Table ofContents

 

 

 

**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 June 30, 2009** |
| ** **                                            |
| **o**                                                 | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Commission file number 033-19694**

 

**FirstCity Financial Corporation**

(Exact name of registrant as specified in its charter)

* *

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

 

**(254) 761-2800**

(Registrant’s telephone number, including area code)

 

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

 

Indicate by check mark whether the registrant has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes  o   No  o

 

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

 

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

 

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

 

The number of shares of common stock, par value$.01 per share, outstanding at August 3, 2009 was 9,831,937.

 

 

 

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Table of Contents

 

**TABLE OF CONTENTS**

 
| **PART I**                     | ** **                                                                                      |
|--------------------------------|-------------------------------------------------------------------------------------------------|
| ** **                     | ** **                                                                                      | ** ** |
| **Item 1.**                    | **Financial  Statements**                                                                       | **1** |
| ** **                     | **Consolidated Balance Sheets**                                                                 | **1** |
| ** **                     | **Consolidated Statements of Operations**                                                       | **2** |
| ** **                     | **Consolidated Statements of Stockholders’ Equity**                                        | **3** |
| ** **                     | **Consolidated Statements of Cash Flows**                                                       | **4** |
| ** **                     | **Notes to Consolidated Financial Statements**                                                  | **5** |
| **Item 2.**                    | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | **37** |
| **Item 3.**                    | **Quantitative  and Qualitative Disclosures About Market Risk**                                 | **54** |
| **Item 4.**                    | **Controls and  Procedures**                                                                    | **55** |
| ** **                     | ** **                                                                                      | ** ** |
| **PART II OTHER  INFORMATION** | **57**                                                                                          |
| ** **                     | ** **                                                                                      | ** ** |
| **Item 1.**                    | **Legal Proceedings**                                                                           | **57** |
| **Item 1A.**                   | **Risk Factors**                                                                                | **57** |
| **Item 2.**                    | **Unregistered  Sales of Equity Securities and Use of Proceeds**                                | **57** |
| **Item 3.**                    | **Defaults  Upon Senior Securities**                                                            | **57** |
| **Item 4.**                    | **Submission  of Matters to a Vote of Security Holders**                                        | **57** |
| **Item 5.**                    | **Other Information**                                                                           | **57** |
| **Item 6.**                    | **Exhibits**                                                                                    | **57** |
| **SIGNATURES**                 | **62**                                                                                          |

 

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Table ofContents

 

**PART I**

 

**FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements (Unaudited)**

** **

**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDBALANCE SHEETS**

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

** **

 
| ** **                                                                                                                       | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                       | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| ** **                                                                                                                       | ** ** | **(Unaudited)**   | ** ** | **(See Note 2)**      | ** ** |
| **ASSETS**                                                                                                                       | ** ** | ** **        | ** ** | ** **            | ** ** |
| Cash and cash equivalents                                                                                                        |       | $                 | 25,521     |                  | $          | 19,103 |   |
| Restricted cash                                                                                                                  |       | 1,115             |       | 1,217                 |       |
| Portfolio Assets:                                                                                                                |       |              |       |                  |       |
| Loan portfolios, net                                                                                                             |       | 212,511           |       | 121,137               |       |
| Real estate held for sale                                                                                                        |       | 15,280            |       | 17,484                |       |
| Real estate held for  investment, net                                                                                            |       | 9,635             |       | 9,592                 |       |
| Total Portfolio Assets                                                                                                           |       | 237,426           |       | 148,213               |       |
| Loans receivable:                                                                                                                |       |              |       |                  |       |
| Loans receivable -  affiliates                                                                                                   |       | 29,746            |       | 27,080                |       |
| Loans receivable - SBA held  for sale                                                                                            |       | 3,492             |       | 4,901                 |       |
| Loans receivable - SBA held  for investment, net                                                                                 |       | 16,203            |       | 14,405                |       |
| Loans receivable - other                                                                                                         |       | 11,698            |       | 13,533                |       |
| Total loans receivable                                                                                                           |       | 61,139            |       | 59,919                |       |
| Investment security  available for sale                                                                                          |       | 2,993             |       | 5,251                 |       |
| Equity investments                                                                                                               |       | 70,214            |       | 72,987                |       |
| Service fees receivable  ($864 and $553 from affiliates, respectively)                                                           |       | 941               |       | 626                   |       |
| Servicing assets - SBA  loans                                                                                                    |       | 974               |       | 722                   |       |
| Other assets, net                                                                                                                |       | 21,014            |       | 20,899                |       |
| Total Assets                                                                                                                     |       | $                 | 421,337    |                  | $          | 328,937 |   |
| ** **                                                                                                                       | ** ** | ** **        | ** ** | ** **            | ** ** |
| **LIABILITIES  AND EQUITY**                                                                                                      |       |              |       |                  |       |
| Liabilities:                                                                                                                     |       |              |       |                  |       |
| Notes payable to banks                                                                                                           |       | $                 | 295,975    |                  | $          | 242,889 |   |
| Note payable to affiliate                                                                                                        |       | 8,658             |       | 8,658                 |       |
| Other liabilities                                                                                                                |       | 17,585            |       | 11,515                |       |
| Total Liabilities                                                                                                                |       | 322,218           |       | 263,062               |       |
| Commitments and  contingencies (Note 17)                                                                                         |       |              |       |                  |       |
| 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; 11,331,937 shares issued;  9,831,937 shares outstanding) |       | 113               |       | 113                   |       |
| Treasury stock, at cost: 1,500,000  shares                                                                                       |       | (10,923           | )          | (10,923               | )          |
| Paid in capital                                                                                                                  |       | 102,779           |       | 101,875               |       |
| Accumulated deficit                                                                                                              |       | (28,683           | )          | (37,073               | )          |
| Accumulated other  comprehensive loss                                                                                            |       | (1,145            | )          | (3,726                | )          |
| FirstCity Stockholders’  Equity                                                                                             |       | 62,141            |       | 50,266                |       |
| Noncontrolling interests                                                                                                         |       | 36,978            |       | 15,609                |       |
| Total Equity                                                                                                                     |       | 99,119            |       | 65,875                |       |
| Total Liabilities and  Equity                                                                                                    |       | $                 | 421,337    |                  | $          | 328,937 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                                                                                                                                                    | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                                                                                    | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                                                                                                                                    | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenues:                                                                                                                                                                     |       |                   |       |                 |       |   |   |   |   |
| Servicing fees ($2,137 and  $2,484 from affiliates for the three month periods, respectively, and $4,264  and $4,648 from affiliates for the six month periods, respectively) |       | $                      | 2,403      |                 | $          | 2,706 |   | $ | 4,795 |   | $ | 4,906 |   |
| Income from Portfolio  Assets                                                                                                                                                 |       | 14,077                 |       | 5,622                |       | 23,120 |   | 10,557 |   |
| Gain on sale of SBA loans  held for sale, net                                                                                                                                 |       | 610                    |       | 133                  |       | 610 |   | 142 |   |
| Interest income from SBA  loans                                                                                                                                               |       | 295                    |       | 366                  |       | 641 |   | 842 |   |
| Interest income from loans  receivable - affiliates                                                                                                                           |       | 939                    |       | 483                  |       | 1,862 |   | 633 |   |
| Interest income from loans  receivable - other                                                                                                                                |       | 364                    |       | 355                  |       | 793 |   | 630 |   |
| Revenue from railroad  operations                                                                                                                                             |       | 705                    |       | 859                  |       | 1,452 |   | 1,664 |   |
| Other income                                                                                                                                                                  |       | 1,268                  |       | 965                  |       | 3,069 |   | 1,619 |   |
| Total revenues                                                                                                                                                                |       | 20,661                 |       | 11,489               |       | 36,342 |   | 20,993 |   |
| Expenses:                                                                                                                                                                     |       |                   |       |                 |       |   |   |   |   |
| Interest and fees on notes  payable to banks                                                                                                                                  |       | 3,145                  |       | 3,758                |       | 6,189 |   | 7,441 |   |
| Interest and fees on notes  payable to affiliate                                                                                                                              |       | 444                    |       | —               |       | 877 |   | — |   |
| Salaries and benefits                                                                                                                                                         |       | 6,032                  |       | 5,297                |       | 11,086 |   | 10,327 |   |
| Provision for loan and  impairment losses                                                                                                                                     |       | 677                    |       | 7,090                |       | 1,783 |   | 10,120 |   |
| Asset-level expenses                                                                                                                                                          |       | 1,417                  |       | 1,427                |       | 2,654 |   | 2,988 |   |
| Occupancy, data processing  and other                                                                                                                                         |       | 2,182                  |       | 3,303                |       | 5,588 |   | 5,758 |   |
| Total expenses                                                                                                                                                                |       | 13,897                 |       | 20,875               |       | 28,177 |   | 36,634 |   |
| Equity in net earnings of  subsidiaries                                                                                                                                       |       | 1,198                  |       | 3,008                |       | 1,052 |   | 5,848 |   |
| Gain on step acquisition                                                                                                                                                      |       | 1,455                  |       | —               |       | 1,455 |   | — |   |
| Earnings (loss) before  income taxes                                                                                                                                          |       | 9,417                  |       | (6,378               | )          | 10,672 |   | (9,793 | ) |
| Income tax expense                                                                                                                                                            |       | (440                   | )          | (98                  | )          | (703 | ) | (289 | ) |
| Net earnings (loss)                                                                                                                                                           |       | 8,977                  |       | (6,476               | )          | 9,969 |   | (10,082 | ) |
| Less: Net income  attributable to noncontrolling interests (See Note 2)                                                                                                       |       | 1,231                  |       | 53                   |       | 1,579 |   | 31 |   |
| Net earnings (loss)  attributable to FirstCity                                                                                                                                |       | $                      | 7,746      |                 | $          | (6,529 | ) | $ | 8,390 |   | $ | (10,113 | ) |
|                                                                                                                                                                          |       |                   |       |                 |       |   |   |   |   |
| Basic earnings (loss) per  share                                                                                                                                              |       | $                      | 0.79       |                 | $          | (0.63 | ) | $ | 0.85 |   | $ | (0.97 | ) |
| Diluted earnings (loss) per  share                                                                                                                                            |       | $                      | 0.76       |                 | $          | (0.63 | ) | $ | 0.84 |   | $ | (0.97 | ) |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**AND COMPREHENSIVE INCOME (LOSS)**

**(Dollars in thousands)**

** **
| ** **                                                      | ** ** | **FirstCity  Stockholders** | ** ** | ** **   | ** ** | ** **   | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------|------------|--------------|------------|--------------|------------|
| ** **                                                      | ** ** | ** **                  | ** ** | ** **   | ** ** | ** **   | ** ** | **Retained** | ** ** | **Accumulated** | ** ** | **Non-** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | ** **                  | ** ** | ** **   | ** ** | ** **   | ** ** | **Earnings** | ** ** | **Other** | ** ** | **controlling** | ** ** | ** ** | ** ** |
| ** **                                                      | ** ** | **Common**                  | ** ** | **Treasury** | ** ** | **Paid  in** | ** ** | **(Accumulated** | ** ** | **Comprehensive** | ** ** | **Interests** | ** ** | **Total** | ** ** |
| ** **                                                      | ** ** | **Stock**                   | ** ** | **Stock**    | ** ** | **Capital**  | ** ** | **Deficit)** | ** ** | **Income  (Loss)** | ** ** | **(See  Note 2)** | ** ** | **Equity** | ** ** |
| ** **                                                      | ** ** | ** **                  | ** ** | ** **   | ** ** | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Balances, December 31, 2007**                            |       | $                           | 113        |         | $          | (5,978       | )          | $ | 101,240 |   | $ | 9,602 |   | $ | 1,846 |   | $ | 3,209 |   | $ | 110,032 |   |
| Repurchase of common stock                                      |       | —                      |       | (3,245       | )          | —       |       | — |   | — |   | — |   | (3,245 | ) |
| Stock option compensation expense                               |       | —                      |       | —       |       | 422          |       | — |   | — |   | — |   | 422 |   |
| Investment in majority-owned entities                           |       | —                      |       | —       |       | —       |       | — |   | — |   | 475 |   | 475 |   |
| Distributions to noncontrolling interests                       |       | —                      |       | —       |       | —       |       | — |   | — |   | (773 | ) | (773 | ) |
| Other activity                                                  |       | —                      |       | —       |       | —       |       | — |   | — |   | 10 |   | 10 |   |
| Comprehensive loss:                                             |       |                        |       |         |       |         |       |   |   |   |   |   |   |   |   |
| Net loss                                                        |       | —                      |       | —       |       | —       |       | (10,113 | ) | — |   | 31 |   | (10,082 | ) |
| Foreign currency translation adjustments                        |       | —                      |       | —       |       | —       |       | — |   | 305 |   | 114 |   | 419 |   |
| Total comprehensive loss                                        |       |                        |       |         |       |         |       |   |   |   |   |   |   | (9,663 | ) |
| **Balances, June 30, 2008**                                |       | $                           | 113        |         | $          | (9,223       | )          | $ | 101,662 |   | $ | (511 | ) | $ | 2,151 |   | $ | 3,066 |   | $ | 97,258 |   |
|                                                            |       |                        |       |         |       |         |       |   |   |   |   |   |   |   |   |
| **Balances, December 31, 2008**                            |       | $                           | 113        |         | $          | (10,923      | )          | $ | 101,875 |   | $ | (37,073 | ) | $ | (3,726 | ) | $ | 15,609 |   | $ | 65,875 |   |
| Stock option compensation expense                               |       | —                      |       | —       |       | 130          |       | — |   | — |   | — |   | 130 |   |
| Purchases of subsidiary shares in noncontrolling  interests     |       | —                      |       | —       |       | 774          |       | — |   | — |   | (3,591 | ) | (2,817 | ) |
| Investments in majority-owned entities                          |       | —                      |       | —       |       | —       |       | — |   | — |   | 25,410 |   | 25,410 |   |
| Distributions to noncontrolling interests                       |       | —                      |       | —       |       | —       |       | — |   | — |   | (2,245 | ) | (2,245 | ) |
| Comprehensive income:                                           |       |                        |       |         |       |         |       |   |   |   |   |   |   |   |   |
| Net earnings                                                    |       | —                      |       | —       |       | —       |       | 8,390 |   | — |   | 1,579 |   | 9,969 |   |
| Change in net unrealized gain on securities available  for sale |       | —                      |       | —       |       | —       |       | — |   | 310 |   | — |   | 310 |   |
| Foreign currency translation adjustments                        |       | —                      |       | —       |       | —       |       | — |   | 2,271 |   | 216 |   | 2,487 |   |
| Total comprehensive income                                      |       |                        |       |         |       |         |       |   |   |   |   |   |   | 12,766 |   |
| **Balances, June 30, 2009  (unaudited)**                   |       | $                           | 113        |         | $          | (10,923      | )          | $ | 102,779 |   | $ | (28,683 | ) | $ | (1,145 | ) | $ | 36,978 |   | $ | 99,119 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Dollars in thousands)**

**(Unaudited)**

 
| ** **                                                                              | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                              | ** ** | **June 30,**    | ** ** |
| ** **                                                                              | ** ** | **2009**             | ** ** | **2008** | ** ** |
| ** **                                                                              | ** ** | **(See Note 2)**     | ** ** |
| **Cash flows  from operating activities:**                                              |       |                 |       |   |   |
| Net earnings (loss)                                                                     |       | $                    | 9,969      |   | $ | (10,082 | ) |
| Adjustments to reconcile  net earnings (loss) to net cash used in operating activities: |       |                 |       |   |   |
| Net principal advances on  SBA loans held for sale                                      |       | (11,437              | )          | (4,811 | ) |
| Proceeds from the sale of  SBA loans held for sale, net                                 |       | 13,819               |       | 2,993 |   |
| Purchases of Portfolio  Assets                                                          |       | (134,966             | )          | (47,345 | ) |
| Proceeds applied to  principal on Portfolio Assets                                      |       | 82,089               |       | 30,924 |   |
| Income from Portfolio  Assets                                                           |       | (23,120              | )          | (10,557 | ) |
| Capitalized interest and  costs on Portfolio Assets and loans receivable                |       | (768                 | )          | (982 | ) |
| Provision for loan and  impairment losses                                               |       | 1,783                |       | 10,120 |   |
| Foreign currency  transaction (gains) losses, net                                       |       | (300                 | )          | 198 |   |
| Equity in net earnings of  non-consolidated subsidiaries                                |       | (1,052               | )          | (5,848 | ) |
| Gain on sale of SBA loans  held for sale, net                                           |       | (610                 | )          | (142 | ) |
| Gain on sale of railroad  property                                                      |       | (920                 | )          | — |   |
| Gain on step acquisition                                                                |       | (1,455               | )          | — |   |
| Depreciation and  amortization                                                          |       | 1,991                |       | 1,834 |   |
| Net premium amortization of  loans receivable                                           |       | (33                  | )          | (199 | ) |
| Stock option compensation  expense                                                      |       | 130                  |       | 422 |   |
| Decrease (increase) in  restricted cash                                                 |       | 102                  |       | (681 | ) |
| Decrease (increase) in  service fees receivable                                         |       | (336                 | )          | 131 |   |
| Increase in other assets                                                                |       | (965                 | )          | (8,960 | ) |
| Increase in other liabilities                                                           |       | 5,379                |       | 1,465 |   |
| Net cash used in operating  activities                                                  |       | (60,700              | )          | (41,520 | ) |
| **Cash flows  from investing activities:**                                              |       |                 |       |   |   |
| Purchases of property and  equipment, net                                               |       | (1,358               | )          | (1,220 | ) |
| Proceeds from sale of  railroad property                                                |       | 1,350                |       | — |   |
| Cash paid for business  combination, net of cash acquired                               |       | (7,149               | )          | — |   |
| Net principal advances on  loans receivable                                             |       | (1,611               | )          | (23,377 | ) |
| Net principal collections  (advances) on SBA loans held for investment                  |       | (2,020               | )          | 445 |   |
| Net principal paydowns on  investment security available for sale                       |       | 2,242                |       | — |   |
| Contributions to  non-consolidated subsidiaries                                         |       | (1,222               | )          | (2,491 | ) |
| Distributions from  non-consolidated subsidiaries                                       |       | 7,034                |       | 11,052 |   |
| Net cash used in investing  activities                                                  |       | (2,734               | )          | (15,591 | ) |
| **Cash flows  from financing activities:**                                              |       |                 |       |   |   |
| Borrowings under note  payable to affiliate                                             |       | —               |       | 8,658 |   |
| Borrowings under notes  payable to banks                                                |       | 137,604              |       | 93,807 |   |
| Principal payments of notes  payable to banks, net                                      |       | (84,570              | )          | (51,773 | ) |
| Payments of debt issuance  costs and loan fees                                          |       | (647                 | )          | (921 | ) |
| Contributions from  noncontrolling interests                                            |       | 22,270               |       | 475 |   |
| Distributions to  noncontrolling interests                                              |       | (2,245               | )          | (773 | ) |
| Repurchase of common stock                                                              |       | —               |       | (3,245 | ) |
| Cash paid for subsidiary  shares in noncontrolling interests                            |       | (2,796               | )          | — |   |
| Net cash provided by financing  activities                                              |       | 69,616               |       | 46,228 |   |
| **Effect of  exchange rate changes on cash and cash equivalents**                       |       | 236                  |       | 162 |   |
| **Net  increase (decrease) in cash and cash equivalents**                               |       | 6,418                |       | (10,721 | ) |
| **Cash and  cash equivalents, beginning of period**                                     |       | 19,103               |       | 23,037 |   |
| **Cash and  cash equivalents, end of period**                                           |       | $                    | 25,521     |   | $ | 12,316 |   |
| **Supplemental  disclosure of cash flow information:**                                  | ** ** | ** **           | ** ** | ** ** | ** ** |
| Cash paid during the period  for:                                                       | ** ** | ** **           | ** ** | ** ** | ** ** |
| Interest                                                                                |       | $                    | 4,852      |   | $ | 6,154 |   |
| Income taxes, net of  refunds received                                                  |       | 90                   |       | 179 |   |

 

See accompanying notes to consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**June 30, 2009**

**(Unaudited)**

 

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

 

***Nature of Operations***

 

FirstCity Financial Corporation and subsidiaries (collectively, “FirstCity”,“Company”, “we”, “us” or “our”) is a financial services company with offices inthe United States and Mexico, and a presence in Europe and South America.FirstCity engages in two major business segments – Portfolio Asset Acquisitionand Resolution and Special Situations Platform. The Portfolio Asset Acquisitionand Resolution business has been the Company’s core business operation sincecommencing operations in 1986. In the Portfolio Asset Acquisition andResolution business, the Company acquires portfolios of performing andnon-performing commercial and consumer loans and other assets (collectively, “PortfolioAssets” or “Portfolios”), generally at a discount to their legal principalbalances or appraised values, and services and resolves such Portfolio Assetsin an effort to maximize the present value of the ultimate cash recoveries.FirstCity acquires the Portfolio Assets for its own account or throughinvestment entities formed with one or more other co-investors (each suchentity, an “Acquisition Partnership”). The Company engages in its SpecialSituations Platform business through its majority ownership interest inFirstCity Denver Investment Corp. (“FirstCity Denver”) – which was formed in April 2007.Through its Special Situations Platform business, the Company providesinvestment capital to privately-held middle-market companies through flexiblecapital structuring arrangements to generate an attractive risk-adjustedreturn. These capital investments primarily take the form of senior and juniorfinancing arrangements, but also include direct equity investments, commonequity warrants, distressed debt transactions, and buyouts. Refer to Note 16for additional information on the Company’s major business segments.

 

***Basis of Presentation***

 

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

 

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

 

We have performeda review of subsequent events through August 13, 2009, the date theconsolidated financial statements were issued, and concluded there were noevents or transactions occurring during the period that required recognition ordisclosure in our consolidated financial statements.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

On January 1,2009, the Company adopted SFAS No. 160, *NoncontrollingInterests in Consolidated Financial Statements — an amendment of ARB No. 51*(“SFAS 160”), which changed the presentation requirements for noncontrolling(minority) interests. Refer to Note 2 for more information. In addition to thechanges prescribed by SFAS 160, certain other amounts in prior period financialstatements have been reclassified to conform to the current periodpresentation. These certain other reclassifications are not significant andhave no impact on earnings, total assets or stockholders’ equity.

 

***Use of Estimates***

 

The preparation of financial statements in conformity with U.S.generally accepted accounting principles requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the consolidatedfinancial statements and the reported amounts of revenues and expenses duringthe reporting period. Estimates that are particularly susceptible tosignificant change in the near-term relate to the estimation of futurecollections on Portfolio Assets used in the calculation of income fromPortfolio Assets; valuation of deferred tax assets and assumptions used in thecalculation of income taxes; valuation of servicing assets, investmentsecurities, loans receivable (including loans receivable held in securitizationtrusts), and real estate; guarantee obligations; indemnifications; and legalcontingencies. These estimates and assumptions are based on management’s bestestimates and judgment. Management evaluates its estimates and assumptions onan ongoing basis using historical experience and other factors, including thecurrent economic environment. We adjust such estimates and assumptions whenfacts and circumstances dictate. Illiquid credit markets; volatile financial,real estate and foreign currency markets; and declines in business and consumerspending have combined to increase the uncertainty inherent in such estimatesand assumptions. As future events and their effects cannot be determined withprecision, actual results could differ significantly from these estimates.Changes in these estimates resulting from continuing changes in the economicenvironment will be reflected in the financial statements in future periods.

 

***PortfolioAssets***

 

The Companyinvests in performing and non-performing commercial and consumer loans, realestate and certain other assets (“Portfolio Assets” or “Portfolios”), andservices and resolves such Portfolio Assets in an effort to maximize the presentvalue of the ultimate cash recoveries. The Portfolio Assets are generallynon-homogeneous assets, including loans of varying qualities that are securedby diverse collateral types and real estate. Some Portfolio Assets are loansfor which resolution is tied primarily to the real estate securing the loan,while others may be collateralized business loans, the resolution of which maybe based on the cash flows of the business or the underlying collateral.

 

On January 1,2005, FirstCity adopted and began accounting for its acquisitions of loanportfolios with credit deterioration in accordance with the provisions of AICPAStatement of Position 03-3, *Accounting for CertainLoans or Debt Securities Acquired in a Transfer* (“SOP 03-3”). SOP03-3 addresses accounting differences between contractual cash flows and cashflows expected to be collected from an investor’s initial investment inacquired loans if those differences are attributable, at least in part, tocredit quality. SOP 03-3 requires acquired loans with credit deterioration tobe initially recorded at fair value and prohibits “carrying over” or thecreation of valuation allowances in the initial accounting of acquired loansthat are within the scope of SOP 03-3. Under SOP 03-3, the excess cash flows expectedat acquisition over the loan portfolio’s purchase price is recorded as interestincome over the life of the portfolio.

 

Loans Acquired Prior to 2005

 

For PortfolioAssets acquired before January 1, 2005, the Company initially recorded thepurchased assets at cost, and acquisition-date purchase discounts and loan lossallowances of the underlying assets were included as components of the cost andcarrying value of the Portfolio Assets, as applicable. Income recognition forloans acquired prior to 2005 is based on management’s initial designation ofthe purchased Portfolio Assets as non-performing or performing. Suchdesignations were made on the acquisition date and do not subsequently changeeven though the actual performance of the Portfolio Assets may subsequentlychange.

 

Income onnon-performing Portfolio Assets acquired prior to 2005 is recognized only tothe extent that collections exceed a pro-rata portion of allocated cost fromthe pool. Cost allocation is based on a proration of actual collections dividedby total estimated collections of the pool. Interest income is not recognizedseparately on non-performing Portfolio Assets. All collection proceeds, ofwhatever type, are included in the determination of income recognition forthese Portfolio Assets. The Company accounts for these non-performing PortfolioAssets on a pool basis.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

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

 

Loans With CreditDeterioration Acquired After 2004

 

A substantial portion of the Company’s loans acquiredafter 2004 have experienced deterioration of credit quality between originationand the Company’s acquisition of the accounts. The amounts paid for the loansreflect the Company’s determination that the loans have experienceddeterioration in credit quality since origination and that it is probable theCompany will be unable to collect all amounts due according to the contractualterms of the underlying loans. Commencing January 1, 2005, FirstCityadopted and began accounting for its acquisitions of loan portfolios withcredit deterioration in accordance with the provisions of SOP 03-3.

 

At acquisition,the Company reviews the individual loans purchased to determine whether there isevidence of credit quality deterioration since origination and for which it isprobable that the Company will be unable to collect all amounts due accordingto the loan’s contractual terms. If both conditions exist, the Companydetermines whether each such loan account is to be accounted for individuallyor whether such loan accounts will be assembled into static pools based oncommon risk characteristics (primarily loan type and collateral). As permittedby SOP 03-3, static pools of individual loan accounts may be established andaccounted for as a single economic unit for the recognition of income,principal payments and loss provision. Once a static loan pool is established,individual accounts are generally not added to or removed from the pool (unlessthe Company sells, forecloses or writes-off the loan). At acquisition,FirstCity determines the excess of the scheduled contractual payments over allcash flows expected to be collected for the loan or loan pool as an amount thatshould not be accreted (“nonaccretable difference”). The excess of the cashflows from the loan or loan pool expected to be collected at acquisition overthe initial investment (“accretableyield”) is generally accreted into interest income over the remaininglife of the loan or loan pool. The discount (i.e. the difference between thecost of each loan or static pool and the related aggregate contractualreceivable balance) is not recorded because the Company does not expect tofully collect each contractual receivable balance for the loan or loan pool. Asa result, loans and loan pools are generally recorded at cost (whichapproximates fair value) at the time of acquisition.

 

In accordance withSOP 03-3, the Company accounts for its investments in SOP 03-3 loans and loanpools using either the interest method or the non-accrual method (throughapplication of the cost-recovery basis of accounting). Application of theinterest method is dependent on management’s ability to develop a reasonableexpectation as to both the timing and amount of cash flows expected to becollected. In the event the Company cannot develop or establish a reasonableexpectation as to both the timing and amount of cash flows expected to becollected, SOP 03-3 permits the use of the cost-recovery method.

 

Under the interestmethod, an effective interest rate, or IRR, is applied to the cost basis of theloan or loan pool. SOP 03-3 requires that the excess of the contractual cashflows over expected cash flows not be recognized as an adjustment of income orexpense or on the balance sheet. SOP 03-3 requires the IRR that is estimatedwhen the loan accounts are purchased to remain constant as the basis forsubsequent impairment testing (performed at least quarterly) and incomerecognition. Significant increases in actual, or expected future cash flows, isused first to reverse any existing valuation allowance for that loan or loanpool; and any remaining increase may be recognized prospectively through anupward adjustment of the IRR over the remaining life of the loan or loan pool.Any increase to the IRR then becomes the new benchmark for impairment testingand income recognition. Under SOP 03-3, subsequent decreases in projected cashflows do not change the IRR, but are recognized as an impairment of the costbasis of the loan or loan pool (to maintain the then-current IRR), and arereflected in the consolidated statements of operations through provisionscharged to operations, with a corresponding valuation allowance off-setting theloan or loan pool in the consolidated balance sheets. FirstCity establishesvaluation allowances for loans and loan pools acquired with creditdeterioration to reflect only those losses incurred after acquisition — thatis, the cash flows expected at acquisition that are no longer expected to becollected. Income from loans and loan pools accounted for under the interestmethod is accrued based on the IRR of each loan or loan pool applied to theirrespective adjusted cost basis. Gross collections in excess of the interestaccrual and impairments will reduce the carrying value of the loan or loanpool, while gross 

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

collections less than theinterest accrual will increase the carrying value. The IRR is estimated basedon the timing and amount of anticipated cash flows using the Company’s proprietarycollection models. A loan or loan pool can become fully amortized (zero-basiscarrying balance on the balance sheet) while still generating cash collections.In this case, cash collections are recognized as income when received.

 

If the amount andtiming of future cash collections on a loan or loan pool are not reasonablyestimable, the Company accounts for such assets on the cost-recovery method.Under the cost-recovery method, no income is recognized until the Company hasfully collected the cost of the loan or loan pool, or until such time theCompany considers the timing and amount of collections to be reasonablyestimable and begins to recognize income based on the interest method asdescribed above. At least quarterly, the Company performs an evaluation todetermine if the remaining amount that is probable of collection is less thanthe carrying value of the loan or loan pool, and if so, recognizes impairmentthrough provisions charged to operations. At June 30, 2009 and December 31,2008, the carrying value of SOP 03-3 loans and loan pools accounted for underthe cost-recovery method approximated $73.2 million and $20.7 million,respectively.

 

Real Estate

 

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

 

*Classification and Impairment Evaluation*

 

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

 

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

 

*Cost Capitalization and Allocation*

 

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

 

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

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(2)  Recently AdoptedAccounting Standards**

 

Business Combinations and NoncontrollingInterests

 

In December 2007, the FASB issued SFAS No. 141(R),*Business Combinations* (“SFAS 141R”).SFAS 141R establishes principle requirements for how the acquirer of a businessrecognizes and measures in its financial statements the identifiable assetsacquired, the liabilities assumed, and any non-controlling interest in theacquiree. SFAS 141R also provides guidance for recognizing and measuring thegoodwill acquired in the business combination, recognizing assets acquired andliabilities assumed arising from contingencies, and determining whatinformation to disclose to enable users of the financial statements to evaluatethe nature and financial impact of the business combination. We adopted SFAS141R effective January 1, 2009 and it applies to all business combinationsprospectively from that date. The impact of SFAS 141R on our consolidatedfinancial statements will depend upon the nature, terms and size of theacquisitions that the Company consummates in the future.

 

In April 2009,the FASB issued Staff Position No. FSP FAS 141(R)-1, *Accountingfor Assets Acquired and Liabilities Assumed in a Business Combination ThatArise from Contingencies* (“FSP FAS 141R-1”). This FSP amends theaccounting in SFAS 141R for assets and liabilities arising from contingenciesin a business combination. FSP FAS 141R-1 requires that pre-acquisition contingenciesbe recognized at fair value, if fair value can be reasonably determined. Iffair value cannot be reasonably determined, FSP FAS 141R-1 requires measurementbased on the best estimate in accordance with SFAS No. 5, *Accounting for Contingencies*. FSP FAS 141R-1 is effective asof January 1, 2009 in connection with the adoption of SFAS 141R.

 

In December 2007,the FASB issued SFAS 160, which defines noncontrolling interest as the portionof equity in a subsidiary not attributable, directly or indirectly, to theparent. SFAS 160 requires the ownership interests in subsidiaries held byparties other than the parent (previously referred to as minority interest) tobe clearly presented in the consolidated balance sheet within equity, butseparate from the parent’s equity. The amount of consolidated net incomeattributable to the parent and to any noncontrolling interest must be clearlypresented on the face of the consolidated statement of operations. Changes inthe parent’s ownership interest while the parent retains its controllingfinancial interest (greater than 50 percent ownership) are to be accountedfor as equity transactions with no remeasurement to fair value. Upon a loss ofcontrol, any gain or loss on the interest sold will be recognized in earnings.Additionally, any ownership interest retained will be re-measured at fair valueon the date control is lost, with any gain or loss recognized in earnings. SFAS160 also requires companies to report a consolidated net income (loss) measurethat includes the amount attributable to such noncontrolling interests. Weadopted SFAS 160 effective January 1, 2009, and it applies tononcontrolling interests prospectively from that date. However, thepresentation and disclosure requirements of SFAS 160 were appliedretrospectively for all periods presented. As a result of this adoption, wereclassified noncontrolling interests in the amount of $15.6 million from totalliabilities to equity in the December 31, 2008 consolidated balance sheet;and net distributions to noncontrolling interests of $0.3 million fromoperating activities to financing activities in the consolidated statement ofcash flows for the six-month period ended June 30, 2008.

 

Fair Value

 

In2006, the FASB issued SFAS No. 157, *Fair Value Measurements*(“SFAS 157”). SFAS 157 defines fair value, establishes a market-based frameworkor hierarchy for measuring fair value and expands disclosures about fair valuemeasurements. SFAS 157 is applicable whenever another accounting pronouncementrequires or permits assets and liabilities to be measured at fair value. SFAS157 does not expand or require any new fair value measures, however theapplication of SFAS 157 may change current practice. We adopted SFAS 157 forfinancial assets and liabilities effective January 1, 2008 and fornon-financial assets and liabilities effective January 1, 2009. Theadoption of SFAS 157 did not have a material impact on our consolidatedfinancial statements. See Note 13 for additional information.

 

In April 2009,the FASB issued three FASB Staff Positions (“FSPs”) in order to provideadditional application guidance and enhance disclosures regarding fair valuemeasurements and impairments of securities.

 

·                  FSP FAS 157-4, *Determining Fair ValueWhen the Volume and Level of Activity for the Asset or Liability HaveSignificantly Decreased and Identifying Transactions That Are Not Orderly*(“FSP FAS 157-4”). FSP FAS 157-4 relates to determining fair values when thereis no active market or where the price inputs being used represent distressedsales. It reaffirms the need to use judgment to ascertain if a formerly activemarket has become inactive and in determining fair values when markets havebecome inactive.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

·                  FSP FAS 115-2 and FAS 124-2, *Recognitionand Presentation of Other-Than-Temporary Impairments*. This FSP isintended to bring consistency to the timing of impairment recognition, andprovide improved disclosures about the credit and noncredit components ofimpaired debt securities that are not expected to be sold. The measure ofimpairment in comprehensive income remains fair value. The FSP also requiresincreased and more-timely disclosures regarding expected cash flows, creditlosses, and an aging of securities with unrealized losses.

·                  FSP FAS 107-1 and APB 28-1, *InterimDisclosures about Fair Value of Financial Instruments*. This FSPrelates to fair value disclosures for financial instruments that are notcurrently reflected on the balance sheet at fair value. Prior to issuing thisFSP, fair values for these assets and liabilities were only disclosed once ayear. The FSP now requires these disclosures on a quarterly basis, providingqualitative and quantitative information about fair value estimates for allthose financial instruments not measured on the balance sheet at fair value.

 

Weadopted the FSPs effective April 1, 2009. The adoption of the provisionsof the FSPs did not have a material impact on our consolidated financialstatements. See Note 13 for additional information.

 

Other

 

Effective January 1,2009, the Company adopted SFAS No. 161, *Disclosuresabout Derivative Instruments and Hedging Activities* (“SFAS 161”), anamendment to SFAS No. 133, *Accounting for DerivativeInstruments and Hedging Activities*. SFAS 161 applies to all entitiesand requires enhanced disclosures about derivative instruments and hedged itemsthat are accounted for under SFAS No. 133 and related interpretations. TheCompany applied the requirements of SFAS 161 on a prospective basis.Accordingly, disclosures related to interim periods prior to the date ofadoption have not been presented. Since SFAS 161 relates to disclosures only,it had no impact on the Company’s financial condition or results of operations.See Note 18 for additional information.

 

Effective January 1, 2009, the Company adopted EITF Issue No. 08-6,*Equity-Method Investment Accounting* (“EITF08-6”). EITF 08-6 addresses a number of matters associated with the impact thatSFAS 141R and SFAS 160 might have on the accounting for equity-method investments.EITF 08-6 clarifies the following: (1) the cost basis of a newequity-method investment should be determined using a cost-accumulation mode,which would continue the practice of including transaction costs in the cost ofinvestment and would exclude the value of contingent consideration; and (2) equity-methodinvestments should continue to be subject to other-than-temporary impairmentanalysis pursuant to APB Opinion No. 18. EITF 08-6 also provides guidanceon gain recognition when a portion of the investor’s ownership is sold, howchanges in classification from equity-method to cost-method should be treated,and certain other issues. The adoption of EITF 08-6 did not have a materialimpact on the Company’s consolidated financial statements.

 

In May 2009, the FASB issued SFAS No. 165, *Subsequent Events* (“SFAS 165”). SFAS 165establishes the general standards of accounting for and disclosure ofsubsequent events. In addition, it requires disclosureof the datethrough which an entity has evaluated subsequent events and the basis for thatdate. This new accounting standard wasadopted for ourfinancial statements for the quarterly period ending June 30, 2009. Theadoption of SFAS 165 did not have a materialimpact on theCompany’s consolidatedfinancial statements. See Note 1 for additionalinformation.

 

**(3)  Recently IssuedAccounting Standards**

 

In June 2009, the FASB issued SFAS No. 166,*Accounting for Transfers of Financial Assets — anamendment of FASB Statement No. 140* (“SFAS 166”). SFAS 166 amendsSFAS 140 by including the following: the elimination of the qualifyingspecial-purpose entity (QSPE) concept; a new participating interest definitionthat must be met for transfers of portions of financial assets to be eligiblefor sale accounting; clarifications and changes to the de-recognition criteriafor a transfer to be accounted for as a sale; and a change to the amount ofrecognized gain or loss on a transfer of financial assets accounted for as asale when beneficial interests are received by the transferor. Additionally,the standard requires extensive new disclosures regarding an entity’sinvolvement in a transfer of financial assets. Finally, existing QSPEs (priorto the effective date of SFAS 166) must be evaluated for consolidation byreporting entities in accordance with the applicable consolidation guidanceupon the elimination of this concept. SFAS 166 is effective for fiscal yearsbeginning after November 15, 2009. Accordingly, the Company will adopt theprovisions of SFAS 166 in the first quarter of 2010. We are currentlyevaluating the impact of the provisions of SFAS 166.

 

In June 2009, the FASB issued SFAS No. 167,*Amendments to FASB Interpretation No. 46R*(“SFAS167”). SFAS 167replaces the quantitative-based risks and rewards calculation for determiningwhich enterprise, if any, has a controlling financial interest in a variableinterest entity with a qualitative approach focused on identifying whichenterprise has both the power to direct the activities of 

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

the variableinterest entity that most significantly impacts the entity’s economicperformance and has the obligation to absorb losses or the right to receivebenefits that could be significant to the entity. In addition, SFAS 167requires reconsideration of whether an entity is a variable interest entitywhen any changes in facts and circumstances occur such that the holders of theequity investment at risk, as a group, lose the power from voting rights orsimilar rights of those investments to direct the activities of the entity thatmost significantly impact the entity’s economic performance. It alsorequires ongoing assessments of whether an enterprise is the primarybeneficiary of a variable interest entity and additional disclosures about anenterprise’s involvement in variable interest entities. SFAS 167 is effectivefor fiscal years beginning after November 15, 2009. Accordingly, theCompany will adopt the provisions of SFAS 167 in the first quarter of2010. We are currently evaluating the impact of the provisions of SFAS167.

 

In June 2009,the FASB issued SFAS No. 168, *The FASB AccountingStandards Codification and the Hierarchy of Generally Accepted AccountingPrinciples*(“SFAS 168”). SFAS 168 establishes the FASB AccountingStandards Codification (the Codification) as the single source ofauthoritative, nongovernmental U.S. GAAP. The Codification does not changeU.S. GAAP. All existing accounting standard documents will be supersededand all other accounting literature not included in the Codification will beconsidered non-authoritative. SFAS 168 is effective for interim and annualperiods ending after September 15, 2009. Accordingly, the Companywill adopt the provisions of SFAS 168 and revise its financial statementdisclosures in compliance with the new codification numbering system in thethird quarter ended September 30, 2009. The Company does not expectthe adoption of the provisions of SFAS 168 to have any impact on the Company’sfinancial condition or results of operations.

 

**(4)  Business Acquisitions**

 

The following is a summary of acquisitions completed by the Companyduring the six-month period ended June 30, 2009 that were accounted for asa purchase business combination pursuant to SFAS 141R or noncontrollinginterest purchases pursuant to SFAS 160:

 

*French Acquisition Partnerships*

 

In May 2009, the Company, through a majority-owned subsidiary(UBN, SA), acquired additional ownership interests (ranging from 55.0% to95.0%) in sixteen French Acquisition Partnerships for $7.8 million in cash. Asa result of the transaction, the Company acquired a majority ownership interest(i.e. controlling financial interest) in each of the sixteen French entities —resulting in the entities becoming consolidated subsidiaries of the Company.Prior to this transaction, the Company, through a wholly-owned subsidiary,owned a direct equity-method investment in nine of the French entities (theaggregate carrying value of the Company’s equity-method investments in thesenine French entities approximated $0.5 million at the time of the transaction).In addition, prior to this transaction, the Company, through an equity-methodinvestee, owned an indirect equity-method investment in all of the Frenchentities.

 

The transaction was accounted for as a business combination under SFAS141R, and accordingly, the French entities’ assets (primarily loans thatCompany management considers to be SOP 03-3 loans) and liabilities and thenoncontrolling interests were measured at fair value on the acquisition dateand included in the Company’s consolidated balance sheet. The fair value of thePortfolio Assets was measured using a discounted cash flow model, employing a20% market discount rate, based on the projected future cash flows of theunderlying loan portfolios. In management’s opinion, the market discount rateused in the cash flow model reflects the rate of return a market participantwould consider for this type of loan investment. The amounts attributable tothe French entities that were included in the Company’s consolidated balancesheet on the acquisition date are as follows (in thousands):

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

 

In addition, pursuant to provisions under SFAS 141R, the Company’s previously-helddirect equity-method investments in nine of the French entities were remeasuredto fair value at the acquisition date. The fair value of the Company’spreviously-held equity interests exceeded the aggregate carrying value of $0.5million by approximately $1.5 million. As such, under SFAS 141R, the Companyrecognized a $1.5 million gain attributable to the remeasurement of itspreviously-held equity interests on the acquisition date (presented as “Gain onstep acquisition” on the face of the Company’s consolidated statement ofoperations for the six-month period ended June 30, 2009).

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

*Acquisitions of Noncontrolling Interests*

 

In May 2009, the Company purchased noncontrolling interests in twomajority-owned subsidiaries (UBN, SA and WAMCO 80) already included in theCompany’s consolidated financial statements. The Company paid $2.8 million incash for the purchased noncontrolling interests. On the respective acquisitiondates, the Company’s carrying values of the purchased noncontrolling interestsapproximated $3.6 million. Under SFAS 160, the Company accounted for thepurchased noncontrolling interests as equity transactions, and recognized the$0.8 million difference between the purchase prices and the carrying values ofthe noncontrolling interests acquired as an increase to the Company’sconsolidated paid-in capital.

 

**(5)  Portfolio Assets**

 

Portfolio Assets are summarizedas follows:

 
| ** **                                   | ** ** | **June 30,**          | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)** | ** ** |
| Loan Portfolios                              | ** ** | ** **                 | ** ** | ** **            | ** ** |
| Loans Acquired Prior to 2005                 | ** ** | ** **                 | ** ** | ** **            | ** ** |
| Non-performing Portfolio  Assets             |       | $                          | 3,049      |                  | $          | 3,410 |   |
| Performing Portfolio Assets                  |       | 487                        |       | 833                   |       |
| Loans Acquired After 2004                    | ** ** | ** **                 | ** ** | ** **            | ** ** |
| Loans acquired with credit  deterioration    |       | 211,759                    |       | 125,108               |       |
| Loans acquired with no  credit deterioration |       | 2,132                      |       | 2,757                 |       |
| Other (1)                                    |       | 64,166                     |       | 65,394                |       |
| Outstanding balance                          |       | 281,593                    |       | 197,502               |       |
| Allowance for loan losses  (1)               |       | (69,082                    | )          | (76,365               | )          |
| Carrying amount of loans,  net of allowance  |       | 212,511                    |       | 121,137               |       |
|                                         |       |                       |       |                  |       |
| Real estate held for sale                    |       | 15,280                     |       | 17,484                |       |
| Real estate held for investment,  net (2)    |       | 9,635                      |       | 9,592                 |       |
| Portfolio Assets, net                        |       | $                          | 237,426    |                  | $          | 148,213 |   |

 

----

(1)         Includes loans and related allowanceacquired in a step acquisition of a former equity-method investee in September 2008.

 

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

 

Certain Portfolio Assets are pledged to secure a$100.0 million revolving loan facility between FH Partners LLC, an indirectwholly-owned affiliate of FirstCity, and Bank of Scotland. See Note 2 to theconsolidated financial statements included in the Company’s 2008 Form 10-Kfor a description of this revolving credit agreement. In addition, certainPortfolio Assets are pledged to secure notes payable of certain consolidatedaffiliates of FirstCity that are generally non-recourse to FirstCity or anyaffiliate other than the acquiring entity that incurred the debt.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

Income from Portfolio Assets issummarized as follows:

 
| ** **                                   | ** ** | **Three Months Ended**     | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------|------------|----------------------|------------|
| ** **                                   | ** ** | **June 30,**          | ** ** | **June 30,**    | ** ** |
| ** **                                   | ** ** | **2009**                   | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)** | ** ** |
| Loan Portfolios                              |       |                       |       |                 |       |   |   |   |   |
| Loans Acquired Prior to  2005                |       |                       |       |                 |       |   |   |   |   |
| Non-performing Portfolio  Assets             |       | $                          | 50         |                 | $          | 75 |   | $ | 91 |   | $ | 255 |   |
| Performing Portfolio Assets                  |       | 152                        |       | 37                   |       | 258 |   | 143 |   |
| Loans Acquired After 2004                    | ** ** | ** **                 | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans acquired with credit  deterioration    |       | 13,530                     |       | 4,913                |       | 22,253 |   | 8,466 |   |
| Loans acquired with no  credit deterioration |       | 94                         |       | 97                   |       | 173 |   | 209 |   |
| Real Estate Portfolios                       |       | 170                        |       | 447                  |       | (10 | ) | 1,376 |   |
| Other                                        |       | 81                         |       | 53                   |       | 355 |   | 108 |   |
| Income from Portfolio  Assets                |       | $                          | 14,077     |                 | $          | 5,622 |   | $ | 23,120 |   | $ | 10,557 |   |

 

The Companyrecorded a provision for loan and impairment losses on Portfolio Assets ofapproximately $0.7 million for the six month period ended June 30, 2009 —which is comprised of a $0.4 million impairment charge on real estateportfolios and a $0.3 million provision for loan losses, net of recoveries. Forthe six month period ended June 30, 2008, the Company recorded a provisionfor loan and impairment losses on Portfolio Assets of $9.9 million — which iscomprised of a $1.0 million impairment charge on real estate portfolios and an$8.9 million provision for loan losses.

 

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

 
| ** **              | ** ** | **Three Months Ended**     | ** ** | **Six Months Ended** | ** ** |
|-------------------------|------------|----------------------------|------------|----------------------|------------|
| ** **              | ** ** | **June 30,**          | ** ** | **June 30,**    | ** ** |
| ** **              | ** ** | **2009**                   | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **              | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance       |       | $                          | (71,922    | )                    | $          | (4,273 | ) | $ | (76,365 | ) | $ | (1,723 | ) |
| Provisions              |       | 581                        |       | (6,287               | )          | (660 | ) | (9,154 | ) |
| Recoveries              |       | 70                         |       | 107                  |       | 382 |   | 262 |   |
| Charge-offs             |       | 6,220                      |       | —               |       | 7,647 |   | 162 |   |
| Translation adjustments |       | (4,031                     | )          | (1                   | )          | (86 | ) | (1 | ) |
| Ending Balance          |       | $                          | (69,082    | )                    | $          | (10,454 | ) | $ | (69,082 | ) | $ | (10,454 | ) |

 

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

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 
| ** **                                           | ** ** | **Three Months Ended**     | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------|------------|----------------------|------------|
| ** **                                           | ** ** | **June 30,**          | ** ** | **June 30,**    | ** ** |
| ** **                                           | ** ** | **2009**                   | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                           | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                                    |       | $                          | 56,640     |                 | $          | 31,318 |   | $ | 58,114 |   | $ | 35,951 |   |
| Additions                                            |       | 12,146                     |       | 16,898               |       | 23,077 |   | 20,213 |   |
| Accretion                                            |       | (5,562                     | )          | (3,476               | )          | (10,460 | ) | (6,734 | ) |
| Reclassification from (to)  nonaccretable difference |       | (1,022                     | )          | 11,394               |       | 1,459 |   | 7,556 |   |
| Disposals                                            |       | (11,033                    | )          | (1,257               | )          | (19,477 | ) | (2,451 | ) |
| Translation adjustments                              |       | 1,767                      |       | 307                  |       | 223 |   | 649 |   |
| Ending Balance                                       |       | $                          | 52,936     |                 | $          | 55,184 |   | $ | 52,936 |   | $ | 55,184 |   |

 

For the three- and six-month periods ended June 30,2008, the Company adjusted the accretable yield schedules on certain loans toreflect the residual excess of the expected future cash flows over theircarrying values. The tabular presentation above for the three- and six-monthperiods ended June 30, 2008 includes a $10.2 million increase to “Reclassificationfrom (to) nonaccretable difference”. The adjustment to the underlyingaccretable yield schedule did not impact the Company’s consolidated financialposition or results of operations.

 

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

 
| ** **                                                              | ** ** | **Three Months Ended**     | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------|------------|----------------------|------------|
| ** **                                                              | ** ** | **June 30,**          | ** ** | **June 30,**    | ** ** |
| ** **                                                              | ** ** | **2009**                   | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                              | ** ** | **(Dollars in thousands)** | ** ** |
| Face value at acquisition                                               |       | $                          | 112,058    |                 | $          | 64,903 |   | $ | 252,830 |   | $ | 74,755 |   |
| Cash flows expected to be  collected at acquisition, net of adjustments |       | 83,306                     |       | 53,150               |       | 164,428 |   | 63,285 |   |
| Basis in acquired loans at  acquisition (1)                             |       | 64,497                     |       | 36,252               |       | 134,688 |   | 43,072 |   |
|                                                                         |            |                            |            |                      |            |  |  |  |  |  |  |  |  |

 

----

(1)          Includes $28.3 million and $30.7 millionof loans accounted for under the cost-recovery accounting method under SOP 03-3upon acquisition for the three and six month periods ended June 30, 2009.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(6)  Loans Receivable**

 

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

** **
| ** **                            | ** ** | **June 30,**          | ** **   | **December 31,** | ** ** |
|---------------------------------------|------------|----------------------------|--------------|-----------------------|------------|
| ** **                            | ** ** | **2009**                   | ** **   | **2008**              | ** ** |
| ** **                            | ** ** | **(Dollars in thousands)** | ** **   |
| Domestic:                             |       |                       |         |                  |       |
| Commercial and industrial:            |       |                       |         |                  |       |
| Affiliates                            |       | $                          |  15,366 |                  | $          |  12,794 |   |
| SBA                                   |       | 19,807                     |         | 19,340                |       |
| Other                                 |       | 3,667                      |         | 3,313                 |       |
| Real estate:                          |       |                       |         |                  |       |
| Other                                 |       | 9,579                      |         | 10,801                |       |
|                                  |       |                       |         |                  |       |
| Foreign - commercial and  industrial: |       |                       |         |                  |       |
| Affiliates                            |       | 14,380                     |         | 14,286                |       |
|                                  |       |                       |         |                  |       |
| Total loans                           |       | 62,799                     |         | 60,534                |       |
| Less: allowance for loan  losses      |       | (1,660                     | )            | (615                  | )          |
| Total loans, net                      |       | $                          |  61,139 |                  | $          |  59,919 |   |

 

***Loansreceivable — affiliates***

 

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

 
| ** **                     | ** ** | **June 30,**          | ** **   | **December 31,** | ** ** |
|--------------------------------|------------|----------------------------|--------------|-----------------------|------------|
| ** **                     | ** ** | **2009**                   | ** **   | **2008**              | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** **   |
| Outstanding balance            |       | $                          |  28,244 |                  | $          |  25,747 |   |
| Capitalized interest           |       | 1,502                      |         | 1,333                 |       |
| Carrying amount of loans,  net |       | $                          |  29,746 |                  | $          |  27,080 |   |

 

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

 
| ** **                       | ** ** | **Three Months Ended**     | ** **   | **Six Months Ended** | ** ** |
|----------------------------------|------------|----------------------------|--------------|----------------------|------------|
| ** **                       | ** ** | **June 30,**          | ** **   | **June 30,**    | ** ** |
| ** **                       | ** ** | **2009**                   | ** **   | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                       | ** ** | **(Dollars in thousands)** | ** **   |
| Beginning Balance                |       | $                          |  27,827 |                 | $          |  5,403 |   | $ |  27,080 |   | $ |  5,447 |   |
| Advances                         |       | 2,852                      |         | 13,500               |       | 5,152 |   | 13,500 |   |
| Payments received                |       | (1,333                     | )            | (46                  | )          | (2,610 | ) | (514 | ) |
| Capitalized interest             |       | 88                         |         | 95                   |       | 169 |   | 191 |   |
| Foreign exchange gains  (losses) |       | 312                        |         | 28                   |       | (45 | ) | 356 |   |
| Ending Balance                   |       | $                          |  29,746 |                 | $          |  18,980 |   | $ |  29,746 |   | $ |  18,980 |   |

 

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

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

withinthe portfolios, which is generally real estate; whereas advances to affiliatesfor business expansion and working capital purposes are generally secured bybusiness assets (i.e. accounts, inventory and equipment).

 

Managementevaluates the need for impairment based upon the performance of the loans andvarious other factors. Impairment is evaluated by analyzing expected futurecash flows and evaluating values of the underlying loan collateral. Foradvances secured by loan portfolios, management analyzes the expected cashflows within each pool to determine that the cash flows are sufficient to repaythese notes. For loans secured by business assets, management analyzes theexpected future cash flows from the borrowing entity (discounted for the loan’srisk-adjusted rate), and the values of the underlying collateral, to determinewhether the Company expects to ultimately collect all contractual principal andinterest. The results of management’s evaluations indicated that projected cashflows and underlying collateral are sufficient to repay the loans and noallowances for impairment are necessary. The Company recorded no provisions forimpairment on loans receivable — affiliates for the six months ended June 30,2009 and 2008.

 

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

 

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

 
| ** **                     | ** ** | **June 30,**          | ** **  | **December 31,** | ** ** |
|--------------------------------|------------|----------------------------|-------------|-----------------------|------------|
| ** **                     | ** ** | **2009**                   | ** **  | **2008**              | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** **  |
| Outstanding balance            |       | $                          |  3,449 |                  | $          |  4,840 |   |
| Capitalized costs              |       | 43                         |        | 61                    |       |
| Carrying amount of loans,  net |       | $                          |  3,492 |                  | $          |  4,901 |   |

 

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

 
| ** **                          | ** ** | **Three Months Ended**     | ** **  | **Six Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------|-------------|----------------------|------------|
| ** **                          | ** ** | **June 30,**          | ** **  | **June 30,**    | ** ** |
| ** **                          | ** ** | **2009**                   | ** **  | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)** | ** **  |
| Beginning Balance                   |       | $                          |  9,720 |                 | $          |  1,055 |   | $ |  4,901 |   | $ |  133 |   |
| Originations and advances  of loans |       | 6,787                      |        | 3,752                |       | 11,600 |   | 4,842 |   |
| Payments received                   |       | (88                        | )           | (29                  | )          | (163 | ) | (31 | ) |
| Capitalized costs                   |       | (99                        | )           | 7                    |       | (18 | ) | 26 |   |
| Loans sold, net                     |       | (12,828                    | )           | (2,566               | )          | (12,828 | ) | (2,751 | ) |
| Ending Balance                      |       | $                          |  3,492 |                 | $          |  2,219 |   | $ |  3,492 |   | $ |  2,219 |   |

 

Loans receivable — SBA held for sale represent U.S. Small BusinessAdministration (“SBA”) loans acquired by the Company in February 2007 andSBA loan originations and advances made since such time. SBA loans held forsale represent the portions of the loans that are guaranteed by the SBA, andare reflected at the lower of aggregate cost or estimated fair value. Netunrealized losses, if any, are recognized through a valuation allowance bycharges to income. The carrying value of SBA loans held for sale is net ofpremiums as well as deferred origination fees and costs. Premiums and netorigination fees and costs are deferred and included in the basis of the loansin calculating gains and losses upon sale. SBA loans are generally secured bythe borrowing entities’ assets such as accounts, property and equipment, andother assets. The Company generally sells the guaranteed portion of each loanto a third party and retains the servicing rights. The difference between theproceeds received and the allocated carrying value of the loans sold arerecognized as net gains on sales of loans. The non-guaranteed portion isgenerally held in the portfolio and classified as held for investment. TheCompany recorded no write-downs of SBA loans held for sale below their cost forthe six months ended June 30, 2009 and 2008.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

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

 

Loans receivable — SBA held for investment aresummarized as follows:

 
| ** **                     | ** ** | **June 30,**          | ** **   | **December 31,** | ** ** |
|--------------------------------|------------|----------------------------|--------------|-----------------------|------------|
| ** **                     | ** ** | **2009**                   | ** **   | **2008**              | ** ** |
| ** **                     | ** ** | **(Dollars in thousands)** | ** **   |
| Outstanding balance            |       | $                          |  17,482 |                  | $          |  15,509 |   |
| Allowance for loan losses      |       | (112                       | )            | (34                   | )          |
| Discounts, net                 |       | (1,260                     | )            | (1,120                | )          |
| Capitalized costs              |       | 93                         |         | 50                    |       |
| Carrying amount of loans,  net |       | $                          |  16,203 |                  | $          |  14,405 |   |

 

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

 
| ** **                          | ** ** | **Three Months Ended**     | ** **   | **Six Months Ended** | ** ** |
|-------------------------------------|------------|----------------------------|--------------|----------------------|------------|
| ** **                          | ** ** | **June 30,**          | ** **   | **June 30,**    | ** ** |
| ** **                          | ** ** | **2009**                   | ** **   | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)** | ** **   |
| Beginning Balance                   |       | $                          |  15,673 |                 | $          |  12,988 |   | $ |  14,405 |   | $ |  14,234 |   |
| Originations and advances  of loans |       | 1,163                      |         | 1,241                |       | 2,767 |   | 1,604 |   |
| Payments received                   |       | (405                       | )            | (457                 | )          | (793 | ) | (2,071 | ) |
| Capitalized costs                   |       | 17                         |         | 20                   |       | 43 |   | 27 |   |
| Provision for SBA loan  losses, net |       | (63                        | )            | (110                 | )          | (78 | ) | (82 | ) |
| Discount accretion, net             |       | (182                       | )            | 10                   |       | (141 | ) | 145 |   |
| Charge-offs                         |       | —                     |         | —               |       | — |   | (165 | ) |
| Ending Balance                      |       | $                          |  16,203 |                 | $          |  13,692 |   | $ |  16,203 |   | $ |  13,692 |   |

 

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

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

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

 
| ** **        | ** ** | **Three Months Ended**     | ** ** | **Six Months Ended** | ** ** |
|-------------------|------------|----------------------------|------------|----------------------|------------|
| ** **        | ** ** | **June 30,**          | ** ** | **June 30,**    | ** ** |
| ** **        | ** ** | **2009**                   | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **        | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance |       | $                          |  (49  | )                    | $          |  (123 | ) | $ |  (34 | ) | $ |  (151 | ) |
| Provisions        |       | (76                        | )          | (110                 | )          | (97 | ) | (234 | ) |
| Recoveries        |       | 13                         |       | —               |       | 19 |   | 2 |   |
| Charge-offs       |       | —                     |       | —               |       | — |   | 150 |   |
| Ending Balance    |       | $                          |  (112 | )                    | $          |  (233 | ) | $ |  (112 | ) | $ |  (233 | ) |

 

***Loansreceivable — other***

 

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

 
| ** **                      | ** ** | **June 30,**          | ** **   | **December 31,** | ** ** |
|---------------------------------|------------|----------------------------|--------------|-----------------------|------------|
| ** **                      | ** ** | **2009**                   | ** **   | **2008**              | ** ** |
| ** **                      | ** ** | **(Dollars in thousands)** | ** **   |
| Outstanding balance             |       | $                          |  13,008 |                  | $          |  13,929 |   |
| Allowance for loan losses       |       | (1,548                     | )            | (581                  | )          |
| Discounts, net                  |       | (11                        | )            | (20                   | )          |
| Capitalized interest and  costs |       | 249                        |         | 205                   |       |
| Carrying amount of loans,  net  |       | $                          |  11,698 |                  | $          |  13,533 |   |

 

Changes in loans receivable — other are as follows:

 
| ** **                       | ** ** | **Three Months Ended**     | ** **   | **Six Months Ended** | ** ** |
|----------------------------------|------------|----------------------------|--------------|----------------------|------------|
| ** **                       | ** ** | **June 30,**          | ** **   | **June 30,**    | ** ** |
| ** **                       | ** ** | **2009**                   | ** **   | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                       | ** ** | **(Dollars in thousands)** | ** **   |
| Beginning Balance                |       | $                          |  13,411 |                 | $          |  5,965 |   | $ |  13,533 |   | $ |  5,995 |   |
| Advances                         |       | 1,381                      |         | 10,480               |       | 3,368 |   | 10,472 |   |
| Payments received                |       | (2,170                     | )            | (58                  | )          | (4,299 | ) | (81 | ) |
| Capitalized interest and  costs  |       | 26                         |         | 84                   |       | 44 |   | 93 |   |
| Provision for loan  impairment   |       | (967                       | )            | —               |       | (967 | ) | — |   |
| Discount accretion, net          |       | 2                          |         | 18                   |       | 9 |   | 24 |   |
| Foreign exchange gains  (losses) |       | 15                         |         | 3                    |       | 10 |   | (11 | ) |
| Ending Balance                   |       | $                          |  11,698 |                 | $          |  16,492 |   | $ |  11,698 |   | $ |  16,492 |   |

 

Loans receivable — other include loans made to non-affiliated entitiesand are secured by the borrowing entities’ assets such as accounts receivable,inventory, property and equipment, and various other assets. The loans arereported at their outstanding principal balances adjusted for unearneddiscounts, loan origination fees, and the allowance for loan losses. Interestis accrued when earned in accordance with the contractual terms of the loans.Interest is recognized on an accrual basis at the applicable interest rate onthe principal amount outstanding. Loan origination fees and direct costs aregenerally amortized as level-yield adjustments over the respective loan terms.Unamortized net fees or costs are recognized upon early repayment of the loans.Management evaluates the need for impairment based upon the performance of the loansand various other factors. Impairment is evaluated by analyzing the expectedfuture 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 Company recorded impairment provisions on loans receivable —other of approximately $1.0 million for the six-month period ended June 30,2009. The Company recorded no provisions for impairment for the six-monthperiod ended June 30, 2008.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(7)  Equity Investments**

 

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

 

**Condensed Combined Balance Sheets**

 
| ** **                                             | ** ** | **June 30,**          | ** **    | **December 31,** | ** ** |
|--------------------------------------------------------|------------|----------------------------|---------------|-----------------------|------------|
| ** **                                             | ** ** | **2009**                   | ** **    | **2008**              | ** ** |
| ** **                                             | ** ** | **(Dollars in thousands)** | ** **    |
| **Acquisition  Partnerships:**                         | ** ** | ** **                 | ** **    | ** **            | ** ** |
| Assets                                                 |       | $                          |  286,666 |                  | $          |  297,805 |   |
| Liabilities                                            |       | $                          |  96,755  |                  | $          |  92,654 |   |
| Net equity                                             |       | 189,911                    |          | 205,151               |       |
|                                                   |       | $                          |  286,666 |                  | $          |  297,805 |   |
| **Servicing  and operating entities:**                 |       |                       |          |                  |       |
| Assets                                                 |       | $                          |  136,196 |                  | $          |  126,136 |   |
| Liabilities                                            |       | $                          |  86,316  |                  | $          | 77,182 |   |
| Net equity                                             |       | 49,880                     |          | 48,954                |       |
|                                                   |       | $                          | 136,196       |                  | $          | 126,136 |   |
| **Total:**                                             | ** ** | ** **                 | ** **    | ** **            | ** ** |
| Assets                                                 |       | $                          | 422,862       |                  | $          | 423,941 |   |
| Liabilities                                            |       | $                          | 183,071       |                  | $          | 169,836 |   |
| Net equity                                             |       | 239,791                    |          | 254,105               |       |
|                                                   |       | $                          | 422,862       |                  | $          | 423,941 |   |
| ** **                                             | ** ** | ** **                 | ** **    | ** **            | ** ** |
| Equity investment in  Acquisition Partnerships         |       | $                          |  42,839  |                  | $          |  46,084 |   |
| Equity investment in  servicing and operating entities |       | 27,375                     |          | 26,903                |       |
|                                                   |       | $                          |  70,214  |                  | $          |  72,987 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**Condensed Combined Summary of Operations**

 
| ** **                                                     | ** ** | **Three Months Ended**     | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------|------------|----------------------------|------------|----------------------|------------|
| ** **                                                     | ** ** | **June 30,**          | ** ** | **June 30,**    | ** ** |
| ** **                                                     | ** ** | **2009**                   | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                     | ** ** | **(Dollars in thousands)** | ** ** |
| **Acquisition Partnerships:**                                  |       |                       |       |                 |       |   |   |   |   |
| Income from Portfolio  Assets                                  |       | $                          | 10,799     |                 | $          | 26,781 |   | $ | 21,275 |   | $ | 51,072 |   |
| Other income                                                   |       | 293                        |       | 765                  |       | 227 |   | 1,094 |   |
| Revenues                                                       |       | 11,092                     |       | 27,546               |       | 21,502 |   | 52,166 |   |
| Interest expense                                               |       | 1,252                      |       | 5,337                |       | 2,626 |   | 7,213 |   |
| Service fees                                                   |       | 2,727                      |       | 8,214                |       | 5,933 |   | 13,162 |   |
| Provision for loan and  impairment losses                      |       | 4,286                      |       | 3,388                |       | 5,892 |   | 8,746 |   |
| Asset-level expenses                                           |       | 1,809                      |       | 3,587                |       | 3,690 |   | 5,481 |   |
| Other operating costs                                          |       | 1,460                      |       | 2,015                |       | 2,183 |   | 5,937 |   |
| Foreign currency gains                                         |       | (13,897                    | )          | (5,435               | )          | (2,752 | ) | (8,380 | ) |
| Income tax expense  (benefit) and other taxes                  |       | (110                       | )          | 705                  |       | (164 | ) | 1,737 |   |
| Expenses                                                       |       | (2,473                     | )          | 17,811               |       | 17,408 |   | 33,896 |   |
| Equity in earnings of  investments                             |       | —                     |       | 859                  |       | — |   | 1,636 |   |
| Net earnings                                                   |       | $                          | 13,565     |                 | $          | 10,594 |   | $ | 4,094 |   | $ | 19,906 |   |
|                                                           |       |                       |       |                 |       |   |   |   |   |
| **Servicing  and operating entities:**                         |       |                       |       |                 |       |   |   |   |   |
| Income from Portfolio  Assets                                  |       | $                          | 6,065      |                 | $          | 9,825 |   | $ | 12,334 |   | $ | 18,636 |   |
| Servicing fees                                                 |       | 5,539                      |       | 9,420                |       | 10,506 |   | 16,731 |   |
| Other income, net                                              |       | 4,539                      |       | 2,636                |       | 14,031 |   | 4,663 |   |
| Total revenues                                                 |       | 16,143                     |       | 21,881               |       | 36,871 |   | 40,030 |   |
| Expenses                                                       |       | 18,601                     |       | 18,974               |       | 37,584 |   | 33,591 |   |
| Net earnings (loss)                                            |       | $                          | (2,458     | )                    | $          | 2,907 |   | $ | (713 | ) | $ | 6,439 |   |
|                                                           |       |                       |       |                 |       |   |   |   |   |
| Equity in earnings of  Acquisition Partnerships                |       | $                          | 2,133      |                 | $          | 3,017 |   | $ | 1,242 |   | $ | 5,338 |   |
| Equity in earnings (loss)  of servicing and operating entities |       | (935                       | )          | (9                   | )          | (190 | ) | 510 |   |
|                                                           |       | $                          | 1,198      |                 | $          | 3,008 |   | $ | 1,052 |   | $ | 5,848 |   |

 

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

 

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

 
| ** **               | ** ** | **June 30,**          | ** ** | **December 31,** | ** ** |
|--------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **               | ** ** | **(Dollars in thousands)** | ** ** |
| Assets:                  |       |                       |       |                  |       |
| Domestic:                |       |                       |       |                  |       |
| Acquisition Partnerships |       | $                          | 53,104     |                  | $          | 62,249 |   |
| Operating entities       |       | 21,354                     |       | 19,787                |       |
| Latin America:           |       |                       |       |                  |       |
| Acquisition Partnerships |       | 145,677                    |       | 142,340               |       |
| Servicing entities       |       | 13,999                     |       | 14,122                |       |
| Europe:                  |       |                       |       |                  |       |
| Acquisition Partnerships |       | 87,885                     |       | 93,216                |       |
| Servicing entities       |       | 100,843                    |       | 92,227                |       |
|                     |       | $                          | 422,862    |                  | $          | 423,941 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 
| ** **                                                                            | ** ** | **June 30,**          | ** **    | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------|---------------|-----------------------|------------|
| ** **                                                                            | ** ** | **2009**                   | ** **    | **2008**              | ** ** |
| ** **                                                                            | ** ** | **(Dollars in thousands)** | ** **    |
| Equity:                                                                               |       |                       |          |                  |       |
| Domestic:                                                                             |       |                       |          |                  |       |
| Acquisition Partnerships                                                              |       | $                          | 26,580        |                  | $          | 29,614 |   |
| Operating entities                                                                    |       | 2,317                      |          | 3,710                 |       |
| Latin America:                                                                        |       |                       |          |                  |       |
| Acquisition Partnerships                                                              |       | 122,974                    |          | 128,416               |       |
| Servicing entities                                                                    |       | 1,466                      |          | 1,970                 |       |
| Europe:                                                                               |       |                       |          |                  |       |
| Acquisition Partnerships                                                              |       | 40,357                     |          | 47,121                |       |
| Servicing entities                                                                    |       | 46,097                     |          | 43,274                |       |
|                                                                                  |       | $                          |  239,791 |                  | $          | 254,105 |   |
|                                                                                  |       |                       |          |                  |       |
| Equity investment in  Acquisition Partnerships, and Servicing and Operating entities: |       |                       |          |                  |       |
| Domestic:                                                                             |       |                       |          |                  |       |
| Acquisition Partnerships                                                              |       | $                          | 12,097        |                  | $          | 14,542 |   |
| Operating entities                                                                    |       | 929                        |          | 953                   |       |
| Latin America:                                                                        |       |                       |          |                  |       |
| Acquisition Partnerships                                                              |       | 18,215                     |          | 18,657                |       |
| Servicing entities                                                                    |       | 2,913                      |          | 2,876                 |       |
| Europe:                                                                               |       |                       |          |                  |       |
| Acquisition Partnerships                                                              |       | 12,527                     |          | 12,885                |       |
| Servicing entities                                                                    |       | 23,533                     |          | 23,074                |       |
|                                                                                  |       | $                          |  70,214  |                  | $          | 72,987 |   |

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

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

 
| ** **                                                                                    | ** ** | **Three Months Ended**     | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------|------------|
| ** **                                                                                    | ** ** | **June 30,**          | ** ** | **June 30,**    | ** ** |
| ** **                                                                                    | ** ** | **2009**                   | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                                    | ** ** | **(Dollars in thousands)** | ** ** |
| Revenues:                                                                                     |       |                       |       |                 |       |   |   |   |   |
| Domestic:                                                                                     |       |                       |       |                 |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | $                          | 2,966      |                 | $          | 3,232 |   | $ | 4,606 |   | $ | 6,347 |   |
| Operating entities                                                                            |       | 4,192                      |       | 2,164                |       | 13,193 |   | 2,164 |   |
| Latin America:                                                                                |       |                       |       |                 |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | 2,912                      |       | 12,495               |       | 5,437 |   | 23,726 |   |
| Servicing entities                                                                            |       | 3,036                      |       | 5,223                |       | 5,324 |   | 10,449 |   |
| Europe:                                                                                       |       |                       |       |                 |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | 5,214                      |       | 11,819               |       | 11,459 |   | 22,093 |   |
| Servicing entities                                                                            |       | 8,915                      |       | 14,494               |       | 18,354 |   | 27,417 |   |
| ** **                                                                                    |       | $                          | 27,235     |                 | $          | 49,427 |   | $ | 58,373 |   | $ | 92,196 |   |
|                                                                                          |       |                       |       |                 |       |   |   |   |   |
| Net earnings (loss):                                                                          |       |                       |       |                 |       |   |   |   |   |
| Domestic:                                                                                     |       |                       |       |                 |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | $                          | 1,310      |                 | $          | (310 | ) | $ | 1,414 |   | $ | 243 |   |
| Operating entities                                                                            |       | (1,961                     | )          | (900                 | )          | 18 |   | (900 | ) |
| Latin America:                                                                                |       |                       |       |                 |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | 11,344                     |       | 3,007                |       | (1,029 | ) | 5,990 |   |
| Servicing entities                                                                            |       | (409                       | )          | (484                 | )          | (935 | ) | (69 | ) |
| Europe:                                                                                       |       |                       |       |                 |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | 911                        |       | 7,897                |       | 3,709 |   | 13,673 |   |
| Servicing entities                                                                            |       | (88                        | )          | 4,291                |       | 204 |   | 7,408 |   |
|                                                                                          |       | $                          | 11,107     |                 | $          | 13,501 |   | $ | 3,381 |   | $ | 26,345 |   |
| Equity in earnings (loss)  of Acquisition Partnerships, and Servicing and Operating entities: |       |                       |       |                 |       |   |   |   |   |
| Domestic:                                                                                     |       |                       |       |                 |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | $                          | 515        |                 | $          | (112 | ) | $ | 516 |   | $ | 154 |   |
| Operating entities                                                                            |       | (642                       | )          | (356                 | )          | 197 |   | (356 | ) |
| Latin America:                                                                                |       |                       |       |                 |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | 1,391                      |       | 735                  |       | (253 | ) | 1,104 |   |
| Servicing entities                                                                            |       | (204                       | )          | (147                 | )          | (467 | ) | 56 |   |
| Europe:                                                                                       |       |                       |       |                 |       |   |   |   |   |
| Acquisition Partnerships                                                                      |       | 227                        |       | 2,394                |       | 979 |   | 4,080 |   |
| Servicing entities                                                                            |       | (89                        | )          | 494                  |       | 80 |   | 810 |   |
|                                                                                          |       | $                          | 1,198      |                 | $          | 3,008 |   | $ | 1,052 |   | $ | 5,848 |   |

 

At June 30,2009, the Company had $29.1 million in Euro-denominated debt that wasdesignated as a hedge to partially off-set the Company’s business exposure toforeign currency exchange risk attributable to our net equity investments inEurope. Refer to Note 18 for additionalinformation.

 

**(8)  Servicing Assets — SBALoans**

 

In accordance with SFAS 156, servicing rights purchased or resultingfrom the sale of loans are initially recognized at fair value at the date ofacquisition or transfer. Subsequent to the date of purchase or sale, theCompany elected to measure the carrying value of the servicing assets by usingthe amortization method — which amortizes the servicing assets in proportion toand over the period of estimated net servicing income, and evaluates servicingassets for impairment based on fair value at each reporting date. The Companyevaluates the possible impairment of servicing assets based on the differencebetween the carrying amount and current fair value of the servicing assets.Impairment is charged to servicing fees in the period recognized.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

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

 
| ** **                                   | ** ** | **Three Months Ended**     | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------|------------|----------------------|------------|
| ** **                                   | ** ** | **June 30,**          | ** ** | **June 30,**    | ** ** |
| ** **                                   | ** ** | **2009**                   | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)** | ** ** |
| Beginning Balance                            |       | $                          | 739        |                 | $          | 839 |   | $ | 785 |   | $ | 885 |   |
| Servicing Assets  capitalized                |       | 312                        |       | 52                   |       | 312 |   | 54 |   |
| Servicing Assets amortized                   |       | (50                        | )          | (50                  | )          | (96 | ) | (98 | ) |
| Ending Balance                               |       | $                          | 1,001      |                 | $          | 841 |   | $ | 1,001 |   | $ | 841 |   |
| ** **                                   | ** ** | ** **                 | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Reserve for impairment of  servicing assets: | ** ** | ** **                 | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Beginning Balance                            |       | $                          | (44        | )                    | $          | (110 | ) | $ | (63 | ) | $ | (42 | ) |
| Impairments                                  |       | (16                        | )          | (1                   | )          | (16 | ) | (69 | ) |
| Recoveries                                   |       | 33                         |       | 19                   |       | 52 |   | 19 |   |
| Charge-offs                                  |       | —                     |       | —               |       | — |   | — |   |
| Ending Balance                               |       | $                          | (27        | )                    | $          | (92 | ) | $ | (27 | ) | $ | (92 | ) |
|                                         |       |                       |       |                 |       |   |   |   |   |
| Ending Balance (net of  reserve)             |       | $                          | 974        |                 | $          | 749 |   | $ | 974 |   | $ | 749 |   |
| ** **                                   | ** ** | ** **                 | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fair value of amortized  servicing assets:   |       |                       |       |                 |       |   |   |   |   |
| Beginning balance                            |       | $                          | 695        |                 | $          | 729 |   | $ | 722 |   | $ | 843 |   |
| Ending balance                               |       | $                          | 974        |                 | $          | 749 |   | $ | 974 |   | $ | 749 |   |

 

The Company relies primarily on a discounted cash flow model toestimate the fair value of its servicing assets. The model calculates estimatedfair value of the servicing assets using predominant risk characteristics ofservicing assets such as discount rate, prepayment speed, weighted average lifeof the loans sold and the interest rate. The estimated fair value of servicingassets was determined using discount rates ranging from 5.4% to 11.2%,prepayment speeds of 14.0% to 15.0% (depending on certain characteristics ofthe related loans), and weighted average lives of the underlying assets rangingfrom 52 to 280 months and a combined weighted average life of 186 months.In the event future prepayments aresignificant or impairments are incurred, and future expected cash flows areinadequate to cover the unamortized servicing assets, additional amortizationor impairment charges would be recognized.

 

**(9)  Income Taxes**

 

The Company has substantial net operating loss carryforwards for federalincome tax purposes (“NOLs”), which can be used to off-set the tax liabilityassociated with the Company’s pre-tax earnings until the earlier of theexpiration or utilization of such NOLs. The Company accounts for the benefit ofthe NOLs and other income tax items under the asset and liability method in accordancewith SFAS No. 109, *Accounting for IncomeTaxes*(“SFAS 109”). Deferred tax assets and liabilities arerecognized based on the future tax consequences attributable to temporarydifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases and operating loss and taxcredit carryforwards. Deferred tax assets and liabilities are measured usingenacted tax rates expected to apply to taxable income in the years in whichthose temporary differences are expected to be recovered or settled. SFAS 109requires a reduction of the carrying amounts of deferred tax assets by avaluation allowance if, based on the available evidence, it is more likely thannot that such assets will not be realized. Accordingly, the need to establishvaluation allowances for deferred tax assets is assessed periodically by theCompany based on the SFAS 109 more-likely-than-not realization thresholdcriterion. In the assessment, appropriate consideration is given to allpositive and negative evidence related to the realization of the deferred taxassets. This assessment considers, among other factors, the nature, frequencyand severity of current and cumulative losses, forecasts of futureprofitability, excess of appreciated asset value over the tax basis of netassets, the duration of statutory carryforward periods, the Company’sexperience with utilizing available operating loss and tax creditcarryforwards, and tax planning strategies. In making such assessments,significant weight is given to evidence that can be objectively verified. At June 30,2009 and December 31, 2008, the Company established a full valuationallowance for its deferred tax assets due to the lack of sufficient objectiveevidence regarding the realization of these assets in the foreseeable future.

 

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**FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

Pursuant to the provisionsof FASB Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109* (“FIN 48”), the Company recognizesthe effect of income tax positions only if those positions are more likely thannot of being sustained. Recognized income tax positions are measured at thelargest amount that is greater than 50% likely of being realized. Changes inrecognition or measurement are reflected in the period in which the change injudgment occurs. The difference between the benefit recognized for a positionin accordance with this FIN 48 model and the tax benefit claimed on a taxreturn is referred to as an unrecognized tax benefit (“UTB”). The gross amountof UTBs on uncertain tax positions as of June 30, 2009 totaled $336,000,which if recognized, would impact the Company’s effective income tax rate.

 

Over the next twelve months, due to the expiration of the statute oflimitations related to certain UTBs, the Company anticipates that it isreasonably possible that the amount of UTBs could be reduced by approximately$50,000, which would impact the Company’s effective tax rate. The Companyrecords interest and penalties related to income tax uncertainties in theprovision for income taxes. At June 30, 2009, interest and penalties of$92,000 are included in “Other liabilities” as income taxes payable.

 

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

 

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

 

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

 
| ** **                                                                        | ** ** | **Three Months Ended**     | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------|------------|----------------------|------------|
| ** **                                                                        | ** ** | **June 30,**          | ** ** | **June 30,**    | ** ** |
| ** **                                                                        | ** ** | **2009**                   | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                        | ** ** | **(Dollars in thousands)** | ** ** |
| ** **                                                                        | ** ** | ** **                 | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net earnings (loss)                                                               |       | $                          | 8,977      |                 | $          | (6,476 | ) | 9,969 |   | (10,082 | ) |
| Less: net income  attributable to the noncontrolling interest                     |       | 1,231                      |       | 53                   |       | 1,579 |   | 31 |   |
| Net earnings (loss)  attributable to FirstCity                                    |       | $                          | 7,746      |                 | $          | (6,529 | ) | $ | 8,390 |   | $ | (10,113 | ) |
|                                                                              |       |                       |       |                 |       |   |   |   |   |
| Weighted average  outstanding shares of common stock (in thousands)               |       | 9,832                      |       | 10,357               |       | 9,832 |   | 10,471 |   |
| Dilutive effect of:                                                               |       |                       |       |                 |       |   |   |   |   |
| Warrants                                                                          |       | 181                        |       | —               |       | 99 |   | — |   |
| Employee stock options                                                            |       | 122                        |       | —               |       | 52 |   | — |   |
| Weighted average  outstanding shares of common stock and common stock equivalents |       | 10,135                     |       | 10,357               |       | 9,983 |   | 10,471 |   |
|                                                                              |       |                       |       |                 |       |   |   |   |   |
| Net earnings (loss) per  share:                                                   |       |                       |       |                 |       |   |   |   |   |
| Basic                                                                             |       | $                          | 0.79       |                 | $          | (0.63 | ) | $ | 0.85 |   | $ | (0.97 | ) |
| Diluted                                                                           |       | $                          | 0.76       |                 | $          | (0.63 | ) | $ | 0.84 |   | $ | (0.97 | ) |
|                                                                              |       |                       |       |                 |       |   |   |   |   |
| Dilutive shares excluded  from above (in thousands):                              |       |                       |       |                 |       |   |   |   |   |
| Warrants                                                                          |       | —                     |       | 231                  |       | — |   | 265 |   |
| Employee stock options                                                            |       | —                     |       | 174                  |       | — |   | 210 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(11)  Stock-Based Compensation**

 

Theimpact on the results of operations of recording stock-based compensation forthe three and six month periods ended June 30, 2009 and 2008 follows:

 
| ** **                                          | ** ** | **Three Months Ended**     | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------|------------|----------------------------|------------|----------------------|------------|
| ** **                                          | ** ** | **June 30,**          | ** ** | **June 30,**    | ** ** |
| ** **                                          | ** ** | **2009**                   | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                          | ** ** | **(Dollars in thousands)** | ** ** |
| Amount  of compensation cost recognized in expenses |       | $                          | 25         |                 | $          | 197 |   | $ | 130 |   | $ | 422 |   |
| Tax  benefit recognized in income                   |       | $                          | —     |                 | $          | — |   | $ | — |   | $ | — |   |
| Amount  capitalized as part of an asset             |       | $                          | —     |                 | $          | — |   | $ | — |   | $ | — |   |

 

Asummary of stock option activity as of June 30, 2009 and changes duringthe period then ended is presented below:

 
| ** **            | ** ** | ** ** | ** ** | ** **   | ** ** | **Weighted**    | ** ** | ** **         | ** ** |
|-----------------------|------------|------------|------------|--------------|------------|-----------------|------------|--------------------|------------|
| ** **            | ** ** | ** ** | ** ** | ** **   | ** ** | **Average**     | ** ** | ** **         | ** ** |
| ** **            | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Remaining**   | ** ** | ** **         | ** ** |
| ** **            | ** ** | ** ** | ** ** | **Average**  | ** ** | **Contractual** | ** ** | **Aggregate**      | ** ** |
| ** **            | ** ** | ** ** | ** ** | **Exercise** | ** ** | **Term**        | ** ** | **Intrinsic**      | ** ** |
| ** **            | ** ** | **Shares** | ** ** | **Price**    | ** ** | **(Years)**     | ** ** | **Value**          | ** ** |
| ** **            | ** ** | ** ** | ** ** | ** **   | ** ** | ** **      | ** ** | **(in thousands)** | ** ** |
| Outstanding  at       |       |       |       |         |       |            |       |               |       |
| January 1,  2009 |       | 811,150    |       | $            | 6.24       |            |       |               |       |   |
| Granted               |       | —     |       | —       |       |            |       |               |       |
| Exercised             |       | —     |       | —       |       |            |       |               |       |
| Expired               |       | —     |       | —       |       |            |       |               |       |
| Forfeited             |       | (2,500     | )          | 9.85         |       |            |       |               |       |
| Outstanding  at       |       |       |       |         |       |            |       |               |       |
| June 30,  2009   |       | 808,650    |       | $            | 6.23       |            | 4.02       |               | $          | 619 |   |
| Exercisable  at       |       |       |       |         |       |            |       |               |       |
| June 30,  2009   |       | 718,112    |       | $            | 5.73       |            | 3.53       |               | $          | 619 |   |

 

Therewere no stock options exercised during the six-month periods ended June 30,2009 and 2008. As of June 30, 2009, there was approximately $438,000 oftotal unrecognized compensation cost related to unvested share-based compensationarrangements granted under the stock option plans. That cost is expected to berecognized over a weighted average period of 1.0 years.

 

Asummary of the status and changes of FirstCity’s non-vested shares as of June 30,2009, and changes during the six months ended June 30, 2009 is presentedbelow:

 
| ** **                          | ** ** | ** ** | ** ** | **Weighted-**  | ** ** |
|-------------------------------------|------------|------------|------------|----------------|------------|
| ** **                          | ** ** | ** ** | ** ** | **Average**    | ** ** |
| ** **                          | ** ** | ** ** | ** ** | **Grant-Date** | ** ** |
| ** **                          | ** ** | **Shares** | ** ** | **Fair Value** | ** ** |
| Non-vested  at January 1, 2009 |       | 107,913    |       | $              | 7.06       |   |
| Granted                             |       | —     |       | $              | —     |   |
| Vested                              |       | (15,500    | )          | $              | 1.58       |   |
| Forfeited                           |       | (1,875     | )          | $              | 9.85       |   |
| Non-vested  at June 30, 2009   |       | 90,538     |       | $              | 7.36       |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

**(12)  Accumulated Other Comprehensive Loss**

 

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

 
| ** **                                                 | ** ** | **June 30,  2009**    | ** ** | **December 31,  2008** | ** ** |
|------------------------------------------------------------|------------|----------------------------|------------|-----------------------------|------------|
|                                                       |       | **(Dollars in thousands)** |       |
| Cumulative  foreign currency translation adjustments       |       | $                          | (1,495     | )                           | $          | (3,766 | ) |
| Net  unrealized gains on securities available for sale (1) |       | 350                        |       | 40                          |       |
| Total  accumulated other comprehensive loss                |       | $                          | (1,145     | )                           | $          | (3,726 | ) |

 

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(1)   Includes $326,000 at June 30,2009 attributable to FirstCity’s proportionate share of net unrealized gainsrecorded by an investee accounted for under the equity method of accounting.

 

**(13)  Fair Value**

 

FairValue Measurements

 

The fair value of an asset or liability is the pricethat would be received to sell that asset or paid to transfer that liability inan orderly transaction occurring in the principal market (or most advantageousmarket in the absence of a principal market) for such asset or liability. Inestimating fair value, the Company utilizes valuation techniques that areconsistent with the market approach, the income approach and/or the costapproach. Such valuation techniques are consistently applied. Inputs tovaluation techniques include the assumptions that market participants would usein pricing an asset or liability. SFAS 157 establishes a fair valuehierarchy that prioritizes the inputs to valuation techniques to measure fairvalue. The hierarchy gives the highest priority to unadjusted quoted prices inactive markets for identical assets or liabilities (Level 1 measurements) andthe lowest priority to measurements involving significant unobservable inputs(Level 3 measurements). The three levels of the fair value hierarchy aredescribed below:

 

·                  Level 1 — Valuations are based upon quoted prices(unadjusted) in active exchange markets involving identical assets andliabilities that the Company has the ability to access at the measurement date.

 

·                  Level 2 — Observable inputs other than Level 1 prices,such as quoted prices for similar instruments in active markets; quoted pricesand valuations for identical or similar instruments in markets that are notactive; and model-based valuation techniques with significant assumptions andinputs that are observable in the market or can be derived principally from orcorroborated by observable market data.

 

·                  Level 3 — Valuations are derived from model-basedtechniques that use inputs and significant assumptions that are supported bylittle or no observable market data. Valuation techniques include the use ofpricing models, discounted cash flow models and similar methodologies.

 

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

 

*Asset Measured at Fair Value on a Recurring Basis*

 

At June 30, 2009, the only financial ornon-financial item that the Company measures at fair value on a recurring basiswas its investment security available for sale (represents a beneficialinterest attributable to loans sold through a securitization transaction thatthe Company purchased in 2008). The Company measures fair value for thisinvestment security using a discounted cash flow model based on assumptions andinputs that are corroborated by little or no observable market data (Level 3measurement). The Company uses this measurement technique because pricinginformation and market-participant assumptions for purchased beneficialinterests in similar securitization transactions are not readily accessible andfrequently released to the public. At June 30, 2009 and December 31,2008, the carrying value of this investment security (at fair value)approximated $3.0 million and $5.2 million, respectively. The table belowsummarizes the changes to this Level 3 asset measured at fair value on arecurring basis for the three- and six-month periods ended June 30, 2009:

 

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** **

**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 
| ** **                                            | ** ** | **Three Months  Ended** | ** ** | **Six Months  Ended**  | ** ** |
|-------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| **(Dollars  in thousands)**                           | ** ** | **June 30, 2009**  | ** ** | **June 30, 2009** | ** ** |
| Balance,  beginning of period                         |       | $                       | 4,279      |                   | $          | 5,251 |   |
| Total  net gains (losses) for the period included in: |       |                    |       |                   |       |
| Net  income (loss)                                    |       | —                  |       | —                 |       |
| Other  comprehensive income (loss)                    |       | (9                      | )          | (16                    | )          |
| Purchases,  sales, issuances and settlements, net     |       | (1,277                  | )          | (2,242                 | )          |
| Net  transfers into Level 3                           |       | —                  |       | —                 |       |
| Balance,  end of period                               |       | $                       | 42,987     |                   | $          | 42,987 |   |

 

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

 

The Company may be required, from time to time, tomeasure certain financial and non-financial assets at fair value on anon-recurring basis. These adjustments to fair value generally result fromwrite-downs of financial and non-financial assets as a result of impairment orapplication of lower-of-cost or fair value accounting. For assets measured atfair value on a non-recurring basis and carried at fair value on the balancesheet at June 30, 2009, the following table provides the valuation levelsused to determine the fair value of the financial assets:

 
| ** **                     | ** ** | **Carrying Value at June 30, 2009** | ** ** |
|--------------------------------|------------|------------------------------------------|------------|
| **(Dollars  in thousands)**    | ** ** | **Total**                                | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Portfolio  Assets - loans (1)  |       | $                                        | 1,925      |   | $ | — |   | $ | — |   | $ | 1,925 |   |
| Real  estate held for sale (2) |       | 7,534                                    |       | — |   | 7,534 |   | — |   |
|                                |            |                                          |            |  |  |  |  |  |  |  |  |  |  |

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

 

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

(2)   Represents the carrying value and relatedlosses of foreclosed real estate properties that were measured at fair valueupon their initial recognition as real estate held for sale or subsequentimpairment.

(3)   Pursuant to the Company’s adoption of FSP FAS157-2 in 2008, the Company did not apply the provisions of SFAS 157 to non-recurringfair value measurements of non-financial Portfolio Assets (i.e. real estateheld for sale) upon recognition of impairment charges on such assets during2008. In accordance with FSP FAS 157-2, the Company applied the provisions ofSFAS 157 to fair value measurements of non-financial Portfolio Assets effectiveJanuary 1, 2009.

 

The fair values of “Portfolio Assets — loans” and “SBAloans held for investment,” as measured on a non-recurring basis, are based oncollateral valuations using observable and unobservable inputs, adjusted forvarious considerations such as market conditions, economic and competitiveenvironment, and other assets with similar characteristics (i.e. type,location, etc.) that, in management’s opinion, reflect elements a marketparticipant would consider. The Company classifies its fair value measurementtechniques for these assets as Level 3 inputs for the following reasons: (1) distressedasset transactions generally occur in inactive markets for which observablemarket prices are not readily available (i.e. price quotations varysubstantially over time and among market-makers, and pricing information isgenerally not released to the public); and (2) the Company’s valuationtechniques that are most-significant to the fair value measurements areprincipally derived from assumptions and inputs that are corroborated by littleor no observable market data.

 

The fair value of “Servicing assets — SBA loans,” asmeasured on a non-recurring basis, is based on the Company’s discounted cashflow model. This model estimates fair value of the servicing assets usingpredominant risk characteristics of servicing assets such as discount rate, prepaymentspeed, and weighted average lives and interest rates of the underlying loans.The Company classifies its fair value measurement techniques for servicingassets as Level 3 inputs since the Company’s valuation techniques that aremost-significant to the fair value measurements are principally derived fromassumptions and inputs that are corroborated by little or no observable marketdata.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

The fair value of “Real estate held for sale,” asmeasured on a non-recurring basis, is generally based on collateral valuationsusing observable inputs.

 

Under SFAS 157, we attempt to base our fair values onthe price that would be received to sell an asset in an orderly transactionbetween market participants at the measurement date. It is our policy tomaximize the use of observable inputs, when reasonably available and withoutundue cost, and minimize the use of unobservable inputs when developing fairvalue measurements in accordance with the fair value hierarchy in SFAS 157.Fair value measurements for assets where there exists limited or no observablemarket data and, therefore, are based principally on our own estimates andassumptions, are often calculated based on collateral valuations adjusted forthe economic and competitive environment, the characteristics of the asset, andother such factors. Additionally, there may be inherent weaknesses in anyvaluation technique, and changes in the underlying assumptions used, includingdiscount rates and estimates of future cash flows, that could significantlyaffect the results of current or future values.

 

EstimatedFair Values of Financial Instruments Not Recorded at Fair Value in theirEntirety on a Recurring Basis

 

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

 

***Cash and Cash Equivalents: ***The carrying amount of cash and cash equivalents approximatedfair value at June 30, 2009 and December 31, 2008.

 

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

 

***Portfolio Assets — Loans and LoansReceivable: ***Estimated fair values of Portfolio Assets — loans and fixed-rate loansreceivable are generally determined using a discounted cash flow model,adjusted by an amount for estimated losses, that employs market discount ratesand other adjustments that would be expected to be made by a marketparticipant. The estimated fair value for variable-rate loans that re-pricefrequently is based on carrying values adjusted for estimated credit losses andother adjustments that would be expected to be made by a market participant.The estimated fair value for impaired loans is generally based on collateral valuations using observableand unobservable inputs, adjusted for various considerations that would beexpected to be made by a market participant; or discounted cash flowmodels that employ market discount rates and other adjustments that would be expected tobe made by a market participant. Management estimates and assumptionsregarding credit risk, cash flows and discount rates are judgmentallydetermined using available market and specific borrower information. At June 30,2009 and December 31, 2008, the carrying amounts of Portfolio Assets —loans and loans receivable (including accrued interest) approximated $273.0million and $178.0 million, respectively, and the estimated fair valuesapproximated $377.0 million and $238.4 million, respectively.

 

***Servicing Assets: ***The Company relies primarily on a combination of adiscounted cash flow model of future net servicing income and analysis ofcurrent market data to estimate the fair value of its servicing assets. The keyassumptions used to calculate estimated fair value of the servicing assetsinclude prepayment speeds; discount rate; and weighted average lives andinterest rates of the underlying loans. The fair value estimate excludes thevalue of the servicing rights for loans sold in which the servicing rights havenot been capitalized. At June 30, 2009 and December 31, 2008, thecarrying amount of servicing assets approximated fair value.

 

***Notes Payable: ***Management believes the interest ratesand terms on its debt obligations approximate the rates and terms currentlyoffered by other lenders for similar debt instruments of comparable terms. Assuch, management believes that the carrying amount of notes payableapproximates fair value at June 30, 2009 and December 31, 2008.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 

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

 

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

 

Inorder to determine if we are considered to be the primary beneficiary of a VIE,we first perform a qualitative analysis, which requires certain subjectivedecisions regarding our assessments, including, but not limited to, the designof the entity, the variability that the entity was designed to create and passalong to its interest holders, the rights of the parties, and the purpose ofthe arrangement. If we cannot conclude after qualitative analysis whether weare the primary beneficiary, we perform a quantitative analysis. Quantifyingthe variability of a VIE’s assets is complex and subjective, requiring analysisof a significant number of possible future outcomes as well as probability ofeach outcome occurring. The result of each possible outcome is allocated to theparties holding interests in the VIE and, based on the allocation, acalculation is performed to determine which party, if any, is the primarybeneficiary.

 

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

 

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

 

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

 

The following table summarizes the carrying amounts ofthe assets and liabilities and the maximum loss exposure as of June 30,2009 related to the Company’s variable interests in non-consolidated VIEs. TheCompany does not have any consolidated VIEs for which it holds a minority votinginterest in the entity.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

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

 
| ** **                    | ** ** | **Assets on  FirstCity’s** | ** ** | **FirstCity’s** | ** ** |
|-------------------------------|------------|---------------------------------|------------|----------------------|------------|
| ** **                    | ** ** | **Balance  Sheet**              | ** ** | **Maximum**          | ** ** |
| ** **                    | ** ** | **Loans**                       | ** ** | **Equity**           | ** ** | **Exposure** | ** ** |
| **Type of VIE**               | ** ** | **Receivable**                  | ** ** | **Investment**       | ** ** | **to Loss (1)** | ** ** |
| ** **                    | ** ** | **(Dollars in  thousands)**     | ** ** |
| Acquisition  Partnership VIEs |       | $                               | 2,139      |                 | $          | 20,292 |   | $ | 24,010 |   |
|                          |       |                            |       |                 |       |   |   |
| Operating  Entity VIEs        |       | 18,703                          |       | 325                  |       | 19,028 |   |
|                          |       |                            |       |                 |       |   |   |
| Net  assets acquired          |       | $                               | 20,842     |                 | $          | 20,617 |   | $ | 43,038 |   |

 

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(1)          Includes maximum exposure to lossattributable to FirstCity’s debt guarantees provided for certain AcquisitionPartnership VIEs.

 

**(15)  Other Related Party Transactions**

 

TheCompany has contracted with the Acquisition Partnerships and related parties asa third party loan servicer. Servicing fees and due diligence fees (included inother income) derived from such affiliates totaled $2.1 million and $2.5million for the three month periods ended June 30, 2009 and 2008,respectively, and $4.3 million and $4.6 million for the six month periods endedJune 30, 2009 and 2008, respectively.

 

FirstCityServicing Corporation (“FCSC”), an indirect wholly-owned affiliate of theCompany, and MCS et Associates (“MCS”), in which FCSC is an 11.89% shareholderas of December 31, 2008, are parties to Consulting, License andConfidentiality Agreements dated June 30, 1999 pursuant to which FCSCprovides consultation services and personnel to be employed by MCS to assist indeveloping and managing due diligence and servicing systems. Pursuant to thoseagreements, MCS provides the supplied personnel with compensation, taxequalization payments, housing allowances, transportation allowance, and taxpreparation. MCS also pays consulting fees to FCSC and reimburses FCSC fortravel, hotel, airfare, and meal expenses incurred related to the provision ofthe services. FirstCity recorded fees from MCS included in other income of$101,000 and $127,000 during the three month periods ended June 30, 2009and 2008, respectively, and $199,000 and $240,000 during the six month periodsended June 30, 2009 and 2008, respectively.

 

**(16)  Segment Reporting**

 

TheCompany is engaged in two major business segments — Portfolio Asset Acquisitionand Resolution and Special Situations Platform.

 

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

 

TheCompany engages in its Special Situations Platform business through itsmajority ownership interest in FirstCity Denver — which was formed in April 2007.Through its Special Situations Platform business, the Company providesinvestment capital to privately-held middle-market companies through flexiblecapital structuring arrangements. The nature of the capital investmentsprimarily take the form of senior and junior financing arrangements, but alsoinclude direct equity investments, common equity warrants, distressed debttransactions, and leveraged buyouts. FirstCity Denver’s primary investmentobjective is to generate both 

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS – (continued)**

 

current income andcapital appreciation through debt and equity investments, and to generallystructure the investments to be repaid or exited in twelve to thirty-sixmonths.

 

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

 
| ** **                                                                         | ** ** | **Three  Months Ended**     | ** ** | **Six Months  Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------|------------|
| ** **                                                                         | ** ** | **June 30,**           | ** ** | **June 30,**     | ** ** |
| ** **                                                                         | ** ** | **2009**                    | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                         | ** ** | **(Dollars in  thousands)** | ** ** |
| **Portfolio Asset Acquisition and Resolution:**                                    |       |                        |       |                  |       |   |   |   |   |
| Total  revenues                                                                    |       | $                           | 18,969     |                  | $          | 10,017 |   | $ | 32,266 |   | $ | 18,250 |   |
| Operating  contribution (loss), net of direct taxes                                |       | $                           | 11,138     |                  | $          | (5,007 | ) | $ | 12,054 |   | $ | (7,072 | ) |
| ** **                                                                         | ** ** | ** **                  | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Special Situations Platform:**                                                   |       |                        |       |                  |       |   |   |   |   |
| Total  revenues                                                                    |       | $                           | 1,575      |                  | $          | 1,427 |   | $ | 3,913 |   | $ | 2,516 |   |
| Operating  contribution (loss), net of direct taxes                                |       | $                           | (1,132     | )                     | $          | 186 |   | $ | 205 |   | $ | 451 |   |
| Total  operating income (loss), net of direct taxes                                |       | $                           | 10,006     |                  | $          | (4,821 | ) | $ | 12,259 |   | $ | (6,621 | ) |
| ** **                                                                         | ** ** | ** **                  | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Corporate Overhead:**                                                            | ** ** | ** **                  | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Salaries  and benefits, occupancy, professional and other income and expenses, net |       | 2,157                       |       | 1,821                 |       | 3,779 |   | 3,491 |   |
| Income  taxes                                                                      |       | 103                         |       | (113                  | )          | 90 |   | 1 |   |
| Net  earnings (loss) attributable to FirstCity                                     |       | $                           | 7,746      |                  | $          | (6,529 | ) | $ | 8,390 |   | $ | (10,113 | ) |

 

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

 
| ** **     | ** ** | **Three  Months Ended**     | ** ** | **Six Months  Ended** | ** ** |
|----------------|------------|-----------------------------|------------|-----------------------|------------|
| ** **     | ** ** | **June 30,**           | ** ** | **June 30,**     | ** ** |
| ** **     | ** ** | **2009**                    | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **     | ** ** | **(Dollars in  thousands)** | ** ** |
| Domestic       |       | $                           | 15,785     |                  | $          | 6,177 |   | $ | 25,518 |   | $ | 11,807 |   |
| Latin  America |       | 4,355                       |       | 3,853                 |       | 5,274 |   | 6,888 |   |
| Europe         |       | 661                         |       | 3,340                 |       | 2,313 |   | 5,735 |   |
| Other          |       | 8                           |       | 11                    |       | 16 |   | 24 |   |
| Total          |       | $                           | 20,809     |                  | $          | 13,381 |   | $ | 33,121 |   | $ | 24,454 |   |

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS – (continued)**

 

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

 
| ** **                                    | ** ** | **June 30,**           | ** ** | **December 31,** | ** ** |
|-----------------------------------------------|------------|-----------------------------|------------|-----------------------|------------|
| ** **                                    | ** ** | **2009**                    | ** ** | **2008**              | ** ** |
| ** **                                    | ** ** | **(Dollars in  thousands)** | ** ** |
| Cash  and cash equivalents                    |       | $                           | 25,521     |                  | $          | 19,103 |   |
| Restricted  cash                              |       | 1,115                       |       | 1,217                 |       |
| Portfolio  acquisition and resolution assets: |       |                        |       |                  |       |
| Domestic                                      |       | 236,465                     |       | 167,211               |       |
| Latin  America                                |       | 42,463                      |       | 42,426                |       |
| Europe                                        |       | 63,802                      |       | 48,612                |       |
| Other                                         |       | —                      |       | 228                   |       |
| Special  situations platform assets           |       | 40,483                      |       | 37,786                |       |
| Other  non-earning assets, net                |       | 11,488                      |       | 12,354                |       |
| Total  assets                                 |       | $                           | 421,337    |                  | $          | 328,937 |   |

 

**(17)  Commitments and Contingencies**

 

*LegalProceedings*

 

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

 

On June 4, 2009, the Company received notice ofthe issuance of an opinion by the Court of Appeals for the First District ofTexas in FCLT Loans Asset Corp. and Timothy J. Blair, class representative v.FirstCity Financial Corporation in which the Court of Appeals denied the jointmotion of the parties to the suit to abate the appeal, reversed the judgment infavor of FirstCity and remanded the case to the trial court. The Court heldthat JPMorgan, as successor trustee, is the legal owner of the demutualizedproceeds interpled by Prudential Financial, Inc., and that the trustee’sparticipation is necessary to determine the appropriate disbursement of thedemutualization proceeds. On June 19, 2009, FirstCity filed a motion forrehearing in the First District Court of Appeals on the basis that the Court ofAppeals could not reverse the decision of the trial court on basis of errorthat was not assigned, presented, preserved, or briefed by the parties onappeal.

 

The Interpleader Suit was originally filed byPrudential to determine the ownership of stock and dividends that becameavailable as a result of the demutualization of Prudential Insurance Company ofAmerica (“Prudential Insurance”). On March 21, 2006, the trial courtentered an order granting FirstCity’s motion for partial summary judgment andrendered judgment in favor of FirstCity as to the ownership of thedemutualization proceeds. On November 25, 2008, the parties to the suitreached a preliminary agreement to settle the lawsuit involving the disputedownership of approximately $18.6 million of proceeds from the demutualizationof Prudential Insurance Company. A court-ordered mediation was held on November 18,2008 and following the unsuccessful mediation the mediator submitted hisproposal to the three claimants. The mediator’s proposal accepted by theclaimants on November 25, 2008 provided for each of the parties to receive25% of the demutualization proceeds (approximately $4,650,000 each) uponapproval of the settlement by the trial court, and for the remaining 25%($4,650,000) to be held pending the determination of the appeal by the Court ofAppeals. The settlement was subject to the approval by the Court of Appeals ofthe motion to abate the appeal to allow the trial court to consider approval ofthe settlement involving the class of former employees, which motion was deniedby the Court of Appeals in its opinion.

 

*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 

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS – (continued)**

 

FirstCity,Consumer Corp. or Funding LP in connection with the transaction. The indemnityobligations under the 2004 Securities Purchase Agreement survive for a maximumperiod of five (5) years from November 1, 2004. Neither FirstCity,Consumer Corp., Funding LP, nor Funding GP is required to make any payments asa result of the indemnity provided under the 2004 Securities Purchase Agreementuntil the aggregate amount payable exceeds $250,000, and then only for theamount in excess of $250,000 in the aggregate; however certain representationsand warranties are not subject to this $250,000 threshold. At this time,management does not believe that this potential obligation will have a materialadverse impact on the Company’s consolidated results of operations, financialposition or liquidity.

 

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 Sellers agreed toindemnify the Buyer and AIG Entities from damages resulting from a breach ofany representation or warranty contained in the Interest Purchase and SaleAgreement 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 the InterestPurchase and Sale Agreement survives for a period of the statute of limitationsfor matters related to taxes, existence and authority, capitalization and goodstanding of the LLCs and SRLs and for a period of two years from August 8,2006, the closing date with respect to all other representations andwarranties. The Sellers are not required to make any payments as a resultof the indemnity provisions of the Interest Purchase and Sale Agreement untilthe aggregate amount payable under that agreement and the Asset PurchaseAgreement exceeds $250,000; however, claims related to taxes and fraud are notsubject to this $250,000 threshold.  The Interest Purchase and SaleAgreement limits the liability of the Sellers for indemnifiable losses underthe Interest Purchase and Sale Agreement and the Asset Purchase Agreement tothe Aggregate Purchase Price (without duplication of amounts recovered pursuantto the terms of the Asset Purchase Agreement). At this time, management doesnot believe that this potential obligation will have a material adverse impacton the Company’s consolidated results of operations, financial position orliquidity.

 

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

 

*Subordinated Equity Investment*

 

During the period from December 1998 to March 2005,FirstCity Mexico, Inc. and Strategic Mexican Investment Partners, L.P. (“SMIP”),each affiliates of FirstCity and Cargill Financial Services International, Inc.(“CFSI”) and, in some instances, other investors, acquired 12 residential andcommercial non-performing loan portfolios from financial institutions in Mexico(the “Mexican Portfolios”). Each portfolio was acquired by a Mexicanlimited liability company (each a “Mexican SRL”) that was owned by a Delawarelimited liability company formed by each investor group.  On August 8,2006, SMIP and National Union Fire Insurance Company of Pittsburgh, Pa.,American General Life Insurance Company and American General Life and AccidentInsurance Company, affiliates of AIG Global Asset Management Holdings Corp.(collectively the “AIG Entities”) formed Bidmex Holding, LLP 

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS – (continued)**

 

for the purpose of acquiring the Mexican Portfolios by purchasing theinterests of Cargill and SMIP in eleven of the Mexican limited liabilitycompanies (the “LLCs”) and purchasing the loan portfolio of one of the Mexicanlimited liability companies (the “Purchased Portfolio”) for an aggregatepurchase price of U.S. $119.3 million as of that date (the “Aggregate PurchasePrice”). SMIP acquired 15% of the membership interests in Bidmex Holding,LLC. A 9% interest acquired by SMIP is of equivalent standing tomembership interests held by the AIG affiliates representing 85% of themembership interests. The remaining 6% membership interest acquired by SMIPis subordinate to the other owners of interests in Bidmex Holding, LLC, whowill receive the return of and a return on their contribution equivalent to an9% internal rate of return with respect to their interests prior to SMIPreceiving the return of and a return on its capital contribution equivalent toa 9% internal rate of return with respect to its 6% interest.

 

*Commitments to Repurchase Loans*

 

Inconnection with the Interest Purchase and Sale Agreement, Recuperación deCarteras Mexicanas, S. de R.L. de C.V., as optionor (“RCM”), an affiliate ofSMIP and CFSI, granted a put option to Bidmex Holding LLC, as optionee,pursuant to the terms of a Put Option Agreement dated August 8, 2006 byand among RCM, Bidmex Holding LLC, Bidmex 6 LLC (the parent entity of RCM),CFSI and SMIP. RCM granted a put option to Bidmex Holding LLC related tothe 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, pursuant to certain terms and conditions. Pursuant to the put optionagreement, Bidmex Holding LLC delivered a notice to exercise the put option on March 31,2008 for qualifying loans with a purchase price of approximately $635,000. In January 2009,RCM, Bidmex Holding LLC, Bidmex 6 LLC, CFSI and SMIP entered into an agreementto terminate the put option agreement. Under terms of the terminationagreement, Residencial Oeste, S. de R.L. de C.V., an affiliate of SMIP andCFSI, purchased certain loans for approximately 1.4 million Mexican pesos(approximately $99,000) from Bidmex Holding LLC in settlement of the put optionclaims and termination of the put option agreement.

 

Financial SecurityAssurance Inc. (“FSA”), in its capacity as certificate insurer under thePooling and Servicing Agreement, relating to the FirstCity Capital Home EquityLoan Trust 1998-2 (the “Trust”), dated as of November 1, 1998 by and amongFC Capital Corp., in its capacities as seller and master servicer, and The Bankof New York, in its capacity as trustee, made demand on FC Capital Corp. torepurchase certain loans that were subject to repurchase due to fraud of thirdparties in connection with the origination of the loans. FC Capital Corp.agreed to provide a letter of credit in the amount of the repurchase price forthe loans in lieu of being required to purchase the loans from the Trust.FirstCity has obtained and delivered to FSA, for the benefit of FC CapitalCorp., an irrevocable letter of credit in the amount of $0.5 million from theBank of Scotland. Pursuant to the agreement with FSA, FC Capital Corp. has theoption to purchase the loans for $0.5 million prior to a call under the letterof credit. In July 2009, FirstCity funded this $0.5 million letter ofcredit pursuant to a demand made by FSA as a result of the line of creditissuer failing to maintain the long-term ratings as required under theagreement. In the opinion of management, this transaction will not have amaterial adverse impact on the Company’s consolidated results of operations,financial position or liquidity.

 

*Lettersof Credit and Other Guarantees*

 

Fondo de Inversion Privado NPL Fund One (“PIF1”), anequity-method investment of FirstCity, has a credit facility with BancoSantander Chile, S.A. with an unpaid principal balance of $10.75 million at June 30,2009. PIF1 uses the credit facility to finance the purchases of loanportfolios. Pursuant to terms of the credit facility, FirstCity was required toprovide a stand-by letter of credit from Bank of Scotland that would satisfythe current loan balance upon demand. At June 30, 2009, FirstCity had aletter of credit in the amount of $10.75 million from Bank of Scotland underthe terms of FirstCity’s revolving acquisition facility with Bank of Scotland,with Banco Santander Chile, S.A. as the letter of credit beneficiary. In theevent that a demand is made under the $10.75 million letter of credit,FirstCity would be required to reimburse Bank of Scotland by making payment toBank of Scotland for all amounts disbursed or to be disbursed by Bank ofScotland under the letter of credit.

 

On November 29, 2006, FirstCity Mexico SA de CV,a Mexican affiliate of FirstCity, entered into a loan agreement with BancoSantander, S.A. that allows loans to be made in Mexican pesos. At June 30,2009, the Company had 142,240,000 in Mexican peso-denominated debt, which wasequivalent to U.S. $10.8 million. The proceeds were used to pay down theacquisition facility with the Bank of Scotland. Pursuant to the terms of the credit facility, FirstCity Mexico SA de CVwas required to provide a stand-by letter of credit from Bank of Scotland thatwould satisfy the loan balance upon demand.  At June 30, 2009,FirstCity had a letter of credit in the amount of $12.6 million from Bank ofScotland under the terms of FirstCity’s revolving acquisition facility withBank of Scotland.  In the event that a demand is made under the $12.6million letter of credit, FirstCity is required to reimburse Bank of Scotlandby making payment to Bank of Scotland for all amounts disbursed or to bedisbursed by Bank of Scotland under the letter of credit.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS – (continued)**

 

American Business Lending, Inc. (“ABL”), amajority-owned subsidiary of FirstCity, has a $25.0 million revolving loanfacility with Wells Fargo Foothill, LLC (“WFF”), as amended in February 2009,for the purpose of financing and acquiring SBA loans. The obligations underthis facility are secured by substantially all of the assets of ABL. At June 30,2009, the balance of this facility was $13.7 million. In connection withthis arrangement, FirstCity provides WFF with an unconditional guaranty on ABL’sobligations under the loan facility up to a maximum of $5.0 million plusenforcement cost.

 

FirstCityCommercial Corp. (“FirstCity Commercial”), a wholly-owned affiliate ofFirstCity, provides guarantees to various financial institutions for financingassociated investments and operations of certain Acquisition Partnerships. Theunderlying financing arrangements of these Acquisitions Partnerships havevarious maturities ranging from July 2009 to May 2011, and aresecured primarily by certain real estate properties held by the AcquisitionPartnerships. At June 30, 2009, FirstCity Commercial’s maximum commitmentsunder these guaranty arrangements totaled $2.2 million, and the total unpaiddebt obligations of these Acquisition Partnerships attributed to FirstCityCommercial’s underlying guaranty approximated $1.8 million.

 

*EnvironmentalMatters*

 

The Company generally retains environmentalconsultants to conduct or update environmental assessments in connection withthe Company’s foreclosed and acquired real estate properties. Theseenvironmental assessments have not revealed environmental conditions that theCompany believes will have a material adverse effect on its business, assets,financial condition, results of operations or liquidity, and the Company is nototherwise aware of environmental conditions with respect to properties that theCompany believes would have such a material adverse effect. However, from timeto time, environmental conditions at the Company’s properties have required andmay in the future require environmental testing and/or regulatory filings, aswell as remedial action. Liabilities for futureremediation costs are recorded when environmental assessments and/or remedialefforts are probable and the costs can be reasonably estimated. Other than forassessments, the timing and magnitude of these accruals generally are based onthe completion of investigations or other studies or a commitment to a formalplan of action.

 

*Limited-LifeSubsidiaries*

 

SFAS No. 150, *Accounting for CertainFinancial Instruments with Characteristics of both Liabilities and Equity*(“SFAS 150”), establishes standards on how an issuer classifies and measurescertain financial instruments with characteristics of both liabilities andequity. Certain provisions of SFAS 150 would have required us to classifynon-controlling interests in consolidated limited-life subsidiaries asliabilities adjusted to their settlement values in our consolidated financialstatements. However, the FASB indefinitely deferred application of themeasurement and recognition provisions, but not the disclosure requirements, ofSFAS 150 with respect to these non-controlling interests. At June 30,2009, the estimated settlement value of the Company’s non-controlling interestsin consolidated limited-life subsidiaries was $4.3 million. The Company’scarrying value of the non-controlling interests recognized on the consolidatedbalance sheet related to these limited-life subsidiaries approximated $2.7million at June 30, 2009.

 

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

 

We usedebt as a non-derivative financial instrument to partially off-set the Company’sbusiness exposure to foreign currency exchange risk attributable to our netinvestments in Europe. Our focus is to manage the economic risks associatedwith our European subsidiaries, which are the foreign currency exchange risksthat will ultimately be realized when we exchange one currency for another. Tohelp protect the Company’s net investment in certain of its European subsidiaryoperations from adverse changes in foreign currency exchange rates, wedenominate a portion of our debt in the same functional currency used by theEuropean subsidiaries. At June 30, 2009, the Company carried $29.1 millionin Euro-denominated debt and designated the debt as a non-derivative hedge ofits net investment in certain European subsidiaries. The Company designated thehedging relationship such that changes in the net investments being hedged areexpected to be naturally off-set by corresponding changes in the value of theEuro-denominated debt. We consider our investments in European subsidiaries tobe denominated in a relatively stable currency and of a long-term nature.

 

Theeffective portion of the net foreign investment hedge is reported inaccumulated other comprehensive income (loss) as part of the cumulativetranslation adjustment. Any ineffective portion of the net foreign investmenthedge is recognized in earnings as other income (expense) during the period ofchange. Effectiveness of the hedging relationship is measured and designated atthe beginning of each month by comparing the outstanding balance of theEuro-denominated debt to the carrying value of the designated net equityinvestments.

 

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**FIRSTCITYFINANCIAL CORPORATION AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS – (continued)**

 

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

 
| **Non-Derivative Instrument** | ** ** | ** **             | ** ** | ** **   | ** ** |
|-------------------------------|------------|------------------------|------------|--------------|------------|
| **in Net Investment**         | ** ** | **Balance  Sheet**     | ** ** | **Carrying** | ** ** |
| **Hedging Relationship**      | ** ** | **Location**           | ** ** | **Value**    | ** ** |
|                          |       |                   |       |         |       |
| Euro-denominated  debt        |       | Notes payable to banks |       | $            | 29,055     |   |
|                               |            |                        |            |              |            |  |

 

Theeffect of the non-derivative instrument qualifying and designated as a hedginginstrument in net foreign investment hedges on the consolidated financialstatements for the three and six month periods ended June 30, 2009 was asfollows (in thousands):

 
| ** **                     | ** ** | ** **                | ** ** | ** **                  | ** ** | ** **                   | ** ** | **Amount of Gain (Loss)** | ** ** |
|--------------------------------|------------|---------------------------|------------|-----------------------------|------------|------------------------------|------------|---------------------------|------------|
| ** **                     | ** ** | ** **                | ** ** | ** **                  | ** ** | ** **                   | ** ** | **Recognized in Income**  | ** ** |
| ** **                     | ** ** | **Amount of Gain (Loss)** | ** ** | ** **                  | ** ** | **(Ineffective Portion and** | ** ** |
| ** **                     | ** ** | **Recognized in AOCL**    | ** ** | **Location of Gain (Loss)** | ** ** | **Amount Excluded from**     | ** ** |
| **Non-Derivative  Instrument** | ** ** | **(Effective Portion)**   | ** ** | **Reclassified from**       | ** ** | **Effectiveness Testing)**   | ** ** |
| **in Net  Investment**         | ** ** | **Three Months Ended**    | ** ** | **Six Months Ended**        | ** ** | **AOCL into Income**         | ** ** | **Three Months Ended**    | ** ** | **Six Months Ended** | ** ** |
| **Hedging  Relationship**      | ** ** | **June 30, 2009**    | ** ** | **June 30, 2009**      | ** ** | **(Effective Portion)**      | ** ** | **June 30, 2009**    | ** ** | **June 30, 2009** | ** ** |
|                           |       |                      |       |                        |       |                         |       |                      |       |   |   |
| Euro-denominated debt          |       | $                         | (1,753     | )                           | $          | 259                          |       | Other income (expense)    |       | $ | — |   | $ | — |   |
|                                |            |                           |            |                             |            |                              |            |                           |            |  |  |  |  |  |  |

 

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

 

**Overview**

 

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

 

The Company recorded net earnings of $7.7 million forthe second quarter of 2009, an increase of $14.2 million from the $6.5 millionnet loss reported for the second quarter of 2008. The diluted net income percommon share was $0.76 in the second quarter of 2009, compared to the dilutednet loss per common share of $0.63 for the same period in 2008. Revenue streamsgenerated by the Company’s earnings assets and servicing platform positivelyimpacted earnings in the second quarter of 2009 — as revenues in the secondquarter of 2009 increased to $20.7 million compared to $11.5 million in thesecond quarter of 2008. The Company’s earnings in the second quarter of 2009include $14.1 million of income and gains from Portfolio Assets; $1.6 millionof interest income from loans receivable; $2.4 million of fee incomeattributable to our loan servicing platform, $0.7 million of revenue and gainsattributable to our majority-owned railroad operations; and a $1.5 million stepacquisition gain attributable to additional equity purchased in certain of ourEuropean Acquisition Partnerships. The increase in earnings in the secondquarter of 2009 from the comparable prior quarter were also positively impactedby a $6.4 million decrease in net impairment provisions, and a $2.0 millionincrease in foreign currency transaction gains. The impact of net impairmentprovisions and foreign currency transaction gains to our earnings in the secondquarter of 2009 are further explained below. In addition, see **Results of Operations** below for a detailed review of theCompany’s operations for the second quarter of 2009 compared to the secondquarter of 2008.

 

In thesecond quarter of 2009, the Company was involved in acquiring $67.1 million ofdomestic Portfolio Asset investments with a face value of approximately $117.8million — of which FirstCity’s investment share was $48.6 million. In additionto its Portfolio Asset acquisitions in the second quarter of 2009, FirstCityinvested $7.9 million in the form of SBA loan originations and advances; and$3.2 million in the form of debt and equity investments under its Special SituationsPlatform (“FirstCity Denver”). FirstCity also invested $11.2 million in directequity investments in the second quarter of 2009 (attributable primarily toEuropean entity acquisitions). At June 30, 2009, FirstCity’s earningassets (Portfolio Assets, equity investments, loans receivable and entity-levelearning assets) totaled $383.2 million. FirstCity’s global distribution ofearning assets (at carrying value) at June 30, 2009 included $276.9million in the United States; $63.8 million in Europe; and $42.5 million inLatin America.

 

*NetImpairment Provisions*

 

TheCompany recorded $2.0 million of net impairment provisions in the secondquarter of 2009 — comprised of $0.7 million of net provisions recorded to ourconsolidated loans and portfolios, and $1.3 million as our share of netimpairment provisions recorded to loans and portfolios held in ourunconsolidated Acquisition Partnerships. The global distribution of the $2.0million of net impairment provisions recorded by the Company in the second quarterof 2009 includes $2.9 million in the United States, $0.2 million in LatinAmerica, and $1.1 million in net recoveries in Europe. The impairmentprovisions in the second quarter of 2009 were attributed primarily to declinesin values of loan collateral and real estate assets in our domestic loans andportfolios. The impairment provisions were identified in connection withmanagement’s quarterly evaluation of the collectability of the Company’sPortfolio Assets and loans receivable. Theprocess for evaluating and measuring impairment is critical to our financialresults, as it requires subjective and complex judgments due to the need tomake estimates about the impact of matters that are uncertain. This processalso requires estimates that are susceptible to significant revision as moreinformation becomes available. It remains unclear what impact the illiquidmarkets, real estate value declines and the overall economic slowdown willultimately have on our financial results. Therefore, we cannot provide assurancethat, in any particular period, we will not incur additional impairmentprovisions in the future.

 

*ForeignCurrency Transaction Gains*

 

Thecombined impact of foreign currency transactions from the Company’sconsolidated and non-consolidated foreign operations resulted in a $2.2 millionforeign currency exchange gain in the second quarter of 2009 (compared to acombined impact of $0.2 million in foreign currency transaction gains in thesecond quarter of 2008). The global distribution of the Company’s combined 

 

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foreign currencyexchange gain in the second quarter of 2009 was comprised of $0.4 million from Europeanoperations and $1.8 million from Latin American operations. It remains unclear what impact the generalglobal economic conditions will have on our financial holdings and investmentsfrom our European and Latin American operations. As such, we cannot provideassurance that, in any particular period, we will not incur foreign currencytransaction losses in the future.

 

*Management’s Outlook*

 

Inspite of the substantial losses reported in the financial services sector overthe past two years and downward pressure on economic growth due to a decline ingeneral economic conditions, management remains positive on the outlook of theCompany. Management believes that current market conditions should not hinderFirstCity’s ability to expand its business, and that asset acquisitionopportunities at attractive margins are available. As mentioned above,FirstCity was involved in acquiring $67.1 million of portfolio investments witha face value of approximately $117.8 million in the second quarter of 2009 — ofwhich FirstCity’s investment share was $48.6 million, and the Company investedan additional $22.3 million in the form of loan and direct equity investments.In addition, subsequent to June 30, 2009, the Company was involved inacquiring $36.4 million of Portfolio Assets with a face value of approximately$52.1 million — of which FirstCity’s investment share was $18.3 million. TheCompany also funded an additional $3.0 million in SBA loan originations andother investments subsequent to June 30, 2009.

 

In addition, notwithstanding tightened creditstandards and restrained lending in the marketplace, management believes thatthe volatility and disruptions in the financial markets will not impactFirstCity’s ability to finance its operations. FirstCity presently has (1) $350.0 million of credit facility commitmentsavailable to (i) finance the senior debt and equity portions of portfolioand asset purchases; (ii) finance equity investments in new ventures; and (iii) providefor the issuance of letters of credit working capital loans; and (2) a$25.0 million credit facility commitment to finance SBA loan originations andadvances.

 

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

 

Components of the results ofoperations for the three and six month periods ended June 30, 2009 and2008, respectively, are detailed below (dollars in thousands except per sharedata):

 
| ** **                                     | ** ** | **Three  Months Ended**     | ** ** | **Six Months  Ended** | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **June 30,**           | ** ** | **June 30,**     | ** ** |
| ** **                                     | ** ** | **2009**                    | ** ** | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                     | ** ** | **(Dollars in  thousands)** | ** ** |
| Portfolio  Asset Acquisition and Resolution    |       | $                           | 11,138     |                  | $          | (5,007 | ) | $ | 12,054 |   | $ | (7,072 | ) |
| Special  Situations Platform                   |       | (1,132                      | )          | 186                   |       | 205 |   | 451 |   |
| Operating  contribution (loss)                 |       | 10,006                      |       | (4,821                | )          | 12,259 |   | (6,621 | ) |
| Corporate  overhead                            |       | (2,260                      | )          | (1,708                | )          | (3,869 | ) | (3,492 | ) |
| Net  earnings (loss) attributable to FirstCity |       | $                           | 7,746      |                  | $          | (6,529 | ) | $ | 8,390 |   | $ | (10,113 | ) |
| Diluted  earnings (loss) per common share      |       | $                           | 0.76       |                  | $          | (0.63 | ) | $ | 0.84 |   | $ | (0.97 | ) |

 

**Results of Operations**

 

The following discussion andanalysis is based on the segment reporting information presented in Note 16 tothe Consolidated Financial Statements of the Company included in Item 1 of thisForm 10-Q, and should be read in conjunction with the ConsolidatedFinancial Statements (including the Notes thereto) included elsewhere in this Form 10-Q.

 

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***Second Quarter 2009 Compared to SecondQuarter 2008***

 

The Company reported netearnings of $7.7 million in the second quarter of 2009 compared to net lossesof $6.5 million in the second quarter of 2008. Diluted net earnings to commonstockholders were $0.76 per common share in the second quarter of 2009 comparedto $0.63 of diluted net losses per common share in the second quarter of 2008.

 

*Portfolio Asset Acquisition andResolution*

 

The operating contribution fromthe Portfolio Asset Acquisition and Resolution segment resulted in an $11.1million operating gain in the second quarter of 2009 compared to a $5.0 millionoperating loss for the same period in 2008. FirstCity was involved in acquiring$67.1 million of Portfolio Assets in the second quarter of 2009 with anapproximate face value of $117.8 million, compared to its involvement inacquiring $36.7 million of Portfolio Assets in the second quarter of 2008 withan approximate face value of $92.1 million. In the second quarter of 2009,FirstCity’s investment share in the Portfolio Asset acquisitions was $48.6million — with $48.0 million acquired through consolidated Portfolios. In thesecond quarter of 2008, the Company’s investment share in the Portfolio Assetacquisitions was $33.4 million — all acquired through consolidated Portfolios.

 

FirstCity invested an additional$7.9 million in the second quarter of 2009 in the form of****SBA loan originations and advances, compared to $5.0 million for the same period in2008. FirstCity also invested $11.2 million in direct equity investmentsin the second quarter of 2009 (attributable primarily to European entityacquisitions).

 

The following is a summary ofthe results of operations for the Company’s Portfolio Asset Acquisition andResolution business segment for the three-month periods ended June 30,2009 and 2008:

 
| ** **                                             | ** ** | **Three  Months Ended**     | ** ** |
|--------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                             | ** ** | **June 30,**           | ** ** |
| ** **                                             | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **                                             | ** ** | **(Dollars in  thousands)** | ** ** |
| **Portfolio Asset Acquisition and Resolution:**        |       |                        |       |   |   |
| Revenues:                                              |       |                        |       |   |   |
| Servicing  fees                                        |       | $                           | 2,403      |   | $ | 2,706 |   |
| Income  from Portfolio Assets                          |       | 14,077                      |       | 5,622 |   |
| Gain  on sale of SBA loans held for sale, net          |       | 610                         |       | 133 |   |
| Interest  income from SBA loans                        |       | 295                         |       | 366 |   |
| Interest  income from loans receivable - affiliates    |       | 553                         |       | 147 |   |
| Interest  income from loans receivable - other         |       | 207                         |       | 123 |   |
| Other  income                                          |       | 824                         |       | 920 |   |
| Total  revenues                                        |       | 18,969                      |       | 10,017 |   |
| Expenses:                                              |       |                        |       |   |   |
| Interest  and fees on notes payable                    |       | 3,438                       |       | 3,707 |   |
| Salaries  and benefits                                 |       | 3,952                       |       | 3,829 |   |
| Provision  for loan and impairment losses              |       | (290                        | )          | 7,090 |   |
| Asset-level  expenses                                  |       | 1,244                       |       | 1,424 |   |
| Occupancy,  data processing and other                  |       | 908                         |       | 2,064 |   |
| Total  expenses                                        |       | 9,252                       |       | 18,114 |   |
| Equity  in net earnings of unconsolidated subsidiaries |       | 1,840                       |       | 3,364 |   |
| Gain  on step acquisition                              |       | 1,455                       |       | — |   |
| Net  income attributable to noncontrolling interests   |       | (1,611                      | )          | (67 | ) |
| Operating  contribution (loss) before direct taxes     |       | $                           | 11,401     |   | $ | (4,800 | ) |
| Operating  contribution (loss), net of direct taxes    |       | $                           | 11,138     |   | $ | (5,007 | ) |

 

*Servicing fee revenues. *Servicing fee revenues decreasedslightly to $2.4 million in the second quarter of 2009 from $2.7 million in thesecond quarter of 2008. Servicing fees from domestic Acquisition Partnershipstotaled $0.6 million in the second quarter of 2009 compared to $0.3 million forthe same period in 2008, while servicing fees from Latin American AcquisitionPartnerships totaled $1.7 million in the second quarter of 2009 compared to$2.3 million for the same period in 2008. The decline in servicing fees fromLatin American Acquisition Partnerships for the second quarter of 2009 incomparison to the same period in 2008 is attributable primarily to foreigncurrency exchange rate fluctuations during the respective periods that the feeswere recorded. Servicing fees from

 

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domestic Acquisition Partnerships are generallybased on a percentage of the collections received from the portfolios held bythese non-consolidated partnerships; whereas servicing fees from Latin AmericanAcquisition Partnerships are generally based on the cost of servicing plus aprofit margin.

 

*Income from Portfolio Assets*.  Income from Portfolio Assets increased to$14.1 million in the second quarter of 2009 compared to $5.6 million in thesecond quarter of 2008. FirstCity’s average investment in consolidatedPortfolio Assets increased significantly to $205.6 million for the secondquarter of 2009 from $121.7 million for the second quarter of 2008 (a majorityof FirstCity’s portfolio investments over the past year were acquired throughconsolidated subsidiaries). The significant increase in income from PortfolioAssets is attributed primarily to an increase in collections to $51.7 millionin the second quarter of 2009 compared to $11.4 million for the same period in2008; $8.3 million of gains recorded on loan settlements in the second quarterof 2009 compared to $2.0 million of settlement gains recorded for the sameperiod in 2008; and increased income accretion recorded by the Company as aresult of its rising investment level in Portfolio Assets. Refer to Note 5 tothe Consolidated Financial Statements included in Item 1 of this Form 10-Qfor a summary of income from Portfolio Assets.

 

*Gain onsale of SBA loans held for sale. *The Company recorded a $0.6 million gain on the sales of SBA loans in the second quarter of2009 with a $13.2 million net basis in the loans sold, compared to $0.1 millionof gains recorded in the second quarter of 2008 with a $2.6 million net basisin the loans sold. Gains on SBA loan sales reflect the Company’s participationin the SBA guaranteed loan program. Under the SBA 7(a) program, the SBAguarantees up to 90 percent of the principal on a qualifying loan. The Companygenerally sells the guaranteed portions of originated loans into the secondarymarket and retains the unguaranteed portion for investment. The increasedactivity in the second quarter of 2009 is attributable to the return ofinvestor demand for SBA loans as a result of certain federal governmentprograms and initiatives that were implemented over the past six months.

 

*Interest income from SBAloans. *Interest income from SBA loansdecreased slightly to $0.3 million during the second quarter of 2009 comparedto $0.4 million during the second quarter of 2008. Even though FirstCity’saverage investment in SBA loans increased to $22.2 million for the secondquarter of 2009 compared to $15.5 million for the second quarter of 2008, thedecline in interest income is attributable to a steady decline in marketinterest rates since the second quarter of 2008 (the Company’s SBA loans arepriced at variable interest rates).

 

*Interest income from loansreceivable — affiliates. *Interest incomefrom loans receivable — affiliates increased to $0.6 million in the secondquarter of 2009 compared to $0.1 million for the same period in 2008. Theincreased income is attributed to FirstCity’s average investment level in loansreceivable — affiliates rising to $14.2 million for the second quarter of 2009compared to $5.4 million for the second quarter of 2008.

 

*Interest income from loansreceivable — other. * Interest income from loans receivable — otherslightly increased by $0.1 million in the second quarter of 2009 compared tothe second quarter of 2008. The increase is attributed to the Company’sincreased investment level in loans to non-affiliated entities. FirstCity’saverage investment in loans receivable — other was $7.0 million and $5.3million for the second quarters of 2009 and 2008, respectively.

 

*Other income*.  Other income for the second quarter of 2009remained constant in comparison to the second quarter of 2008.

 

*Expenses. *Operating expenses approximated$9.3 million and $18.1 million in the second quarters of 2009 and 2008, respectively.The following is a discussion of the major components of operating expenses.

 

Interest expense and fees onnotes payable totaled $3.4 million and $3.7 million in the second quarters of2009 and 2008, respectively. FirstCity’s average outstanding debt increased to$291.4 million in the second quarter of 2009 from $192.0 million in the secondquarter of 2008 as a result of its increased investment activity. However, theCompany’s average cost of borrowings decreased to 4.7% in the second quarter of2009 compared to 7.7% in 2008 due to a decline in market interest rates overthe past twelve months.

 

Salaries and benefits totaled$4.0 million and $3.8 million in the second quarters of 2009 and 2008,respectively. The total number of personnel within the Portfolio AssetAcquisition and Resolution segment was 209 and 204 at June 30, 2009 and2008, respectively.

 

Net recoveries for loan and impairment losses totaled$0.3 million in the second quarter of 2009 compared to $7.1 million in netprovisions for loan and impairment losses for the same period in 2008. In thesecond quarter of 2009, the Company recorded net impairment provisions of $1.7million to consolidated domestic loan portfolios, which was off-set by $2.0million of net recoveries from consolidated European loan portfolios. Thesignificant provisions recorded in the second quarter of 2008 derived from thethen-developing adverse effects of the global economic crisis. The need forimpairment provisions and recoveries are identified in 

 

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connection with management’s regular evaluation of the collectibilityof the Company’s Portfolio Assets and loans receivable. The process for evaluating and measuring impairment and recoveries iscritical to our financial results, as it requires subjective and complexjudgments due to the need to make estimates about the impact of matters thatare uncertain; and requires estimates that are susceptible to significantrevision as more information becomes available.

 

Asset-level expenses, whichgenerally represent costs incurred by FirstCity to support foreclosedproperties and to protect its security interests in loan collateral, decreasedto $1.2 million inthe second quarter of 2009 compared to $1.4million for the same period in 2008.The decrease is attributed primarily to a decline in the Company’s holdings offoreclosed properties in 2009 compared to 2008. The Company’s investment inforeclosed properties decreased by $4.8 million over the past twelve months to$15.3 million at June 30, 2009.

 

Occupancy, data processing andother expenses decreased to $0.9 million for the second quarter of 2009 from$2.1 million in the second quarter of 2008. The decrease is attributedprimarily to $0.9 million of foreign currency exchange gains from our foreignconsolidated investments in the second quarter of 2009 compared to $0.4 millionof foreign currency exchange losses for the same period in 2008 — a $1.3million favorable impact.

 

*Equity in net earnings ofunconsolidated subsidiaries. *Equity in netearnings of unconsolidated subsidiaries decreased to $1.8 million in the secondquarter of 2009 compared to $3.4 million in the second quarter of 2008. Equityin earnings of Acquisition Partnerships decreased to $2.1 million in the secondquarter of 2009 from $3.0 million for the same period in 2008, and equity inearnings of servicing entities decreased to a $0.3 million loss in the secondquarter of 2009 compared to $0.3 million of net earnings in the second quarterof 2008. The following is a discussion of equity in earnings from FirstCity’sAcquisition Partnerships by geographic region. Refer to Note 7 of theConsolidated Financial Statements included in Item 1 on this Form 10-Q fora summary of revenues, earnings and equity in earnings of FirstCity’s equityinvestments by region.

 

·                *Domestic* — Total revenues reported by domestic AcquisitionPartnerships decreased to $3.0 million in the second quarter of 2009 from $3.2million for the same period in 2008. However, total net earnings reported by domestic partnerships increased to $1.3 millionin the second quarter of 2009 compared to a $0.3 million loss in the secondquarter of 2008. The decrease in total partnership revenues wasattributed primarily to a decrease in portfolio asset holdings (i.e. earningassets) to $50.5 million in the second quarter of 2009 from $73.8 million forthe same period in 2008, off-set partially by a significant increase incollections to $9.9 million in the second quarter of 2009 from $6.4 million inthe second quarter of 2008. The increase in total net earnings was attributableto the increased collections discussed above, and a decline in total provisionsreported by the domestic partnerships to $0.6 million in the second quarter of2009 from $2.3 million for the same period in 2008. The collective activitydescribed above translated to an increase in FirstCity’s share of net earningsin domestic Acquisition Partnerships to $0.5 million in earnings for the secondquarter of 2009 over $0.1 million in losses for the same period in 2008.

 

FirstCity’s average investment in domestic AcquisitionPartnerships decreased to $13.9 million in the second quarter of 2009 from$21.8 million in the second quarter of 2008. As a result, FirstCity’s share ofdomestic partnership revenues experienced a decrease as discussed above(although the revenue decrease was off-set by a significant increase incollections as discussed above). Since amajority of FirstCity’s portfolio acquisitions over the past two years wereacquired through consolidated Portfolios instead of equity investments inAcquisition Partnerships, the Company expects income from consolidatedPortfolios to off-set the decline in domestic partnerships revenues.

 

·         *Latin America* — Total revenues reported by Latin American Acquisition Partnershipsdecreased to $2.9 million in the second quarter of 2009 from $12.5 million inthe second quarter of 2008. However, LatinAmerican partnerships reported total net income of $11.3 million in the secondquarter of 2009 compared to $3.0 million of earnings for the same period in2008. The decrease in total partnership revenues was attributedprimarily to a decrease in collections to $5.8 million in the second quarter of2009 from $28.8 million in the second quarter of 2008 (which corresponds to adecrease in the Latin American partnership portfolio asset holdings (i.e.earning assets) to $142.5 million in the second quarter of 2009 from $214.1million for the same period in 2008). The increase in total earnings reportedby the Latin American partnerships wasattributed primarily to foreign currency transaction gains of $13.9 millionrecorded in the second quarter of 2009 compared to $5.4 million ofcurrency transaction gains in the second quarter of 2008 — an $8.5 million positive impact. The collective activitydescribed above translated to an increase in FirstCity’s share of net earningsin Latin American Acquisition Partnerships to $1.4 million in earnings for thesecond quarter of 2009 from $0.7 million in earnings for the same period in2008.

 

FirstCity’s average investment in Latin AmericanAcquisition Partnerships decreased to $17.5 million in the second quarter of2009 from $23.8 million in the second quarter of 2008. As a result, FirstCity’sshare of Latin American partnership revenues 

 

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experienced a decrease as discussed above. Since a majority of FirstCity’s portfolioacquisitions over the past two years were acquired through consolidatedPortfolios instead of equity investments in Acquisition Partnerships, theCompany expects income from consolidated Portfolios to off-set the decline inLatin American partnerships revenues.

 

·             *Europe*—****Total revenues reported by European AcquisitionPartnerships decreased to $5.2 million in the second quarter of 2009 from $11.8million in the second quarter of 2008. In addition, total net earnings reported by European partnershipsdecreased to $0.9 million in the second quarter of 2009 compared to $7.9million the same period in 2008. The decrease in total partnershiprevenues and earnings was attributed primarily to a decrease in collections to$6.3 million in the second quarter of 2009 from $20.4 million for the sameperiod in 2008 (which corresponds to a decrease in the European partnershipportfolio asset holdings (i.e. earning assets) to $83.5 million in the secondquarter of 2009 from $124.9 million for the same period in 2008). The decreasein total partnership revenues and earnings was also attributable to an increasein total provisions reported by the European partnerships to $2.7 million of netimpairment provisions in the second quarter of 2009 from $0.5 million of netrecoveries in the second quarter of 2008. The collective activity describedabove translated to a decrease in FirstCity’s share of European partnershipearnings to $0.2 million for the second quarter of 2009 from $2.4 million forthe second quarter of 2008.

 

FirstCity’s average investment in European AcquisitionPartnerships decreased to $12.8 million in the second quarter of 2009 from$31.2 million in the second quarter of 2008. As a result, FirstCity’s share ofEuropean partnership revenues experienced a decrease as discussed above. Since a majority of FirstCity’s portfolioacquisitions over the past two years were acquired through consolidatedPortfolios instead of equity investments in Acquisition Partnerships, theCompany expects income from consolidated Portfolios to off-set the decline inEuropean partnerships revenues.

 

*Gain on stepacquisition. *In the secondquarter of 2009, the Company recorded a $1.5 million gain attributable to astep acquisition transaction in which the Company acquired a controllingfinancial interest in certain French Acquisition Partnerships. The Companyowned a noncontrolling equity interest in these entities prior to thetransaction. Pursuant to new business combination accounting standards (SFAS141R), the Company’s previously-held noncontrolling interests in the Frenchentities were remeasured to fair value on the acquisition date (May 2009) —which resulted in the Company’s recognition of the $1.5 million gain. Refer toNote 4 to the Consolidated Financial Statements included in Item 1 of this Form 10-Qfor additional information on this transaction.

 

*Net income attributable to noncontrollinginterests. *The amount of net income attributable to noncontrollinginterests increased to $1.6 million for the second quarter of 2009 from $0.1million for the same period in 2008. The increase is attributed primarily to arise in the Company’s level of co-investments in portfolio purchases with otherinvestors through consolidated subsidiaries over the past twelve months. TheCompany’s carrying value of noncontrolling interests on its consolidatedbalance sheet, which represents the equity in consolidated subsidiaries notattributable to FirstCity, increased to $37.0 million at June 30, 2009 from$3.1 million at June 30, 2008.

 

***Special Situations PlatformBusiness Segment***

 

The operating contribution from the Special SituationsPlatform business segment (“FirstCity Denver”) resulted in a $1.1 millionoperating loss in the second quarter of 2009 compared to a $0.2 millionoperating gain for the same period in 2008. In the second quarter of 2009,FirstCity Denver provided $3.2 million of investment capital to privately-heldmiddle-market companies in the form of debt and direct equity investments.Since its inception in April 2007, FirstCity Denver has been involved inmiddle-market transactions with total investment values approximating $57.4million, and has provided $37.0 million of investment capital in connectionwith these investments.

 

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

 
| ** **                                          | ** ** | **Three  Months Ended**     | ** ** |
|-----------------------------------------------------|------------|-----------------------------|------------|
| ** **                                          | ** ** | **June 30,**           | ** ** |
| ** **                                          | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **                                          | ** ** | **(Dollars in  thousands)** | ** ** |
| **Special Situations Platform:**                    |       |                        |       |   |   |
| Revenues:                                           |       |                        |       |   |   |
| Interest  income from loans receivable              |       | $                           | 544        |   | $ | 568 |   |
| Revenue  from railroad operations                   |       | 705                         |       | 859 |   |
| Other  income                                       |       | 326                         |       | — |   |
| Total  revenues                                     |       | 1,575                       |       | 1,427 |   |
| Expenses:                                           |       |                        |       |   |   |
| Interest  and fees on notes payable                 |       | 136                         |       | 51 |   |
| Salaries  and benefits                              |       | 514                         |       | 403 |   |
| Provision  for loan and impairment losses           |       | 967                         |       | — |   |
| Other                                               |       | 754                         |       | 441 |   |
| Total  expenses                                     |       | 2,371                       |       | 895 |   |
| Equity  in net loss of unconsolidated subsidiaries  |       | (642                        | )          | (356 | ) |
| Net  loss attributable to noncontrolling interests  |       | 380                         |       | 14 |   |
| Operating  contribution (loss) before taxes         |       | $                           | (1,058     | ) | $ | 190 |   |
| Operating  contribution (loss), net of direct taxes |       | $                           | (1,132     | ) | $ | 186 |   |

 

*Interest income from loansreceivable. * Interest income from loans receivable in the second quarter of 2009 remained constant in comparison to the sameperiod in 2008. FirstCity Denver’s average investment in loans receivableincreased to $20.8 million for the second quarter of 2009 from $15.9 millionfor the second quarter of 2008.

 

*Revenue from railroadoperations*.  Revenue fromrailroad operations in thesecond quarter of 2009 remained relativelyconstant in comparison to the same period in 2008.

 

*Expenses. *Total expenses approximated $2.4 millionin the second quarter of 2009 compared to $0.9 million in the second quarter of 2008. The increase is attributable primarily to a $1.0million impairment provision recorded to a middle-market company debtinvestment in the second quarter of 2009. The impairment provision wasidentified in connection with management’s regular evaluation of thecollectibility of FirstCity Denver’s debt investments. The process for evaluating and measuring impairment is critical to ourfinancial results, as it requires subjective and complex judgments due to theneed to make estimates about the impact of matters that are uncertain; andrequires estimates that are susceptible to significant revision as moreinformation becomes available.

 

*Equity in net losses ofunconsolidated subsidiaries. *Equity in netlosses of unconsolidated subsidiaries totaled $0.6 million in the second quarter of 2009 and $0.4 million in losses in the second quarterof 2008 — which in each period is comprised primarily of FirstCity Denver’sequity earnings in its equity-method investment in a coal mine operation. Thecoal mine operation reported a loss in the second quarter of 2008 due to theoperation’s start-up status at the time (the coal mine commenced operations in April 2008).For the second quarter of 2009, the Company’s equity in earnings attributableto the coal mine’s operations approximated $0.5 million; however, the Company’sshare of net earnings in the coal mine was off-set by its share ($1.1 million) ofa one-time charge incurred by the coal mine company in the second quarter of2009 to relinquish its future reclamation liability.

 

***First Six Months of 2009 Compared to FirstSix Months of 2008***

 

The Company reported netearnings of $8.4 million in the first six months 2009 compared to a net loss of$10.1 million in the first six months of 2008. Diluted net earnings to commonstockholders were $0.84 per common share in the first six months of 2009compared to $0.97 of diluted net losses per common share in the first sixmonths of 2008.

 

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*Portfolio Asset Acquisition andResolution*

 

The operating contribution fromthe Portfolio Asset Acquisition and Resolution segment resulted in a $12.1million operating gain in the first six months of 2009 compared to a $7.1million operating loss in the first six months of 2008. FirstCity was involvedin acquiring $137.3 million of Portfolio Assets in the first six months of 2009with an approximate face value of $258.5 million, compared to its involvementin acquiring $56.6 million of Portfolio Assets in first six months 2008 with anapproximate face value of $638.1 million. In the first six months of 2009,FirstCity’s investment share in the Portfolio Asset acquisitions was $113.5million — primarily acquired through consolidated Portfolios. In the first sixmonths of 2008, the Company’s investment share in the Portfolio Assetacquisitions was $41.9 million — comprised of $40.1 million acquired throughconsolidated Portfolios and $1.8 million through Acquisition Partnerships.

 

FirstCity invested an additional$14.4 million in the first six months of 2009 in the form of****SBA loan originations and advances. The Company invested an additional $16.9million in the form of SBA loan originations and advances and other debt financing arrangements in thefirst six months 2008. FirstCity also invested $11.2 million in directequity investments in the first six months of 2009 (attributable primarily toEuropean entity acquisitions).

 

The following is a summary ofthe results of operations for the Company’s Portfolio Asset Acquisition andResolution business segment for the six-month periods ended June 30, 2009and 2008:

 
| ** **                                             | ** ** | **Six Months  Ended**       | ** ** |
|--------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                             | ** ** | **June 30,**           | ** ** |
| ** **                                             | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **                                             | ** ** | **(Dollars in  thousands)** | ** ** |
| **Portfolio Asset Acquisition and Resolution:**        |       |                        |       |   |   |
| Revenues:                                              |       |                        |       |   |   |
| Servicing  fees                                        |       | $                           | 4,795      |   | $ | 4,906 |   |
| Income  from Portfolio Assets                          |       | 23,120                      |       | 10,557 |   |
| Gain  on sale of SBA loans held for sale, net          |       | 610                         |       | 142 |   |
| Interest  income from SBA loans                        |       | 641                         |       | 842 |   |
| Interest  income from loans receivable - affiliates    |       | 1,089                       |       | 297 |   |
| Interest  income from loans receivable - other         |       | 414                         |       | 136 |   |
| Other  income                                          |       | 1,597                       |       | 1,370 |   |
| Total  revenues                                        |       | 32,266                      |       | 18,250 |   |
| Expenses:                                              |       |                        |       |   |   |
| Interest  and fees on notes payable                    |       | 6,762                       |       | 7,383 |   |
| Salaries  and benefits                                 |       | 7,521                       |       | 7,388 |   |
| Provision  for loan and impairment losses              |       | 816                         |       | 10,120 |   |
| Asset-level  expenses                                  |       | 2,350                       |       | 2,980 |   |
| Occupancy,  data processing and other                  |       | 3,167                       |       | 3,336 |   |
| Total  expenses                                        |       | 20,616                      |       | 31,207 |   |
| Equity  in net earnings of unconsolidated subsidiaries |       | 855                         |       | 6,204 |   |
| Gain  on step acquisition                              |       | 1,455                       |       | — |   |
| Net  income attributable to noncontrolling interests   |       | (1,528                      | )          | (38 | ) |
| Operating  contribution (loss) before direct taxes     |       | $                           | 12,432     |   | $ | (6,791 | ) |
| Operating  contribution (loss), net of direct taxes    |       | $                           | 12,054     |   | $ | (7,072 | ) |

 

*Servicing fee revenues. *Servicing fee revenues in thefirst six months of 2009 remained constant in comparison to the first sixmonths of 2008. Servicing fees from domestic Acquisition Partnerships totaled$1.2 million in the first six months of 2009 compared to $0.7 million in thefirst six months of 2008, while servicing fees from Latin American AcquisitionPartnerships totaled $3.5 million in the first six months of 2009 compared to$4.1 million in the first six months of 2008. The decline in servicing feesfrom Latin American Acquisition Partnerships for the first six months of 2009in comparison to the same period in 2008 is attributable primarily to foreigncurrency exchange rate fluctuations during the respective periods that the feeswere recorded. Servicing fees from domestic Acquisition Partnerships aregenerally based on a percentage of the collections received from the portfoliosheld by these non-consolidated partnerships; whereas servicing fees from LatinAmerican Acquisition Partnerships are generally based on the cost of servicingplus a profit margin.

 

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*Income from Portfolio Assets*.  Income from Portfolio Assets increased to$23.1 million in the first six months of 2009 compared to $10.6 million in thefirst six months of 2008. FirstCity’s average investment in consolidatedPortfolio Assets increased significantly to $181.2 million for the first sixmonths of 2009 from $120.5 million for the first six months of 2008 (a majorityof FirstCity’s portfolio investments over the past year were acquired throughconsolidated subsidiaries). The significant increase in income from PortfolioAssets is attributed primarily to an increase in collections to $82.2 millionin the first six months of 2009 compared to $30.9 million in the first sixmonths of 2008; $12.0 million of gains recorded on loan settlements in thefirst six months of 2009 compared to $3.4 million of settlement gains recordedin the first six months of 2008; and increased income accretion recorded by theCompany as a result of its rising investment level in Portfolio Assets. Referto Note 5 to the Consolidated Financial Statements included in Item 1 of this Form 10-Qfor a summary of income from Portfolio Assets.

 

*Gain onsale of SBA loans held for sale. *The Company recorded a $0.6 million gain on the sales of SBA loans in the first six months of2009 with a $13.2 million basis in the loans sold, compared to a $0.1 milliongain recorded in the first six months of 2008 with a $2.8 million basis in theloans sold. Gains on SBA loan sales reflect the Company’s participation in theSBA guaranteed loan program. Under the SBA 7(a) program, the SBAguarantees up to 90 percent of the principal of a qualifying loan. The Companygenerally sells the guaranteed portions of originated loans into the secondarymarket and retains the unguaranteed portion for investment. The increasedactivity in second quarter of 2009 is attributable to the return of investordemand for SBA loans as a result of certain federal government programs andinitiatives that were implemented over the past six months.

 

*Interest income from SBAloans. *Interest income from SBA loansdecreased slightly to $0.6 million during the first six months of 2009 comparedto $0.8 million during the first six months of 2008. Even though FirstCity’saverage investment in SBA loans increased to $22.0 million for the first sixmonths of 2009 from $14.9 million for the first six months of 2008, the declinein interest income is attributable to a steady decline in market interest ratessince the second quarter of 2008 (the Company’s SBA loans are priced atvariable interest rates).

 

*Interest income from loansreceivable — affiliates. *Interest incomefrom loans receivable — affiliates increased to $1.1 million in first sixmonths 2009 compared to $0.3 million in first six months 2008. The increasedincome is attributed to FirstCity’s average investment level in loansreceivable — affiliates rising to $14.1 million for the first six months of2009 from $5.4 million for the first six months of 2008.

 

*Interest income from loansreceivable — other. * Interest income from loans receivable — otherincreased by $0.3 million in the first six months of 2009 compared to the firstsix months of 2008. The increase is attributed to the Company’s increasedinvestment level in loans to non-affiliated entities. FirstCity’s averageinvestment in loans receivable — other was $7.2 million and $3.2 million forthe first six months of 2009 and 2008, respectively.

 

*Other income*.  Other income for the first six months of 2009increased by $0.2 million in comparison to the first six months of 2008primarily due to $0.4 million of interest income earned on the Company’sinvestment security in 2009 (purchased in October 2008).

 

*Expenses. *Operating expenses approximated$20.6 million and $31.2 million in the first six months of 2009 and 2008,respectively. The following is a discussion of the major components ofoperating expenses.

 

Interest expense and fees on notespayable totaled $6.8 million and $7.4 million in the first six months of 2009and 2008, respectively. FirstCity’s average outstanding debt increased to$274.3 million for the first six months of 2009 from $183.1 million for thefirst six months of 2008 as a result of its increased investment activity.However, the Company’s average cost of borrowings decreased to 4.9% in thefirst six months of 2009 compared to 8.1% in 2008 due to a decline in marketinterest rates over the past eighteen months.

 

Salaries and benefits remainedconstant at $7.5 million and $7.4 million in the first six months of 2009 and2008, respectively. The total number of personnel within the Portfolio AssetAcquisition and Resolution segment was 209 and 204 at June 30, 2009 and2008, respectively.

 

Net provisions for loan and impairment losses totaled$0.8 million in the first six months of 2009 compared to $10.1 million in thefirst six months of 2008. In 2009, the Company recorded net impairmentprovisions of $2.9 million to consolidated domestic loan portfolios; off-setpartially by $2.1 million of net recoveries from consolidated European loanportfolios. The significant provisions recorded in the first six months of 2008derived from the then-developing adverse effects of the global economic crisis.The need for 

 

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impairment provisions and recoveries are identified in connection withmanagement’s regular evaluation of the collectibility of the Company’sPortfolio Assets and loans receivable. Theprocess for evaluating and measuring impairment and recoveries is critical toour financial results, as it requires subjective and complex judgments due tothe need to make estimates about the impact of matters that are uncertain. Thisprocess requires estimates that are susceptible to significant revision as moreinformation becomes available.

 

Asset-level expenses, whichgenerally represent costs incurred by FirstCity to support foreclosedproperties and to protect its security interests in loan collateral, decreasedto $2.4 million inthe first six months of 2009 compared to $3.0million in the first six months of 2008. The decrease is attributed primarily to a decline in the Company’sholdings of foreclosure properties in 2009 compared to 2008. The Company’sinvestment in foreclosed properties decreased by $4.8 million over the pasttwelve months to $15.3 million at June 30, 2009.

 

Occupancy, data processing andother expenses for the first six months of 2009 remained constant at $3.2million in comparison to $3.3 million for the first six months of 2008.

 

*Equity in net earnings ofunconsolidated subsidiaries. *Equity in netearnings of unconsolidated subsidiaries decreased to $0.9 million in the firstsix months of 2009 compared to $6.2 million in the first six months of 2008.Equity in earnings of Acquisition Partnerships decreased to $1.2 million in2009 from $5.3 million in 2008, and equity in earnings of servicing entitiesdecreased to a $0.4 million loss in 2009 compared to $0.9 million of earningsin 2008. The following is a discussion of equity in earnings from FirstCity’sAcquisition Partnerships by geographic region. Refer to Note 7 of the ConsolidatedFinancial Statements included in Item 1 on this Form 10-Q for a summary ofrevenues, earnings and equity in earnings of FirstCity’s equity investments byregion.

 

·             *Domestic* — Total revenues reported by domestic AcquisitionPartnerships decreased to $4.6 million in the first six months of 2009 from$6.3 million in 2008. However, total netearnings reported by domestic partnerships increased to $1.4 million in thefirst six months of 2009 compared to $0.2 million in 2008. The decreasein total partnership revenues was attributed primarily to a decrease incollections to $14.4 million in the first six months of 2009 from $17.6 millionin the first six months of 2008 (which corresponds to a decrease in domesticpartnership portfolio asset holdings (i.e. earning assets) to $50.5 million at June 30,2009 from $73.8 million at June 30, 2008). The increase in total netearnings was attributed primarily to a decline in total provisions to $0.9million for the first six months of 2009 from $2.9 million in 2008. Thecollective activity described above translated to an increase in FirstCity’sshare of net earnings in domestic Acquisition Partnerships to $0.5 million inearnings for the first six months of 2009 from $0.2 million in 2008.

 

FirstCity’s average investment in domestic AcquisitionPartnerships decreased to $14.4 million in the first six months of 2009 from$22.9 million in 2008. As a result, FirstCity’s share of domestic partnershiprevenues experienced a decrease as discussed above. Since a majority of FirstCity’s portfolio investments over the past twoyears were acquired through consolidated Portfolios instead of equityinvestments in Acquisition Partnerships, the Company expects income fromconsolidated Portfolios to off-set the decline in domestic partnershipsrevenues.

 

·         *Latin America* — Total revenues reported by Latin American Acquisition Partnershipssignificantly decreased to $5.4 million in the first six months of 2009 from$23.7 million in the first six months of 2008. In addition, Latin American partnerships reported a total netloss of $1.0 million in the first six months of 2009 compared to $6.0 millionof total net earnings in the first six months of 2008. The decrease in totalrevenues and earnings reported by Latin American partnerships was attributedprimarily to the following: (1) foreign currency transaction gains of $2.8million recorded in the first six months of 2009 compared to $8.4million of foreign currency transaction gains in 2008 — a $5.6 million negative impact; and (2) decrease incollections to $11.9 million in the first six months of 2009 from $40.5 millionin 2008 (which corresponds to a decrease in the Latin American partnershipportfolio asset holdings (i.e. earning assets) to $142.5 million at June 30,2009 from $214.1 million at June 30, 2008). The negative impact of thesefactors to total net earnings by Latin American partnerships was partiallyoff-set by the following: (1) decrease in net impairment provisions to$1.4 million in the first six months of 2009 compared from $5.3 million in thefirst six months of 2008; (2) $4.8 million decrease in service feesexpense in the first six months of 2009 in comparison to the same period in2008; (3) $5.5 million decrease in property protection costs and otheroperating expenses in the first six months of 2009 compared to the same periodin 2008; and (4) $2.7 million decrease in interest expense in the firstsix months of 2009 compared to the same period in 2008.  The collective activity described above translated to a decreasein FirstCity’s share of net earnings in Latin American partnerships to a $0.3million loss for the first six months of 2009 from $1.1 million of net earningsfor the same period in 2008.

 

FirstCity’s average investment in Latin AmericanAcquisition Partnerships decreased to $17.8 million for the first six months of2009 from $23.3 million for 2008. As a result, FirstCity’s share of LatinAmerican partnership revenues experienced a 

 

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decrease as discussed above. Since a majority of FirstCity’s portfolio acquisitions over the past twoyears were acquired through consolidated Portfolios instead of equity investmentsin Acquisition Partnerships, the Company expects income from consolidatedPortfolios to off-set the decline in Latin American partnerships revenues.

 

·             *Europe*—****Total revenues reported by European AcquisitionPartnerships decreased to $11.5 million in the first six months of 2009 from$22.1 million in the first six months of 2008. In addition, total net earnings reported by Europeanpartnerships decreased to $3.7 million in the first six months of 2009 comparedto $13.7 million in the first six months of 2008. The decrease in totalpartnership revenues and earnings was attributed primarily to the following: (1) decreasein collections to $15.4 million in the first six months of 2009 from $33.1million in 2008 (which corresponds to a decrease in the European partnershipportfolio asset holdings (i.e. earning assets) to $83.5 million at June 30,2009 from $124.9 million at June 30, 2008); and (2) increase in totalprovisions reported by the European partnerships to $3.6 million of netimpairment provisions in the first six months of 2009 from $0.5 million in2008. The collective activity described above translated to a decrease inFirstCity’s share of European partnership earnings to $1.0 million for thefirst six months of 2009 from $4.1 million for 2008.

 

FirstCity’s average investment in European AcquisitionPartnerships decreased to $13.0 million for the first six months of 2009 from$30.8 million for 2008. As a result, FirstCity’s share of European partnershiprevenues experienced a decrease as discussed above. Since a majority of FirstCity’s portfolio acquisitions over the past twoyears were acquired through consolidated Portfolios instead of equityinvestments in Acquisition Partnerships, the Company expects income fromconsolidated Portfolios to off-set the decline in European partnershipsrevenues.

 

*Gain on stepacquisition. *In the first sixmonths of 2009, the Company recorded a $1.5 million gain attributable to a stepacquisition transaction in which the Company acquired a controlling financialinterest in certain French Acquisition Partnerships. The Company owned anoncontrolling equity interest in these entities prior to the transaction.Pursuant to new business combination accounting standards (SFAS 141R), theCompany’s previously-held noncontrolling interests in the French entities wereremeasured to fair value on the acquisition date (May 2009) — whichresulted in the Company’s recognition of the $1.5 million gain. Refer to Note 4to the Consolidated Financial Statements included in Item 1 of this Form 10-Qfor additional information on this transaction.

 

*Net income attributable tononcontrolling interests.*  Theamount of net income attributable to noncontrolling interests increased to $1.5million for the first six months of 2009 from $38,000 for the same period in2008. The increase is attributed primarily to a rise in the Company’s level ofco-investments in portfolio purchases with other investors through consolidatedsubsidiaries over the past twelve months. The Company’s carrying value of noncontrollinginterests on its consolidated balance sheet, which represents the equity inconsolidated subsidiaries not attributable to FirstCity, increased to $37.0million at June 30, 2009 from $3.1 million at June 30, 2008.

 

***Special Situations Platform BusinessSegment***

 

The operating contribution from the Special SituationsPlatform business segment (“FirstCity Denver”) totaled $0.2 million in thefirst six months of 2009 compared to $0.5 million in 2008. In the first six months of 2009, FirstCity Denver provided$5.6 million of investment capital to privately-held middle-market companies inthe form of debt investments and direct equity investments. Since its inceptionin April 2007, FirstCity Denver has been involved in middle-markettransactions with total investment values approximating $57.4 million, and hasprovided $37.0 million of investment capital in connection with theseinvestments.

 

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

 
| ** **                                                    | ** ** | **Six Months  Ended**       | ** ** |
|---------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                    | ** ** | **June 30,**           | ** ** |
| ** **                                                    | ** ** | **2009**                    | ** ** | **2008** | ** ** |
| ** **                                                    | ** ** | **(Dollars in  thousands)** | ** ** |
| **Special Situations Platform:**                              |       |                        |       |   |   |
| Revenues:                                                     |       |                        |       |   |   |
| Interest  income from loans receivable                        |       | $                           | 1,152      |   | $ | 830 |   |
| Revenue  from railroad operations                             |       | 1,452                       |       | 1,664 |   |
| Other  income                                                 |       | 1,309                       |       | 22 |   |
| Total  revenues                                               |       | 3,913                       |       | 2,516 |   |
| Expenses:                                                     |       |                        |       |   |   |
| Interest  and fees on notes payable                           |       | 286                         |       | 58 |   |
| Salaries  and benefits                                        |       | 950                         |       | 805 |   |
| Provision  for loan and impairment losses                     |       | 967                         |       | — |   |
| Other                                                         |       | 1,416                       |       | 846 |   |
| Total  expenses                                               |       | 3,619                       |       | 1,709 |   |
| Equity  in net earnings (loss) of unconsolidated subsidiaries |       | 197                         |       | (356 | ) |
| Net  loss (income) attributable to noncontrolling interests   |       | (51                         | )          | 7 |   |
| Operating  contribution before taxes                          |       | $                           | 440        |   | $ | 458 |   |
| Operating  contribution, net of direct taxes                  |       | $                           | 205        |   | $ | 451 |   |

 

*Interest income from loansreceivable. * Interest income from loans receivable increasedto $1.2 million in the firstsix months of 2009 from $0.8 million in thefirst six months of 2008. The increased income is attributable to an increasein FirstCity Denver’s average investment in loans receivable to $19.7 millionfor the first six months of 2009 from $11.5 million for 2008. The increasedinvestment level is attributable primarily to middle-market company debtinvestments funded by FirstCity Denver over the past twelve months.

 

*Revenue from railroadoperations*.  Revenue fromrailroad operations of $1.5 million for the first six months of 2009 remained relatively constant in comparison to $1.7 million for the firstsix months of 2008.

 

*Other income*.  Other income for the first six months of 2009 increased by $1.3 million in comparison to 2008primarily due to a $0.9 million gain recognized by FirstCity Denver’smajority-owned railroad operation in the first six months of 2009 in connectionwith a property sale.

 

*Expenses. *Total expenses approximated $3.6 millionin the first six months of 2009 compared to $1.7 million in 2008. Theincrease is attributable primarily to a $1.0 million impairment provisionrecorded to a middle-market company debt investment in 2009. Theimpairment provision was identified in connection with management’s regularevaluation of the collectibility of the FirstCity Denver’s loan investments. The process for evaluating and measuringimpairment is critical to our financial results, as it requires subjective andcomplex judgments due to the need to make estimates about the impact of mattersthat are uncertain; and requires estimates that are susceptible to significantrevision as more information becomes available. The increase in total expensesis also attributable to $0.6 million of additional operating expenses incurredin the first six months of 2009 in connection with FirstCity’s investment in aretail/office building it acquired in June 2008.

 

*Equity in net earnings(loss) of unconsolidated subsidiaries. *Equity in netearnings of unconsolidated subsidiaries increased to $0.2 million in the first six months of 2009 from $0.4 of losses in 2008 — which is comprisedprimarily of FirstCity Denver’s equity earnings in its equity-method investmentin a coal mine operation. The coal mine operation reported a loss for the firstsix months of 2008 due to the operation’s start-up status at the time (the coalmine commenced operations in April 2008). For the first six months of2009, the Company’s equity in earnings attributable to the coal mine’soperations approximated $1.3 million; however, the Company’s share of netearnings in the coal mine was off-set by its share ($1.1 million) of a one-timecharge incurred by the coal mine company in 2009 to relinquish its futurereclamation liability.

 

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#### **Financial Condition**

 

Significant changes in FirstCity’sfinancial condition during the first six months of 2009 resulted from thefollowing:

 

Consolidated assets of $421.3million at June 30, 2009 were $92.4 million higher than consolidatedassets at December 31, 2008. The increase in consolidated assets isattributed primarily to a $90.4 million net increase in Portfolio Assets andloan investments related to FirstCity’s investment activities during the firstsix months of the year.

 

Consolidated liabilities of$322.2 million as of June 30, 2009 were $59.2 million higher thanconsolidated liabilities at December 31, 2008. Total notes payable increasedby $53.1 million primarily to finance the Company’s investment activitiesduring the first six months of 2009. In addition, the Company’s operatingliabilities increased by $1.8 million since December 31, 2008 inconnection with its business acquisitions that closed in May 2009.

 

FirstCity’s reported amount ofnoncontrolling interests (included as a component of equity) increased by $21.4million since December 31, 2008 in connection with its co-investments inportfolio purchases with other investors through consolidated entities duringthe first six months of 2009, and its step acquisition of certain FrenchAcquisition Partnerships in May 2009 (refer to Note 4 to the ConsolidatedFinancial Statements included in Item 1 of this Form 10-Q for additionalinformation on this transaction).

 

#### **Portfolio AssetAcquisitions — Portfolio Asset Acquisition and Resolution Business Segment**

 

Aggregate Portfolio Assetacquisitions by the Company for the six months ended June 30, 2009 and thelast five full fiscal years are as follows (in thousands):

 
| ** **                | ** ** | **Purchase**                | ** ** | **FirstCity**  | ** ** |
|---------------------------|------------|-----------------------------|------------|----------------|------------|
| ** **                | ** ** | **Price**                   | ** ** | **Investment** | ** ** |
| ** **                | ** ** | **(Dollars in  thousands)** | ** ** |
| First  six months of 2009 |       | $                           | 137,323    |           | $          | 113,466 |   |
| Total  2008               |       | 89,314                      |       | 72,307         |       |
| Total  2007               |       | 214,333                     |       | 126,714        |       |
| Total  2006               |       | 296,990                     |       | 144,048        |       |
| Total  2005               |       | 146,581                     |       | 71,405         |       |
| Total  2004               |       | 174,139                     |       | 59,762         |       |
|                           |            |                             |            |                |            |  |  |

 

Subsequentto June 30, 2009, the Company was involved in acquiring $36.4 million ofPortfolio Assets with a face value of approximately $52.1 million — of whichFirstCity’s investment share was $18.3 million. FirstCity also funded $1.7million of additional loan investments subsequent to June 30, 2009.

 

Revenueswith respect to the Company’s Portfolio Asset Acquisition and Resolutionbusiness segment consist primarily of (i) servicing fees from AcquisitionPartnerships for the performance of servicing activities related to the assetsheld in the Acquisition Partnerships; (ii) interest income from PortfolioAssets and loans receivable; and (iii) gains on the disposition andsettlement of Portfolio Assets and other assets. The Company also recordsequity in earnings of non-consolidated Acquisition Partnerships and servicingentities accounted for under the equity-method of accounting.

 

Due touncertainties related primarily to estimating the timing and/or amount ofcollections on SOP 03-3 loans as a result of the current economic environment,the Company’s level of SOP 03-3 loans and loan pools accounted for under thecost-recovery method (i.e. non-accrual method) of accounting increased to $73.2million at June 30, 2009 from $20.7 million at December 31, 2008. Under SOP03-3, the interest method (i.e. accrual method) of accounting is not appropriateif management does not have the ability to develop a reasonable expectation ofboth the timing and amount of future cash flows to be collected (refer to Note1 of the Consolidated Financial Statements included in Item 1 on this Form 10-Qfor a summary description of the Company’s SOP 03-3 accounting policy). SinceDecember 31, 2008, the Company acquired $30.7 million of SOP 03-3 loans andloan pools that were accounted for under the cost-recovery accounting method atacquisition. In addition, in May 2009, the Company acquired $12.9 million ofSOP 03-3 loan pools in connection with a step acquisition of certain FrenchAcquisition Partnerships, and such loans were accounted for under thecost-recovery accounting method at acquisition (refer to Note 4 of theConsolidated Financial Statements included in Item 1 on this Form 10-Q foradditional information on this transaction). Under the cost-recovery accountingmodel, collections are applied first against the carrying value of the asset,and income is recognized when any additional collections are received after theasset’s carrying amount has been reduced to zero.

 

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

 

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

 
| ** **               | ** ** | **Total**                  | ** ** | **FirstCity Denver’s Investment** | ** ** |
|--------------------------|------------|----------------------------|------------|----------------------------------------|------------|
| ** **               | ** ** | **Investment**             | ** ** | **Debt**                               | ** ** | **Equity** | ** ** | **Total** | ** ** |
| ** **               | ** ** | **(Dollars in thousands)** | ** ** |
| First six months of 2009 |       | $                          | 6,310      |                                   | $          | 5,177 |   | $ | 387 |   | $ | 5,564 |   |
| Total 2008               |       | 28,750                     |       | 16,650                                 |       | 3,256 |   | 19,906 |   |
| Total 2007               |       | 22,314                     |       | 5,630                                  |       | 5,900 |   | 11,530 |   |
|                          |            |                            |            |                                        |            |  |  |  |  |  |  |  |  |

 

Subsequent to June 30, 2009, FirstCity Denver provided anadditional $1.3 million of investment capital in connection with middle-markettransactions.

 

Revenues with respect to the Company’s Special Situations Platformbusiness segment consist primarily of (i) interest and fee income fromloan investments; (ii) revenues from majority-owned operating entities;and (iii) equity in earnings of non-consolidated investments accounted forunder the equity-method of accounting.

 

**Provision for Income Taxes**

 

The Company has substantial NOLs which can beused to off-set the tax liability associated with the Company’s pre-taxearnings until the earlier of the expiration or utilization of such NOLs. TheCompany accounts for the benefit of the NOLs and other income tax items under the asset and liability method inaccordance with SFAS 109. Deferred tax assets and liabilities are recognizedbased on the future tax consequences attributable to temporary differencesbetween the financial statement carrying amounts of existing assets andliabilities and their respective tax bases and operating loss and tax creditcarryforwards. Deferred tax assets and liabilities are measured using enactedtax rates expected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. SFAS 109 requires areduction of the carrying amounts of deferred tax assets by a valuationallowance if, based on the available evidence, it is more likely than not thatsuch assets will not be realized. Accordingly, the need to establish valuationallowances for deferred tax assets is assessed periodically by the Companybased on the SFAS 109 more-likely-than-not realization threshold criterion. Inthe assessment, appropriate consideration is given to all positive and negativeevidence related to the realization of the deferred tax assets. This assessmentconsiders, among other factors, the nature, frequency and severity of currentand cumulative losses, forecasts of future profitability, excess of appreciatedasset value over the tax basis of net assets, the duration of statutorycarryforward periods, the Company’s experience with utilizing availableoperating loss and tax credit carryforwards, and tax planning strategies. Inmaking such assessments, significant weight is given to evidence that can beobjectively verified. At June 30, 2009, the Company carried a fullvaluation allowance for its deferred tax assets due to the lack of sufficientobjective evidence regarding the realization of these assets in the foreseeablefuture.

 

**Liquidity and Capital Resources**

 

***Overview***

 

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

 

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

 

***Consolidated Statements of Cash Flows***

 

Our operatingactivities used cash of $60.7 million and $41.5 million for the six-monthperiods ended June 30, 2009 and 2008, respectively. For the six months endedJune 30, 2009, net cash used in operations was attributable primarily toPortfolio Asset purchases of $52.9 million (net of principal collections); andnon-cash deductions of $23.1 million for income accretion on Portfolio Assets,$1.1 million for equity earnings from equity-method investments, and $1.5million for a step acquisition gain – off-set partially by $10.0 million of netearnings, a $5.4 million increase in other liabilities, and $3.8 million ofnon-cash add-backs related to depreciation, amortization, and provisions forloan and impairment losses. Net cash used for the six-month period ended June30, 2008 was attributable primarily to a net loss of $10.1 million; PortfolioAssets purchases of $16.4 million (net of principal collections); $1.8 millionof net principal advances on SBA loans held for sale; $9.0 million increase inother assets; and non-cash deductions of $10.6 million for income accretion on PortfolioAssets and $5.8 million for equity earnings from equity-method investments –off-set partially by a $1.5 million increase in other liabilities and $12.0million of non-cash add-backs related to depreciation, amortization, andprovisions for loan and impairment losses. The remaining changes in the periodswere due primarily to net changes in other accounts related to our operatingactivities.

 

      Our investing activities used cash of $2.7 million and $15.6million for the six-month periods ended June 30, 2009 and 2008, respectively.For the six months ended June 30, 2009, net cash used in investing activitieswas attributable primarily to $7.1 million paid for business combinations; $1.4million of property and equipment purchases; $1.2 million of equity investmentcontributions; and $3.6 million of net advances and originations for loaninvestments – off-set partially by $7.0 million of distributions fromequity-method investments, $2.2 million payments on an investment security available for sale, and $1.4 millionof proceeds from a property sale. Net cash used in investing activities for thesix-month period ended June 30, 2008 was attributable primarily to $22.9million of net advances and originations for loan investments and $1.2 millionof property and equipment purchases – off-set partially by $11.1 million ofdistributions from equity-method investments. The remaining changes in theperiods were due primarily to net changes in other accounts related to ourinvesting activities.

 

Our financing activitiesprovided cash of $69.6 million and $46.2 million for the six-month periodsended June 30, 2009 and 2008, respectively. For the six months ended June 30,2009, net cash provided by financing activities was attributable to $52.4million of net borrowings to finance our Portfolio Asset acquisitions and otherinvestments and $22.3 million of contributions from noncontrolling interestsprimarily to invest in Portfolio Assets through consolidated subsidiaries –off-set partially $2.2 million of cash distributions to noncontrollinginterests and $2.8 million of cash paid to acquire additional equity innoncontrolling interests. Net cash provided by financing activities for thesix-month period ended June 30, 2008 was attributable primarily to $49.8 millionof net borrowings to finance our Portfolio Asset acquisitions and otherinvestments – off-set partially by $3.2 million of common stock repurchases.The remaining changes in the periods were due primarily to net changes in otheraccounts related to our financing activities.

 

Cash paid forinterest expense approximated $4.9 million and $6.2 million for the six-monthperiods ended June 30, 2009 and 2008, respectively. Substantially all of ourinterest expense was paid on our credit facilities and other borrowings. FirstCity’s average outstanding debt increased to$285.3 million for the first six months of 2009 from $186.3 million for thefirst six months of 2008, while the average cost of borrowings decreased to4.95% in 2009 compared to 7.99% in 2008. The increase in the Company’sdebt level since June 30, 2008 is a result of increased net borrowings tofinance the Company’s growth and investment transactions.

 

***Credit Facilities***

 

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

 

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

 

FirstCity has a $225.0 million revolving acquisitionfacility with Bank of Scotland plc (“Bank of Scotland”) that matures in November 2010.The revolving loan facility is used to finance the senior debt and equityportion of portfolio and asset purchases made by FirstCity and to provide forthe issuance of letters of credit and working capital loans. The obligations ofFirstCity under this 

 

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facility are guaranteed by substantially all of the wholly-ownedsubsidiaries of FirstCity and are secured by security interests insubstantially all of the assets of FirstCity and its wholly-owned subsidiaries.

 

The primary terms and key covenants of this loanfacility are described in our 2008 Form 10-K. On March 30, 2009,FirstCity and Bank of Scotland entered into an amendment to the $225.0 millionrevolving loan facility to amend the definitions of “indebtedness” and “tangiblenet worth” such that in the determination of “tangible net worth” and thecomputation of the ratio of “indebtedness to tangible net worth” for the fiscalquarters ending December 31, 2008 and thereafter, “tangible net worth” and“indebtedness” would be adjusted by deducting non-controlling interests (i.e.minority interests) in subsidiaries from liabilities and adding non-controllinginterests in subsidiaries to equity as provided under GAAP (pursuant to SFAS160). At June 30, 2009, the Company was in compliance with all covenantsor other requirements set forth in the credit agreement or other agreementswith Bank of Scotland.

 

FirstCity has$29.1 million in Euro-denominated debt on the $225.0 million revolving loanfacility that was designated as a hedge to partially off-set the Company’sbusiness exposure to foreign currency exchange risk attributable to our netequity investments in Europe. Refer to Note18 to our Consolidated Financial Statements included in Item 1 of this Form 10-Q.

 

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

 

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

 

The primary terms and key covenants of this loanfacility are described in our 2008 Form 10-K. On March 30, 2009, FHPartners and Bank of Scotland entered into an amendment to the $100.0 millionrevolving loan facility to amend the definitions of “indebtedness” and “tangiblenet worth” such that in the determination of “tangible net worth” and thecomputation of the ratio of “indebtedness to tangible net worth” for the fiscalquarters ending December 31, 2008 and thereafter, “tangible net worth” and“indebtedness” would be adjusted by deducting non-controlling interests (i.e.minority interests) in subsidiaries from liabilities and adding non-controllinginterests in subsidiaries to equity as provided under GAAP (pursuant to SFAS160). At June 30, 2009, the Company was in compliance with all covenantsor other requirements set forth in the credit agreement or other agreementswith Bank of Scotland.

 

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

 

FirstCityhas a $25.0 million subordinated credit agreement with BoS(USA), Inc. (“BoS(USA)”),a subsidiary of Bank of Scotland, which may be used to finance equityinvestments in new ventures, equity investments made in connection withportfolio and asset purchases and loans made by FirstCity and its subsidiariesto acquisition entities, provide for the issuance of letters of credit, and forworking capital loans. This credit facility matures in November 2010 andis guaranteed by substantially all of FirstCity’s wholly-owned subsidiaries andsecured by substantially all of the assets of FirstCity and its wholly-ownedsubsidiaries.

 

Theprimary terms and key covenants of this loan facility are described in our 2008Form 10-K. On March 30, 2009, FirstCity and BoS(USA) entered into anamendment to the $25.0 million subordinated credit agreement to amend thedefinitions of “indebtedness” and “tangible net worth” such that in thedetermination of “tangible net worth” and the computation of the ratio of “indebtednessto tangible net worth” for the fiscal quarters ending December 31, 2008and thereafter, “tangible net worth” and “indebtedness” would be adjusted bydeducting non-controlling interests (i.e. minority interests) in subsidiariesfrom liabilities and adding non-controlling interests in subsidiaries to equityas provided under GAAP (pursuant to SFAS 160). At June 30, 2009, theCompany was in compliance with all covenants or other requirements set forth inthe credit agreement or other agreements with BoS(USA).

 

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

 

*BancoSantander, S.A.*

 

FirstCity MexicoSA de CV, a Mexican affiliate of FirstCity, has a term note with BancoSantander, S.A. with an unpaid principal balance of 142,240,000 Mexican pesosat June 30, 2009, which was equivalent to $10.8 million U.S. dollars onthat date. The loan proceeds are used to pay down the acquisition facility withthe Bank of Scotland. Pursuant to the terms of the credit facility, FirstCity 

 

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Mexico SA de CV wasrequired to provide a stand-by letter of credit from Bank of Scotland thatwould satisfy the loan balance upon demand. At June 30, 2009,FirstCity had a letter of credit in the amount of $12.6 million from Bank ofScotland under the terms of FirstCity’s revolving acquisition facility withBank of Scotland. In the event that a demand is made under the $12.6million letter of credit, FirstCity would be required to reimburse Bank ofScotland by making payment to Bank of Scotland for all amounts disbursed or tobe disbursed by Bank of Scotland under the letter of credit.

 

*Wells Fargo Foothill, LLC*

 

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

 

Theprimary terms and key covenants of this loan facility are described in our 2008Form 10-K. In February 2009, ABL and WFF entered into an agreement toamend the revolving credit facility by making the following changes to theprimary terms and key covenants of the existing loan facility as follows: (i) reducedthe maximum outstanding amount of the credit line from $40.0 million to $25.0million, (ii) provided for the guaranty by FirstCity of all indebtednessunder the loan facility up to a maximum of $5.0 million plus enforcement cost; (iii) revisedthe interest rates applicable to base rate loans; (iv) extended thematurity date to January 31, 2010; (v) reduced the minimum tangiblenet worth requirement for the fiscal quarter ending March 31, 2009, andfor each quarter thereafter to $5.5 million, plus 100% of the positive amountsof ABL’s net income for each fiscal quarter after March 31, 2009; (vi) revisedthe facility fee of one-quarter of one percent (0.25%) per annum to be chargedfor non-use of the available maximum credit line to be calculated using $25.0million as the amount of the maximum credit line on or after February 1,2009; and (vii) revised the borrowing base for originating loans to bechanged to an amount equal to 70% of the net eligible non-guaranteed loansoriginated by ABL that are borrower originated mixed collateral loans. At June 30,2009, ABL was in compliance with all covenants or other requirements set forthin the credit agreement or other agreements with WFF.

 

Excluding the termacquisition facilities of the Company’s Acquisition Partnerships and otherunconsolidated subsidiaries, as of June 30, 2009, the Company and itsconsolidated subsidiaries had credit facilities providing for borrowings in anaggregate principal amount of $416 million and outstanding borrowings of $305million.

 

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

 

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**CreditFacilities**

 
| ** **                                                           | ** ** | **Funded and**             | ** ** | ** **        | ** ** | ** **                                                                                                                                   | ** ** | ** **                                                                                                      | ** ** |
|----------------------------------------------------------------------|------------|----------------------------|------------|-------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                           | ** ** | **Unfunded**               | ** ** | **Outstanding**   | ** ** | ** **                                                                                                                                   | ** ** | ** **                                                                                                      | ** ** |
| ** **                                                           | ** ** | **Commitment**             | ** ** | **Borrowings**    | ** ** | ** **                                                                                                                                   | ** ** | ** **                                                                                                      | ** ** |
| ** **                                                           | ** ** | **Amount as of**           | ** ** | **as of**         | ** ** | ** **                                                                                                                                   | ** ** | ** **                                                                                                      | ** ** |
| ** **                                                           | ** ** | **July 31,**          | ** ** | **June 30,** | ** ** | ** **                                                                                                                                   | ** ** | ** **                                                                                                      | ** ** |
| ** **                                                           | ** ** | **2009**                   | ** ** | **2009**          | ** ** | **Interest  Rate**                                                                                                                           | ** ** | **Other  Terms and Conditions**                                                                                 | ** ** |
| ** **                                                           | ** ** | **(Dollars  in millions)** | ** ** | ** **        | ** ** | ** **                                                                                                                                   | ** ** |
|                                                                 |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| Bank of Scotland $225 million  revolving loan facility (1)           |       | $                          | 225        |              | $          | 162                                                                                                                                          |       | LIBOR + 2.0% - 2.50%                                                                                            |       | Secured by security interests in assets of FirstCity and wholly-owned subsidiaries,  matures November 2010 |   |
|                                                                 |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| Bank of Scotland $100  million revolving loan facility               |       | 100                        |       | 78                |       | LIBOR + 2.0%                                                                                                                                 |       | Secured by assets of FH Partners and guaranteed by FirstCity, matures November 2010                        |       |
|                                                                 |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| BoS(USA) $25 million  subordinated credit agreement                  |       | 25                         |       | 11                |       | LIBOR + 5.0%                                                                                                                                 |       | Secured by security interests in assets of FirstCity and wholly-owned subsidiaries,  matures November 2010 |       |
|                                                                 |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| American Bank term loan                                              |       | 1                          |       | 1                 |       | 5.0% fixed                                                                                                                                   |       | Secured by assets of FC Washington and guaranteed by FirstCity,  matures May 2011                          |       |
|                                                                 |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| Participation payable                                                |       | 1                          |       | 1                 |       | 10.38% imputed rate                                                                                                                          |       | Participation agreement on 33% of net cash flows received on a  portfolio                                       |       |
|                                                                 |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| Banco Santander term loan denominated  in Mexican pesos              |       | 11                         |       | 11                |       | Rate based on 28 day Mexican index rate (TIIE) plus 2.0%                                                                                     |       | Secured by Bank of Scotland letter of credit, matures  November 2009, commitment amount 142.2 million MXN  |       |
|                                                                 |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| Wells Fargo  Foothill, Inc. $25 million revolving loan facility |       | 25                         |       | 14                |       | Greater of (1) LIBOR+ margin or 3.625%, or (2) greater of 7.5%  or (i) Wells Fargo prime + 2.625% or (ii) LIBOR + 2.625% |       | Secured by assets of ABL and guaranteed by FirstCity, matures January 2010                                 |       |
| ** **                                                           |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| Bank of America term loan                                            |       | 3                          |       | 3                 |       | LIBOR + 2.25%                                                                                                                                |       | Secured by assets of consolidated railroad subsidiaries, matures  March 2011                               |       |
|                                                                 |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| Bank of America revolving  loan facility                             |       | 1                          |       | —            |       | Option of Base Rate (greater of prime or federal funds rate + 0.5%)  plus margin, or LIBOR plus margin                                       |       | Secured by assets of consolidated railroad subsidiaries, matures  March 2011                               |       |
|                                                                 |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| Merrill Lynch Mortgage  Trust term loan                              |       | 8                          |       | 8                 |       | 6.07% fixed                                                                                                                                  |       | Secured by assets of Oregon Short Line Building, matures  April 2016                                       |       |
|                                                                 |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| B.E.S.V. term loan                                                   |       | 7                          |       | 7                 |       | one month Eurobor + 3.5%                                                                                                                     |       | Secured by UBN, SA’s beneficial interests in certain entities, matures  May 2011                      |       |
|                                                                 |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| Notes payable to banks                                               |       | 407                        |       | 296               |       |                                                                                                                                         |       |                                                                                                            |       |
|                                                                 |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| MCS Trust SA de CV term  loan (affiliate note payable)               |       | 9                          |       | 9                 |       | 20.0% fixed                                                                                                                                  |       | Secured by assets of FC Acquisitions, SRL de CV, matures  June 2020                                        |       |
|                                                                 |       |                       |       |              |       |                                                                                                                                         |       |                                                                                                            |       |
| Total                                                                |       | $                          | 416        |              | $          | 305                                                                                                                                          |       |                                                                                                            |       |   |   |

 

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(1)          The Bank of Scotland facility allows loans to be madein Euros up to a maximum amount in Euros that is equivalent to $50.0 million.At June 30, 2009, the Company had approximately $29.1 million outstandingunder the Euro-denominated portion of this facility.

 

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**Forward-Looking Statements**

 

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

 

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

 

Forward-looking statementsspeak only as of the date the statement is made, and we have no obligation topublicly update or revise our forward-looking statements to reflect facts,circumstances, assumptions or events that occur after the date theforward-looking statements are made. Actual results could differ materiallyfrom those anticipated in forward-looking statements, and future results coulddiffer materially from historical performance.

 

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

 

**Interest Rate Risk**

 

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

 

The Companyinvests in Portfolio Assets both directly through consolidated subsidiaries andindirectly through equity investments in Acquisition Partnerships. 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.

 

Loans receivableconsist primarily of loans made to affiliated entities (including Acquisition Partnerships)and non-affiliated entities, and generally bear interest at fixed rates. Therepayment of the loans is generally dependent upon future cash flows of theborrowers, future cash flows of the underlying collateral, and distributionsfrom affiliated entities. Since these loans are predominantly fixed-ratefinancial instruments, changes in market interest rates would not have asignificant impact on the collectibility of these loans.

 

SBA loans receivable were $19.7 million at June 30, 2009, of which$3.5 million were related to the guaranteed portion of these loans. Theguaranteed portion is backed by the full faith and credit of the U.S. SmallBusiness Administration, and is generally sold into the secondary market.Virtually all of the SBA loans have variable interest rates. Assuming that thebalance sheet were to remain constant and no actions were taken to modify theexisting interest rate sensitivity, a hypothetical immediate change in interestrates would have a minimal effect on interest income from SBA loans for thesecond quarter of 2009. Although management believes that this measure isindicative of our sensitivity to interest rate changes, it does not adjust forpotential changes in credit quality, size and composition of the assets on thebalance sheet, and other business developments that could affect a net increase(decrease) in assets. Accordingly, no assurances can be given that actualresults would not differ materially from the potential outcome simulated bythis estimate.

 

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FirstCityhad $304.6 million in debt outstanding at June 30, 2009. The Company isexposed to interest rate risk primarily through its variable rate debt, whichtotaled $287.9 million or 94.5% of the Company’s total debt. A 50 basispoint change in interest rates would increase or decrease FirstCity’s annualinterest expense by approximately $1.4 million.

 

**ForeignCurrency Risk**

 

TheCompany currently has loans and equity investments in Europe and Latin America(i.e. Mexico, Argentina, Brazil and Chile). The Company’s investments in theseregions are primarily in the form of equity and represent a significant portionof the Company’s total equity investments. As previously discussed, therevolving acquisition facility with Bank of Scotland for $225.0 millionprovides that the Company may borrow up to a maximum amount in Euros that isequivalent to U.S. $50 million. At June 30, 2009, the Company had U.S.$29.1 million in Euro-denominated debt for the purpose of hedging a portion ofthe net equity investments in Europe. In November 2006, the Companyacquired a term note with Banco Santander, S.A. At June 30, 2009, theCompany had 142,240,000 in Mexican peso-denominated debt, which was equivalentto U.S. $10.8 million. Management of the Company feels that these loanagreements will help reduce the risk of adverse effects of currency changes onthese investments.

 

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

 
| ** ** | ** ** | ** ** | ** ** | **One U.S.  dollar  equals** | ** ** | **Estimated decline in  valuation of investments  resulting from  incremental depreciation  of foreign currency of  (dollars in thousands)** | ** ** |
|------------|------------|------------|------------|------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** ** | ** ** | ** ** | ** ** | ** **                   | ** ** | **5%**                                                                                                                                       | ** ** | **10%** | ** ** |
|       |       |       |       |                         |       |                                                                                                                                         |       |   |   |
| Europe     |       | EUR        |       | 0.71                         |       | $                                                                                                                                            | 2,045      |   | $ | 3,915 |   |
|       |       |       |       |                         |       |                                                                                                                                         |       |   |   |
| Mexico     |       | MXN        |       | 13.20                        |       | $                                                                                                                                            | 1,905      |   | $ | 3,679 |   |
|       |       |       |       |                         |       |                                                                                                                                         |       |   |   |
| Chile      |       | CLP        |       | 539.98                       |       | $                                                                                                                                            | 164        |   | $ | 312 |   |
|       |       |       |       |                         |       |                                                                                                                                         |       |   |   |
| Brazil     |       | BRL        |       | 1.95                         |       | $                                                                                                                                            | 21         |   | $ | 41 |   |
|       |       |       |       |                         |       |                                                                                                                                         |       |   |   |
| Argentina  |       | ARS        |       | 3.80                         |       | $                                                                                                                                            | 31         |   | $ | 60 |   |

 

**Item 4.  Controls and Procedures.**

 

*Evaluation of DisclosureControls and Procedures*

 

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

 

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*Changes in Internal Controls*

 

In connection with the evaluation required byparagraph (d) of Rule 13a-15 under the Exchange Act, there was nochange identified in our internal control over financial reporting thatoccurred during the last fiscal quarter that has materially affected, or isreasonably likely to materially affect, our internal control over financialreporting.

 

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**PART II**

 

**OTHER INFORMATION**

** **

**Item 1.  Legal Proceedings.**

 

Thefollowing information and discussion supplements and amends the discussionunder Part I, Item 3 “Legal Proceedings” in our 2008 Form 10-K.

 

On June 4,2009, the Company received notice of the issuance of an opinion by the Court ofAppeals for the First District of Texas in FCLT Loans Asset Corp. and TimothyJ. Blair, class representative v. FirstCity Financial Corporation in which theCourt of Appeals denied the joint motion of the parties to the suit to abatethe appeal, reversed the judgment in favor of FirstCity and remanded the caseto the trial court. The Court held that JPMorgan, as successor trustee, is thelegal owner of the demutualized proceeds interpled by Prudential Financial, Inc.,and that the trustee’s participation is necessary to determine the appropriatedisbursement of the demutualization proceeds. On June 19, 2009, FirstCirtyfiled a motion for rehearing in the First District Court of Appeals on thebasis that the Court of Appeals could not reverse the decision of the trialcourt on basis of error that was not assigned, presented, preserved, or briefedby the parties on appeal.

 

The Interpleader Suit was originally filed byPrudential to determine the ownership of stock and dividends that becameavailable as a result of the demutualization of Prudential Insurance Company ofAmerica (“Prudential Insurance”). On March 21, 2006, the trial courtentered an order granting FirstCity’s motion for partial summary judgment andrendered judgment in favor of FirstCity as to the ownership of thedemutualization proceeds. On November 25, 2008, the parties to the suitreached a preliminary agreement to settle the lawsuit involving the disputedownership of approximately $18.6 million of proceeds from the demutualizationof Prudential Insurance Company. A court-ordered mediation was held on November 18,2008 and following the unsuccessful mediation the mediator submitted hisproposal to the three claimants. The mediator’s proposal accepted by theclaimants on November 25, 2008 provided for each of the parties to receive25% of the demutualization proceeds (approximately $4,650,000 each) uponapproval of the settlement by the trial court, and for the remaining 25%($4,650,000) to be held pending the determination of the appeal by the Court ofAppeals. The settlement was subject to the approval by the Court of Appeals ofthe motion to abate the appeal to allow the trial court to consider approval ofthe settlement involving the class of former employees, which motion was deniedby the Court of Appeals in its opinion.

 

**Item 1A.  Risk Factors.**

 

There have been no material changes to the risk factors as previously disclosedunder Item 1A in our 2008 Form 10-K.

 

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

 

None.

 

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

 

None.

 

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

 

None.

 

**Item 5.  OtherInformation.**

 

The Compensation Committee of the Board of Directorsapproved a bonus to Joe Greak, an executive officer of the Company, in theamount of $100,000 payable upon receipt of a settlement payment from anysettlement of the Prudential Litigation. The recommendation of the Compensation Committee was approved by theBoard of Directors of FirstCity.

 

**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) |

 

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| 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   |   | — | Contribution and  Assumption Agreement by and between Funding LP and Drive dated as of  August 18, 2000. (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)                                                                                                                                                                                                 |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.2   |   | — | 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)                                                                                                                                                                                                  |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.3   |   | — | 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)                                                                                                                                                                                                                                                 |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.4   |   | — | 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)                                                                                     |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.5   |   | — | Revolving Credit  Agreement, dated November 12, 2004, among FirstCity Financial  Corporation as Borrower and the Lenders named therein, as Lenders, and Bank  of Scotland, as Agent (incorporated herein by reference to Exhibit 10.12  of the Company’s Form 10-Q dated November 15, 2004)                                                                                                                                                                          |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.6   |   | — | 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)                                                                                                                                                                                                                                                                                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.7   |   | — | 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)                                                                                                                                                                                                                                                                                                            |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.8   |   | — | 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)                                                                                                                                                                                                                                                                                                              |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.9   |   | — | 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)                                                                                                                                                                                          |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.10  |   | — | 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) |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
| 10.11  |   | — | 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)                                                                                                           |

 

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

 

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|   |   |   | herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  September 10, 2007)                                                                                                                                                                                                                                                                            |
|--------|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.29  |   | — | Letter agreement  between FirstCity Financial Corporation and Bank of Scotland extending time  period for closing of subordinate credit facility to be provided by BoS  (USA,) Inc. to October 2, 2007 (incorporated herein by reference to  Exhibit 10.2 of the Company’s Form 8-K dated September 10,  2007)                                                  |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.30  |   | — | Letter agreement  between FirstCity Financial Corporation and BoS(USA), Inc. extending  time period for closing of subordinate credit facility to be provided by  BoS(USA), Inc. to October 31, 2007 (incorporated herein by reference  to Exhibit 10.1 of the Company’s Form 8-K dated October 5,  2007)                                             |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.31  |   | — | Letter agreement  between FirstCity Financial Corporation and Bank of Scotland extending time  period for closing of subordinate credit facility to be provided by BoS(USA), Inc.  to October 31, 2007 (incorporated herein by reference to  Exhibit 10.2 of the Company’s Form 8-K dated October 5, 2007)                                                 |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.32  |   | — | Letter agreement  between FirstCity Financial Corporation and BoS(USA), Inc. extending  time period for closing of subordinate credit facility to be provided by  BoS(USA), Inc. to November 16, 2007 (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  November 8, 2007)                                           |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.33  |   | — | Letter agreement  between FirstCity Financial Corporation and Bank of Scotland which amended  the Revolving Credit Agreement to extend time period for closing of  subordinate credit facility to be provided by BoS(USA), Inc. to  November 16, 2007 (incorporated herein by reference to Exhibit 10.2  of the Company’s Form 8-K dated November 8, 2007) |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.34  |   | — | Amendment and  Consent No. 25 to Revolving Credit Agreement, dated as of July 14,  2008, among FirstCity Financial Corporation as Borrower and the Lenders named  therein, as Lenders, and Bank of Scotland, as Agent (incorporated herein by  reference to Exhibit 10.1 of the Company’s Form 8-K dated  July 18, 2008)                                   |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.35  |   | — | Amendment and  Consent No. 12 to Subordinated Delayed Draw Credit Agreement, dated as  of July 14, 2008, among FirstCity Financial Corporation as Borrower and  the Lenders named therein, as Lenders, and BoS(USA), Inc., as Agent  (incorporated herein by reference to Exhibit 10.2 of the Company’s  Form 8-K dated July 18, 2008)                |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.36  |   | — | Amendment and  Consent No. 6 to Revolving Credit Agreement, dated as of July 14,  2008, among FH Partners, LLC, as Borrower, and the Lenders named therein, as  Lenders, and Bank of Scotland, as Agent (incorporated herein by reference to  Exhibit 10.3 of the Company’s Form 8-K dated July 18, 2008)                                                  |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.37  |   | — | Conditional Waiver  Agreement Regarding Event of Default dated effective September 30,  2008, between American Business Lending, Inc., an affiliate of  FirstCity, as borrower, and Wells Fargo Foothill, LLC, as lender  (incorporated herein by reference to Exhibit 10.40 of the Company’s  Form 10-Q dated November 10, 2008)                |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.38  |   | — | Conditional  Waiver Under Loan Agreement dated November 10, 2008, between American  Business Lending, Inc., an affiliate of FirstCity, as borrower, and  Wells Fargo Foothill, LLC, as lender (incorporated herein by reference to  Exhibit 10.41 of the Company’s Form 10-Q dated November 10,  2008)                                                     |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.39  |   | — | Amendment and  Consent No. 27 to Revolving Credit Agreement, dated as of  December 12, 2008, among FirstCity Financial Corporation as Borrower and  the Lenders named therein, as Lenders, and Bank of Scotland, as Agent  (incorporated herein by reference to Exhibit 10.1 of the Company’s  Form 8-K dated December 15, 2008)                           |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.40  |   | — | Amendment and  Consent No. 14 to Subordinated Delayed Draw Credit Agreement, dated as  of December 12, 2008, among FirstCity Financial Corporation as Borrower  and the Lenders named therein, as Lenders, and BoS(USA), Inc., as Agent  (incorporated herein by reference to Exhibit 10.2 of the Company’s  Form 8-K dated December 15, 2008)        |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.41  |   | — | Amendment and  Consent No. 7 to Revolving Credit Agreement, dated as of  December 12, 2008, among FH Partners, LLC, as Borrower, and the Lenders  named therein, as Lenders, and Bank of Scotland, as Agent (incorporated  herein by reference to Exhibit 10.3 of the Company’s Form 8-K dated  December 15, 2008)                                         |
|   |   |   |                                                                                                                                                                                                                                                                                                                                                                                     |
| 10.42  |   | — | Mediator’s Proposal, dated November 20, 2008,  among Michael S. Wilk, as mediator appointed by the Court of Appeals for the  First District for the State of Texas, and agreed to by the FCLT Loans Asset  Corporation*,*FirstCity                                                                                                                                             |

 

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|   |   |       | Financial  Corporation*,*Timothy J. Blair,  Class Representative of former employees of FirstCity Bancorporation of  Texas, Inc.*,*and JP Morgan  Chase Bank, N.A., successor trustee (incorporated herein by reference to  Exhibit 10.4 of the Company’s Form 8-K dated December 15,  2008)                                                   |
|--------|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |       |                                                                                                                                                                                                                                                                                                                                                                         |
| 10.43  |   | —     | Conditional  Waiver Agreement Regarding Event of Default, dated and effective as of  December 31, 2008, between American Business Lending, Inc., an  affiliate of FirstCity, as borrower, and Wells Fargo Foothill, Inc., as  lender (incorporated herein by reference to Exhibit 10.1 of the  Company’s Form 8-K dated February 4, 2009) |
|   |   |       |                                                                                                                                                                                                                                                                                                                                                                         |
| 10.44  |   | —     | Amendment  No. 3 to Loan Agreement, dated February 18, 2009, by and  between American Business Lending, Inc., as Borrower, and Wells Fargo  Foothill, LLC, as Lender (incorporated herein by reference to  Exhibit 10.44 of the Company’s Form 10-Q dated May 12, 2009)                                                         |
|   |   |       |                                                                                                                                                                                                                                                                                                                                                                         |
| 10.45  |   | —     | Amended and  Restated General Continuing Limited Guaranty, dated February 18, 2009,  by FirstCity Financial Corporation, as Guarantor, and Wells Fargo Foothill,  LLC, as Lender (incorporated herein by reference to Exhibit 10.45 of the  Company’s Form 10-Q dated May 12, 2009)                                                                 |
|   |   |       |                                                                                                                                                                                                                                                                                                                                                                         |
| 10.46  |   | —     | Separation  Agreement, Release and Amendment to Award Agreements dated June 4, 2009,  by and between Richard J. Vander Woude, FirstCity Servicing Corporation and  FirstCity Financial Corporation (incorporated herein by reference to  Exhibit 10.1 of the Company’s Form 8-K dated June 5, 2009)                                                 |
|   |   | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                   |
| 10.47  |   | —     | Retainer  Agreement, dated June 4, 2009, by and between Richard J. Vander Woude,  FirstCity Servicing Corporation and FirstCity Financial Corporation  (incorporated herein by reference to Exhibit 10.2 of the Company’s  Form 8-K dated June 5, 2009)                                                                                             |
|   |   |       |                                                                                                                                                                                                                                                                                                                                                                         |
| 31.1*  |   | —     | Certification of  the Chief Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                |
|   |   |       |                                                                                                                                                                                                                                                                                                                                                                         |
| 31.2*  |   | —     | Certification of  the Chief Financial Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                                |
|   |   |       |                                                                                                                                                                                                                                                                                                                                                                         |
| 32.1*  |   | —     | Certification of  the Chief Executive Officer pursuant to 18 U.S.C Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                              |
|   |   |       |                                                                                                                                                                                                                                                                                                                                                                         |
| 32.2*  |   | —     | Certification of  the Chief Financial Officer pursuant to 18 U.S.C Section 1350 as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                              |

 

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* Filed herewith.

 

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**SIGNATURES**

 

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

 
|                        | FIRSTCITY FINANCIAL CORPORATION |
|-----------------------------|---------------------------------|
| Dated: August 13, 2009 |                            |   |
|                        |                            |   |
|                        |                            |   |
|                        | By:                             | /s/ JAMES T. SARTAIN |
|                        |                            | James T. Sartain |
| * *                    |                            | *President and Chief Executive* |
| * *                    |                            | *Officer and Director* |
| * *                    |                            | *(Duly authorized officer and* |
| * *                    |                            | *Principal Executive Officer)* |
| * *                    | * *                        | * * |
| * *                    | * *                        | * * |
|                        | By:                             | /s/J. BRYAN BAKER |
|                        |                            | J. Bryan Baker |
| * *                    |                            | *Senior Vice President and Chief* |
| * *                    |                            | *Financial Officer* |
| * *                    |                            | *(Duly authorized officer and* |
| * *                    |                            | *Principal Financial Officer)* |

 

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