                                                    |       | (254                    | )          | (198 | ) |
| Increase in other assets                                                                |       | (1,756                  | )          | (1,317 | ) |
| Increase (decrease) in  other liabilities                                               |       | 5,594                   |       | 676 |   |
| Net cash provided by (used  in) operating activities                                    |       | 1,455                   |       | (14,023 | ) |
| **Cash flows  from investing activities:**                                              |       |                    |       |   |   |
| Purchases of property and  equipment, net                                               |       | (2,071                  | )          | (1,795 | ) |
| Proceeds from sale of  railroad property                                                |       | 1,350                   |       | — |   |
| Cash paid for business  combination, net of cash acquired                               |       | (7,149                  | )          | (300 | ) |
| Net principal advances on  loans receivable                                             |       | (1,946                  | )          | (28,338 | ) |
| Net principal collections  (advances) on SBA loans held for investment                  |       | (1,830                  | )          | (156 | ) |
| Net principal paydowns on  investment security available for sale                       |       | 3,469                   |       | — |   |
| Purchases of Portfolio  Assets                                                          |       | (171,921                | )          | (50,121 | ) |
| Proceeds applied to  principal on Portfolio Assets                                      |       | 109,120                 |       | 35,573 |   |
| Contributions to  non-consolidated subsidiaries                                         |       | (3,890                  | )          | (3,037 | ) |
| Distributions from  non-consolidated subsidiaries                                       |       | 9,297                   |       | 14,762 |   |
| Net cash used in investing  activities                                                  |       | (65,571                 | )          | (33,412 | ) |
| **Cash flows  from financing activities:**                                              |       |                    |       |   |   |
| Borrowings under note  payable to affiliate                                             |       | —                  |       | 8,577 |   |
| Borrowings under notes  payable to banks                                                |       | 160,872                 |       | 107,525 |   |
| Principal payments of notes  payable to affiliates                                      |       | (600                    | )          | — |   |
| Principal payments of notes  payable to banks, net                                      |       | (110,082                | )          | (76,658 | ) |
| Payments of debt issuance  costs and loan fees                                          |       | (854                    | )          | (1,291 | ) |
| Contributions from  noncontrolling interests                                            |       | 40,991                  |       | 4,140 |   |
| Distributions to noncontrolling  interests                                              |       | (9,961                  | )          | (1,043 | ) |
| Repurchase of common stock                                                              |       | —                  |       | (3,814 | ) |
| Cash paid for subsidiary  shares in noncontrolling interests                            |       | (2,796                  | )          | — |   |
| Proceeds from issuance of  common stock                                                 |       | 113                     |       | 12 |   |
| Net cash provided by  financing activities                                              |       | 77,683                  |       | 37,448 |   |
| **Effect of  exchange rate changes on cash and cash equivalents**                       |       | 322                     |       | (66 | ) |
| **Net  increase (decrease) in cash and cash equivalents**                               |       | 13,889                  |       | (10,053 | ) |
| **Cash and  cash equivalents, beginning of period**                                     |       | 19,103                  |       | 23,037 |   |
| **Cash and  cash equivalents, end of period**                                           |       | $                       | 32,992     |   | $ | 12,984 |   |
| **Supplemental  disclosure of cash flow information:**                                  | ** ** | ** **              | ** ** | ** ** | ** ** |
| Cash paid during the period  for:                                                       | ** ** | ** **              | ** ** | ** ** | ** ** |
| Interest                                                                                |       | $                       | 7,279      |   | $ | 9,607 |   |
| Income taxes, net of  refunds received                                                  |       | 222                     |       | 215 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**September 30, 2009**

**(Unaudited)**

 

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

 

***Nature of Operations***

 

FirstCity Financial Corporation and subsidiaries (collectively, “FirstCity,”“Company,” “we,” “us” or “our”) is a financial services company with offices inthe United States and Mexico, and a presence in Europe and South America.FirstCity engages in two major business segments — Portfolio Asset Acquisitionand Resolution and Special Situations Platform. The Portfolio Asset Acquisitionand Resolution business has been the Company’s core business operation sincecommencing operations in 1986. In the Portfolio Asset Acquisition andResolution business, the Company acquires portfolios of performing andnon-performing commercial and consumer loans and other assets (collectively, “PortfolioAssets” or “Portfolios”), generally at a discount to their legal principalbalances or appraised values, and services and resolves such Portfolio Assetsin an effort to maximize the present value of the ultimate cash recoveries.FirstCity acquires the Portfolio Assets for its own account or throughinvestment entities formed with one or more other co-investors (each suchentity, an “Acquisition Partnership”). The Company engages in its SpecialSituations Platform business through its majority ownership interest in FirstCityDenver Investment Corp. (“FirstCity Denver”) — which was formed in April 2007.Through its Special Situations Platform business, the Company providesinvestment capital to privately-held middle-market companies through flexiblecapital structuring arrangements to generate an attractive risk-adjustedreturn. These capital investments primarily take the form of senior and juniorfinancing arrangements, but also include direct equity investments, commonequity warrants, distressed debt transactions, and buyouts. Refer to Note 17for additional information on the Company’s major business segments.

 

***Basis of Presentation***

 

The consolidated financial statements in this Quarterly Report on Form 10-Qinclude the accounts of FirstCity and all other entities in which FirstCity hasa controlling financial interest. All significant intercompany balances andtransactions have been eliminated in consolidation. The accounting andfinancial reporting policies the Company follows conform, in all materialrespects, to U.S. generally accepted accounting principles and to generalpractices within the financial services industry.

 

The consolidatedfinancial statements in this Quarterly Report on Form 10-Q have not beenaudited by an independent registered public accounting firm, but in the opinionof management, reflect all adjustments necessary for a fair presentation of theCompany’s financial position and results of operations. All such adjustmentswere of a normal and recurring nature. We have prepared the accompanying unauditedconsolidated financial statements in accordance with the accounting policiesdescribed in our 2008 Annual Report on Form 10-K, as amended (“2008 Form 10-K”),and with the instructions to Form 10-Q. Accordingly, the accompanyingunaudited consolidated financial statements do not include all of theinformation and note disclosures normally included in our annual financialstatements prepared in accordance with U.S. generally accepted accountingprinciples, and should be read in conjunction with the Company’s consolidatedfinancial statements, and notes thereto, included in our 2008 Form 10-K.Operating results for the interim periods disclosed herein are not necessarilyindicative of the results that may be expected for a full year or any futureperiod. Certain amounts in the consolidated financial statements anddisclosures for prior periods have been reclassified to conform to the currentperiod’s presentation. These reclassifications are not significant and have noimpact on earnings, total assets or stockholders’ equity.

 

We have performeda review of subsequent events through November 12, 2009, the date theconsolidated financial statements were issued, and concluded there were noevents or transactions occurring during the period that required recognition ordisclosure in our consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

On January 1,2009, the Company adopted the FASB guidance (issued in December 2007) thatestablished new accounting and reporting standards for noncontrolling(minority) interests in a subsidiary. Refer to Note 2 for more information.

 

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

 

The Company determined that it has incorrectlyreported certain amounts related to Portfolio Asset activities as “Cash flowsfrom operating activities” in the Consolidated Statements of Cash Flows for allreporting periods prior to September 30, 2009. Upon subsequent review, theCompany determined that applicable Portfolio Asset transactions, primarilypurchases and principal collections, should be reported as “Cash flows frominvesting activities.” In this Form 10-Q for the quarterly period ended September 30,2009, for reasons described below, the Company is revising its ConsolidatedStatements of Cash Flows so that applicable Portfolio Asset transactions arereported as “Cash flows from investing activities” instead of “Cash flows fromoperating activities” for the current and prior reporting period. All financialinformation contained in this Form 10-Q gives effect to these revisions.The revisions did not result in a change to the Company’s previously-reportedrevenues, expenses, net earnings (loss), cash and cash equivalents, orstockholders’ equity.

 

Company management considered all of the relevantquantitative and qualitative factors related to the correction of the errorunder SEC Staff Accounting Bulletin Topic 1N, Financial Statements — *Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements*(“SAB 108”), anddetermined that the impact on previously-issued and current period consolidatedfinancial statements was not material. Therefore, the Company is revising theprior period Consolidated Statements of Cash Flows for the immaterial error inthis Form 10-Q and is not amending previously-filed reports.

 

The following tables reconcile the Company’sConsolidated Statements of Cash Flows from the previously-reported results tothe revised results for the nine-month period ended September 30, 2008 andfor the years ended December 31, 2008, 2007 and 2006 (which includes, asapplicable, the impact of reclassification on change in reportingnoncontrolling interests attributable to the Company’s adoption of the FASBguidance that established new accounting and reporting standards fornoncontrolling interests — see Note 2):

 
| ** **                                                                               | ** ** | **Nine Months Ended**      | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------|------------|-----------------------------------|------------|------------|------------|------------|------------|
| ** **                                                                               | ** ** | **September 30,**     | ** ** | **Years Ended December 31,** | ** ** |
| ** **                                                                               | ** ** | **2008**                   | ** ** | **2008**                          | ** ** | **2007**   | ** ** | **2006**   | ** ** |
| ** **                                                                               | ** ** | **(Dollars in thousands)** | ** ** | **(Dollars in thousands)**        | ** ** |
| Consolidated Statements of  Cash Flows:                                                  |       |                       |       |                              |       |       |       |       |       |
| Cash flows from operating  activities (as reported)                                      |       | $                          | (25,528    | )                                 | $          | (49,189    | )          | $          | (16,649    | ) | $ | (63,298 | ) |
| Impact of revision on  purchases of Portfolio Assets                                     |       | 50,121                     |       | 78,516                            |       | 77,188     |       | 96,493     |       |
| Impact of revision on  proceeds applied to principal on Portfolio Assets                 |       | (35,573                    | )          | (47,735                           | )          | (69,416    | )          | (42,532    | )          |
| Impact of reclassification  on change in reporting noncontrolling interests (see Note 2) |       | (3,097                     | )          | (2,212                            | )          | (1,641     | )          | (473       | )          |
| Other                                                                                    |       | 54                         |       | —                            |       | —     |       | —     |       |
| Cash flows from operating  activities (as revised)                                       |       | $                          | (14,023    | )                                 | $          | (20,620    | )          | $          | (10,518    | ) | $ | (9,810 | ) |
|                                                                                     |       |                       |       |                              |       |       |       |       |       |
| Cash flows from investing  activities (as reported)                                      |       | $                          | (18,864    | )                                 | $          | (18,435    | )          | $          | 39,521     |   | $ | (19,623 | ) |
| Impact of revision on  purchases of Portfolio Assets                                     |       | $                          | (50,121    | )                                 | $          | (78,516    | )          | $          | (77,188    | ) | $ | (96,493 | ) |
| Impact of revision on  proceeds applied to principal on Portfolio Assets                 |       | 35,573                     |       | 47,735                            |       | 69,416     |       | 42,532     |       |
| Cash flows from investing  activities (as revised)                                       |       | $                          | (33,412    | )                                 | $          | (49,216    | )          | $          | 31,749     |   | $ | (73,584 | ) |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

***Use of Estimates***

 

The preparation of financial statements in conformity with U.S.generally accepted accounting principles requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the consolidatedfinancial statements and the reported amounts of revenues and expenses duringthe reporting period. 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 fromPortfolio Assets; valuation of deferred tax assets and assumptions used in thecalculation of income taxes; valuation of servicing assets, investmentsecurities, loans receivable (including loans receivable held in securitizationtrusts), and real estate; valuation of assets, liabilities, non-controllinginterests and contingencies attributable to business combinations; guaranteeobligations and indemnifications; and legal contingencies. These estimates andassumptions are based on management’s best estimates and judgment. Managementevaluates its estimates and assumptions on an ongoing basis using historicalexperience and other factors, including the current economic environment. Weadjust such estimates and assumptions when facts and circumstances dictate.Illiquid credit markets; volatile financial, real estate and foreign currencymarkets; and declines in business and consumer spending have combined toincrease the uncertainty inherent in such estimates and assumptions. As futureevents and their effects cannot be determined with precision, actual resultscould differ significantly from these estimates. Changes in these estimatesresulting from continuing changes in the economic environment will be reflectedin the financial statements in future periods.

 

***PortfolioAssets***

 

The Companyinvests in performing and non-performing commercial and consumer loans, realestate and certain other assets (“Portfolio Assets” or “Portfolios”), andservices and resolves such Portfolio Assets in an effort to maximize thepresent value of the ultimate cash recoveries. The Portfolio Assets aregenerally non-homogeneous assets, including loans of varying qualities that aresecured by diverse collateral types and real estate. Some Portfolio Assets areloans for which resolution is tied primarily to the real estate securing theloan, while others may be collateralized business loans, the resolution ofwhich may be based on the cash flows of the business or the underlyingcollateral.

 

Commencing January 1,2005, FirstCity adopted the FASB’s accounting guidance (issued in December 2003)related to acquisitions of loans and loan portfolios with evidence of creditdeterioration. This guidance addresses accounting differences betweencontractual cash flows and cash flows expected to be collected from an investor’sinitial investment in acquired loans if those differences are attributable, atleast in part, to credit quality. The guidance also requires acquired loanswith credit deterioration to be initially recorded at fair value and prohibits “carryingover” or the creation of valuation allowances in the initial accounting ofacquired loans that are within its scope. The excess cash flows expected atacquisition over the loan portfolio’s purchase price is recorded as interestincome over the life of the portfolio.

 

Loans Acquired Prior to 2005

 

For PortfolioAssets acquired before January 1, 2005, the Company initially recorded thepurchased assets at cost, and acquisition-date purchase discounts and loan lossallowances of the underlying assets were included as components of the cost andcarrying value of the Portfolio Assets, as applicable. Income recognition forthese loans is based on management’s initial designation of the purchasedPortfolio Assets as non-performing or performing. Such designations were madeon the acquisition date and do not subsequently change even though the actualperformance of the Portfolio Assets may subsequently change.

 

Income on non-performingloans acquired before January 1, 2005 is recognized only to the extentthat collections exceed a pro-rata portion of allocated cost from the pool.Cost allocation is based on a proration of actual collections divided by totalestimated collections of the pool. Interest income is not recognized separatelyon non-performing Portfolio Assets. All collection proceeds, of whatever type,are included in the determination of income recognition for these PortfolioAssets. The Company accounts for these non-performing Portfolio Assets on apool basis.

 

Income onperforming loans acquired before January 1, 2005 is recognized using theinterest method, based on the Portfolio’s internal rate of return (“IRR”), andacquisition discounts for the Portfolios as a whole are accreted as anadjustment to yield over the estimated life of the respective Portfolios.Income on performing Portfolio Assets is accrued monthly based on each loanpool’s effective IRR. Significant increases in expected future cash flows may berecognized prospectively through an upward adjustment of the IRR over aportfolio’s remaining life. Any increase to the IRR then becomes the newbenchmark for impairment testing. Cash flows greater than the interest accrualwill reduce the carrying value of the pool. Likewise, cash flows that are lessthan the accrual will increase the carrying balance. The IRR is estimated basedon the timing and amount of anticipated cash flows using the Company’sproprietary collection model. Gains are recognized on performing PortfolioAssets when sufficient funds are received to fully satisfy the obligation onloans included in the pool, either from collections received from the borroweror proceeds received from the sale of the loan. The gain recognized representsthe difference between the proceeds received and the allocated carrying valueof the individual loan in the pool. The Company accounts for these performingPortfolio Assets on a pool basis.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

Loans With CreditDeterioration Acquired After 2004

 

A substantial portion of the Company’s loans and loanpools acquired after 2004 have experienced deterioration of credit qualitybetween origination and the Company’s acquisition of the accounts. The amountspaid for the loans reflect the Company’s determination that the loans haveexperienced deterioration in credit quality since origination and that it isprobable the Company will be unable to collect all amounts due according to thecontractual terms of the underlying loans. Commencing January 1, 2005,FirstCity adopted and began accounting for its acquisitions of loans and loanportfolios with credit deterioration in accordance with the FASB’s accountingguidance (issued in December 2003) on loans with credit deteriorationacquired after 2004.

 

At acquisition,the Company reviews the individual loans purchased to determine whether thereis evidence of credit quality deterioration since origination and if it isprobable that the Company will be unable to collect all amounts due accordingto the loan’s contractual terms. If both conditions exist, the Companydetermines whether each such loan is to be accounted for individually orwhether such loans will be assembled into static pools based on common riskcharacteristics (primarily loan type and collateral). Static pools of individualloan accounts may be established and accounted for as a single economic unitfor the recognition of income, principal payments and loss provision. Once astatic loan pool is established, individual accounts are generally not added toor removed from the pool (unless the Company sells, forecloses or writes-offthe loan). At acquisition, FirstCity determines the excess of the scheduledcontractual payments over all cash flows expected to be collected for the loanor loan pool as an amount that should not be accreted (“nonaccretabledifference”). The excess of the cash flows from the loan or loan pool expectedto be collected at acquisition over the initial investment (“accretable yield”) is accreted intointerest income over the remaining life of the loan or loan pool. The discount(i.e. the difference between the cost of each loan or static pool and therelated aggregate contractual receivable balance) is not recorded because theCompany does not expect to fully collect each contractual receivable balancefor the loan or loan pool. As a result, loans and loan pools are recorded atcost (which approximates fair value) at the time of acquisition.

 

The Companyaccounts for its investments in loans with credit deterioration acquired after2004 using either the interest method or a non-accrual method (throughapplication of the cost-recovery or cash basis of accounting). Application ofthe interest method is dependent on management’s ability to develop areasonable expectation as to both the timing and amount of cash flows expectedto be collected. In the event the Company cannot develop or establish areasonable expectation as to both the timing and amount of cash flows expectedto be collected, the Company uses the cost-recovery or cash basis method of accounting.The Company generally does not allow accretion in the first three to six monthswhile management is performing its post-purchase evaluation (includingfinalizing cash flow budgets).

 

*Interestmethod of accounting*.  Under the interest method, an effectiveinterest rate, or IRR, is applied to the cost basis of the loan or loan pool.The excess of the contractual cash flows over expected cash flows not berecognized as an adjustment of income or expense or on the balance sheet. TheIRR that is calculated when the loan is purchased remains constant as the basisfor subsequent impairment testing (performed at least quarterly) and incomerecognition. Significant increases in actual, or expected future cash flows, isused first to reverse any existing valuation allowance for that loan or loanpool; and any remaining increase may be recognized prospectively through anupward adjustment of the IRR over the remaining life of the loan or loan pool.Any increase to the IRR then becomes the new benchmark for impairment testingand income recognition. Subsequent decreases in projected cash flows do notchange the IRR, but are recognized as an impairment of the cost basis of theloan or loan pool (to maintain the then-current IRR), and are reflected in theconsolidated statements of operations through provisions charged to operations,with a corresponding valuation allowance off-setting the loan or loan pool inthe consolidated balance sheets. FirstCity establishes valuation allowances forloans and loan pools acquired with credit deterioration to reflect only thoselosses incurred after acquisition — that is, the cash flows expected atacquisition that are no longer expected to be collected. Income from loans andloan pools accounted for under the interest method is accrued based on the IRRof each loan or loan pool applied to their respective adjusted cost basis.Gross collections in excess of the interest accrual and impairments will reducethe carrying value of the loan or loan pool, while gross collections less thanthe interest accrual will increase the carrying value. The IRR is calculatedbased on the timing and amount of anticipated cash flows using the Company’sproprietary collection models.

 

*Cost-recoverymethod of accounting. *If the amount and timing of future cashcollections on a loan are not reasonably estimable, the Company accounts forsuch asset on the cost-recovery method. Under the cost-recovery method, noincome is recognized until the Company has fully collected the cost of theloan, or until such time as the Company considers the timing and amount ofcollections to be reasonably estimable and begins to recognize income based onthe interest method as described above. At least quarterly, the Companyperforms an evaluation to determine if the remaining amount that is probable ofcollection is less than the carrying value of the loan or loan pool, and if so,recognizes impairment through provisions charged to operations. Thecost-recovery accounting model is permitted by FASB’s accounting guidance applicableto loans with credit deterioration acquired after 2004. The carrying value ofloans accounted for under the cost-recovery method approximated $87.1 million(including $8.3 million of loans pending management’s post-purchase evaluation)at September 30, 2009, and $20.7 million (including $4.2 million of loanspending management’s post-purchase evaluation) at December 31, 2008.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

*Cashbasis method of accounting.*  If only theamount of future cash collections on a loan is reasonably estimable, theCompany accounts for such asset on an individual loan basis under the cashbasis method of accounting. Under the cash basis method, no income isrecognized unless collections are received during the period. Income isrecognized for the difference between the collections and a pro-rata portion ofcost on a loan. Cost allocation is based on a proration of actual collectionsdivided by total projected collections on the loan. Significant increases incash flows may be recognized prospectively as income over the remaining life ofthe loan through increased amounts allocated to income when collections aresubsequently received. Subsequent decreases in projected cash flows will berecognized as impairment of the loan’s cost basis to maintain a constant costallocation based on initial projections. The cash basis method accounting modelis permitted by FASB’s accounting guidance applicable to loans with creditdeterioration acquired after 2004. Management implemented the cash basis methodof accounting for such eligible loans in the third quarter of 2009 as a resultof increased uncertainty in the timing of future collections onrecently-acquired loans (attributable primarily to the borrowers’ inability toobtain financing to refinance the loan). The carrying value of these loansaccounted for under the cash basis method approximated $65.1 million at September 30,2009.

 

UBN Loan Portfolio

 

In September 2008, the Company, through awholly-owned subsidiary, acquired an additional ownership interest in UBN, SA (“UBN”)in a transaction that was accounted for as a step-acquisition under FASB’sbusiness combination accounting guidance. As a result of the transaction, UBNbecame a consolidated subsidiary of the Company. As such, FirstCity added UBN’sloan portfolio to its consolidated balance sheet in September 2008. On thedate of the acquisition, the amount of the loans and allowance for loan lossesrelated to UBN’s loan portfolio approximated $69.1 million (including $67.3million of non-performing loans) and $66.6 million, respectively.

 

The allowance for loan losses on the UBN loanportfolio represents management’s estimate of credit losses inherent in theloan portfolio at the balance sheet date. Management establishes an allowancefor loan losses through a provision charged to operations when a loan isdetermined to be impaired. A loan is considered to be impaired when, based oncurrent information and events, it is probable the Company will not be able tocollect all amounts due according to the contractual terms of the loan agreement.Loans are charged-off against the allowance when all possible means ofcollection have been exhausted and the remaining balance due is deemeduncollectible. At least quarterly, management evaluates the need for anallowance on an individual-loan basis for the UBN loan portfolio by consideringinformation about specific borrower situations, legal collection proceedings,estimated collateral values, general economic conditions, and other factors.This evaluation is inherently subjective as it requires estimates that aresusceptible to significant revisions as more information becomes available.

 

Real Estate

 

Real estatePortfolio Assets consist of real estate properties purchased from a variety ofsellers or acquired through loan foreclosure. Rental income, net of expenses,is generally recognized when received. The Company accounts for its real estateproperties on an individual-asset basis as opposed to a pool basis. Thefollowing is a description of the classifications and related accounting policiesfor the Company’s various classes of real estate Portfolio Assets:

 

*Classificationand Impairment Evaluation*

 

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

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

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

 

*Cost Capitalization and Allocation*

 

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

 

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

 

**(2)  Recently AdoptedAccounting Standards**

 

Accounting Standards Codification

 

On July 1, 2009, the Company adopted SFAS No. 168, *The FASBAccounting Standards Codification**TM** and the Hierarchy of Generally AcceptedAccounting Principles*(“SFAS 168”). SFAS 168 establishes the *FASBAccounting Standards Codification**TM* (“the Codification”) as the sole authoritativesource of U.S. GAAP for non-governmental entities, except for certainauthoritative rules and interpretive releases issued by the Securities andExchange Commission (“SEC”). **This Codification** re-organizescurrent GAAP for non-governmental entities into a topical index to facilitateaccounting research and to provide users additional assurance that they havereferenced all related literature pertaining to a given topic. ExistingGAAP prior to the Codification was not altered in compilation of the GAAPCodification. The GAAP Codification encompasses all FASB Statements ofFinancial Accounting Standards (SFAS), Emerging Issues Task Force (EITF)statements, FASB Staff Positions (FSP), FASB Interpretations (FIN), FASBDerivative Implementation Guides (DIG), American Institute of Certified PublicAccountants (AICPA) Statement of Positions (SOPs), Accounting Principles Board(APB) Opinions and Accounting Research Bulletins (ARBs), along with theremaining body of GAAP, effective as of June 30, 2009. Rules andinterpretive releases of the SEC are also sources of authoritative GAAP for SECregistrants. Financial statements issued for all interim and annual periodsending after September 15, 2009 will reference accounting guidanceembodied in the Codification as opposed to referencing the previouslyauthoritative pronouncements. Accounting literature included in theCodification is referenced by Topic, Subtopic, Section, Paragraph andSubparagraph.

 

BusinessCombinations and Noncontrolling Interests

 

In December 2007, the FASB issued accounting andreporting guidance on business combinations in consolidated financialstatements. The guidance on business combinations establishes principalrequirements for how the acquirer of a business recognizes and measures in itsfinancial statements the identifiable assets acquired, the liabilities assumed,and any non-controlling interest in the acquiree. This guidance also providesguidance for recognizing and measuring the goodwill acquired in the businesscombination, recognizing assets acquired and liabilities assumed arising fromcontingencies, and determining what information to disclose to enable users ofthe financial statements to evaluate the nature and financial impact of thebusiness combination. We adopted this new guidance on January 1, 2009 andit applies to all business combinations prospectively from that date. Theimpact of this guidance on our consolidated financial statements will dependupon the nature, terms and size of the acquisitions that the Companyconsummates in the future.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

In April 2009,the FASB issued guidance that amends the accounting requirements for assets andliabilities arising from contingencies in a business combination. This guidanceamends the applicable business combination accounting guidance that the FASBissued in December 2007. This amended guidance requires thatpre-acquisition contingencies be recognized at fair value, if fair value can bereasonably determined. If fair value cannot be reasonably determined, theguidance requires measurement based on the best estimate in accordance withcontingency accounting guidance. This amended guidance is effective as of January 1,2009 in connection with the adoption of the FASB’s business combinationguidance issued in December 2007 as discussed above.

 

In December 2007, the FASB issued accounting andreporting guidance on noncontrolling interests in consolidated financialstatements. Thisguidance defines noncontrolling interest as the portion of equity in asubsidiary not attributable, directly or indirectly, to the parent. The newguidance requires the ownership interests in subsidiaries held by parties otherthan the parent (previously referred to as minority interest) to be clearlypresented in the consolidated balance sheet within equity, but separate fromthe parent’s equity. The amount of consolidated net income attributable to theparent and to any noncontrolling interest must be clearly presented on the faceof the consolidated statement of operations. Changes in the parent’s ownershipinterest while the parent retains its controlling financial interest (greaterthan 50 percent ownership) are to be accounted for as equity transactionswith no remeasurement to fair value. Upon a loss of control, any gain or losson the interest sold will be recognized in earnings. Additionally, anyownership interest retained will be re-measured at fair value on the date controlis lost, with any gain or loss recognized in earnings. The new guidance alsorequires companies to report a consolidated net income (loss) measure thatincludes the amount attributable to such noncontrolling interests. We adoptedthis guidance on January 1, 2009, and it applies to noncontrollinginterests prospectively from that date. However, the presentation anddisclosure requirements of this guidance were applied retrospectively for allperiods presented. As a result of this adoption, we reclassified noncontrollinginterests in the amount of $15.6 million from total liabilities to equity inthe December 31, 2008 consolidated balance sheet; and net distributions tononcontrolling interests of $3.1 million from operating activities to financingactivities in the consolidated statement of cash flows for the nine-monthperiod ended September 30, 2008.

 

Fair Value

 

In2006, the FASB issued accounting guidance on fair value measurements thatprovides a common definition of fair value, establishes a market-basedframework or hierarchy for measuring fair value and expands disclosures aboutfair value measurements. This guidance is applicable whenever anotheraccounting pronouncement requires or permits assets and liabilities to bemeasured at fair value. In February 2008, the FASB issued additionalguidance that (1) deferred the effective date of the original guidance forone year for certain non-financial assets and liabilities; and (2) removedcertain leasing transactions from the scope of the original guidance. Weadopted this new guidance for financial assets and liabilities on January 1,2008, and for non-financial assets and liabilities on January 1, 2009. Theadoption of this guidance did not have a material impact on our consolidatedfinancial statements. See Note 14 for additional information.

 

In April 2009,the FASB issued accounting guidance that provides additional applicationguidance regarding fair value measurements. This guidance relates todetermining fair value when there is no active market or where the price inputsbeing used represent distressed sales. This new guidance reaffirms the need touse judgment to ascertain if a formerly active market has become inactive andin determining fair values when markets have become inactive. We adopted this guidanceeffective April 1, 2009. The adoption of the provisions of this guidancedid not have a material impact on our consolidated financial statements. SeeNote 14 for additional information.

 

In April 2009,the FASB issued guidance that establishes enhanced disclosures regarding fairvalue measurements. This guidance relates to fair value disclosures forfinancial instruments that are not currently reflected on the balance sheet atfair value. Prior to issuing this guidance, fair values for these assets andliabilities were disclosed only once a year. The new guidance requires thesedisclosures on a quarterly basis, providing qualitative and quantitativeinformation about fair value estimates for all those financial instruments notmeasured on the balance sheet at fair value.We adopted this guidance effective April 1, 2009.The adoption of the provisions of this guidance did not have a material impacton our consolidated financial statements. See Note 14 for additionalinformation.

 

Other

 

In May 2009, the FASB issued guidance that establishes the generalstandards of accounting for and disclosure of subsequent events. In addition,the guidance requires disclosure of the date through which an entity hasevaluated subsequent events and the basis for that date. This new accountingstandard was adopted for our financial statements for the quarterly periodended September 30, 2009. The adoption of this new guidance did not have amaterial impact on the Company’s consolidated financial statements. See Note 1for additional information.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

In April 2009,the FASB issued accounting guidance that is intended to bring consistency tothe timing of impairment recognition, and provide improved disclosures aboutthe credit and noncredit components of impaired debt securities that are notexpected to be sold. The measure of impairment that is credit-related isrecognized in earnings with the remaining amount recognized in comprehensiveincome. This guidance also requires increased and more-timely disclosuresregarding expected cash flows, credit losses, and an aging of securities withunrealized losses. We adopted this guidance effective April 1, 2009. Theadoption of the provisions of this guidance did not have a material impact onour consolidated financial statements.

 

In March 2008,the FASB issued accounting guidance that expands disclosures about derivativeinstruments and hedging activities. We adopted this new guidance on January 1,2009 and applied the new requirements on a prospective basis. Accordingly,disclosures related to interim periods prior to the date of adoption have notbeen presented. As this guidance relates to disclosures only, it had no impacton the Company’s financial condition or results of operations. See Note 19 foradditional information.

 

In November 2008, the FASB issued guidance that clarifies theaccounting for certain transactions and impairment considerations involvingequity-method investments. This guidance clarifies the following: (1) thecost basis of a new equity-method investment should be determined using acost-accumulation mode, which would continue the practice of includingtransaction costs in the cost of investment and would exclude the value ofcontingent consideration; and (2) equity-method investments shouldcontinue to be subject to other-than-temporary impairment analysis pursuant toexisting accounting guidance. This guidance also provides guidance on gainrecognition when a portion of the investor’s ownership is sold, how changes inclassification from equity-method to cost-method should be treated, and certainother issues. We adopted this new guidance on January 1, 2009 and appliedthe new requirements on a prospective basis. The adoption of this guidance didnot have a material impact on the Company’s consolidated financial statements.

 

**(3)  Recently IssuedAccounting Standards**

 

In August 2009,the FASB issued accounting guidance that clarifies existing guidance for thefair value measurement of liabilities. The new guidance provides clarificationthat in circumstances in which a quoted price in an active market for theidentical liability is not available, a reporting entity is required to measurefair value using one or more of the following techniques: a valuation techniquethat uses the quoted price of the identical liability when traded as an assetor a quoted price for a similar liability when traded as an asset, or anothervaluation method that is consistent with existing accounting guidance for fairvalue measurement principles. This new guidance also provides clarificationthat when estimating the fair value of a liability, a reporting entity is notrequired to include a separate input or adjustments to other inputs relating tothe existence of a restriction that prevents the transfer of the liability. Theeffective date for this guidance is the first reporting period beginning afterissuance. Accordingly, the Company will adopt the provisions of this guidancein the fourth quarter 2009. We do not expect the adoption of theprovisions of this guidance to have a material impact on the Company’sconsolidated financial statements.

 

In June 2009, the FASB issued accountingguidance on accounting for transfers of financial assets. This guidance amendsprevious guidance by including the following: the elimination of the qualifyingspecial-purpose entity (“QSPE”) concept; a new participating interestdefinition that must be met for transfers of portions of financial assets to beeligible for sale accounting; clarifications and changes to the de-recognitioncriteria for a transfer to be accounted for as a sale; and a change to theamount of recognized gain or loss on a transfer of financial assets accountedfor as a sale when beneficial interests are received by the transferor.Additionally, the new standard requires extensive new disclosures regarding anentity’s involvement in a transfer of financial assets. Finally, existing QSPEs(prior to the effective date of this new guidance) must be evaluated forconsolidation by reporting entities in accordance with the applicable consolidationguidance upon the elimination of this concept. This guidance is effective forfiscal years beginning after November 15, 2009. Accordingly, the Companywill adopt the provisions of the new guidance in the first quarter of 2010. Weare currently evaluating the impact this guidance will have on our consolidatedfinancial statements.

 

In June 2009, the FASB issued accountingguidance on the consolidation of variable interest entities (“VIEs”). This newguidance revises previous guidance by replacing the quantitative-based risks and rewards calculationfor determining which enterprise, if any, has a controlling financial interestin a VIE with a qualitative approach focused on identifying which enterprisehas both the power to direct the activities of the VIE that most significantlyimpacts the entity’s economic performance and has the obligation to absorblosses or the right to receive benefits that could be significant to theentity. In addition, this guidance requires reconsideration of whether anentity is a VIE when any changes in facts and circumstances occur such that theholders of the equity investment at risk, as a group, lose the power fromvoting rights or similar rights of those investments to direct the activitiesof the entity that most significantly impact the entity’s economicperformance. It also requires ongoing assessments of whether an enterpriseis the primary beneficiary of a VIE and additional disclosures about anenterprise’s involvement in variable interest entities. This guidance is effectivefor fiscal years beginning after November 15, 2009. Accordingly, theCompany will adopt the provisions of the new guidance in the first quarter of2010. We are currently evaluating the impact this guidancewill have on our consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(4)  Business Acquisitions**

 

The following is a summary of acquisitions completed by the Companyduring the nine-month period ended September 30, 2009 that were accountedfor as a purchase business combination or noncontrolling interest purchases:

 

*French Acquisition Partnerships*

 

In May 2009, the Company, through a majority-owned subsidiary(UBN), acquired additional ownership interests (ranging from 55.0% to 95.0%) insixteen French Acquisition Partnerships for $7.8 million in cash. As a resultof the transaction, the Company acquired a majority ownership interest (i.e.controlling financial interest) in each of the sixteen French entities —resulting in the entities becoming consolidated subsidiaries of the Company.Prior to this transaction, the Company, through a wholly-owned subsidiary,owned a direct equity-method investment in nine of the French entities (theaggregate carrying value of the Company’s equity-method investments in thesenine French entities approximated $0.5 million at the time of the transaction).In addition, prior to this transaction, the Company, through an equity-methodinvestee, owned an indirect equity-method investment in all of the Frenchentities.

 

The transaction was accounted for as a business combination, andaccordingly, the French entities’ assets (primarily non-performing loans) andliabilities and the noncontrolling interests were measured at fair value on theacquisition date and included in the Company’s consolidated balance sheet. Thefair value of the Portfolio Assets was measured using a discounted cash flowmodel, employing a 20% market discount rate, based on the projected future cashflows of the underlying loan portfolios. In management’s opinion, the marketdiscount rate used in the cash flow model reflects the rate of return a marketparticipant would consider for this type of loan investment. The amountsattributable to the French entities that were included in the Company’sconsolidated balance sheet on the acquisition date are as follows (inthousands):

 
| Cash                                                             |   | $      | 766    |   |
|------------------------------------------------------------------|--------|--------|--------|--------|
| Portfolio Assets                                                 |   | 12,912 |   |
| Other liabilities                                                |   | 766    |   |
| Noncontrolling interests (component of FirstCity’s  equity) |   | 3,080  |   |

 

In addition, pursuant to accounting provisions applicable to businesscombinations, the Company’s previously-held direct equity-method investments innine of the French entities were remeasured to fair value at the acquisitiondate. The fair value of the Company’s previously-held equity interests exceededthe aggregate carrying value of $0.5 million by approximately $1.5 million. Assuch, the Company recognized a $1.5 million gain attributable to theremeasurement of its previously-held equity interests on the acquisition date(presented as “Gain on step acquisition” on the face of the Company’sconsolidated statement of operations for the nine-month period ended September 30,2009).

 

*Acquisitions of Noncontrolling Interests*

 

In May 2009, the Company purchased noncontrolling interests in twomajority-owned subsidiaries (UBN and WAMCO 80) already included in the Company’sconsolidated financial statements. The Company paid $2.8 million in cash forthe purchased noncontrolling interests. On the respective acquisition dates,the Company’s carrying values of the purchased noncontrolling interestsapproximated $3.6 million. Under accounting provisions applicable tononcontrolling interest transactions, the Company accounted for the purchasednoncontrolling interests as equity transactions, and recognized the $0.8million difference between the purchase prices and the carrying values of thenoncontrolling interests acquired as an increase to the Company’s consolidatedpaid-in capital.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(5)  Portfolio Assets**

 

Portfolio Assets are summarizedas follows:

 
| ** **                       | ** ** | **September 30, 2009** | ** ** |
|----------------------------------|------------|-----------------------------|------------|
| ** **                       | ** ** | **(Dollars in thousands)**  | ** ** |
| ** **                       | ** ** | **Outstanding**             | ** ** | **Allowance for** | ** ** | **Outstanding** | ** ** |
| ** **                       | ** ** | **Balance**                 | ** ** | **Loan Losses** | ** ** | **Balance, net** | ** ** |
| Loan Portfolios:                 |       |                        |       |   |   |   |   |
| Loans Acquired Prior to  2005:   |       |                        |       |   |   |   |   |
| Non-performing Portfolio  Assets |       | $                           | 2,991      |   | $ | 52 |   | $ | 2,939 |   |
| Performing Portfolio Assets      |       | 417                         |       | 197 |   | 220 |   |
| Loans Acquired After 2004:       |       |                        |       |   |   |   |   |
| With credit deterioration        |       | 215,779                     |       | 5,813 |   | 209,966 |   |
| With no credit  deterioration    |       | 2,023                       |       | 22 |   | 2,001 |   |
| UBN (1):                         |       |                        |       |   |   |   |   |
| Non-performing loans             |       | 58,482                      |       | 56,204 |   | 2,278 |   |
| Performing loans                 |       | 1,421                       |       | — |   | 1,421 |   |
| Other                            |       | 1,300                       |       | — |   | 1,300 |   |
| Total                            |       | $                           | 282,413    |   | $ | 62,288 |   | $ | 220,125 |   |

 
| ** **                       | ** ** | **December 31, 2008** | ** ** |
|----------------------------------|------------|----------------------------|------------|
| ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| ** **                       | ** ** | **Outstanding**            | ** ** | **Allowance for** | ** ** | **Outstanding** | ** ** |
| ** **                       | ** ** | **Balance**                | ** ** | **Loan Losses** | ** ** | **Balance, net** | ** ** |
| Loan Portfolios:                 |       |                       |       |   |   |   |   |
| Loans Acquired Prior to  2005:   |       |                       |       |   |   |   |   |
| Non-performing Portfolio  Assets |       | $                          | 3,410      |   | $ | 74 |   | $ | 3,336 |   |
| Performing Portfolio Assets      |       | 833                        |       | 192 |   | 641 |   |
| Loans Acquired After 2004:       |       |                       |       |   |   |   |   |
| With credit deterioration        |       | 125,108                    |       | 13,909 |   | 111,199 |   |
| With no credit  deterioration    |       | 2,757                      |       | 40 |   | 2,717 |   |
| UBN (1):                         |       |                       |       |   |   |   |   |
| Non-performing loans             |       | 62,208                     |       | 62,150 |   | 58 |   |
| Performing loans                 |       | 1,705                      |       | — |   | 1,705 |   |
| Other                            |       | 1,481                      |       | — |   | 1,481 |   |
| Total                            |       | $                          | 197,502    |   | $ | 76,365 |   | $ | 121,137 |   |

 
| ** **                                | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **                                | ** ** | **(Dollars in thousands)** | ** ** |
| Real Estate Portfolios:                   | ** ** | ** **                 | ** ** | ** **            | ** ** |
| Real estate held for sale                 |       | $                          | 16,639     |                  | $          | 17,484 |   |
| Real estate held for  investment, net (2) |       | 9,514                      |       | 9,592                 |       |
| Total                                     |       | $                          | 26,153     |                  | $          | 27,076 |   |

 

----

(1)   Represents a loan portfolio that wasadded to FirstCity’s consolidated balance sheet in September 2008 inconnection with its step-acquisition of UBN (former equity-method investee).See Note 1.

 

(2)   Includes lease-related intangible balances(net) of approximately $0.9 million and $1.0 million at September 30, 2009and December 31, 2008, respectively.

 

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 theconsolidated financial statements included in the Company’s 2008 Form 10-Kfor a description of this revolving credit agreement. In addition, certainPortfolio Assets are pledged to secure notes payable of certain consolidatedaffiliates of FirstCity that are generally non-recourse to FirstCity or anyaffiliate other than the acquiring entity that incurred the debt.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

Income from Portfolio Assets issummarized as follows:

 
| ** **                       | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                       | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| Loan Portfolios:                 |       |                       |       |                   |       |   |   |   |   |
| Loans Acquired Prior to  2005:   |       |                       |       |                   |       |   |   |   |   |
| Non-performing Portfolio  Assets |       | $                          | 35         |                   | $          | 93 |   | $ | 126 |   | $ | 348 |   |
| Performing Portfolio Assets      |       | 18                         |       | 55                     |       | 276 |   | 198 |   |
| Loans Acquired After 2004:       | ** ** | ** **                 | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| With credit deterioration        |       | 10,626                     |       | 4,454                  |       | 32,879 |   | 12,920 |   |
| With no credit  deterioration    |       | 59                         |       | 116                    |       | 232 |   | 325 |   |
| UBN                              |       | 260                        |       | 128                    |       | 535 |   | 128 |   |
| Other                            |       | 38                         |       | 54                     |       | 118 |   | 162 |   |
| Real Estate Portfolios           |       | 1,098                      |       | 329                    |       | 1,088 |   | 1,705 |   |
| Income from Portfolio  Assets    |       | $                          | 12,134     |                   | $          | 5,229 |   | $ | 35,254 |   | $ | 15,786 |   |

 

The Companyrecorded a provision for loan and impairment losses on Portfolio Assets ofapproximately $0.8 million for the nine month period ended September 30,2009 — which is comprised of a $0.6 million impairment charge on real estateportfolios and a $0.2 million provision for loan losses, net of recoveries. Forthe nine month period ended September 30, 2008, the Company recorded aprovision for loan and impairment losses on Portfolio Assets of $11.0 million —which is comprised of a $1.0 million impairment charge on real estateportfolios and a $10.0 million provision for loan losses.

 

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

 
| ** **                            | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                            | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                            | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                            | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                     |       | $                          | (69,082    | )                      | $          | (10,454 | ) | $ | (76,365 | ) | $ | (1,723 | ) |
| Provisions                            |       | (2,958                     | )          | (1,413                 | )          | (3,618 | ) | (10,567 | ) |
| Recoveries                            |       | 3,023                      |       | 341                    |       | 3,405 |   | 603 |   |
| Charge-offs                           |       | 7,372                      |       | —                 |       | 15,019 |   | 162 |   |
| Increase due to UBN step  acquisition |       | —                     |       | (65,557                | )          | — |   | (65,557 | ) |
| Translation adjustments               |       | (643                       | )          | (1                     | )          | (729 | ) | (2 | ) |
| Ending Balance                        |       | $                          | (62,288    | )                      | $          | (77,084 | ) | $ | (62,288 | ) | $ | (77,084 | ) |

 

Accretable yieldrepresents the amount of income the Company can expect to generate over theremaining life of its existing loans acquired after 2004 with evidence ofcredit deterioration based on estimated future cash flows. Reclassificationsfrom nonaccretable difference to accretable yield primarily result from theCompany’s increase in its estimates of future cash flows. Reclassifications to nonaccretable differencefrom accretable yield primarily results from the Company’s decrease in itsestimates of future cash flows. Changes in accretable yield for loansacquired after 2004 with evidence of credit deterioration are as follows:

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 
| ** **                                           | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                           | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                                           | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                           | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                                    |       | $                          | 52,936     |                   | $          | 55,184 |   | $ | 58,114 |   | $ | 35,951 |   |
| Additions                                            |       | —                     |       | (4,692                 | )          | 23,077 |   | 15,521 |   |
| Accretion                                            |       | (3,769                     | )          | (3,824                 | )          | (14,229 | ) | (10,558 | ) |
| Reclassification from (to)  nonaccretable difference |       | 656                        |       | (1,652                 | )          | 2,115 |   | 5,905 |   |
| Disposals                                            |       | (2,353                     | )          | (629                   | )          | (8,545 | ) | (2,361 | ) |
| Transfer to non-accrual                              |       | (25,127                    | )          | (416                   | )          | (38,412 | ) | (1,135 | ) |
| Translation adjustments                              |       | (90                        | )          | 58                     |       | 133 |   | 706 |   |
| Ending Balance                                       |       | $                          | 22,253     |                   | $          | 44,029 |   | $ | 22,253 |   | $ | 44,029 |   |

 

For the three- and nine-month periods ended September 30, 2008,the Company adjusted the accretable yield schedules on certain loans to reflectthe residual excess of the expected future cash flows over their carryingvalues. These adjustments to the underlying accretable yield schedules did notimpact the Company’s consolidated financial condition or results of operations.

 

Loans acquired during each period for which it wasprobable at acquisition that all contractually required payments would not becollected are as follows:

 
| ** **                                                              | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                                              | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                                                              | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                              | ** ** | **(Dollars in thousands)** | ** ** |
| Face value at acquisition                                               |       | $                          | 53,358     |                   | $          | 10,784 |   | $ | 306,188 |   | $ | 85,539 |   |
| Cash flows expected to be  collected at acquisition, net of adjustments |       | 70,252                     |       | (2,092                 | )          | 234,680 |   | 61,193 |   |
| Basis in acquired loans at  acquisition                                 |       | 36,932                     |       | 2,600                  |       | 171,620 |   | 45,672 |   |
|                                                                         |            |                            |            |                        |            |  |  |  |  |  |  |  |  |

 

**(6)  Loans Receivable**

 

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

 
| ** **                                                            | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                                            | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **                                                            | ** ** | **(Dollars in thousands)** | ** ** |
| Domestic:                                                             |       |                       |       |                  |       |
| Commercial and industrial:                                            |       |                       |       |                  |       |
| Affiliates                                                            |       | $                          | 17,485     |                  | $          | 12,794 |   |
| SBA, net of allowance for  loan losses of $441 and $34, respectively  |       | 17,245                     |       | 19,306                |       |
| Other, net of allowance for  loan losses of $0 and $581, respectively |       | 1,702                      |       | 2,732                 |       |
| Real estate:                                                          |       |                       |       |                  |       |
| Other                                                                 |       | 9,181                      |       | 10,801                |       |
|                                                                  |       |                       |       |                  |       |
| Foreign - commercial and  industrial:                                 |       |                       |       |                  |       |
| Affiliates                                                            |       | 13,726                     |       | 14,286                |       |
|                                                                  |       |                       |       |                  |       |
| Total loans                                                           |       | $                          | 59,339     |                  | $          | 59,919 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

***Loansreceivable — affiliates***

 

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

 
| ** **                     | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** ** |
| Outstanding balance            |       | $                          | 29,865     |                  | $          | 25,747 |   |
| Discounts, net                 |       | (259                       | )          | —                |       |
| Capitalized interest           |       | 1,605                      |       | 1,333                 |       |
| Carrying amount of loans,  net |       | $                          | 31,211     |                  | $          | 27,080 |   |

 

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

 
| ** **                       | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                       | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                |       | $                          | 29,746     |                   | $          | 18,980 |   | $ | 27,080 |   | $ | 5,447 |   |
| Advances                         |       | 3,486                      |       | 8,710                  |       | 8,638 |   | 22,210 |   |
| Payments received                |       | (2,334                     | )          | (1,941                 | )          | (4,944 | ) | (2,455 | ) |
| Capitalized interest             |       | 103                        |       | 581                    |       | 272 |   | 772 |   |
| Discount accretion, net          |       | 15                         |       | —                 |       | 15 |   | — |   |
| Other noncash adjustments        |       | —                     |       | (163                   | )          | — |   | (163 | ) |
| Foreign exchange gains  (losses) |       | 195                        |       | (434                   | )          | 150 |   | (78 | ) |
| Ending Balance                   |       | $                          | 31,211     |                   | $          | 25,733 |   | $ | 31,211 |   | $ | 25,733 |   |

 

Loans receivable — affiliates represent advances to AcquisitionPartnerships and other affiliated entities to acquire portfolios of performingand non-performing commercial and consumer loans and other assets; and seniordebt financing arrangements with equity-method investees to provide capital forbusiness expansion and operations. The loans are reported at their outstandingprincipal balances adjusted for unaccreted discounts, unamortized net loanfees, and the allowance for loan losses. Interest is accrued when earned and,if applicable, capitalized as part of loan principal in accordance with thecontractual terms of the loans. Interest is recognized on an accrual basis atthe applicable interest rate on the principal amount outstanding. Loanorigination fees and direct costs are generally amortized as level-yieldadjustments over the respective loan terms. Unamortized net fees or costs arerecognized upon early repayment of the loans. 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; whereas advances to affiliates for business expansionand working capital purposes are generally secured by business assets (i.e.accounts, inventory and equipment).

 

Managementevaluates the need for impairment based upon the performance of the loans andvarious other factors. We consider a loan to be impaired when, based on currentinformation and events, we determine that we will not be able to collect allamounts due according to the loan’s contractual terms (including scheduledinterest payments). When management identifies a loan as impaired, we measurethe impairment based on the present value of expected future cash flows, exceptwhen the source of repayment is the operation or liquidation of the collateral.In these cases, we use the current fair value of the collateral, less estimatedselling costs when foreclosure is probable, instead of discounted cash flows.The results of management’s evaluations indicated that projected cash flows andunderlying collateral are sufficient to repay the loans and no allowances forimpairment are necessary. The Company recorded no provisions for impairment onloans receivable — affiliates for the nine months ended September 30, 2009and 2008.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

***Loans receivable — SBA held for sale***

 

Loans receivable — SBA held for sale are summarized asfollows:

 
| ** **                     | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** ** |
| Outstanding balance            |       | $                          | 1,582      |                  | $          | 4,840 |   |
| Capitalized costs              |       | 1                          |       | 61                    |       |
| Carrying amount of loans,  net |       | $                          | 1,583      |                  | $          | 4,901 |   |

 

Changes in loans receivable — SBA held for sale are asfollows:

 
| ** **                          | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                          | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                          | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                   |       | $                          | 3,492      |                   | $          | 2,219 |   | $ | 4,901 |   | $ | 133 |   |
| Originations and advances  of loans |       | 2,115                      |       | 3,167                  |       | 13,715 |   | 8,009 |   |
| Payments received                   |       | (61                        | )          | (40                    | )          | (224 | ) | (71 | ) |
| Capitalized costs                   |       | (43                        | )          | 4                      |       | (61 | ) | 30 |   |
| Loans sold                          |       | (3,920                     | )          | (2,157                 | )          | (16,748 | ) | (4,908 | ) |
| Ending Balance                      |       | $                          | 1,583      |                   | $          | 3,193 |   | $ | 1,583 |   | $ | 3,193 |   |

 

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 forsale represent the portions of the loans that are guaranteed by the SBA, andare reflected at the lower of aggregate cost or estimated fair value. Netunrealized losses, if any, are recognized through a valuation allowance bycharges to income. The carrying value of SBA loans held for sale is net ofpremiums as well as deferred origination fees and costs. Premiums and netorigination fees and costs are deferred and included in the basis of the loansin calculating gains and losses upon sale. SBA loans are generally secured bythe borrowing entities’ assets such as accounts, property and equipment, andother assets. The Company sells the guaranteed portion of each loan to a thirdparty and retains the servicing rights. The difference between the proceedsreceived and the allocated carrying value of the loans sold are recognized asnet gains on sales of loans. The non-guaranteed portion is generally held inthe portfolio and classified as held for investment. The Company recorded nowrite-downs of SBA loans held for sale below their cost for the nine monthsended September 30, 2009 and 2008.

 

***Loans receivable — SBA held for investment, net***

 

Loans receivable — SBA held for investment aresummarized as follows:

 
| ** **                     | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** ** |
| Outstanding balance            |       | $                          | 17,262     |                  | $          | 15,509 |   |
| Allowance for loan losses      |       | (441                       | )          | (34                   | )          |
| Discounts, net                 |       | (1,255                     | )          | (1,120                | )          |
| Capitalized costs              |       | 96                         |       | 50                    |       |
| Carrying amount of loans,  net |       | $                          | 15,662     |                  | $          | 14,405 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

Changes in loans receivable — SBA held for investment areas follows:

 
| ** **                          | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                          | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                          | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                   |       | $                          | 16,203     |                   | $          | 13,692 |   | $ | 14,405 |   | $ | 14,234 |   |
| Originations and advances  of loans |       | 288                        |       | 1,056                  |       | 3,055 |   | 2,660 |   |
| Payments received                   |       | (484                       | )          | (464                   | )          | (1,277 | ) | (2,535 | ) |
| Capitalized costs                   |       | 3                          |       | 9                      |       | 46 |   | 36 |   |
| Provision for SBA loan  losses, net |       | (329                       | )          | 208                    |       | (407 | ) | 126 |   |
| Discount accretion, net             |       | 6                          |       | 21                     |       | (135 | ) | 166 |   |
| Charge-offs                         |       | (25                        | )          | (228                   | )          | (25 | ) | (393 | ) |
| Ending Balance                      |       | $                          | 15,662     |                   | $          | 14,294 |   | $ | 15,662 |   | $ | 14,294 |   |

 

Loans receivable —SBA held for investment represent SBA loans acquired by the Company in February 2007and SBA loan originations and advances made since such time. SBA loans held forinvestment are reported at their outstanding principal balances adjusted forunearned discounts, net deferred loan origination costs and the allowance forloan losses. Interest is recognized on an accrual basis at the applicableinterest rate on the principal amount outstanding. Loan origination fees anddirect costs as well as premiums and discounts are generally amortized as levelyield adjustments over the respective loan terms. Unamortized net fees or costsare recognized upon early repayment of the loans. SBA loans held for investmentare generally secured by the borrowing entities’ assets such as accounts,property and equipment, and other assets.

 

Managementevaluates the need for impairment based upon the performance of the loans andother portfolio characteristics, such as industry concentrations and loancollateral, which also impacts management’s estimates of the impairment.Impairment is evaluated by analyzing the expected future cash flows from theborrowing entity (discounted for the loans’ risk-adjusted rates), and thevalues of the underlying collateral, to determine whether the Company expectsto ultimately collect all contractual principal and interest. The adequacy ofthe allowance for loan losses is reviewed by management on a regular basis andadjustments, if necessary, are reflected in operations during the periods inwhich they become known. Considerations in this evaluation include past andcurrent loss experience, risks inherent in the current portfolio, andevaluation of commercial and real estate collateral as well as current economicconditions.

 

Changes in the allowance for loan losses related toloans receivable — SBA held for investment are as follows:

 
| ** **        | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|-------------------|------------|----------------------------|------------|------------------------|------------|
| ** **        | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **        | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **        | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance |       | $                          | (112       | )                      | $          | (233 | ) | $ | (34 | ) | $ | (151 | ) |
| Provisions        |       | (364                       | )          | (7                     | )          | (461 | ) | (243 | ) |
| Recoveries        |       | 12                         |       | 2                      |       | 31 |   | 4 |   |
| Charge-offs       |       | 23                         |       | 213                    |       | 23 |   | 365 |   |
| Ending Balance    |       | $                          | (441       | )                      | $          | (25 | ) | $ | (441 | ) | $ | (25 | ) |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

***Loansreceivable — other***

 

Loans receivable — other, which are designated bymanagement as held for investment, are summarized as follows:

 
| ** **                      | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)** | ** ** |
| Outstanding balance             |       | $                          | 10,643     |                  | $          | 13,929 |   |
| Allowance for loan losses       |       | —                     |       | (581                  | )          |
| Discounts, net                  |       | (9                         | )          | (20                   | )          |
| Capitalized interest and  costs |       | 249                        |       | 205                   |       |
| Carrying amount of loans,  net  |       | $                          | 10,883     |                  | $          | 13,533 |   |

 

Changes in loans receivable — other are as follows:

 
| ** **                       | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                       | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                       | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                       | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                |       | $                          | 11,698     |                   | $          | 16,492 |   | $ | 13,533 |   | $ | 5,995 |   |
| Advances                         |       | 1,737                      |       | 528                    |       | 5,105 |   | 11,000 |   |
| Payments received                |       | (2,554                     | )          | (2,337                 | )          | (6,853 | ) | (2,418 | ) |
| Capitalized interest and  costs  |       | —                     |       | (355                   | )          | 44 |   | (262 | ) |
| Provision for loan  impairment   |       | 1,548                      |       | —                 |       | 581 |   | — |   |
| Discount accretion, net          |       | 2                          |       | (14                    | )          | 11 |   | 10 |   |
| Charge-offs                      |       | (1,548                     | )          | —                 |       | (1,548 | ) | — |   |
| Foreign exchange gains  (losses) |       | —                     |       | (7                     | )          | 10 |   | (18 | ) |
| Ending Balance                   |       | $                          | 10,883     |                   | $          | 14,307 |   | $ | 10,883 |   | $ | 14,307 |   |

 

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. Loan origination fees and direct costs aregenerally amortized as level-yield adjustments over the respective loan terms.Unamortized net fees or costs are recognized upon early repayment of the loans.

 

Management evaluates the need for impairment based upon the performanceof the loans and various other factors. We consider a loan to be impaired when,based on current information and events, we determine that we will not be ableto collect all amounts due according to the loan’s contractual terms (includingscheduled interest payments). When management identifies a loan as impaired, wemeasure the impairment based on the present value of expected future cashflows, except when the source of repayment is the operation or liquidation ofthe collateral. In these cases, we use the current fair value of thecollateral, less estimated selling costs when foreclosure is probable, insteadof discounted cash flows. The Company recorded impairment provisions on loans receivable— other of approximately $1.0 million for the nine-month period ended September 30,2009. The Company recorded no provisions for impairment for the nine-monthperiod ended September 30, 2008.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

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

 
| ** **        | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|-------------------|------------|----------------------------|------------|------------------------|------------|
| ** **        | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **        | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **        | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance |       | $                          | (1,548     | )                      | $          | — |   | $ | (581 | ) | $ | — |   |
| Provisions        |       | —                     |       | —                 |       | (967 | ) | — |   |
| Charge-offs       |       | 1,548                      |       | —                 |       | 1,548 |   | — |   |
| Ending Balance    |       | $                          | —     |                   | $          | — |   | $ | — |   | $ | — |   |

 

At September 30, 2009, the Company’s recorded investment inimpaired and non-accrual loans receivable — other totaled $9.9 million. Theaverage recorded investment in these impaired and non-accrual loansapproximated $10.0 million and $4.3 million for the three-month and nine-monthperiods ended September 30, 2009, respectively. At September 30,2009, there were no valuation allowances specifically related to these loans.

 

**(7)  Equity Investments**

 

The Company has investments in Acquisition Partnerships, and investments in servicing and operatingentities, that are accounted for under the equity method of accounting.The condensed combined financial position and results of operations of theAcquisition Partnerships (which include the domestic and foreign AcquisitionPartnerships and their general partners), and the servicing and operatingentities are summarized as follows:

 

**Condensed Combined Balance Sheets**

 
| ** **                                             | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                             | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **                                             | ** ** | **(Dollars in thousands)** | ** ** |
| **Acquisition  Partnerships:**                         | ** ** | ** **                 | ** ** | ** **            | ** ** |
| Assets                                                 |       | $                          | 286,390    |                  | $          | 297,805 |   |
| Liabilities                                            |       | $                          | 94,575     |                  | $          | 92,654 |   |
| Net equity                                             |       | 191,815                    |       | 205,151               |       |
|                                                   |       | $                          | 286,390    |                  | $          | 297,805 |   |
| **Servicing  and operating entities:**                 |       |                       |       |                  |       |
| Assets                                                 |       | $                          | 149,634    |                  | $          | 126,136 |   |
| Liabilities                                            |       | $                          | 92,480     |                  | $          | 77,182 |   |
| Net equity                                             |       | 57,154                     |       | 48,954                |       |
|                                                   |       | $                          | 149,634    |                  | $          | 126,136 |   |
| **Total:**                                             | ** ** | ** **                 | ** ** | ** **            | ** ** |
| Assets                                                 |       | $                          | 436,024    |                  | $          | 423,941 |   |
| Liabilities                                            |       | $                          | 187,055    |                  | $          | 169,836 |   |
| Net equity                                             |       | 248,969                    |       | 254,105               |       |
|                                                   |       | $                          | 436,024    |                  | $          | 423,941 |   |
|                                                   |       |                       |       |                  |       |
| Equity investment in Acquisition  Partnerships         |       | $                          | 42,694     |                  | $          | 46,084 |   |
| Equity investment in  servicing and operating entities |       | 30,342                     |       | 26,903                |       |
|                                                   |       | $                          | 73,036     |                  | $          | 72,987 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**Condensed Combined Summary of Operations**

 
| ** **                                              | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                              | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                                              | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                              | ** ** | **(Dollars in thousands)** | ** ** |
| **Acquisition  Partnerships:**                          | ** ** | ** **                 | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income from Portfolio  Assets                           |       | $                          | 7,051      |                   | $          | 23,794 |   | $ | 28,326 |   | $ | 74,866 |   |
| Other income                                            |       | 140                        |       | (275                   | )          | 367 |   | 819 |   |
| Revenues                                                |       | 7,191                      |       | 23,519                 |       | 28,693 |   | 75,685 |   |
| Interest expense                                        |       | 1,109                      |       | 1,737                  |       | 3,735 |   | 8,950 |   |
| Service fees                                            |       | 2,581                      |       | 6,657                  |       | 8,514 |   | 19,819 |   |
| Provision for loan and  impairment losses               |       | 3,621                      |       | 3,059                  |       | 9,513 |   | 11,805 |   |
| Asset-level expenses                                    |       | 1,507                      |       | 3,848                  |       | 5,197 |   | 9,329 |   |
| Other operating costs                                   |       | 1,040                      |       | 2,941                  |       | 3,223 |   | 8,878 |   |
| Foreign currency gains                                  |       | 673                        |       | (3,081                 | )          | (2,079 | ) | (11,461 | ) |
| Income tax expense  (benefit) and other taxes           |       | (55                        | )          | (101                   | )          | (219 | ) | 1,636 |   |
| Expenses                                                |       | 10,476                     |       | 15,060                 |       | 27,884 |   | 48,956 |   |
| Equity in earnings (loss)  of investments               |       | —                     |       | (69                    | )          | — |   | 1,567 |   |
| Net earnings (loss)                                     |       | $                          | (3,285     | )                      | $          | 8,390 |   | $ | 809 |   | $ | 28,296 |   |
|                                                    |       |                       |       |                   |       |   |   |   |   |
| **Servicing  and operating entities:**                  |       |                       |       |                   |       |   |   |   |   |
| Income from Portfolio  Assets                           |       | $                          | 6,797      |                   | $          | 3,306 |   | $ | 19,131 |   | $ | 21,942 |   |
| Servicing fees                                          |       | 4,548                      |       | 8,554                  |       | 15,054 |   | 25,285 |   |
| Other income, net                                       |       | 10,544                     |       | 11,226                 |       | 24,575 |   | 15,889 |   |
| Total revenues                                          |       | 21,889                     |       | 23,086                 |       | 58,760 |   | 63,116 |   |
| Expenses                                                |       | 19,117                     |       | 22,090                 |       | 56,701 |   | 55,681 |   |
| Net earnings                                            |       | $                          | 2,772      |                   | $          | 996 |   | $ | 2,059 |   | $ | 7,435 |   |
|                                                    |       |                       |       |                   |       |   |   |   |   |
| Equity in earnings (loss)  of Acquisition Partnerships  |       | $                          | (797       | )                      | $          | 1,582 |   | $ | 445 |   | $ | 6,920 |   |
| Equity in earnings of  servicing and operating entities |       | 1,218                      |       | 588                    |       | 1,028 |   | 1,098 |   |
|                                                    |       | $                          | 421        |                   | $          | 2,170 |   | $ | 1,473 |   | $ | 8,018 |   |

 

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

 

The combinedassets and equity of the underlying Acquisition Partnerships and the servicingand operating entities, and the Company’s equity investments in those entities,are summarized by geographic region below.

 
| ** **               | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** |
|--------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **               | ** ** | **(Dollars in thousands)** | ** ** |
| Assets:                  |       |                       |       |                  |       |
| Domestic:                |       |                       |       |                  |       |
| Acquisition Partnerships |       | $                          | 61,946     |                  | $          | 62,249 |   |
| Operating entities       |       | 34,296                     |       | 19,787                |       |
| Latin America:           |       |                       |       |                  |       |
| Acquisition Partnerships |       | 141,683                    |       | 142,340               |       |
| Servicing entities       |       | 13,486                     |       | 14,122                |       |
| Europe:                  |       |                       |       |                  |       |
| Acquisition Partnerships |       | 82,761                     |       | 93,216                |       |
| Servicing entities       |       | 101,852                    |       | 92,227                |       |
|                     |       | $                          | 436,024    |                  | $          | 423,941 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 
| ** **                                                                            | ** ** | **September 30,**     | ** **    | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------|---------------|-----------------------|------------|
| ** **                                                                            | ** ** | **2009**                   | ** **    | **2008**              | ** ** |
| ** **                                                                            | ** ** | **(Dollars in thousands)** | ** **    |
| Equity:                                                                               |       |                       |          |                  |       |
| Domestic:                                                                             |       |                       |          |                  |       |
| Acquisition Partnerships                                                              |       | $                          | 36,887        |                  | $          | 29,614 |   |
| Operating entities                                                                    |       | 6,343                      |          | 3,710                 |       |
| Latin America:                                                                        |       |                       |          |                  |       |
| Acquisition Partnerships                                                              |       | 119,935                    |          | 128,416               |       |
| Servicing entities                                                                    |       | 1,062                      |          | 1,970                 |       |
| Europe:                                                                               |       |                       |          |                  |       |
| Acquisition Partnerships                                                              |       | 34,993                     |          | 47,121                |       |
| Servicing entities                                                                    |       | 49,749                     |          | 43,274                |       |
|                                                                                  |       | $                          |  248,969 |                  | $          | 254,105 |   |
|                                                                                  |       |                       |          |                  |       |
| Equity investment in  Acquisition Partnerships, and Servicing and Operating entities: |       |                       |          |                  |       |
| Domestic:                                                                             |       |                       |          |                  |       |
| Acquisition Partnerships                                                              |       | $                          | 13,750        |                  | $          | 14,542 |   |
| Operating entities                                                                    |       | 2,321                      |          | 953                   |       |
| Latin America:                                                                        |       |                       |          |                  |       |
| Acquisition Partnerships                                                              |       | 17,760                     |          | 18,657                |       |
| Servicing entities                                                                    |       | 2,758                      |          | 2,876                 |       |
| Europe:                                                                               |       |                       |          |                  |       |
| Acquisition Partnerships                                                              |       | 11,184                     |          | 12,885                |       |
| Servicing entities                                                                    |       | 25,263                     |          | 23,074                |       |
|                                                                                  |       | $                          | 73,036        |                  | $          | 72,987 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

Revenues and earnings (losses) of the underlyingAcquisition Partnerships and the servicing and operating entities, and theCompany’s share of equity in earnings (losses) of those entities, aresummarized by geographic region below.

 
| ** **                                                                                    | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                                                                    | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                                                                                    | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                                    | ** ** | **(Dollars in thousands)** | ** ** |
| Revenues:                                                                                     |       |                       |       |                   |       |   |   |   |   |
| Domestic:                                                                                     |       |                       |       |                   |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | $                          | 1,087      |                   | $          | 2,573 |   | $ | 5,693 |   | $ | 8,920 |   |
| Operating entities                                                                            |       | 10,108                     |       | 9,757                  |       | 23,301 |   | 11,921 |   |
| Latin America:                                                                                |       |                       |       |                   |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | 3,805                      |       | 8,769                  |       | 9,242 |   | 32,495 |   |
| Servicing entities                                                                            |       | 2,427                      |       | 5,207                  |       | 7,751 |   | 15,656 |   |
| Europe:                                                                                       |       |                       |       |                   |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | 2,299                      |       | 12,177                 |       | 13,758 |   | 34,270 |   |
| Servicing entities                                                                            |       | 9,354                      |       | 8,122                  |       | 27,708 |   | 35,539 |   |
| ** **                                                                                    |       | $                          | 29,080     |                   | $          | 46,605 |   | $ | 87,453 |   | $ | 138,801 |   |
|                                                                                          |       |                       |       |                   |       |   |   |   |   |
| Net earnings (loss):                                                                          |       |                       |       |                   |       |   |   |   |   |
| Domestic:                                                                                     |       |                       |       |                   |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | $                          | (277       | )                      | $          | (535 | ) | $ | 1,137 |   | $ | (292 | ) |
| Operating entities                                                                            |       | 3,322                      |       | 2,357                  |       | 3,340 |   | 1,457 |   |
| Latin America:                                                                                |       |                       |       |                   |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | (2,015                     | )          | 2,485                  |       | (3,044 | ) | 8,475 |   |
| Servicing entities                                                                            |       | (439                       | )          | (177                   | )          | (1,374 | ) | (246 | ) |
| Europe:                                                                                       |       |                       |       |                   |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | (993                       | )          | 6,440                  |       | 2,716 |   | 20,113 |   |
| Servicing entities                                                                            |       | (111                       | )          | (1,184                 | )          | 93 |   | 6,224 |   |
|                                                                                          |       | $                          | (513       | )                      | $          | 9,386 |   | $ | 2,868 |   | $ | 35,731 |   |
| Equity in earnings (loss)  of Acquisition Partnerships, and Servicing and Operating entities: |       |                       |       |                   |       |   |   |   |   |
| Domestic:                                                                                     |       |                       |       |                   |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | $                          | (300       | )                      | $          | (448 | ) | $ | 216 |   | $ | (294 | ) |
| Operating entities                                                                            |       | 1,464                      |       | 932                    |       | 1,661 |   | 576 |   |
| Latin America:                                                                                |       |                       |       |                   |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | (207                       | )          | 405                    |       | (460 | ) | 1,509 |   |
| Servicing entities                                                                            |       | (220                       | )          | (183                   | )          | (687 | ) | (127 | ) |
| Europe:                                                                                       |       |                       |       |                   |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | (290                       | )          | 1,625                  |       | 689 |   | 5,705 |   |
| Servicing entities                                                                            |       | (26                        | )          | (161                   | )          | 54 |   | 649 |   |
|                                                                                          |       | $                          | 421        |                   | $          | 2,170 |   | $ | 1,473 |   | $ | 8,018 |   |

 

At September 30,2009, the Company had $27.1 million in Euro-denominated debt that wasdesignated as a hedge to partially off-set the Company’s business exposure toforeign currency exchange risk attributable to our net equity investments inEurope. Refer to Note 19 for additionalinformation.

 

**(8)  Servicing Assets — SBALoans**

 

Servicing rights purchased or resulting from the sale of loans areinitially recognized at fair value at the date of acquisition or transfer.Subsequent to the date of purchase or sale, the Company elected to measure thecarrying value of the servicing assets by using the amortization method — whichamortizes the servicing assets in proportion to and over the period ofestimated net servicing income, and evaluates servicing assets for impairmentbased on fair value at each reporting date. The Company evaluates the possibleimpairment of servicing assets based on the difference between the carryingamount and current fair value of the servicing assets. Impairment is charged toservicing fees in the period recognized.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

Changes in the Company’s amortized servicing assets areas follows:

 
| ** **                                   | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                   | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                                   | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                            |       | $                          | 1,001      |                   | $          | 841 |   | $ | 785 |   | $ | 885 |   |
| Servicing Assets  capitalized                |       | 97                         |       | 40                     |       | 409 |   | 94 |   |
| Servicing Assets amortized                   |       | (59                        | )          | (49                    | )          | (155 | ) | (147 | ) |
| Ending Balance                               |       | $                          | 1,039      |                   | $          | 832 |   | $ | 1,039 |   | $ | 832 |   |
| ** **                                   | ** ** | ** **                 | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Reserve for impairment of  servicing assets: | ** ** | ** **                 | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Beginning Balance                            |       | $                          | (27        | )                      | $          | (92 | ) | $ | (63 | ) | $ | (42 | ) |
| Impairments                                  |       | (27                        | )          | (10                    | )          | (43 | ) | (79 | ) |
| Recoveries                                   |       | —                     |       | 22                     |       | 52 |   | 41 |   |
| Charge-offs                                  |       | —                     |       | —                 |       | — |   | — |   |
| Ending Balance                               |       | $                          | (54        | )                      | $          | (80 | ) | $ | (54 | ) | $ | (80 | ) |
|                                         |       |                       |       |                   |       |   |   |   |   |
| Ending Balance (net of  reserve)             |       | $                          | 985        |                   | $          | 752 |   | $ | 985 |   | $ | 752 |   |
| ** **                                   | ** ** | ** **                 | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fair value of amortized  servicing assets:   |       |                       |       |                   |       |   |   |   |   |
| Beginning balance                            |       | $                          | 974        |                   | $          | 749 |   | $ | 722 |   | $ | 843 |   |
| Ending balance                               |       | $                          | 985        |                   | $          | 752 |   | $ | 985 |   | $ | 752 |   |

 

The Company relies primarily on a discounted 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 loans sold and the interest rate. The estimated fair value of servicingassets was determined using discount rates ranging from 5.4% to 11.2%,prepayment speeds of 14.0% to 15.0% (depending on certain characteristics ofthe related loans), and weighted average lives of the underlying assets rangingfrom 60 to 299 months and a combined weighted average life of 190 months.In the event future prepayments aresignificant or impairments are incurred, and future expected cash flows areinadequate to cover the unamortized servicing assets, additional amortizationor impairment charges would be recognized.

 

**(9)  Income Taxes**

 

The Company has substantial net operating loss carryforwards for federalincome tax purposes (“NOLs”), which can be used to off-set the tax liabilityassociated with the Company’s pre-tax earnings until the earlier of theexpiration or utilization of such NOLs. The Company accounts for the benefit ofthe NOLs and other income tax items under the asset and liability method. Deferred taxassets and liabilities are recognized based on the future tax consequencesattributable to temporary differences between the financial statement carryingamounts of existing assets and liabilities and their respective tax bases andoperating loss and tax credit carryforwards. Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to berecovered or settled. We reduce the carrying amounts of deferred tax assets bya valuation allowance if, based on the available evidence, it is more likelythan not that such assets will not be realized. Accordingly, the need toestablish valuation allowances for deferred tax assets is assessed periodicallyby the Company based on the more-likely-than-not realization thresholdcriterion. In the assessment, appropriate consideration is given to all positiveand negative evidence related to the realization of the deferred tax assets.This assessment considers, among other factors, the nature, frequency andseverity of current and cumulative losses, forecasts of future profitability,excess of appreciated asset value over the tax basis of net assets, theduration of statutory carryforward periods, the Company’s experience withutilizing available operating loss and tax credit carryforwards, and taxplanning strategies. In making such assessments, significant weight is given toevidence that can be objectively verified. At September 30, 2009 and December 31,2008, the Company established a full valuation allowance for its deferred taxassets due to the lack of sufficient objective evidence regarding the realizationof these assets in the foreseeable future.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

The Companyrecognizes the effect of income tax positions only if those positions are morelikely than not of being sustained. Recognized income tax positions aremeasured at the largest amount that is greater than 50% likely of beingrealized. Changes in recognition or measurement are reflected in the period inwhich the change in judgment occurs. The difference between the benefitrecognized for a position in accordance with this FIN 48 model and the tax benefitclaimed on a tax return is referred to as an unrecognized tax benefit (“UTB”).The gross amount of UTBs on uncertain tax positions as of September 30,2009 totaled $299,000, which if recognized, would impact the Company’seffective income tax rate.

 

Over the next twelve months, due to the expiration of the statute oflimitations related to certain UTBs, the Company anticipates that it isreasonably possible that the amount of UTBs could be reduced by approximately$50,000, which would impact the Company’s effective tax rate. The Companyrecords interest and penalties related to income tax uncertainties in theprovision for income taxes. At September 30, 2009, interest and penaltiesof $85,000 are included in “Other liabilities” as income taxes payable.

 

In a letter dated March 26, 2008, the Internal Revenue Servicenotified FirstCity of the completion of its examination on the Company’s 2004federal income tax return. The examination results were that no changes weremade to FirstCity’s original tax return as filed. FirstCity currently files taxreturns in approximately 35 states and is currently being examined in threestates for the year 2004. Tax year 1994 and subsequent years are open tofederal examination, and tax year 2005 and subsequent years are open to stateexamination.

 

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

 

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

 
| ** **                                                                        | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                                                        | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                                                                        | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                        | ** ** | **(Dollars in thousands)** | ** ** |
| ** **                                                                        | ** ** | ** **                 | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net earnings (loss)                                                               |       | $                          | 3,588      |                   | $          | (1,531 | ) | 13,557 |   | (11,613 | ) |
| Less: net income  attributable to the noncontrolling interest                     |       | 1,588                      |       | 224                    |       | 3,167 |   | 255 |   |
| Net earnings (loss)  attributable to FirstCity                                    |       | $                          | 2,000      |                   | $          | (1,755 | ) | $ | 10,390 |   | $ | (11,868 | ) |
|                                                                              |       |                       |       |                   |       |   |   |   |   |
| Weighted average  outstanding shares of common stock (in thousands)               |       | 9,838                      |       | 10,232                 |       | 9,834 |   | 10,391 |   |
| Dilutive effect of:                                                               |       |                       |       |                   |       |   |   |   |   |
| Warrants                                                                          |       | 276                        |       | —                 |       | 194 |   | — |   |
| Employee stock options                                                            |       | 211                        |       | —                 |       | 132 |   | — |   |
| Weighted average  outstanding shares of common stock and common stock equivalents |       | 10,325                     |       | 10,232                 |       | 10,160 |   | 10,391 |   |
|                                                                              |       |                       |       |                   |       |   |   |   |   |
| Net earnings (loss) per  share:                                                   |       |                       |       |                   |       |   |   |   |   |
| Basic                                                                             |       | $                          | 0.20       |                   | $          | (0.17 | ) | $ | 1.06 |   | $ | (1.14 | ) |
| Diluted                                                                           |       | $                          | 0.19       |                   | $          | (0.17 | ) | $ | 1.02 |   | $ | (1.14 | ) |
|                                                                              |       |                       |       |                   |       |   |   |   |   |
| Dilutive shares excluded  from above (in thousands):                              |       |                       |       |                   |       |   |   |   |   |
| Warrants                                                                          |       | —                     |       | 210                    |       | — |   | 247 |   |
| Employee stock options                                                            |       | —                     |       | 150                    |       | — |   | 190 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(11)  Stock-Based Compensation**

 

The impact on the results of operations of recordingstock-based compensation for the three and nine month periods ended September 30,2009 and 2008 follows:

 
| ** **                                          | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                          | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                                          | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                          | ** ** | **(Dollars in thousands)** | ** ** |
| Amount of compensation cost  recognized in expenses |       | $                          | 308        |                   | $          | 73 |   | $ | 438 |   | $ | 495 |   |
| Tax benefit recognized in  income                   |       | $                          | —     |                   | $          | — |   | $ | — |   | $ | — |   |
| Amount capitalized as part  of an asset             |       | $                          | —     |                   | $          | — |   | $ | — |   | $ | — |   |

 

A summary of stock option activity as of September 30,2009 and changes during the period then ended is presented below:

 
| ** **                              | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **         | ** ** |
|-----------------------------------------|------------|------------|------------|--------------|------------|-----------------|------------|--------------------|------------|
| ** **                              | ** ** | ** ** | ** ** | ** **   | ** ** | **Average**     | ** ** | ** **         | ** ** |
| ** **                              | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Remaining**   | ** ** | ** **         | ** ** |
| ** **                              | ** ** | ** ** | ** ** | **Average**  | ** ** | **Contractual** | ** ** | **Aggregate**      | ** ** |
| ** **                              | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Term**        | ** ** | **Intrinsic**      | ** ** |
| ** **                              | ** ** | **Shares** | ** ** | **Price**    | ** ** | **(Years)**     | ** ** | **Value**          | ** ** |
| ** **                              | ** ** | ** ** | ** ** | ** **   | ** ** | ** **      | ** ** | **(in thousands)** | ** ** |
| Outstanding at January 1,  2009    |       | 811,150    |       | $            | 6.24       |            |       |               |       |   |
| Granted                                 |       | 300,000    |       | 6.93         |       |            |       |               |       |
| Exercised                               |       | (37,000    | )          | 3.06         |       |            |       |               |       |
| Expired                                 |       | —     |       | —       |       |            |       |               |       |
| Forfeited                               |       | (2,500     | )          | 9.85         |       |            |       |               |       |
| Outstanding at September 30,  2009 |       | 1,071,650  |       | $            | 6.53       |            | 5.60       |               | $          | 2,275 |   |
| Exercisable at September 30,  2009 |       | 711,112    |       | $            | 5.92       |            | 3.71       |               | $          | 1,960 |   |

 

The totalintrinsic value of stock options exercised during the nine month periods ended September 30,2009 and 2008 was $174,000 and $14,000, respectively. As of September 30,2009, there was approximately $1.7 million of total unrecognized compensationcost related to unvested share-based compensation arrangements granted underthe stock option plans. That cost is expected to be recognized over a weightedaverage period of 1.7 years.

 

The fair value ofstock options granted was estimated on the grant date using the Black-Scholesoptions-pricing model. Expected volatilities are based on historical volatilityof the Company’s stock. The Company estimated the expected term of its unvestedoptions by taking into account the percentage of option exercises, thepercentage of options that expire unexercised, and the percentage of optionsoutstanding. The expected life represents the period of time that optionsgranted are expected to be outstanding. The risk-free rate is based on the U.S.Treasury rate with a maturity date corresponding to the options’ expected life.The Company does not currently anticipate paying any cash dividends on itscommon stock. Consequently, the Company uses an expected dividend yield of zeroin the options-pricing model. The following table sets forth the weightedaverage assumptions used to calculate the fair value of the stock options foreach respective period:

 
| ** **                              | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                              | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                              | ** ** | **2009**               | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| Weighted average grant date  fair value | ** ** | $5.21-$6.04            | ** ** | $                      | —     |   | $5.21-$6.04 |   | $ | 3.05 |   |
| Volatility                              |       | 78%-92%                |       | 0                      | %          | 78%-92% |   | 78 | % |
| Risk-free interest rate                 |       | 2.5%                   |       | 0.00                   | %          | 2.5% |   | 3.73 | % |
| Expected life in years                  |       | 7.8-10                 |       | 0                      |       | 7.8-10 |   | 5 |   |
| Dividend yield                          |       | Zero                   |       | Zero                   |       | Zero |   | Zero |   |
|                                         |            |                        |            |                        |            |  |  |  |  |  |  |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

A summary of thestatus and changes of FirstCity’s non-vested shares as of September 30,2009, and changes during the nine months ended September 30, 2009 ispresented below:

 
| ** **                             | ** ** | ** ** | ** ** | **Weighted-**  | ** ** |
|----------------------------------------|------------|------------|------------|----------------|------------|
| ** **                             | ** ** | ** ** | ** ** | **Average**    | ** ** |
| ** **                             | ** ** | ** ** | ** ** | **Grant-Date** | ** ** |
| ** **                             | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
| Non-vested at  January 1, 2009    |       | 107,913    |       | $              | 7.06       |   |
| Granted                                |       | 300,000    |       | $              | 5.72       |   |
| Vested                                 |       | (45,500    | )          | $              | 4.71       |   |
| Forfeited                              |       | (1,875     | )          | $              | 9.85       |   |
| Non-vested at  September 30, 2009 |       | 360,538    |       | $              | 6.10       |   |

 

**(12)  Accumulated Other Comprehensive Loss**

 

Accumulated other comprehensiveloss is comprised of the following as of September 30, 2009 and December 31,2008:

 
| ** **                                                      | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                                      | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **                                                      | ** ** | **(Dollars in thousands)** | ** ** |
| Cumulative foreign currency  translation adjustments            |       | $                          | (1,809     | )                     | $          | (3,766 | ) |
| Net unrealized gains on  securities available for sale (1) |       | 1,350                      |       | 40                    |       |
| Total accumulated other  comprehensive loss                     |       | $                          | (459       | )                     | $          | (3,726 | ) |

 

----

(1)   Includes $1.3 million at September 30,2009 attributable to FirstCity’s proportionate share of net unrealized gainsrecorded by an investee accounted for under the equity method of accounting.

 

**(13)  Railroad Operation Expenses**

 

The following table displays the amount of expenses attributable to theCompany’s consolidated railroad operations that are included in the totalamounts reported for the corresponding captions in the Company’s ConsolidatedStatements of Operations for the three-month and nine-month periods ended September 30,2009 and 2008:

 
| ** **                                                    | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                                    | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                                                    | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                    | ** ** | **(Dollars in thousands)** | ** ** |
| Interest and fees on notes  payable                           |       | $                          | 29         |                   | $          | 54 |   | $ | 84 |   | $ | 113 |   |
| Salaries and benefits                                         |       | 252                        |       | 229                    |       | 731 |   | 701 |   |
| Asset-level expenses                                          |       | —                     |       | 2                      |       | — |   | 10 |   |
| Occupancy, data processing  and other                         |       | 225                        |       | 340                    |       | 808 |   | 926 |   |
| Total operating expenses  attributable to railroad operations |       | $                          | 506        |                   | $          | 625 |   | $ | 1,623 |   | $ | 1,750 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(14)  Fair Value**

 

Fair ValueMeasurements

 

The fair value of an asset or liability is the price that would be receivedto sell that asset or paid to transfer that liability in an orderly transactionoccurring in the principal market (or most advantageous market in the absenceof a principal market) for such asset or liability. In estimating fair value,the Company utilizes valuation techniques that are consistent with the marketapproach, the income approach and/or the cost approach. Such valuationtechniques are consistently applied. Inputs to valuation techniques include theassumptions that market participants would use in pricing an asset orliability. The accounting guidance on fair value measurements (see Note 2)establishes a fair value hierarchy that prioritizes the inputs to valuationtechniques to measure fair value. The hierarchy gives the highest priority tounadjusted quoted prices in active markets for identical assets or liabilities(Level 1 measurements) and the lowest priority to measurements involvingsignificant unobservable inputs (Level 3 measurements). The three levels of thefair value hierarchy are described below:

 

·      Level1 — Valuations are based upon quoted prices (unadjusted) in active exchangemarkets involving identical assets and liabilities that the Company has theability to access at the measurement date.

 

·      Level2 — Observable inputs other than Level 1 prices, such as quoted prices forsimilar instruments in active markets; quoted prices and valuations foridentical or similar instruments in markets that are not active; andmodel-based valuation techniques with significant assumptions and inputs thatare observable in the market or can be derived principally from or corroboratedby observable market data.

 

·      Level3 — Valuations are derived from model-based techniques that use inputs andsignificant assumptions that are supported by little or no observable marketdata. Valuation techniques include the use of pricing models, discounted cashflow models and similar methodologies.

 

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

 

*Asset Measured at Fair Value on a Recurring Basis*

 

At September 30, 2009, the only financial or non-financial itemthat the Company measured at fair value on a recurring basis was its investmentsecurity available for sale (represents a beneficial interest attributable toloans sold through a securitization transaction that the Company purchased in2008). The Company measures fair value for this investment security using adiscounted cash flow model based on assumptions and inputs that arecorroborated by little or no observable market data (Level 3 measurement). TheCompany uses this measurement technique because pricing information andmarket-participant assumptions for purchased beneficial interests in similarsecuritization transactions are not readily accessible and frequently releasedto the public. At September 30, 2009 and December 31, 2008, thecarrying value of this investment security (at fair value) approximated $1.8million and $5.3 million, respectively. The table below summarizes the changesto this Level 3 asset measured at fair value on a recurring basis for thethree- and nine-month periods ended September 30, 2009:

 
| ** **                                            | ** ** | **Three Months  Ended** | ** ** | **Nine Months  Ended** | ** ** |
|-------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                            | ** ** | **September 30,**  | ** ** | **September 30,** | ** ** |
| **(Dollars in thousands)**                            | ** ** | **2009**                | ** ** | **2009**               | ** ** |
| Balance, beginning of  period                         |       | $                       | 2,993      |                   | $          | 5,251 |   |
| Total net gains (losses)  for the period included in: |       |                    |       |                   |       |
| Net income (loss)                                     |       | —                  |       | —                 |       |
| Other comprehensive income  (loss)                    |       | (10                     | )          | (26                    | )          |
| Purchases, sales, issuances  and settlements, net     |       | (1,228                  | )          | (3,470                 | )          |
| Net transfers into Level 3                            |       | —                  |       | —                 |       |
| Balance, end of period                                |       | $                       | 1,755      |                   | $          | 1,755 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

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

 

The Company may be required, from time to time, to measure certainfinancial and non-financial assets at fair value on a non-recurring basis.These adjustments to fair value generally result from write-downs of financialand non-financial assets as a result of impairment or application oflower-of-cost or fair value accounting. For assets measured at fair value on anon-recurring basis that were still on the Company’s consolidated balance sheetat September 30, 2009 and December 31, 2008, the following tableprovides (1) the level of valuation assumptions used to determine eachadjustment; (2) the carrying values of the related assets; and (3) thedecrease in value of the assets that were measured at fair value on anon-recurring basis for which the fair value adjustment has been included inthe Company’s operations relating to the assets held at period-end:

 
| ** **                         | ** ** | ** **                                    | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** | **Total Losses**        | ** ** |
|------------------------------------|------------|-----------------------------------------------|------------|------------------------|------------|------------------------|------------|------------|------------|-------------------------|------------|
| ** **                         | ** ** | ** **                                    | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** | **Three Months  Ended** | ** ** | **Nine Months  Ended** | ** ** |
| ** **                         | ** ** | **Carrying Value at September 30, 2009** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| **(Dollars in thousands)**         | ** ** | **Level 1**                                   | ** ** | **Level 2**            | ** ** | **Level 3**            | ** ** | **Total**  | ** ** | **2009**                | ** ** | **2009** | ** ** |
| Portfolio Assets - loans  (1)      |       | $                                             | —     |                   | $          | —                 |       | $          | 4,930      |                    | $          | 4,930 |   | $ | (244 | ) | $ | (1,007 | ) |
| SBA loans held for investment  (1) |       | —                                        |       | —                 |       | 1,030                  |       | 1,030      |       | (352                    | )          | (430 | ) |
| Real estate held for sale  (2)     |       | —                                        |       | 4,447                  |       | —                 |       | 4,447      |       | (137                    | )          | (583 | ) |
|                               |       |                                          |       |                   |       |                   |       |       |       | $                       |  (733 | ) | $ | (2,020 | ) |
|                                    |            |                                               |            |                        |            |                        |            |            |            |                         |            |  |  |  |  |  |  |  |  |

 
| ** **                         | ** ** | ** **                                       | ** ** | ** **     | ** ** | ** **  | ** ** | ** ** | ** ** | **Total Losses**           | ** **   |
|------------------------------------|------------|--------------------------------------------------|------------|----------------|------------|-------------|------------|------------|------------|----------------------------|--------------|
| ** **                         | ** ** | **Carrying Value at December 31, 2008 (3)** | ** ** | **Year Ended** | ** ** |
| **(Dollars in thousands)**         | ** ** | **Level 1**                                      | ** ** | **Level 2**    | ** ** | **Level 3** | ** ** | **Total**  | ** ** | **December 31, 2008** | ** **   |
| Portfolio Assets - loans  (1)      |       | $                                                | —     |           | $          | —      |       | $          | 5,677      |                       | $            | 5,677 |   | $ | (2,148 | ) |
| SBA loans held for  investment (1) |       | —                                           |       | —         |       | 140         |       | 140        |       | (248                       | )            |
| Servicing assets - SBA  loans      |       | —                                           |       | —         |       | 534         |       | 534        |       | (21                        | )            |
|                               |       |                                             |       |           |       |        |       |       |       | $                          |  (2,417 | ) |
|                                    |            |                                                  |            |                |            |             |            |            |            |                            |              |  |  |  |  |  |

 

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(1)   Represents the carrying value and relatedlosses 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.

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

(3)   Pursuant to the Company’s adoption ofFASB’s accounting guidance on fair value measurements in 2008, the Company didnot apply the fair value measurement provisions to non-recurring fair valuemeasurements of non-financial Portfolio Assets (i.e. real estate held for sale)upon recognition of impairment charges on such assets during 2008. Inaccordance with guidance, the Company applied the fair value measurementprovisions to non-financial Portfolio Assets effective January 1, 2009.See Note 2.

 

The fair values of “Portfolio Assets — loans” and “SBA loans held forinvestment,” as measured on a non-recurring basis, are based on collateralvaluations using observable and unobservable inputs, adjusted for variousconsiderations such as market conditions, economic and competitive environment,and other assets with similar characteristics (i.e. type, location, etc.) that,in management’s opinion, reflect elements a market participant would consider.The Company classifies its fair value measurement techniques for these assetsas Level 3 inputs for the following reasons: (1) distressed assettransactions generally occur in inactive markets for which observable marketprices are not readily available (i.e. price quotations vary substantially overtime and among market-makers, and pricing information is generally not releasedto the public); and (2) the Company’s valuation techniques that aremost-significant to the fair value measurements are principally derived fromassumptions and inputs that are corroborated by little or no observable marketdata.

 

The fair value of “Servicing assets — SBA loans,” as measured on anon-recurring basis, is based on the Company’s discounted cash flow model. Thismodel estimates fair value of the servicing assets using predominant riskcharacteristics of servicing assets such as discount rate, prepayment speed,and weighted average lives and interest rates of the underlying loans. TheCompany classifies its fair value measurement techniques for servicing assetsas Level 3 inputs since the Company’s valuation techniques that aremost-significant to the fair value measurements are principally derived fromassumptions and inputs that are corroborated by little or no observable marketdata.

 

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

 

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

 

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

 

Estimated Fair Values of Financial Instruments Not Recordedat Fair Value in their Entirety on a Recurring Basis

 

In addition to themethods and assumptions we use to measure the fair value of financialinstruments as discussed in the section above, we used the following methodsand assumptions to estimate the fair value of our financial instruments thatare not recorded at fair value in their entirety on a recurring basis on theCompany’s consolidated balance sheets. The fair value estimates were based onpertinent information that was available to management as of the respectivedates. The fair value estimates have not been revalued for purposes of thesefinancial statements since those dates and, therefore, current estimates offair value may differ significantly from the amounts presented. Furthermore, becauseactive markets do not exist for a significant portion of the Company’sfinancial instruments, management uses present value techniques and othervaluation models to estimate the fair values of its financial instruments.These valuation methods require considerable judgment, and the resultingestimates of fair value can be significantly affected by the assumptions madeand methods used. Accordingly, the estimates provided herein do not necessarilyindicate amounts which could be realized in a current exchange. The Companybelieves the imprecision of an estimate could be significant.

 

***Cash and Cash Equivalents: ***Thecarrying amount of cash and cash equivalents approximated fair value at September 30,2009 and December 31, 2008.

 

***LoansReceivable Held-for-Sale: ***Loans held-for-sale (primarily SBA loansheld-for-sale) are carried on the Company’s consolidated balance sheet at thelower of cost or fair value. The fair value of loans held-for-sale is generallybased on what secondary markets are currently offering for loans with similarcharacteristics. The carrying amount of loans held-for-sale approximated fairvalue at September 30, 2009 and December 31, 2008.

 

***Portfolio Assets — Loans and Loans Receivable: ***Estimatedfair values of Portfolio Assets — loans and fixed-rate loans receivable aregenerally determined using a discounted cash flow model, adjusted by an amountfor estimated losses, that employs market discount rates and other adjustmentsthat would be expected to be made by a market participant. The estimated fairvalue for variable-rate loans that re-price frequently is based on carryingvalues adjusted for estimated credit losses and other adjustments that would beexpected to be made by a market participant. The estimated fair value forimpaired loans is generally based on collateral valuations using observable andunobservable inputs, adjusted for various considerations that would beexpected to be made by a market participant; or discounted cash flowmodels that employ market discount rates and other adjustments that would be expected tobe made by a market participant. Management estimates and assumptionsregarding credit risk, cash flows and discount rates are judgmentallydetermined using available market and specific borrower information. At September 30,2009 and December 31, 2008, the carrying amounts of Portfolio Assets —loans and loans receivable (including accrued interest) approximated $281.3million and $178.0 million, respectively, and the estimated fair valuesapproximated $385.7 million and $238.4 million, respectively.

 

***Servicing Assets: ***The Company relies primarily on acombination of a discounted cash flow model of future net servicing income andanalysis of current market data to estimate the fair value of its servicingassets. The key assumptions used to calculate estimated fair value of theservicing assets include prepayment speeds; discount rate; and weighted averagelives and interest rates of the underlying loans. The fair value estimateexcludes the value of the servicing rights for loans sold in which theservicing rights have not been capitalized. At September 30, 2009 and December 31,2008, the carrying amount of servicing assets approximated fair value.

 

***Notes Payable: ***Management believes the interest rates and terms on itsdebt obligations approximate the rates and terms currently offered by otherlenders for similar debt instruments of comparable terms. As such, managementbelieves that the carrying amount of notes payable approximates fair value at September 30,2009 and December 31, 2008.

 

**(15)****  Variable InterestEntities**

 

In the normalcourse of business, the Company enters into various types of on- andoff-balance sheet transactions with entities that involve variable interests.Variable interests are generally defined as contractual, ownership or othereconomic interests in an entity that change with fluctuations in the entity’snet asset value. If certain characteristics are present in these transactions,the entity is subject to a variable interests consolidation analysis, andconsolidation is based on variable interests, and not solely on ownership ofthe entity’s outstanding voting stock. If an entity is determined to be avariable interest entity (“VIE”), we determine if our variable interest causesus to be considered the primary beneficiary. We are the primary beneficiary andare required to consolidate the entity if we absorb a majority of expectedlosses or receive a majority of residual returns (if the losses or returnsoccur), or both. In making the determination as to whether we are the primarybeneficiary, we evaluate the design of the entity, including the risks thatcause variability, the purpose for which the entity was created, and thevariability that the entity was designed to create and pass along to itsinterest holders. When the primary beneficiary cannot be identified throughqualitative analysis, we use internal cash flow models to compute and allocateexpected losses or residual returns to each variable interest holder. Theallocation of expected cash flows is based upon the relative contractual rightsand preferences of each interest holder in the VIE’s capital structure.

 

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

 

In order todetermine if we are considered to be the primary beneficiary of a VIE, we firstperform a qualitative analysis, which requires certain subjective decisionsregarding our assessments, including, but not limited to, the design of theentity, the variability that the entity was designed to create and pass alongto its interest holders, the rights of the parties, and the purpose of thearrangement. If we cannot conclude after qualitative analysis whether we arethe primary beneficiary, we perform a quantitative analysis. Quantifying thevariability of a VIE’s assets is complex and subjective, requiring analysis ofa significant number of possible future outcomes as well as probability of eachoutcome occurring. The result of each possible outcome is allocated to theparties holding interests in the VIE and, based on the allocation, acalculation is performed to determine which party, if any, is the primarybeneficiary.

 

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

 

AcquisitionPartnership VIEs —The Company is involved with certain Acquisition Partnerships that were formedwith one or more investors to invest in Portfolio Assets. These AcquisitionPartnership VIEs are typically financed through debt and/or equity provided bythe investors (including FirstCity). The investors and third-party creditorsgenerally have recourse only to the extent of the assets held by these VIEs.The Acquisition Partnerships included in this disclosure are VIEs becausegenerally they do not have sufficient equity to finance their activitieswithout additional subordinated financial support, or the investors do not havethe ability to make significant decisions about the Acquisition Partnership’sactivities. The Company is not the primary beneficiary of the AcquisitionPartnership VIEs as the majority of the variable interests are expected toaccrue to the other investors. The Company does not generally provide financialsupport to any Acquisition Partnership VIE beyond that which is contractuallyrequired.

 

Operating EntityVIEs — TheCompany has significant variable interests with certain operating entities.FirstCity provided financing in the form of debt and/or equity to help financethe activities of the Operating Entity VIEs. The voting interests of theOperating Entity VIEs are either wholly-owned or majority-owned bynon-affiliated investors. The investors and creditors, including FirstCity,generally have recourse only to the extent of the assets held by these VIEs.The Operating Entities included in this disclosure are VIEs because generallythey do not have sufficient equity to finance their activities withoutadditional subordinated financial support. The Company is not the primarybeneficiary of the Operating Entity VIEs as the majority of the variableinterests are expected to accrue to other non-affiliated investors. The Companydoes not generally provide financial support to any Operating Entity VIE beyondthat which is contractually required.

 

The following table summarizes the carrying amounts of the assets andliabilities and the maximum loss exposure as of September 30, 2009 relatedto the Company’s variable interests in non-consolidated VIEs. The Company doesnot have any consolidated VIEs for which it holds a minority voting interest inthe entity.

 
| ** **                    | ** ** | **Assets on FirstCity’s** | ** ** | **FirstCity’s** | ** ** |
|-------------------------------|------------|--------------------------------|------------|----------------------|------------|
| ** **                    | ** ** | **Balance Sheet**              | ** ** | **Maximum**          | ** ** |
| ** **                    | ** ** | **Loans**                      | ** ** | **Equity**           | ** ** | **Exposure** | ** ** |
| **Type of VIE**               | ** ** | **Receivable**                 | ** ** | **Investment**       | ** ** | **to Loss (1)** | ** ** |
| ** **                    | ** ** | **(Dollars  in thousands)**    | ** ** |
| Acquisition Partnership  VIEs |       | $                              | 2,214      |                 | $          | 19,502 |   | $ | 23,295 |   |
|                          |       |                           |       |                 |       |   |   |
| Operating Entity VIEs         |       | 23,191                         |       | 1,809                |       | 25,000 |   |
|                          |       |                           |       |                 |       |   |   |
| Net assets acquired           |       | $                              | 25,405     |                 | $          | 21,311 |   | $ | 48,295 |   |

 

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

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(16)  Other Related Party Transactions**

 

The Company hascontracted with the Acquisition Partnerships and related parties as a thirdparty loan servicer. Servicing fees and due diligence fees (included in otherincome) derived from such affiliates totaled $2.0 million and $3.5 million forthe three month periods ended September 30, 2009 and 2008, respectively,and $6.3 million and $8.2 million for the nine month periods ended September 30,2009 and 2008, 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 September 30, 2009, 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. FirstCity recorded fees from MCS included in other income of$107,000 and $84,000 during the three month periods ended September 30,2009 and 2008, respectively, and $307,000 and $324,000 during the nine monthperiods ended September 30, 2009 and 2008, respectively.

 

**(17)  Segment Reporting**

 

The Company isengaged in two major business segments — Portfolio Asset Acquisition andResolution and Special Situations Platform.

 

In the PortfolioAsset Acquisition and Resolution business, the Company acquires and resolvesportfolios of performing and non-performing loans and other assets(collectively, “Portfolio Assets” or “Portfolios”), which are generallyacquired at a discount to their legal principal balance or appraised value.Purchases may be in the form of pools of assets or single assets. The PortfolioAssets are generally aggregated, including loans of varying qualities that aresecured or unsecured by diverse collateral types and real estate. SomePortfolio Assets are loans for which resolution is linked primarily to the realestate securing the loan, while others may be collateralized business loans forwhich resolution may be based either on real estate, business assets or othercollateral cash flow. Portfolio Assets are acquired on behalf of the Company orits consolidated subsidiaries, and on behalf of domestic and foreignpartnerships and other entities (“Acquisition Partnerships”) in which apartially-owned affiliate of the Company is the general partner and the Companyand other investors are limited partners. The Company services, manages andultimately resolves or otherwise disposes of substantially all Portfolio Assetsacquired by the Company, its Acquisition Partnerships, or other relatedentities. The Company services such assets until they are collected or sold.

 

The Companyengages in its Special Situations Platform business through its majorityownership interest in FirstCity Denver — which was formed in April 2007.Through its Special Situations Platform business, the Company providesinvestment capital to privately-held middle-market companies through flexiblecapital structuring arrangements. The nature of the capital investmentsprimarily takes the form of senior and junior financing arrangements, but alsoinclude direct equity investments, common equity warrants, distressed debttransactions, and leveraged buyouts. FirstCity Denver’s primary investment objectiveis to generate both current income and capital appreciation through debt andequity investments, and to generally structure the investments to be repaid orexited in twelve to thirty-six months.

 

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

 

Operating segment revenues andprofitability, and a reconciliation to net earnings (loss) before deduction ofnet income attributable to noncontrolling interests for the three and ninemonths ended September 30, 2009 and 2008 are as follows:

 
| ** **                                                                         | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|
| ** **                                                                         | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                                                                         | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                         | ** ** | **(Dollars in thousands)** | ** ** |
| **Portfolio  Asset Acquisition and Resolution:**                                   |       |                       |       |                   |       |   |   |   |   |
| Total revenues                                                                     |       | $                          | 16,817     |                   | $          | 10,886 |   | $ | 49,083 |   | $ | 29,136 |   |
| Operating contribution  (loss), net of direct taxes                                |       | $                          | 2,028      |                   | $          | (1,691 | ) | $ | 14,082 |   | $ | (8,763 | ) |
| ** **                                                                         | ** ** | ** **                 | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Special  Situations Platform:**                                                  |       |                       |       |                   |       |   |   |   |   |
| Total revenues                                                                     |       | $                          | 1,820      |                   | $          | 1,715 |   | $ | 5,733 |   | $ | 4,231 |   |
| Operating contribution, net  of direct taxes                                       |       | $                          | 1,615      |                   | $          | 1,181 |   | $ | 1,820 |   | $ | 1,632 |   |
| Total operating income  (loss), net of direct taxes                                |       | $                          | 3,643      |                   | $          | (510 | ) | $ | 15,902 |   | $ | (7,131 | ) |
| ** **                                                                         | ** ** | ** **                 | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Corporate  Overhead:**                                                           | ** ** | ** **                 | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Salaries and benefits,  occupancy, professional and other income and expenses, net |       | 1,754                      |       | 1,581                  |       | 5,533 |   | 5,072 |   |
| Income taxes                                                                       |       | (111                       | )          | (336                   | )          | (21 | ) | (335 | ) |
| Net earnings (loss)  attributable to FirstCity                                     |       | $                          | 2,000      |                   | $          | (1,755 | ) | $ | 10,390 |   | $ | (11,868 | ) |

 

Revenues and equity in earnings of investments fromthe Special Situations Platform segment are all attributable to domesticoperations. Revenues and equity in earningsof investments from the Portfolio Asset Acquisition and Resolution segment areattributable to domestic and foreign operations as follows:

 
| ** **    | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**  | ** ** |
|---------------|------------|----------------------------|------------|------------------------|------------|
| ** **    | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **    | ** ** | **2009**                   | ** ** | **2008**               | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **    | ** ** | **(Dollars in thousands)** | ** ** |
| Domestic      |       | $                          | 12,506     |                   | $          | 5,725 |   | $ | 38,024 |   | $ | 17,532 |   |
| Latin America |       | 2,811                      |       | 4,433                  |       | 8,085 |   | 11,321 |   |
| Europe        |       | 457                        |       | 1,956                  |       | 2,770 |   | 7,691 |   |
| Other         |       | —                     |       | 10                     |       | 16 |   | 34 |   |
| Total         |       | $                          | 15,774     |                   | $          | 12,124 |   | $ | 48,895 |   | $ | 36,578 |   |

 

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

 
| ** **                                    | ** ** | **September 30,**     | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **                                    | ** ** | **(Dollars in thousands)** | ** ** |
| Cash and cash equivalents                     |       | $                          | 32,992     |                  | $          | 19,103 |   |
| Restricted cash                               |       | 1,039                      |       | 1,217                 |       |
| Portfolio acquisition and  resolution assets: |       |                       |       |                  |       |
| Domestic                                      |       | 246,447                    |       | 167,211               |       |
| Latin America                                 |       | 41,458                     |       | 42,426                |       |
| Europe                                        |       | 60,908                     |       | 48,612                |       |
| Other                                         |       | —                     |       | 228                   |       |
| Special situations platform  assets           |       | 44,161                     |       | 37,786                |       |
| Other non-earning assets,  net                |       | 11,082                     |       | 12,354                |       |
| Total assets                                  |       | $                          | 438,087    |                  | $          | 328,937 |   |

 

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

 

**(18)  Commitments and Contingencies**

 

*Legal Proceedings*

 

The following information supplements and amends our discussion setforth under Part I, Item 3 “Legal Proceedings” in our 2008 Form 10-K.

 

On September 25,2009, FirstCity, FCLT Loans Asset Corporation and Tony J. Blair, individuallyand as representative of a class of former employee beneficiaries, entered intoan Agreement and Stipulation of Settlement, subject to Court approval, whichprovides for the settlement of the pending lawsuit related to the ownership ofproceeds from the sale of Prudential stock and dividends interpled byPrudential Financial Inc. The settlement provides for each party to receiveone-third of the demutualization proceeds ten days after an order of the trialcourt approving the settlement is final and non-appealable. Each of the partiesto the lawsuit will release the other parties from all claims related to thelawsuit. The demutualization proceeds are being held by JP Morgan Chase Bank,National Association (“JP Morgan”) subject to the resolution of all issues in thelawsuit. According to report of JP Morgan dated as of August 3, 2009, thedemutualization proceeds total approximately $18.6 million. Pursuant to thesettlement, JP Morgan will hold approximately $250,000 of the funds as areserve to pay fees, expenses and tax payments. On September 29, 2009, thetrial court granted preliminary approval of the terms of the settlement. On October 16,2009, the trial court entered an amended order which granted preliminaryapproval of the settlement, set the hearing on the fairness of the settlementon November 12, 2009, and approved the form and content of the notice toclass members and the method of providing notice to the class members. Thesettlement is subject to notice to the class of the action and final approval bythe trial court after hearings on the fairness of the settlement with respectto the class of former employees.  If thetrial court does not approve the settlement the parties will be restored totheir positions in the suit prior to the entry into the Agreement andStipulation of Settlement.

 

*Indemnification Obligation 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, nor Funding GP is required to make any payments asa result of the indemnity provided under the 2004 Securities Purchase Agreementuntil the aggregate amount payable exceeds $250,000, and then only for theamount in excess of $250,000 in the aggregate; however certain representationsand warranties are not subject to this $250,000 threshold. Under terms of theagreement, the indemnity obligation period expired on November 1, 2009. Nolosses were incurred by FirstCity, Consumer Corp., Funding LP or Funding GPduring the term of this indemnity obligation agreement.

 

On August 8,2006, an Interest Purchase and Sale Agreement was entered into by and amongBidmex Holding LLC (“Buyer” or “Bidmex Holding”), as buyer, and StrategicMexican Investment Partners L.P. (“SMIP”), a wholly-owned subsidiary ofFirstCity, and Cargill Financial Services International Inc. (“CFSI”),(collectively, the “Sellers”), as seller, and eleven U.S. limited liabilitycompanies (“LLCs”) which invested in Mexican portfolio acquisition entities (“SRLs”)and the AIG entities as additional parties.  In the Interest Purchase andSale Agreement, the Sellers and the LLCs made various representations andwarranties concerning (i) the existence and ownership of the LLCs and therelated SRLs, (ii) the assets and liabilities of the LLCs, (iii) taxesrelated to periods prior to August 8, 2006, and (iv) the operationsof the LLCs and SRLs. The Sellers agreed to indemnify the Buyer and AIGEntities from damages resulting from a breach of any representation or warrantycontained in the Interest Purchase and Sale Agreement on a several and notjoint basis according to their respective ownership percentages in each LLC asto any matter related to a particular LLC, or on the basis of 80% to CFSI and20% to SMIP as to any matter that could not be identified to a particular LLC.The indemnity obligation under the Interest Purchase and Sale Agreementsurvives for a period of the statute of limitations for matters related totaxes, existence and authority, capitalization and good standing of the LLCsand SRLs and for a period of two years from August 8, 2006, the closingdate with respect to all other representations and warranties. The Sellersare not required to make any payments as a result of the indemnity provisionsof the Interest Purchase and Sale Agreement until the aggregate amount payableunder that agreement and the Asset Purchase Agreement exceeds $250,000;however, claims related to taxes and fraud are not subject to this $250,000threshold.  The Interest Purchase and Sale Agreement limits the liabilityof the Sellers for indemnifiable losses under the Interest Purchase and SaleAgreement and the Asset Purchase Agreement to the Aggregate Purchase Price(without duplication of amounts recovered pursuant to the terms of the AssetPurchase Agreement). At this time, management does not believe that thispotential obligation will have a material adverse impact on the Company’sconsolidated results of operations, financial position or liquidity.

 

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

 

Also on August 8,2006, Bidmex Holding entered into an Agreement for the Onerous Transfer ofLoans and Litigious Rights (the “Asset Purchase Agreement”) between and amongResidencial Oeste S. de R.L. de C.V., as seller (the “Asset Seller”), anaffiliate of CFSI and SMIP, Residencial Oeste 2 S. de R.L. de C.V., as purchaser(the “Asset Purchaser”), and CFSI, SMIP, and Bidmex Acquisition LLC, the parentof the Asset Purchaser, as additional parties. The Asset Purchase Agreementprovides for the sale of the loan portfolio owned by the Seller to thePurchaser for a purchase price of $10.1 million on the closing date, whichpurchase price is part of the Aggregate Purchase Price.  In the AssetPurchase Agreement, the Asset Seller and the Sellers made variousrepresentations and warranties concerning (i) the existence and ownershipof the Seller, (ii) the ownership of the loan portfolio, (iii) taxesrelated to periods arising prior to the closing date, and (iv) theexistence of the loans comprising the loan portfolio and other matters relatedto the loan portfolio. The Asset Seller agreed to indemnify the AssetPurchaser from damages resulting from a breach of any representation orwarranty. The indemnity obligation under the Asset Purchase Agreement survivesfor a period of the statute of limitations for matters related to existence andownership of the Seller, ownership of the loans, and taxes for periods prior toAugust 8, 2006, and for a period of two years from August 8, 2006,with respect to all other representations and warranties. The Seller isnot required to make any payments as a result of the indemnity provisions ofthe Asset Purchase Agreement until the aggregate amount payable under thatAgreement exceeds $25,000; however, claims related to taxes and fraud are notsubject to this $25,000 threshold. The Interest Purchase and SaleAgreement limits the liability of the Sellers for indemnifiable losses underthe Asset Purchase Agreement to the Aggregate Purchase Price. At this time,management does not believe that this potential obligation will have a materialadverse impact on the Company’s consolidated results of operations, financialposition or liquidity.

 

*Subordinated Equity Investment*

 

During the period from December 1998 to March 2005, FirstCityMexico Inc. and SMIP, each wholly-owned subsidiaries of FirstCity, and CargillFinancial Services International Inc. (“CFSI”) and, in some instances, otherinvestors, acquired 12 residential and commercial non-performing loanportfolios from financial institutions in Mexico (the “Mexican Portfolios”). Eachportfolio was acquired by a Mexican limited liability company (each a “MexicanSRL”) that was owned by a Delaware limited liability company formed by eachinvestor group.  On August 8, 2006, SMIP and National Union FireInsurance Company of Pittsburgh, Pa., American General Life Insurance Companyand American General Life and Accident Insurance Company, affiliates of AIGGlobal Asset Management Holdings Corp. (collectively the “AIG Entities”) formedBidmex Holding for the purpose of acquiring the Mexican Portfolios by purchasingthe interests of Cargill and SMIP in eleven of the Mexican limited liabilitycompanies (the “LLCs”) and purchasing the loan portfolio of one of the Mexicanlimited liability companies (the “Purchased Portfolio”) for an aggregatepurchase price of U.S. $119.3 million as of that date (the “Aggregate PurchasePrice”). SMIP acquired 15% of the membership interests in BidmexHolding. A 9% interest acquired by SMIP is of equivalent standing tomembership interests held by the AIG affiliates representing 85% of themembership interests. The remaining 6% membership interest acquired bySMIP is subordinate to the other owners of interests in Bidmex Holding, whowill receive the return of and a return on their contribution equivalent to an9% internal rate of return with respect to their interests prior to SMIPreceiving the return of and a return on its capital contribution equivalent toa 9% internal rate of return with respect to its 6% interest. At September 30,2009, the carrying value of SMIP’s membership interests in Bidmex Holding thatis included in the Company’s consolidated balance sheet approximated $12.1million ($5.6 million for the 9% membership interest and $6.5 million for the6% membership interest).

 

*Commitments to Repurchase Loans*

 

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 with FSA, FC Capital Corp. has the optionto purchase the loans for $0.5 million prior to a call under the letter ofcredit. In July 2009, FirstCity funded this $0.5 million letter of creditpursuant to a demand made by FSA as a result of the line of credit issuerfailing to maintain the long-term ratings as required under the agreement.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

*Letters of Credit and Other Guarantees*

 

Fondo de Inversion Privado NPL Fund One (“PIF1”), an equity-methodinvestment of FirstCity, has a credit facility with Banco Santander Chile, S.A.with an unpaid principal balance of $10.15 million at September 30, 2009.PIF1 uses the credit facility to finance the purchases of loan portfolios.Pursuant to terms of the credit facility, FirstCity was required to provide astand-by letter of credit from Bank of Scotland that would satisfy the currentloan balance upon demand. At September 30, 2009, FirstCity had a letter ofcredit in the amount of $10.75 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 $10.75 million letter of credit, FirstCity would berequired to reimburse Bank of Scotland by making payment to Bank of Scotlandfor all amounts disbursed or to be disbursed by Bank of Scotland under theletter of credit.

 

On November 29, 2006, FirstCity Mexico SA de CV, a Mexicanaffiliate of FirstCity, entered into a loan agreement with Banco Santander,S.A. that allows loans to be made in Mexican pesos. At September 30, 2009,the Company had 142,240,000 in Mexican peso-denominated debt, which wasequivalent to U.S. $10.7 million. The proceeds were used to pay down theacquisition facility with the Bank of Scotland. Pursuant to the terms of the credit facility, FirstCity Mexico SA de CVwas required to provide a stand-by letter of credit from Bank of Scotland thatwould satisfy the loan balance upon demand.  At September 30, 2009,FirstCity had a letter of credit in the amount of $12.6 million from Bank ofScotland under the terms of FirstCity’s revolving acquisition facility withBank of Scotland.  In the event that a demand is made under the $12.6million letter of credit, FirstCity is required to reimburse Bank of Scotlandby making payment to Bank of Scotland for all amounts disbursed or to bedisbursed by Bank of Scotland under the letter of credit.

 

American Business Lending, Inc. (“ABL”), a majority-ownedsubsidiary of FirstCity, has a $25.0 million revolving loan facility with WellsFargo Foothill, LLC (“WFF”), as amended in February 2009, for the purposeof financing and acquiring SBA loans. The obligations under this facility aresecured by substantially all of the assets of ABL. At September 30, 2009,the balance of this facility was $11.4 million. In connection with thisarrangement, FirstCity provides WFF with an unconditional guaranty on ABL’sobligations under the loan facility up to a maximum of $5.0 million plusenforcement cost.

 

FirstCity CommercialCorp. (“FirstCity Commercial”), a wholly-owned affiliate of FirstCity, providesguarantees to various financial institutions for financing associatedinvestments and operations of certain Acquisition Partnerships. The underlyingfinancing arrangements of these Acquisitions Partnerships have variousmaturities ranging from July 2009 to May 2011, and are securedprimarily by certain real estate properties held by the AcquisitionPartnerships. At September 30, 2009, FirstCity Commercial’s maximumcommitments under these guaranty arrangements totaled $2.1 million, and thetotal unpaid debt obligations of these Acquisition Partnerships attributed toFirstCity Commercial’s underlying guaranty approximated $1.8 million.

 

*Environmental Matters*

 

The Company generally retains environmental consultants to conduct orupdate environmental assessments in connection with the Company’s foreclosedand acquired real estate properties. These environmental assessments have notrevealed environmental conditions that the Company believes will have amaterial adverse effect on its business, assets, financial condition, resultsof operations or liquidity, and the Company is not otherwise aware ofenvironmental conditions with respect to properties that the Company believeswould have such a material adverse effect. However, from time to time,environmental conditions at the Company’s properties have required and may inthe future require environmental testing and/or regulatory filings, as well asremedial action. Liabilities for future remediation costs arerecorded when environmental assessments and/or remedial efforts are probableand the costs can be reasonably estimated. Other than for assessments, thetiming and magnitude of these accruals generally are based on the completion ofinvestigations or other studies or a commitment to a formal plan of action.

 

*Limited-LifeSubsidiaries*

 

At September 30, 2009, the estimated settlement value of theCompany’s non-controlling interests in consolidated limited-life subsidiariesapproximated $3.9 million. The Company’s carrying value of the non-controllinginterests recognized on the consolidated balance sheet related to theselimited-life subsidiaries approximated $2.2 million at September 30, 2009.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(19)  Foreign Currency Exchange Risk Management**

 

We use debt as anon-derivative financial instrument to partially off-set the Company’s businessexposure to foreign currency exchange risk attributable to our net investmentsin Europe. Our focus is to manage the economic risks associated with ourEuropean subsidiaries, which are the foreign currency exchange risks that willultimately be realized when we exchange one currency for another. To helpprotect the Company’s net investment in certain of its European subsidiaryoperations from adverse changes in foreign currency exchange rates, wedenominate a portion of our debt in the same functional currency used by theEuropean subsidiaries. At September 30, 2009, the Company carried $27.1million in Euro-denominated debt and designated the debt as a non-derivativehedge of its net investment in certain European subsidiaries. The Companydesignated the hedging relationship such that changes in the net investmentsbeing hedged are expected to be naturally off-set by corresponding changes inthe value of the Euro-denominated debt. We consider our investments in Europeansubsidiaries to be denominated in a relatively stable currency and of along-term nature.

 

The effectiveportion of the net foreign investment hedge is reported in accumulated othercomprehensive income (loss) as part of the cumulative translation adjustment.Any ineffective portion of the net foreign investment hedge is recognized inearnings as other income (expense) during the period of change. Effectivenessof the hedging relationship is measured and designated at the beginning of eachmonth by comparing the outstanding balance of the Euro-denominated debt to thecarrying value of the designated net equity investments.

 

At September 30,2009, the carrying value and line item caption of the Company’s non-derivativeinstrument was reported on the consolidated balance sheet as follows (inthousands):

 
| **Non-Derivative**        | ** ** | ** **             | ** ** | ** **   | ** ** |
|---------------------------|------------|------------------------|------------|--------------|------------|
| **Instrument  in**        | ** ** | ** **             | ** ** | ** **   | ** ** |
| **Net  Investment**       | ** ** | **Balance Sheet**      | ** ** | **Carrying** | ** ** |
| **Hedging  Relationship** | ** ** | **Location**           | ** ** | **Value**    | ** ** |
|                      |       |                   |       |         |       |
| Euro-denominated debt     |       | Notes payable to banks |       | $            | 27,087     |   |
|                           |            |                        |            |              |            |  |

 

The effect of the non-derivative instrument qualifyingand designated as a hedging instrument in net foreign investment hedges on theconsolidated financial statements for the three and nine month periods ended September 30,2009 was as follows (in thousands):

 
| ** **               | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** **                    | ** ** | **Amount  of Gain (Loss)**   | ** ** |
|--------------------------|------------|------------------------------|------------|------------------------------|------------|-------------------------------|------------|------------------------------|------------|
| ** **               | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** **                    | ** ** | **Recognized  in Income**    | ** ** |
| ** **               | ** ** | **Amount  of Gain (Loss)**   | ** ** | ** **                   | ** ** | **(Ineffective  Portion and** | ** ** |
| **Non-Derivative**       | ** ** | **Recognized  in AOCL**      | ** ** | **Location  of Gain (Loss)** | ** ** | **Amount  Excluded from**     | ** ** |
| **Instrument in**        | ** ** | **(Effective  Portion)**     | ** ** | **Reclassified  from**       | ** ** | **Effectiveness  Testing)**   | ** ** |
| **Net Investment**       | ** ** | **Three  Months Ended**      | ** ** | **Nine  Months Ended**       | ** ** | **AOCL  into Income**         | ** ** | **Three  Months Ended**      | ** ** | **Nine  Months Ended** | ** ** |
| **Hedging Relationship** | ** ** | **September 30,  2009** | ** ** | **September 30,  2009** | ** ** | **(Effective  Portion)**      | ** ** | **September 30,  2009** | ** ** | **September 30,  2009** | ** ** |
|                     |       |                         |       |                         |       |                          |       |                         |       |   |   |
| Euro-denominated debt    |       | $                            | (857       | )                            | $          | (598                          | )          | Other income  (expense)      |       | $ | — |   | $ | — |   |
|                          |            |                              |            |                              |            |                               |            |                              |            |  |  |  |  |  |  |

 

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

 

**Overview**

 

FirstCityFinancial is a financial services company that engages in two major businesssegments — Portfolio Asset Acquisition and Resolution and Special SituationsPlatform. In the Portfolio Asset Acquisition and Resolution business, theCompany acquires portfolios of performing and non-performing loans and otherassets (collectively, “Portfolio Assets” or “Portfolios”), generally at adiscount to their legal principal balances or appraised values, and servicesand resolves such Portfolio Assets in an effort to maximize the present valueof the ultimate cash recoveries. Through its Special Situations Platformbusiness, the Company provides investment capital to privately-heldmiddle-market companies through flexible capital structuring arrangements togenerate an attractive risk-adjusted return. These capital investmentsprimarily take the form of senior and subordinate financing arrangements, butalso include direct equity investments, common equity warrants, distressed debttransactions, and leveraged buyouts.

 

TheCompany recorded net earnings of $2.0 million for the third quarter of 2009, anincrease of $3.8 million from the $1.8 million net loss reported for the thirdquarter of 2008. Diluted net earnings to common stockholders were $0.19 pershare in the third quarter of 2009, compared to diluted net losses of $0.17 percommon share for the same period in 2008. Revenue streams generated by theCompany’s earnings assets and servicing platform positively impacted earningsin the third quarter of 2009 — as revenues in the third quarter of 2009increased to $18.7 million compared to $12.7 million in the third quarter of2008. The Company’s revenues in the third quarter of 2009 include $12.1 millionof income and gains from Portfolio Assets; $1.5 million of interest income fromloans receivable; $2.2 million of fee income attributable to our loan servicingplatform, and $0.8 million of revenue attributable to our majority-ownedrailroad operations. The increase in earnings in the third quarter of 2009 fromthe comparable prior quarter in 2008 were also positively impacted by a $0.6million decrease in net impairment provisions, and a $0.6 million increase inforeign currency transaction gains. The impact of net impairment provisions andforeign currency transaction gains to our earnings in the third quarter of 2009are further explained below. In addition, see **Results ofOperations** below for a detailed review of the Company’s operationsfor the third quarter of 2009 compared to the third quarter of 2008.

 

In the thirdquarter of 2009, the Company was involved in acquiring $48.7 million ofdomestic Portfolio Asset investments with a face value of approximately $115.1million — of which FirstCity’s investment share was $21.0 million. In additionto its Portfolio Asset acquisitions in the third quarter of 2009, FirstCity invested$2.4 million in the form of SBA loan originations and advances; and $3.5million in the form of debt investments under its Special Situations Platform (“FirstCityDenver”). At September 30, 2009, the carrying value of FirstCity’s earningassets (Portfolio Assets, equity investments, loans receivable and entity-levelearning assets) totaled $393.0 million. The global distribution of FirstCity’searning assets (at carrying value) at September 30, 2009 included $290.6million in the United States; $60.9 million in Europe; and $41.5 million inLatin America.

 

*NetImpairment Provisions*

 

The Companyincurred $1.5 million of net impairment provisions in the third quarter of 2009— comprised of $0.4 million of net provisions recorded to our consolidated loansand portfolios, and $1.1 million as our share of net impairment provisionsrecorded to loans and portfolios held in our unconsolidated AcquisitionPartnerships. The global distribution of the $1.5 million of net impairmentprovisions recorded by the Company in the third quarter of 2009 includes $1.5million in the United States, $0.2 million in Latin America, and $0.2 millionof net recoveries in Europe. The impairment provisions in the third quarter of2009 were attributed primarily to declines in values of loan collateral andreal estate assets in our domestic loans and portfolios. The impairmentprovisions were identified in connection with management’s quarterly evaluationof the collectability of the Company’s Portfolio Assets and loans receivable. The process for evaluating and measuringimpairment is critical to our financial results, as it requires subjective andcomplex judgments due to the need to make estimates about the impact of mattersthat are uncertain. This process also requires estimates that are susceptibleto significant revision as more information becomes available. It remainsunclear what impact the illiquid markets, real estate value declines and theoverall economic slowdown will ultimately have on our financial results.Therefore, we cannot provide assurance that, in any particular period, we willnot incur additional impairment provisions in the future.

 

*ForeignCurrency Transaction Gains*

 

The combinedimpact of foreign currency transactions from the Company’s consolidated andnon-consolidated foreign operations resulted in a $0.1 million foreign currencyexchange gain in the third quarter of 2009 (compared to a combined impact of$0.5 million in foreign currency transaction losses in the third quarter of2008). The Company’s combined foreign currency exchange gain in the thirdquarter of 2009 was attributable primarily to our European operations. It remains unclear what impact the generalglobal economic conditions will have on our financial holdings and investmentsfrom our European and Latin American operations. As such, we cannot provideassurance that, in any particular period, we will not incur foreign currencytransaction losses in the future.

 

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*Management’s Outlook*

 

In spite of thesubstantial losses reported in the financial services sector over the past twoyears and downward pressure on economic growth due to continued weaknesses ingeneral economic conditions, management remains positive on the outlook of theCompany. Management believes that current market conditions should not hinderFirstCity’s ability to expand its business, and that asset acquisitionopportunities at attractive margins are available. As mentioned above,FirstCity was involved in acquiring $48.7 million of portfolio investments witha face value of approximately $115.1 million in the third quarter of 2009 — ofwhich FirstCity’s investment share was $21.0 million, and the Company investedan additional $5.9 million in the form of loan investments.

 

FirstCity presently has (1) $350.0million of credit facility commitments available to (i) finance the senior debtand equity portions of portfolio and asset purchases; (ii) finance equityinvestments in new ventures; and (iii) provide for the issuance of letters ofcredit working capital loans; and (2) a $25.0 million credit facilitycommitment to finance SBA loan originations and advances.

 

As a result ofsignificant period-to-period fluctuations in our revenues and earnings,period-to-period comparisons of the results of our operations may not bemeaningful. The Company’s financial results are impacted by many factorsincluding, but not limited to, general economic conditions; fluctuations ininterest rates and foreign currency exchange rates; fluctuations in theunderlying values of real estate and other assets; the timing and ability tocollect and liquidate assets; increased competition from other market players inthe industries in which we operate; and the availability, prices and terms forloan portfolios and other investments in all of the Company’s businesses. TheCompany’s business and results of operations are also impacted by theavailability of financing with terms acceptable to the Company, and our accessto capital markets. Such factors, individually or combined with other factors,may result in significant fluctuations in our reported operations and in thetrading price of our common stock.

 

Components of the results of operations for thethree and nine month periods ended September 30, 2009 and 2008, respectively,are detailed below (dollars in thousands except per share data):

 
| ** **                                     | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **September 30,**          | ** ** | **September 30,**     | ** ** |
| ** **                                     | ** ** | **2009**                   | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                     | ** ** | **(Dollars in thousands)** | ** ** |
| Portfolio Asset Acquisition  and Resolution    |       | $                          | 2,028      |                  | $          | (1,691 | ) | $ | 14,082 |   | $ | (8,763 | ) |
| Special Situations Platform                    |       | 1,615                      |       | 1,181                 |       | 1,820 |   | 1,632 |   |
| Operating contribution  (loss)                 |       | 3,643                      |       | (510                  | )          | 15,902 |   | (7,131 | ) |
| Corporate overhead                             |       | (1,643                     | )          | (1,245                | )          | (5,512 | ) | (4,737 | ) |
| Net earnings (loss)  attributable to FirstCity |       | $                          | 2,000      |                  | $          | (1,755 | ) | $ | 10,390 |   | $ | (11,868 | ) |
| Diluted earnings (loss) per  common share      |       | $                          | 0.19       |                  | $          | (0.17 | ) | $ | 1.02 |   | $ | (1.14 | ) |

 

**Results of Operations**

 

The following discussion and analysis is based onthe segment reporting information presented in Note 17 to the ConsolidatedFinancial Statements of the Company included in Item 1 of this Form 10-Q, andshould be read in conjunction with the Consolidated Financial Statements(including the Notes thereto) included elsewhere in this Form 10-Q.

 

***Third Quarter 2009 Compared to Third Quarter2008***

 

The Company reported net earnings of $2.0 millionin the third quarter of 2009 compared to net losses of $1.8 million in thethird quarter of 2008. Diluted net earnings to common stockholders were $0.19per common share in the third quarter of 2009 compared to $0.17 of diluted netlosses per common share in the third quarter of 2008.

 

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*Portfolio Asset Acquisition andResolution*

 

The operating contribution from the PortfolioAsset Acquisition and Resolution segment resulted in a $2.0 million operatinggain in the third quarter of 2009 compared to a $1.7 million operating loss forthe same period in 2008. FirstCity was involved in acquiring $48.7 million ofPortfolio Assets in the third quarter of 2009 with an approximate face value of$115.1 million, compared to its involvement in acquiring $4.5 million ofPortfolio Assets in the third quarter of 2008 with an approximate face value of$78.1 million. In the third quarter of 2009, FirstCity’s investment share inthe Portfolio Asset acquisitions was $21.0 million — with $18.6 millionacquired through consolidated Portfolios and $2.4 million through AcquisitionPartnerships. In the third quarter of 2008, the Company’s investment share inthe Portfolio Asset acquisitions was $3.2 million — comprised of $2.9 millionacquired through consolidated Portfolios and $0.3 million through AcquisitionPartnerships.

 

FirstCity invested an additional $2.4 million inthe third quarter of 2009 in the form of****SBA loanoriginations and advances, compared to $4.2million for the same period in 2008. FirstCity also invested $1.8million in direct equity investments in the third quarter of 2008.

 

The following is a summary of the results ofoperations for the Company’s Portfolio Asset Acquisition and Resolution businesssegment for the three-month periods ended September 30, 2009 and 2008:

 
| ** **                                                    | ** ** | **Three Months Ended**     | ** ** |
|---------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                    | ** ** | **September 30,**          | ** ** |
| ** **                                                    | ** ** | **2009**                   | ** ** | **2008** | ** ** |
| ** **                                                    | ** ** | **(Dollars in thousands)** | ** ** |
| **Portfolio  Asset Acquisition and Resolution:**              |       |                       |       |   |   |
| Revenues:                                                     |       |                       |       |   |   |
| Servicing fees                                                |       | $                          | 2,222      |   | $ | 3,842 |   |
| Income from Portfolio  Assets                                 |       | 12,134                     |       | 5,229 |   |
| Gain on sale of SBA loans  held for sale, net                 |       | 301                        |       | 85 |   |
| Interest income from SBA  loans                               |       | 299                        |       | 368 |   |
| Interest income from loans  receivable - affiliates           |       | 471                        |       | 442 |   |
| Interest income from loans  receivable - other                |       | —                     |       | 297 |   |
| Other income                                                  |       | 1,390                      |       | 623 |   |
| Total revenues                                                |       | 16,817                     |       | 10,886 |   |
| Expenses:                                                     |       |                       |       |   |   |
| Interest and fees on notes  payable                           |       | 3,366                      |       | 4,359 |   |
| Salaries and benefits                                         |       | 3,687                      |       | 4,208 |   |
| Provision for loan and  impairment losses                     |       | 425                        |       | 1,123 |   |
| Asset-level expenses                                          |       | 1,858                      |       | 996 |   |
| Occupancy, data processing  and other                         |       | 1,653                      |       | 2,767 |   |
| Total expenses                                                |       | 10,989                     |       | 13,453 |   |
| Equity in net earnings  (loss) of unconsolidated subsidiaries |       | (1,043                     | )          | 1,238 |   |
| Net income attributable to  noncontrolling interests          |       | (1,326                     | )          | (55 | ) |
| Operating contribution  (loss) before direct taxes            |       | $                          | 3,459      |   | $ | (1,384 | ) |
| Operating contribution  (loss), net of direct taxes           |       | $                          | 2,028      |   | $ | (1,691 | ) |

 

*Servicing fee revenues. *Servicing fee revenues decreasedto $2.2 million in the third quarter of 2009 from $3.8 million in the thirdquarter of 2008. Servicing fees from domestic Acquisition Partnerships totaled$0.5 million in the third quarter of 2009 compared to $1.2 million for the sameperiod in 2008, while servicing fees from Latin American Acquisition Partnershipstotaled $1.7 million in the third quarter of 2009 compared to $2.6 million forthe same period in 2008. Servicing fees from domestic Acquisition Partnershipsare generally based on a percentage of the collections received from theportfolios held by these non-consolidated partnerships; whereas servicing feesfrom Latin American Acquisition Partnerships are generally based on the cost ofservicing plus a profit margin. The decline in servicing fees from domesticAcquisition Partnerships for the third quarter of 2009 in comparison to thesame period in 2008 is attributable to a decline in portfolio collections to$4.7 million from $13.2 million for the respective periods. The decline inservicing fees from Latin American Acquisition Partnerships for the thirdquarter of 2009 in comparison to the same period in 2008 is attributableprimarily to foreign currency exchange rate fluctuations during the respectiveperiods that the fees were recorded.

 

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*Income from Portfolio Assets*.  Income from Portfolio Assets increased to$12.1 million in the third quarter of 2009 compared to $5.2 million in thethird quarter of 2008. FirstCity’s average investment in consolidated PortfolioAssets increased significantly to $230.6 million for the third quarter of 2009from $132.5 million for the third quarter of 2008 (a majority of FirstCity’sportfolio investments over the past year were acquired through consolidatedsubsidiaries). The significant increase in income from Portfolio Assets isattributed primarily to an increase in consolidated collections to $42.5million in the third quarter of 2009 compared to $15.6 million for the same periodin 2008; and $7.9 million of gains recorded on loan settlements in the thirdquarter of 2009 compared to $1.1 million of settlement gains recorded for thesame period in 2008. Refer to Note 5 to the Consolidated Financial Statementsincluded in Item 1 of this Form 10-Q for a summary of income from PortfolioAssets.

 

*Gain on sale of SBA loans heldfor sale. *The Company recorded a $301,000 gain on the sales of SBA loans in the third quarter of 2009with a $4.0 million net basis in the loans sold, compared to a $85,000 gainrecorded in the third quarter of 2008 with a $2.2 million net basis in theloans sold. Gains on SBA loan sales reflect the Company’s participation in theSBA guaranteed loan program. Under the SBA 7(a) program, the SBA guarantees upto 90 percent of the principal on a qualifying loan. The Company generallysells the guaranteed portions of originated loans into the secondary market andretains the unguaranteed portion for investment. The increased activity in thethird quarter of 2009 is attributable to the return of investor demand for SBAloans as a result of certain federal government programs and initiatives thatwere implemented during the past year.

 

*Interest income from SBAloans. *Interest income from SBA loansdecreased slightly to $0.3 million during the third quarter of 2009 compared to$0.4 million during the third quarter of 2008. Even though FirstCity’s averageinvestment in SBA loans increased to $18.3 million for the third quarter of2009 compared to $16.9 million for the third quarter of 2008, the decline ininterest income is attributable to a steady decline in market interest ratessince the third quarter of 2008 (the Company’s SBA loans are priced at variablemarket interest rates).

 

*Interest income from loansreceivable — affiliates. *Interest incomefrom loans receivable — affiliates increased to $0.5 million in the thirdquarter of 2009 compared to $0.4 million for the same period in 2008. Theincreased income is attributed to FirstCity’s average investment level in loansreceivable — affiliates growing to $14.0 million for the third quarter of 2009compared to $9.5 million for the third quarter of 2008.

 

*Interest income from loansreceivable — other. * Interest income from loans receivable — otherdecreased by $0.3 million for the third quarter of 2009 compared to the sameperiod in 2008. FirstCity’s average investment in loans receivable — other was$6.4 million and $9.3 million for the third quarters of 2009 and 2008,respectively. During the third quarter of 2009, the Company’s loans receivable —other were accounted for under the cost recovery method.

 

*Other income*.  Other income for the third quarter of 2009increased to $1.4 million in the third quarter of 2009 compared to $0.6 millionfor the same period in 2008. The increased income is attributable to $0.4million of additional due diligence income recorded in the third quarter of2009 compared to the same period in 2008, and $0.2 million of additional netrevenues recorded by certain foreclosed properties in the third quarter of 2009compared to the same period in 2008.

 

*Expenses. *Operating expenses approximated$11.0 million and $13.5 million in the third quarters of 2009 and 2008,respectively. The following is a discussion of the major components ofoperating expenses.

 

Interest expense and fees on notes payabletotaled $3.4 million and $4.4 million in the third quarters of 2009 and 2008,respectively. FirstCity’s average outstanding debt increased to $292.2 millionin the third quarter of 2009 from $220.2 million in the third quarter of 2008 —primarily to finance its increased investment activity. However, the Company’saverage cost of borrowings decreased to 4.6% in the third quarter of 2009compared to 7.9% in 2008 due to a decline in market interest rates.

 

Salaries and benefits totaled $3.7 million and$4.2 million in the third quarters of 2009 and 2008, respectively. The totalnumber of personnel within the Portfolio Asset Acquisition and Resolutionsegment was 216 and 207 at September 30, 2009 and 2008, respectively.

 

Net provisions for loan and impairment losses totaled $0.4 million inthe third quarter of 2009 compared to $1.1 million for the same period in 2008.In the third quarter of 2009, the Company recorded net impairment provisions of$1.3 million to consolidated domestic loan portfolios, which was off-setpartially by $0.9 million of net recoveries from consolidated European loanportfolios. The need for impairment provisions and recoveries is identified inconnection with management’s regular evaluation of the collectibility of theCompany’s Portfolio Assets and loans receivable. The process for evaluating and measuring impairment and recoveries iscritical to our financial results, as it requires subjective and complexjudgments due to the need to make estimates about the impact of matters thatare uncertain; and requires estimates that are susceptible to significantrevision as more information becomes available.

 

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Asset-level expenses, which generally representcosts incurred by FirstCity to manage consolidated Portfolio Assets, supportforeclosed properties and to protect its security interests in loan collateral,increased to $1.9 million in the third quarter of 2009 compared to $1.0 million for the same period in 2008. The rise in expenses is attributed primarily to the Company’s increasedholdings in consolidated Portfolio Assets (the Company’s average investment inconsolidated Portfolio Assets totaled $230.6 million for the third quarter of2009 from $132.5 million for the third quarter of 2008).

 

Occupancy, data processing and other expensesdecreased to $1.7 million for the third quarter of 2009 from $2.8 million inthe third quarter of 2008. The decrease is attributed primarily to $0.1 millionof foreign currency exchange gains from our foreign consolidated investments inthe third quarter of 2009 compared to $0.8 million of foreign currency exchangelosses for the same period in 2008 — a $0.9 million favorable impact.

 

*Equity in net earnings (loss) ofunconsolidated subsidiaries. *Equity in netearnings (loss) of unconsolidated subsidiaries (Acquisition Partnership andservicing entities) sharply decreased to a $1.0 million loss in the thirdquarter of 2009 compared to $1.2 million in earnings in the third quarter of2008. Equity in net earnings (loss) of the unconsolidated AcquisitionPartnerships decreased to a $0.8 million loss in the third quarter of 2009 from$1.6 million in earnings for the same period in 2008, and equity in earnings(loss) of the unconsolidated servicing entities decreased to a $0.2 million netloss in the third quarter of 2009 compared to a $0.3 million net loss in thethird quarter of 2008. The following is a discussion of equity in earnings fromFirstCity’s Acquisition Partnerships by geographic region. Refer to Note 7 ofthe Consolidated Financial Statements included in Item 1 on this Form 10-Q fora summary of revenues, earnings and equity in earnings of FirstCity’s equityinvestments by region.

 

·                *Domestic* — Total revenues reported by domestic AcquisitionPartnerships decreased to $1.1 million in the third quarter of 2009 from $2.6million for the same period in 2008. However, the total net loss reported by domestic partnerships decreased to $0.3 million inthe third quarter of 2009 compared to a $0.5 million net loss in the thirdquarter of 2008. The decrease in total partnership revenues wasattributed primarily to a significant decrease in portfolio collections to $4.7million in the third quarter of 2009 from $13.2 million in the third quarter of2008. The negative impact to net earnings as a result of the total partnershiprevenues decline was off-set partially by a $1.2 million decline in propertyprotection expenses in the third quarter of 2009 compared to the same period in2008. Portfolio assets (i.e. earning assets) held by the domestic partnershipsdecreased to $58.3 million in the third quarter of 2009 from $63.1 million forthe same period in 2008. The collective activity described above translated toa decrease in FirstCity’s share of net loss in domestic AcquisitionPartnerships to $0.3 million for the third quarter of 2009 from $0.4 millionfor the same period in 2008.

 

FirstCity’s average investment in domestic Acquisition Partnershipsdecreased to $12.4 million in the third quarter of 2009 from $20.7 million inthe third quarter of 2008 — which contributed to a decline in FirstCity’s shareof domestic partnership revenues as discussed above. Since a majority of FirstCity’s 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 domestic partnershipsrevenues.

 

·         *Latin America* — Total revenues reported by Latin American Acquisition Partnershipsdecreased to $3.8 million in the third quarter of 2009 from $8.8 million in thethird quarter of 2008. Latin Americanpartnerships reported a total net loss of $2.0 million in the third quarter of2009 compared to $2.5 million of net earnings for the same period in 2008. Thedecrease in net earnings was attributed primarily to a significant decrease incollections to $8.7 million in the third quarter of 2009 from $16.4 million inthe third quarter of 2008 (which negatively impacted revenues), and foreigncurrency transaction losses of $0.7 millionrecorded in the third quarter of 2009 compared to $3.1 million offoreign currency transaction gains in the third quarter of 2008 — a $3.8 million negative impact. LatinAmerican partnership portfolio asset holdings (i.e. earning assets) decreasedto $135.7 million at September 30, 2009 from $184.2 million at September 30,2008.  The collective activitydescribed above translated to a decrease in FirstCity’s share of net earningsin Latin American Acquisition Partnerships to $0.2 million in net losses forthe third quarter of 2009 from $0.4 million in net earnings for the same periodin 2008.

 

FirstCity’s average investment in Latin American AcquisitionPartnerships decreased to $18.0 million in the third quarter of 2009 from $24.2million in the third quarter of 2008 — which contributed to a decline inFirstCity’s share of Latin American partnership revenues as discussed above. Since a majority of FirstCity’s portfolioacquisitions over the past two years were acquired through consolidatedPortfolios instead of equity investments in Acquisition Partnerships, theCompany expects income from consolidated Portfolios to off-set the decline inLatin American partnerships revenues.

 

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·             *Europe*—****Total revenues reported by European AcquisitionPartnerships sharply decreased to $2.3 million in the third quarter of 2009from $12.2 million in the third quarter of 2008. In addition, total net earnings reported by European partnershipsdecreased to $1.0 million of net losses in the third quarter of 2009 comparedto $6.4 million of net earnings in the same period of 2008. The decreasein total partnership net earnings was attributed primarily to a significantdecrease in collections to $7.2 million in the third quarter of 2009 from $17.0million for the same period in 2008 (which negatively impacted revenues), andan increase in total provisions reported by the European partnerships to $2.1million in the third quarter of 2009 from $1.0 million in the third quarter of2008. European partnership portfolio asset holdings (i.e. earning assets)decreased to $77.2 million at September 30, 2009 from $109.2 million at September30, 2008. The collective activity described above translated to a decrease inFirstCity’s share of European partnership earnings to $0.3 million in lossesfor the third quarter of 2009 from $1.6 million in earnings for the thirdquarter of 2008.

 

FirstCity’s average investment in European Acquisition Partnershipsdecreased to $11.9 million in the third quarter of 2009 from $27.8 million inthe third quarter of 2008 — which contributed to a decline in FirstCity’s shareof European partnership revenues as discussed above. Since a majority of FirstCity’s 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 European partnershipsrevenues.

 

*Net income attributable tononcontrolling interests. *The amount of netincome attributable to noncontrolling interests increased to $1.3 million forthe third quarter of 2009 from $55,000 for the same period in 2008. Theincrease is attributed primarily to a rise in the Company’s level ofco-investments in portfolio purchases with other investors through consolidatedsubsidiaries over the past two years. The Company’s carrying value ofnoncontrolling interests on its consolidated balance sheet, which representsthe equity in consolidated subsidiaries not attributable to FirstCity,increased to $52.3 million at September 30, 2009 from $16.7 million at September30, 2008.

 

***Special Situations PlatformBusiness Segment***

 

The operating contribution from the Special Situations Platformbusiness segment (“FirstCity Denver”) resulted in a $1.6 million operating gainin the third quarter of 2009 compared to a $1.2 million operating gain for thesame period in 2008. In the third quarter of 2009, FirstCity Denver provided$3.5 million of investment capital to privately-held middle-market companies inthe form of debt investments. Since its inception in April 2007, FirstCityDenver has been involved in middle-market transactions with total investmentvalues approximating $60.9 million, and has provided $40.5 million ofinvestment capital in connection with these investments.

 

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The following is a summary of the results ofoperations for the Company’s Special Situations Platform business segment for the three months ended September 30, 2009 and2008:

 
| ** **                                             | ** ** | **Three Months Ended**     | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|
| ** **                                             | ** ** | **September 30,**          | ** ** |
| ** **                                             | ** ** | **2009**                   | ** ** | **2008** | ** ** |
| ** **                                             | ** ** | **(Dollars in thousands)** | ** ** |
| **Special  Situations Platform:**                      |       |                       |       |   |   |
| Revenues:                                              |       |                       |       |   |   |
| Interest income from loans  receivable                 |       | $                          | 706        |   | $ | 677 |   |
| Revenue from railroad  operations                      |       | 776                        |       | 810 |   |
| Other income                                           |       | 338                        |       | 228 |   |
| Total revenues                                         |       | 1,820                      |       | 1,715 |   |
| Expenses - Railroad  Operations:                       |       |                       |       |   |   |
| Interest and fees on notes  payable                    |       | 29                         |       | 54 |   |
| Salaries and benefits                                  |       | 252                        |       | 229 |   |
| Other                                                  |       | 225                        |       | 342 |   |
| Total railroad expenses                                |       | 506                        |       | 625 |   |
| Expenses - Other:                                      |       |                       |       |   |   |
| Interest and fees on notes  payable                    |       | 116                        |       | 158 |   |
| Salaries and benefits                                  |       | 280                        |       | 170 |   |
| Other                                                  |       | 571                        |       | 359 |   |
| Total other expenses                                   |       | 967                        |       | 687 |   |
| Total expenses                                         |       | 1,473                      |       | 1,312 |   |
| Equity in net earnings of  unconsolidated subsidiaries |       | 1,464                      |       | 932 |   |
| Net income attributable to  noncontrolling interests   |       | (262                       | )          | (169 | ) |
| Operating contribution  before taxes                   |       | $                          | 1,549      |   | $ | 1,166 |   |
| Operating contribution, net  of direct taxes           |       | $                          | 1,615      |   | $ | 1,181 |   |

 

*Interest income from loansreceivable. * Interest income from loans receivable in the third quarter of 2009 remained constant in comparison to the sameperiod in 2008. FirstCity Denver’s average investment in loans receivable was$20.9 million for the third quarter of 2009 — including $3.0 million accountedfor under the cost recovery method. For the third quarter of 2008, FirstCityDenver’s average investment in loans receivable was $19.2 million.

 

*Revenue from railroad operations*.  Revenue from railroad operations in the third quarter of 2009 remained relatively constant in comparison to thesame period in 2008.

 

*Expenses — Railroad Operations. *Total expenses from FirstCity Denver’smajority-owned railroad operations remained relatively constant in comparisonto the same period in 2008.

 

*Expenses — Other. *Other expenses increased by $0.3 millionin the third quarter of 2009 compared to the same period in 2008 primarily as aresult of additional due diligence and consultant costs in light of increasedtransaction activity in the third quarter of 2009.

 

*Equity in net earnings ofunconsolidated subsidiaries. *Equity in netearnings of unconsolidated subsidiaries increased to $1.5 million in the third quarter of 2009 from $0.9 million in the third quarter of 2008.Equity in net earnings for the third quarter of 2009 is attributable primarilyto FirstCity Denver’s share of net earnings from its equity-method investmentsin a coal mine operation ($0.9 million) and ceramic-ware manufacturing entity($0.7 million — which includes $0.4 million related to a gain on businessacquisition). Equity in net earnings for the third quarter of 2008 isattributable to FirstCity Denver’s share of net earnings from its equity-methodinvestment in the coal mine operation.

 

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***First Nine Months of 2009 Compared to FirstNine Months of 2008***

 

The Company reported net earnings of $10.4million in the first nine months 2009 compared to a net loss of $11.9 millionin the first nine months of 2008. Diluted net earnings to common stockholderswas $1.02 per common share in the first nine months of 2009 compared to $1.14of diluted net losses per common share in the first nine months of 2008.

 

*Portfolio Asset Acquisition andResolution*

 

The operating contribution from the PortfolioAsset Acquisition and Resolution segment resulted in a $14.1 million operatinggain in the first nine months of 2009 compared to an $8.8 million net operatingloss in the first nine months of 2008. FirstCity was involved in acquiring$186.0 million of Portfolio Assets in the first nine months of 2009 with anapproximate face value of $373.6 million, compared to its involvement inacquiring $61.1 million of Portfolio Assets in first nine months 2008 with anapproximate face value of $716.2 million. In the first nine months of 2009,FirstCity’s investment share in the Portfolio Asset acquisitions was $134.5million — comprised of $131.5 million acquired through consolidated Portfoliosand $3.0 million through Acquisition Partnerships. In the first nine months of2008, the Company’s investment share in the Portfolio Asset acquisitions was$45.1 million — comprised of $43.1 million acquired through consolidatedPortfolios and $2.0 million through Acquisition Partnerships.

 

FirstCity invested an additional $16.8 million inthe first nine months of 2009 in the form of****SBA loanoriginations and advances. The Companyinvested an additional $21.1 million in the form of SBA loanoriginations and advances and other debtfinancing arrangements in the first nine months 2008. FirstCity alsoinvested $11.2 million in direct equity investments in the first nine months of2009 (attributable primarily to European entity acquisitions), compared to $1.8million in the first nine months of 2008.

 

The following is a summary of the results ofoperations for the Company’s Portfolio Asset Acquisition and Resolutionbusiness segment for the nine-month periods ended September 30, 2009 and 2008:

 
| ** **                                                    | ** ** | **Nine Months Ended**      | ** ** |
|---------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                    | ** ** | **September 30,**          | ** ** |
| ** **                                                    | ** ** | **2009**                   | ** ** | **2008** | ** ** |
| ** **                                                    | ** ** | **(Dollars in thousands)** | ** ** |
| **Portfolio  Asset Acquisition and Resolution:**              |       |                       |       |   |   |
| Revenues:                                                     |       |                       |       |   |   |
| Servicing fees                                                |       | $                          | 7,017      |   | $ | 8,748 |   |
| Income from Portfolio  Assets                                 |       | 35,254                     |       | 15,786 |   |
| Gain on sale of SBA loans  held for sale, net                 |       | 911                        |       | 227 |   |
| Interest income from SBA  loans                               |       | 940                        |       | 1,210 |   |
| Interest income from loans  receivable - affiliates           |       | 1,560                      |       | 739 |   |
| Interest income from loans  receivable - other                |       | 414                        |       | 433 |   |
| Other income                                                  |       | 2,987                      |       | 1,993 |   |
| Total revenues                                                |       | 49,083                     |       | 29,136 |   |
| Expenses:                                                     |       |                       |       |   |   |
| Interest and fees on notes  payable                           |       | 10,128                     |       | 11,742 |   |
| Salaries and benefits                                         |       | 11,208                     |       | 11,596 |   |
| Provision for loan and  impairment losses                     |       | 1,241                      |       | 11,243 |   |
| Asset-level expenses                                          |       | 4,208                      |       | 3,976 |   |
| Occupancy, data processing  and other                         |       | 4,820                      |       | 6,103 |   |
| Total expenses                                                |       | 31,605                     |       | 44,660 |   |
| Equity in net earnings  (loss) of unconsolidated subsidiaries |       | (188                       | )          | 7,442 |   |
| Gain on step acquisition                                      |       | 1,455                      |       | — |   |
| Net income attributable to  noncontrolling interests          |       | (2,854                     | )          | (93 | ) |
| Operating contribution  (loss) before direct taxes            |       | $                          | 15,891     |   | $ | (8,175 | ) |
| Operating contribution  (loss), net of direct taxes           |       | $                          | 14,082     |   | $ | (8,763 | ) |

 

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*Servicing fee revenues. *Servicing fee revenues decreasedto $7.0 million in the first nine months of 2009 from $8.7 million in the firstnine months of 2008. Servicing fees from domestic Acquisition Partnershipstotaled $1.8 million in the first nine months of 2009 compared to $2.0 millionin the first nine months of 2008, while servicing fees from Latin AmericanAcquisition Partnerships totaled $5.2 million in the first nine months of 2009compared to $6.7 million in the first nine months of 2008. Servicing fees fromdomestic Acquisition Partnerships are generally based on a percentage of thecollections received from the portfolios held by these non-consolidated partnerships;whereas servicing fees from Latin American Acquisition Partnerships aregenerally based on the cost of servicing plus a profit margin. The decline inservicing fees from domestic Acquisition Partnerships for the first nine monthsof 2009 in comparison to the same period in 2008 is attributable to a declinein portfolio collections to $19.0 million from $30.7 million for the respectiveperiods. The decline in servicing fees from Latin American AcquisitionPartnerships for the first nine months of 2009 in comparison to the same periodin 2008 is attributable primarily to foreign currency exchange ratefluctuations during the respective periods that the fees were recorded.

 

*Income from Portfolio Assets*.  Income from Portfolio Assets increased to $35.3million in the first nine months of 2009 compared to $15.8 million in the firstnine months of 2008. FirstCity’s average investment in consolidated PortfolioAssets increased significantly to $196.3 million for the first nine months of2009 from $123.5 million for the first nine months of 2008 (a majority ofFirstCity’s portfolio investments over the past year were acquired throughconsolidated subsidiaries). The significant increase in income from PortfolioAssets is attributed primarily to an increase in collections to $124.6 millionin the first nine months of 2009 compared to $46.5 million in the first ninemonths of 2008; $19.9 million of gains recorded on loan settlements in thefirst nine months of 2009 compared to $4.4 million of settlement gains recordedin the first nine months of 2008; and additional interest accretion recorded bythe Company as a result of its increased investment level in loan PortfolioAssets. Refer to Note 5 to the Consolidated Financial Statements included inItem 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 $0.9 million gain on the sales of SBA loans in the first nine months of2009 with a $17.2 million basis in the loans sold, compared to a $0.2 milliongain recorded in the first nine months of 2008 with a $5.1 million basis in theloans sold. Gains on SBA loan sales reflect the Company’s participation in theSBA guaranteed loan program. Under the SBA 7(a) program, the SBA guarantees upto 90 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. The increased activity in thefirst nine months of 2009 is attributable to the return of investor demand forSBA loans as a result of certain federal government programs and initiativesthat were implemented during the past year.

 

*Interest income from SBAloans. *Interest income from SBA loansdecreased to $0.9 million during the first nine months of 2009 compared to $1.2million during the first nine months of 2008. Even though FirstCity’s averageinvestment in SBA loans increased to $20.8 million for the first nine months of2009 from $15.6 million for the first nine months of 2008, the decline ininterest income is attributable to a steady decline in market interest ratessince the third quarter of 2008 (the Company’s SBA loans are priced at variablemarket interest rates).

 

*Interest income from loans receivable— affiliates. *Interest incomefrom loans receivable — affiliates increased to $1.6 million in first ninemonths 2009 compared to $0.7 million in first nine months 2008. The increasedincome is attributed to FirstCity’s average investment level in loansreceivable — affiliates growing to $14.0 million for the first nine months of2009 from $7.0 million for the first nine months of 2008.

 

*Interest income from loansreceivable — other. * Interest income from loans receivable remainedconstant in the first nine months of 2009 compared to the first nine months of2008. FirstCity’s average investment in loans receivable — other was $6.9million for the first nine months of 2009 — including $2.1 million accountedfor under the cost recovery method. For the first nine months of 2008,FirstCity’s average investment in loans receivable — other was $4.9 million.

 

*Other income*.  Other income for the first nine months of2009 increased by $1.0 million in comparison to the first nine months of 2008primarily due to $0.5 million of interest income earned on the Company’sinvestment security in 2009 (purchased in October 2008), and $0.3 million ofadditional due diligence income recorded in the first nine months of 2009compared to the same period in 2008.

 

*Expenses. *Operating expenses approximated$31.6 million and $44.7 million in the first nine months of 2009 and 2008,respectively. The following is a discussion of the major components ofoperating expenses.

 

Interest expense and fees on notes payabletotaled $10.1 million and $11.7 million in the first nine months of 2009 and2008, respectively. FirstCity’s average outstanding debt increased to $279.5million for the first nine months of 2009 from $193.3 million for the firstnine months of 2008 — primarily to finance its increased investment activity.However, the Company’s average cost of borrowings decreased to 4.8% in thefirst nine months of 2009 compared to 8.1% in 2008 due to a decline in marketinterest rates.

 

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Salaries and benefits totaled $11.2 million and$11.6 million in the first nine months of 2009 and 2008, respectively. Thetotal number of personnel within the Portfolio Asset Acquisition and Resolutionsegment was 216 and 207 at September 30, 2009 and 2008, respectively.

 

Net provisions for loan and impairment losses totaled $1.2 million inthe first nine months of 2009 compared to $11.2 million in the first ninemonths of 2008. In 2009, the Company recorded net impairment provisions of $4.2million to consolidated domestic loan portfolios; off-set partially by $3.0million of net recoveries from consolidated European loan portfolios. Thesignificant provisions recorded in the first nine months of 2008 derived fromthe then-developing adverse effects of the global economic crisis. The need forimpairment provisions and recoveries are identified in connection withmanagement’s regular evaluation of the collectibility of the Company’sPortfolio Assets and loans receivable. Theprocess for evaluating and measuring impairment and recoveries is critical toour financial results, as it requires subjective and complex judgments due tothe need to make estimates about the impact of matters that are uncertain. Thisprocess requires estimates that are susceptible to significant revision as moreinformation becomes available.

 

Asset-level expenses, which generally representcosts incurred by FirstCity to manage consolidated Portfolio Assets, supportforeclosed properties and to protect its security interests in loan collateral,increased to $4.2 million in the first nine months of 2009 compared to $4.0 million in the first nine months of 2008. The increase is attributed primarily to theCompany’s increased holdings in consolidated Portfolio Assets (the Company’saverage investment in consolidated Portfolio Assets totaled $196.3 million forthe first nine months of 2009 from $123.5 million for the same period in 2008).

 

Occupancy, data processing and other expensesdecreased to $4.8 million for the first nine months of 2009 from $6.1 millionfor the first nine months of 2008. The decrease is attributed primarily to $0.4million of foreign currency exchange gains from our foreign consolidatedinvestments in the first nine months of 2009 compared to $1.0 million offoreign currency exchange losses for the same period in 2008 — a $1.4 millionfavorable impact.

 

*Equity in net earnings (loss) ofunconsolidated subsidiaries. *Equity in netearnings (loss) of unconsolidated subsidiaries (Acquisition Partnership andservicing entities) decreased to $0.2 million in losses in the first ninemonths of 2009 compared to $7.4 million in earnings in the first nine months of2008. Equity in earnings of unconsolidated Acquisition Partnerships decreasedto $0.4 million in 2009 from $6.9 million in 2008, and equity in earnings(loss) of unconsolidated servicing entities decreased to a $0.6 million loss in2009 compared to $0.5 million of earnings in 2008. The following is adiscussion of equity in earnings from FirstCity’s Acquisition Partnerships bygeographic region. Refer to Note 7 of the Consolidated Financial Statementsincluded in Item 1 on this Form 10-Q for a summary of revenues, earnings andequity in earnings of FirstCity’s equity investments by region.

 

·             *Domestic* — Total revenues reported by domesticAcquisition Partnerships decreased to $5.7 million in the first nine months of2009 from $8.9 million in 2008. However, totalnet earnings reported by domestic partnerships increased to $1.1 million in thefirst nine months of 2009 compared to a $0.3 million loss in 2008. Thenegative impact to net earnings as a result of the total partnership revenuesdecline was off-set partially by a $1.7 million decline in net provisions and a$1.1 million decline in property protection expenses in the first nine monthsof 2009 compared to the same period in 2008. Portfolio assets (i.e. earningassets) held by the domestic partnerships decreased to $58.3 million at September30, 2009 from $63.1 million at September 30, 2008. The collective activitydescribed above translated to an increase in FirstCity’s share of net earningsin domestic Acquisition Partnerships to $0.2 million in earnings for the firstnine months of 2009 from a $0.3 million loss in 2008.

 

FirstCity’s average investment in domestic Acquisition Partnershipsdecreased to $13.8 million in the first nine months of 2009 from $22.2 millionin 2008 — which contributed to a decline in FirstCity’s share of domesticpartnership revenues as discussed above. Sincea majority of FirstCity’s portfolio investments over the past two years wereacquired through consolidated Portfolios instead of equity investments inAcquisition Partnerships, the Company expects income from consolidatedPortfolios to off-set the decline in domestic partnerships revenues.

 

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·         *Latin America* — Total revenues reported by Latin American Acquisition Partnershipssignificantly decreased to $9.2 million in the first nine months of 2009 from$32.5 million in the first nine months of 2008. In addition, Latin American partnerships reported a total netloss of $3.0 million in the first nine months of 2009 compared to $8.5 millionof total net earnings in the first nine months of 2008. The decrease in netearnings reported by Latin American partnerships was attributed primarily tothe following: (1) foreign currency transaction gains of $2.1 million recordedin the first nine months of 2009 compared to $11.5 million of foreigncurrency transaction gains in 2008 — a $9.4million negative impact; and (2) decrease in collections to $20.5 millionin the first nine months of 2009 from $56.9 million in 2008. The negativeimpact of these factors to total net earnings by Latin American partnershipswas partially off-set by the following: (1) decrease in net impairmentprovisions by $4.8 million in the first nine months of 2009 compared to thefirst nine months of 2008; (2) $6.6 million decrease in service fees expense inthe first nine months of 2009 in comparison to the same period in 2008; (3) $2.3million decrease in property protection costs in the first nine months of 2009compared to the same period in 2008; and (4) $3.0 million decrease in interestexpense in the first nine months of 2009 compared to the same period in 2008.  Latin American partnership portfolioasset holdings (i.e. earning assets) decreased to $135.7 million at September 30,2009 from $184.2 million at September 30, 2008.  The collective activity described above translated to a decreasein FirstCity’s share of net earnings in Latin American partnerships to a $0.5million loss for the first nine months of 2009 from $1.5 million of netearnings for the same period in 2008.

 

FirstCity’s average investment in Latin American AcquisitionPartnerships decreased to $17.8 million for the first nine months of 2009 from$23.6 million for 2008 — which contributed to a decline in FirstCity’s share ofLatin American partnership revenues as discussed above. Since a majority of FirstCity’s 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 Latin American partnershipsrevenues.

 

·             *Europe*—****Total revenues reported by European AcquisitionPartnerships decreased to $13.8 million in the first nine months of 2009 from$34.3 million in the first nine months of 2008. In addition, total net earnings reported by Europeanpartnerships decreased to $2.7 million in the first nine months of 2009compared to $20.1 million in the first nine months of 2008. The decreasein total partnership net earnings was attributed primarily to a significantdecrease in collections to $22.6 million in the first nine months of 2009 from$50.1 million for the same period in 2008 (which negatively impacted revenues),and a $4.3 million increase in total provisions reported by the Europeanpartnerships in the first nine months of 2009 compared to the same period in2008. The negative impact of these factors to total net earnings by Europeanpartnerships was partially off-set by the following: (1) decrease in interestexpense by $1.4 million in the first nine months of 2009 compared to the firstnine months of 2008; (2) $4.0 million decrease in service fees expense in thefirst nine months of 2009 in comparison to the same period in 2008; and (3) $2.0million decrease in property protection costs and legal and accounting expensesin the first nine months of 2009 in comparison to the same period in 2008.European partnership portfolio asset holdings (i.e. earning assets) decreasedto $77.2 million at September 30, 2009 from $109.2 million at September 30,2008. The collective activity described above translated to a decrease inFirstCity’s share of European partnership earnings to $0.7 million for thefirst nine months of 2009 from $5.7 million for 2008.

 

FirstCity’s average investment in European Acquisition Partnershipsdecreased to $12.6 million for the first nine months of 2009 from $29.6 millionfor 2008 — which contributed to a decline in FirstCity’s share of Europeanpartnership revenues as discussed above. Sincea majority of FirstCity’s portfolio acquisitions over the past two years wereacquired through consolidated Portfolios instead of equity investments inAcquisition Partnerships, and in light of FirstCity’s step-acquisitiontransactions and resulting consolidations of UBN (former unconsolidatedEuropean Acquisition Partnership) in September 2008 and sixteen French entities(former unconsolidated European Acquisition Partnerships) in May 2009, the Companyexpects income from consolidated Portfolios to off-set the decline in Europeanpartnerships revenues.

 

*Gain on step acquisition. *In the first nine months of2009, the Company recorded a $1.5 million gain attributable to a stepacquisition transaction in which the Company acquired a controlling financialinterest in certain French Acquisition Partnerships. The Company owned anoncontrolling equity interest in these entities prior to the transaction.Pursuant to business combination accounting standards, the Company’spreviously-held noncontrolling interests in the French entities were remeasuredto fair value on the acquisition date (May 2009) — which resulted in theCompany’s recognition of the $1.5 million gain. Refer to Note 4 to theConsolidated Financial Statements included in Item 1 of this Form 10-Q foradditional information on this transaction.

 

*Net income attributable tononcontrolling interests. *The amount of netincome attributable to noncontrolling interests increased to $2.9 million for thefirst nine months of 2009 from $93,000 for the same period in 2008. Theincrease is attributed primarily to a rise in the Company’s level ofco-investments in portfolio purchases with other investors through consolidatedsubsidiaries over the past two years. The Company’s carrying value ofnoncontrolling interests on its consolidated balance sheet, which representsthe equity in consolidated subsidiaries not attributable to FirstCity,increased to $52.3 million at September 30, 2009 from $16.7 million at September30, 2008.

 

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***Special Situations Platform Business Segment***

 

The operating contribution from the Special Situations Platformbusiness segment (“FirstCity Denver”) totaled $1.8 million in the first ninemonths of 2009 compared to $1.6 million in 2008.In the first nine months of 2009, FirstCity Denver provided $9.0 million ofinvestment capital to privately-held middle-market companies in the form ofdebt investments and direct equity investments. Since its inception in April 2007,FirstCity Denver has been involved in middle-market transactions with totalinvestment values approximating $60.9 million, and has provided $40.5 millionof investment capital in connection with these investments.

 

The following is a summary of the results ofoperations for the Company’s Special Situations Platform business segment for the nine months ended September 30, 2009 and 2008:

 
| ** **                                             | ** ** | **Nine Months Ended**      | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|
| ** **                                             | ** ** | **September 30,**          | ** ** |
| ** **                                             | ** ** | **2009**                   | ** ** | **2008** | ** ** |
| ** **                                             | ** ** | **(Dollars in thousands)** | ** ** |
| **Special  Situations Platform:**                      |       |                       |       |   |   |
| Revenues:                                              |       |                       |       |   |   |
| Interest income from loans  receivable                 |       | $                          | 1,858      |   | $ | 1,507 |   |
| Revenue from railroad  operations                      |       | 2,228                      |       | 2,446 |   |
| Other income                                           |       | 1,647                      |       | 278 |   |
| Total revenues                                         |       | 5,733                      |       | 4,231 |   |
| Expenses - Railroad  Operations:                       |       |                       |       |   |   |
| Interest and fees on notes  payable                    |       | 84                         |       | 113 |   |
| Salaries and benefits                                  |       | 731                        |       | 701 |   |
| Other                                                  |       | 808                        |       | 936 |   |
| Total railroad expenses                                |       | 1,623                      |       | 1,750 |   |
| Expenses - Other:                                      |       |                       |       |   |   |
| Interest and fees on notes  payable                    |       | 347                        |       | 157 |   |
| Salaries and benefits                                  |       | 751                        |       | 503 |   |
| Provision for loan and  impairment losses              |       | 967                        |       | — |   |
| Other                                                  |       | 1,404                      |       | 611 |   |
| Total other expenses                                   |       | 3,469                      |       | 1,271 |   |
| Total expenses                                         |       | 5,092                      |       | 3,021 |   |
| Equity in net earnings of  unconsolidated subsidiaries |       | 1,661                      |       | 576 |   |
| Net income attributable to  noncontrolling interests   |       | (313                       | )          | (162 | ) |
| Operating contribution  before taxes                   |       | $                          | 1,989      |   | $ | 1,624 |   |
| Operating contribution, net  of direct taxes           |       | $                          | 1,820      |   | $ | 1,632 |   |

 

*Interest income from loansreceivable. * Interest income from loans receivableincreased to $1.9 million in the first nine months of 2009 from $1.5 million in the first nine months of 2008. FirstCity Denver’saverage investment in loans receivable was $20.1 million for the first ninemonths of 2009 — including $1.9 million accounted for under the cost recoverymethod. For the first nine months of 2008, FirstCity Denver’s averageinvestment in loans receivable was $13.7 million.

 

*Revenue from railroad operations*.  Revenue from railroad operations of $2.2million for the firstnine months of 2009 remained relativelyconstant in comparison to $2.4 million for the first nine months of 2008.

 

*Other income*.  Other income for the first nine months of 2009 increased by $1.4 million in comparison to 2008primarily due to a $1.2 million of gains recognized by FirstCity Denver’smajority-owned railroad operation in the first nine months of 2009 inconnection with a property and equipment sales.

 

*Expenses — Railroad Operations. *Total expenses from FirstCity Denver’smajority-owned railroad operations remained relatively constant in comparisonto the same period in 2008.

 

*Expenses — Other. *Provision for loanand impairment losses in the first nine months of 2009 is attributable to a$1.0 million impairment provision recorded to a middle-market company debtinvestment in 2009.The impairment provision was identified in connection with management’s regularevaluation of the collectibility of the FirstCity Denver’s loan investments. The process for evaluating and measuringimpairment is critical to our financial results, as it requires subjective andcomplex judgments due to the need to make estimates about the impact of mattersthat are uncertain; and requires estimates that are susceptible to significantrevision as more information becomes available. Other expenses for the firstnine months of 2009 increased by $0.8 million in comparison to the same periodin 2008 primarily due to $0.6 million of additional operating expenses incurredin the first nine months of 2009 in connection with FirstCity Denver’sinvestment in a real estate property it acquired in June 2008.

 

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*Equity in net earnings ofunconsolidated subsidiaries. *Equity in netearnings of unconsolidated subsidiaries increased to $1.7 million in the first nine months of 2009 from $0.6 million in 2008 — which is comprisedprimarily of FirstCity Denver’s equity earnings in its equity-methodinvestments in a coal mine operation (for 2008 and 2009) and ceramic-waremanufacturing entity (for 2009 only). For the first nine months of 2009,FirstCity Denver’s equity in earnings attributable to the coal mine’s operationapproximated $2.3 million; however, FirstCity Denver’s share of net earnings inthe coal mine was off-set partially by its share ($1.1 million) of a one-timecharge incurred by the coal mine company in the second quarter of 2009 torelinquish its future reclamation liability. FirstCity Denver’s share of netearnings in the ceramic-ware manufacturing entity was $0.7 million for thefirst nine months of 2009 — which includes $0.4 million related to a gain onbusiness acquisition). Equity in net earnings for the first nine months of 2008is attributable to FirstCity Denver’s share of net earnings from itsequity-method investment in the coal mine operation.

 

#### **FinancialCondition**

#### ** **

Significant changes in FirstCity’s financialcondition during the first nine months of 2009 resulted from the following:

 

Consolidated assets of $438.1 million at September30, 2009 were $109.2 million higher than consolidated assets at December 31,2008. The increase in consolidated assets is attributed primarily to a $97.5million net increase in Portfolio Assets and loan investments related toFirstCity’s investment activities during the first nine months of the year. Inaddition, the Company’s cash and cash equivalents increased by $13.9 millionsince December 31, 2008.

 

Consolidated liabilities of $320.6 million as of September30, 2009 were $57.6 million higher than consolidated liabilities at December 31,2008. Total notes payable increased by $51.3 million primarily to finance theCompany’s investment activities during the first nine months of 2009.

 

FirstCity’s reported amount of noncontrollinginterests (included as a component of equity) increased by $36.7 million since December31, 2008 in connection with its co-investments in portfolio purchases withother investors through consolidated entities during the first nine months of2009, and its step acquisition of certain French Acquisition Partnerships in May2009 (refer to Note 4 to the Consolidated Financial Statements included in Item1 of this Form 10-Q for additional information on this transaction).

 

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

#### ** **

Revenues with respect to the Company’s Portfolio AssetAcquisition and Resolution business segment consist primarily of (i) incomefrom Portfolio Assets and loans receivable; (ii) gains on the disposition andsettlement of Portfolio Assets and other assets; and (iii) servicing fees fromAcquisition Partnerships for the performance of servicing activities related tothe assets held in the Acquisition Partnerships. The Company also recordsequity in earnings of non-consolidated Acquisition Partnerships and servicingentities accounted for under the equity-method of accounting.

 

Aggregate Portfolio Assetacquisitions by the Company for the nine months ended September 30, 2009 andthe last five full fiscal years are as follows:

 
| ** **                | ** ** | **Purchase**               | ** ** | **FirstCity**  | ** ** |
|---------------------------|------------|----------------------------|------------|----------------|------------|
| ** **                | ** ** | **Price**                  | ** ** | **Investment** | ** ** |
| ** **                | ** ** | **(Dollars in thousands)** | ** ** |
| First nine months of 2009 |       | $                          | 185,982    |           | $          | 134,466 |   |
| Total 2008                |       | 89,314                     |       | 72,307         |       |
| Total 2007                |       | 214,333                    |       | 126,714        |       |
| Total 2006                |       | 296,990                    |       | 144,048        |       |
| Total 2005                |       | 146,581                    |       | 71,405         |       |
| Total 2004                |       | 174,139                    |       | 59,762         |       |
|                           |            |                            |            |                |            |  |  |

 

The table belowprovides a summary of our Loan Portfolio Assets as of September 30, 2009 and December31, 2008. The loans with credit deterioration acquired after 2004 arecategorized based on the common risk characteristics that management generallyuses for pooling purposes (when management elects to pool groups of purchasedloans).

 

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| ** **                                            | ** ** | **September 30,**          | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------|------------|----------------------------|------------|------------------|------------|
| **Loan and  Loan Pool Type**                          | ** ** | **2009**                   | ** ** | **2008**         | ** ** |
| ** **                                            | ** ** | **(Dollars in thousands)** | ** ** |
| Loans with credit  deterioration acquired after 2004: |       |                       |       |             |       |
| Domestic:                                             |       |                       |       |             |       |
| Commercial real eatate                                |       | $                          | 143,845    |             | $          | 87,701 |   |
| Business assets                                       |       | 42,531                     |       | 19,689           |       |
| Other                                                 |       | 3,759                      |       | 1,078            |       |
| Latin America                                         |       | 10,506                     |       | 11,141           |       |
| Europe                                                |       | 15,138                     |       | 5,499            |       |
| UBN loan portfolio:                                   |       |                       |       |             |       |
| Non-performing loans                                  |       | 58,482                     |       | 62,208           |       |
| Performing loans                                      |       | 1,421                      |       | 1,705            |       |
| Other                                                 |       | 6,731                      |       | 8,481            |       |
| Outstanding balance                                   |       | 282,413                    |       | 197,502          |       |
| Allowance for loan losses                             |       | (62,288                    | )          | (76,365          | )          |
| Carrying amount, net                                  |       | $                          | 220,125    |             | $          | 121,137 |   |

 

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

** **
| ** **                          | ** ** | **Loans  With Credit Deterioration Acquired After 2004** | ** ** | **Other**    | ** ** | ** ** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|--------------|------------|------------|------------|
| ** **                          | ** ** | **Domestic**                                             | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                          | ** ** | **Commercial**                                           | ** ** | **Business** | ** ** | ** ** | ** ** | **Latin** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **(dollars in thousands)**          | ** ** | **Real  Estate**                                         | ** ** | **Assets**   | ** ** | **Other**  | ** ** | **America** | ** ** | **Europe** | ** ** | **UBN** | ** ** | **Other** | ** ** | **Total** | ** ** |
| Beginning Balance,  January 1, 2009 |       | $                                                        | 10,440     |         | $          | 2,811      |       | $ | 538 |   | $ | 120 |   | $ | — |   | $ | 62,150 |   | $ | 306 |   | $ | 76,365 |   |
| Provisions                          |       | 2,982                                                    |       | 333          |       | 191        |       | 19 |   | — |   | — |   | 93 |   | 3,618 |   |
| Recoveries                          |       | (151                                                     | )          | (236         | )          | (5         | )          | — |   | — |   | (2,998 | ) | (15 | ) | (3,405 | ) |
| Charge offs                         |       | (8,175                                                   | )          | (2,582       | )          | (334       | )          | (138 | ) | — |   | (3,677 | ) | (113 | ) | (15,019 | ) |
| Translation adjustments             |       | —                                                   |       | —       |       | —     |       | — |   | — |   | 729 |   | — |   | 729 |   |
| Ending Balance,  September 30, 2009 |       | $                                                        | 5,096      |         | $          | 326        |       | $ | 390 |   | $ | 1 |   | $ | — |   | $ | 56,204 |   | $ | 271 |   | $ | 62,288 |   |

 

Due touncertainties related primarily to estimating the timing and/or amount ofcollections on loans with credit deterioration acquired after 2004 as a resultof the current economic environment, the Company’s levels of such loans andloan pools accounted for on a non-accrual method of accounting (cost-recoveryor cash basis) increased to $152.2 million at September 30, 2009 from $20.7million at December 31, 2008. Under GAAP, the interest method (i.e. accrualmethod) of accounting is not appropriate if management does not have theability to develop a reasonable expectation of both the timing and amount offuture cash flows to be collected. Refer to Note 1 of the Consolidated Financial Statements included in Item 1 on this Form 10-Qfor additional information and accounting policies related to our loans withcredit deterioration acquired after 2004.

 

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

 

Revenues with respect to the Company’s SpecialSituations Platform business segment consist primarily of (i) interest and feeincome from loan investments; (ii) revenues from majority-owned operatingentities; and (iii) equity in earnings of non-consolidated investmentsaccounted for under the equity-method of accounting.

 

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

** **
| ** **                | ** ** | **Total**                  | ** ** | **FirstCity Denver’s Investment** | ** ** |
|---------------------------|------------|----------------------------|------------|----------------------------------------|------------|
| ** **                | ** ** | **Investment**             | ** ** | **Debt**                               | ** ** | **Equity** | ** ** | **Total** | ** ** |
| ** **                | ** ** | **(Dollars in thousands)** | ** ** |
| First nine months of 2009 |       | $                          | 9,792      |                                   | $          | 8,658 |   | $ | 387 |   | $ | 9,045 |   |
| Total 2008                |       | 28,750                     |       | 16,650                                 |       | 3,256 |   | 19,906 |   |
| Total 2007                |       | 22,314                     |       | 5,630                                  |       | 5,900 |   | 11,530 |   |
|                           |            |                            |            |                                        |            |  |  |  |  |  |  |  |  |

 

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**Provision for Income Taxes**

 

The Company has substantial NOLswhich can be used to off-set the tax liability associated with the Company’spre-tax earnings until the earlier of the expiration or utilization of suchNOLs. The Company accounts for the benefit of the NOLs and other income taxitems under the assetand liability method. Deferred tax assets and liabilities are recognized basedon the future tax consequences attributable to temporary differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective tax bases and operating loss and tax credit carryforwards.Deferred tax assets and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. We reduce the carryingamounts of deferred tax assets by a valuation allowance if, based on theavailable evidence, it is more likely than not that such assets will not berealized. Accordingly, the need to establish valuation allowances for deferredtax assets is assessed periodically by the Company based on themore-likely-than-not realization threshold criterion. In the assessment,appropriate consideration is given to all positive and negative evidencerelated to the realization of the deferred tax assets. This assessmentconsiders, among other factors, the nature, frequency and severity of currentand cumulative losses, forecasts of future profitability, excess of appreciatedasset value over the tax basis of net assets, the duration of statutorycarryforward periods, the Company’s experience with utilizing availableoperating loss and tax credit carryforwards, and tax planning strategies. Inmaking such assessments, significant weight is given to evidence that can beobjectively verified. At September 30, 2009, the Company carried a fullvaluation allowance for its deferred tax assets due to the lack of sufficientobjective evidence regarding the realization of these assets in the foreseeablefuture.

 

**Liquidity and Capital Resources**

 

***Overview***

 

The Companyrequires liquidity to fund its operations, Portfolio Asset acquisitions,investments in and advances to entities formed to acquire Portfolios (“AcquisitionPartnerships”), capital investments in privately-held middle-market companies,other investments, repayments of bank borrowings and other debt, and workingcapital to support our growth. Historically, our primary sources of liquidityhave been funds generated from operations (primarily loan collections andservice fees), equity distributions from the Acquisition Partnerships and othersubsidiaries, interest and principal payments on subordinated intercompanydebt, dividends from the Company’s subsidiaries, borrowings from creditfacilities with external lenders, and other special-purpose short-termborrowings.

 

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

 

***ConsolidatedStatements of Cash Flows***

 

Our operating activitiesprovided cash of $1.5 million and used cash of $14.0 million for the nine-monthperiods ended September 30, 2009 and 2008, respectively. For the ninemonths ended September 30, 2009, net cash provided by operations wasattributable primarily to $13.6 million of net earnings; $18.2 million ofproceeds from sales of SBA loans held for sale; $15.3 million of proceedsapplied to income from Portfolio Assets; $5.6 million increase in otherliabilities; and $5.2 million of non-cash add-backs related to depreciation,amortization, and provisions for loan and impairment losses — off-set partiallyby $13.5 million of net principal advances on SBA loans held for sale; $35.3million for income accretion and gains on Portfolio Assets; $1.5 million ofequity earnings from equity-method investments, and $1.5 million for a stepacquisition gain. Net cash used for the nine-month period ended September 30,2008 was attributable primarily to a net loss of $11.6 million; $7.9 million ofnet principal advances on SBA loans held for sale; $8.0 million for equity inearnings from equity-method investments; and $15.8 million for income accretionand gains on Portfolio Assets — off-set partially by $5.3 million of proceedsfrom sales of SBA loans held for sale; $11.4 million of proceeds applied toincome from Portfolio Assets; and $14.1 million of non-cash add-backs relatedto depreciation, amortization, and provisions for loan and impairment losses.The remaining changes in the periods were due primarily to net changes in otheraccounts related to our operating activities.

 

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Our investingactivities used cash of $65.6 million and $33.4 million for the nine-monthperiods ended September 30, 2009 and 2008, respectively. For the ninemonths ended September 30, 2009, net cash used in investing activities wasattributable primarily to Portfolio Asset purchases of $62.8 million (net ofprincipal collections); $7.1 million paid for business combinations; $2.1million of property and equipment purchases; $3.9 million of equity investmentcontributions; and $3.8 million of net advances and originations for loaninvestments — off-set partially by $9.3 million of distributions fromequity-method investments; $3.5 million of principal payments on an investmentsecurity available for sale; and $1.4 million of proceeds from sales ofproperty. Net cash used in investing activities for the nine-month period endedSeptember 30, 2008 was attributable primarily to Portfolio Assetspurchases of $14.5 million (net of principal collections); $28.5 million of netadvances and originations for loan investments; and $1.8 million of propertyand equipment purchases — off-set partially by $14.8 million of distributionsfrom equity-method investments. The remaining changes in the periods were dueprimarily to net changes in other accounts related to our investing activities.

 

Our financingactivities provided cash of $77.7 million and $37.4 million for the nine-monthperiods ended September 30, 2009 and 2008, respectively. For the ninemonths ended September 30, 2009, net cash provided by financing activitieswas attributable to $49.3 million of net borrowings to finance our PortfolioAsset acquisitions and other investments and $41.0 million of contributionsfrom noncontrolling interests primarily to acquire Portfolio Assets throughconsolidated subsidiaries — off-set partially $10.0 million of cashdistributions to noncontrolling interests and $2.8 million of cash paid toacquire additional equity in noncontrolling interests. Net cash provided byfinancing activities for the nine-month period ended September 30, 2008was attributable primarily to $38.2 million of net borrowings to finance ourPortfolio Asset acquisitions and other investments and $4.1 million ofcontributions from noncontrolling interests primarily to acquire PortfolioAssets through consolidated subsidiaries — off-set partially by $3.8 million ofcommon stock repurchases and $1.0 million of cash distributions tononcontrolling interests. The remaining changes in the periods were dueprimarily to net changes in other accounts related to our financing activities.

 

Cash paid forinterest expense approximated $7.3 million and $9.6 million for the nine-monthperiods ended September 30, 2009 and 2008, respectively. Substantially allof our interest expense was paid on our credit facilities and other borrowings.FirstCity’s average outstanding debt increasedto $290.6 million for the first nine months of 2009 from $198.9 million for thefirst nine months of 2008, while the average cost of borrowings decreased to4.85% in 2009 compared to 8.0% in 2008. The increase in the Company’sdebt level since September 30, 2008 is a result of increased netborrowings to finance the Company’s growth and investment transactions.

 

***RailroadOperation Statements of Cash Flows***

 

The following isan analysis of the cash flows related to FirstCity’s majority-owned railroadoperation for the nine-month periods ended September 30, 2009 and 2008.All significant intercompany balances and transactions have been eliminated inconsolidation.

 

The operatingactivities of the railroad subsidiary provided cash of $1.6 million for the nine-monthperiod ended September 30, 2009 — attributable primarily to $1.7 millionof net earnings and a $1.2 million increase in other liabilities; off-setpartially by $1.2 million of gains on sales of property and equipment. Therailroad subsidiary’s investing activities used cash of $0.3 million for thenine-month period ended September 30, 2009. Net cash provided by investingactivities included $1.6 million of proceeds from property and equipment sales;off-set by $1.5 million of property and equipment purchases. The railroadsubsidiary’s financing activities used cash of $1.4 million for the nine-monthperiod ended September 30, 2009 — attributable primarily to providing $1.3million of capital to FirstCity (parent company) through principal repaymentson a capital note (eliminated in consolidation).

 

The railroadsubsidiary’s operating activities provided cash of $0.8 million for thenine-month period ended September 30, 2008 — attributable primarily to$0.3 million of net earnings and a $0.5 million increase in other liabilities.The railroad subsidiary’s investing activities used cash of $1.0 million forthe nine-month period ended September 30, 2008 to purchase property andequipment. For the nine-month period ended September 30, 2008, therailroad subsidiary’s financing activities included $3.6 million of netborrowings under a bank note payable; off-set by $3.6 million of capitaldistributions to the equity owners and FirstCity (parent company) throughprincipal repayments on a capital note (eliminated in consolidation).

 

***CreditFacilities***

 

FirstCity has$350.0 million of credit facility commitments (subject to borrowing baserequirements of the respective credit facilities) with Bank of Scotland plc (“Bankof Scotland”) and BoS(USA), Inc. (“BoS(USA)”) available to finance itsportfolio and asset purchases, capital investments in new ventures, and toprovide for working capital to support our growth. At September 30, 2009,FirstCity’s maximum unused borrowing capacity under these credit commitments approximated$72.9 million. These credit facilities are available to FirstCity through theirmaturity in November 2010. FirstCity is in discussions with Bank ofScotland and BoS(USA) regarding these credit facilities, but there can be noassurances that FirstCity can obtain an extension or renewal of these loanfacilities on terms that are acceptable to it or agree upon the terms for anextension of these loan facilities.

 

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

 

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*$225.0 Million Revolving Loan Facility — Bank ofScotland plc*

 

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

 

The primary terms and key covenants of this loanfacility are described in our 2008 Form 10-K. On March 30, 2009,FirstCity and Bank of Scotland entered into an amendment to the $225.0 millionrevolving loan facility to amend the definitions of “indebtedness” and “tangiblenet worth” such that in the determination of “tangible net worth” and thecomputation of the ratio of “indebtedness to tangible net worth” for the fiscalquarters ending December 31, 2008 and thereafter, “tangible net worth” and“indebtedness” would be adjusted by deducting non-controlling interests (i.e.minority interests) in subsidiaries from liabilities and adding non-controllinginterests in subsidiaries to equity as provided under GAAP. At September 30,2009, the Company was in compliance with all covenants or other requirementsset forth in the credit agreement or other agreements with Bank of Scotland.

 

FirstCity has$27.1 million in Euro-denominated debt on the $225.0 million revolving loanfacility that was designated as a hedge to partially off-set the Company’sbusiness exposure to foreign currency exchange risk attributable to our netequity investments in Europe. Refer to Note19 to our Consolidated Financial Statements included in Item 1 of this Form 10-Q.

 

*$100.0 Million Revolving Loan Facility — Bank of Scotland*

 

FH Partners LLC (“FH Partners”), an indirectwholly-owned affiliate of FirstCity, has a $100.0 million revolving loanfacility with Bank of Scotland that provides financing for Portfolio and assetpurchases by FH Partners. This revolving loan facility matures in November 2010,and is secured by all assets of FH Partners and a guaranty by FirstCity andcertain of its wholly-owned subsidiaries.

 

The primary terms and key covenants of this loanfacility are described in our 2008 Form 10-K. On March 30, 2009, FHPartners and Bank of Scotland entered into an amendment to the $100.0 millionrevolving loan facility to amend the definitions of “indebtedness” and “tangiblenet worth” such that in the determination of “tangible net worth” and thecomputation of the ratio of “indebtedness to tangible net worth” for the fiscalquarters ending December 31, 2008 and thereafter, “tangible net worth” and“indebtedness” would be adjusted by deducting non-controlling interests (i.e.minority interests) in subsidiaries from liabilities and adding non-controllinginterests in subsidiaries to equity as provided under GAAP. At September 30,2009, the Company was in compliance with all covenants or other requirementsset forth in the credit agreement or other agreements with Bank of Scotland.

 

*$25.0 Million Subordinated Credit Agreement —BoS(USA), Inc.*

 

FirstCity has a $25.0million subordinated credit agreement with BoS(USA), a subsidiary of Bank ofScotland, which may be used to finance equity investments in new ventures,equity investments made in connection with portfolio and asset purchases andloans made by FirstCity and its subsidiaries to acquisition entities, providefor the issuance of letters of credit, and for working capital loans. Thiscredit facility matures in November 2010 and is guaranteed bysubstantially all of FirstCity’s wholly-owned subsidiaries and secured bysubstantially all of the assets of FirstCity and its wholly-owned subsidiaries.

 

The primary terms and keycovenants of this loan facility are described in our 2008 Form 10-K. On March 30,2009, FirstCity and BoS(USA) entered into an amendment to the $25.0 millionsubordinated credit agreement to amend the definitions of “indebtedness” and “tangiblenet worth” such that in the determination of “tangible net worth” and thecomputation of the ratio of “indebtedness to tangible net worth” for the fiscalquarters ending December 31, 2008 and thereafter, “tangible net worth” and“indebtedness” would be adjusted by deducting non-controlling interests (i.e.minority interests) in subsidiaries from liabilities and adding non-controllinginterests in subsidiaries to equity as provided under GAAP. At September 30,2009, the Company was in compliance with all covenants or other requirementsset forth in the credit agreement or other agreements with BoS(USA).

 

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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 own approximately 4.86% of the Company’s voting commonstock. The warrant expires on August 31, 2010, if it is not exercisedprior to that date.

 

*BancoSantander, S.A.*

 

FirstCity MexicoSA de CV, a Mexican affiliate of FirstCity, has a term note with BancoSantander, S.A. with an unpaid principal balance of 142,240,000 Mexican pesosat September 30, 2009, which was equivalent to $10.7 million U.S. dollarson that date. The loan proceeds are used to pay down the acquisition facilitywith the Bank of Scotland. Pursuant to the terms of the credit facility,FirstCity Mexico SA de CV was required to provide a stand-by letter of creditfrom Bank of Scotland that would satisfy the loan balance upon demand. At September 30,2009, FirstCity had a letter of credit in the amount of $12.6 million from Bankof Scotland under the terms of FirstCity’s revolving acquisition facility withBank of Scotland. In the event that a demand is made under the $12.6million letter of credit, FirstCity would be required to reimburse Bank ofScotland by making payment to Bank of Scotland for all amounts disbursed or tobe disbursed by Bank of Scotland under the letter of credit.

 

*Wells Fargo Foothill, LLC*

 

At September 30,2009, ABL had a $25.0 million revolving loan facility with WFF for the purposeof financing and acquiring SBA loans. This credit facility matures in January 2010and is secured by substantially all of the assets of ABL. In addition,FirstCity provides WFF with an unconditional guaranty for all of ABL’sobligations up to a maximum of $5.0 million plus enforcement costs.

 

The primary terms and keycovenants of this loan facility are described in our 2008 Form 10-K. In February 2009,ABL and WFF entered into an agreement to amend the revolving credit facility bymaking the following changes to the primary terms and key covenants of theexisting loan facility as follows: (i) reduced the maximum outstandingamount of the credit line from $40.0 million to $25.0 million, (ii) providedfor the guaranty by FirstCity of all indebtedness under the loan facility up toa maximum of $5.0 million plus enforcement cost; (iii) revised theinterest rates applicable to base rate loans; (iv) extended the maturitydate to January 31, 2010; (v) reduced the minimum tangible net worthrequirement for the fiscal quarter ending March 31, 2009, and for eachquarter thereafter to $5.5 million, plus 100% of the positive amounts of ABL’snet income for each fiscal quarter after March 31, 2009; (vi) revisedthe facility fee of one-quarter of one percent (0.25%) per annum to be chargedfor non-use of the available maximum credit line to be calculated using $25.0million as the amount of the maximum credit line on or after February 1,2009; and (vii) revised the borrowing base for originating loans to bechanged to an amount equal to 70% of the net eligible non-guaranteed loansoriginated by ABL that are borrower originated mixed collateral loans. At September 30,2009, ABL was in compliance with all covenants or other requirements set forthin the credit agreement or other agreements with WFF. On November 2, 2009,ABL and WFF entered into an amendment to the $25.0 million loan agreement,to be effective as of October 30, 2009, which amended certain termsand covenants under the loan facility and is not effective until certainconditions are met, including approval by the SBA. The amendment isdescribed in a Form 8-K filed by the Company on November 10,2009.

 

Excluding the termacquisition facilities of the Company’s Acquisition Partnerships and otherunconsolidated subsidiaries, as of September 30, 2009, the Company and itsconsolidated subsidiaries had credit facilities providing for borrowings in anaggregate principal amount of $414.1 million and outstanding borrowings of$302.9 million.

 

The followingtable summarizes the material terms of the credit facilities of FirstCity andits consolidated subsidiaries as of October 31, 2009, and the outstandingborrowings under such facilities as of September 30, 2009.

 

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**Credit Facilities**

 
| ** **                                                           | ** ** | **Funded and**            | ** ** | ** **             | ** ** | ** **        | ** ** | ** **                                                                                                                                    |
|----------------------------------------------------------------------|------------|---------------------------|------------|------------------------|------------|-------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                           | ** ** | **Unfunded**              | ** ** | **Outstanding**        | ** ** | ** **        | ** ** | ** **                                                                                                                                    |
| ** **                                                           | ** ** | **Commitment**            | ** ** | **Borrowings**         | ** ** | ** **        | ** ** | ** **                                                                                                                                    |
| ** **                                                           | ** ** | **Amount as of**          | ** ** | **as of**              | ** ** | ** **        | ** ** | ** **                                                                                                                                    |
| ** **                                                           | ** ** | **October 31,**      | ** ** | **September 30,** | ** ** | ** **        | ** ** | ** **                                                                                                                                    |
| ** **                                                           | ** ** | **2009**                  | ** ** | **2009**               | ** ** | **Interest Rate** | ** ** | **Other Terms and Conditions**                                                                                                                |
| ** **                                                           | ** ** | **(Dollars in millions)** | ** ** | ** **             | ** ** | ** **        |
|                                                                 |       |                      |       |                   |       |              |       |                                                                                                                                          |
| Bank of Scotland $225  million revolving loan facility (1)           |       | $                         | 225.0      |                   | $          | 174.4             |       | LIBOR + 2.0% - 2.50%                                                                                                                          |   | Secured by security interests in assets of FirstCity and wholly-owned subsidiaries,  matures November 2010 |
|                                                                 |       |                      |       |                   |       |              |       |                                                                                                                                          |
| Bank of Scotland $100 million  revolving loan facility               |       | $                         | 100.0      |                   | $          | 61.9              |       | LIBOR + 2.0%                                                                                                                                  |   | Secured by assets of FH Partners and guaranteed by FirstCity, matures November 2010 |
|                                                                 |       |                      |       |                   |       |              |       |                                                                                                                                          |
| BoS(USA) $25 million  subordinated credit agreement                  |       | $                         | 25.0       |                   | $          | 17.5              |       | LIBOR + 5.0%                                                                                                                                  |   | Secured by security interests in assets of FirstCity and wholly-owned subsidiaries,  matures November 2010 |
|                                                                 |       |                      |       |                   |       |              |       |                                                                                                                                          |
| American Bank term loan                                              |       | $                         | 0.5        |                   | $          | 0.5               |       | 5.0% fixed                                                                                                                                    |   | Secured by assets of FC Washington and guaranteed by FirstCity,  matures May 2011 |
|                                                                 |       |                      |       |                   |       |              |       |                                                                                                                                          |
| Participations payable                                               |       | $                         | 1.5        |                   | $          | 0.9               |       | 9.92% - 23.22% imputed rates                                                                                                                  |   | Participation agreements on 10% - 33% of net cash flows received on a  portfolio |
|                                                                 |       |                      |       |                   |       |              |       |                                                                                                                                          |
| Banco Santander term loan denominated  in Mexican pesos              |       | $                         | 10.9       |                   | $          | 10.7              |       | Rate based on 28 day Mexican index rate (TIIE) plus 2.0%                                                                                      |   | Secured by Bank of Scotland letter of credit, matures  November 2009, commitment amount 142.2 million MXN |
| ** **                                                           |       |                      |       |                   |       |              |       |                                                                                                                                          |
| Wells Fargo  Foothill, Inc. $25 million revolving loan facility |       | $                         | 25.0       |                   | $          | 11.4              |       | Greater of (1) LIBOR + margin or 3.625%, or (2) greater of 7.5%  or (i) Wells Fargo prime + 2.625% or (ii) LIBOR + 2.625% |   | Secured by assets of ABL and guaranteed by FirstCity, matures January 2010 |
|                                                                 |       |                      |       |                   |       |              |       |                                                                                                                                          |
| Bank of America term loan                                            |       | $                         | 3.2        |                   | $          | 3.2               |       | LIBOR + 2.25%                                                                                                                                 |   | Secured by assets of consolidated

railroad subsidiaries, matures March 2011 |
|                                                                 |       |                      |       |                   |       |              |       |                                                                                                                                          |
| Bank of America $1 million  revolving loan facility                  |       | $                         | 1.0        |                   | $          | 0.4               |       | Option of Base Rate (greater of prime or federal funds rate + 0.5%)  plus margin, or LIBOR plus margin                                        |   | Secured by assets of consolidated railroad subsidiaries, matures  March 2011 |
|                                                                 |       |                      |       |                   |       |              |       |                                                                                                                                          |
| Merrill Lynch Mortgage  Trust term loan                              |       | $                         | 7.5        |                   | $          | 7.5               |       | 6.07% fixed                                                                                                                                   |   | Secured by assets of Oregon Short Line Building, matures  April 2016 |
|                                                                 |       |                      |       |                   |       |              |       |                                                                                                                                          |
| B.E.S.V. term loan                                                   |       | $                         | 6.4        |                   | $          | 6.4               |       | one month Eurobor + 3.5%                                                                                                                      |   | Secured by UBN, SA’s beneficial interests in certain entities, matures  May 2011 |
|                                                                 |       |                      |       |                   |       |              |       |                                                                                                                                          |
| Notes payable to banks                                               |       | $                         | 406.0      |                   | $          | 294.8             |       |                                                                                                                                          |   |   |
|                                                                 |       |                      |       |                   |       |              |       |                                                                                                                                          |
| MCS Trust SA de CV term  loan (affiliate note payable)               |       | $                         | 8.1        |                   | $          | 8.1               |       | 20.0% fixed                                                                                                                                   |   | Secured by assets of FC Acquisitions, SRL de CV, matures  June 2020 |
|                                                                 |       |                      |       |                   |       |              |       |                                                                                                                                          |
| Total                                                                |       | $                         | 414.1      |                   | $          | 302.9             |       |                                                                                                                                          |   |   |

 

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(1)          The Bank of Scotland facility allows loans to be madein Euros up to a maximum amount in Euros that is equivalent to $50.0 million.At September 30, 2009, the Company had approximately $27.1 millionoutstanding under the Euro-denominated portion of this facility.

 

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**Forward-Looking Statements**

 

This QuarterlyReport on Form 10-Q includes forward-looking statements as defined in thePrivate Securities Litigation Reform Act of 1995. In addition, we may makeother written and oral communications from time to time that contain suchstatements. All statements regarding our expected financial position,strategies and growth prospects, anticipated events or trends, and generaleconomic conditions that we expect to exist in the future, are forward-lookingstatements. The words, “anticipates,” “believes,” “feels,” “expects,” “estimates,”“seeks,” “strives,” “plans,” “intends,” “outlook,” “forecast,” “position,” “target,”“mission,” “assume,” “achievable,” “potential,” “strategy,” “goal,” “aspiration,”“outcome,” “continue,” “remain,” “maintain,” “trend,” “objective” andvariations of such words and similar expressions, or future or conditionalverbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may” orsimilar expressions, as they relate to our business, operations and management,are intended to identify forward-looking statements and are not historicalfacts.

 

You are cautionedthat forward-looking statements are subject to numerous assumptions, risks anduncertainties which change over time. As such, our forward-looking statementscould be wrong in light of these and other risks, uncertainties andassumptions. For a discussion on the risks, uncertainties and assumptions thatcould affect our future events, developments or results, you should carefullyreview Item 1A. “Risk Factors” and Item 7. “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” of our 2008 Form 10-K.

 

Forward-lookingstatements speak only as of the date the statement is made, and we have noobligation to publicly update or revise our forward-looking statements toreflect facts, circumstances, assumptions or events that occur after the datethe forward-looking statements are made. Actual results could differ materiallyfrom those anticipated in forward-looking statements, and future results coulddiffer materially from historical performance.

 

**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. Portfolio Assetsconsist of investments in pools of non-homogenous assets that predominantlyconsist of loan and real estate assets. Earnings from these assets are based onthe estimated future cash flows from such assets and recorded when those cashflows occur. The underlying loans within these pools bear both fixed andvariable rates. Due to the non-performing nature and history of these loans,changes in prevailing benchmark rates (such as the prime rate or LIBOR) couldhave an effect on the ultimate future cash flow to be realized from thePortfolio Assets.

 

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 could impactthe collectibility of these loans.

 

SBA loans receivable were $17.2 million at September 30,2009, of which $1.6 million were related to the guaranteed portion of theseloans. The guaranteed portion is backed by the full faith and credit of theU.S. Small Business Administration, and is generally sold into the secondarymarket. Virtually all of the SBA loans have variable interest rates. Assumingthat the balance sheet were to remain constant and no actions were taken tomodify the existing interest rate sensitivity, a hypothetical immediate changein interest rates would have a minimal effect on interest income from SBA loansfor the third quarter of 2009. Although management believes that this measureis indicative of our sensitivity to interest rate changes, it does not adjustfor potential changes in credit quality, size and composition of the assets onthe balance sheet, and other business developments that could affect a netincrease (decrease) in assets. Accordingly, no assurances can be given thatactual results would not differ materially from the potential outcome simulatedby this estimate.

 

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FirstCity had$302.9 million in debt outstanding at September 30, 2009. The Company isexposed to interest rate risk primarily through its variable rate debt, whichtotaled $286.8 million or 94.7% of the Company’s total debt. A 50 basispoint change in interest rates would increase or decrease FirstCity’s annualinterest expense by approximately $1.4 million.

 

**Foreign Currency Risk**

 

The Companycurrently has loans and equity investments in Europe and Latin America (i.e.Mexico, Argentina, Brazil and Chile). The Company’s investments in theseregions are primarily in the form of equity and represent a significant portionof the Company’s total equity investments. As previously discussed, therevolving acquisition facility with Bank of Scotland for $225.0 millionprovides that the Company may borrow up to a maximum amount in Euros that isequivalent to U.S. $50 million. At September 30, 2009, the Company hadU.S. $27.1 million in Euro-denominated debt for the purpose of hedging aportion of the net equity investments in Europe. In November 2006, theCompany acquired a term note with Banco Santander, S.A. At September 30,2009, the Company had 142,240,000 in Mexican peso-denominated debt, which wasequivalent to U.S. $10.7 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, using foreign currency exchange rates as of September 30,2009. These amounts are estimates; consequently, these amounts are not necessarilyindicative of the actual effect of such changes with respect to the Company’sconsolidated financial position or results of operations.

 
| ** ** | ** ** | ** **   | ** ** | **Estimated decline in**     | ** ** |
|------------|------------|--------------|------------|------------------------------|------------|
| ** ** | ** ** | ** **   | ** ** | **valuation of investments** | ** ** |
| ** ** | ** ** | ** **   | ** ** | **resulting from**           | ** ** |
| ** ** | ** ** | ** **   | ** ** | **incremental depreciation** | ** ** |
| ** ** | ** ** | **One U.S.** | ** ** | **of foreign currency of**   | ** ** |
| ** ** | ** ** | **dollar**   | ** ** | **(dollars in thousands)**   | ** ** |
| ** ** | ** ** | **equals**   | ** ** | **5%**                       | ** ** | **10%** | ** ** |
|       |       |         |       |                         |       |   |   |
| Europe     |       | EUR          | 0.69       |                         | $          | 1,977 |   | $ | 3,786 |   |
|       |       |         |       |                         |       |   |   |   |
| Mexico     |       | MXN          | 13.50      |                         | $          | 2,086 |   | $ | 4,033 |   |
|       |       |         |       |                         |       |   |   |   |
| Chile      |       | CLP          | 555.30     |                         | $          | 157 |   | $ | 301 |   |
|       |       |         |       |                         |       |   |   |   |
| Brazil     |       | BRL          | 1.79       |                         | $          | 19 |   | $ | 37 |   |
|       |       |         |       |                         |       |   |   |   |
| Argentina  |       | ARS          | 3.85       |                         | $          | 30 |   | $ | 59 |   |

 

**Item 4.  Controls and Procedures.**

 

*Evaluation of Disclosure Controlsand Procedures*

 

The Company’s management evaluated, with theparticipation of our principal executive officer and principal financialofficer, or persons performing similar functions, the effectiveness of ourdisclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as of the end of theperiod covered by this report. Based on this evaluation, our principalexecutive officer and principal financial officer have concluded that, as ofthe end of the period covered by this report, our disclosure controls andprocedures were effective to ensure that information we are required todisclose in the reports that we file or submit under the Securities ExchangeAct of 1934, as amended, is recorded, processed, summarized and reported withinthe time periods specified in the SEC’s rules and forms relating toFirstCity, including our consolidated subsidiaries, and was accumulated andcommunicated to the Company’s management, including the principal executiveofficer and principal financial officer, or persons performing similarfunctions, as appropriate to allow timely decisions regarding requireddisclosure.

 

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*Changes in Internal Controls*

 

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

 

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**PART II**

 

**OTHER INFORMATION**

** **

**Item 1.  Legal Proceedings.**

 

The following informationand discussion supplements and amends the discussion under Part I, Item 3 “LegalProceedings” in our 2008 Form 10-K.

 

On September 25, 2009, FirstCity, FCLT LoansAsset Corporation and Tony J. Blair, individually and as representative of aclass of former employee beneficiaries, entered into an Agreement andStipulation of Settlement, subject to Court approval, which provides for thesettlement of the pending lawsuit related to the ownership of proceeds from thesale of Prudential stock and dividends interpled by Prudential Financial Inc.The settlement provides for each party to receive one-third of thedemutualization proceeds ten days after an order of the trial court approvingthe settlement is final and non-appealable. Each of the parties to the lawsuitwill release the other parties from all claims related to the lawsuit. Thedemutualization proceeds are being held by JP Morgan Chase Bank, NationalAssociation (“JP Morgan”) subject to the resolution of all issues in thelawsuit. According to report of JP Morgan dated as of August 3, 2009, thedemutualization proceeds total approximately $18.6 million. Pursuant to thesettlement, JP Morgan will hold approximately $250,000 of the funds as areserve to pay fees, expenses and tax payments. On September 29, 2009, thetrial court granted preliminary approval of the terms of the settlement. On October 16,2009, the trial court entered an amended order which granted preliminaryapproval of the settlement, set the hearing on the fairness of the settlementon November 12, 2009, and approved the form and content of the notice toclass members and the method of providing notice to the class members.  The settlement is subject to notice to theclass of the action and final approval by the trial court after hearings on thefairness of the settlement with respect to the class of former employees. Ifthe trial court does not approve the settlement the parties will be restored totheir positions in the suit prior to the entry into the Agreement andStipulation of Settlement.

 

**Item 1A.  Risk Factors.**

 

There have been nomaterial changes to the risk factors as previously disclosed under Item 1A inour 2008 Form 10-K.

 

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

 

None.

 

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

 

None.

 

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

 

None.

 

**Item 5.  OtherInformation.**

 

None.

 

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**Item 6.  Exhibits.**

*** ***
| **Exhibit********Number** | ** ** | **Description  of Exhibit**                                                                                                                                     |
|---------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                      |       |                                                                                                                                                            |
| 31.1*                     | —     | Certification of the  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                   |
|                      |       |                                                                                                                                                            |
| 31.2*                     | —     | Certification of the  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002                                                   |
|                      |       |                                                                                                                                                            |
| 32.1*                     | —     | Certification of the  Chief Executive Officer pursuant to 18 U.S.C Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|                      |       |                                                                                                                                                            |
| 32.2*                     | —     | Certification of the Chief  Financial Officer pursuant to 18 U.S.C Section 1350 as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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* Filed herewith.

 

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**SIGNATURES**

 

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

 
|                          | FIRSTCITY  FINANCIAL CORPORATION |
|-------------------------------|----------------------------------|
| Dated: November 12, 2009 |                             |   |
|                          |                             |   |
|                          |                             |   |
|                          | By:                              | /s/ JAMES T. SARTAIN |
|                          |                             | James T. Sartain |
|                          |                             | *President and Chief Executive* |
|                          |                             | *Officer and Director* |
|                          |                             | *(Duly authorized officer and* |
|                          |                             | *Principal Executive Officer)* |
| * *                      |                             |   |
| * *                      |                             |   |
|                          | By:                              | /s/ J. BRYAN BAKER |
|                          |                             | J. Bryan Baker |
|                          |                             | *Senior Vice President and Chief* |
|                          |                             | *Financial Officer* |
|                          |                             | *(Duly authorized officer and* |
|                          |                             | *Principal Financial  Officer)* |

 

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