**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**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  March 31, 2008** |
| ** **                                              | ** ** | ** ** |
| **o**                                                   | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission file number 033-19694**

 

**FirstCity Financial Corporation**

(Exact name of registrant as specified in its charter)

* *

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

 

**(254) 761-2800**

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of“large accelerated filer,” “accelerated filer,” and “smaller reporting company”in Rule 12b-2 of the Exchange Act. (Check one):

 

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

 

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

 

The number of shares of common stock, par value$.01 per share, outstanding at May 5, 2008 was 10,360,607.

 

 

 

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** **

**TABLEOF CONTENTS**

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

 

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Tableof contents

 

**PART I**

 

**FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements.**

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDBALANCE SHEETS**

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

 
| ** **                                                                                                                                                                                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                    | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                                                                    | ** ** | **(Unaudited)**    | ** ** | ** **            | ** ** |
| **ASSETS**                                                                                                                                                                                    | ** ** | ** **         | ** ** | ** **            | ** ** |
| Cash and cash equivalents                                                                                                                                                                     |       | $                  | 14,395     |                  | $          | 23,546 |   |
| Portfolio Assets, net                                                                                                                                                                         |       | 112,593            |       | 122,001               |       |
| Loans receivable - affiliates                                                                                                                                                                 |       | 5,403              |       | 5,447                 |       |
| Loans receivable - SBA held for sale                                                                                                                                                          |       | 1,055              |       | 133                   |       |
| Loans receivable - SBA held for investment, net                                                                                                                                               |       | 12,988             |       | 14,234                |       |
| Loans receivable - other                                                                                                                                                                      |       | 5,965              |       | 5,995                 |       |
| Equity investments                                                                                                                                                                            |       | 89,643             |       | 87,622                |       |
| Deferred tax asset, net                                                                                                                                                                       |       | 20,101             |       | 20,101                |       |
| Service fees receivable ($883 and $785 from  affiliates, respectively)                                                                                                                        |       | 944                |       | 842                   |       |
| Servicing assets - SBA loans                                                                                                                                                                  |       | 729                |       | 843                   |       |
| Other assets, net                                                                                                                                                                             |       | 16,615             |       | 17,355                |       |
| Total Assets                                                                                                                                                                                  |       | $                  | 280,431    |                  | $          | 298,119 |   |
| ** **                                                                                                                                                                                    | ** ** | ** **         | ** ** | ** **            | ** ** |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                 |       |               |       |                  |       |
| Liabilities:                                                                                                                                                                                  |       |               |       |                  |       |
| Notes payable                                                                                                                                                                                 |       | $                  | 167,579    |                  | $          | 177,329 |   |
| Minority interest                                                                                                                                                                             |       | 2,609              |       | 3,209                 |       |
| Other liabilities                                                                                                                                                                             |       | 9,391              |       | 10,758                |       |
| Total Liabilities                                                                                                                                                                             |       | 179,579            |       | 191,296               |       |
| Commitments and contingencies (note 13)                                                                                                                                                       |       |               |       |                  |       |
| Stockholders’ equity:                                                                                                                                                                    |       |               |       |                  |       |
| Optional preferred stock (par value $.01 per share;  98,000,000 shares authorized; no shares issued or outstanding)                                                                           |       | —             |       | —                |       |
| Common stock (par value $.01 per share; 100,000,000  shares authorized; shares issued: 11,326,937 and 11,326,937, respectively; shares  outstanding: 10,481,907 and 10,746,437, respectively) |       | 113                |       | 113                   |       |
| Treasury stock, at cost: 845,030 shares and 580,500  shares, respectively                                                                                                                     |       | (8,116             | )          | (5,978                | )          |
| Paid in capital                                                                                                                                                                               |       | 101,465            |       | 101,240               |       |
| Retained earnings                                                                                                                                                                             |       | 6,018              |       | 9,602                 |       |
| Accumulated other comprehensive income                                                                                                                                                        |       | 1,372              |       | 1,846                 |       |
| Total Stockholders’ Equity                                                                                                                                                               |       | 100,852            |       | 106,823               |       |
| Total Liabilities and Stockholders’ Equity                                                                                                                                               |       | $                  | 280,431    |                  | $          | 298,119 |   |
|                                                                                                                                                                                               |            |                    |            |                       |            |  |  |  |  |

 

See accompanying notes to consolidated financial statements.

 

2

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Tableof contents

 

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                                                 | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                 | ** ** | **March 31,**               | ** ** |
| ** **                                                                 | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Revenues:                                                                  | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Servicing fees ($2,164 and $2,453 from affiliates,  respectively)          |       | $                                | 2,200      |   | $ | 2,605 |   |
| Income from Portfolio Assets                                               |       | 4,935                            |       | 5,035 |   |
| Gain on sale of SBA loans held for sale, net                               |       | 9                                |       | 281 |   |
| Interest income from SBA loans                                             |       | 476                              |       | 308 |   |
| Interest income from affiliates                                            |       | 150                              |       | 126 |   |
| Interest income from loans receivable - other                              |       | 275                              |       | 907 |   |
| Other income                                                               |       | 1,459                            |       | 459 |   |
| Total revenues                                                             |       | 9,504                            |       | 9,721 |   |
| Expenses:                                                                  |       |                             |       |   |   |
| Interest and fees on notes payable                                         |       | 3,683                            |       | 4,251 |   |
| Salaries and benefits                                                      |       | 5,030                            |       | 3,993 |   |
| Provision for loan and impairment losses                                   |       | 3,030                            |       | 326 |   |
| Occupancy, data processing, property protection and  other                 |       | 3,925                            |       | 3,933 |   |
| Total expenses                                                             |       | 15,668                           |       | 12,503 |   |
| Equity in earnings of investments                                          |       | 2,840                            |       | 1,826 |   |
| Loss from continuing operations before income taxes  and minority interest |       | (3,324                           | )          | (956 | ) |
| Income tax expense                                                         |       | (191                             | )          | (67 | ) |
| Minority interest                                                          |       | 22                               |       | 108 |   |
| Loss from continuing operations                                            |       | (3,493                           | )          | (915 | ) |
| Discontinued operations                                                    |       |                             |       |   |   |
| Loss from discontinued operations                                          |       | (91                              | )          | — |   |
| Net loss                                                                   |       | $                                | (3,584     | ) | $ | (915 | ) |
| Basic and diluted loss per common share are as  follows:                   |       |                             |       |   |   |
| Loss from continuing operations                                            |       | $                                | (0.33      | ) | $ | (0.08 | ) |
| Discontinued operations                                                    |       | $                                | (0.01      | ) | $ | — |   |
| Net loss to common stockholders                                            |       | $                                | (0.34      | ) | $ | (0.08 | ) |
| Weighted average common shares outstanding                                 |       | 10,584                           |       | 10,788 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**AND COMPREHENSIVE INCOME**

**(Dollars in thousands)**

 
| ** **                                                                 | ** ** | ** **            | ** ** | ** **              | ** ** | ** **       | ** ** | ** **       | ** ** | ** **        | ** ** | **Retained**           | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|------------------|------------|------------------|------------|-------------------|------------|------------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                 | ** ** | ** **            | ** ** | ** **              | ** ** | ** **       | ** ** | ** **       | ** ** | ** **        | ** ** | **Earnings**           | ** ** | **Other**       | ** ** | **Total**  | ** ** |
| ** **                                                                 | ** ** | **Common Stock** | ** ** | **Treasury Stock** | ** ** | **Paid in** | ** ** | **(Accumulated** | ** ** | **Comprehensive** | ** ** | **Stockholders’** | ** ** |
| ** **                                                                 | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Shares**       | ** ** | **Amount**       | ** ** | **Capital**       | ** ** | **Deficit)**           | ** ** | **Income**      | ** ** | **Equity** | ** ** |
| ** **                                                                 | ** ** | ** **            | ** ** | ** **              | ** ** | ** **       | ** ** | ** **       | ** ** | ** **        | ** ** | ** **             | ** ** | ** **      | ** ** | ** ** | ** ** |
| **Balances, December 31, 2006**                                       |       | 11,316,937            |       | $                       | 113        |             | 530,300    |             | $          | (5,571            | )          | $                      | 100,562    |            | $          | 7,417      |       | $ | 1,372 |   | $ | 103,893 |   |
| Exercise of common stock options                                           |       | 10,000                |       | —                  |       | —           |       | —           |       | 35                |       | —                 |       | —          |       | 35         |       |
| Repurchase of common stock                                                 |       | —                |       | —                  |       | 50,200           |       | (407             | )          | —            |       | —                 |       | —          |       | (407       | )          |
| Additional paid in capital arising from stock option  compensation expense |       | —                |       | —                  |       | —           |       | —           |       | 643               |       | —                 |       | —          |       | 643        |       |
| Comprehensive income:                                                      |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       |       |       |
| Net earnings for 2007                                                      |       | —                |       | —                  |       | —           |       | —           |       | —            |       | 2,185                  |       | —          |       | 2,185      |       |
| Translation adjustments                                                    |       | —                |       | —                  |       | —           |       | —           |       | —            |       | —                 |       | 474             |       | 474        |       |
| Total comprehensive income                                                 |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       | 2,659      |       |
| **Balances, December 31, 2007**                                       |       | 11,326,937            |       | $                       | 113        |             | 580,500    |             | $          | (5,978            | )          | $                      | 101,240    |            | $          | 9,602      |       | $ | 1,846 |   | $ | 106,823 |   |
| Repurchase of common stock                                                 |       | —                |       | —                  |       | 264,530          |       | (2,138           | )          | —            |       | —                 |       | —          |       | (2,138     | )          |
| Additional paid in capital arising from stock option  compensation expense |       | —                |       | —                  |       | —           |       | —           |       | 225               |       | —                 |       | —          |       | 225        |       |
| Comprehensive income:                                                      |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       |       |       |
| Net loss for the first three months of 2008                           |       | —                |       | —                  |       | —           |       | —           |       | —            |       | (3,584                 | )          | —          |       | (3,584     | )          |
| Translation adjustments                                                    |       | —                |       | —                  |       | —           |       | —           |       | —            |       | —                 |       | (474            | )          | (474       | )          |
| Total comprehensive income                                                 |       |                  |       |                    |       |             |       |             |       |              |       |                   |       |            |       | (4,058     | )          |
| **Balances, March 31, 2008 (unaudited)**                              |       | 11,326,937            |       | $                       | 113        |             | 845,030    |             | $          | (8,116            | )          | $                      | 101,465    |            | $          | 6,018      |       | $ | 1,372 |   | $ | 100,852 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                                                 | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                 | ** ** | **March 31,**               | ** ** |
| ** **                                                                                 | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Cash flows from operating activities:                                                      |       |                             |       |   |   |
| Net loss                                                                                   |       | $                                | (3,584     | ) | $ | (915 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |       |                             |       |   |   |
| Net loss from discontinued operations                                                      |       | 91                               |       | — |   |
| Purchase of SBA loans held for sale                                                        |       | —                           |       | (18,355 | ) |
| Net principal payments (advances) on SBA loans held  for sale                              |       | (1,088                           | )          | 123 |   |
| Proceeds from the sale of SBA loans held for sale,  net                                    |       | 197                              |       | 7,102 |   |
| Purchases of Portfolio Assets                                                              |       | (7,768                           | )          | (34,182 | ) |
| Proceeds applied to principal on Portfolio Assets                                          |       | 19,471                           |       | 19,698 |   |
| Income from Portfolio Assets                                                               |       | (4,935                           | )          | (5,035 | ) |
| Capitalized interest and costs on Portfolio Assets  and loans receivable                   |       | (215                             | )          | (284 | ) |
| Provision for loan and impairment losses                                                   |       | 3,030                            |       | 326 |   |
| Equity in earnings of investments                                                          |       | (2,840                           | )          | (1,826 | ) |
| Gain on sale of SBA loans held for sale, net                                               |       | (9                               | )          | (281 | ) |
| Depreciation and amortization                                                              |       | 892                              |       | 707 |   |
| Net premium amortization of loans receivable                                               |       | (131                             | )          | (69 | ) |
| Stock-based compensation expense related to stock  options                                 |       | 225                              |       | 180 |   |
| Increase in service fees receivable                                                        |       | (102                             | )          | (136 | ) |
| Decrease (increase) in other assets                                                        |       | 560                              |       | (8,205 | ) |
| Increase (decrease) in other liabilities                                                   |       | (2,134                           | )          | 5,877 |   |
| Net cash provided by (used in) operating activities                                        |       | 1,660                            |       | (35,275 | ) |
| Cash flows from investing activities:                                                      |       |                             |       |   |   |
| Purchases of property and equipment, net                                                   |       | (346                             | )          | (214 | ) |
| Net principal collections (advances) on loans  receivable                                  |       | 498                              |       | (3,674 | ) |
| Purchases of SBA loans held for investment                                                 |       | —                           |       | (17,407 | ) |
| Net principal collections on SBA loans held for  investment                                |       | 1,249                            |       | 804 |   |
| Contributions to Acquisition Partnerships and  Servicing Entities                          |       | (2,203                           | )          | (7,552 | ) |
| Distributions from Acquisition Partnerships and  Servicing Entities                        |       | 5,346                            |       | 13,577 |   |
| Net cash provided by (used in) investing activities                                        |       | 4,544                            |       | (14,466 | ) |
| Cash flows from financing activities:                                                      |       |                             |       |   |   |
| Borrowings under notes payable                                                             |       | 16,923                           |       | 81,547 |   |
| Principal payments of notes payable, net                                                   |       | (29,806                          | )          | (32,605 | ) |
| Payments of debt issuance costs and loan fees                                              |       | (330                             | )          | (469 | ) |
| Repurchase of common stock                                                                 |       | (2,138                           | )          | — |   |
| Proceeds from issuance of common stock                                                     |       | —                           |       | 18 |   |
| Net cash provided by (used in) financing activities                                        |       | (15,351                          | )          | 48,491 |   |
| Net cash used in continuing operations                                                     |       | (9,147                           | )          | (1,250 | ) |
| Cash flows from discontinued operations:                                                   |       |                             |       |   |   |
| Net cash used in operating activities                                                      |       | (4                               | )          | (11 | ) |
| Net cash used in discontinued operations                                                   |       | (4                               | )          | (11 | ) |
| Net decrease in cash and cash equivalents                                                  |       | (9,151                           | )          | (1,261 | ) |
| Cash and cash equivalents, beginning of period                                             |       | 23,546                           |       | 18,472 |   |
| Cash and cash equivalents, end of period                                                   |       | $                                | 14,395     |   | $ | 17,211 |   |
| Supplemental disclosure of cash flow information:                                          | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Cash paid during the period for:                                                           | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Interest                                                                                   |       | $                                | 3,277      |   | $ | 3,404 |   |
| Income taxes, net of refunds received                                                      |       | 14                               |       | 18 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**March 31, 2008**

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

**(Unaudited)**

 

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

 

***The Company***

 

FirstCity Financial Corporation and subsidiaries (the “Company” or “FirstCity”)is a financial services company with offices throughout the United States andMexico, and a presence in France, Germany, Brazil, Argentina and Chile. At March 31,2008, the Company was engaged in one principal reportable segment – PortfolioAsset acquisition and resolution. Theportfolio asset acquisition and resolution business involves (i) acquiringportfolios of loans, real estate and other assets or single assets, andinvestments in similar assets (collectively referred to as “Portfolios” or “PortfolioAssets”) generally at a discount to their legal principal balance orappraised value, and servicing andresolving such Portfolios in an effort to maximize the present value of theultimate cash recoveries. The Company also invests in special situations andrestructuring arrangements such as acquiring or financing distressed debt andbusinesses, originating junior- and senior-bridge loans, and executing lowermiddle-market buyouts.

 

***Basis of Presentation***

 

The unaudited consolidated financial statements of FirstCity reflect, inthe opinion of management, all adjustments, consisting only of normal and recurringadjustments, necessary to present fairly FirstCity’s consolidated financialposition at March 31, 2008, its results of operations for the three monthperiods ended March 31, 2008 and 2007 and cash flows for the three monthperiods ended March 31, 2008 and 2007. Certain disclosures have been condensed or omitted from these financialstatements. Accordingly, these financial statements should be read with theconsolidated financial statements included in the Company’s 2007 Annual Reporton Form 10-K, as amended. Certain amounts in the consolidated financialstatements for prior years have been reclassified to conform to currentconsolidated financial statement presentation.

 

***Use of Estimates***

 

The preparation of financial statements inconformity with U.S. generally accepted accounting principles requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Significant estimates include (i) the estimation offuture collections on purchased Portfolio Assets used in the calculation ofincome from Portfolio Assets, (ii) interest rate environments, (iii) valuationof the deferred tax asset, (iv) prepayment speeds and valuation ofservicing assets, (v) valuation of loans receivable (including loansreceivable held in securitization trusts); and (vi) income taxuncertainties. Actual results could differ materially from those estimates.

 

***Reclassifications***

 

Certain amounts inthe consolidated financial statements for prior periods have been reclassifiedto conform to current consolidated financial statement presentation. In allreporting prior to December 31, 2007, FirstCity reported payments of debtissuance costs and loan fees in cash flows from operating activities on theConsolidated Statements of Cash Flows. The Company is now reporting these itemsin cash flows from financing activities. Prior period amounts reported on theConsolidated Statements of Cash Flows have been adjusted to conform to thistreatment which is required under generally accepted accounting principles. Thetotal amount reclassified was $469 for the three month period ended March 31,2007. Management believes that the changes in the Consolidated Statement ofCash Flows for the three month period ended March 31, 2007 are immaterialrelative to the financial statements taken as a whole.  This reclassification has the following impacton the financial statements:

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

| ** **                                                                   | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                   | ** ** | **March 31,**               | ** ** |
| ** **                                                                   | ** ** | **2007**                         | ** ** |
|                                                                         |       |                             |       |
| Statement of Cash Flows:                                                     |       |                             |       |
| Cash flows from operating activities (as reported)                           |       | $                                | (35,744    | ) |
| Impact of reclassification on payments of debt issuance  costs and loan fees |       | 469                              |       |
| Cash flows from operating activities (as corrected)                          |       | $                                | (35,275    | ) |
|                                                                         |       |                             |       |
| Cash flows from financing activities (as reported)                           |       | $                                | 48,960     |   |
| Impact of reclassification on payments of debt issuance  costs and loan fees |       | (469                             | )          |
| Cash flows from financing activities (as corrected)                          |       | $                                | 48,491     |   |
|                                                                              |            |                                  |            |  |  |

 

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

 

***Recently Issued Accounting Standards***

 

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

 

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

 

***Recently Adopted Accounting Standards***

 

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

 

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

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(3)  Discontinued Operations**

 

Discontinued operationsare comprised of two components previously reported as the Company’sresidential and commercial mortgage banking business (“Mortgage”) and the consumerlending business conducted through the Company’s minority interest investmentin Drive Financial Services LP (“Consumer”). In the first quarter of 2008, theCompany recorded a provision of $87 related to the discontinued Mortgageoperations. There was no income or loss from discontinued operations in thefirst three months of 2007. At March 31, 2008 and December 31, 2007,liabilities from discontinued Consumer operations of $677 and $568,respectively, which consists of state income taxes payable, were included inother liabilities.

 

**(4)  Portfolio Assets**

 

Portfolio Assets are summarized as follows:

 
| ** **                                  | ** ** | **March 31,****2008** | ** ** | **December  31,  2007** | ** ** |
|---------------------------------------------|------------|----------------------------|------------|-------------------------|------------|
| Loan Portfolios                             | ** ** | ** **                 | ** ** | ** **              | ** ** |
| Loans Acquired Prior to 2005                | ** ** | ** **                 | ** ** | ** **              | ** ** |
| Non-performing Portfolio Assets             |       | $                          | 3,922      |                    | $          | 4,177 |   |
| Performing Portfolio Assets                 |       | 1,089                      |       | 1,266                   |       |
| Loans Acquired After 2004                   | ** ** | ** **                 | ** ** | ** **              | ** ** |
| Loans acquired with credit deterioration    |       | 91,208                     |       | 97,630                  |       |
| Loans acquired with no credit deterioration |       | 3,142                      |       | 3,871                   |       |
| Outstanding balance                         |       | 99,361                     |       | 106,944                 |       |
| Allowance for loan losses                   |       | (4,413                     | )          | (1,723                  | )          |
| Carrying amount of loans, net of allowance  |       | 94,948                     |       | 105,221                 |       |
|                                        |       |                       |       |                    |       |
| Real Estate Portfolios                      |       | 15,729                     |       | 14,832                  |       |
| Other                                       |       | 1,916                      |       | 1,948                   |       |
| Portfolio Assets, net                       |       | $                          | 112,593    |                    | $          | 122,001 |   |

 

In the first quarter of 2008,the Company discontinued using the income recognition model under AICPAStatement of Position 03-3, *Accounting for CertainLoans or Debt Securities Acquired in a Transfer* (“SOP 03-3”) forpreviously-purchased non-performing loan portfolios in Mexico. Recognition ofincome under SOP 03-3 is dependent on management having the ability to developreasonable expectations as to both the timing and amount of cash flows to becollected. In the event management cannot develop a reasonable expectation ofthe timing and amount of cash flows expected to be collected, SOP 03-3 permitsthe use of the cost-recovery accounting model. Due to uncertainties related tothe legal and economic environment in Mexico, management determined that it nolonger has the ability to develop a reasonable expectation of the timing ofcash flows to be collected, and as of January 1, 2008, began accounting for itsnon-performing loan portfolios in Mexico under the cost-recovery accounting model– which requires collections received to be applied first against the recordedamount of the loan or pool. When the carrying amount of the loan or pool hasbeen reduced to zero, any additional amounts received are recognized as income.The Company evaluates at the balance sheet date if the remaining amount that isprobable of collection is less than the carrying value, and if so, recognizesan impairment. For subsequent increases in the actual cash flows or cash flowsexpected to be collected, management will reverse any existing valuationallowance for that loan or pool. At March 31, 2008, the Company’s carryingamount of non-performing loans in Mexico accounted for using the cost-recoverymodel in the caption “Loans Acquired After 2004 – Loans acquired with creditdeterioration” in the table above approximated $6.2 million. The Company didnot acquire any loans in Mexico with credit deterioration in the first quarterof 2008 that are within the scope of SOP 03-3.

 

Income from Portfolio Assets issummarized as follows:

 
| ** **                                  | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|
| ** **                                  | ** ** | **March 31,**               | ** ** |
| ** **                                  | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Loan Portfolios                             | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Loans Acquired Prior to 2005                | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Non-performing Portfolio Assets             |       | $                                | 180        |   | $ | 742 |   |
| Performing Portfolio Assets                 |       | 106                              |       | 349 |   |
| Loans Acquired After 2004                   | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Loans acquired with credit deterioration    |       | 3,553                            |       | 3,066 |   |
| Loans acquired with no credit deterioration |       | 112                              |       | 492 |   |
| Real Estate Portfolios                      |       | 929                              |       | 328 |   |
| Other                                       |       | 55                               |       | 58 |   |
| Income from Portfolio Assets                |       | $                                | 4,935      |   | $ | 5,035 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

Portfolio Assets are pledged to secure notespayable that are generally non-recourse to FirstCity or any affiliate otherthan the entity that incurred the debt. See Note 2 to the Company’s 2007 Annual Report on Form 10-K filedwith the Securities and Exchange Commission (“SEC” or “Commission”) on March 17,2008 for a description of the Revolving Credit Agreement between FH PartnersLLC, an indirect wholly-owned affiliate of FirstCity, and Bank of Scotland,which is guaranteed by FirstCity and the primary wholly-owned subsidiaries ofFirstCity.

 

The Companyrecorded a provision for loan and impairment losses on Portfolio Assets ofapproximately $2,906 for the three month period ended March 31, 2008,which is comprised of a $194 impairment charge on real estate portfolios and a$2,712 allowance for loan losses, net of recoveries.  For the three month period ended March 31,2007, the Company recorded a provision for loan and impairment losses onPortfolio Assets of $326, which is comprised of a $92 impairment charge on realestate portfolios and a $234 allowance for loan losses.

 

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

 

| ** **        | ** ** | **Three Months Ended** | ** ** |
|-------------------|------------|----------------------------------|------------|
| ** **        | ** ** | **March 31,**               | ** ** |
| ** **        | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Beginning Balance |       | $                                | (1,723     | ) | $ | (333 | ) |
| Provisions        |       | (2,867                           | )          | (234 | ) |
| Recoveries        |       | 155                              |       | — |   |
| Charge Offs       |       | 22                               |       | — |   |
| Ending Balance    |       | $                                | (4,413     | ) | $ | (567 | ) |

 

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

 

| ** **                                          | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                          | ** ** | **March 31,**               | ** ** |
| ** **                                          | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Beginning Balance                                   |       | $                                | 35,951     |   | $ | 32,339 |   |
| Additions                                           |       | 3,315                            |       | 1,269 |   |
| Accretion                                           |       | (3,258                           | )          | (2,714 | ) |
| Reclassification from (to) nonaccretable difference |       | (3,838                           | )          | 5,165 |   |
| Disposals                                           |       | (1,194                           | )          | (352 | ) |
| Translation adjustments                             |       | 342                              |       | (37 | ) |
| Ending Balance                                      |       | $                                | 31,318     |   | $ | 35,670 |   |

 

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** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                         | ** ** | **March 31,**               | ** ** |
| ** **                                         | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Face value at acquisition                          |       | $                                | 9,852      |   | $ | 34,897 |   |
| Cash flows expected to be collected at acquisition |       | 10,135                           |       | 30,122 |   |
| Basis in acquired loans at acquisition             |       | 6,820                            |       | 28,853 |   |
|                                                    |            |                                  |            |  |  |  |  |

 

**(5)  Loans Receivable**

 

***Loansreceivable – affiliates***

 

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

 

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

 

| ** **                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Outstanding balance           |       | $                  | 4,827      |                  | $          | 4,967 |   |
| Capitalized costs             |       | 576                |       | 480                   |       |
| Carrying amount of loans, net |       | $                  | 5,403      |                  | $          | 5,447 |   |

 

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

 

| ** **                    | ** ** | **Three Months Ended** | ** ** |
|-------------------------------|------------|----------------------------------|------------|
| ** **                    | ** ** | **March 31,**               | ** ** |
| ** **                    | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Beginning Balance             |       | $                                | 5,447      |   | $ | 4,755 |   |
| Advances                      |       | —                           |       | 350 |   |
| Payments received             |       | (468                             | )          | (322 | ) |
| Capitalized origination costs |       | 96                               |       | 65 |   |
| Foreign exchange gains        |       | 328                              |       | 28 |   |
| Ending Balance                |       | $                                | 5,403      |   | $ | 4,876 |   |

 

Loans receivable –affiliates represent advances to Acquisition Partnerships and other affiliatedentities to acquire portfolios of performing and nonperforming commercial andconsumer loans and other assets. The loans are reported at their outstandingprincipal balances adjusted for net deferred loan origination and othercapitalized costs and the allowance for loan losses.  Interest is recognized on an accrual basis atthe applicable interest rate on the principal amount outstanding.  Loan origination fees and direct costs areamortized as level yield adjustments over the respective loan terms.  Unamortized net fees or costs are recognizedupon early repayment of the loans.  Loansreceivable – affiliates are generally secured by the underlying collateral ofthe individual notes within the portfolios that were acquired with the loanproceeds, which is generally real estate and foreclosed properties. They areevaluated for impairment by analyzing the expected future cash flows from theunderlying assets within each pool to determine that the cash flows aresufficient to repay these notes. The Company applies the asset valuationmethodology consistently in all venues and uses the same proprietary assetmanagement system to evaluate impairment on all asset pools. The results ofthis evaluation indicated that cash flows from the pools will be sufficient torepay the loans and no allowances for impairment are necessary. The Companyrecorded no provisions for impairment on loans receivable – affiliates for thethree months ended March 31, 2008 and 2007.

 

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

 

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

 

| ** **                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Outstanding balance           |       | $                  | 1,035      |                  | $          | 133 |   |
| Premiums                      |       | 20                 |       | —                |       |
| Carrying amount of loans, net |       | $                  | 1,055      |                  | $          | 133 |   |

 

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

 

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

 

| ** **                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------|------------|
| ** **                         | ** ** | **March 31,**               | ** ** |
| ** **                         | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Beginning Balance                  |       | $                                | 133        |   | $ | — |   |
| Purchases of loans                 |       | —                           |       | 18,355 |   |
| Originations and advances of loans |       | 1,090                            |       | 64 |   |
| Payments received                  |       | (2                               | )          | (187 | ) |
| Capitalized costs                  |       | 19                               |       | — |   |
| Loans sold                         |       | (185                             | )          | (6,560 | ) |
| Premium amortization, net          |       | —                           |       | (188 | ) |
| Ending Balance                     |       | $                                | 1,055      |   | $ | 11,484 |   |

 

Loans receivable – SBA held for sale represent U.S. Small BusinessAdministration (“SBA”) loans acquired by the Company in February 2007 andSBA loan originations and advances made since such time.  SBA loans held for sale represent theguaranteed portions of the loans, and are reflected at the lower of aggregatecost or estimated fair value. Net unrealized losses, if any, are recognizedthrough a valuation allowance by charges to income. The carrying value of SBAloans held for sale is net of premiums as well as deferred origination fees andcosts. Premiums and net origination fees and costs are deferred and included inthe basis of the loans in calculating gains and losses upon sale. The Companygenerally sells the guaranteed portion of each loan to a third party andretains the servicing rights. The difference between the proceeds received andthe allocated carrying value of the loans sold are recognized as net gains onsales of loans.  The non-guaranteedportion is generally held in the portfolio and classified as held forinvestment.  The Company recorded nowrite-downs of SBA loans held for sale below their cost for the three monthsended March 31, 2008 and 2007.

 

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

 

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

 

| ** **                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Outstanding balance           |       | $                  | 14,311     |                  | $          | 15,727 |   |
| Allowance for loan losses     |       | (123               | )          | (151                  | )          |
| Discounts, net                |       | (1,211             | )          | (1,346                | )          |
| Capitalized costs             |       | 11                 |       | 4                     |       |
| Carrying amount of loans, net |       | $                  | 12,988     |                  | $          | 14,234 |   |

 

Changes in loans receivable – SBA held for investmentare as follows:

 

| ** **                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------|------------|----------------------------------|------------|
| ** **                         | ** ** | **March 31,**               | ** ** |
| ** **                         | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Beginning Balance                  |       | $                                | 14,234     |   | $ | — |   |
| Purchases of loans                 |       | —                           |       | 17,406 |   |
| Originations and advances of loans |       | 363                              |       | 22 |   |
| Payments received                  |       | (1,614                           | )          | (825 | ) |
| Capitalized costs                  |       | 7                                |       | — |   |
| Provision for SBA loan losses, net |       | 28                               |       | — |   |
| Discount accretion, net            |       | 135                              |       | (65 | ) |
| Charge offs                        |       | (165                             | )          | — |   |
| Ending Balance                     |       | $                                | 12,988     |   | $ | 16,538 |   |

 

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

 

Loans receivable –SBA held for investment represent SBA loans acquired by the Company in February 2007and SBA loan originations and advances made since such time. SBA loans held forinvestment are reported at their outstanding principal balances adjusted forunearned discounts, net deferred loan origination costs and the allowance forloan losses. Interest is recognized on an accrual basis at the applicableinterest rate on the principal amount outstanding. Loan origination fees anddirect costs as well as premiums and discounts are amortized as level yieldadjustments over the respective loan terms. Unamortized net fees or costs are recognizedupon early repayment of the loans. SBA loans held for investment are generallysecured by the borrowing entities’ assets such as accounts, property andequipment, and other assets. The loans are evaluated for impairment based uponperformance of the loans and other portfolio characteristics, such as industryconcentrations and loan collateral, which also impacts management’s estimatesof the impairment. The adequacy of the allowance for loan losses is reviewed bymanagement on a regular basis and adjustments, if necessary, are reflected inoperations during the periods in which they become known. Considerations inthis evaluation include past and current loss experience, risks inherent in thecurrent portfolio, and evaluation of commercial and real estate collateral aswell as current economic conditions.

 

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

 

| ** **        | ** ** | **Three Months Ended** | ** ** |
|-------------------|------------|----------------------------------|------------|
| ** **        | ** ** | **March 31,**               | ** ** |
| ** **        | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Beginning Balance |       | $                                | (151       | ) | $ | — |   |
| Provisions        |       | (124                             | )          | — |   |
| Recoveries        |       | 2                                |       | — |   |
| Charge Offs       |       | 150                              |       | — |   |
| Ending Balance    |       | $                                | (123       | ) | $ | — |   |

 

***Loansreceivable – other***

 

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

 

| ** **                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Outstanding balance           |       | $                  | 5,465      |                  | $          | 5,502 |   |
| Discounts, net                |       | (26                | )          | (24                   | )          |
| Capitalized costs             |       | 526                |       | 517                   |       |
| Carrying amount of loans, net |       | $                  | 5,965      |                  | $          | 5,995 |   |

 

Changes in loansreceivable – other are as follows:

 

| ** **                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------|------------|----------------------------------|------------|
| ** **                      | ** ** | **March 31,**               | ** ** |
| ** **                      | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Beginning Balance               |       | $                                | 5,995      |   | $ | 23,991 |   |
| Advances                        |       | (8                               | )          | 3,646 |   |
| Payments received               |       | (23                              | )          | — |   |
| Capitalized costs               |       | 9                                |       | 234 |   |
| Discount accretion, net         |       | 6                                |       | 61 |   |
| Foreign exchange gains (losses) |       | (14                              | )          | 24 |   |
| Ending Balance                  |       | $                                | 5,965      |   | $ | 27,956 |   |

 

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 other assets. Interest is accrued whenearned in accordance with the contractual terms of the loans. The loans arereported at their outstanding principal balances adjusted for unearneddiscounts, loan 

 

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

 

origination fees, and theallowance for loan losses. Interest is recognized on an accrual basis at theapplicable interest rate on the principal amount outstanding.  Loan origination fees and direct costs areamortized as level-yield adjustments over the respective loan terms. Unamortizednet fees or costs are recognized upon early repayment of the loans. Managementevaluates these loans for impairment by analyzing the present value of theexpected future cash flows from the borrowing entity discounted for the loans’risk-adjusted rates, and the values of the underlying collateral to determinewhether the Company expects to ultimately collect all contractual principal andinterest. The results of this evaluation indicated that projected cash flowsand underlying collateral are sufficient to repay the loans and no allowancesfor impairment were necessary. The Company recorded no provisions forimpairment on loans receivable – other for the three months ended March 31,2008 and 2007.

 

**(6)  Equity Investments**

 

The Company has investments in AcquisitionPartnerships and their general partners and investments in servicing entitiesthat are accounted for under the equity method. The condensed combined financial position and results of operations ofthe Acquisition Partnerships (excluding servicing entities), which include thedomestic and foreign Acquisition Partnerships and their general partners, aresummarized below:

 

**Condensed Combined Balance Sheets**

 

| ** **                                    | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Assets                                        |       | $                  | 478,610    |                  | $          | 457,490 |   |
| Liabilities                                   |       | $                  | 154,911    |                  | $          | 141,430 |   |
| Net equity                                    |       | 323,699            |       | 316,060               |       |
|                                          |       | $                  | 478,610    |                  | $          | 457,490 |   |
|                                          |       |               |       |                  |       |
| Equity investment in Acquisition Partnerships |       | $                  | 76,490     |                  | $          | 76,078 |   |
| Equity investment in servicing entities       |       | 13,153             |       | 11,544                |       |
|                                          |       | $                  | 89,643     |                  | $          | 87,622 |   |

 

**Condensed Combined Summary of Operations**

 

| ** **                                     | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------|------------|----------------------------------|------------|
| ** **                                     | ** ** | **March 31,**               | ** ** |
| ** **                                     | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Income from Portfolio Assets                   |       | $                                | 24,291     |   | $ | 22,740 |   |
| Other income                                   |       | 329                              |       | 548 |   |
| Revenues                                       |       | 24,620                           |       | 23,288 |   |
| Interest expense                               |       | 1,876                            |       | 3,007 |   |
| Average cost (annualized)                      |       | 5.38                             | %          | 13.46 | % |
| Service fees                                   |       | 4,948                            |       | 4,721 |   |
| Provision for loan and impairment losses       |       | 5,358                            |       | 6,561 |   |
| Other operating costs                          |       | 5,816                            |       | 4,168 |   |
| Foreign currency (gains) losses                |       | (2,945                           | )          | 265 |   |
| Income tax and other taxes                     |       | 1,032                            |       | 34 |   |
| Expenses                                       |       | 16,085                           |       | 18,756 |   |
| Equity in earnings of investments              |       | 777                              |       | 57 |   |
| Net earnings                                   |       | $                                | 9,312      |   | $ | 4,589 |   |
|                                           |       |                             |       |   |   |
| Equity in earnings of Acquisition Partnerships |       | $                                | 2,321      |   | $ | 1,781 |   |
| Equity in earnings of servicing entities       |       | 519                              |       | 45 |   |
|                                           |       | $                                | 2,840      |   | $ | 1,826 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

In the first quarter of 2008,the Company discontinued using the income recognition model under SOP 03-3 forpreviously-purchased non-performing loan portfolios in Mexico (refer to Note 4for a detailed discussion). In accordance with SOP 03-3, the AcquisitionPartnerships now account for their non-performing loan portfolios in Mexicounder the cost-recovery model – which requires collections received to beapplied first against the recorded amount of the loan or pool. At March 31,2008, the Acquisition Partnerships’ carrying amount of non-performing loans inMexico accounted for using the cost-recovery model in the caption “Assets” inthe “Condensed Combined Balance Sheets” table above approximated $156.0million. The Acquisition Partnerships did not acquire any loans in Mexico withcredit deterioration in the first quarter of 2008 that are within the scope ofSOP 03-3.

 

The assets and equity of theAcquisition Partnerships and equity investments in the Acquisition Partnershipsare summarized by geographic region below. The WAMCO Partnerships representlimited partnerships and limited liability companies in which the Company has acommon ownership with Cargill.

 

| ** **                | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Assets:                   |       |               |       |                  |       |
| Domestic:                 |       |               |       |                  |       |
| WAMCO Partnerships        |       | $                  | 75,544     |                  | $          | 87,086 |   |
| Other                     |       | 7,625              |       | 7,758                 |       |
| Latin America             |       | 238,041            |       | 200,780               |       |
| Europe:                   |       |               |       |                  |       |
| P.R.L. Developpement, SAS |       | 24,111             |       | 21,794                |       |
| Other                     |       | 133,289            |       | 140,072               |       |
|                      |       | $                  | 478,610    |                  | $          | 457,490 |   |

 

| ** **                                     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| Equity:                                        |       |               |       |                  |       |
| Domestic:                                      |       |               |       |                  |       |
| WAMCO Partnerships                             |       | $                  | 39,478     |                  | $          | 44,309 |   |
| Other                                          |       | 4,294              |       | 4,237                 |       |
| Latin America                                  |       | 182,492            |       | 168,108               |       |
| Europe:                                        |       |               |       |                  |       |
| P.R.L. Developpement, SAS                      |       | 22,430             |       | 19,728                |       |
| Other                                          |       | 75,005             |       | 79,678                |       |
|                                           |       | $                  | 323,699    |                  | $          | 316,060 |   |
| Equity investment in Acquisition Partnerships: |       |               |       |                  |       |
| Domestic:                                      |       |               |       |                  |       |
| WAMCO Partnerships                             |       | $                  | 19,663     |                  | $          | 22,065 |   |
| Other                                          |       | 2,052              |       | 2,064                 |       |
| Latin America                                  |       | 23,572             |       | 21,555                |       |
| Europe:                                        |       |               |       |                  |       |
| P.R.L. Developpement, SAS                      |       | 10,261             |       | 9,085                 |       |
| Other                                          |       | 20,942             |       | 21,309                |       |
|                                           |       | $                  | 76,490     |                  | $          | 76,078 |   |

 

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

 

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

 

| ** **                               | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **March 31,**               | ** ** |
| ** **                               | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Revenues:                                |       |                             |       |   |   |
| Domestic:                                |       |                             |       |   |   |
| WAMCO Partnerships                       |       | $                                | 2,921      |   | $ | 4,352 |   |
| Other                                    |       | 194                              |       | 245 |   |
| Latin America                            |       | 11,231                           |       | 9,312 |   |
| Europe:                                  |       |                             |       |   |   |
| P.R.L. Developpement, SAS                |       | 297                              |       | 504 |   |
| Other                                    |       | 9,977                            |       | 8,875 |   |
|                                     |       | $                                | 24,620     |   | $ | 23,288 |   |
|                                     |       |                             |       |   |   |
| Net earnings (loss):                     |       |                             |       |   |   |
| Domestic:                                |       |                             |       |   |   |
| WAMCO Partnerships                       |       | $                                | 794        |   | $ | 599 |   |
| Other                                    |       | (241                             | )          | (20 | ) |
| Latin America                            |       | 2,983                            |       | (1,638 | ) |
| Europe:                                  |       |                             |       |   |   |
| P.R.L. Developpement, SAS                |       | 1,178                            |       | 512 |   |
| Other                                    |       | 4,598                            |       | 5,136 |   |
|                                     |       | $                                | 9,312      |   | $ | 4,589 |   |
| Equity in earnings (loss) of Acquisition |       |                             |       |   |   |
| Partnerships:                            |       |                             |       |   |   |
| Domestic:                                |       |                             |       |   |   |
| WAMCO Partnerships                       |       | $                                | 380        |   | $ | 269 |   |
| Other                                    |       | (114                             | )          | (18 | ) |
| Latin America                            |       | 369                              |       | (10 | ) |
| Europe:                                  |       |                             |       |   |   |
| P.R.L. Developpement, SAS                |       | 487                              |       | 223 |   |
| Other                                    |       | 1,199                            |       | 1,317 |   |
|                                     |       | $                                | 2,321      |   | $ | 1,781 |   |

 

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

 

Combining statements ofoperations for the WAMCO Partnerships follow. WAMCO 30 is considered tobe a significant subsidiary of FirstCity.

 

**Three Months Ended March 31, 2008**

 

| ** **                                     | ** ** | **WAMCO** | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|-----------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **30**    | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Income from Portfolio Assets                   |       | $         | 1,543      |             | $          | 1,368        |       | $ | 2,911 |   |
| Other income, net                              |       | 9         |       | 1                |       | 10           |       |
| Revenues                                       |       | 1,552     |       | 1,369            |       | 2,921        |       |
| Interest and fees on notes payable             |       | (473      | )          | (58              | )          | (531         | )          |
| Provision for loan and impairment losses       |       | (223      | )          | (400             | )          | (623         | )          |
| Servicing fees — affiliate                |       | (114      | )          | (310             | )          | (424         | )          |
| General, administrative and operating expenses |       | (473      | )          | (76              | )          | (549         | )          |
| Expenses                                       |       | (1,283    | )          | (844             | )          | (2,127       | )          |
| Net earnings                                   |       | $         | 269        |             | $          | 525          |       | $ | 794 |   |

 

**Three Months Ended March 31, 2007**

 

| ** **                                     | ** ** | **WAMCO** | ** ** | **Other**        | ** ** | ** **   | ** ** |
|------------------------------------------------|------------|-----------|------------|------------------|------------|--------------|------------|
| ** **                                     | ** ** | **30**    | ** ** | **Partnerships** | ** ** | **Combined** | ** ** |
| Income from Portfolio Assets                   |       | $         | 3,294      |             | $          | 1,013        |       | $ | 4,307 |   |
| Other income, net                              |       | 43        |       | 2                |       | 45           |       |
| Revenues                                       |       | 3,337     |       | 1,015            |       | 4,352        |       |
| Interest and fees on notes payable             |       | (700      | )          | (132             | )          | (832         | )          |
| Provision for loan and impairment losses       |       | (1,064    | )          | (415             | )          | (1,479       | )          |
| Servicing fees — affiliate                |       | (344      | )          | (212             | )          | (556         | )          |
| General, administrative and operating expenses |       | (686      | )          | (200             | )          | (886         | )          |
| Expenses                                       |       | (2,794    | )          | (959             | )          | (3,753       | )          |
| Net earnings                                   |       | $         | 543        |             | $          | 56           |       | $ | 599 |   |

 

At March 31,2008, the Company had $41.5 million in Euro-denominated debt for the purpose ofhedging a portion of the net equity investments in Europe. In general, the typeof risk hedged relates to the foreign currency exposure of net investments inEurope caused by movements in Euro exchange rates. The Company designated thehedging relationship such that changes in the net investments being hedged areexpected to be offset by corresponding changes in the values of theEuro-denominated debt.

 

Effectiveness ofthe hedging relationship is measured and designated at the beginning of eachmonth by comparing the outstanding balance of the Euro-denominated debt to thecarrying value of the designated net equity investments. The net foreigncurrency translation gain (loss) included in accumulated other comprehensive incomerelating to the Euro-denominated debt was ($2.4) million for the three monthsended March 31, 2008 and $213 for the same period in 2007.

 

**(7)  Servicing Assets – SBA Loans**

 

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

 

In February 2007,the Company, through its subsidiary American Business Lending, Inc. (“ABL”),acquired a portfolio of SBA loans for $36.8 million. Included in the purchaseprice were the rights to service additional loans with an unpaid balance of$33.8 

 

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

 

million. The Company recorded a servicing asset of$758 relating to these servicing rights. Additional servicing rights have beencapitalized since the portfolio acquisition as a result of loans sold.Servicing rights are recognized as assets when the SBA loans are sold and therights to service those loans are retained. The Company retains servicingresponsibilities and receives servicing fees of approximately 1%.

 

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

 

| ** **                                  | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|
| ** **                                  | ** ** | **March 31,**               | ** ** |
| ** **                                  | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Beginning Balance                           |       | $                                | 885        |   | $ | — |   |
| Servicing Assets capitalized                |       | 2                                |       | 869 |   |
| Servicing Assets amortized                  |       | (48                              | )          | (15 | ) |
| Ending Balance                              |       | $                                | 839        |   | $ | 854 |   |
| ** **                                  | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Reserve for impairment of servicing assets: | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Beginning Balance                           |       | $                                | (42        | ) | $ | — |   |
| Impairments                                 |       | (68                              | )          | (39 | ) |
| Recoveries                                  |       | —                           |       | — |   |
| Charge Offs                                 |       | —                           |       | — |   |
| Ending Balance                              |       | $                                | (110       | ) | $ | (39 | ) |
|                                        |       |                             |       |   |   |
| Ending Balance (net of reserve)             |       | $                                | 729        |   | $ | 815 |   |
| ** **                                  | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Fair value of amortized servicing assets:   |       |                             |       |   |   |
| Beginning balance                           |       | $                                | 843        |   | $ | — |   |
| Ending balance                              |       | 729                              |       | 815 |   |

 

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 9.75% to 11.19%,prepayment speeds of 15%, and weighted average lives ranging from 75 to 299months. In the event future prepayments are significant or impairments areincurred and future expected cash flows are inadequate to cover the unamortizedservicing assets, additional amortization or impairment charges would berecognized.

 

**(8)  Segment Reporting**

 

The Company is engaged in one reportable segment- Portfolio Asset acquisition and resolution. The following is a summary of results of operations for the PortfolioAsset acquisition and resolution segment and reconciliation to losses fromcontinuing operations for the three months ended March 31, 2008 and 2007.

 

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

 

| ** **                                                                         | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                         | ** ** | **March 31,**               | ** ** |
| ** **                                                                         | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| **Portfolio Asset Acquisition and Resolution:**                                    |       |                             |       |   |   |
| Revenues:                                                                          |       |                             |       |   |   |
| Servicing fees                                                                     |       | $                                | 2,200      |   | $ | 2,605 |   |
| Income from Portfolio Assets                                                       |       | 4,935                            |       | 5,035 |   |
| Gain on sale of SBA loans held for sale, net                                       |       | 9                                |       | 281 |   |
| Interest income from SBA loans                                                     |       | 476                              |       | 308 |   |
| Interest income from affiliates                                                    |       | 150                              |       | 126 |   |
| Interest income from loans receivable - other                                      |       | 275                              |       | 907 |   |
| Other                                                                              |       | 1,276                            |       | 330 |   |
| Total                                                                              |       | 9,321                            |       | 9,592 |   |
| Expenses:                                                                          |       |                             |       |   |   |
| Interest and fees on notes payable                                                 |       | 3,683                            |       | 4,251 |   |
| Salaries and benefits                                                              |       | 3,961                            |       | 3,114 |   |
| Provision for loan and impairment losses                                           |       | 3,030                            |       | 326 |   |
| Occupancy, data processing, property protection and  other                         |       | 3,232                            |       | 1,992 |   |
| Minority interest                                                                  |       | (22                              | )          | (108 | ) |
| Total                                                                              |       | 13,884                           |       | 9,575 |   |
| Equity in earnings of investments                                                  |       | 2,840                            |       | 1,826 |   |
| Operating contribution before direct taxes                                         |       | $                                | (1,723     | ) | $ | 1,843 |   |
| Operating contribution, net of direct taxes                                        |       | $                                | (1,800     | ) | $ | 1,870 |   |
|                                                                               |       |                             |       |   |   |
| **Corporate Overhead:**                                                            |       |                             |       |   |   |
| Salaries and benefits, occupancy, professional and  other income and expenses, net |       | 1,693                            |       | 2,785 |   |
| Losses from continuing operations                                                  |       | $                                | (3,493     | ) | $ | (915 | ) |

 

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** | ** ** |
|---------------|------------|----------------------------------|------------|
| ** **    | ** ** | **March 31,**               | ** ** |
| ** **    | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Domestic      |       | $                                | 6,718      |   | $ | 6,967 |   |
| Latin America |       | 3,035                            |       | 2,532 |   |
| Europe        |       | 2,395                            |       | 1,830 |   |
| Other         |       | 13                               |       | 89 |   |
| Total         |       | $                                | 12,161     |   | $ | 11,418 |   |

 

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** **

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

 

Total assets for the PortfolioAsset acquisition and resolution segment and a reconciliation to total assetsare as follows:

 
| ** **                                   | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2008**           | ** ** | **2007**              | ** ** |
| ** **                                   | ** ** | ** **         | ** ** | ** **            | ** ** |
| Cash                                         |       | $                  | 14,395     |                  | $          | 23,546 |   |
| Portfolio acquisition and resolution assets: |       |               |       |                  |       |
| Domestic                                     |       | 151,443            |       | 163,078               |       |
| Latin America                                |       | 36,054             |       | 33,450                |       |
| Europe                                       |       | 48,341             |       | 46,701                |       |
| Other                                        |       | 337                |       | 371                   |       |
| Deferred tax asset, net                      |       | 20,101             |       | 20,101                |       |
| Other non-earning assets, net                |       | 9,760              |       | 10,872                |       |
| Total assets                                 |       | $                  | 280,431    |                  | $          | 298,119 |   |

 

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

 

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

 
| ** **                                                          | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                          | ** ** | **March 31,**               | ** ** |
| ** **                                                          | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| ** **                                                          | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Loss from continuing operations                                     |       | $                                | (3,493     | ) | $ | (915 | ) |
| Loss from discontinued operations                                   |       | (91                              | )          | — |   |
| Net loss available to common shareholders                           |       | $                                | (3,584     | ) | $ | (915 | ) |
|                                                                |       |                             |       |   |   |
| Weighted average outstanding shares of common stock  (in thousands) |       | 10,584                           |       | 10,788 |   |
|                                                                |       |                             |       |   |   |
| Loss from continuing operations per share: Basic and  diluted       |       | $                                | (0.33      | ) | $ | (0.08 | ) |
| Loss from discontinued operations per share: Basic  and diluted     |       | (0.01                            | )          | — |   |
| Loss per share: Basic and diluted                                   |       | $                                | (0.34      | ) | $ | (0.08 | ) |
|                                                                |       |                             |       |   |   |
| Anti-dilutive shares excluded from above:                           |       |                             |       |   |   |
| Warrants                                                            |       | 300                              |       | 334 |   |
| Employee stock options                                              |       | 246                              |       | 309 |   |

 

**(10)  Stock-Based Compensation**

 

The impact on theresults of operations of recording stock-based compensation for the three monthperiods ended March 31, 2008 and 2007 was as follows:

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                         | ** ** | **March 31,**               | ** ** |
| ** **                                         | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Amount of compensation cost recognized in expenses |       | $                                | 225        |   | $ | 180 |   |
| Tax benefit recognized in income                   |       | $                                | —     |   | $ | — |   |
| Amount capitalized as part of an asset             |       | $                                | —     |   | $ | — |   |

 

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

 

A summary of stock option activity as of March 31,2008 and changes during the period then ended is presented below:

 
| ** **                          | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **    | ** ** |
|-------------------------------------|------------|------------|------------|--------------|------------|-----------------|------------|---------------|------------|
| ** **                          | ** ** | ** ** | ** ** | ** **   | ** ** | **Average**     | ** ** | ** **    | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Remaining**   | ** ** | ** **    | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Average**  | ** ** | **Contractual** | ** ** | **Aggregate** | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Term**        | ** ** | **Intrinsic** | ** ** |
| ** **                          | ** ** | **Shares** | ** ** | **Price**    | ** ** | **(Years)**     | ** ** | **Value**     | ** ** |
| Outstanding at January 1, 2008 |       | 879,150    |       | $            | 6.67       |            |       |          |       |   |
| Granted                             |       | —     |       | —       |       |            |       |          |       |
| Exercised                           |       | —     |       | —       |       |            |       |          |       |
| Expired                             |       | —     |       | —       |       |            |       |          |       |
| Forfeited                           |       | —     |       | —       |       |            |       |          |       |
| Outstanding at March 31, 2008  |       | 879,150    |       | $            | 6.67       |            | 5.85       |          | $          | 2,151 |   |
| Exercisable at March 31, 2008  |       | 646,950    |       | $            | 5.64       |            | 4.91       |          | $          | 2,106 |   |

 

The totalintrinsic value of stock options exercised during the three month periods endedMarch 31, 2008 and 2007 was $-0- and $9, respectively. As of March 31,2008, there was approximately $1.2 million of total unrecognized compensationcost related to unvested share-based compensation arrangements granted underthe stock option plans.  That cost isexpected to be recognized over a weighted average period of 2.6 years.

 

A summary of thestatus and changes of FirstCity’s nonvested shares as of March 31, 2008,and changes during the three months ended March 31, 2008 is presentedbelow:

 
| ** **                        | ** ** | ** ** | ** ** | **Weighted-**   | ** ** |
|-----------------------------------|------------|------------|------------|-----------------|------------|
| ** **                        | ** ** | ** ** | ** ** | **Average**     | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Grant-Date**  | ** ** |
| ** **                        | ** ** | **Shares** | ** ** | **Fair  Value** | ** ** |
| Nonvested at January 1, 2008 |       | 240,950    |       | $               | 6.89       |   |
| Granted                           |       | —     |       | $               | —     |   |
| Vested                            |       | (8,750     | )          | $               | 5.26       |   |
| Forfeited                         |       | —     |       | $               | —     |   |
| Nonvested at March 31, 2008  |       | 232,200    |       | $               | 6.95       |   |

 

**(11)  Income Taxes**

 

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

 

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

 

On October 1, 2007 the Entrepreneurial Tax of Unique Rate (referred toby its Spanish acronym, IETU or “Flat Tax”) in Mexico was published. The FlatTax law was effective on January 1, 2008 and replaces the existingasset-based tax. The Flat Taxapplies to a different tax base than the income tax and will be paid if theFlat Tax exceeds the income tax computed under existing law. In accordance withSFAS 109, *Accounting for Income Taxes*, the effectsof the Flat Tax should be reflected in the consolidated financial statements.The Flat Tax has no impact on the Company’s deferred tax assets recognized asof March 31, 2008.

 

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

 

The gross amount of UTBs on uncertain tax positions as of March 31,2008 totaled $577, which if recognized, would impact the Company’s effectiveincome tax rate. A reconciliation of UTBs for the first quarter of 2008follows:

 
| ** **                                                    | ** ** | **2008** | ** ** |
|---------------------------------------------------------------|------------|----------|------------|
| Balance at January 1, 2008                               |       | $        | 579        |   |
| Additions based on tax positions related to the  current year |       | —   |       |
| Payments and settlements                                      |       | (2       | )          |
| Balance at March 31, 2008                                |       | $        | 577        |   |

 

Over the next twelve months, due to the expiration of the statute oflimitations related to certain UTBs, the Company anticipates that it isreasonably possibly that the amount of UTBs could be reduced by approximately$228, which would impact the Company’s effective tax rate. The Company recordsinterest and penalties related to income tax uncertainties in the provision forincome taxes. At March 31, 2008, interest and penalties of $167 areincluded in “Other liabilities” as income taxes payable.

 

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

 

**(12)  Fair Value**

 

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

 

·                  Level 1 – Valuations are based upon quoted prices in active exchangemarkets involving identical assets and liabilities.

 

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

 

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

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

At March 31, 2008, the Company did not have any assets orliabilities that are measured at fair value on a recurring basis. However, theCompany is required to measure certain financial assets at fair value on anon-recurring basis in accordance with generally accepted accountingprinciples. These adjustments to fair value generally result from write-downsof individual assets as a result of impairment or application oflower-of-cost-or-fair value accounting. For assets measured at fair value on anon-recurring basis and carried at fair value on the balance sheet at March 31,2008, the following table provides the level of valuation assumptions used todetermine the fair value of the related individual assets or portfolios atquarter end:

 
| ** **                           | ** ** | ** **                                                    | ** ** | ** **             | ** ** | ** **       | ** ** | ** **       | ** ** | **Total Losses in** | ** ** |
|--------------------------------------|------------|---------------------------------------------------------------|------------|------------------------|------------|------------------|------------|------------------|------------|-------------------------------|------------|
| ** **                           | ** ** | **Carrying Value at March 31, 2008** | ** ** | **Quarter Ended** | ** ** |
| **(Dollars in thousands)** | ** ** | **Total**                                                     | ** ** | **Level 1**       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **March 31, 2008**  | ** ** |
| Portfolio Assets - loans (1)         |       | $                                                             | 2,489      |                   | $          | —           |       | $                | —     |                          | $          | 2,489 |   | $ | (497 | ) |
| SBA loans held for investment (1)    |       | 100                                                           |       | —                 |       | —           |       | 100              |       | (124                          | )          |
| Servicing assets - SBA loans         |       | 578                                                           |       | —                 |       | —           |       | 578              |       | (68                           | )          |
|                                 |       |                                                          |       |                   |       |             |       |             |       | $                             | (689       | ) |
|                                      |            |                                                               |            |                        |            |                  |            |                  |            |                               |            |  |  |  |  |  |

 

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(1)          Represents the carrying value of impaired loans thatwere measured for impairment using the estimated fair value of the collateralfor collateral-dependent loans. The carrying value of loans fully charged-offis zero.

 

The carrying value and related write-downs of “Portfolio Assets – loans”and “SBA loans held for investment” in the table above are based on collateralvaluations using multiple valuation approaches that are derived from observableand unobservable inputs, adjusted for various considerations such as marketconditions, economic and competitive environment, and other assets with similarcharacteristics (i.e. industry, geography, etc.) that, in management’s opinion,reflect elements a marketplace participant would consider. The Companyclassifies its fair value measurement techniques for Portfolio Assets and SBAloans as Level 3 inputs for the following reasons: (1) distressed assetacquisitions generally occur in inactive markets for which observable marketprices are not 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 carrying value and related write-downs of “Servicing assets – SBAloans” in the table above are based on fair value measurements derived from theCompany’s discounted cash flow model. This model estimates fair value of theservicing assets using predominant risk characteristics of servicing assetssuch as discount rate, prepayment speed, weighted average life of theunderlying loans, and the interest rates of the underlying loans. The Companyclassifies its fair value measurement techniques for servicing assets as Level3 inputs since the Company’s valuation techniques that are most-significant tothe fair value measurements are derived from internally-developed models thatare driven by assumptions and inputs that are corroborated by little or noobservable market data.

 

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

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

**(13)  Commitments and Contingencies**

 

*IndemnificationObligation Commitments*

 

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

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

On August 8,2006, an Interest Purchase and Sale Agreement was entered into by and amongBidmex Holding, LLC (“Buyer”), as buyer, and Strategic Mexican InvestmentPartners, L.P. (“SMIP”), an affiliate of the Company and Cargill FinancialServices International, Inc. (“CFSI”), (collectively, the “Sellers”), asseller, and eleven U.S. limited liability companies (“LLCs”) which invested inMexican portfolio acquisition entities (“SRLs”) and the AIG entities asadditional parties.  In the Interest Purchase and Sale Agreement, theSellers and the LLCs made various representations and warranties concerning (i) theexistence and ownership of the LLCs and the related SRLs, (ii) the assetsand liabilities of the LLCs, (iii) taxes related to periods prior to August 8,2006, and (iv) the operations of the LLCs and SRLs.  The Sellersagreed to indemnify the Buyer and AIG Entities from damages resulting from abreach of any representation or warranty contained in the Interest Purchase andSale Agreement on a several and not joint basis according to their respectiveownership percentages in each LLC as to any matter related to a particular LLC,or on the basis of 80% to CFSI and 20% to SMIP as to any matter that could notbe identified to a particular LLC.  The indemnity obligation under theInterest Purchase and Sale Agreement survives for a period of the statute oflimitations for matters related to taxes, existence and authority,capitalization and good standing of the LLCs and SRLs and for a period of twoyears from August 8, 2006, the closing date with respect to all otherrepresentations and warranties.  The Sellers are not required to make anypayments as a result of the indemnity provisions of the Interest Purchase andSale Agreement until the aggregate amount payable under that agreement and theAsset Purchase Agreement exceeds $0.25 million; however, claims related totaxes and fraud are not subject to this $0.25 million threshold.  TheInterest Purchase and Sale Agreement limits the liability of the Sellers forindemnifiable losses under the Interest Purchase and Sale Agreement and theAsset Purchase Agreement to the Aggregate Purchase Price (without duplicationof amounts recovered pursuant to the terms of the Asset Purchase Agreement).  FirstCity does not believe that the potentialliability would have a material adverse effect on the consolidated financialposition, results of operations or liquidity of FirstCity, its subsidiaries,its affiliates or the Acquisition Partnerships.

 

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

 

*Commitments to Repurchase Loans*

 

In connection withthe Interest Purchase and Sale Agreement, Recuperación de Carteras Mexicanas,S. de R.L. de C.V., as optionor (“RCM”), an affiliate of SMIP and CFSI, granteda put option dated August 8, 2006 to Bidmex Holding, LLC, as optionee, relatedto the purchase of any loan of Solución de Activos Residenciales, S. de R.L. deC.V. or Solución de Activos Comerciales, S. de R.L. de C.V., each a MexicanSRL, if any borrower of a loan owned by those entities has filed or files achallenge in a legal proceeding related to any such loan based on, in additionto any other defense claims, a claim on grounds related to the Mexican SupremeCourt Ruling that has put into issue the actions required for transfer of loansby Mexican financial institutions after August 2003, provided that any suchchallenge is asserted on or before the earlier of (i) the reversal of theSupreme Court Ruling, or (ii) February 1, 2008. The purchase price for any loan under the put option is to be theallocated purchase price set by the parties for the loan, plus certain expensesrelated to the transfer and collection of the loan, plus any taxes paid orpayable with respect to the cash flow from each loan, reduced by any cash flowreceived by Bidmex Holding, LLC with respect to the loan. Pursuant to the putoption agreement, Bidmex Holding, LLC delivered a notice to exercise the putoption on March 31, 2008 for qualifying loans with a purchase price ofapproximately $635, of which the Company’s share is approximately $127.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

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

 

*Letters ofCredit and Other Guarantees*

 

On November 5, 2007, Fondo de Inversion Privado NPL Fund One (“PIF1”),an equity investment of FirstCity Chile, Ltda., entered into a revolving lineof credit with a maximum loan amount of $15.0 million with Banco Santander Chile,S.A. The proceeds were used to acquire a loan portfolio at face value fromFirstCity NPL S.A. (a consolidated affiliate of FirstCity Chile, Ltda.) and tofinance the purchase of other loan portfolios from non-affiliated parties.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 maximumloan balance upon demand. At March 31, 2008, FirstCity had a letter ofcredit in the amount of $16.5 million from Bank of Scotland under the terms ofFirstCity’s revolving acquisition facility with Bank of Scotland, with BancoSantander Chile, S.A. as the letter of credit beneficiary. In the event that ademand is made under the $16.5 million letter of credit, FirstCity is requiredto reimburse Bank of Scotland by making payment to Bank of Scotland for allamounts disbursed or to be disbursed by Bank of Scotland under the letter ofcredit.

 

On November 29, 2006, FirstCity Mexico SA de CV, a Mexicanaffiliate of FirstCity, entered into a revolving line of credit with a maximumloan amount in Mexican pesos equivalent to $13.5 million with Banco Santander,S.A. The proceeds were used to pay down the acquisition facility with the Bankof Scotland.  Pursuant to the terms ofthe credit facility, FirstCity Mexico SA de CV was required to provide astand-by letter of credit from Bank of Scotland that would satisfy the loanbalance upon demand.  At March 31, 2008, FirstCity had a letter ofcredit in the amount of $14.1 million from Bank of Scotland under the terms ofFirstCity’s revolving acquisition facility with Bank of Scotland.  In theevent that a demand is made under the $14.1 million letter of credit, FirstCityis required to reimburse Bank of Scotland by making payment to Bank of Scotlandfor all amounts disbursed or to be disbursed by Bank of Scotland under theletter of credit.

 

ABL, asubsidiary of FirstCity, has a $40.0 million revolving loan facility with WellsFargo Foothill, LLC (“WFF”), as most recently amended on July 30, 2007,for the purpose of financing and acquiring SBA loans. The obligations underthis facility are secured by substantially all of the assets of ABL.  At March 31,2008, the balance of this facility was $7.5 million.  In connection withthe first amendment to this facility on February 27, 2007, FirstCityprovided WFF with an unconditional guaranty, up to a maximum of $5 million plusenforcement cost, of the obligations of ABL under the loan facility that relateto funds in the amount of $31.7 advanced by WFF to ABL in connection of aportfolio of SBA loans in February 2007.  This guaranty arrangementremains in effect until the obligations incurred in connection with the advancerelated to the acquisition of the portfolio of SBA loans are paid in full.

 

FirstCityCommercial Corp. (“FirstCity Commercial”), a wholly-owned affiliate ofFirstCity, provides various financial institutions with guarantees of the debtobligations of certain Acquisition Partnerships. The underlying debt financingarrangements of these Acquisitions Partnerships have various maturities rangingfrom September 2008 to February 2010, and are secured primarily bycertain real estate held by the Acquisition Partnerships. At March 31,2008, FirstCity Commercial’s maximum commitments under these guarantyarrangements totaled $2.6 million, and the total outstanding obligations ofthese Acquisition Partnerships attributed to FirstCity Commercial’s guarantyapproximated $2.1 million.

 

*LegalProceedings*

 

Thefollowing information supplements and amends our discussion set forth underPart I, Item 3 “Legal Proceedings” in our Annual Report on Form 10-K for thefiscal year ended December 31, 2007.

 

*Wave TecPools, Inc. Litigation*

 

In thecollection suit filed by FH Partners, LLC (“FH Partners”), an indirectlywholly-owned subsidiary of FirstCity, against Superior Funding, Inc., on March18, 2008, the District Court granted a temporary restraining order againstSuperior Funding, Inc. and Jason Herring and all parties in privity with them,ordering them to turn over all payments on notes in FH Partners’ possession toFH Partners and not to interfere with FH Partners’ collection of note payments.On March 27, 2008, the Court entered a temporary injunction that extended thetemporary restraining order and also ordered Superior Funding, Inc. and Mr.Herring and all parties in privity with them to turn over books and records andexecute transfer documents. Trial has been set in the collection suit forOctober 27, 2008. There is no trial date set in the suit by Superior et al.against FH Partners and Prosperity. FirstCity intends to pursue the collectionsuit and defend the liability suit vigorously.

 

*OtherContingent Commitments*

 

FirstCity hasminority interests in various limited-life partnerships with a net carryingvalue of ($297) at March 31, 2008. The estimated amount that would be paidto the minority interest holder if the instruments were to be settled at March 31,2008 is $1.3 million.

 

**(14)  Other Related Party Transactions**

 

FirstCity hasfinancing and service arrangements with certain Acquisition Partnerships andfinancing arrangements with non-affiliated entities that are considered to bevariable interest entities (“VIEs”), as defined in FASB Interpretation No. 46R,

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

** **

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

 

*Consolidationof Variable Interest Entities* (“FIN 46R”). However, FirstCity is not deemed to bethe primary beneficiary of these entities based on the provisions of FIN 46R.The Company could experience a loss in the event that cash flows from the VIEsor the underlying collateral are not collected as expected. At March 31,2008, FirstCity’s maximum exposure to loss as a result of its involvement withthe VIEs is $35.1 million.

 

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 $2.2 million and $2.5 million inthe first quarters of 2008 and 2007, respectively.

 

FirstCityServicing Corporation (“FCSC”), an affiliate of the Company, and MCS etAssociates (“MCS”), in which FCSC is an 11.89% shareholder as of December 31,2007, are parties to Consulting, License and Confidentiality Agreements dated June 30,1999 pursuant to which FCSC provides consultation services and personnel to beemployed by MCS to assist in developing and managing due diligence andservicing systems. Pursuant to those agreements, MCS provides the suppliedpersonnel with compensation, tax equalization payments, housing allowances, transportationallowance, and tax preparation. MCS also pays consulting fees to FCSC andreimburses FCSC for travel, hotel, airfare, and meal expenses incurred relatedto the provision of the services. In the first quarters of 2008 and 2007, FCSCreceived fees totaling $113 and $131, respectively, from MCS.

 

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

 

**(15)  Equity**

 

The Company has a stock repurchase plan, as authorized by the Board ofDirectors, that provides for the purchase of up to 1,500,000 shares of theCompany’s common stock. The stock repurchase plan expires on August 30,2009. In the first quarter of 2008, FirstCity repurchased 264,530 shares of theCompany’s common stock on the open market for a total of $2.1 million.

 

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

 

**Overview**

 

FirstCity is a financial services company engagedin one principal reportable segment – Portfolio Asset acquisition andresolution. The Portfolio Asset acquisition and resolution business involvesacquiring portfolios of loans, real estate and other assets or similarsingle-asset investments (collectively referred to as “Portfolios” or “PortfolioAssets”). The Company generally acquires Portfolio Assets at a discount to their legal principalbalances or appraised values, and thenservices and resolves the Portfolio Assets in an effort to maximize the presentvalue of the ultimate cash recoveries. FirstCity also has a special situationsplatform that focuses on constructive investments in restructurings,turnarounds, businesses with robust market positions, and other specialsituations. This special situations platform gives FirstCity the ability toacquire or finance distressed businesses, originate junior- and senior-bridgeloans, and executive lower middle-market buyouts.

 

During the firstquarter of 2008, the Company recorded a net loss to common stockholders on adiluted basis of $3.6 million or $0.34 per common share. The operatingcontribution from the Portfolio Asset acquisition and resolution segmentresulted in a $1.8 million operating loss for the first three months of 2008compared with a $1.9 million operating gain for the same period in 2007. See **Results of Operations** below for a more detailed review ofthe first quarter 2008 compared to the first quarter 2007.

 

The Company wasinvolved in acquiring $19.9 million of portfolio investments with a face valueof approximately $546.1 million in the first quarter 2008 – of which FirstCity’sinvestment share was $8.4 million. FirstCity’s global distribution of its firstquarter 2008 investments includes $6.7 million in the United States and $1.7million in Latin America. In addition to its portfolio acquisitions in firstquarter 2008, FirstCity invested $1.5 million in the form of SBA loan advancesand originations. At March 31, 2008, FirstCity’s earning assets (PortfolioAssets, equity investments, loans receivable and entity-level earning assets)totaled $236.2 million, and the global distribution of such earning assets (atcarrying value) included $151.8 million in United States; $48.3 million inEurope; and $36.1 million in Latin America.

 

The Company’searnings in first quarter 2008 were negatively impacted by $4.1 million of netimpairment provisions — comprised of $3.0 million of net provisions recorded toour wholly-owned portfolios, and $1.1 million as our share of net impairmentprovisions recorded to portfolio assets held in our partnership interests. Theglobal distribution of the $4.1 million of net impairment provisions recordedby the Company in first quarter 2008 includes $3.3 million in the UnitedStates, $0.2 million Europe, and $0.6 million in Latin America. The impairmentprovisions in first quarter 2008 were attributed primarily to declines invalues of loan collateral and real estate assets in our domestic portfolios,and additional delays in the timing of collections of expected cash flows onloan portfolios in Latin America and Europe. The impairment provisions wereidentified in connection with management’s regular evaluation of thecollectibility of the Company’s Portfolio Assets. Management’s evaluation isinherently subjective as it requires estimates that are susceptible to revisionin future periods as more information becomes available.

 

Considering therecent deterioration in the financial services sector, management remainspositive on the outlook of the Company. Management believes that current marketconditions will not hinder FirstCity’s ability to expand its business, and thatasset acquisition opportunities at attractive margins are available. Asmentioned above, FirstCity was involved in acquiring $19.9 million of portfolioinvestments with a face value of approximately $546.1 million in the firstquarter 2008 – of which FirstCity’s investment share was $8.4 million. TheCompany is currently evaluating 28 different transactions representing over $7.6billion in face value of assets, although there can be no assurance thatFirstCity will be able to consummate any of these transactions on acceptableterms.

 

In addition, in light of current market conditions that createdliquidity constraints primarily as a result of the deterioration in thesubprime mortgage industry and tightening credit standards in the marketplace,management believes that current market conditions will not impact FirstCity’sability to obtain financing for its operations. Currently, FirstCity has $350.0 million of credit facility commitmentsavailable to (1) finance the senior debt and equity portions of portfolioand asset purchases; (2) finance equity investments in new ventures; and (3) providefor the issuance of letters of credit working capital loans; and a $40.0million credit facility commitment to finance and acquire SBA loans.

 

The Company’sfinancial results are affected by many factors including, but not limited to,fluctuations in interest rates; fluctuations in the underlying values of loan collateral,real estate and other assets; delays and declines in cash receipts on PortfolioAssets and other loans; the timing and ability to liquidate assets; and theavailability of investment and asset acquisition opportunities and the Company’sability to consummate such transactions on acceptable terms. The Company’sbusiness and results of operations are also affected by the availability offinancing with terms acceptable to the Company and the Company’s access tocapital markets, including the securitization markets.

 

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

 

Components of the results for the three monthperiods ended March 31, 2008 and 2007, respectively, are detailed below(dollars in thousands except per share data):

 
| ** **                                 | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|
| ** **                                 | ** ** | **March 31,**               | ** ** |
| ** **                                 | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| Portfolio Asset Acquisition and Resolution |       | $                                | (1,800     | ) | $ | 1,870 |   |
| Corporate overhead                         |       | (1,693                           | )          | (2,785 | ) |
| Loss from continuing operations            |       | (3,493                           | )          | (915 | ) |
| Loss from discontinued operations          |       | (91                              | )          | — |   |
| Net loss to common stockholders            |       | $                                | (3,584     | ) | $ | (915 | ) |
| Diluted loss per common share              |       | $                                | (0.34      | ) | $ | (0.08 | ) |

 

**Results of Operations**

 

The following discussion and analysis is based onthe segment reporting information presented in Note 8 to the ConsolidatedFinancial Statements of the Company included in Item 1. of this Form 10-Q,and should be read in conjunction with the Consolidated Financial Statements(including the Notes thereto) included elsewhere in this Form 10-Q.

 

***First Quarter 2008 Compared to First Quarter 2007***

 

The Company reported net losses of $3.6 millionin the first quarter 2008 compared to net losses of $0.9 million in the firstquarter 2007. On a per share basis, diluted net losses to common stockholderswere $0.34 in the first quarter of 2008 compared to $0.08 diluted net loss inthe first quarter of 2007.

 

*Portfolio Asset Acquisition and Resolution*

 

The operating contribution from the PortfolioAsset acquisition and resolution segment resulted in a $1.8 million operatingloss in the first quarter of 2008 compared to a $1.9 million operating gain inthe first quarter of 2007. FirstCity was involved in acquiring $19.9 million ofPortfolio Asset acquisitions in first quarter 2008 with an approximate facevalue of $546.1 million, compared to its involvement in acquiring $78.8 millionof Portfolio Asset acquisitions in first quarter 2007 with an approximate facevalue of $173.9 million. In first quarter 2008, FirstCity’s investment share inthe Portfolio Asset acquisitions was $8.4 million – comprised of $6.7 millionacquired through wholly-owned Portfolios and $1.7 million through AcquisitionPartnerships. In first quarter 2007, the Company’s investment share in thePortfolio Asset acquisitions was $69.5 million – comprised of $65.7 millionacquired through wholly-owned Portfolios and loan purchases and $3.8 millionthrough Acquisition Partnerships.

 

Additional investments in the form of loanoriginations and equity investments backed by FirstCity totaled $1.5 million infirst quarter 2008 compared to $7.8 million in first quarter 2007.

 

*Servicing fee revenues. *Servicing fee revenues decreased to $2.2 million in the first quarter of2008 from $2.6 million in the first quarter of 2007. Servicing fees fromdomestic Acquisition Partnerships totaled $0.4 million in first quarter 2008compared to $0.7 million in first quarter 2007, while servicing fees from LatinAmerican Acquisition Partnerships totaled $1.8 million in first quarter 2008compared to $1.9 million in first quarter 2007. Contributing to the decrease inservicing fees is a decline in collections from loans held by domesticAcquisition Partnerships to $11.3 million in 2008 from $17.2 million in 2007.Since a majority of the Portfolio Asset acquisitions over the past two yearswere purchased through wholly-owned Portfolios instead of investments inAcquisition Partnerships, the Company expects income from wholly-ownedPortfolio Assets to off-set the decline in servicing fee revenues – which aregenerated primarily from loan portfolios held by domestic and Latin AmericanAcquisition Partnerships.

 

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*Income from Portfolio Assets*.  Incomefrom Portfolio Assets remained constant at $4.9 million in the first quarter of2008 compared to $5.0 million in the first quarter of 2007. FirstCity’s averageinvestment in wholly-owned Portfolio Assets was $117.3 million and $111.2million for the first quarters of 2008 and 2007, respectively. Refer to Note 4to the Consolidated Financial Statements included in Item 1. of this Form 10-Qfor a summary of income from Portfolio Assets.

 

*Gain on sale of SBA loans heldfor sale. *The Company recorded a nominal gain on the sales of SBA loans in first quarter 2008 with abasis in SBA loans sold of $0.2 million, compared to $0.3 million of gainsrecorded in first quarter 2007 with a basis in SBA loans sold of $6.7 million.Gains on SBA loan sales reflect the Company’s participation in the SBAguaranteed loan program. Under the SBA 7(a) program, the SBA guarantees upto 85 percent of the principal of a qualifying loan. The Company generallysells the guaranteed portion of the loan into the secondary market and retainsthe unguaranteed portion for investment.

 

*Interest income from SBAloans. *Interest income from SBA loans experienced amodest increase to $0.5 million during the first quarter of 2008 compared to$0.3 million during the first quarter of 2007. FirstCity’s average investmentin SBA loans was $14.1 million and $16.1 million for the first quarters of 2008and 2007, respectively.

 

*Interest income fromaffiliates. *Interest income from affiliates remained steadyat $0.2 million in first quarter 2008 compared to $0.1 million in first quarter2007.

 

*Interest income from loansreceivable – other. * Interestincome from loans receivable – other was $0.3 million in the first quarter of2008 and $0.9 million in the first quarter of 2007. The income decline isattributed to the Company’s decreased investment level in loans receivable tonon-affiliated entities. FirstCity’s average investment in loans receivable –other was $6.0 million and $26.0 million for the first quarters of 2008 and2007, respectively.

 

*Other income*.  Otherincome for the first quarter of 2008 increased by $0.9 million in comparison tothe first quarter of 2007 primarily due to $0.8 million of revenues in thefirst quarter of 2008 generated by the Company’s majority-owned domesticrailroad company that was acquired in August 2007.

 

*Expenses. *Operating expenses were $13.9 million and $9.6 million in the firstquarters of 2008 and 2007, respectively. The following is a discussion of themajor components of operating expenses.

 

Interest and fees on notes payable were $3.7million and $4.3 million in the first quarters of 2008 and 2007,respectively.  FirstCity’s averageoutstanding debt decreased to $170.0 million in first quarter 2008 from $204.5million in the first quarter of 2007, while the average cost of borrowingsincreased to 8.7% in 2008 compared to 8.3% in 2007.

 

Salaries and benefits increased to $4.0 millionin the first quarter of 2008 from $3.1 million in the first quarter of 2007,primarily due to additional salaries and benefits of $0.7 million in 2008related to ABL (SBA lending platform) and FirstCity Crestone (specialsituations investment platform).****The totalnumber of personnel within the Portfolio Asset acquisition and resolutionsegment were 216 and 174 at March 31, 2008 and 2007, respectively.

 

Net provisions for loan and impairment losses totaled $3.0 million infirst quarter 2008 compared to $0.3 million in first quarter 2007. The increasefrom 2007 to 2008 is attributed to increased net impairment provisions of $2.6million to the Company’s wholly-owned domestic portfolios. The additionalimpairment provisions in 2008 were necessary primarily as a result of declinesin the values of loan collateral and real estate in our domestic portfolios.

 

Occupancy, data processing, property protectionand other expenses increased to $3.2 million for the first quarter of 2008 from$2.0 million in the first quarter of 2007. The increase is primarily attributedto $1.5 million of additional property protection expenses (i.e. propertytaxes, insurance and legal) incurred in 2008 to protect FirstCity’s securityinterests in its wholly-owned domestic real estate properties; off-set by a$0.4 million reduction in foreign currency exchange losses in first quarter2008 compared to first quarter 2007.

 

*Equity in earnings ofinvestments. *Equity in earnings of investments increased to$2.8 million in the first quarter of 2008 compared to $1.8 million in the firstquarter of 2007. Equity in earnings of Acquisition Partnerships increased to$2.3 million in 2008 from $1.8 million in 2007, and equity in earnings ofservicing entities increased by $0.5 million in 2008 compared to 2007. Thefollowing is a discussion of equity in earnings from FirstCity’s AcquisitionPartnerships by geographic region. Refer to Note 6 of the ConsolidatedFinancial Statements included in Item 1. on this Form 10-Q for a summaryof revenues, earnings and equity in earnings of FirstCity’s equity investmentsby region.

 

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·             *Domestic*— Domestic Acquisition Partnerships reflectedtotal net earnings of $0.6 million in both the first quarters 2008 and 2007.Total investments held by the domestic partnerships decreased to $78.9 millionin 2008 from $106.3 in 2007 – and as a result, total revenues decreased to $3.1million in first quarter 2008 from $4.6 million in 2007. The decrease in totalpartnership revenues in 2008 was off-set primarily by a significant decrease intotal partnership impairments – which totaled $0.6 million in first quarter2008 ($0.3 million to FirstCity) compared to $1.5 million in first quarter 2007($0.7 million to FirstCity). The collective activity in the domesticpartnerships described above translated to FirstCity’s share of partnership netearnings remaining constant at $0.3 million for first quarters 2008 and 2007.

 

FirstCity’s average investment in domestic partnerships decreased to$23.7 million in first quarter 2008 from $35.9 million in 2007. As a result,FirstCity’s share of the partnerships’ total revenues experienced acorresponding decrease as discussed above. Sincea majority of FirstCity’s domestic portfolio acquisitions over the past twoyears were acquired through wholly-owned Portfolios instead of equityinvestments in Acquisition Partnerships, the Company expects income fromwholly-owned Portfolios to off-set the decline in equity in earnings from thedomestic partnerships.

 

 ·          *Latin America* —Latin American Acquisition Partnerships reflected total net earnings of $3.0million in first quarter 2008 compared to total net losses of ($1.6) million in2007. As such, FirstCity’s share of the partnerships’ total net earningsincreased by $0.4 million in 2008 compared to 2007. The increase in FirstCity’s share of the partnerships’ totalnet earnings is attributed primarily to an increase in the Company’s averageinvestment in Latin American partnerships to $22.9 million in 2008 from $18.7million in 2007. Other significant factors that contributed to an increase inthe partnerships’ total net earnings, which increased FirstCity’s share of netearnings, relate to (1) a decrease in total impairment provisions – whichtotaled $3.7 million in first quarter 2008 ($0.6 million to FirstCity) and $4.3million in first quarter 2007 ($0.7 million to FirstCity); a $0.6 milliondecrease in total property protection expense in 2008 compared to 2007; and (3) a$1.6 million decrease in total interest expense in 2008 compared to 2007. Totalcollections from Latin American partnership portfolios remained relatively levelat $11.9 million in first quarter 2008 compared to $12.3 million in firstquarter 2007.

 

·             *Europe*—European Acquisition Partnerships reported total revenues of $10.3 million infirst quarter 2008 compared to $9.4 million in first quarter 2007. The increasein total revenues was off-set primarily by (1) an increase in impairmentprovisions — which totaled $1.0 million in first quarter 2008 ($0.2 million toFirstCity) and $0.8 million in first quarter 2007 ($0.2 million to FirstCity); (2) a$0.8 million increase in total interest expense in 2008 compared to 2007; and (3) a$0.2 million increase in total property protection expense in 2008 compared to2007. The combined activity in the European partnerships described aboveresulted in an increase in total net earnings to $5.8 million in first quarter2008 from $5.6 million in 2007, and FirstCity’s share of the partnership’stotal net earnings increased to $1.7 million in first quarter 2008 from $1.5million in 2007.

 

*Other Significant Items Affecting Operations*

 

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

 

*Corporate overhead. *Net corporate overhead expenses (excluding taxes) decreased to $1.6million in the first quarter of 2008 compared to $2.7 million in the firstquarter of 2007, primarily due to $1.2 million in expenses incurred during thefirst quarter of 2007 relating to an independent investigation authorized bythe Company’s audit committee.

 

*Income taxes. *Provision for income tax expense approximated$0.2 million in the first quarter of 2008 and $0.1 million in the first quarterof 2007. Refer to additionalinformation disclosed in Note 11 to the Consolidated Financial Statementsincluded in Item 1. on this Form 10-Q.

 

#### **FinancialCondition**

#### ** **

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

 

Consolidated assets of $280.4 million at March 31,2008 were $17.7 million lower than consolidated assets at December 31,2007. The decrease in consolidated assets is primarily attributed to a $9.4million net decrease in Portfolio Assets and a $9.2 million net decrease incash. The $9.4 million net decrease in Portfolio Assets resulted primarily fromcollections and proceeds outpacing $7.8 million of acquisitions in firstquarter 2008. The $9.2 million net decrease in cash is attributed primarily to$33.1 million of cash disbursed for note principal and interest payments –which exceeded cash receipts derived from Portfolio Assets, distributions from 

 

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equity investments, and working capital loan advances (refer to theConsolidated Statements of Cash Flows included in Item 1. on this Form 10-Q).

 

Consolidated liabilities of $179.6 million as of March 31,2008 were $11.7 million lower than consolidated liabilities at December 31,2007. Total notes payable decreased by $9.8 million primarily due to principalrepayments of $29.8 million in first quarter 2008; off-set primarily byprincipal borrowings of $16.9 million for Portfolio Asset acquisitions, equityinvestments, SBA loan originations, and working capital funds. Otherliabilities decreased by $1.4 million primarily due to a reduction of $1.1million in the Company’s trade accounts payable in first quarter 2008.

 

#### **PortfolioAsset Acquisition and Resolution**

#### ** **

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

 
| ** **                 | ** ** | **Purchase** | ** ** | **FirstCity**  | ** ** |
|----------------------------|------------|--------------|------------|----------------|------------|
| ** **                 | ** ** | **Price**    | ** ** | **Investment** | ** ** |
| First three months of 2008 |       | $            | 19,900     |           | $          | 8,435 |   |
| Total 2007                 |       | 214,333      |       | 126,714        |       |
| Total 2006                 |       | 296,990      |       | 144,048        |       |
| Total 2005                 |       | 146,581      |       | 71,405         |       |
| Total 2004                 |       | 174,139      |       | 59,762         |       |
| Total 2003                 |       | 129,192      |       | 22,944         |       |
|                            |            |              |            |                |            |  |  |

 

**Provision for Income Taxes**

 

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

 

**Liquidity and Capital Resources**

 

The Companyrequires liquidity to fund its operations, working capital, payment of debt,repurchase of the Company’s common stock, equity for acquisition of PortfolioAssets, investments in and advances to entities formed with other investors toacquire Portfolios (“Acquisition Partnerships”) and other investments. Thepotential sources of liquidity are funds generated from operations, equitydistributions from the Acquisition Partnerships, interest and principalpayments on subordinated intercompany debt, dividends from the Company’ssubsidiaries, borrowings from revolving lines of credit and other creditfacilities, proceeds from equity market transactions, securitization and otherstructured finance transactions, and other special purpose short-termborrowings.

 

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

 

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

 

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

 

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

·                  Theavailable interest rates under the loan facility are LIBOR plus 2.00% to 2.50%per annum;

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

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

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

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

·                  Theratio of EBITDA to Interest Coverage should not be not less than 1.50 to 1.00for each twelve month period;

·                  Theratio of Indebtedness to Tangible Net Worth should be equal to or less than 3.5to 1.00 for the last day of the fiscal quarter;

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

·                  Theratio of Cumulative Current Recovered and Projected Collections to CumulativeOriginal Projected Collections should not be less than 0.90 to 1.00.

 

At March 31,2008, the Company was in compliance with all material covenants or otherrequirements set forth in the credit agreements or other agreements with Bankof Scotland, with the exception of the EBITDA to Interest Coverage ratiorequirement (“EBITDA Ratio”) defined above. On May 8, 2008, FirstCityreached agreement with Bank of Scotland to amend the revolving creditagreement. Pursuant to terms of the amendment, Bank of Scotland removed theEBITDA Ratio covenant from the revolving credit agreement, as amended, andwaived any default that may have occurred as a result of the Company’s failureto satisfy the EBITDA Ratio covenant for the quarter ended March 31, 2008.

 

FirstCity has$41.5 million in Euro-denominated debt outstanding on the $225.0 millionrevolving credit facility with Bank of Scotland described above for the purposeof hedging a portion of the net equity investments in Europe. In general, thetype of risk hedged relates to the foreign currency exposure of net investmentsin Europe caused by movements in Euro exchange rates. The Company entered intothe hedging relationship such that changes in the net investments being hedgedare expected to be offset by corresponding changes in the values of theEuro-denominated debt. Effectiveness of the hedging relationship is measuredand designated at the beginning of each month by comparing the outstandingbalance of the Euro-denominated debt to the carrying value of the designatednet equity investments. The net foreign currency translation gain (loss)included in accumulated other comprehensive income relating to theEuro-denominated debt was ($2.4) million for the three months ended March 31,2008, and $213,000 for the same period in 2007.

 

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

 

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

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

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

·                  Provides that FHPartners must maintain a ratio of Cumulative Current Recovered and ProjectedCollections to Cumulative Original Projected Collections of not less than 0.90to 1.00;

·                  Provides for aninterest rate of LIBOR plus 2.0%; and

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

 

At March 31,2008, the Company was in compliance with all material covenants or otherrequirements set forth in the credit agreements or other agreements with Bankof Scotland, with the exception of the EBITDA Ratio covenant as discussedabove.

 

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

 

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subsidiaries and guaranteed by substantially all ofFirstCity’s wholly-owned subsidiaries. The primary terms and key covenants ofthis $25.0 million loan facility are as follows:

 

·                  Allowsloans to be made in maximum aggregate amount of $25.0 million during the termof the loan facility;

·                  Providesfor interest rates, at FirstCity’s election, of London Interbank Offered Rateplus 5.0%, Bank of Scotland base or prime rate plus 3.0%, or a fixed rate for aperiod agreed to by FirstCity and BoS (USA) as agent;

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

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

·                  Providesfor inclusion in the borrowing base of loans made to FirstCity DenverInvestment Corp. (a majority-owned subsidiary of FirstCity) for the purpose ofinvesting in distressed debt, special loan originations, leveraged buyouts andother special opportunities;

·                  Providesfor inclusion in the borrowing base of certain loans made by FirstCitysubsidiaries to non-affiliated entities that are secured by real estate; and

·                  Includesfinancial covenants that the ratio of earnings before interest, taxes depreciationand amortization to interest coverage will be not less than 1.50 to 1.00 foreach twelve month period, that the ratio of indebtedness to tangible net worthshould be equal to or less than 3.5 to 1.00 for the last day of each fiscalquarter, and that the ratio of cumulative current recovered and projectedcollections to cumulative original projected collections should not be lessthan 0.90 to 1.00 for each fiscal quarter.

 

At March 31,2008, the Company was in compliance with all material covenants or otherrequirements set forth in the credit agreements or other agreements with BoS(USA), with the exception of the EBITDA Ratio covenant as discussed above.

 

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

 

*BancoSantander, S.A.*

 

FirstCity Mexico SA de CV, a Mexican affiliate of FirstCity, has arevolving line of credit with a maximum loan amount of 148,096,800 Mexicanpesos with Banco Santander, S.A., which was equivalent to $13.8 million U.S.dollars at March 31, 2008.  The loanproceeds are used to pay down the acquisition facility with the Bank ofScotland. Pursuant to the terms of the credit facility, FirstCity Mexico SA deCV was required to provide a stand-by letter of credit from Bank of Scotlandthat would satisfy the loan balance upon demand.  At March 31, 2008,FirstCity had a letter of credit in the amount of $14.1 million from Bank ofScotland under the terms of FirstCity’s revolving acquisition facility withBank of Scotland.  In the event that a demand is made under the $14.1million letter of credit, FirstCity is required to reimburse Bank of Scotlandby making payment to Bank of Scotland for all amounts disbursed or to bedisbursed by Bank of Scotland under the letter of credit.

 

*Wells Fargo Foothill, LLC*

 

AmericanBusiness Lending, Inc. (“ABL”), a subsidiary of FirstCity, has a $40.0million revolving loan facility with Wells Fargo Foothill, LLC (“WFF”) for thepurpose of financing and acquiring SBA loans. The obligations under thisfacility are secured by substantially all of the assets of ABL.  Inaddition, FirstCity provided WFF with an unconditional guaranty, up to amaximum of $5 million plus enforcement cost, of the obligations of ABL underthe loan facility that relate to funds in the amount of $31.7 million advancedby WFF to ABL in connection of a portfolio of SBA loans in February 2007. Thisguaranty arrangement remains in effect until the obligations incurred in connectionwith the advance related to the acquisition of the portfolio of SBA loans arepaid in full. The primary terms and key covenants of the $40.0 millionrevolving loan facility, as amended, are as follows:

 

·                  Allows advances in the maximum amountof $40.0 million (the “Maximum Credit Line”) to be made under the facility;

·                  Provides for a borrowing base fororiginating loans by which (a) the sum of (1) up to one hundredpercent (100%) of the net eligible SBA guaranteed loans originated by ABL, plus(2) up to eighty percent (80%) of the net eligible 

 

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non-guaranteed loans originated by ABL, exceeds (b) thesum of (1) any reserves for obligations of ABL related to the bankproducts, plus (2) the aggregate amount, if any, of loan reserves thenestablished and outstanding, plus (3) the aggregate amount of any otherreserves established by WFF;

·                  Provides for a borrowing base for theportfolio of SBA loans acquired in February 2007 by which (a) the sumof (1) up to one hundred percent (100%) of the net eligible SBA guaranteedperforming loans acquired by ABL in February 2007, (provided, that suchpercentage shall be reduced by five percent (5%) on November 1, 2007 andon the first day of each month thereafter), plus (2) up to eighty percent(80%) of the net eligible non-guaranteed performing loans acquired by ABL,exceeds (b) the sum of (1) any reserves with respect to acquiredperforming loans related to the bank products, plus (2) the aggregateamount, if any, of loan reserves then established and outstanding, plus (3) theaggregate amount of any other reserves established by WFF;

·                  Providesfor an interest rate of LIBOR plus 2.625% or, alternatively, the greater of (x) theWells Fargo prime rate or (y) seven and one-half percent (7.50%) perannum;

·                  Providesfor an unused credit line fee in an amount equal to one-quarter of one percent(0.25%) per annum of the average daily difference during the month in question(or portion thereof) between the Maximum Credit Line and the aggregateoutstanding principal amount of the advances outstanding under the facility forsuch month (or portion thereof);

·                  Provides in the event of thetermination of the facility by ABL for a prepayment fee of three percent (3.0%)of the Maximum Credit Line if paid prior to December 14, 2007, two percent(2.0%) of the Maximum Credit Line if paid during the period beginning December 15,2007 and ending December 14, 2008, and one percent (1.0%) of the MaximumCredit Line if paid during the period beginning December 15, 2008 andending December 13, 2009; and

·                  Provides for a maturity date of December 14,2009.

 

#### **The securityagreement executed by ABL to secure the obligations under this credit facilitygrants a security interest to WFF in all of the assets of ABL, except theunguaranteed portions of certain SBA-guaranteed loans, certain other assets,and the Small Business Lending Corporation license. At March 31, 2008, ABLwas in compliance with all material covenants or other requirements set forthin the credit agreement or other agreements with WFF.**

#### ** **

Excluding the termacquisition facilities of the unconsolidated Acquisition Partnerships, as of March 31,2008, the Company and its subsidiaries had credit facilities providing forborrowings in an aggregate principal amount of $413 million and outstandingborrowings of $168 million.

 

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

 

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

 

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**CreditFacilities**

 
| ** **                                                                                              | ** ** | **Funded and**        | ** ** | ** **             | ** ** | ** **                                                                                            | ** ** | ** **                                                                                                       | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------------------|------------|-------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                              | ** ** | **Unfunded**               | ** ** | **Outstanding**        | ** ** | ** **                                                                                            | ** ** | ** **                                                                                                       | ** ** |
| ** **                                                                                              | ** ** | **Commitment**             | ** ** | **Borrowings**         | ** ** | ** **                                                                                            | ** ** | ** **                                                                                                       | ** ** |
| ** **                                                                                              | ** ** | **Amount as of** | ** ** | **as of**         | ** ** | ** **                                                                                            | ** ** | ** **                                                                                                       | ** ** |
| ** **                                                                                              | ** ** | **April 30,**         | ** ** | **March 31,**     | ** ** | ** **                                                                                            | ** ** | ** **                                                                                                       | ** ** |
| ** **                                                                                              | ** ** | **2008**                   | ** ** | **2008**               | ** ** | ** **                                                                                            | ** ** | ** **                                                                                                       | ** ** |
| ** **                                                                                              |       | **(Dollars  in millions)** |       | **Interest Rate** |       | **Other Terms and Conditions**                                                         |       |
|                                                                                                    |       |                       |       |                   |       |                                                                                                  |       |                                                                                                             |       |
| Bank of Scotland $225 million portfolio acquisition  and working capital facility (1)                   |       | $                          | 225        |                   | $          | 95                                                                                                    |       | $64 at LIBOR + 2.0% -  2.50%

$30 at 18-month fixed  rate of 7.86%

$1 at prime + .5%                            |       | Secured by equity  interests and other assets of FirstCity, matures November 2010 |   |
|                                                                                                    |       |                       |       |                   |       |                                                                                                  |       |                                                                                                             |       |
| Bank of Scotland $100 million portfolio acquisition  - revolving credit                                 |       | 100                        |       | 44                     |       | LIBOR + 2.0%                                                                                          |       | Secured by assets of FH  Partners, L.P. and guaranteed by the Company, matures November 2010                |       |
|                                                                                                    |       |                       |       |                   |       |                                                                                                  |       |                                                                                                             |       |
| Bank of Scotland $25 million subordinated delayed  draw credit                                          |       | 25                         |       | —                 |       | option of LIBOR plus 5%,  or prime plus 3%, or fixed rate                                             |       | Secured by security  interests in assets of FIrstCity and wholly-owned subsidiaries, matures  November 2010 |       |
|                                                                                                    |       |                       |       |                   |       |                                                                                                  |       |                                                                                                             |       |
| American Bank term loan for portfolio acquisition by  FC Washington                                     |       | 1                          |       | 1                      |       | Fixed 5.625%                                                                                          |       | Secured by assets of FC  Washington and guaranteed by the Company, matures 2008                                  |       |
|                                                                                                    |       |                       |       |                   |       |                                                                                                  |       |                                                                                                             |       |
| Participation payable                                                                                   |       | 1                          |       | 1                      |       | 35.12% imputed rate                                                                                   |       | Participation agreement  on 33% of net cash flows received on one portfolio                                      |       |
|                                                                                                    |       |                       |       |                   |       |                                                                                                  |       |                                                                                                             |       |
| Banco Santander line of credit facility                                                                 |       | 14                         |       | 14                     |       | Rate based on 28 day Mexican  index rate plus 1.5%                                                    |       | Secured by Bank of  Scotland letter of credit, matures November 2008                                        |       |
|                                                                                                    |       |                       |       |                   |       |                                                                                                  |       |                                                                                                             |       |
| Wells Fargo Foothill, Inc. $40 million revolving  loan facility                                    |       | 40                         |       | 7                      |       | LIBOR + 2.625% or greater  of Wells Fargo prime or 7.5%                                               |       | Secured by assets of  American Business Lending, Inc., matures December 2009                           |       |
|                                                                                                    |       |                       |       |                   |       |                                                                                                  |       |                                                                                                             |       |
| The First National Bank of Central Texas term loan  for portfolio acquisition by MPortfolio Corporation |       | 2                          |       | 2                      |       | LIBOR + 1.75%                                                                                         |       | Secured by assets of  MPortfolio Corporation, matures June 2010                                             |       |
|                                                                                                    |       |                       |       |                   |       |                                                                                                  |       |                                                                                                             |       |
| LaSalle Bank NA term loan                                                                               |       | 4                          |       | 4                      |       | LIBOR + 2.25%                                                                                         |       | Secured by assets of  East Penn Railroad LLC, matures March 2011                                            |       |
|                                                                                                    |       |                       |       |                   |       |                                                                                                  |       |                                                                                                             |       |
| LaSalle Bank NA revolving loan facility                                                                 |       | 1                          |       | —                 |       | option of Base Rate (greater  of prime or Federal Funds Rate + .5%) plus margin, or LIBOR plus margin |       | Secured by assets of  East Penn Railroad LLC, matures March 2011                                            |       |
|                                                                                                    |       |                       |       |                   |       |                                                                                                  |       |                                                                                                             |       |
| Total                                                                                                   |       | $                          | 413        |                   |       | $                                                                                                     | 168        |                                                                                                             |       |   |   |   |
|                                                                                                         |            |                            |            |                        |            |                                                                                                       |            |                                                                                                                  |            |  |  |  |  |  |

 

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(1)          The Bank of Scotlandfacility allows loans to be made in Euros up to a maximum amount in Euros thatis equivalent to $50.0 million. At March 31, 2008, the Company hadapproximately $41.5 million outstanding under the Euro-denominated portion ofthis facility.

 

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**Forward-Looking Statements**

 

Certain statements contained in this Quarterly Report onForm 10-Q are incorporated by reference from time to time, including, butnot limited to, statements relating to the Company’s strategic objectives andfuture performance, which are not historical facts, may be deemed to beforward-looking statements under the Private Securities Litigation Reform Actof 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended (“Exchange Act”).Forward-looking statements include, without limitation, statements regardingour future financial position, business strategy, and plans and objectives ofmanagement for future operations, as well as any statement that may project,indicate or imply future results, performance or achievements, and may containthe words “expect,” “intend,” “plan,” “anticipate,” “estimate,” “believe,” “may,”“could,” “will be,” “will continue,” “will likely result,” “indication”  and similar expressions. Forward-lookingstatements are not guarantees of future performance and involve certain risks,uncertainties and assumptions that are difficult to predict. Actual results andoutcomes may differ materially from those expressed in, or implied by, ourforward-looking statements.

 

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

 

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

 

**Interest Rate Risk**

 

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

 

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

 

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

 

SBA loans receivable were $14.0 million at March 31, 2008, ofwhich $1.1 million were related to the guaranteed portion of these loans.  The guaranteed portion is backed by the fullfaith and credit of the U.S. Small Business Administration, and is generallysold into the secondary market. Virtually all of the SBA loans have variable interest rates.  Assuming that the balance sheet were toremain constant and no actions were taken to alter the existing interest ratesensitivity, a hypothetical immediate change in interest rates would have aminimal effect on interest income from SBA loans for the first quarter of 2008.Although management believes that this measure is indicative of our sensitivityto interest rate changes, it does not adjust for potential changes in creditquality, size and composition of the assets on the balance sheet, and otherbusiness developments that could affect a net increase (decrease) in assets.Accordingly, no assurances can be given that actual results would not differmaterially from the potential outcome simulated by this estimate.

 

FirstCity had$167.6 million in debt outstanding at March 31, 2008. The Company isexposed to interest rate risk primarily through its variable rate debt, whichtotaled $136.6 million or 81.5% of the Company’s total debt. A 50 basispoint change in interest rates would increase or decrease FirstCity’s interestexpense by approximately $0.8 million annually.

 

**Foreign Currency Risk**

 

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

 

In Europe and inMexico, the Company’s investments are primarily in the form of equity andrepresent a significant portion of the Company’s total equity investments. Aspreviously discussed, the revolving acquisition facility with Bank of Scotlandfor $225.0 million allows the Company to loans to be made in Euros up to amaximum amount in Euros that is equivalent to $50.0 million U.S. dollars. At March 31,2008, the Company had $41.5 million in Euro-denominated debt for the purpose ofhedging a portion of the net equity investments in Europe.  In November 2006, the Company acquired aline of credit facility with Banco Santander, S.A. that allows loans to be madeup to a maximum of 148,096,800 Mexican pesos. At March 31, 2008, theCompany had 148,096,800 in Mexican peso-denominated debt, which was equivalentto $13.8 million U.S. dollars. Management of the Company feels that these loan agreements will helpreduce the risk of adverse effects of currency changes on these investments.

 

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

 

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| ** **         | ** ** | ** ** | ** ** | ** **        | ** ** | **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        |       | 0.63              |       | $                                         | 2,189      |   | $ | 4,189 |   |
|               |       |       |       |              |       |                                      |       |   |   |
| Mexico             |       | MXN        |       | 10.70             |       | $                                         | 1,890      |   | $ | 3,647 |   |
|               |       |       |       |              |       |                                      |       |   |   |
| Argentina          |       | ARS        |       | 3.16              |       | $                                         | 50         |   | $ | 97 |   |
|               |       |       |       |              |       |                                      |       |   |   |
| Dominican Republic |       | DOP        |       | 34.56             |       | $                                         | 18         |   | $ | 34 |   |
|               |       |       |       |              |       |                                      |       |   |   |
| Chile              |       | CLP        |       | 440.00            |       | $                                         | 292        |   | $ | 557 |   |
|               |       |       |       |              |       |                                      |       |   |   |
| Canada             |       | CAD        |       | 1.02              |       | $                                         | 16         |   | $ | 32 |   |
|               |       |       |       |              |       |                                      |       |   |   |
| Brazil             |       | BRL        |       | 1.75              |       | $                                         | 29         |   | $ | 56 |   |

 

**Item 4.  Controls and Procedures.**

 

*Disclosure Controls andProcedures*

 

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

 

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

 

*Internal Control Over FinancialReporting*

 

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

 

·                  pertain to the maintenance of recordsthat in reasonable detail accurately and fairly reflect the transactions anddispositions of assets of the company;

·                  provide reasonable assurance that transactionsare recorded as necessary to permit preparation of financial statements inaccordance with GAAP, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and

·                  provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof the company’s assets that could have a material effect on the financialstatements.

 

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Because of itsinherent limitations, internal control over financial reporting may not preventor detect misstatements. Projections of any evaluation of effectiveness to futureperiods are subject to the risk that controls may become inadequate because ofchanges in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

 

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

 

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**PART II**

 

**OTHERINFORMATION**

** **

**Item 1.  Legal Proceedings.**

 

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

 

*Wave Tec**Pools, Inc.Litigation*

 

In the collection suit filed by FH Partners, LLC (“FH Partners”), anindirectly wholly-owned subsidiary of FirstCity, against Superior Funding, Inc.,on March 18, 2008, the District Court granted a temporaryrestraining order against Superior Funding, Inc. and Jason Herring and allparties in privity with them, ordering them to turn over all payments on notesin FH Partners’ possession to FH Partners and not to interfere with FH Partners’collection of note payments. On March 27, 2008, the Court entered atemporary injunction that extended the temporary restraining order andalso ordered Superior Funding, Inc. and Mr. Herring and all partiesin privity with them to turn over books and records and execute transferdocuments. Trial has been set in the collection suit for October 27,2008. There is no trial date set in the suit by Superior et al. against FHPartners and Prosperity. FirstCity intends to pursue the collectionsuit and defend the liability suit vigorously.

 

**Item 1A.  Risk Factors.**

 

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

 

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

 

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

 
| ** ** | ** ** | ** **            | ** ** | ** **          | ** ** | **Total Number**                  | ** ** | **Maximum Number**               | ** ** |
|------------|------------|-----------------------|------------|---------------------|------------|----------------------------------------|------------|---------------------------------------|------------|
| ** ** | ** ** | ** **            | ** ** | ** **          | ** ** | **of Shares Purchased**      | ** ** | **of Shares that May** | ** ** |
| ** ** | ** ** | **Total Number** | ** ** | **Average**         | ** ** | **as Part of Publicly** | ** ** | **Yet Be Purchased**        | ** ** |
| ** ** | ** ** | **of Shares**    | ** ** | **Price Paid** | ** ** | **Announced Plans**               | ** ** | **Under the Plans**         | ** ** |
| **Month**  | ** ** | **Purchased**         | ** ** | **Per Share**  | ** ** | **or Programs (1)**          | ** ** | **or Programs**                  | ** ** |
| January    |       | 67,500                |       | $                   | 8.12       |                                   | 67,500     |                                  |       |   |
| February   |       | 197,030               |       | $                   | 8.07       |                                   | 197,030    |                                  |       |   |
| March      |       | —                |       | $                   | —     |                                   | —     |                                  |       |   |
| Total      |       | 264,530               |       | $                   | 8.08       |                                   | 264,530    |                                  | 654,970    |   |

 

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

 

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

 

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

 

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

 

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|   |   |   |   | amended the Revolving  Credit Agreement to extend time period for closing of subordinate credit  facility to be provided by BoS (USA), Inc. to November 16, 2007  (incorporated herein by reference to Exhibit 10.2 of the Company’s  Form 8-K dated November 8, 2007) |
|--------|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                                                                 |
| 31.1*  |   | — |   | Certification of the  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                       |
|   |   |   |   |                                                                                                                                                                                                                                                                                                 |
| 31.2*  |   | — |   | Certification of the  Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                       |
|   |   |   |   |                                                                                                                                                                                                                                                                                                 |
| 32.1*  |   | — |   | Certification of the  Chief Executive Officer pursuant to 18 U.S.C Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                     |
|   |   |   |   |                                                                                                                                                                                                                                                                                                 |
| 32.2*  |   | — |   | Certification of the  Chief Financial Officer pursuant to 18 U.S.C Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                     |

 

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* Filed herewith.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                                |     | FIRSTCITY FINANCIAL CORPORATION |
|-------------------------------------|----------|---------------------------------|
|                                |     |                            |
|                                |     |                            |
|                                |     | By:                             |   | /s/   JAMES T.  SARTAIN |
|                                |     |                            | James T. Sartain |
| * *                            | * * | * *                        | *President and Chief  Executive* |
| * *                            | * * | * *                        | *Officer and Director* |
| * *                            | * * | * *                        | *(Duly authorized officer  and* |
| * *                            | * * | * *                        | *Principal Executive  Officer)* |
| * *                            | * * | * *                        | * * |
| * *                            | * * | * *                        | * * |
|                                |     | By:                             |   | /s/   J. BRYAN  BAKER |
|                                |     |                            | J. Bryan Baker |
| * *                            | * * | * *                        | *Senior Vice President and  Chief* |
| * *                            | * * | * *                        | *Financial Officer* |
| * *                            | * * | * *                        | *(Duly authorized officer  and* |
| * *                            | * * | * *                        | *Principal Financial  Officer)* |
| Dated:  May 12, 2008 |     |                            |   |

 

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**Exhibit Index**

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

 

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

 

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

 

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|   |   |   |   | amended the Revolving  Credit Agreement to extend time period for closing of subordinate credit  facility to be provided by BoS (USA), Inc. to November 16, 2007  (incorporated herein by reference to Exhibit 10.2 of the Company’s  Form 8-K dated November 8, 2007) |
|--------|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |   |                                                                                                                                                                                                                                                                                                 |
| 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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