Quarterly Report (10-q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

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) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

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

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

Large accelerated filer o		Accelerated filer o

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

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

The number of shares of common stock, par value $.01 per share, outstanding at May 7, 2013 was 10,563,697.

Table of Contents

TABL E OF CONTENTS

	PART I

Item 1.	Financial Statements	3
	Consolidated Balance Sheets	3
	Consolidated Statements of Operations	4
	Consolidated Statements of Comprehensive Income (Loss)	5
	Consolidated Statements of Stockholders’ Equity	6
	Consolidated Statements of Cash Flows	7
	Notes to Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	43
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	65
Item 4.	Controls and Procedures	65

	PART II OTHER INFORMATION	66

Item 1.	Legal Proceedings	66
Item 1A.	Risk Factors	66
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	66
Item 3.	Defaults Upon Senior Securities	66
Item 4.	Mine Safety Disclosures	66
Item 5.	Other Information	66
Item 6.	Exhibits	67
SIGNATURES		68

Table of Contents

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

	March 31,			December 31,
	2013			2012
	(Unaudited)
ASSETS
Cash and cash equivalents	$	33,076		$	39,347
Portfolio Assets:
Loan portfolios, net of allowance for loan losses of $417 and $394	39,331			44,904
Real estate held for sale, net	12,133			10,171
Total Portfolio Assets	51,464			55,075
Loans receivable:
Loans receivable - affiliates	6,522			6,584
Loans receivable - other, net of allowance for loan losses of $-0- and $1,083	5,168			7,530
Total loans receivable, net	11,690			14,114
Investment securities available for sale	1,314			1,670
Investments in unconsolidated subsidiaries	67,219			77,466
Service fees receivable ($704 and $793 from affiliates)	721			817
Assets held for sale	27,439			24,143
Other assets	30,234			32,005
Total Assets (1)	$	223,157		$	244,637

LIABILITIES AND EQUITY
Liabilities:
Notes payable to banks and other debt obligations	$	49,277		$	61,731
Liabilities associated with assets held for sale	19,896			16,664
Other liabilities	19,803			28,975
Total Liabilities (2)	88,976			107,370
Commitments and contingencies (Note 17)
Stockholders’ equity:
Optional preferred stock (par value $.01 per share; 98,000,000 shares authorized; no shares issued or outstanding)	—			—
Common stock (par value $.01 per share; 100,000,000 shares authorized; shares issued: 12,056,197 and 12,056,197, respectively; shares outstanding: 10,556,197 and 10,556,197, respectively)	121			121
Treasury stock, at cost: 1,500,000 shares	(10,923		)	(10,923		)
Paid in capital	107,636			107,378
Retained earnings	30,221			32,729
Accumulated other comprehensive loss	(534		)	(577		)
FirstCity Stockholders’ Equity	126,521			128,728
Noncontrolling interests	7,660			8,539
Total Equity	134,181			137,267
Total Liabilities and Equity	$	223,157		$	244,637

(1) Our consolidated assets at March 31, 2013 and December 31, 2012 include the following assets of certain variable interest entities (“VIEs”) that can only be used to settle the liabilities of those VIEs: Cash and cash equivalents, $15.7 million and $22.3 million; Portfolio Assets, $39.4 million and $42.1 million; Loans receivable, $10.2 million and $12.7 million; Equity investments, $11.7 million and $21.6 million; Assets held for sale, $27.4 million and $24.1 million; various other assets, $28.5 million and $31.1 million; and Total assets, $132.9 million and $153.8 million, respectively.

(2) Our consolidated liabilities at March 31, 2013 and December 31, 2012 include the following VIE liabilities for which the VIE creditors do not have recourse to FirstCity: Notes payable, $22.6 million and $26.5 million; Liabilities associated with assets held for sale, $1.5 million and $1.4 million; Other liabilities, $12.2 million and $16.8 million; and Total liabilities, $36.3 million and $44.7 million, respectively.

See accompanying notes to consolidated financial statements.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

(Dollars in thousands, except per share data)

	Three Months Ended
	March 31,
	2013			2012
Revenues:
Servicing fees ($2,411 and $5,505 from affiliates, respectively)	$	2,449		$	5,575
Income from Portfolio Assets	1,936			8,505
Interest income from loans receivable - affiliates	79			280
Interest income from loans receivable - other	90			101
Revenue from railroad operations	4,118			1,685
Other income	1,402			2,541
Total revenues	10,074			18,687
Costs and expenses:
Interest and fees on notes payable to banks and other	745			1,519
Salaries and benefits	4,734			5,840
Provision for loan and impairment losses	58			224
Asset-level expenses	615			1,055
Costs and expenses from railroad operations	3,428			1,228
Other costs and expenses	3,451			3,196
Total costs and expenses	13,031			13,062
Earnings (loss) before other revenue and income taxes	(2,957		)	5,625
Equity income from unconsolidated subsidiaries	799			4,467
Earnings (loss) before income taxes	(2,158		)	10,092
Income tax expense (benefit)	(75		)	832
Earnings (loss) from continuing operations, net of tax	(2,083		)	9,260
Discontinued operations
Income from discontinued operations, net of provision for income taxes of $1 and $1, respectively	111			213
Net earnings (loss)	(1,972		)	9,473
Less: Net income attributable to noncontrolling interests	536			1,108
Net earnings (loss) attributable to FirstCity	$	(2,508	)	$	8,365

Basic earnings (loss) per share of common stock
Earnings (loss) from continuing operations	$	(0.25	)	$	0.78
Discontinued operations	$	0.01		$	0.02
Net earnings (loss)	$	(0.24	)	$	0.80

Diluted earnings (loss) per share of common stock
Earnings (loss) from continuing operations	$	(0.25	)	$	0.78
Discontinued operations	$	0.01		$	0.02
Net earnings (loss)	$	(0.24	)	$	0.80

See accompanying notes to consolidated financial statements.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)

(Dollars in thousands)

	Three Months Ended
	March 31,
	2013			2012
Net earnings (loss)	$	(1,972	)	$	9,473
Other comprehensive income (loss), net of tax:
Net unrealized gain (loss) on securities available for sale	(51		)	460
Foreign currency translation adjustments	95			1,607
Total other comprehensive income, net of tax	44			2,067
Total comprehensive income (loss)	(1,928		)	11,540
Less comprehensive income attributable to noncontrolling interests:
Net income	(536		)	(1,108		)
Net unrealized (gain) loss on securities available for sale, net of tax	—			(13		)
Foreign currency translation adjustments	(1		)	(317		)
Comprehensive income (loss) attributable to FirstCity	$	(2,465	)	$	10,102

See accompanying notes to consolidated financial statements.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (Unaudited)

(Dollars in thousands)

	FirstCity Stockholders
												Accumulated
												Other			Non-
	Common		Treasury			Paid in			Retained			Comprehensive			controlling			Total
	Stock		Stock			Capital			Earnings			Income (Loss)			Interests			Equity

Balances, December 31, 2011	$	119	$	(10,923	)	$	106,330		$	18,391		$	(1,941	)	$	25,427		$	137,403
Net earnings	—		—			—			8,365			—			1,108			9,473
Change in net unrealized gain on securities available for sale, net of tax	—		—			—			—			447			13			460
Foreign currency translation adjustments	—		—			—			—			1,290			317			1,607
Issuance of common stock under stock- based compensation plans	2		—			(2		)	—			—			—			—
Stock-based compensation expense	—		—			204			—			—			—			204
Distributions to noncontrolling interests	—		—			—			—			—			(2,189		)	(2,189		)
Balances, March 31, 2012	$	121	$	(10,923	)	$	106,532		$	26,756		$	(204	)	$	24,676		$	146,958

Balances, December 31, 2012	$	121	$	(10,923	)	$	107,378		$	32,729		$	(577	)	$	8,539		$	137,267
Net loss	—		—			—			(2,508		)	—			536			(1,972		)
Change in net unrealized gain on securities available for sale, net of tax	—		—			—			—			(51		)	—			(51		)
Foreign currency translation adjustments	—		—			—			—			94			1			95
Stock-based compensation expense	—		—			258			—			—			—			258
Distributions to noncontrolling interests	—		—			—			—			—			(1,416		)	(1,416		)
Balances, March 31, 2013	$	121	$	(10,923	)	$	107,636		$	30,221		$	(534	)	$	7,660		$	134,181

See accompanying notes to consolidated financial statements.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

	Three Months Ended
	March 31,
	2013			2012

Cash flows from operating activities:
Net earnings (loss)	$	(1,972	)	$	9,473
Less income from discontinued operations	(111		)	(213		)
Adjustments to reconcile net earnings to net cash used in operating activities:
Proceeds applied to income from Portfolio Assets	14			347
Income from Portfolio Assets	(1,936		)	(8,505		)
Provision for loan and impairment losses	58			224
Foreign currency transaction (gains) losses, net	238			(161		)
Equity income from unconsolidated subsidiaries	(799		)	(4,467		)
Depreciation and amortization, net	770			878
Decrease (increase) in other assets	1,455			(3,213		)
Increase (decrease) in other liabilities	(9,058		)	194
Other, net	416			292
Net cash used in operating activities	(10,925		)	(5,151		)
Cash flows from investing activities:
Purchases of property and equipment, net	(322		)	(423		)
Net principal payments on loans receivable	2,472			2,211
Net principal payments on investment securities available for sale	308			413
Purchases of Portfolio Assets	(106		)	(30		)
Proceeds applied to principal on Portfolio Assets	5,720			25,564
Contributions to unconsolidated subsidiaries	(12,590		)	(9,305		)
Distributions from unconsolidated subsidiaries	23,641			8,521
Net cash provided by investing activities	19,123			26,951
Cash flows from financing activities:
Borrowings under notes payable to banks and other	—			350
Principal payments of notes payable to banks and other	(12,822		)	(14,158		)
Distributions to noncontrolling interests	(1,416		)	(2,189		)
Other, net	(64		)	(40		)
Net cash used in financing activities	(14,302		)	(16,037		)
Effect of exchange rate changes on cash and cash equivalents	(30		)	681
Net cash used in continuing operations	(6,134		)	6,444
Cash flows from discontinued operations (see Note 3):
Net cash used in operating activities	(2,128		)	4,844
Net cash used in investing activities	(1,085		)	(634		)
Net cash provided by financing activities	3,076			(4,229		)
Net cash used in discontinued operations	(137		)	(19		)
Net increase (decrease) in cash and cash equivalents	(6,271		)	6,425
Cash and cash equivalents, beginning of period	39,347			34,326
Cash and cash equivalents, end of period	$	33,076		$	40,751

Supplemental disclosure of cash flow information:
Cash paid during the period for interest from continuing operations	$	261		$	735
Cash paid during the period for interest from discontinued operations	151			221
Cash paid during the period for income taxes, net of refunds	215			328

See accompanying notes to consolidated financial statements.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(1) Basis of Presentation and Summary of Significant Accounting Policies

Nature of Operations

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

The Company engages in two major business segments — Portfolio Asset Acquisition and Resolution and Special Situations Platform. The Portfolio Asset Acquisition and Resolution business has been the Company’s core business segment since it commenced operations in 1986. In the Portfolio Asset Acquisition and Resolution business, the Company acquires portfolios of under-performing and non-performing loans, and to a lesser extent, performing loans and other assets (collectively, “Portfolio Assets” or “Portfolios”), generally at a discount to their legal principal balances or appraised values, and services and resolves such Portfolio Assets in an effort to maximize the present value of the ultimate cash recoveries. FirstCity acquires the Portfolio Assets for its own account or through investment entities formed with one or more other co-investors (each such entity, an “Acquisition Partnership”). The Company engages in its Special Situations Platform business through its majority ownership in a subsidiary that was formed in April 2007. Through its Special Situations Platform, the Company provides investment capital to privately-held lower middle-market companies through flexible capital structuring arrangements to generate an attractive risk-adjusted return. These capital investments primarily take the form of senior and junior financing arrangements, but also include direct equity investments and common equity warrants. In addition, our Special Situations Platform business engages in distressed debt transactions and leveraged buyouts. Refer to Note 16 for additional information on the Company’s major business segments.

In December 2012, the Company entered into a definitive merger agreement with Hotspurs Holdings LLC (“Parent”) and Hotspurs Acquisition Corporation (“Merger Subsidiary”) pursuant to which the Company will become a private company that is wholly owned by Parent. Parent and Merger Subsidiary are affiliates of certain private investment funds governed by Värde Partners, Inc. (“Värde”). Under the terms of the merger agreement, FirstCity stockholders will receive $10.00 per share in cash for each share of FirstCity stock they own. The transaction is expected to close in the second quarter of 2013. Consummation of the merger is subject to various customary conditions, including the adoption of the merger agreement by the holders of at least a majority of the outstanding shares of the Company’s common stock. The Company has filed a preliminary proxy statement with the Securities and Exchange Commission recommending that the Company’s stockholders adopt the merger agreement.

Basis of Presentation

The accompanying unaudited consolidated financial statements in this Form 10-Q were prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the consolidated financial statements do not include all of the information and footnote disclosures required by GAAP for complete consolidated financial statements. In the opinion of management, the accompanying consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the Company’s financial position and results of operations. The interim results of operations disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period. These interim consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and footnotes thereto included in our annual report on Form 10-K for the year ended December 31, 2012 (“2012 Form 10-K”).

The accompanying consolidated financial statements in this Form 10-Q include the accounts of FirstCity, its wholly-owned and majority-owned subsidiaries, and certain variable interest entities in which we are the primary beneficiary as prescribed by the Financial Accounting Standards Board’s (the “FASB”) accounting guidance on variable interest entities (see discussion below). All significant intercompany transactions and balances have been eliminated in consolidation. Certain amounts in the consolidated financial statements and disclosures for prior periods were reclassified to conform to the current period presentation. These reclassifications were not significant and have no impact on FirstCity’s net earnings, total assets or stockholders’ equity.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Consolidated Subsidiaries

If we determine that we have a controlling financial interest in an entity, then we must consolidate the assets, liabilities and noncontrolling interests of the entity in our consolidated financial statements. A controlling financial interest typically arises as a result of ownership of a majority of the voting interests of an entity. However, we may also have a controlling financial interest in an entity through an arrangement that does not involve voting interests, such as a variable interest entity (“VIE”). We consolidate all VIEs in which we are the primary beneficiary as prescribed by the FASB’s accounting guidance on the consolidation of VIEs. The primary beneficiary of a VIE is the party that has the power to direct the activities that most-significantly impact the economic performance of the entity and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the entity. Refer to Note 14 for more information regarding the Company’s involvement with VIEs.

Unconsolidated Subsidiaries

The Company does not consolidate investments in entities that are not VIEs in which the Company does not have an effective controlling interest, or investments in entities that are VIEs in which the Company is not the primary beneficiary. Rather, such investments, which represent equity investments in non-publicly-traded entities, are accounted for under the equity method of accounting since the Company has the ability to exercise significant influence (but not control) over operating and financial policies of such subsidiaries (including certain entities where we have less than 20% ownership). FirstCity has the ability to exercise significant influence over the operating and financial policies of its less-than-20%-owned entities, despite its comparatively smaller ownership percentage, due primarily to its active participation in the policy-making process as well as its involvement in the daily management activities of the entities.

Under the equity method of accounting, the Company’s investments in these unconsolidated entities are carried at the cost of acquisition, plus the Company’s share of equity in undistributed earnings or losses since acquisition. We eliminate transactions with our equity-method subsidiaries to the extent of our ownership in such subsidiaries. Accordingly, our share of the income or losses of these equity-method subsidiaries is included in our consolidated net income.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates that are particularly susceptible to significant change in the near-term relate to (1) the estimation of future collections on Portfolio Assets used in the calculation of income from Portfolio Assets; (2) valuation of deferred tax assets and assumptions used in the calculation of income taxes; (3) valuation of servicing assets, investment securities, loans receivable (including loans receivable held in securitization entities) and related allowances for loan losses, real estate, and investments in unconsolidated subsidiaries; (4) guarantee obligations and indemnifications; and (5) legal contingencies. In addition, management has made significant estimates with respect to the valuation of assets, liabilities, non-controlling interests and contingencies attributable to business combinations. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment. We adjust such estimates and assumptions when facts and circumstances dictate. The continuance of challenging economic conditions and disruptions in the financial, capital, real estate and foreign currency markets, have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in these estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.

Portfolio Assets

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

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

The following is a description of the classifications and related accounting policies for the Company’s significant classes of Portfolio Assets:

Purchased Credit-Impaired Loans

The Company accounts for acquired loans and loan portfolios with evidence of credit deterioration since origination (“Purchased Credit-Impaired Loans”) at fair value on the acquisition date. The amounts paid for Purchased Credit-Impaired Loans reflect the Company’s determination that the loans have experienced deterioration in credit quality since origination and that it is probable the Company will be unable to collect all amounts due according to the contractual terms of the underlying loans. At acquisition, the Company reviews each individual loan to determine whether there is evidence of deterioration of credit quality since origination and if it is probable that the Company will be unable to collect all amounts due according to the loan’s contractual terms. If both conditions exist, the Company determines whether each such loan is to be accounted for individually or whether such loans will be assembled into static pools based on common risk characteristics (primarily loan type and collateral). Static pools of individual loan accounts may be established and accounted 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 (unless the Company sells, forecloses or writes off the loan). At acquisition, the Company determines the excess of the scheduled contractual payments over all cash flows expected to be collected for the loan or loan pool as an amount that should not be accreted (“nonaccretable difference”). The excess of the cash flows from the loan or loan pool expected to be collected at acquisition over the initial investment (“accretable difference”) is recognized as interest income over the remaining life of the loan or loan pool on a level-yield basis (“accretable yield”). The discount (i.e. the difference between the cost of each loan or loan pool and the related aggregate contractual receivable balance) is not recorded because the Company does not expect to fully collect each contractual receivable balance. As a result, these loans and loan pools are recorded at cost (which approximates fair value) at the time of acquisition.

The Company accounts for Purchased Credit-Impaired Loans using either the interest method or a non-accrual method (through application of the cost-recovery or cash basis method of accounting). Application of the interest method is dependent on management’s ability to develop a reasonable expectation as to both the timing and amount of cash flows expected to be collected. In the event the Company cannot develop or establish a reasonable expectation as to both the timing and amount of cash flows expected to be collected, the Company uses the cost-recovery or cash basis method of accounting.

Interest method of accounting . Under the interest method, an effective interest rate, or IRR, is applied to the cost basis of the loan or loan pool. The excess of the contractual cash flows over expected cash flows cannot be recognized as an adjustment of income or expense or on the balance sheet. The IRR that is calculated when the loan is purchased remains constant as the basis for subsequent impairment testing (performed at least quarterly) and income recognition. Significant increases in actual, or expected future cash flows, are used first to reverse any existing valuation allowance for that loan or loan pool; and any remaining increase may be recognized prospectively through an upward 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 testing and income recognition. Subsequent decreases in projected cash flows do not change the IRR, but are recognized as an impairment of the cost basis of the loan or loan pool (to maintain the then-current IRR), and are reflected in the consolidated statements of earnings through provisions charged to operations, with a corresponding valuation allowance offsetting the loan or loan pool in the consolidated balance sheets. FirstCity establishes valuation allowances for loans and loan pools acquired with credit deterioration to reflect only those losses incurred after acquisition — that is, the cash flows expected at acquisition that are no longer expected to be collected. Income from loans and loan pools accounted for under the interest method is accrued based on the IRR of each loan or loan pool applied to their respective adjusted cost basis. Gross collections in excess of the interest accrual and impairments will reduce the carrying value of the loan or loan pool, while gross collections less than the interest accrual will increase the carrying value. The IRR is calculated based on the timing and amount of anticipated cash flows using the Company’s proprietary collection models.

Cost-recovery method of accounting. If the amount and timing of future cash collections on a loan are not reasonably estimable, the Company accounts for such asset on the cost-recovery method. Under the cost-recovery method, no income is recognized until the Company has fully collected the cost of the loan, or until such time as the Company considers the timing and amount of collections to be reasonably estimable and begins to recognize income based on the interest method as described above. At least quarterly, the Company performs an evaluation to determine if the remaining amount that is probable of collection is less than the carrying value of the loan or loan pool, and if so, recognizes impairment through provisions charged to operations, with a corresponding valuation allowance offsetting the loan or loan pool in the consolidated balance sheets. The carrying value of Purchased Credit-Impaired Loans accounted for under the cost-recovery method approximated $18.3 million at March 31, 2013 and $22.1 million at December 31, 2012.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Cash basis method of accounting. If only the amount of future cash collections on a loan is reasonably estimable, the Company accounts for such asset on an individual loan basis under the cash basis method of accounting. Under the cash basis method, no income is recognized unless collections are received during the period, or until such time as the Company considers the timing of collections to be reasonably estimable and begins to recognize income based on the interest method as described above. Income is recognized for the difference between the collections and a pro-rata portion of cost on a loan. Cost allocation is based on a proration of actual collections divided by total projected collections on the loan. Significant increases in future cash flows may be recognized prospectively as income over the remaining life of the loan through increased amounts allocated to income when collections are subsequently received. Subsequent decreases in projected cash flows are recognized as impairment of the loan’s cost basis to maintain a constant cost allocation based on initial projections. The Company evaluates the projected cash flows for these loans and loan pools at least quarterly to determine if impairment exists, and if so, recognizes the impairment through provisions charged to operations, with a corresponding valuation allowance offsetting the loan or loan pool in the consolidated balance sheets. Management uses the cash basis method of accounting for such eligible loans primarily due to the increased uncertainty in the timing of future collections (attributable primarily to the borrowers’ inability to obtain financing to refinance the loans). The carrying value of Purchased Credit-Impaired Loans accounted for under the cash basis method approximated $16.5 million and $17.6 million at March 31, 2013 and December 31, 2012, respectively.

Troubled debt restructurings (TDRs): Modified Purchased Credit-Impaired Loans are not removed from a loan pool even if those loans would otherwise be deemed TDRs. Modified Purchased Credit-Impaired Loans that are accounted for on an individual basis are considered TDRs if there has been a concession granted to the borrower and the Company does not expect to recover its recorded investment in the loan. Purchased Credit-Impaired Loans that are classified as TDRs are measured for impairment. See Troubled debt restructurings (TDRs) below for accounting guidance on loan modifications that result in classification as TDRs.

Real Estate

Real estate Portfolio Assets consist of real estate properties purchased from a variety of sellers or acquired through loan foreclosure. Rental income, net of expenses, is generally recognized when received. The Company accounts for its real estate properties on an individual-asset basis as opposed to a pool basis. The Company classifies a property as held for sale if (1) management commits to a plan to sell the property; (2) the Company actively markets the property in its current condition for a price that is reasonable in comparison to its fair value; and (3) management considers the sale of such property within one year of the balance sheet date to be probable. Real estate held for sale is stated at the lower of cost or fair value less estimated disposition costs. Real estate is not depreciated while it is classified as held for sale. Impairment losses are recorded if a property’s fair value less estimated disposition costs is less than its carrying amount, and charged to operations in the period the impairment is identified.

Real estate properties acquired through loan foreclosure are initially recorded at the lower of cost (i.e. the underlying loan’s carrying value) or estimated fair value less disposition costs 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’s fair value less estimated disposition costs at the foreclosure date is charged as a loss against operations. Expenditures for repairs, maintenance, and other holding costs are charged to operations as incurred.

Gains on disposition of real estate are recognized upon the sale of the underlying property if the transaction qualifies for gain recognition under the full accrual method, as prescribed by the FASB’s accounting guidance on real estate sales transactions. If the transaction does not meet the criteria for the full accrual method of profit recognition based on our assessment, we account for the sale based on an appropriate deferral method determined by the nature and extent of the buyer’s investment and our continuing involvement.

Loans Receivable

Loans Held for Investment

Loans receivable consisting of loans made to affiliated entities (including Acquisition Partnerships and other equity-method investees) and non-affiliated entities are classified by management as held for investment. These loans are reported at their outstanding principal balances net of any unearned income, charge-offs, unamortized deferred fees and costs on originated loans, and unamortized premiums or discounts on purchased loans. Loan origination fees and costs, as well as purchase premiums and discounts, are amortized as level-yield adjustments over the respective loan terms. Unamortized net fees, costs, premiums or discounts are

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

recognized upon early repayment or sale of the loan. Repayment of the loans is generally dependent upon future cash flows of the borrowers, future cash flows of the underlying collateral, and distributions made from affiliated entities. Interest is accrued when earned in accordance with the contractual terms of the loans, except for loans on non-accrual status. Interest is recognized on an accrual basis at the applicable interest rate on the principal amount outstanding.

The Company has established an allowance for loan losses to absorb probable, estimable losses inherent in its portfolio of loans receivable held for investment. This allowance for loan losses includes specific allowances, based on individual evaluations of certain loans and loan relationships, and allowances for pools of loans with similar risk characteristics. Management’s determination of the adequacy of the allowance is a quarterly process and is based on evaluating the collectibility of the loans in light of various factors, as applicable, such as quality and composition of the loan portfolio segments, estimated future cash receipts of the borrower’s operations or underlying collateral, historical experience, estimated value of underlying collateral, prevailing economic conditions, industry concentrations and conditions, and other relevant factors. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Actual losses experienced in the future may vary from management’s estimates. Management attributes portions of the allowance to loans that it evaluates and determines to be impaired and to groups of loans that it evaluates collectively.

In determining the appropriate level of allowance, management uses information to stratify its portfolio of loans receivable held for investment into loan pools with common risk characteristics. Classes in the affiliated and non-affiliated portfolio asset and commercial loan portfolio segments are generally disaggregated by accrual status (which is generally based on management’s assessment on the probability of default). Certain portions of the allowance are attributed to loan pools based on various factors and analyses, including but not limited to, current and historical loss experience trends, collateral, region, current economic conditions, and industry concentrations and conditions. Loans deemed to be impaired, including loans with an increased probability of default as determined by management, are evaluated individually rather than on a pool basis as described above. We consider a loan to be impaired when, based on current information and events, we determine it is probable that we will not be able to collect all amounts due according to the loan’s contractual terms (including scheduled interest payments). When management identifies a loan as impaired, we measure the impairment based on discounted future cash flows, except when foreclosure is probable or the source of repayment is the operation or liquidation of the collateral. In these cases, we use the current fair value of the collateral, less estimated selling costs, instead of discounted cash flows. When a loan is determined to be impaired, we cease to accrue interest on the note and interest previously accrued but not collected becomes part of our recorded investment in the loan and is collectively reviewed for impairment. When ultimate collectibility of the impaired note is in doubt, all collections are applied to reduce the principal amount of such notes until the principal has been recovered, and collections thereafter are recognized as interest income. We return a loan to accrual status when we determine that the collectibility of principal and interest is reasonably assured. Impairment losses are charged against an allowance account through provisions charged to operations in the period impairment is identified. Loans are written-off against the allowance when all possible means of collection have been exhausted and the potential for recovery is considered remote.

Troubled debt restructurings (TDRs): In situations where, for economic or legal reasons related to a borrower’s financial difficulties, the Company grants a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a TDR. Modification of loan terms that may be considered a concession to the borrower may include rate reductions, principal forgiveness, term extensions, payment forbearance and other actions intended to minimize our economic loss and to avoid foreclosure or repossession of the collateral. For modifications where we may forgive loan principal, the entire amount of such principal forgiveness is immediately charged-off. Loans classified as TDRs are considered impaired loans.

Accounting for Transfers and Servicing of Financial Assets

The Company accounts for transfers of financial assets as sales when control over the transferred assets is surrendered. Control is generally considered to have been surrendered when (1) the transferred assets are legally isolated from the Company or its consolidated affiliates; (2) the transferee has the right to pledge or exchange the assets with no conditions that constrain the transferee and provide more than a trivial benefit to the Company; and (3) the Company does not maintain the obligation or unilateral ability to reclaim or repurchase the assets. If these sale criteria are met, the transferred assets are removed from the Company’s balance sheet and a gain or loss on sale is recognized. If not met, the transfer is recorded as a secured borrowing, and the assets remain on the Company’s balance sheet, the proceeds from the transaction are recognized as a liability, and gain or loss on sale is deferred until the sale criterion are achieved.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

The Company generally services Portfolio Assets acquired through its investments in Acquisition Partnerships. The Company does not recognize capitalized servicing rights related to its Portfolio Assets owned by the Acquisition Partnerships because (1) servicing is not contractually separated from the underlying assets by sale or securitization of the assets with servicing retained or separate purchase or assumption of the servicing; (2) consideration is not exchanged between the Company and the Acquisition Partnerships for the servicing rights of the acquired Portfolio Assets; (3) the Company has ownership interests in the Acquisition Partnerships that own the Portfolio Assets it services; and (4) the Company does not have the risks and rewards of ownership of servicing rights. The Company services, in all material respects, the Portfolio Assets owned for its own account, the Portfolio Assets owned by the Acquisition Partnerships and, to a very limited extent, certain Portfolio Assets owned by third parties. In connection with the Acquisition Partnerships in the United States, the Company generally earns a servicing fee, which is based on a percentage of gross cash collections generated from the Portfolio Assets. The rate of servicing fee charged is generally a function of the average face value of the assets within each pool being serviced (the larger the average face value of the assets in a Portfolio, the lower the fee percentage within the prescribed range), the type of assets and the level of servicing required for each asset. For the Mexican Acquisition Partnerships, the Company earns a servicing fee based on costs of servicing plus a profit margin. The Acquisition Partnerships in Europe and South America are serviced by various entities in which the Company maintains non-controlling equity interests. In all cases, service fees are recognized when they are earned in accordance with the servicing agreements.

The Company has servicing contracts with certain of its Acquisition Partnerships that entitle the Company to receive additional compensation for servicing after a specified return to the investors has been achieved. The Company recognizes revenue related to these contracts when the required level of returns specified in the investor contracts are attained. There is no guarantee that the required level of returns to the investors will be achieved or that any additional compensation to the Company related to the contracts will be realized. The Acquisition Partnerships accrue a liability for these contingent fees provided that payment of the fees is probable and reasonably estimable.

(2) Recently Issued and Adopted Accounting Guidance

Testing of Indefinite-Lived Intangible Assets for Impairment

In July 2012, the FASB issued guidance on testing indefinite-lived intangible assets for impairment. This guidance simplifies the testing for indefinite lived intangible assets impairment by allowing an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of an indefinite lived intangible asset is less than its carrying amount before proceeding to the quantitative impairment test. We adopted this guidance for the quarterly period ended March 31, 2013. The adoption of this guidance did not have a material impact on our consolidated financial statements.

Disclosures About Offsetting Assets and Liabilities

In December 2011, the FASB issued guidance on disclosures about offsetting assets and liabilities. This guidance requires an entity to disclose both gross and net information about financial instruments, such as sales and repurchase agreements and reverse sale and repurchase agreements and securities borrowing/lending arrangements, and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement. We adopted this guidance for the quarterly period ended March 31, 2013. The adoption of this guidance did not have a material impact on our consolidated financial statements.

Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income

In February 2013, the FASB issued guidance on reporting of amounts reclassified out of accumulated other comprehensive income. This guidance requires an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. We adopted this guidance for the quarterly period ended March 31, 2013. The adoption of this guidance did not have a material impact on our consolidated financial statements.

Accounting for Cumulative Translation Adjustments

In March 2013, the FASB issued guidance guidance with respect to the reclassification into income of the cumulative translation adjustment (“CTA”) recorded in accumulated other comprehensive income associated with a foreign entity of a parent company. The guidance differentiates between transactions occurring within a foreign entity and transactions/events affecting an investment in a foreign entity. For transactions within a foreign entity, the full CTA associated with the foreign entity would be reclassified into income only when the sale of a subsidiary or group of net assets within the foreign entity represents the substantially complete liquidation of that foreign entity. For transactions/events affecting an investment in a foreign entity (for example, control or ownership of shares in a foreign entity), the full CTA associated with the foreign entity would be reclassified into income only if the parent no longer has a controlling interest in that foreign entity as a result of the transaction/event. In addition, acquisitions of a foreign entity completed in stages will trigger release of the CTA associated with an equity method investment in that entity at the point a controlling interest in the foreign entity is obtained. For the Company, this guidance is effective prospectively beginning January 1, 2014, with early adoption permitted. This guidance would impact the Company’s consolidated results of operations and financial condition only in the instance of an event/transaction as described above.

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(3) Discontinued Operations

On January 22, 2013, FirstCity Business Lending Corporation, an indirect wholly-owned subsidiary of the Company, entered into a stock purchase agreement with CS ABL Holdings, LLC to sell all of the common stock and the preferred stock of American Business Lending, Inc. (“ABL”) to CS ABL Holdings, LLC, a direct wholly-owned subsidiary of CapitalSpring Finance Company, LLC, for a total estimated purchase price of approximately $11.2 million. At December 31, 2012, the carrying value of the Company’s investment was $7.5 million. The sale is subject to the approval of the U.S. Small Business Administration, and the satisfaction of other conditions of the stock purchase agreement. ABL is included in the Company’s Portfolio Asset Acquisition and Resolution business segment. The table below represents the carrying amounts of the major classes of ABL’s assets and liabilities:

American Business Lending, Inc.

Balance Sheets

(Dollars in thousands)

	March 31,		December 31,
	2013		2012

Assets
Cash and cash equivalents	$	297	$	594
Restricted cash	1,273		1,154
Loans receivable - SBA held for sale	3,588		1,087
Loans receivable - SBA held for investment, net of allowance for loan losses of $559 and $518	20,392		19,372
Service fees receivable	58		55
Servicing assets - SBA loans	1,122		1,131
Other assets	709		750
Total Assets	$	27,439	$	24,143

Liabilities
Notes payable to bank	$	18,290	$	15,214
Other liabilities	1,606		1,450
Total Liabilities	$	19,896	$	16,664

The major components of income from discontinued operations in the consolidated statements of earnings are as follows:

American Business Lending, Inc.

Statements of Earnings

(Dollars in thousands)

	March 31,		March 31,
	2013		2012

Revenues	$	778	$	1,100
Costs and expenses	666		886
Earnings before income taxes	112		214
Income tax expense	1		1
Income from discontinued operations	$	111	$	213

ABL has a $25 million revolving loan facility with Wells Fargo Capital Finance (“WFCF”) that provides funding for ABL to finance and acquire SBA 7(a) loans. This loan facility is secured by substantially all of ABL’s assets and matures January 31, 2015. Outstanding borrowings bear interest at alternate annual rates equal to (i) LIBOR rate plus 3.50% for LIBOR rate loans; (ii) base rate (higher of LIBOR rate or Wells Fargo prime rate) plus 0.75% for base rate loans; or (iii) base rate plus 0.75%. FirstCity provides WFCF with an unconditional limited guaranty for all of ABL’s obligations under this facility up to a maximum amount of $5.0 million plus enforcement costs.

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(4) Portfolio Assets

Portfolio Assets are summarized as follows:

	March 31, 2013
	(Dollars in thousands)
	Carrying		Allowance for		Carrying
	Value		Loan Losses		Value, net
Loan Portfolios:
Purchased Credit-Impaired Loans
Domestic:
Commercial real estate	$	24,518	$	29	$	24,489
Business assets	3,712		26		3,686
Other	2,669		—		2,669
Latin America - commercial real estate	1,046		331		715
Europe - commercial real estate	3,242		—		3,242
Other	4,561		31		4,530
Total Loan Portfolios	$	39,748	$	417	39,331

Real estate held for sale, net					12,133

Total Portfolio Assets					$	51,464

	December 31, 2012
	(Dollars in thousands)
	Carrying		Allowance for		Carrying
	Value		Loan Losses		Value, net
Loan Portfolios:
Purchased Credit-Impaired Loans
Domestic:
Commercial real estate	$	28,487	$	—	$	28,487
Business assets	4,047		26		4,021
Other	3,087		—		3,087
Latin America - commercial real estate	1,034		327		707
Europe - commercial real estate	3,449		—		3,449
Other	5,194		41		5,153
Total Loan Portfolios	$	45,298	$	394	44,904

Real estate held for sale, net					10,171

Total Portfolio Assets					$	55,075

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Certain Portfolio Assets are pledged to secure a loan facility with Bank of Scotland and Bank of America (see Note 7). In addition, certain Portfolio Assets are pledged to secure notes payable of certain consolidated affiliates of FirstCity that are generally non-recourse to FirstCity or any affiliate other than the entity that incurred the debt.

In March 2012, a real estate property with a carrying value of $6.9 million (owned by a subsidiary under the Company’s Special Situations Platform business segment) was acquired by the creditor holding the mortgage secured by this property in a foreclosure transaction. The Company had the legal right to bring the account into good standing by paying all past due payments; however, the Company believed it would be unable to facilitate a positive cash flow on the property for an extended period of time based on local economic conditions. Management further believed that the property’s liquidation value was less than the debt obligation securing the property. Upon acquisition of the real estate property by the creditor and legal release from the obligation, the Company de-recognized the related non-recourse debt obligation from its consolidated balance sheet. This non-cash activity did not have a material impact on the Company’s results of operations for the three-month period ended March 31, 2012.

Income from Portfolio Assets is summarized as follows:

	Three Months Ended
	March 31,
	2013		2012
	(Dollars in thousands)
Loan Portfolios:
Purchased Credit-Impaired Loans	$	1,605	$	7,575
Purchased performing loans	91		71
Other	36		35
Real Estate Portfolios	204		824
Income from Portfolio Assets	$	1,936	$	8,505

Accretable yield represents the amount of income the Company can expect to generate over the remaining life of its existing income-accruing Purchased Credit-Impaired Loans based on estimated future cash flows as of March 31, 2013 and 2012, respectively. Reclassifications from nonaccretable difference to accretable yield primarily result from the Company’s increase in its estimates of future cash flows on Purchased Credit-Impaired Loans, whereas reclassifications to nonaccretable difference from accretable yield primarily result from the Company’s decrease in its estimates of future cash flows on these loans. Transfers from (to) non-accrual primarily result from adjustments to the income-recognition method applied to Purchased Credit-Impaired Loans based on management’s ability to reasonably estimate both the timing and amount of future cash flows (see Note 1). Changes in accretable yield related to the Company’s Purchased Credit-Impaired Loans for the three-month periods ended March 31, 2013 and 2012 are as follows:

	Three Months Ended
	March 31,
	2013			2012
	(Dollars in thousands)
Beginning Balance	$	—		$	4,732
Accretion	(14		)	(347		)
Reclassification from (to) nonaccretable difference	42			18
Disposals	(28		)	(25		)
Ending Balance	$	—		$	4,378

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Acquisitions of Purchased Credit-Impaired Loans for the three-month month periods ended March 31, 2013 and 2012, respectively, are summarized in the table below:

	Three Months Ended
	March 31,
	2013		2012
	(Dollars in thousands)
Face value at acquisition	$	3,599	$	5,205
Cash flows expected to be collected at acquisition, net of adjustments	612		1,699
Basis in acquired loans at acquisition	356		382

During the three-month period ended March 31, 2013, the Company sold loan Portfolio Assets with an aggregate carrying value of $0.2 million. The Company sold loan Portfolio Assets with an aggregate carrying value of $8.4 million during the three-month period ended March 31, 2012.

For the three-month period ended March 31, 2013, the Company recorded provisions for loan and impairment losses, net of recoveries, through a charge to income of $106,000 — which was comprised of a $51,000 provision for loan losses, net of recoveries, and a $55,000 impairment charge on real estate portfolios. For the three-month period ended March 31, 2012, the Company recorded provisions for loan and impairment losses, net of recoveries, through a charge to income of $0.2 million — which was comprised of a $0.1 million provision for loan losses, net of recoveries, and a $0.1 million impairment charge on real estate portfolios.

Changes in the allowance for loan losses related to our loan Portfolio Assets for the three-month month periods ended March 31, 2013, are as follows:

	Purchased Credit-Impaired Loans
	Domestic							Latin America				Europe
	Commercial			Business				Commercial		Residential		Commercial
(dollars in thousands)	Real Estate			Assets		Other		Real Estate		Real Estate		Real Estate		Other			Total
Beginning balance, January 1, 2013	$	—		$	26	$	—	$	327	$	—	$	—	$	41		$	394
Provisions	61			—		—		—		—		—		—			61
Recoveries	—			—		—		—		—		—		(10		)	(10		)
Charge offs	(32		)	—		—		—		—		—		—			(32		)
Translation adjustments	—			—		—		4		—		—		—			4
Ending balance, March 31, 2013	$	29		$	26	$	—	$	331	$	—	$	—	$	31		$	417

Changes in the allowance for loan losses related to our loan Portfolio Assets for the three-month month period ended March 31, 2012, are as follows:

	Purchased Credit-Impaired Loans
	Domestic									Latin America				Europe
	Commercial			Business						Commercial		Residential		Commercial
(dollars in thousands)	Real Estate			Assets			Other			Real Estate		Real Estate		Real Estate		Other		Total
Beginning balance, January 1, 2012	$	553		$	185		$	38		$	—	$	—	$	—	$	5	$	781
Provisions	128			62			5			—		—		—		—		195
Recoveries	—			(44		)	—			—		—		—		—		(44		)
Charge offs	(171		)	(3		)	(5		)	—		—		—		—		(179		)
Translation adjustments	—			—			—			—		—		—		—		—
Ending balance, March 31, 2012	$	510		$	200		$	38		$	—	$	—	$	—	$	5	$	753

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

The following table presents our recorded investment in loan Portfolio Assets by collateral type. Our loan Portfolio Assets, which are primarily comprised of Purchased Credit-Impaired Loans, are categorized by collateral type based on the common risk characteristics that management generally uses for pooling purposes (when management elects to pool purchased loans).

	March 31,		December 31,
	2013		2012
	(Dollars in thousands)
Commercial real estate	$	28,446	$	32,643
Business assets	3,686		4,021
Other commercial	7,199		8,240
	$	39,331	$	44,904

(5) Loans Receivable

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

	March 31,		December 31,
	2013		2012
	(Dollars in thousands)
Domestic:
Commercial loans:
Affiliates	$	6,522	$	6,584
Other, net of allowance for loan losses of of $-0- and $1,083	5,168		7,530

Total loans, net	$	11,690	$	14,114

Loans receivable — affiliates

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

	March 31,		December 31,
	2013		2012
	(Dollars in thousands)
Outstanding balance	$	6,141	$	6,203
Discounts, net	—		—
Capitalized interest	381		381
Carrying amount of loans, net	$	6,522	$	6,584

A summary of activity in loans receivable — affiliates follows:

	Three Months Ended
	March 31,
	2013			2012
	(Dollars in thousands)
Beginning Balance	$	6,584		$	6,719
Advances	—			—
Payments received	(62		)	(128		)
Capitalized costs, net	—			64
Discount accretion, net	—			22
Ending Balance	$	6,522		$	6,677

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Loans receivable — affiliates represent advances to Acquisition Partnerships and other affiliates to acquire portfolios of under-performing and non-performing commercial and consumer loans and other assets; and senior debt financing arrangements with equity-method investees to provide capital for business expansion and operations. Advances to affiliates to acquire loan portfolios are secured by the underlying collateral of the individual notes within the portfolios, which is generally real estate; whereas advances to affiliates for capital investments and working capital are generally secured by business assets (i.e. accounts receivable, inventory and equipment).

The Company did not record any provisions for impairment or sell any affiliated loans during the three-month periods ended March 31, 2013 and 2012. Information related to the credit quality and loan loss allowances related to loans receivable — affiliates is presented under the heading “Credit Quality and Allowance for Loan Losses — Loans Held for Investment” below.

Loans receivable — other

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

	March 31,			December 31,
	2013			2012
	(Dollars in thousands)
Outstanding balance	$	5,414		$	8,859
Allowance for loan losses	—			(1,083		)
Capitalized interest and costs	(246		)	(246		)
Carrying amount of loans, net	$	5,168		$	7,530

Changes in loans receivable — other are as follows:

	Three Months Ended
	March 31,
	2013			2012
	(Dollars in thousands)
Beginning Balance	$	7,530		$	12,212
Advances	—			379
Payments received	(2,410		)	(2,462		)
Change in allowance for loan losses	1,083			—
Charge-offs	(1,035		)	—
Ending Balance	$	5,168		$	10,129

Loans receivable — other include loans made to non-affiliated entities and are secured primarily by business assets such as accounts receivable, inventory, property and equipment, and real estate. The Company recorded $48,000 in recovery of provisions for impairment for the three-month period ended March 31, 2013, and did not record any provisions for impairment for the three-month period ended March 31, 2012. Information related to the credit quality and loan loss allowances related to loans receivable — other is presented under the heading “Credit Quality and Allowance for Loan Losses — Loans Held for Investment” below.

Credit Quality and Allowance for Loan Losses — Loans Held for Investment

The Company has established an allowance for loan losses to absorb probable, estimable losses inherent in its portfolio of loans receivable held for investment. This allowance for loan losses includes specific allowances, based on individual evaluations of certain loans and loan relationships, and allowances for pools of loans with similar risk characteristics. In determining the appropriate level of allowance, management uses information to stratify its portfolio of loans receivable held for investment into loan pools with common risk characteristics. Certain portions of the allowance are attributed to loan pools based on various factors and analyses. Loans deemed to be impaired, including loans with an increased probability of default as determined by management, are evaluated individually rather than on a pool basis. Management’s determination of the adequacy of the allowance is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Actual losses experienced in the future may vary from management’s estimates. Management attributes portions of the allowance to loans that it evaluates and determines to be impaired and to groups of loans that it evaluates collectively.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

The following tables summarizes the activity in the allowance for loan losses by our portfolio of loans held for investment for the three-month month periods ended March 31, 2013 and 2012:

	Allowance for Loan Losses:
(Dollars in thousands)	Affiliates		Other			Total
Balance, January 1, 2013	$	—	$	1,083		$	1,083
Provisions	—		—			—
Recoveries	—		(48		)	(48		)
Charge-offs	—		(1,035		)	(1,035		)
Balance, March 31, 2013	$	—	$	—		$	—

Balance, January 1, 2012	$	—	$	1,083		$	1,083
Provisions	—		—			—
Recoveries	—		—			—
Charge-offs	—		—			—
Balance, March 31, 2012	$	—	$	1,083		$	1,083

The following table presents an analysis of the allowance for loan losses and recorded investment in loans (excluding loans held for sale):

	Commercial Loans:
(Dollars in thousands)	Affiliates		Other		Total
March 31, 2013:
Loans individually evaluated for impairment	$	6,522	$	5,168	$	11,690
Loans collectively evaluated for impairment	—		—		—
Total loans evaluated for impairment (excluding loans held for sale)	$	6,522	$	5,168	$	11,690

Allowance for loans individually evaluated for impairment	$	—	$	—	$	—
Allowance for loans collectively evaluated for impairment	—		—		—
Total allowance for loan losses	$	—	$	—	$	—

December 31, 2012:
Loans individually evaluated for impairment	$	6,584	$	8,613	$	15,197
Loans collectively evaluated for impairment	—		—		—
Total loans evaluated for impairment (excluding loans held for sale)	$	6,584	$	8,613	$	15,197

Allowance for loans individually evaluated for impairment	$	—	$	1,083	$	1,083
Allowance for loans collectively evaluated for impairment	—		—		—
Total allowance for loan losses	$	—	$	1,083	$	1,083

The following tables present our recorded investment in loans (excluding loans held for sale) by credit quality indicator as of March 31, 2013 and December 31, 2012.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Classes in the affiliated and non-affiliated portfolio asset and commercial loan portfolios are disaggregated by accrual status (which is generally based on management’s assessment on the probability of default).

(Dollars in thousands)	Accrual		Non-Accrual		Total
March 31, 2013:
Affiliates - commercial loans	$	3,260	$	3,262	$	6,522
Other - commercial loans (1)	3,299		1,869		5,168
	$	6,559	$	5,131	$	11,690

Total loans (excluding loans held for sale)					$	11,690

(Dollars in thousands)	Accrual		Non-Accrual		Total
December 31, 2012:
Affiliates - commercial loans	$	3,323	$	3,261	$	6,584
Other - commercial loans (1)	3,484		5,129		8,613
	$	6,807	$	8,390	$	15,197

Total loans (excluding loans held for sale)					$	15,197

(1) Represents loans made to U.S. non-affiliated entities that are secured primarily by business assets (as disclosed previously under the heading “Loans receivable — other” of this footnote).

The following tables include an aging analysis of our recorded investment in loans held for investment as of March 31, 2013 and December 31, 2012:

	Loans Past Due and Still Accruing
	31-60		61-90		Over				Non-Accrual		Current		Total
(Dollars in thousands)	Days		Days		90 Days		Total		Loans		Loans		Loans
March 31, 2013:
Commercial loans:
Affiliates	$	—	$	—	$	—	$	—	$	3,262	$	3,260	$	6,522
Other	—		—		—		—		1,869		3,299		5,168
Total loans (excluding loans held for sale)	$	—	$	—	$	—	$	—	$	5,131	$	6,559	$	11,690

December 31, 2012:
Commercial loans:
Affiliates	$	—	$	—	$	—	$	—	$	3,261	$	3,323	$	6,584
Other	—		—		—		—		5,129		3,484		8,613
Total loans (excluding loans held for sale)	$	—	$	—	$	—	$	—	$	8,390	$	6,807	$	15,197

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

The following table presents additional information regarding the Company’s impaired loans as of March 31, 2013 and December 31, 2012:

	Recorded Investment In:
	Impaired		Impaired
	Loans		Loans								Average
	Without a		With a		Total		Unpaid		Related		Impaired
	Related		Related		Impaired		Principal		Valuation		Loans for
(Dollars in thousands)	Allowance		Allowance		Loans		Balance		Allowance		the Year
March 31, 2013:
Commercial loans:
Affiliates	$	—	$	—	$	—	$	—	$	—	$	—
Other	1,869		—		1,869		3,817		—		3,474
Total loans (excluding loans held for sale)	$	1,869	$	—	$	1,869	$	3,817	$	—	$	3,474

December 31, 2012:
Commercial loans:
Affiliates	$	—	$	—	$	—	$	—	$	—	$	—
Other	2,159		2,970		5,129		7,027		1,083		6,984
Total loans (excluding loans held for sale)	$	2,159	$	2,970	$	5,129	$	7,027	$	1,083	$	6,984

The Company did not recognize any significant amounts of interest income on impaired loans during the three-month periods ended March 31, 2013 and 2012.

(6) Investments in Unconsolidated Subsidiaries

The Company has investments in Acquisition Partnerships and various servicing and operating entities that are accounted for under the equity method of accounting (refer to Note 1). The condensed combined financial position and results of operations of the Acquisition Partnerships (which include our U.S. and foreign Acquisition Partnerships) and the servicing and operating entities (collectively, the “Equity Investees”), are summarized as follows:

Condensed Combined Balance Sheets

	March 31,		December 31,
	2013		2012
	(Dollars in thousands)
Acquisition Partnerships:
Assets	$	467,574	$	437,176
Liabilities	$	54,622	$	14,783
Net equity	412,952		422,393
	$	467,574	$	437,176
Servicing and operating entities:
Assets	$	31,975	$	45,676
Liabilities	$	22,300	$	22,818
Net equity	9,675		22,858
	$	31,975	$	45,676
Total:
Assets	$	499,549	$	482,852
Liabilities	$	76,922	$	37,601
Net equity	422,627		445,251
	$	499,549	$	482,852

Equity investment in Acquisition Partnerships	$	60,543	$	60,581
Equity investment in servicing and operating entities	6,676		16,885
	$	67,219	$	77,466

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Condensed Combined Summary of Operations

	Three Months Ended
	March 31,
	2013			2012
	(Dollars in thousands)
Acquisition Partnerships:
Revenues	$	11,471		$	26,954
Costs and expenses	8,416			5,703
Net earnings (loss)	$	3,055		$	21,251

Servicing and operating entities:
Revenues	$	9,994		$	26,059
Costs and expenses	10,314			21,313
Net earnings (loss)	$	(320	)	$	4,746

Equity income (loss) from Acquisition Partnerships	$	935		$	2,328
Equity income (loss) from servicing and operating entities	(136		)	2,139
	$	799		$	4,467

At March 31, 2013 and December 31, 2012, the Acquisition Partnerships’ total carrying value of loans accounted for under non-accrual methods of accounting (i.e. cost-recovery or cash basis method) approximated $380.9 million and $350.3 million, respectively.

The combined assets and equity of the Equity Investees, and the Company’s carrying value of its equity investments in the Equity Investees, are summarized by geographic region below.

	March 31,		December 31,
	2013		2012
	(Dollars in thousands)
Combined assets of the Equity Investees:
Domestic:
Acquisition Partnerships	$	382,589	$	352,123
Operating entities	27,288		40,531
Latin America:
Acquisition Partnerships	84,985		85,053
Servicing entities	1,830		2,057
Europe - servicing entities	2,857		3,088
	$	499,549	$	482,852

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

	March 31,		December 31,
	2013		2012
	(Dollars in thousands)
Combined equity of the Equity Investees:
Domestic:
Acquisition Partnerships	$	335,725	$	344,045
Operating entities	6,358		19,511
Latin America:
Acquisition Partnerships	77,227		78,348
Servicing entities	909		828
Europe - servicing entities	2,408		2,519
	$	422,627	$	445,251

Company’s carrying value of its investments in the Equity Investees:
Domestic:
Acquisition Partnerships	$	57,323	$	57,802
Operating entities	2,939		13,199
Latin America:
Acquisition Partnerships	3,220		2,779
Servicing entities	3,087		3,008
Europe - servicing entities	650		678
	$	67,219	$	77,466

Revenues and net earnings (losses) of the Equity Investees, and the Company’s share of equity income (loss) of those entities, are summarized by geographic region below. The tables below include individual entities and combined entities under common management that are considered to be significant Equity Investees of FirstCity at March 31, 2013.

	Three Months Ended
	March 31,
	2013		2012
	(Dollars in thousands)
Revenues of the Equity Investees:
Domestic:
Combined Värde Acquisition Partnerships	$	9,407	$	22,597
Other Acquisition Partnerships	212		29
FC Crestone Oak LLC (operating entity) (1)	56		1,711
Other operating entities	6,698		5,718
Latin America:
Acquisition Partnerships	1,852		4,328
Servicing entity	2,227		2,273
Europe:
MCS et Associes (servicing entity)	—		15,117
Other servicing entities	1,013		1,240
	$	21,465	$	53,013

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

	Three Months Ended
	March 31,
	2013			2012
	(Dollars in thousands)
Net earnings (loss) of the Equity Investees:
Domestic:
Combined Värde Acquisition Partnerships	$	3,233		$	13,628
Other Acquisition Partnerships	82			(827		)
FC Crestone Oak LLC (operating entity) (1)	56			640
Other operating entities	(409		)	(635		)
Latin America:
Acquisition Partnerships	(260		)	8,450
Servicing entity	69			175
Europe:
MCS et Associes (servicing entity)	—			4,370
Other servicing entities	(36		)	196
	$	2,735		$	25,997

Company’s equity income (loss) from the Equity Investees:
Domestic:
Combined Värde Acquisition Partnerships	$	344		$	2,524
Other Acquisition Partnerships	45			(405		)
FC Crestone Oak LLC (operating entity) (1)	27			313
Other operating entities	(188		)	(378		)
Latin America:
Acquisition Partnerships	546			209
Servicing entity	34			87
Europe:
MCS et Associes (servicing entity)	—			2,069
Other servicing entities	(9		)	48
	$	799		$	4,467

(1) FC Crestone Oak LLC operated in the prefabricated building manufacturing industry.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(7) Notes Payable to Banks and Other Debt Obligations

The Company’s notes payable and other debt obligations at March 31, 2013 and December 31, 2012 consisted of the following (dollars in thousands):

		March 31,		December 31,
Description	Terms and Conditions	2013		2012

Bank of Scotland reducing note facility, net of unamortized discount (“BoS Facility A”) [1] [2]	Secured by substantially all assets and subsidiaries of FC Commercial (excluding FH Partners) and guaranteed by FirstCity, matures December 2014	$	21,756	$	29,991

BOS (USA) $25.0 million term note (“BoS Facility B”) [1]	Secured by all assets of FLBG2, matures December 2014	—		—

Bank of America term note [1]	Secured by all assets of FH Partners, matures December 2014	12,887		16,194

FNBCT $15.0 million revolving loan facility [3]	Secured by assets of FC Investment and its subsidiaries, and guaranteed by FirstCity, matures August 2013	2,000		2,000

Non-recourse bank notes payable of various U.S. Portfolio Entities	Secured by assets (primarily Portfolio Assets) of the underlying entities, various maturities through October 2015	3,932		4,712

Non-recourse bank notes payable of consolidated railroad subsidiaries	Secured by assets of the subsidiaries, various maturities through March 2016	6,950		7,044

Other notes and debt obligations		1,752		1,790

Total notes payable and other debt obligations		$	49,277	$	61,731

[1] In December 2011, FirstCity entered into a debt refinancing arrangement with Bank of Scotland that resulted in the amendment and restatement of the Reducing Note Facility (“BoS Facility A”) and a new loan agreement with BOS (USA) (“BoS Facility B”). In connection with this debt refinancing arrangement, FirstCity also obtained a new credit facility with Bank of America. This debt refinancing transaction was accounted for as a debt extinguishment and, as such, BoS Facility A and BoS Facility B were initially recorded at their estimated fair values of $91.6 million and $-0-, respectively, in December 2011.

[2] The unamortized discount on this loan facility at March 31, 2013 and December 31, 2012 was $0.7 million and $1.1 million, respectively.

[3] FC Investment, a FirstCity wholly-owned subsidiary, obtained this revolving loan facility in May 2012 (see discussion below).

First National Bank of Central Texas (FC Investment Holdings Corporation)

On May 21, 2012, FC Investment Holdings Corporation (“FC Investment”), a FirstCity wholly-owned subsidiary, as borrower, and FirstCity, as guarantor, and First National Bank of Central Texas (“FNBCT”), as lender, entered into a loan agreement dated May 16, 2012 (the “FNBCT Loan Facility”). In addition, on May 21, 2012, FirstCity executed a guaranty agreement that provided for its unlimited guaranty for repayment of the indebtedness of FC Investment including, without limitation, under the FNBCT Loan Facility. The FNBCT Loan Facility is a $15.0 million revolving loan facility that provides funding for FC Investment and its subsidiaries to finance the purchase of loans and other assets, to make investments in equity interests in or capital contributions to affiliates which are owned with other investors, and for working capital. The primary terms and conditions of the FNBCT Loan Facility are as follows:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

· Provides maximum outstanding borrowings up to $15.0 million;

· The loan facility is secured by security interests in substantially all of the assets of FC Investment and its subsidiaries (the “Covered Entities”). FirstCity Servicing Corporation (“FC Servicing”), a FirstCity wholly-owned subsidiary, provides a security interest in servicing fees payable to it by the Covered Entities and the non-wholly owned portfolio entities owned by the Covered Entities. FC Servicing does not provide a security interest in servicing agreements entered into with the Covered Entities, or in any of its other assets and does not guaranty the obligations under this loan facility;

· Provides that no advance will be made that causes the outstanding balance of the loan facility to exceed an amount equal to 25.0% of the net present value of the equity interests and loans and other assets owned by the Covered Entities which are pledged to secure the loan facility reduced by any reserves established by FNBCT related to the pledged loans and other assets and the pledged equity interests (“Net Present Collateral Value”);

· Provides for a fluctuating interest rate equal to the greater of (i) the rate of interest published in the Wall Street Journal as the prime rate of commercial banks, or (ii) 4.0%;

· Provides for a maturity date of August 15, 2013;

· Provides that all net cash flow from the pledged assets be deposited into a pledged account with FNBCT on a monthly basis, and for funds to be distributed out of the pledged account and applied in the following manner and priority: (i) to interest due under the loan facility, (ii) to fees and expenses due under the loan facility, (iii) payment of principal outstanding under the loan facility in an amount required to reduce the outstanding principal balance of the loan as is required so that the principal balance of the loan is equal to 25.0% of the Net Present Collateral Value, (iv) payment of principal if an event of default has occurred, (v) payment of the principal in such additional amount as may be determined by FNBCT in its discretion, and (vi) any remaining balance to FC Investment;

· Provides that FNBCT is only required to fund up to $7.5 million, with the balance of the commitment under the revolving loan facility to be funded by a participating bank in the loan facility;

· Provides for (i) an administration fee of $25,000 for the period through the maturity date, which fee was paid at closing, (ii) a facility fee in the amount of $93,750 for the period through the maturity date, which fee was paid at closing, and (iii) a non-utilization fee payable following each calendar quarter equal to 0.50% of the average daily amount by which the outstanding principal amount of the revolving loan during the preceding calendar quarter is less than $15.0 million, provided, in the event the financial institution participating in the revolving loan fails to advance its pro-rata share of any advance in a circumstance in which FNBCT is funding the advance, the non-utilization fee shall be calculated based on the average daily amount by which the total amount funded by FNBCT from its own funds during the preceding calendar quarter is less than $7.5 million;

· FC Investment must maintain a minimum interest coverage ratio, based on net cash flows from the pledged assets, of 2.0 to 1.0 (on a consolidated basis);

· FC Investment must maintain a minimum tangible net worth (defined) of $75.0 million (on a consolidated basis); and

· The FNBCT Loan Facility and other loan documents do not create any security interest in the property of, or impose any contractual limitations upon, FirstCity Commercial Corporation, FH Partners LLC (“FH Partners”), FLBG Corporation or any of their subsidiaries, which are FirstCity subsidiaries and are parties to, or provide guaranties or security interests with respect to, FirstCity’s loan facility with Bank of Scotland.

In addition to the foregoing, the FNBCT Loan Facility contains representations, warranties and certain other covenants on the part of FC Investment, FirstCity and the other Covered Entities that are typical for a loan facility of this type. Furthermore, the FNBCT Loan Facility and related loan documents contain customary events of default, including, failure to make required payments, failure to comply with certain agreements or covenants, failure to pay, or default under, certain other indebtedness, certain events of bankruptcy and insolvency, and failure to pay certain judgments. In the event that an event of default occurs and is continuing, FNBCT may accelerate the indebtedness under this loan facility.

At March 31, 2013, the Company was in compliance with all covenants or other requirements set forth in its loan facilities.

(8) Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss is composed of the following as of March 31, 2013 and December 31, 2012:

	March 31,			December 31,
	2013			2012
	(Dollars in thousands)
Cumulative foreign currency translation adjustments	$	(441	)	$	(534	)
Net unrealized gain (loss) on securities available for sale	(93		)	(43		)
Total accumulated other comprehensive loss	$	(534	)	$	(577	)

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(9) Foreign Currency Exchange Risk Management

Prior to December 2012, we used Euro-denominated debt as a non-derivative financial instrument to partially offset the Company’s business exposure to foreign currency exchange risk attributable to our net investments in Europe. Our focus was to manage the foreign currency exchange risks associated with our European subsidiaries. To help protect the Company’s net investment in certain of its European subsidiary operations from adverse changes in foreign currency exchange rates, management denominated a portion of the Euro-denominated debt in the same functional currency used by the European subsidiaries. In December 2012, the Company paid off its remaining balance in the Euro-denominated debt, and the hedging relationship no longer exists.

The effective portion of the net foreign investment hedge was reported in accumulated other comprehensive income (loss) (“AOCI”) as part of the cumulative translation adjustment. Any ineffective portion of the net foreign investment hedge was recognized in earnings as other income (expense) during the period of change. Effectiveness of the hedging relationship was measured and designated at the beginning of each month by comparing the outstanding balance of the Euro-denominated debt to the carrying value of the designated net equity investments.

The effect of the non-derivative instrument qualifying and designated as a hedging instrument in net foreign investment hedges on the consolidated financial statements for the three-month month periods ended March 31, 2013 and 2012 was as follows (in thousands):

Amount of Gain (Loss)

Recognized in Income

Amount of Gain (Loss)

(Ineffective Portion and

Recognized in AOCI

Amount Excluded from

Non-Derivative

(Effective Portion)

Location of Gain (Loss)

Effectiveness Testing)

Instrument in

Three Months Ended

Reclassified from

Three Months Ended

Net Investment

March 31,

AOCI into Income

March 31,

Hedging Relationship

2013

2012

(Effective Portion)

2013

2012

Euro-denominated debt

—

(398

)

Other income (expense)

—

(10) Income Taxes

We are subject to income taxes in both the United States and the non-U.S. jurisdictions in which we operate. Income tax expense (benefit) for the three-month month periods ended March 31, 2013 and 2012 consisted of the following:

	Three Months Ended
	March 31,
	2013			2012
	(Dollars in thousands)

U.S. state current income tax expense (benefit)	$	(56	)	$	177
Foreign current income tax expense	2			89
Foreign deferred income tax expense (benefit)	(21		)	566
Total	$	(75	)	$	832

The Company recognizes deferred tax assets and liabilities in both the U.S. and foreign jurisdictions based on the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for net operating loss and tax credit carryforwards. Deferred income tax assets and liabilities attributable to our consolidated foreign operations were not significant at March 31, 2013 and December 31, 2012. However, the Company has a substantial amount of U.S. deferred tax assets attributable primarily to net operating loss carryforwards for U.S. federal income tax purposes, and differences between the carrying amounts and the tax bases of Acquisition Partnership investments. At March 31, 2013 and December 31, 2012, the Company established a full valuation allowance for its U.S. deferred tax assets due to the lack of sufficient objective evidence regarding the realization of these assets in the foreseeable future. We will continue to evaluate the deferred tax asset valuation allowance balances in all of our U.S. and foreign subsidiaries throughout 2013 to determine the appropriate level of valuation allowances.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(11) Stock-Based Compensation

Accounting for stock-based compensation requires that the cost resulting from all stock-based payments be recognized in the financial statements based on the grant-date fair value of the award. The Company’s stock-based compensation expense consists of stock options and restricted stock awards. All stock option and restricted stock grants are amortized ratably over the requisite service periods of the underlying awards, which are generally the vesting periods. The Company recognizes share-based compensation expense only for those shares that are expected to vest, based on the Company’s historical experience and future expectations. We recognized stock-based compensation cost of approximately $0.3 million and $0.2 million for the three-month month periods ended March 31, 2013 and 2012, respectively.

Stock Options

A summary of the Company’s stock options and related activity as of and for the three months ended March 31, 2013 is presented below:

				Weighted
				Average
		Weighted		Remaining
		Average		Contractual	Aggregate
		Exercise		Term	Intrinsic
	Shares	Price		(Years)	Value
					(in thousands)
Options outstanding at January 1, 2013	714,900	$	8.06
Granted	—	—
Exercised	—	—
Expired	—	—
Forfeited	—	—
Options outstanding at March 31, 2013	714,900	$	8.06	4.19	$	1,450

Options exercisable at March 31, 2013	649,900	$	8.17	3.97	$	1,259

As of March 31, 2013, there was approximately $0.1 million of total unrecognized compensation cost related to unvested stock options to be recognized over a weighted average period of 0.4 years.

Restricted Stock Awards

A summary of the Company’s restricted stock awards and related activity as of and for the three months ended March 31, 2013 is presented below:

	Number of
	Shares
Shares outstanding at December 31, 2012	211,521
Shares granted	—
Shares vested	(95,658	)
Shares outstanding at March 31, 2013	115,863

In March 2011, the Company granted (i) 27,258 shares of restricted stock awards to non-employee directors that cliff-vest one year from the grant date; and (ii) 68,868 shares of restricted stock awards to executive management that time-vest over a three-year period. The weighted-average grant-date fair value of the awards was $6.58 — which was based on the fair value of our common stock on the respective grant dates. In March 2012, the Company granted (i) 26,250 shares of restricted stock awards to non-employee directors that cliff-vest one year from the grant date; and (ii) 139,357 shares of restricted stock awards to executive management that time-vest over a three-year period. The weighted-average grant-date fair value of the awards was $8.78 — which was based on the fair value of our common stock on the respective grant dates. Holders of the restricted stock awards have voting rights, and vesting of the grants is based on their continued service. Sales of the restricted stock are prohibited until the awards vest. As of March 31, 2013, there was approximately $0.9 million of total unrecognized compensation cost related to unvested restricted stock awards to be recognized over a weighted average period of 1.8 years.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(12) Earnings per Common Share

The Company calculates basic and diluted earnings per common share using the two-class method. Under the two-class method, net earnings are allocated to each class of common stock and participating security as if all of the net earnings for the period had been distributed. The Company’s participating securities consist of unvested restricted stock awards that contain a non-forfeitable right to receive dividends and, therefore, are considered to participate in undistributed earnings with common stockholders.

Basic earnings per common share excludes dilution and is calculated by dividing net earnings allocable to common shares by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share is calculated by dividing net earnings allocable to common shares by the weighted-average number of common shares outstanding for the period, as adjusted for the potential dilutive effect of stock-based awards. We exclude potentially dilutive securities from the computation of diluted earnings per share when the effect of their inclusion would be anti-dilutive.

The following table sets forth the computation of basic and diluted earnings per common share for the three-month month periods ended March 31, 2013 and 2012:

	Three Months Ended
	March 31,
(In thousands, except per share data)	2013			2012

Earnings (loss) from continuing operations	$	(2,083	)	$	9,260
Income from discontinued operations	111			213
Net earnings (loss)	$	(1,972	)	$	9,473
Less: Net income attributable to noncontrolling interests	536			1,108
Net earnings (loss) attributable to FirstCity	$	(2,508	)	$	8,365
Less: Net earnings (loss) allocable to participating securities	(48		)	82
Net earnings (loss) allocable to common shares	$	(2,460	)	$	8,283

Weighted-average common shares outstanding - basic	10,353			10,299
Dilutive effect of restricted stock shares	—			53
Dilutive effect of stock options	—			45
Weighted-average common shares outstanding - diluted	10,353			10,397

Earnings (loss) from continuing operations per share:
Basic	$	(0.25	)	$	0.78
Diluted	$	(0.25	)	$	0.78
Income from discontinued operations per share:
Basic	$	0.01		$	0.02
Diluted	$	0.01		$	0.02

Dilutive shares excluded from above as a result of the Company reporting a net loss during the period (in thousands):
Restrictive stock shares	99			—
Stock options	128			—

For the three-month periods ended March 31, 2013 and 2012, potentially dilutive securities representing approximately 210,000 and 654,000 shares of common stock, respectively, were excluded from the computation of diluted earnings per common share because their effect would have been anti-dilutive.

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(13) Fair Value

We use fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value for applicable fair value disclosures. Investment securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value certain other assets and liabilities on a non-recurring basis, Portfolio Assets, loans receivable, real estate investments, servicing assets, investments in unconsolidated subsidiaries, and various other assets held for sale (including liabilities related to the assets held for sale). These non-recurring fair value adjustments typically involve lower-of-cost-or-market accounting or write-downs of individual assets.

Fair Value Hierarchy

The accounting guidance on fair value measurements establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to measurements involving significant unobservable inputs (Level 3 measurements). We group our assets and liabilities measured at fair value in three levels of the fair value hierarchy, based on the fair value measurement technique, as described below:

· Level 1 — Valuation is based upon quoted prices (unadjusted) for identical assets and liabilities in active exchange markets that the Company has the ability to access at the measurement date.

· Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques with significant assumptions and inputs that are observable in the market or can be derived principally from or corroborated by observable market data.

· Level 3 — Valuation is derived from model-based techniques that use inputs and significant assumptions that are supported by little or no observable market data. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of pricing models, discounted cash flow models and similar techniques.

The level of fair value hierarchy within which a fair value measurement in its entirety falls is based on the lowest-level input that is most-significant to the fair value measurement in its entirety. In the determination of the classification of assets and liabilities in Level 2 or Level 3 of the fair value hierarchy, we consider all available information, including observable market data, indications of market conditions, and our understanding of the valuation techniques and significant inputs used. Based upon the specific facts and circumstances, judgments are made regarding the significance of the Level 3 inputs to the fair value measurements of the respective assets and liabilities in their entirety. If the valuation techniques that are most-significant to the fair value measurements are principally derived from assumptions, inputs and qualitative considerations that are corroborated by little or no observable market data, the asset or liability is classified as Level 3.

Determination of Fair Value

We attempt to base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs, when reasonably available, and minimize the use of unobservable inputs when developing fair value measurements. However, active market pricing information and other observable market data are not available for a portion of the Company’s financial instruments (primarily investments in unconsolidated subsidiaries, non-public debt instruments and, on occasion, distressed assets). In instances where there is limited or no observable market data, fair value measurements are based principally upon our own valuation models and estimates, or combination of our own valuation models and estimates plus independent vendor or broker pricing, and the measurements are often calculated, as applicable, based on current pricing adjusted for the economic and competitive environment, the characteristics of the asset or liability, and other such factors that, in management’s opinion, reflect elements a market participant would consider. As with any valuation technique used to estimate fair value, changes in underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values. Accordingly, these fair value estimates may not be

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realized in an actual sale or immediate settlement of the asset or liability. The Company believes the imprecision of an estimate could significantly impact the fair value measurement.

Following are descriptions of the valuation methodologies used for assets and liabilities recorded at fair value on a recurring or non-recurring basis, and for estimating fair value for financial instruments not reported at fair value on our consolidated balance sheet for disclosure purposes.

Cash and Cash Equivalents and Restricted Cash: Cash and cash equivalents and restricted cash are carried at historical cost. The carrying amount approximates fair value due to the short-term nature of these instruments.

Portfolio Assets — Loans: See Note 1 for information on the carrying value of loan Portfolio Assets. The Company does not carry its loan Portfolio Assets at fair value on a recurring basis. However, periodically, we may record non-recurring adjustments to the carrying value of impaired loans to reflect partial write-downs, which are reported as non-recurring fair value measurements when the adjustment is based on the observable market price of the loan or the fair value of collateral. The fair values of impaired loans are generally based on appraised value of collateral. Non-recurring fair value adjustments to loans that are based on observable market prices and collateral valuations using observable inputs are classified as Level 2 measurements. When management determines that the fair value of the collateral requires additional adjustments, such as a result of non-current appraisal value or when there is no observable market price, the Company generally employs internal valuation processes consisting primarily of market comparable pricing and discounted cash flow techniques. These internal valuation techniques include various significant unobservable inputs, such as market discount rates, liquidity discounts, comparability adjustments, loss severity, and market/collateral condition adjustments. The Company classifies its fair value measurements using internal valuation techniques for these assets as Level 3 for non-recurring fair value adjustments, because these valuation techniques are principally derived from assumptions, inputs and qualitative considerations that are corroborated by little or no observable market data.

Additionally, for disclosure purposes, the Company is required to provide fair value estimates for its loan Portfolio Assets that are not recorded at fair value on a recurring or non-recurring basis. The Company estimates fair value for this disclosure using a discounted cash flow model that employs market discount rates that reflect the Company’s current pricing for loans with similar characteristics, adjusted for various considerations such as market conditions and credit risk. This fair value measurement technique is a Level 3 measurement, because it is principally derived from assumptions, inputs and qualitative considerations that are corroborated by little or no observable market data.

Portfolio Assets — Real Estate: See Note 1 for information on the carrying value of our real estate investments held for sale and held for investment. Fair value measurements for our real estate investments are generally based on collateral valuations using observable inputs and, accordingly, we classify these assets as Level 2 for non-recurring fair value adjustments.

Loans Receivable Held for Investment: See Note 1 for information on the carrying value of loans receivable held for investment. The Company does not carry its loans receivable held for investment at fair value on a recurring basis. However, periodically, we may record non-recurring adjustments to the carrying value of impaired loans to reflect partial write-downs, which are reported as non-recurring fair value measurements when the adjustment is based on the observable market price of the loan or the fair value of collateral. The fair values of impaired loans are generally based on appraised value of collateral. Non-recurring fair value adjustments to loans that are based on observable market prices and collateral valuations using observable inputs are classified as Level 2 measurements. When management determines that the fair value of the collateral requires additional adjustments, such as a result of non-current appraisal value or when there is no observable market price, the Company generally employs internal valuation processes consisting primarily of market comparable pricing and discounted cash flow techniques. These internal valuation techniques include various significant unobservable inputs, such as market discount rates, liquidity discounts, comparability adjustments, loss severity, and market/collateral condition adjustments. The Company classifies its fair value measurements using internal valuation techniques for these assets as Level 3 for non-recurring fair value adjustments, because these valuation techniques are principally derived from assumptions, inputs and qualitative considerations that are corroborated by little or no observable market data.

Additionally, for disclosure purposes, the Company is required to provide fair value estimates for its loans receivable held for investment that are not recorded at fair value on a recurring basis. For this disclosure, estimated fair values of fixed-rate loans receivable, including affiliated loans, are generally determined using a discounted cash flow model, adjusted by an amount for estimated losses that employs market discount rates and other adjustments that would be expected to be made by a market participant. Estimated fair values of variable-rate loans that re-price frequently at market interest rates are based on carrying values adjusted for estimated credit losses and other adjustments that would be expected to be made by a market participant. The estimated fair value for

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impaired loans is generally based on collateral valuations using observable inputs, adjusted for various considerations that would be expected to be made by a market participant; or discounted cash flow models that employ market discount rates and other adjustments that would be expected to be made by a market participant. These fair value measurement techniques are classified as Level 3 measurements, because they are principally derived from assumptions, inputs and qualitative considerations that are corroborated by little or no observable market data.

Investment Securities Available for Sale: Investment securities available for sale are carried at fair value on our consolidated balance sheet. The Company measures fair value for its marketable equity investment using quoted market prices in an active exchange market for identical assets (Level 1). The Company measures fair value for its asset-backed securities using discounted cash flow models based on assumptions and inputs that are corroborated by little or no observable market data (Level 3). The Company uses this measurement technique for these assets because pricing information and market-participant assumptions for its asset-backed securities are not readily accessible and frequently released to the public.

Assets Held for Sale, Net of Related Liabilities: Assets held for sale, net of related liabilities, represents the net assets of American Business Lending (“ABL”) that management expects to sell, and are carried at the lower-of-cost or market (see Note 3). The composition of these assets and liabilities comprised primarily of loans receivable held for sale and investment, servicing assets, and a note payable. The estimated fair value of the net assets related to ABL was based primarily on a price quotation from a prospective buyer and, accordingly, we classify these assets and liabilities as Level 2 for non-recurring fair value measurements.

Notes Payable and Other Debt Obligations: Notes payable and other debt obligations are carried at amortized cost, net of unamortized discounts. For disclosure purposes, we are required to estimate the fair value of our notes payable and debt obligations. For our debt instruments, quoted market prices or interest rates for similar debt with comparable terms (or when traded by market participants as an asset) are not readily observable in active trading markets. As such, we estimated the fair value of our debt obligations with Bank of Scotland by discounting the future cash flows of each debt instrument at rates currently offered to us for loan facilities with other creditors that include similar terms and maturities (these discount rates include our current spread levels). For the remainder of our non-affiliated notes payable and debt obligations, management believes that carrying value approximates fair value since the interest rates and terms on these debt instruments approximate the rates, market spreads and terms currently offered by other lenders for similar debt instruments of comparable terms. Fair values of the Company’s affiliated notes payable (including related interest payable) were based on discounted cash flow models that employ market discount rates and other adjustments that would be expected to be made by a market participant.

Assets Measured at Fair Value on a Recurring Basis

The table below presents the Company’s balances of assets measured at fair value on a recurring basis at March 31, 2013 and December 31, 2012. The Company did not have any liabilities that were measured at fair value on a recurring basis at March 31, 2013 and December 31, 2012.

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	At March 31, 2013
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Investment securities available for sale:
Asset-backed securities	$	—	$	—	$	1,314	$	1,314
	$	—	$	—	$	1,314	$	1,314

	At December 31, 2012
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Investment securities available for sale:
Asset-backed security	$	—	$	—	$	1,670	1,670
	$	—	$	—	$	1,670	$	1,670

At March 31, 2013 and December 31, 2012, the amortized cost of the Company’s asset-backed securities approximated $1.4 million and $1.7 million, respectively. The Company used a discounted cash flow model (valuation technique), with a 20% discount rate (significant unobservable input), to measure the estimated fair value of its asset-backed security (Level 3 asset) at March 31, 2013 and December 31, 2012.

For the three-month month periods ended March 31, 2013 and 2012, there were no transfers of assets recorded at fair value on a recurring basis in or out of the Level 1, 2 or 3 fair value measurement levels.

The table below summarizes the changes to the Company’s Level 3 assets measured at fair value on a recurring basis for the three-month periods ended March 31, 2013 and 2012:

	Three Months Ended
	March 31,
(Dollars in thousands)	2013			2012
Balance, beginning of period	$	1,670		$	2,798
Total realized and unrealized gains for the
period included in:
Net income (loss)	3			159
Other comprehensive income	(51		)	(50		)
Purchases	—			—
Sales	—			—
Issuances	—			—
Settlements	(308		)	(413		)
Foreign currency translation adjustments	—			—
Net transfers into Level 3	—			—
Balance, end of period	$	1,314		$	2,494

Assets Measured at Fair Value on a Non-Recurring Basis

The Company may be required, from time to time, to measure certain financial and non-financial assets at fair value on a non-recurring basis. These adjustments to fair value generally result from write-downs of financial and non-financial assets as a result of impairment or application of lower-of-cost or fair value accounting. The following table provides the fair value hierarchy and the carrying value of assets on the Company’s consolidated balance sheet at March 31, 2013 and December 31, 2012 that were measured at fair value on a non-recurring basis during the respective three- and twelve-month periods then ended:

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	Carrying Value at March 31, 2012
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Portfolio Assets - loans (1)	$	—	$	441	$	121	$	562
Real estate held for sale (2)	—		322		—		322

	Carrying Value at December 31, 2012
(Dollars in thousands)	Level 1		Level 2		Level 3		Total
Portfolio Assets - loans (1)	$	—	$	4,074	$	1,757	$	5,831
Real estate held for sale (2)	—		1,452		—		1,452

(1) Represents the carrying value of impaired loans for which adjustments were based on the collateral value.

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

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

	Three Months Ended
	March 31,
(Dollars in thousands)	2013			2012
Portfolio Assets - loans (1)	$	(50	)	$	(99	)
Real estate held for sale (2)	(35		)	(70		)
Total	$	(85	)	$	(169	)

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

(2) Represents losses on foreclosed real estate properties that were measured at fair value subsequent to their initial classification as foreclosed assets.

The fair value adjustment reductions in the table above for the three-month periods ended March 31, 2013 and 2012 involved assets held in our Portfolio Asset Acquisition and Resolution business segment.

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

The table below presents the carrying amount and estimated fair value of the Company’s financial instruments, including accrued interest (where applicable), that are not recorded at fair value in their entirety on a recurring basis on the Company’s consolidated balance sheets at March 31, 2013 and December 31, 2012. These fair value estimates are generally based on pertinent information that was available to management as of the respective measurement dates. The fair value estimates have not been revalued for purposes of these financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented. We have not included assets that are not financial instruments in our disclosure, such as the value of our servicing assets and investments in unconsolidated subsidiaries.

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	March 31, 2013										December 31, 2012
	Carrying		Estimated Fair Value								Carrying		Estimated
(Dollars in thousands)	Amount		Level 1		Level 2		Level 3		Total		Amount		Fair Value (2)
Cash, cash equivalents and restricted cash	$	33,076	$	33,076	$	—	$	—	$	33,076	$	39,347	$	39,347
Loan Portfolio Assets and loans receivable held for investment	51,162		—		—		72,069		72,069		59,276		83,880
Assets held for sale, net of related liabilities (1)	7,543		—		11,243		—		11,243		7,479		11,179
Notes payable and other debt obligations	49,277		—		—		49,277		49,277		61,731		61,731

(1) Comprised primarily of SBA loans held for sale and investment, servicing assets and a note payable (see Note 3).

(2) The estimated fair value hierarchy remains unchanged from December 31, 2012 to March 31, 2013.

(14) Variable Interest Entities

In the normal course of business, the Company enters into various types of on- and off-balance sheet transactions with entities that involve variable interests. Variable interests are generally defined as contractual, ownership or other economic interests in an entity that change with fluctuations in the entity’s net asset value. If certain characteristics are present in these transactions, the entity is subject to a variable interests consolidation analysis, and consolidation is based on variable interests, and not solely on ownership of the entity’s outstanding voting stock. In making the determination as to whether an entity is considered to be a variable interest entity (“VIE”), we first perform a qualitative analysis, which requires certain subjective decisions regarding our assessments, including, but not limited to, the design of the entity, the variability that the entity was designed to create and pass along to its interest holders, the rights of the parties, and the purpose of the arrangement. If we cannot conclude after a qualitative analysis whether an entity is a VIE, we perform a quantitative analysis.

In general, a VIE is an entity that has one or more of the following characteristics (1) the entity has total equity at risk that is not sufficient to finance its principal activities without additional subordinated financial support from other entities; (2) the group of equity owners does not have the ability to make significant decisions about the entity’s activities; (3) the group of equity owners does not have the obligation to absorb losses or the right to receive residual returns generated by its operations, or both; or (4) the voting rights of some investors are not proportional to their obligations to absorb the losses or the right to receive residual returns of the entity, or both, and substantially all of the entity’s activities either involve or are conducted on behalf of an investor that has disproportionately few voting rights. If any of these characteristics is present, the entity is subject to a variable interests consolidation analysis, and consolidation is based on variable interests, and not solely on ownership of the entity’s outstanding voting stock.

If an entity is determined to be a VIE, we determine if our variable interest causes us to be considered the primary beneficiary. We are the primary beneficiary and are required to consolidate the entity if we have the power to direct the activities of the VIE that most-significantly impact the entity’s economic performance and we have the obligation to absorb losses or the right to receive returns that could be significant to the entity. The assessment of the party that has the power to direct the activities of the VIE may require significant management judgment when more than one party has power, or more than one party is involved in the design of the VIE but no party has the power to direct the ongoing activities that could be significant. We are required to continually assess whether we are the primary beneficiary and, therefore, may consolidate a VIE through the duration of our involvement. Examples of certain events that may change whether or not we consolidate the VIE include a change in the design of the entity or a change in our ownership. Generally, if we are the primary beneficiary of a VIE, then we initially record the assets, liabilities and noncontrolling interests of the VIE in our consolidated financial statements at fair value. If we cease to be deemed the primary beneficiary of a consolidated VIE, then we deconsolidate the VIE.

The following provides a summary of different types of VIEs with which the Company has entered into significant transactions:

Acquisition Partnership VIEs — The Company is involved with Acquisition Partnerships that were formed with one or more investors to invest in Portfolio Assets. These Acquisition Partnerships are typically financed through debt and/or equity provided by the investors (including FirstCity). Certain of these Acquisition Partnerships are VIEs primarily because they do not have sufficient equity to finance their activities without additional subordinated financial support, or the investors do not have the ability to make certain significant decisions about the Acquisition Partnership’s activities. The voting interests for all but four of the Acquisition

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Partnership VIEs are either wholly-owned or majority-owned by non-affiliated investors, and the Company determined that it was not the primary beneficiary of these minority-owned Acquisition Partnership VIEs. However, the Company is deemed to be the primary beneficiary for four Acquisition Partnership VIEs in which the Company and respective non-affiliated investors each hold equal ownership and voting interests (these four Acquisition Partnership VIEs are consolidated by our Special-Purpose Investment Entity VIEs described below). The investors and third-party creditors, including FirstCity, generally have recourse only to the extent of the assets held by the Acquisition Partnership VIEs. Certain third-party creditors have recourse to both FirstCity and the non-affiliated investors where we jointly provide a guaranty to the Acquisition Partnership VIE. The Company does not generally provide financial support to any Acquisition Partnership VIE beyond that which is contractually required, but may provide additional liquidity alongside the non-affiliated investors to fund additional investments.

Operating Entity VIEs — The Company has variable interests with various commercial enterprise entities (attributable primarily to certain equity and debt investments made by our Special Situations Platform business). FirstCity provided financing in the form of debt and/or equity to help finance the activities of the Operating Entity VIEs. These Operating Entities are VIEs primarily because they do not have sufficient equity to finance their activities without additional subordinated financial support. The voting interests for all but one of the Operating Entity VIEs are either wholly-owned or majority-owned by non-affiliated investors, and the Company determined that it was not the primary beneficiary of these minority-owned Operating Entity VIEs. The Company was deemed to be the primary beneficiary for the Operating Entity VIE in which the Company holds a majority ownership and voting interest (this Operating Entity VIE is consolidated by our Special-Purpose Investment Entity VIEs described below). The investors and creditors, including FirstCity, generally have recourse only to the extent of the assets held by the Operating Entity VIEs. The Company does not generally provide financial support to any Operating Entity VIE beyond that which is contractually required.

Special-Purpose Investment Entity VIEs — The Company has significant variable interests with special-purpose investment entities that were created to invest in Portfolio Assets, debt and equity investments, and various other types of investments. Certain of these special-purpose investment entities are VIEs because they do not have sufficient equity to finance their activities without additional subordinated financial support. The Company owns all of the voting and equity interests in these Special-Purpose Investment Entity VIEs, and the Company was determined to be the primary beneficiary of these entities. Third-party creditors have recourse to FirstCity up to $29.5 million under guaranty provisions related to certain debt obligations of these Special-Purpose Investment Entity VIEs and certain of their unconsolidated subsidiaries, which are collateralized by their assets, only to the extent that such pledged assets of the respective entities do not generate sufficient cash to service and repay their debt obligations (see Note 17). The Company does not generally provide financial support to the Special-Purpose Investment Entity VIEs beyond that which is contractually required.

The following table displays the carrying amount and classification of assets and liabilities of the Company’s consolidated Special-Purpose Investment Entity VIEs (which include the accounts of the consolidated Acquisition Partnership VIEs and Operating Entity VIE described above) that are included in its consolidated balance sheet as of March 31, 2013. In general, third-party creditors have recourse only to the assets of the Special-Purpose Investment Entity VIEs and do not have recourse to FirstCity, except where we provided a guaranty to the entity. We record third-party ownership in these consolidated VIEs in “Noncontrolling interests” in our consolidated balance sheet.

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	Special-Purpose
(Dollars in thousands)	Investment VIEs
Cash	$	15,657
Portfolio Assets, net	39,397
Loans receivable	10,227
Equity investments	11,707
Assets held for sale	27,439
Other assets	28,535
Total assets of consolidated VIEs (1)	$	132,962

Notes payable (2)	$	44,352
Liabilities associated with assets held for sale (2)	19,896
Other liabilites (2)	12,165
Total liabilities of consolidated VIEs	$	76,413

(1) These assets can only be used to settle the liabilities of these consolidated VIEs.

(2) Includes $22.6 million of notes payable, $1.5 million of liabilities associated with assets held for sale, and $12.2 million of other liabilities for which creditors do not have recourse to FirstCity.

The following table summarizes the carrying amounts of the assets included in the Company’s consolidated balance sheet and the maximum loss exposure as of March 31, 2013 related to the Company’s variable interests in unconsolidated VIEs.

	Assets on FirstCity’s					FirstCity’s
	Consolidated Balance Sheet					Maximum
	Loans		Equity			Exposure
Type of VIE	Receivable		Investment			to Loss (1)
	(Dollars in thousands)
Acquisition Partnership VIEs	$	—	$	(1,036	)	$	1,020
Operating Entity VIEs	7,039		366			7,405
Total	$	7,039	$	(670	)	$	8,425

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

(15) Other Related Party Transactions

The Company has contracted with the Acquisition Partnerships and related parties as a third-party loan servicer. Servicing fees and due diligence fees (included in other income) derived from such affiliates totaled $2.4 million and $5.5 million for the three-month periods ended March 31, 2013 and 2012, respectively.

(16) Segment Reporting

At March 31, 2013 and 2012, the Company was engaged in two major business segments — Portfolio Asset Acquisition and Resolution business and Special Situations Platform business.

In the Portfolio Asset Acquisition and Resolution business, the Company acquires and resolves portfolios of under-performing and non-performing loans, and to a lesser extent, performing loans and other assets (collectively, “Portfolio Assets” or “Portfolios”), which are generally acquired 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 Portfolio Assets are generally aggregated, including loans of varying qualities that are secured or unsecured by diverse collateral types and real estate. Some Portfolio Assets are loans for which resolution is linked primarily to the

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real estate securing the loan, while others may be collateralized business loans for which resolution may be based either on real estate, business assets or other collateral cash flow. Portfolio Assets are acquired on behalf of the Company or its consolidated subsidiaries, and on behalf of U.S. and foreign investment entities formed with co-investors (“Acquisition Partnerships”). The Company services, manages and ultimately resolves or otherwise disposes of substantially all Portfolio Assets acquired by the Company, its Acquisition Partnerships, or other related entities. The Company services such assets until they are collected or sold.

The Company engages in its Special Situations Platform business through its majority ownership interest in FirstCity Denver Investment Corp. (“FirstCity Denver”). Through its Special Situations Platform business, the Company provides investment capital to privately-held middle-market companies through flexible capital structuring arrangements. The nature of the capital investments primarily takes the form of senior and junior financing arrangements, but also includes direct equity investments and common equity warrants. In addition, our Special Situations Platform business engages in other types of investment activity including distressed debt transactions and leveraged buyouts. FirstCity Denver’s primary investment objective is to generate both current income and capital appreciation through debt and equity investments, and to generally structure the investments to be repaid or exited in 12 to 60 months.

We evaluate the performance of our Portfolio Asset Acquisition and Resolution and Special Situations Platform business segments based primarily on the results of the segments without allocating certain corporate and administrative expenses and other items. “Corporate and Other” in the tables below represent the portions of our expenses (primarily salaries and benefits, accounting fees and legal expenses) and certain other items that are not allocable to our business segments.

The following tables set forth summarized information by segment for the three-month month periods ended March 31, 2013 and 2012:

	Three Months Ended
	March 31, 2013
	(Dollars in thousands)
	Portfolio Asset			Special
	Acquisition			Situations			Corporate
	and Resolution			Platform			and Other			Total
Revenues	$	5,687		$	4,267		$	120		$	10,074
Costs and expenses	(6,562		)	(3,638		)	(2,831		)	(13,031		)
Equity income (loss) from unconsolidated subsidiaries	960			(161		)	—			799
Income tax (expense) benefit	24			(4		)	55			75
Net income attributable to noncontrolling interests	(302		)	(234		)	—			(536		)
Earnings (loss) from continuing operations	(193		)	230			(2,656		)	(2,619		)
Income from discontinued operations	111			—			—			111
Net earnings (loss)	$	(82	)	$	230		$	(2,656	)	$	(2,508	)

	Three Months Ended
	March 31, 2012
	(Dollars in thousands)
	Portfolio Asset			Special
	Acquisition			Situations			Corporate
	and Resolution			Platform			and Other			Total
Revenues	$	16,074		$	2,528		$	85		$	18,687
Costs and expenses	(8,275		)	(1,873		)	(2,914		)	(13,062		)
Equity income (loss) from unconsolidated subsidiaries	4,532			(65		)	—			4,467
Income tax (expense) benefit	(761		)	(20		)	(51		)	(832		)
Net income attributable to noncontrolling interests	(953		)	(155		)	—			(1,108		)
Earnings (loss) from continuing operations	10,617			415			(2,880		)	8,152
Income from discontinued operations	213			—			—			213
Net earnings (loss)	$	10,830		$	415		$	(2,880	)	$	8,365

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Revenues and equity income (loss) from investments in unconsolidated subsidiaries from the Special Situations Platform segment are all attributable to U.S. operations. Revenues and equity income (loss) of unconsolidated subsidiaries from the Portfolio Asset Acquisition and Resolution segment are attributable to U.S. and foreign operations as summarized as follows:

	Three Months Ended
	March 31,
	2013		2012
	(Dollars in thousands)
Domestic	$	4,444	$	15,815
Latin America	1,820		2,085
Europe	383		2,706
Total	$	6,647	$	20,606

Total assets for each segment and a reconciliation to total assets are as follows:

	March 31,		December 31,
	2013		2012
	(Dollars in thousands)
Cash and cash equivalents	$	33,076	$	39,347
Portfolio acquisition and resolution assets:
Domestic	107,825		111,935
Latin America	7,023		6,495
Europe	5,406		6,049
Assets held for sale	24,086		20,552
Special situations platform assets	32,717		45,158
Other non-earning assets, net	13,024		15,101
Total assets	$	223,157	$	244,637

(17) Commitments and Contingencies

Legal Proceedings

Class Action Litigation

On January 15, 2013, a putative class action lawsuit was filed in the District Court in McLennan County, Texas against the Company, its directors, Parent, Merger Subsidiary and Värde purportedly on behalf of the Company’s stockholders, under the caption Eric J. Drayer v. James T. Sartain, et. al. , Cause No. 2013-246-5. The lawsuit alleged, among other things, that the director defendants breached their fiduciary duties to the Company’s stockholders in connection with Värde’s proposal and that Värde, Parent and Merger Subsidiary have aided and abetted such breaches. The plaintiff sought declaratory and injunctive relief, reasonable attorneys’ and experts’ fees and in the event the transaction is consummated, rescission of the transaction, rescissory damages and an accounting of all damages, profits and special benefits. On February 13, 2013, a first amended petition was filed. The amended petition alleged that the director defendants breached their fiduciary duties by (i) failing to maximize the value of the Company, (ii) taking steps to avoid competitive bidding, (iii) failing to properly value the Company and (iv) omitting material information and providing materially misleading information in the preliminary proxy statement, and sought the same relief and asserted the same claims as the original petition.

On January 29, 2013, a putative class action lawsuit was filed in the Court of Chancery of the State of Delaware against the Company, its directors, Parent, Merger Subsidiary and Värde purportedly on behalf of the Company’s stockholders, under the caption Paul Perry v. FirstCity Financial Corporation, et. al., Case No. 8259-VCG. The lawsuit alleged, among other things, that the director defendants breached their fiduciary duties to the Company’s stockholders by entering into the merger agreement and that the Company, Värde, Parent and Merger Subsidiary aided and abetted such breaches. The plaintiff sought declaratory and injunctive relief, reasonable attorneys’ and experts’ fees and in the event the transaction is consummated, rescission of the transaction and an accounting of all damages, profits and special benefits. On February 15, 2013, a first amended complaint was filed adding Värde Management, L.P. as a defendant. The amended complaint alleged that the director defendants breached their fiduciary duties by (i) agreeing to the merger consideration which undervalues the Company, (ii) agreeing to the terms of the merger agreement which deter other bidders and (iii) omitting material information and providing materially misleading information in the preliminary proxy statement, and sought the same relief and asserted the same claims as the original complaint.

On April 10, 2013, the Company, its directors, Parent, Merger Subsidiary, Värde and Värde Management, L.P., as defendants in the Perry lawsuit and the Drayer lawsuit, reached an agreement in principle with the plaintiffs in such actions providing for the settlement of the actions on the terms and subject to the conditions set forth in the memorandum of understanding dated April 10, 2013, which was amended on April 22, 2013 (the “MOU”), which terms included, but are not limited to, an obligation by the Company to make certain additional disclosures in the proxy statement regarding the proposed transaction. If the settlement becomes effective, the attorneys for the plaintiff class will seek an award of attorney’s fees and expenses. The settlement is subject to, among other things, the execution of definitive settlement documentation, the completion of confirmatory discovery, dismissal of the actions, consummation of the proposed transaction and the approval of the Texas and Delaware courts. Upon effectiveness of the settlement, the Perry and Drayer lawsuits will be dismissed with prejudice and all claims under federal and state law that were or could have been asserted in such suits or which arise out of or relate to the proposed transaction will be released by the plaintiff class. The defendants entered into the MOU to eliminate the uncertainty, burden, risk, expense and distraction of further litigation.

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Investment Agreement with Värde Investment Partners, L.P. (“VIP”)

FirstCity Diversified Holdings (“FC Diversified”) and FC Servicing, wholly-owned subsidiaries of FirstCity, and VIP, are parties to an investment agreement that provides, among other things, a “right of first refusal” provision to VIP. Pursuant to the investment agreement, FC Diversified and FC Servicing granted VIP a right of first refusal to participate in distressed asset investment opportunities in which the aggregate amount of the proposed investment is to exceed $3.0 million. FC Diversified and FC Servicing are required to follow a prescribed notice procedure pursuant to which VIP has the option to participate in a proposed investment, whether in the form of a direct purchase, equity investment or loan, by requiring that the purchase, acquisition or loan be effected through an acquisition entity formed by FC Diversified (or its affiliate) and VIP (or its affiliate). An affiliate of FC Diversified will own from 5% to 25% of the acquisition entity at FC Diversified’s determination. The investment agreement has a termination date of June 30, 2015, which is subject to consecutive automatic one-year extensions without any action by FC Diversified, FC Servicing and VIP. FC Servicing will be the servicer for all of the acquisition entities formed by FC Diversified and VIP (subject to removal by VIP on a pool-level basis under certain conditions). The parties may terminate the investment agreement prior to June 30, 2015 under certain conditions.

Indemnification Obligation Commitments

Strategic Mexican Investment Partners L.P. (“SMIP”), a wholly-owned subsidiary of FirstCity, Cargill Financial Services International Inc. (“CFSI”), and a Mexican acquisition partnership that is collectively owned by SMIP and CFSI (collectively, the “Sellers”), are parties to indemnification arrangements that originated in 2006 in connection with their respective sales of eleven Mexican portfolio entities to Bidmex Holding LLC (“Bidmex Holding”) and a loan portfolio to a Bidmex Holding subsidiary. Bidmex Holding is a Mexican acquisition partnership that was formed by certain subsidiaries of American International Group, Inc. (“AIG Entities”), as the 85%-majority owner, and SMIP, as the 15%-minority owner, to acquire the interests of the portfolio entities and loan portfolio from the Sellers. In connection with these sales transactions, the Sellers made various representations and warranties concerning (i) the existence and ownership of the portfolio entities, (ii) the assets and liabilities of the portfolio entities, (iii) taxes related to periods prior to the sales transaction date, (iv) the operations of the portfolio entities, and (v) the ownership of the loan portfolio and existence of the underlying loans. The Sellers agreed to indemnify Bidmex Holding and AIG Entities from damages resulting from a breach of these representation and warranty conditions according to their respective ownership percentages in each Mexican portfolio entity, or on the basis of 80% to CFSI and 20% to SMIP as to any matter that was not related to a particular portfolio entity. The indemnity obligation survives for a period of the statute of limitations for matters related to taxes, existence and authority, capitalization and good standing of the Mexican portfolio entities. The Sellers are not required to make any payments as a result of the indemnity provisions until the aggregate amount payable exceeds certain thresholds (ranging from $25,000 for the loan portfolio transaction to $250,000 for the Mexican portfolio entities transaction). However, claims related to taxes and fraud are not subject to these thresholds. At this time, management does not believe that this potential obligation will have a material adverse impact on the Company’s consolidated results of operations, financial position or liquidity.

Guarantees and Letters of Credit

FC Commercial has a term loan facility with Bank of Scotland. The obligations under this loan facility are secured by substantially all assets and subsidiaries of FC Commercial (excluding FH Partners). FirstCity provides an unlimited guaranty for the repayment of

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

the indebtedness under this loan facility. At March 31, 2013, the unpaid principal balance on this loan was $22.5 million. Refer to Note 7 for additional information.

ABL has a $25.0 million revolving loan facility with WFCF. The obligations under this facility are secured by substantially all of the assets of ABL, and FirstCity provides WFCF with an unconditional guaranty on ABL’s obligations under the loan facility up to a maximum of $5.0 million plus enforcement cost. At March 31, 2013, the unpaid principal balance on this loan facility was $18.3 million.

FC Investment has a $15.0 million revolving loan facility with FNBCT. The obligations under this facility are secured by substantially all of the assets of FC Investment and its subsidiaries. FirstCity provides an unlimited guaranty for the repayment of the indebtedness under this revolving loan facility. At March 31, 2013, the unpaid principal balance on this loan facility was $2.0 million. Refer to Note 7 for additional information.

Certain of the Company’s consolidated subsidiaries provide guarantees to various financial institutions related to their financing arrangements with certain Acquisition Partnerships. The underlying financing arrangements of these Acquisitions Partnerships mature at various dates through September 2015, and are secured primarily by certain real estate properties held by the Acquisition Partnerships. At March 31, 2013, the unpaid debt obligations of these Acquisition Partnerships attributed to the underlying guarantees of the Company’s subsidiaries approximated $1.5 million.

Fondo de Inversion Privado NPL Fund One (“PIF1”), an equity-method investment of FirstCity, has a credit facility with Banco Santander Chile, S.A. with an unpaid principal balance of $5.3 million at March 31, 2013. PIF1 uses the credit facility to finance the purchases of loan portfolios. Pursuant to terms of the credit facility, FirstCity was required to provide a stand-by letter of credit from Bank of Scotland that would satisfy the current loan balance upon demand. At March 31, 2013, FirstCity had a letter of credit in the amount of $5.0 million from Bank of Scotland under the terms of FirstCity’s loan facility with Bank of Scotland (see Note 7), with Banco Santander Chile, S.A. as the letter of credit beneficiary. In the event that a demand is made under the $5.0 million letter of credit, FirstCity would be required to reimburse Bank of Scotland by making payment to Bank of Scotland for all amounts disbursed or to be disbursed by Bank of Scotland under the letter of credit.

Environmental Matters

The Company generally retains environmental consultants to conduct or update environmental assessments in connection with the Company’s foreclosed and acquired real estate properties. These environmental assessments have not revealed environmental conditions that the Company believes will have a material adverse effect on its business, assets, financial condition, results of operations or liquidity, and the Company is not otherwise aware of environmental conditions with respect to properties that the Company believes would have such a material adverse effect. However, from time to time, environmental conditions at the Company’s properties have required and may in the future require environmental testing and/or regulatory filings, as well as remedial action. Liabilities for future remediation costs are recorded when environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated. Other than for assessments, the timing and magnitude of these accruals generally are based on the completion of investigations or other studies or a commitment to a formal plan of action.

Income Taxes

We are subject to income taxes in both the United States and the non-U.S. jurisdictions in which we operate. Certain of our entities are under examination by the relevant taxing authorities for various tax years. We regularly assess the potential outcome of current and future examinations in each of the taxing jurisdictions when determining the adequacy of the provision for income taxes. We have only recorded financial statement benefits for tax positions which we believe reflect the “more-likely-than-not” criteria incorporated in the FASB’s authoritative guidance on accounting for uncertainty in income taxes, and we have established income tax reserves in accordance with this authoritative guidance where necessary. Once a financial statement benefit for a tax position is recorded or a tax reserve is established, we adjust it only when there is more information available or when an event occurs necessitating a change. While we believe that the amount of the recorded financial statement benefits and tax reserves reflect the more-likely-than-not criteria, it is possible that the ultimate outcome of current or future examinations may result in a reduction to the tax benefits previously recorded on the financial statements or may exceed the current income tax reserves in amounts that could be material.

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

Overview

FirstCity is a multi-national specialty financial services company headquartered in Waco, Texas with offices throughout the United States and Mexico and a presence in Europe and South America. FirstCity, as an opportunistic investor, focuses on distressed asset investment opportunities in both the United States and, to a lesser extent, international markets, and distressed transaction and special situations investment opportunities in U.S. lower middle-market companies. The Company has strategically aligned its operations into two major business segments — Portfolio Asset Acquisition and Resolution and Special Situations Platform.

The Portfolio Asset Acquisition and Resolution business has been the Company’s core business segment since it commenced operations in 1986. In the Portfolio Asset Acquisition and Resolution business, the Company acquires portfolios of performing and non-performing loans and other assets (collectively, “Portfolio Assets” or “Portfolios”), generally at a discount to their legal principal balances or appraised values, and services and resolves (i.e. liquidates) such Portfolio Assets in an effort to maximize the present value of the ultimate cash recoveries. FirstCity acquires the Portfolio Assets for its own account or through investment entities formed with co-investors (each such entity, an “Acquisition Partnership”).

Through its Special Situations Platform business, the Company provides investment capital to privately-held lower middle-market companies through flexible capital structuring arrangements to generate an attractive risk-adjusted return. These capital investments primarily take the form of senior and junior financing arrangements, but also include direct equity investments and common equity warrants. The Company also engages in other investment activities, including leveraged buyouts and distressed debt transactions, through its Special Situations Platform business.

In December 2012, the Company entered into a definitive merger agreement with Hotspurs Holdings LLC (“Parent”) and Merger Subsidiary pursuant to which the Company will become a private company that is wholly owned by Parent. Parent and Merger Subsidiary are affiliates of certain private investment funds governed by Värde. Under the terms of the merger agreement, FirstCity stockholders will receive $10.00 per share in cash for each share of FirstCity stock they own. The transaction is expected to close in May 2013. Consummation of the transaction is subject to various customary conditions, including the adoption of the merger agreement by the holders of at least a majority of the outstanding shares of the Company’s common stock. On April 17, 2013, the Company filed a definitive proxy statement with the Securities and Exchange Commission recommending that the Company’s stockholders vote to adopt the merger agreement.

Summary Financial Results

FirstCity recorded a net loss of $2.5 million, or $0.24 per common share on a fully diluted basis, for the three-month period ended March 31, 2013 (“Q1 2013”), compared to net earnings of $8.4 million, or $0.80 per common share on a fully diluted basis, for the three-month period ended March 31, 2012 (“Q1 2012”). Components of FirstCity’s results of operations for the three-month periods ended March 31, 2013 and 2012 are presented in the tables below.

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	Three Months Ended
	March 31, 2013
	(Dollars in thousands)
	Portfolio Asset			Special
	Acquisition			Situations			Corporate
	and Resolution			Platform			and Other			Total
Revenues	$	5,687		$	4,267		$	120		$	10,074
Costs and expenses	(6,562		)	(3,638		)	(2,831		)	(13,031		)
Equity income (loss) from unconsolidated subsidiaries	960			(161		)	—			799
Income tax (expense) benefit	24			(4		)	55			75
Net income attributable to noncontrolling interests	(302		)	(234		)	—			(536		)
Earnings (loss) from continuing operations	(193		)	230			(2,656		)	(2,619		)
Income from discontinued operations	111			—			—			111
Net earnings (loss)	$	(82	)	$	230		$	(2,656	)	$	(2,508	)

	Three Months Ended
	March 31, 2012
	(Dollars in thousands)
	Portfolio Asset			Special
	Acquisition			Situations			Corporate
	and Resolution			Platform			and Other			Total
Revenues	$	16,074		$	2,528		$	85		$	18,687
Costs and expenses	(8,275		)	(1,873		)	(2,914		)	(13,062		)
Equity income (loss) from unconsolidated subsidiaries	4,532			(65		)	—			4,467
Income tax (expense) benefit	(761		)	(20		)	(51		)	(832		)
Net income attributable to noncontrolling interests	(953		)	(155		)	—			(1,108		)
Earnings (loss) from continuing operations	10,617			415			(2,880		)	8,152
Income from discontinued operations	213			—			—			213
Net earnings (loss)	$	10,830		$	415		$	(2,880	)	$	8,365

As an opportunistic investor in the distressed asset and special situations markets, FirstCity’s mix of revenues and earnings in its business segments will significantly fluctuate from period to period. Refer to the heading “ Results of Operations ” below for a detailed review of the Company’s operations for the comparative periods presented in the table above.

Portfolio Asset Acquisition and Resolution. The Company’s net earnings related to its Portfolio Asset Acquisition and Resolution business segment decreased to $82,000 in losses in Q1 2013 from $10.8 million of earnings in Q1 2012. The reduction in net earnings in Q1 2013 compared to Q1 2012 was attributed primarily to a $6.6 million decrease in income from Portfolio Assets, a $3.6 million decrease in equity income of unconsolidated subsidiaries, and a $3.1 million decrease in servicing fee revenues.

In January 2013, FirstCity Business Lending Corporation, an indirect wholly-owned subsidiary of the Company, entered into a stock purchase agreement with CS ABL Holdings, LLC to sell all of the common stock and the preferred stock of American Business Lending, Inc. (“ABL”) to CS ABL Holdings, LLC. Accordingly, the results of operations from ABL are reported as discontinued operations within our Portfolio Asset Acquisition and Resolution business segment for the three-month periods ended March 31, 2013 and 2012, respectively. Refer to the heading “ Results of Operations ” below for additional discussion on the discontinued operations and a detailed review of the Company’s operations in this business segment for the comparative periods presented in the table above.

Special Situations Platform. The Company’s net earnings from its Special Situations Platform business segment decreased to $0.2 million in Q1 2013 compared to $0.4 million in Q1 2012. The decrease in net earnings in Q1 2013 compared to Q1 2012 was attributed primarily to a $0.2 million decrease in interest income from loans receivable and a $0.5 million decrease in other income, partially offset by a decrease of $0.2 million decrease in other costs and expenses. Refer to the heading “ Results of Operations ” below for a detailed discussion of the Company’s operations in this business segment for the comparative periods presented in the table above.

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Corporate and Other. Net costs and expenses not allocable to our Portfolio Asset Acquisition and Resolution and Special Situations Platform business segments, consisting primarily of certain corporate salaries and benefits, legal and other professional expenses, and accounting fees, decreased to $2.7 million for Q1 2013 compared to $2.9 million for Q1 2012.

Summary Investment Activity

In Q1 2013, FirstCity and its investment partners acquired $61.9 million of U.S. Portfolio Asset investments and $0.4 million of European Portfolio Asset investments with an aggregate face value of approximately $133.3 million — of which FirstCity’s investment acquisition share was $12.9 million. In addition to its Portfolio Asset acquisitions in Q1 2013, FirstCity invested $6.1 million in non-portfolio investments, consisting of $6.0 million in the form of SBA loan originations and advances, and $0.1 million in the form of equity investments. In Q1 2012, FirstCity and its investment partners acquired $90.8 million of U.S. Portfolio Asset investments and $0.4 million of European Portfolio Asset investments with a face value of approximately $210.1 million — of which FirstCity’s investment acquisition share was $9.5 million. In addition to its Portfolio Asset acquisitions in Q1 2012, FirstCity invested $4.9 million in non-portfolio investments, including $3.8 million in the form of SBA loan originations and advances, $1.0 million in the form loan originations under its Special Situations Platform (“FirstCity Denver”), and $0.1 in the form of equity investments.

At March 31, 2013, the carrying value of FirstCity’s earning assets (primarily Portfolio Assets, equity investments, loans receivable and entity-level earning assets) approximated $177.1 million — compared to $190.2 million at December 31, 2012 and $285.9 million at March 31, 2012. The global distribution of FirstCity’s earning assets (at carrying value) at March 31, 2013 included $164.7 million in the United States (including $24.1 million related to ABL); $5.4 million in Europe; and $7.0 million in Latin America. Since mid-2010, a significant majority of our Portfolio Asset investments have been acquired through minority-owned, unconsolidated U.S. Acquisition Partnerships (instead of majority-owned, consolidated Portfolio Asset investments) under terms of an investment agreement with Värde Investment Partners, L.P. (“VIP”). As such, total footings of our consolidated earning assets have experienced a corresponding decrease, resulting primarily from a decline in our holdings of consolidated Portfolio Assets.

Refer to the headings “ Portfolio Asset Acquisitions — Portfolio Asset Acquisition and Resolution Business Segment ” and “ Lower Middle-Market Company Capital Investments — Special Situations Platform Business Segment ” below for additional information related to our investment activities and composition.

Management’s Outlook

Our revenues consist primarily of (1) income and gains from our Portfolio Assets and loan investments; (2) equity income from our Acquisition Partnerships; (3) servicing fee income and incentive fee income from Acquisition Partnerships based on the performance of our servicing activities on the assets held by these unconsolidated partnerships; and (4) income generated by our debt and equity investments (consolidated and unconsolidated) in privately-held lower middle-market companies. Our ability to maintain and grow revenues depends on our ability to secure investment opportunities, obtain financing for transactions, and to consummate investments and deliver attractive risk-adjusted returns. Our ability to execute this strategy depends upon a number of market conditions — including the strength and liquidity of U.S. and global economies and financial markets.

While we continue to see signs of improvement and stabilization in U.S. and global economic conditions and financial markets, these conditions and markets remain challenging and their recovery has been imbalanced. More recently, U.S. debt ceiling and fiscal policy concerns, together with uncertainty related to sovereign debt conditions in Europe, have increased volatility and uncertainty that could adversely affect the U.S. and global financial markets and economic conditions. The recent economic recession in general, combined with the disruptions in the financial and capital markets in particular, have negatively impacted market liquidity and increased the cost of debt and equity capital.

Market commentators and analysts have expressed the belief that it will take some time for the U.S. and global economies and financial markets to fully recover, but it is not clear if adverse conditions will again intensify. As a result, the continued challenging economic conditions could still materially and adversely impact (i) our ability to price and fund new distressed asset and lower middle-market capital investment opportunities on attractive terms; (ii) the ability of our borrowers to repay or refinance their debt obligations to us; (iii) the value of the underlying real estate properties and other assets securing our purchased and originated loan investments; and/or (iv) the financial condition, operations and liquidity of the underlying servicing and operating entities in which we have an equity investment. There can be no assurance that the value of our Portfolio Assets, loan investments and other investment assets, or the performance of our equity-method investees and consolidated subsidiaries, will not be negatively impacted by challenging economic conditions which could have a negative impact on our future results.

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Despite substantial losses reported in the financial services sector in recent years, and continued volatility and uncertainty in U.S. and global economies and financial markets, management remains positive on the outlook of the business of acquiring distressed portfolio assets and believes that current market conditions should not hinder FirstCity’s ability to expand its business. While disruptions and uncertainty in the markets may adversely affect our existing positions, we believe such conditions generally present significant new investment opportunities for distressed asset acquisition and special situations transactions. Our ability to profit in our industry, however, depends on our ability to acquire sufficient funding for our operations.

As a specialty finance company, the Company depends on third-party financing to fund (i) acquisitions of distressed asset portfolios in the U.S. and Europe and equity investments in acquisition entities in connection with its Portfolio Asset Acquisition and Resolution business and (ii) capital investments in other companies in connection with its Special Situations Platform business acquisitions. Since 1986, the Company has acquired for its own account or through investment entities formed with co-investors more than $12.8 billion face value amount of portfolio assets, with the Company’s equity investment of approximately $1.1 billion, focusing principally on commercial real estate loans and commercial and industrial loan portfolios.

Following the economic crisis in 2008, management believed that the purchasing environment for distressed loan portfolios was more attractive than it had been at any time in the Company’s history due to the conditions listed below. Management believed that the following factors would increase the trend of financial institutions, government agencies and other sellers to package and sell asset portfolios to investors, generally at a discount as a means of disposing of under-performing and non-performing loans or other surplus or non-strategic assets:

· an increase generally in the amount of loans that were considered under-performing or non-performing following the economic crisis;

· the fact that the sale by financial institutions of under-performing and non-performing loans would improve their regulatory capital position;

· the opportunities that might arise if any of the significant corporate real estate loans maturing within a few years were not repaid or refinanced; and

· the opportunities that might arise in Europe as a result of European banks selling non-performing loans following the debt crisis there.

Historically, the Company’s primary sources of funding for purchasing distressed loan portfolios were loans under credit facilities with third-party lenders, other special purpose short-term borrowings, funds generated from operations, equity distributions from acquisition entities and other subsidiaries and interest and principal payments on subordinated intercompany debt. A substantial majority of the Company’s portfolio investments prior to July 2010 were funded through loan facilities provided by Bank of Scotland and BoS(USA), Inc.

Although Bank of Scotland had provided financing to the Company for several years, following Lloyds Banking Group’s acquisition of Bank of Scotland, Bank of Scotland and BoS(USA), Inc. placed the Company’s revolving loan facility in a wind-down structure. In June 2010, the facilities with Bank of Scotland and BoS(USA), Inc. were restructured into one facility with a principal amount of $268.6 million (“Reducing Note Facility”) under which Bank of Scotland and BoS(USA), Inc. had no further obligations to provide financing to the Company. The lack of a corporate line of credit substantially restricted the Company’s ability to acquire loan portfolios. As a result, the Company’s source of funding for acquisitions was primarily limited to its unencumbered cash flow from operations and the cash flow leak-through permitted by the Reducing Note Facility, and the Company began to seek alternative sources of funding, which ultimately proved to be unachievable as the Company was never able to replace this source of funding.

Due to a lack of funding, the Company was unable to pursue an aggressive acquisition strategy for its own account and almost all of the Company’s new acquisitions were off-balance sheet in the form of minority interests (ranging from 10% to 20%) in acquisition entities controlled by larger firms. The Company was unable to obtain financing to purchase investments for its own account on reasonable terms. As a result, the Company’s balance sheet began to shrink as its existing portfolios matured and new acquisitions were off-balance sheet and the value of its servicing platform diminished.

In addition to various other debt and equity investment opportunities, we continue to seek distressed asset investment opportunities under our investment agreement with VIP (see Note 17 of the consolidated financial statements for additional information). The Company’s involvement in these investments will come in the form of minority ownership (ranging from 5% to 25% at

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FirstCity’s determination) of an acquisition entity formed by FirstCity and VIP. FirstCity will also be the servicer for the acquisition entities formed with VIP. FirstCity’s increased holdings in minority-owned, unconsolidated acquisition entities under this investment agreement since mid-2010 represent a shift in the Company’s portfolio asset acquisition history — which primarily consisted of consolidated portfolio assets prior to such time. As such, in the context of the Company’s Portfolio Asset Acquisition and Resolution business segment, management expects to see a gradual shift in the composition of FirstCity’s income attributed to distressed asset investments to “Equity income from unconsolidated subsidiaries” (unconsolidated equity-method investments) from “Income from Portfolio Assets” (consolidated portfolio assets). Management also expects to see a gradual increase in service fee income over time related to the performance of our servicing responsibilities related to these unconsolidated acquisition entities. Refer to the heading “ Results of Operations ” below for additional information related to our Portfolio Asset Acquisition and Resolution operations.

Our ability to make new investments and fund operations is dependent on: (1) anticipated cash flows from unencumbered Portfolio Assets and equity investments; (2) our current holdings of unencumbered cash; (3) residual cash flows from the pledged assets and equity investments after full repayment of our term loan facilities with Bank of Scotland and Bank of America (see Note 7 of the consolidated financial statements); (4) cash leak-through provisions included in our term loan facilities with Bank of Scotland and Bank of America; and (5) our investment agreement with VIP. While management believes that these cash flow sources will provide FirstCity with funding and liquidity to support its operations and investment activities, FirstCity continues to actively seek additional sources of liquidity and alternative funding sources. We remain cognizant about the uncertainty and volatility in U.S. financial markets that currently present challenges for businesses in accessing liquidity and capital, and the resulting impact on our liquidity considerations and operations.

Results of Operations

The following discussion and analysis are based on the segment reporting information presented in Note 16 to the consolidated financial statements of the Company included in Item 1 of this Form 10-Q, and should be read in conjunction with the consolidated financial statements (including the notes thereto) included elsewhere in this Form 10-Q.

As a result of significant period-to-period fluctuations in our revenues and earnings, period-to-period comparisons of the results of our operations may not be meaningful. The Company’s business and results of operations are impacted by the availability of liquidity to fund its investment activity and operations, and its access to credit and capital markets. The Company’s business and results of operations are also impacted by many other factors including, but not limited to, general economic, political and industry conditions; volatility and disruptions in the functioning of financial markets; fluctuations in interest rates and foreign currency exchange rates; fluctuations in the underlying values of real estate and other collateral securing our loan portfolios; the timing and ability to collect and liquidate assets; changes in the performance and creditworthiness of our borrowers and other counterparties; increased competition from other market participants in the industries in which we operate; the availability, pricing and terms of Portfolio Assets, lower middle-market transactions and other investment opportunities in all of the Company’s businesses; and changes in government regulations, statutes and tax or fiscal policies. Such factors, individually or combined with other factors, may result in significant fluctuations in our reported operations and in the trading price of our common stock.

Q1 2013 Compared to Q1 2012

FirstCity’s net loss to common stockholders totaled $2.5 million in Q1 2013 compared to net earnings of $8.4 million in Q1 2012. On a per share basis, diluted net earnings (loss) to common stockholders were ($0.24) in Q1 2013 compared to $0.80 in Q1 2012.

Portfolio Asset Acquisition and Resolution

Through our Portfolio Asset Acquisition and Resolution (“PAA&R”) business segment, FirstCity and its investment partners acquired $62.3 million of Portfolio Assets in Q1 2013 with an approximate face value of $133.3 million, compared to the Company’s involvement in acquiring $91.2 million of Portfolio Assets in Q1 2012 with an approximate face value of $210.1 million. In Q1 2013, FirstCity’s investment acquisition share in the Portfolio Asset acquisitions was $12.9 million — consisting of $0.4 million acquired through consolidated portfolio entities and $12.5 million acquired through unconsolidated Acquisition Partnerships. In Q1 2012, FirstCity’s investment acquisition share in Portfolio Asset acquisitions was $9.5 million — consisting of $0.4 million acquired through consolidated portfolio entities and $9.1 million acquired through unconsolidated Acquisition Partnerships. Generally speaking, income recognized from our investments in consolidated Portfolio Assets is reported as “Income from Portfolio Assets” on our consolidated statements of earnings, whereas income from our investments in unconsolidated subsidiaries that acquire Portfolio Assets is reported as “Equity income from unconsolidated subsidiaries.” Furthermore, since we function as the servicer for the vast majority of

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our U.S. and Latin American unconsolidated Portfolio Assets, we also recognize fee income related to the performance of our servicing responsibilities. This fee income is reported as “Servicing fees” on our consolidated statements of earnings. We also generate service fee income from our U.S. and Latin American consolidated Portfolio Assets that we service; however, this income is eliminated in consolidation and, as such, is not included on our consolidated statements of earnings.

In Q1 2013, FirstCity invested an additional $6.0 million in non-portfolio investments in the form of SBA loan originations and advances and $0.1 million in other investments, compared to $3.8 million in non-portfolio investments in the form of SBA loan originations and advances and $0.1 million in other investments in Q1 2012. Refer to the heading “ Portfolio Asset Acquisitions — Portfolio Asset Acquisition and Resolution Business Segment ” below for additional information related to our investment activities and composition in our PAA&R segment.

Our PAA&R business segment reported $82,000 of net losses in Q1 2013 compared to $10.8 million of net earnings in Q1 2012. The following is a summary of the results of operations for the Company’s PAA&R business segment for Q1 2013 and Q1 2012:

	Three Months Ended
	March 31,
	2013			2012
	(Dollars in thousands)
Portfolio Asset Acquisition and Resolution:
Revenues:
Servicing fees	$	2,449		$	5,575
Income from Portfolio Assets	1,936			8,505
Interest income from loans receivable - other	25			—
Other income	1,277			1,994
Total revenues	5,687			16,074
Costs and expenses:
Interest and fees on notes payable to banks and other	726			1,376
Salaries and benefits	3,471			4,094
Provision for loan and impairment losses, net of recoveries	106			224
Asset-level expenses	605			914
Other costs and expenses	1,654			1,667
Total expenses	6,562			8,275
Equity income of unconsolidated subsidiaries	960			4,532
Income tax (expense) benefit	24			(761		)
Net income attributable to noncontrolling interests	(302		)	(953		)
Earnings from continuing operations	(193		)	10,617
Income from discontinued operations	111			213
Net earnings	$	(82	)	$	10,830

Servicing fee revenues. Servicing fee revenues decreased to $2.4 million in Q1 2013 from $5.6 million in Q1 2012. Servicing fees from U.S. Acquisition Partnerships totaled $1.2 million in Q1 2013 compared to $2.2 million in Q1 2012, while servicing fees from Latin American Acquisition Partnerships totaled $1.1 million in Q1 2013 and $1.5 million in Q1 2012. Servicing fees from U.S. Acquisition Partnerships are generally based on a percentage of the collections received from Portfolio Assets held by these unconsolidated partnerships; whereas servicing fees from Latin American Acquisition Partnerships are generally based on the cost of servicing plus a profit margin. The decrease in servicing fees from U.S. Acquisition Partnerships in Q1 2013 compared to Q1 2012 was attributable to a decrease in collections from unconsolidated U.S. partnerships to $37.9 million in Q1 2013 from $72.0 million in Q1 2012. In addition, FirstCity recognized $1.9 million of additional compensation in the form of incentive fee income in Q1 2012 (compared to $0.2 million in Q1 2013) resulting from the achievement of an investor return threshold from a U.S. Acquisition Partnership.

Since mid-2010, a majority of the Company’s U.S. Portfolio Asset investments have been acquired through equity-method investments in unconsolidated Acquisition Partnerships under the VIP investment agreement instead of consolidated Portfolio Assets. As such, the Company expects service fee income from its unconsolidated U.S. Acquisition Partnerships to gradually increase over time. Refer to the heading “Equity income from unconsolidated subsidiaries” below for information on our unconsolidated U.S. Acquisition Partnership activities.

Income from Portfolio Assets . Income from Portfolio Assets, comprised primarily of liquidation income and gains and accretion income from Portfolio Assets, decreased to $1.9 million in Q1 2013 from $8.5 million in Q1 2012. The following tables provide a summary of the Company’s income from loan Portfolio Assets, including Purchased Credit-Impaired Loans, by income-recognition method for the three months ended March 31, 2013 and 2012.

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	Three Months Ended
	March 31, 2013
	(Dollars in thousands)
	Income-Accruing Loans				Non-Accrual Loans
	Purchased				Purchased Credit-
	Credit-				Impaired Loans					Other
	Impaired							Cost recovery				Cost recovery
	Loans		Other		Cash basis			basis		Cash basis		basis		Real Estate		Total
United States	$	41	$	91	$	981	(1)	$	245	$	36	$	—	$	168	$	1,562

Germany	—		—		281			—		—		—		36		317

Mexico	—		—		—			57		—		—		—		57

Total	$	41	$	91	$	1,262		$	302	$	36	$	—	$	204	$	1,936

(1) Includes $0.1 million of liquidation income generated from loan sales.

	Three Months Ended
	March 31, 2012
	(Dollars in thousands)
	Income-Accruing Loans				Non-Accrual Loans
	Purchased				Purchased Credit-
	Credit-				Impaired Loans						Other
	Impaired							Cost recovery					Cost recovery
	Loans		Other		Cash basis			basis			Cash basis		basis		Real Estate			Total
United States	$	371	$	71	$	5,102	(1)	$	1,759	(2)	$	35	$	—	$	825		$	8,163

Germany	—		—		211			—			—		—		(1		)	210

Mexico	—		—		—			132			—		—		—			132

Total	$	371	$	71	$	5,313		$	1,891		$	35	$	—	$	824		$	8,505

(1) Includes $3.6 million of liquidation income generated from loan sales.

(2) Includes $0.8 million of liquidation income generated from loan sales.

Income from Portfolio Assets from our consolidated U.S. Portfolio Assets decreased by $6.6 million from quarter to quarter. Income from our non-accrual loans decreased by $5.6 million in Q1 2013 compared to Q1 2012, and income from our income-accruing loans decreased by $0.3 million in Q1 2013 compared to Q1 2012. Our average holdings in income-accruing credit-impaired Portfolio Assets decreased to zero for Q1 2013 from $9.4 million for Q1 2012. We apply the interest-accrual income method to Portfolio Assets, as applicable, only when management has the ability to reasonably estimate both the timing and amount of collections. Refer to Note 1 of the consolidated financial statements for a summary of our income-recognition accounting policies related to Portfolio Assets. In addition, income from real estate decreased by $0.7 million in Q1 2013 compared to Q1 2012. FirstCity’s average investment holdings in consolidated U.S. Portfolio Assets for Q1 2013 were $48.9 million, compared to $106.5 million for Q1 2012. The decline in our consolidated U.S. Portfolio Asset holdings in Q1 2013 was due to the majority of our U.S. Portfolio Asset purchases since mid-2010 being made through equity-method investments in unconsolidated U.S. Acquisition Partnerships under the VIP investment agreement. In light of this, the Company expects equity income from U.S. Acquisition Partnerships (and service fee income) to gradually increase over time in comparison to income from consolidated Portfolio Assets.

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Refer to the heading “ Equity income from unconsolidated subsidiaries ” below for information on our unconsolidated U.S. Acquisition Partnership activities.

Income from Portfolio Assets from our consolidated European Portfolio Assets increased by $0.1 million from quarter to quarter. FirstCity’s average investment holdings in consolidated European Portfolio Assets for Q1 2013 were $3.7 million, compared to $4.8 million for Q1 2012.

Income from Portfolio Assets from our consolidated Portfolio Assets in Mexico decreased by $0.1 million from quarter to quarter. FirstCity’s average investment holdings in consolidated Latin America Portfolio Assets for Q1 2013 were $0.7 million, compared to $5.1 million for Q1 2012 (including $5.0 million reported as “Assets held for sale” on our consolidated balance sheet during Q1 2012). The decrease in our consolidated Latin American Portfolio Asset holdings in Q1 2013 was due primarily to the sale of two consolidated Mexican subsidiaries in July 2012.

Interest income from loans receivable — affiliates. The Company did not recognize interest income from loans receivable — affiliates in Q1 2013 or Q1 2012. The Company’s only remaining affiliated loan was sold in the third quarter of 2012 (see Note 3 of the consolidated financial statements).

Interest income from loans receivable — other. Interest income from loans receivable - other was $25,000 for Q1 2013. The Company did not recognize interest income from loans receivable — other in Q1 2012 from its non-affiliated loan investments because management accounted for such loans under the non-accrual income method of accounting during that quarter. FirstCity’s average investment in loans receivable — other in its PAA&R segment was $3.3 million for Q1 2013 compared to $2.9 million for Q1 2012.

Other income . Other income decreased to $1.3 million for Q1 2013 compared to $2.0 million for Q1 2012, due partially to reduced income from a European Acquisition Partnership which was deconsolidated in June 2012. Further, we received less due diligence and credit administration fee income in Q1 2013 compared to Q1 2012. These fees vary from period to period depending upon portfolio investment activity.

Costs and expenses. Operating costs and expenses approximated $6.6 million in Q1 2013 compared to $8.3 million in Q1 2012. The following is a discussion of the major components of operating costs and expenses in its PAA&R business segment:

Interest expense and fees on notes payable and other debt obligations decreased to $0.7 million in Q1 2013 from $1.4 million in Q1 2012, due primarily to the Bank of Scotland loan facilities that were refinanced in December 2011 (see Note 7 of the consolidated financial statements). The Company recorded $0.5 million of interest, loan fee and discount amortization expense on its Bank of Scotland loan facilities in Q1 2013 (based on average debt holdings of $24.8 million) compared to $0.7 million of interest, loan fee and discount amortization expense in Q1 2012 (based on average debt holdings of $83.4 million). Excluding the Company’s debt obligations with Bank of Scotland, the average nonaffiliated debt outstanding in its PAA&R segment was $20.6 million in Q1 2013 (with a 5.2% average cost of funds) compared to $64.2 million in Q1 2012 (with a 4.3% average cost of funds).

Salaries and benefits expense in our PAA&R segment decreased to $3.5 million in Q1 2013 from $4.1 million in Q1 2012, due primarily to less compensation expense recognized in Q1 2013 compared to Q1 2012 under the Company’s executive management compensation plans. The total number of personnel within the PAA&R segment was 180 at March 31, 2013 and 199 at March 31, 2012.

Net provisions for loan and impairment losses on consolidated Portfolio Assets and loans receivable in our PAA&R segment totaled $0.1 million in Q1 2013 compared to $0.2 million in Q1 2012. Net impairment provisions in Q1 2013 were attributed primarily to declines in values of loan collateral and real estate properties related to our U.S. Portfolio Assets investments. The net impairment provisions were identified in connection with management’s quarterly evaluation of the collectibility of the Company’s Portfolio Assets and loans receivable. The process for evaluating and measuring impairment is critical to our financial results, as it requires subjective and complex judgments due to the need to make estimates about the impact of matters that are uncertain. This process also requires estimates that are susceptible to significant revision as more information becomes available. It remains unclear what impact the continuance of challenging economic conditions and disruptions in the financial, capital and real estate markets will ultimately have on our financial results. These conditions could adversely impact our business if commercial real estate properties experience a significant and prolonged decline in value, or if borrowers cannot refinance their loans and/or continue to make payments (which in turn could lead to rising loan defaults and foreclosures on loan collateral). Therefore, we cannot provide assurance that, in any particular future period, we will not incur additional impairment provisions.

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Asset-level expenses, which generally represent costs incurred by FirstCity to manage consolidated Portfolio Assets, support foreclosed properties, and protect its security interests in loan collateral, decreased to $0.6 million in Q1 2013 from $0.9 million in Q1 2012. The decline in asset-level expenses was attributed primarily to a decline in the Company’s average holdings in consolidated Portfolio Assets in its PAA&R segment to $53.3 million for Q1 2013 from $111.3 million for Q1 2012 (a majority of FirstCity’s Portfolio Asset investments have been acquired through unconsolidated Acquisition Partnerships since mid-2010).

Other costs and expenses in the Company’s PAA&R segment were $1.7 million for both Q1 2013 and Q1 2012.

Equity income from unconsolidated subsidiaries. Equity income from unconsolidated subsidiaries (Acquisition Partnerships and servicing entities) from our PAA&R segment decreased by $3.6 million in Q1 2013 compared to Q1 2012. Equity income from our unconsolidated Acquisition Partnerships decreased by $1.4 million in Q1 2013 compared to Q1 2012, whereas equity income from our unconsolidated servicing entities decreased by $2.2 million in Q1 2013 compared to Q1 2012. Our share of equity income and losses from these equity-method investees will vary period-to-period depending on the profitability of the underlying entities and the composition of FirstCity’s ownership mix in the respective entities that report earnings or losses in a period. The following is a discussion of equity income from FirstCity’s Acquisition Partnerships (by geographic region) and servicing entities. Refer to Note 6 of the consolidated financial statements for a summary of revenues, earnings and equity income (loss) of FirstCity’s equity-method investments by region.

· United States — Total combined revenues reported by our U.S. Acquisition Partnerships (FirstCity share 10%-50%) decreased to $9.6 million in Q1 2013 from $22.6 million in Q1 2012. In addition, total combined net earnings reported by our U.S. partnerships decreased to $3.3 million in Q1 2013 from $12.8 million in Q1 2012. The decrease in total revenues and net earnings in Q1 2013 compared to Q1 2012 was attributable primarily to a decrease in Portfolio Asset collections to $37.9 million in Q1 2013 from $72.0 million in Q1 2012, off-set partially by decreases of $2.7 million in service fee expense and $1.3 million in provision expenses reported by these U.S. partnerships in Q1 2013 compared to Q1 2012. The collective activity described above translated to a decrease in FirstCity’s share of U.S. partnership net earnings (i.e. equity income) to $0.4 million for Q1 2013 compared to $2.1 million for Q1 2012.

FirstCity’s average investment in U.S. Acquisition Partnerships remained relatively constant at $56.2 million for Q1 2013 compared to $56.5 million for Q1 2012.

· Latin America — Total combined revenues reported by our Latin American Acquisition Partnerships (FirstCity’s share 8%-50%) decreased to $1.9 million in Q1 2013 from $4.3 million in Q1 2012. Total combined net losses reported by our Latin American partnerships were $0.3 million for Q1 2013 compared to $8.4 million in earnings for Q1 2012. The decrease in combined revenues reported by these partnerships in Q1 2013 compared to Q1 2012 was attributable primarily to a decrease in Portfolio Asset collections to $2.6 million in Q1 2013 compared to $6.4 million in Q1 2012. The decrease in combined net earnings reported by these partnerships in Q1 2013 compared to Q1 2012 was attributable primarily to a $7.4 million reduction in foreign currency exchange gains reported by these partnerships in Q1 2013 compared to Q1 2012. The decrease in foreign currency exchange gains recorded in Q1 2013 stemmed primarily from the translation impact to the U.S. dollar-denominated debt held by certain Latin American partnerships (due to the depreciation in value of the Mexican peso relative to the U.S. dollar in Q1 2013, compared to the appreciation in value of the Mexican peso relative to the U.S. dollar in Q1 2012). The collective activity described above resulted in the Company recording $0.5 million of equity income for its share of Latin American partnership net losses in Q1 2013, compared to recording $0.2 million of equity income in Q1 2012 for its share of net income reported by these partnerships.

The Company’s equity income from its Latin America partnerships in Q1 2013 included $0.1 million of foreign currency transaction gains, whereas its equity income from these partnerships in Q1 2012 included $0.7 million of foreign currency transaction gains — a $0.6 million unfavorable swing. Our financial position and results of operations may fluctuate significantly due to the impact of currency exchange rate fluctuations on our Latin American Acquisition Partnerships. Due to the constantly changing currency exposures impacting these partnerships and the volatility of currency exchange rates, we cannot provide assurance that, in any particular period, we will not incur foreign currency transaction losses.

FirstCity’s average investment in Latin American Acquisition Partnerships was $2.9 million for Q1 2013 compared to $4.4 million for Q1 2012.

· Europe — The Company did not carry any equity-method investments in European Acquisition Partnerships during Q1 2013 or Q1 2012.

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· Servicing Entities — Total combined revenues (mainly service fee income and investment income) reported by our foreign unconsolidated servicing entities (FirstCity’s share 25%-50%) decreased to $3.2 million in Q1 2013 from $18.6 million in Q1 2012. In addition, total combined net earnings available to common stockholders reported by these entities decreased to $32,000 in Q1 2013 from $4.7 million in Q1 2012. The decrease in total net earnings reported by the underlying servicing entities was attributed primarily to a restructure (in June 2012) and ultimate sale of the Company’s investment in a French servicing entity. The collective activity described above translated to a decrease in FirstCity’s share of net earnings (i.e. equity income) from its foreign servicing entities to $25,000 in Q1 2013 from $2.2 million in Q1 2012.

Income tax expense. Our PAA&R segment reported a $24,000 income tax benefit in Q1 2013 compared to an income tax provision of $0.8 million in Q1 2012 (comprised primarily of foreign income tax provisions). Refer to Note 10 of the consolidated financial statements for additional information on income taxes.

Net income attributable to noncontrolling interests . Net income attributable to noncontrolling interests represents the portions of net earnings that are attributable to the noncontrolling equity interests held by co-investors in our consolidated Acquisition Partnerships (FirstCity’s ownership in these consolidated partnerships ranges from 50%-90%). The amount of net income attributable to noncontrolling interests in these consolidated Acquisition Partnerships decreased to $0.3 million for Q1 2013 from $1.0 million for Q1 2012. Q1 2012 included $0.4 million of net income attributable to noncontrolling interests in our French Acquisition Partnerships compared to $-0- in Q1 2013, as we deconsolidated a French Acquisition Partnership in June 2012 as a result of an ownership restructure within that entity. This decrease also includes a decrease in the net earnings of consolidated U.S. Acquisition Partnerships in Q1 2013 compared to Q1 2012 (i.e. a decrease in the amount of net earnings reported by these consolidated entities translates to a decrease in the amount of net earnings apportioned to the noncontrolling investors).

Income from discontinued operations . In January 2013, FirstCity Business Lending Corporation, an indirect wholly-owned subsidiary of the Company, entered into a stock purchase agreement with CS ABL Holdings, LLC, a direct wholly-owned subsidiary of Capital Spring Finance Company, LLC, to sell all of the common stock and the preferred stock of American Business Lending, Inc. (“ABL”) to CS ABL Holdings, LLC. Accordingly, the results of operations from ABL are reported as discontinued operations within our Portfolio Asset Acquisition and Resolution business segment for the three-month periods ended March 31, 2013 and 2012, respectively. Our PAA&R segment reported income from discontinued operations of $0.1 million in Q1 2013, compared to $0.2 million in Q1 2012.

Special Situations Platform Business Segment

Our Special Situations Platform business segment (“FirstCity Denver”) reported net earnings of $0.2 million in Q1 2013 compared to $0.4 million of net earnings in Q1 2012. FirstCity Denver reported no investments in this segment in Q1 2013 compared to $1.0 million in the form of debt investments in Q1 2012. Since its inception in 2007, FirstCity Denver has been involved in U.S. lower middle-market transactions with total investment values of $89.2 million, and has provided $61.4 million of investment capital and other financings in connection with these investments.

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The following is a summary of the results of operations for the Company’s Special Situations Platform business segment for Q1 2013 and Q1 2012:

	Three Months Ended
	March 31,
	2013			2012
	(Dollars in thousands)
Special Situations Platform:
Revenues:
Interest income from loans receivable	$	144		$	381
Revenue from railroad operations	4,118			1,685
Other income	5			462
Total revenues	4,267			2,528
Costs and expenses - railroad operations:
Interest and fees on notes payable	62			52
Salaries and benefits	720			499
Other	2,646			677
Total railroad costs and expenses	3,428			1,228
Costs and expenses - other:
Interest and fees on notes payable	19			143
Salaries and benefits	170			215
Recovery of provision for loan and impairment losses	(48		)	—
Other costs and expenses	69			287
Total other expenses	210			645
Total expenses	3,638			1,873
Equity income (loss) from unconsolidated subsidiaries	(161		)	(65		)
Income tax expense	(4		)	(20		)
Net income attributable to noncontrolling interests	(234		)	(155		)
Net earnings	$	230		$	415

Interest income from loans receivable. Interest income from loans receivable decreased to $0.1 million in Q1 2013 from $0.4 million in Q1 2012. FirstCity Denver’s average investment in loans receivable was $9.5 million for Q1 2013 — including $4.9 million accounted for under the non-accrual method of accounting. For Q1 2012, FirstCity Denver’s average investment in loans receivable was $15.0 million — including $5.8 million accounted for under the non-accrual method of accounting.

Revenue, costs and expenses from railroad operations . Revenue, costs and expenses from railroad operations represent the results of operations recorded by FirstCity Denver’s majority-owned railroad companies (engaged primarily in interchanging rail cars with connecting carriers, providing rail freight services for on-line customers, operating a transload facility, and operating a rail-served debris transfer station). Revenue from railroad operations increased to $4.1 million in Q1 2013 from $1.7 million in Q1 2012. Total costs and expenses attributable to the railroad operations approximated $3.4 million in Q1 2013 compared to $1.2 million in Q1 2012. The additional revenue, costs and expenses recorded by our majority-owned railroad operations was due primarily to an increase in rail car movement services provided to new and existing customers in Q1 2013 compared to Q1 2012 from its existing operations, combined with activities from a rail-served debris transfer station acquired in June 2012, as well as activities from a railroad signal construction company that FirstCity Denver acquired in July 2012.

Other income . Other income decreased by $0.5 million in Q1 2013 compared to Q1 2012. Other income in Q1 2012 relates primarily to income generated by FirstCity Denver’s consolidated commercial real estate property and other ancillary activities. In March 2012, FirstCity Denver removed the commercial real estate property from its balance sheet after the property was acquired by the creditor holding the mortgage secured by this property (refer to Note 4 of the consolidated financial statements).

Costs and expenses — other. Other costs and expenses decreased by $0.4 million in Q1 2013 compared to Q1 2012 primarily due to the removal of FirstCity Denver’s consolidated commercial real estate property mentioned above.

Equity income from unconsolidated subsidiaries. FirstCity Denver recorded $0.2 million of equity losses from unconsolidated subsidiaries in Q1 2013 compared to $0.1 million of losses in Q1 2012.

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Net income attributable to noncontrolling interests. Net income attributable to noncontrolling interests represents the portions of net earnings related to FirstCity Denver (a FirstCity 80%-owned subsidiary) and its consolidated, less-than-wholly-owned subsidiaries (FirstCity Denver’s ownership in these consolidated entities ranges from 70%-90%) that are attributable to the noncontrolling equity interests held by co-investors. The amount of net income attributable to noncontrolling interests under our Special Situations platform remained constant at $0.2 million in Q1 2013 and Q1 2012.

Corporate and Other

Costs and expenses not allocable to our PAA&R and Special Situations business segments consist primarily of certain corporate salaries and benefits, legal and other professional expenses, and accounting fees. These costs and expenses decreased to $2.7 million for Q1 2013 compared to $2.9 million for Q1 2012, due primarily to a $0.4 million decrease in salaries and benefits expense, offset by a $0.2 million increase in accounting, legal and other professional expenses in the periods compared.

Financial Condition

Significant changes in FirstCity’s financial condition during Q1 2013 resulted from the following:

FirstCity’s consolidated assets of $223.2 million at March 31, 2013 were $21.5 million lower than its consolidated assets at December 31, 2012. The decrease in consolidated assets was attributed primarily to a $10.2 million net reduction to our investments in unconsolidated subsidiaries (see Note 6 of the consolidated financial statements for additional information), and $3.6 million of net decreases in the Company’s consolidated Portfolio Assets in Q1 2013, mainly due to net principal collections out-pacing consolidated Portfolio Asset purchases. Also contributing to the net decrease in the Company’s consolidated assets was a $6.3 million reduction in cash, and a $2.4 million net reduction to our loans receivable (see Note 5 of the consolidated financial statements for additional information), partially offset by a $3.3 million increase in assets held for sale (see Note 3 of the consolidated financial statements for additional information).

FirstCity’s consolidated liabilities of $89.0 million as of March 31, 2013 were $18.4 million lower than its consolidated liabilities at December 31, 2012. The decrease in consolidated liabilities was attributed primarily to a $12.5 million net decrease in notes payable in Q1 2013 primarily from net principal repayments on notes payable to banks. Also contributing to the net decrease in the Company’s consolidated liabilities was a $9.2 million reduction in other liabilities as a result of payments made for accrued bonuses and other legal costs.

Portfolio Asset Acquisitions — Portfolio Asset Acquisition and Resolution Business Segment

Revenues with respect to the Company’s PAA&R business segment consist primarily of (1) income and gains from our Portfolio Assets and loan investments; (2) equity income from our Acquisition Partnerships; and (3) servicing fee income and incentive fee income from Acquisition Partnerships based on the performance of our servicing activities on the assets held by these unconsolidated partnerships. Generally speaking, income recognized from our investments in consolidated Portfolio Assets is reported as “Income from Portfolio Assets” on our consolidated statements of earnings, whereas income from our investments in unconsolidated subsidiaries that acquire Portfolio Assets is reported as “Equity income from unconsolidated subsidiaries.” Furthermore, since we operate as the servicer for the vast majority of our U.S. and Latin American unconsolidated Portfolio Assets, we also recognize fee income related to the performance of our servicing responsibilities. This fee income is reported as “Servicing fees” on our consolidated statements of earnings. We also generate service fee income from our U.S. and Latin American consolidated Portfolio Assets that we service; however, this income is eliminated in consolidation and, as such, is not included on our consolidated statements of earnings.

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The following table includes information related to Portfolio Assets acquired by the Company in Q1 2013 and Q1 2012.

	Three Months Ended
	March 31, 2013
	Wholly-Owned		Majority-Owned
	Consolidated		Consolidated		Unconsolidated		Total
	(Dollars in thousands)
Face Value	$	3,599	$	—	$	129,673	$	133,272
Total purchase price	$	356	$	—	$	61,896	$	62,252
Total equity invested by all investors	$	356	$	—	$	62,548	$	62,904
Total equity invested by FirstCity	$	356	$	—	$	12,510	$	12,866
Total number of Portfolio Assets	24		—		433		457

	Three Months Ended
	March 31, 2012
	Wholly-Owned		Majority-Owned
	Consolidated		Consolidated		Unconsolidated		Total
	(Dollars in thousands)
Face Value	$	5,205	$	—	$	204,894	$	210,099
Total purchase price	$	382	$	—	$	90,853	$	91,235
Total equity invested by all investors	$	382	$	—	$	91,663	$	92,045
Total equity invested by FirstCity	$	382	$	—	$	9,166	$	9,548
Total number of Portfolio Assets	139		—		433		572

The table below provides a summary of our Portfolio Assets as of March 31, 2013 and December 31, 2012. Our Purchased Credit-Impaired Loans are categorized based on the common risk characteristics that management generally uses for pooling purposes (when management elects to pool purchased loans).

	March 31,			December 31,
	2013			2012
	(Dollars in thousands)
Loan Portfolios:
Purchased Credit-Impaired Loans
Domestic:
Commercial real estate	$	24,518		$	28,487
Business assets	3,712			4,047
Other	2,669			3,087
Latin America - commercial real estate	1,046			1,034
Europe - commercial real estate	3,242			3,449
Other	4,561			5,194
Outstanding balance	39,748			45,298
Allowance for loan losses	(417		)	(394		)
Total Loan Portfolios, net	39,331			44,904

Real estate held for sale, net	12,133			10,171

Total Portfolio Assets, net	$	51,464		$	55,075

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The following table provides a summary of the changes in the allowance for loan losses related to our loan Portfolio Assets:

	Purchased Credit-Impaired Loans
	Domestic							Latin America
	Commercial			Business				Commercial
(dollars in thousands)	Real Estate			Assets		Other		Real Estate		Other			Total
Beginning balance,
January 1, 2013	$	—		$	26	$	—	$	327	$	41		$	394
Provisions	61			—		—		—		—			61
Recoveries	—			—		—		—		(10		)	(10		)
Charge offs	(32		)	—		—		—		—			(32		)
Translation adjustments	—			—		—		4		—			4
Ending balance,
March 31, 2013	$	29		$	26	$	—	$	331	$	31		$	417

Due to uncertainties related primarily to estimating the timing and/or amount of collections on Purchased Credit-Impaired Loans as a result of the current economic environment, the Company accounts for certain of these loans and loan pools on a non-accrual income-recognition method of accounting (cost-recovery or cash basis). Under U.S. GAAP, the interest method (i.e. accrual method) of accounting is not appropriate for Purchased Credit-Impaired Loans if management does not have the ability to develop a reasonable expectation of both the timing and amount of future cash flows to be collected. Refer to Note 1 of the consolidated financial statements for additional information and accounting policies related to our Purchased Credit-Impaired Loans. The following tables provide a summary of the Company’s loan Portfolio Assets, including Purchased Credit-Impaired Loans, by income-recognition method as of March 31, 2013 and December 31, 2012 (dollars in thousands):

	March 31, 2013
	Income-Accruing Loans				Non-Accrual Loans
	Purchased				Purchased Credit-
	Credit-				Impaired Loans
	Impaired						Cost recovery		Other
	Loans		Other		Cash basis		basis		Cash basis		Total
United States	$	—	$	4,391	$	13,795	$	17,049	$	139	$	35,374

Germany	—		—		2,726		516		—		3,242

Mexico	—		—		—		715		—		715

Total	$	—	$	4,391	$	16,521	$	18,280	$	139	$	39,331

	December 31, 2012
	Income-Accruing Loans				Non-Accrual Loans
	Purchased				Purchased Credit-
	Credit-				Impaired Loans
	Impaired						Cost recovery		Other
	Loans		Other		Cash basis		basis		Cash basis		Total
United States	$	—	$	4,914	$	14,685	$	20,910	$	239	$	40,748

Germany	—		—		2,927		522		—		3,449

Mexico	—		—		—		707		—		707

Total	$	—	$	4,914	$	17,612	$	22,139	$	239	$	44,904

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Lower Middle-Market Company Capital Investments — Special Situations Platform Business Segment

Revenues with respect to the Company’s Special Situations Platform business segment consist primarily of: (i) interest and fee income from loan investments; (ii) revenues from majority-owned operating entities; and (iii) equity income from unconsolidated investments accounted for under the equity method of accounting.

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

	Total		FirstCity Denver’s Investment
(Dollars in thousands)	Investment		Debt		Equity		Total

First three months of 2013	$	—	$	—	$	—	$	—
Total 2012	1,000		1,000		—		1,000
Total 2011	3,301		1,200		2,101		3,301
Total 2010	13,739		8,825		4,395		13,220
Total 2009	20,058		12,023		392		12,415
Total 2008	28,750		16,650		3,256		19,906
Total 2007	22,314		5,630		5,900		11,530

Provision for Income Taxes

The Company has a substantial amount of U.S. deferred tax assets attributable primarily to net operating loss carryforwards (“NOLs”) and differences between the carrying amounts and tax bases of Acquisition Partnership investments for U.S. federal income tax purposes. The deferred tax assets attributable to the NOLs can be used to off-set the tax liability associated with the Company’s pre-tax earnings until the earlier of their expiration or utilization. The Company recognizes deferred tax assets and liabilities in both the U.S. and non-U.S. jurisdictions based on the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for net operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates, if any, would be recognized in earnings in the period that includes the enactment date. We reduce the carrying amounts of deferred tax assets through a valuation allowance if, based on the available evidence, it is more likely than not that such assets will not be realized. Accordingly, the need to establish valuation allowances for deferred tax assets is assessed periodically by the Company based on the more-likely-than-not realization threshold criterion. In this assessment, appropriate consideration is given to all positive and negative evidence related to the realization of the deferred tax assets. This assessment considers, among other factors, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability, excess of appreciated asset value over the tax basis of net assets, impact of gains or charges from one-time events, the duration of statutory carryforward periods, the Company’s experience with utilizing available operating loss and tax credit carryforwards, and tax planning strategies. In making such assessments, significant weight is given to evidence that can be objectively verified. This process involves significant management judgment about assumptions that are subject to change from period to period based on changes in tax laws between our projected operating performance, our actual results and other factors. At March 31, 2013, the Company carried a full valuation allowance for its U.S. deferred tax assets due to the lack of sufficient objective evidence regarding the realization of these assets in the foreseeable future. We will continue to evaluate the deferred tax asset valuation allowance balances in all of our U.S. and foreign subsidiaries throughout 2013 to determine the appropriate level of valuation allowances.

Liquidity and Capital Resources

Overview

The Company requires liquidity to fund its operations, Portfolio Asset acquisitions, investments in and advances to Acquisition Partnerships, capital investments in privately-held lower middle-market companies, other debt and equity investments, repayments of bank borrowings and other debt, and working capital to support our growth. Historically, our primary sources of liquidity have been funds generated from operations (primarily loan and real estate collections and service fees), equity distributions from the Acquisition Partnerships and other subsidiaries, interest and principal payments on subordinated intercompany debt, dividends from the Company’s subsidiaries, borrowings from credit facilities with external lenders, and other special-purpose short-term borrowings. The majority of the Company’s assets remain pledged to secure bank debt, making it more difficult to obtain third-party financing. At March 31, 2013, the Company had $33.1 million of cash on its consolidated balance sheet, but $15.7 million of this cash could only be used to settle the liabilities of certain consolidated variable interest entities (see Note 14 of the consolidated financial statements for additional information) and was not available for our general operations.

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Our ability to fund operations and make new investments is dependent on (1) anticipated cash flows from our unencumbered Portfolio Assets and equity investments; (2) our current holdings of unencumbered cash; (3) residual cash flows from the pledged assets and equity investments after full repayment of our term loan facilities with Bank of Scotland and Bank of America (as discussed below); (4) cash leak-through provisions included in our term loan facilities with Bank of Scotland and Bank of America (as discussed below); and (5) our investment agreement with VIP (as discussed below). Many factors, including general economic conditions, are essential to our ability to generate cash flows. Fluctuations in our collections, investment income, credit availability, and adverse changes in other factors could have a negative impact on our ability to generate sufficient cash flows to support our business.

Bank of Scotland and Bank of America Loan Facilities

The Reducing Note Facility capped FirstCity’s financing arrangements with Bank of Scotland, and as such, Bank of Scotland had no further obligation to provide financing to fund FirstCity’s investment activities and operations after June 2010. In December 2011, FirstCity refinanced the Reducing Note Facility with Bank of Scotland. As a result, FirstCity’s debt obligation under the Reducing Note Facility was divided into two separate term loan facilities with Bank of Scotland, and the Company concurrently closed on a new $50.0 million term loan facility with Bank of America (net proceeds from this term loan were applied against the Reducing Note Facility at closing). The assets and related cash flows that had served as collateral under the Reducing Note Facility with Bank of Scotland, were allocated and respectively pledged as collateral among the Company’s new term loan facilities with Bank of Scotland and Bank of America (i.e. FirstCity did not pledge additional assets as security interests in these new loan facilities). Given the nature of the term loan facilities, Bank of Scotland and Bank of America have no obligation to provide FirstCity with financing to fund new Portfolio Assets investments under terms of their respective credit facilities that resulted from the December 2011 debt refinancing arrangement. However, FirstCity was able to significantly reduce its aggregate future cash outlay to Bank of Scotland and Bank of America under these new loan facilities in comparison to the repayment terms under the former Reducing Note Facility with Bank of Scotland — which, in turn, will provide more liquidity to fund future investment opportunities. Additional information regarding our debt refinancing arrangement with Bank of Scotland and the resulting two new term loan facilities with them, along with our new loan facility with Bank of America, is included under the heading “ Credit Facilities ” below.

First National Bank of Central Texas Loan Facility

FC Investment Holdings Corporation (“FC Investment”) has a $15.0 million revolving loan facility with First National Bank of Central Texas (“FNBCT”) for the purpose of financing the purchase of loans and other assets, to make investments in equity interests in or capital contributions to affiliates which are owned with other investors, and for working capital. At March 31, 2013, the unpaid principal balance under this revolving loan facility was $2.0 million. Additional information regarding this loan facility is included under the heading “ Credit Facilities ” below.

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Investment Agreement with Värde Investment Partners, L.P.

FirstCity and Värde Investment Partners, L.P. (“VIP”) are parties to an investment agreement, effective April 1, 2010, whereby VIP may invest, at its discretion, in distressed loan portfolios and similar investment opportunities alongside FirstCity, subject to the terms and conditions contained in the agreement. The primary terms of the investment agreement are as follows:

· FirstCity acts as the exclusive servicer for the investment portfolios;

· FirstCity provides VIP with a “right of first refusal” with regard to distressed asset investment opportunities in excess of $3.0 million sourced by FirstCity;

· FirstCity, at its determination, co-invests between 5% and 25% in each investment;

· FirstCity receives a $200,000 monthly fee and VIP pays FirstCity’s pro rata share of due diligence expenses incurred in connection with proposed investments based upon its respective equity percentage of the acquisition entity;

· FirstCity receives a base servicing fee (based on investment portfolio collections) and is eligible to receive additional incentive-based servicing fees (depending on the performance of the portfolios acquired); and

· FirstCity is eligible to receive incentive-based management fees (depending on the aggregate amount and performance of the portfolios acquired).

The investment agreement has a termination date of June 30, 2015, which is subject to certain renewals or earlier termination. FirstCity Servicing Corporation (“FC Servicing”) will be the servicer for all of the acquisition entities formed by FC Diversified Holdings LLC (“FC Diversified”) and VIP (subject to removal by Värde on a pool-level basis under certain conditions).

The cash flows from the assets and equity interests from the Company’s Portfolio Asset investments made in connection with the investment agreement with VIP, which are held by FC Investment Holdings and its subsidiaries, are not subject to the security interest requirements of the Bank of Scotland and Bank of America loan facilities described below.

Cash Flow Activity

Consolidated Cash Flows

The following table summarizes our consolidated cash flow activity for Q1 2013 and Q1 2012 (in thousands):

	Three Months Ended
	March 31,
	2013			2012
Net cash used in operating activities	$	(10,925	)	$	(5,151	)
Net cash provided by investing activities	19,123			26,951
Net cash used in financing activities	(14,302		)	(16,037		)
Effect of exchange rate changes on cash and cash equivalents	(30		)	681
Net increase (decrease) in cash and cash equivalents	$	(6,134	)	$	6,444

Our operating activities used cash of $10.9 million in Q1 2013 and $5.2 million in Q1 2012. Net cash used by our operating activities in Q1 2013 was comprised primarily of $2.0 million of net loss; $1.9 million of net non-cash reductions for Portfolio Asset income accretion and gains; a $0.8 million non-cash deduction for equity income from our unconsolidated subsidiaries; and $0.8 million of non-cash add-backs related to provisions for loan and impairment losses, depreciation and amortization. Net cash used by our operating activities in Q1 2012 was comprised primarily of $9.5 million of net earnings; $8.2 million of net non-cash reductions for Portfolio Asset income accretion and gains; $4.5 million of non-cash deductions for equity earnings from our unconsolidated subsidiaries (i.e. equity-method investments); and $1.1 million of non-cash add-backs related to provisions for loan and impairment losses, depreciation and amortization. The remaining changes in all periods were due to net changes in other accounts related to our operating activities.

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Our investing activities provided cash of $19.1 million in Q1 2013 and $27.0 million in Q1 2012. Net cash provided by investing activities in Q1 2013 was attributable primarily to $5.6 million of Portfolio Asset principal collections (net of purchases), and $23.6 million of distributions from our unconsolidated subsidiaries, off-set partially by $12.6 million of contributions to our unconsolidated subsidiaries (to fund Portfolio Asset investments acquired by our Acquisition Partnerships). Net cash provided by investing activities in Q1 2012 was attributable primarily to $25.5 million of Portfolio Asset principal collections (net of purchases) and $8.5 million of distributions from our unconsolidated subsidiaries — off-set partially by $9.3 million of contributions to our unconsolidated subsidiaries (to fund Portfolio Asset investments acquired by our Acquisition Partnerships. The remaining changes in all periods were due to net changes in other accounts related to our investing activities.

Our financing activities used cash of $14.3 million in Q1 2013 and $16.0 million in Q1 2012. In Q1 2013, net cash used by financing activities was attributable primarily to $12.8 million of net principal payments on notes payable (net of borrowings), and $1.4 million of cash distributions to noncontrolling interests. In Q1 2012, net cash used by financing activities was attributable primarily to $13.8 million of net principal payments on notes payable (net of borrowings); and $2.2 million of cash distributions to noncontrolling interests. The remaining changes in the periods were due primarily to net changes in other accounts related to our financing activities.

Cash paid for interest on our credit facilities and other borrowings approximated $0.3 million and $0.7 million for Q1 2013 and Q1 2012, respectively. FirstCity’s average outstanding debt decreased to $53.8 million for Q1 2013 from $159.7 million for Q1 2012, while the average cost of borrowings increased to 6.0% in Q1 2013 compared to 3.9% in Q1 2012. The decrease in the Company’s debt level since March 31, 2012 is primarily a result of principal payments on our Bank of Scotland loan facility, combined with the results from our refinancing this loan facility with Bank of Scotland in December 2011. The increase in the Company’s average cost of borrowings was due primarily to the acceleration of fair value discount amortization on the Bank of Scotland loan facility. Refer to the heading “ Credit Facilities ” below for more information on the Company’s loan facilities with Bank of Scotland.

Cash Flows from Consolidated Railroad Operations

The following is an analysis of the cash flows related to FirstCity’s majority-owned railroad operations for Q1 2013 and Q1 2012. The cash flow effects described below are included in the Company’s analysis of its consolidated cash flows for Q1 2013 and Q1 2012, as applicable, as discussed above. All significant intercompany balances and transactions have been eliminated in consolidation.

The operating activities of the railroad subsidiary provided cash of $1.0 million in Q1 2013 due primarily to net earnings of $0.6 million, $0.2 million of non-cash add-backs related to depreciation and amortization, and $0.2 million of net increases related to changes in operating assets and liabilities. The railroad subsidiary’s investing activities used cash of $0.3 million in Q1 2013, attributable to purchases of property and equipment. The railroad subsidiary’s financing activities used cash of $0.4 million in Q1 2013, attributable to $0.1 million of net payments on bank notes payable and $0.3 million of distributions to the noncontrolling equity owners and FirstCity (eliminated in consolidation).

The operating activities of the railroad subsidiary provided cash of $0.5 million in Q1 2012 due primarily to net earnings. The railroad subsidiary’s investing activities used cash of $0.4 million in Q1 2012 from property and equipment purchases. The railroad subsidiary’s financing activities provided cash of $0.2 million in Q1 2012 from net borrowings on bank notes payable.

Credit Facilities

Bank of Scotland Credit Facilities

In June 2010, FirstCity refinanced its then-existing acquisition loan facilities with Bank of Scotland and closed on a $268.6 million Reducing Note Facility Agreement (“Reducing Note Facility”) that provided for repayment to Bank of Scotland over time as cash flows from the underlying assets securing the term loan facility were realized. The Company’s outstanding indebtedness and letter of credit obligations under its then-existing loan facilities with Bank of Scotland were refinanced by the Reducing Note Facility. This term loan facility capped FirstCity’s financing arrangements with Bank of Scotland, and as such, Bank of Scotland had no further obligation to provide financing to fund FirstCity’s investment activities and operations after June 2010. The Reducing Note Facility was secured by substantially all of the assets of FirstCity’s subsidiaries that were subject to the obligations of the former loan facilities with Bank of Scotland. FC Investment and its subsidiaries, which hold investments made in connection with FirstCity’s investment agreement with VIP (discussed above), and various other investments that FirstCity originated subsequent to June 2010, were not subject to the security interest requirements of the Reducing Note Facility.

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In December 2011, FirstCity entered into an agreement to amend and restate the Reducing Note Facility with Bank of Scotland, which had an unpaid principal balance of approximately $173.2 million at closing. As a result, FirstCity’s primary obligation under the Reducing Note Facility, as amended (defined as “BoS Facility A”), was reduced by the assumption of $25.0 million of debt (defined as “BoS Facility B”) by a newly-formed, wholly-owned subsidiary of FirstCity, combined with a $53.4 million reduction primarily from proceeds obtained by FirstCity from its new $50.0 million credit facility with Bank of America (“BoA Loan”) and other cash payments at closing. FirstCity’s remaining $94.8 million debt obligation under BoS Facility A (post-closing) carries a 0.25% annual interest rate through maturity (December 2014), and allows for repayment over time as cash flows from the underlying pledged assets are realized. FirstCity’s $25.0 million debt obligation under BoS Facility B does not bear interest, and allows for repayment over time as cash flows from the underlying pledged assets, if any, are realized (FirstCity has not received any significant cash flows from these underlying assets and has not allocated any value to these assets for the past three years). As a result of its December 2011 debt refinancing arrangements, FirstCity was able to significantly reduce its aggregate future cash outlay to Bank of Scotland and Bank of America under these new loan facilities in comparison to the repayment terms under the former Reducing Note Facility with Bank of Scotland — which, in turn, will provide more liquidity in the future to fund investment opportunities.

BoS Facility A — Bank of Scotland

At March 31, 2013, the unpaid principal balance on BoS Facility A was $22.5 million and the unamortized fair value discount was $0.7 million. Prior to December 2012, a portion of the unpaid principal balance included Euro-denominated debt that FirstCity used to partially off-set its business exposure to foreign currency exchange risk attributable to its net equity investments in Europe. The Euro-denominated debt was paid off in December out of proceeds from the sale of the Company’s investment in UBN, SAS. The primary terms and conditions of FC Commercial’s loan facility with Bank of Scotland under BoS Facility A are as follows:

· Release of assets of FH Partners (the “FH Partners Assets”) which secured the Reducing Note Facility to allow FH Partners to pledge the FH Partners Assets as collateral for the BoA Loan (Bank of Scotland was granted a subordinated security interest in these assets);

· Repayment will be made over time (no scheduled amortization) as cash flows are realized from the pledged assets (primarily loans, real estate and equity investments) other than the FH Partners Assets;

· Additional repayment will be made from residual cash flows from the FH Partners Assets from excess cash flow released to FH Partners under the loan facility for the BoA Loan (“FH Partners Excess Cash Flow”) and after the payment of the BoA Loan;

· Fixed annual interest rate equal to 0.25%;

· Maturity date of December 19, 2014;

· Unlimited guaranty provided by FirstCity for the repayment of the indebtedness under BoS Facility A;

· No advances will be made under this loan facility, except for draws on an outstanding letter of credit in the amount of $5.0 million;

· FirstCity will receive a management fee after payment to Bank of Scotland of interest and fees, certain expenses and other items, which is equal to 10% of the monthly collections from the underlying pledged assets other than the FH Partners Assets, and 5% of the of the monthly collections from the FH Partners Assets as FH Partners Excess Cash Flow is paid to Bank of Scotland (i.e. cash “leak-through”), which fees are not required to be applied to the debt owed to Bank of Scotland; the 5% management fee related to the FH Partners Assets is in addition to a 5% servicing fee paid under the loan facility for the BoA Loan and is deferred on a cumulative basis until the FH Partners Excess Cash Flow is paid to Bank of Scotland;

· After payment of the BoA Loan, FirstCity will receive a management fee equal to 10% of any monthly collections from the FH Partners Assets, after payment to Bank of Scotland of interest and fees, certain expenses and other items;

· FirstCity must maintain a minimum tangible net worth (as defined in the amended and restated Reducing Note Facility agreement with Bank of Scotland) of $90.0 million;

· Release of FC Commercial, FH Partners, FLBG Corp, FirstCity, and certain FirstCity subsidiaries obligated under the Reducing Note Facility from liability for payment to Bank of Scotland or BoS-USA for the $25.0 million loan principal amount assumed by FLBG2 (under BoS Facility B with BoS-USA); and

· Guaranty provided by FLBG Corp. and a substantial majority of its subsidiaries, which are the entities that were primarily subject to the obligations of the Reducing Note Facility (the “Covered Entities”).

This loan facility is secured by substantially all of the assets of the Covered Entities. FH Partners provides a subordinated guaranty of the BoS Facility A (subordinated to the BoA Loan) and a subordinated security interest in the FH Partners Assets. FC Servicing does not guarantee the BoS Facility A, but provides a non-recourse security interest in certain equity interests owned by it and in most of the servicing fees from agreements entered into prior to the execution of the Reducing Note Facility.

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BoS Facility A contains covenants, representations and warranties on the part of FirstCity, FC Commercial and FLBG Corp. that are typical for a loan facility of this type. In addition, BoS Facility A contains customary events of default, including failure to make required payments, failure to comply with certain agreements or covenants, failure to pay, or default under, certain other indebtedness, certain events of bankruptcy and insolvency, and failure to pay certain judgments. In the event that an event of default occurs and is continuing, Bank of Scotland may accelerate the indebtedness under this loan facility. At March 31, 2013, FirstCity was in compliance with all covenants or other requirements set forth in BoS Facility A.

BoS Facility B — Bank of Scotland

At March 31, 2013, the Company did not have a recorded carrying value on its consolidated balance sheet for BoS Facility B (this debt instrument was initially recorded at its estimated fair value of $-0- on the loan closing date). The primary terms and conditions of FLBG2’s $25.0 million debt obligation with BoS-USA under BoS Facility B are as follows:

· Source of repayment will be derived solely from future cash flows, if any, from the assets of FLBG2 (loans with nominal value — see discussion below);

· No interest accrues under this loan facility (subject to default interest provisions);

· Maturity date of December 19, 2014 (see discussion below); and

· FirstCity will receive a management fee equal to 10% of the monthly collections on the assets of FLBG2 (i.e. cash “leak-through”), if any, after payment to BoS-USA of any fees.

The assets of FLBG2 consist of loans transferred to it by the Covered Entities for nominal consideration. FirstCity has not received any significant cash flows from the assets of FLBG2 and has not allocated any value to such assets for the past two years. FLBG2 has no assets other than the loans pledged to this loan facility, and has no intent to actively pursue collection of these assets. FLBG2 has no alternative sources of income or liquidity. FirstCity and its other subsidiaries are not obligated to provide any additional funds or capital to FLBG2, do not guaranty the repayment of BoS Facility B, and do not intend to contribute any funds to FLBG2 or pay any amounts owed by FLBG2 under BoS Facility B (before or after its maturity).

At maturity of the BoS Facility B, there will likely be a default by FLBG2 as no collections are projected by FirstCity to be received from the assets of FLBG2. The sole recourse of Bank of Scotland on any such default will be to foreclose on the assets of FLBG2. Any default will not have a material adverse effect on FirstCity, as there is no carrying value for this loan facility on FirstCity’s consolidated balance sheet.

BoS Facility B contains limited covenants, representations and warranties on the part of FLGB2 in light of the nature of the assets of FLBG2 and the lack of liquidity or sources of funds for FLBG2. In addition, BoS Facility B contains customary events of default, including failure to make required payments, failure to comply with certain agreements or covenants, failure to pay, or default under, certain other indebtedness, certain events of bankruptcy and insolvency, and failure to pay certain judgments. In the event that an event of default occurs and is continuing, Bank of Scotland may accelerate the indebtedness under this loan facility. At March 31, 2013, FLBG2 was in compliance with all covenants or other requirements set forth in BoS Facility B.

Bank of America

In December 2011, FH Partners, as borrower, and Bank of America, as lender, entered into a $50.0 million term loan facility (“ BoA Loan ”) that allows for repayment over time as cash flows from the underlying assets securing this loan facility are realized. FirstCity used the proceeds from this loan facility to reduce the principal balance outstanding under the Reducing Note Facility, as amended (as described above). At March 31, 2013, the unpaid principal balance under this loan facility was $12.9 million. The primary terms and conditions under the BoA Loan are as follows:

· Minimum principal payments through maturity so that the total principal balance outstanding does not exceed the following amounts on the dates indicated: $45.0 million at June 30, 2012; $30.0 million at December 31, 2012; $25.0 million at June 30, 2013; $20.0 million at December 31, 2013; $15.0 million at June 30, 2014; and $10.0 million at December 31, 2014 (initial maturity);

· Initial maturity date of December 31, 2014, which may be extended one year (subject to certain terms and conditions);

· Variable annual interest rate based on LIBOR daily floating rate plus 2.75%;

· FirstCity will receive a servicing fee equal to 5% of the monthly collections (i.e. cash “leak-through”) from the pledged assets after payment to Bank of America of interest, fees and required principal payment reductions;

· Minimum debt service coverage ratio (defined) of 1.4 to 1.0 (beginning with the quarterly period ended March 31, 2012); and

· FC Servicing must maintain a minimum net worth of $1.0 million.

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The BoA Loan contains covenants, representations and warranties on the part of FH Partners that are typical for a loan facility of this type. In addition, the BoA Loan contains customary events of default, including failure to make required payments, failure to comply with certain agreements or covenants, failure to pay, or default under, certain other indebtedness, certain events of bankruptcy and insolvency, and failure to pay certain judgments. In the event that an event of default occurs and is continuing, Bank of America may accelerate the indebtedness under this loan facility. At March 31, 2013, FH Partners was in compliance with all covenants or other requirements set forth in the BoA Loan.

FNBCT Loan Facility

FC Investment has a $15.0 million revolving loan facility with FNBCT for the purpose of financing the purchase of loans and other assets, to make investments in equity interests in or capital contributions to affiliates which are owned with other investors, and for working capital. At March 31, 2013, the unpaid principal balance under this revolving loan facility was $2.0 million. This credit facility matures in August 2013, and is secured by substantially all of the assets of FC Investment and its subsidiaries. In addition, FirstCity provided FNBCT with an unlimited guaranty for the repayment of the indebtedness under this revolving loan facility. The primary terms and key covenants of this loan facility are described in Note 7 of the consolidated financial statements. At March 31, 2013, FC Investment was in compliance with all covenants or other requirements set forth in the credit agreement or other agreements with FNBCT.

The following table summarizes the material terms of the credit facilities of FirstCity and its consolidated subsidiaries and the outstanding borrowings under such facilities as of March 31, 2013 and December 31, 2011 (dollars in thousands):

			Outstanding		Outstanding
			Borrowings		Borrowings
			as of		as of
			March 31,		December 31,
Description	Interest Rate	Other Terms and Conditions	2013		2012

Bank of Scotland reducing note facility, net of unamortized discount (“BoS Facility A”) [1] [2]	0.25% fixed	Secured by substantially all assets and subsidiaries of FC Commercial (excluding FH Partners) and guaranteed by FirstCity, matures December 2014	$	21,756	$	29,991

BOS (USA) $25.0 million term note (“BoS Facility B”) [1]	None	Secured by all assets of FLBG2, matures December 2014	—		—

Bank of America term note [1]	LIBOR + 2.75%	Secured by all assets of FH Partners, matures December 2014	12,887		16,194

FNBCT $15.0 million revolving loan facility [3]	Greater of WSJ prime rate or 4.0%	Secured by assets of FC Investment and its subsidiaries, and guaranteed by FirstCity, matures August 2013	2,000		2,000

Non-recourse bank notes payable of various U.S. Portfolio Entities	Interest rates ranging from 3.0% to 5.0% (weighted average interest rate of 4.5%)	Secured by assets (primarily Portfolio Assets) of the underlying entities, various maturities through August 2014	3,932		4,712

Non-recourse bank notes payable of consolidated railroad subsidiaries:	Prime Rate + margin (0.50-1.50%) or LIBOR + margin (2.25-3.25%)	Secured by assets of the subsidiaries
Term loan		Matures March 2016	3,000		3,094
$1.0 million revolving facility		Matures March 2014	—		—
$5.0 million acquisition facility		Advances mature March 2016; unused commitment matures March 2014	3,950		3,950

Other notes and debt obligations			1,752		1,790

Total notes payable and other debt obligations			$	49,277	$	61,731

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[2] The unamortized discount on this loan facility at March 31, 2013 and December 31, 2012 was $0.7 million and $1.1 million, respectively.

[3] FC Investment, a FirstCity wholly-owned subsidiary, obtained this revolving loan facility in May 2012 (see Note 7 of the consolidated financial statements).

Off-Balance Sheet Arrangements

The Company’s off-balance sheet arrangements relate primarily to indemnification obligations and guaranty agreements (refer to Note 17 of the consolidated financial statements). We do not believe that these or any other off-balance sheet arrangements have or are reasonably likely to have a current or future effect on the Company’s financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity or capital expenditures or capital resources that is material to investors. However, there can be no assurance that such arrangements will not have any such future effects on the Company.

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Cautionary Statement Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q includes forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. In addition, we may make other written and oral communications from time to time that contain such statements. All statements, other than statements of historical fact, are forward-looking statements, including statements regarding our expected financial position, future financial performance, overall trends, liquidity and capital needs, and other statements of expectations, beliefs, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts. In this context, words such as “anticipates,” “believes,” “expects,” “estimates,” “plans,” “intends,” “could,” “should,” “will,” “may” and similar words or expressions are intended to identify forward-looking statements and are not historical facts.

These forward-looking statements involve risks, uncertainties and assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. For a discussion on the risks, uncertainties and assumptions that affect our business, operating results and financial condition, you should carefully review the “CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS” qualification and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2012 Form 10-K, and Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-Q.

We are also subject to other risks detailed herein or detailed from time-to-time in our filings with the Securities and Exchange Commission. The listed risks referenced above are not intended to be exhaustive and the order in which the risks appear is not intended as an indication of their relative weight or importance. We operate in continually changing business environments, and new risk factors emerge from time to time. We cannot predict these new risk factors, nor can we assess the impact, if any, of these new risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those projected in any forward-looking statements.

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

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

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

The Company’s management evaluated, with the participation of our principal executive officer and principal financial officer, or persons performing similar functions, the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer have concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms relating to FirstCity, including our consolidated subsidiaries, and was accumulated and communicated to the Company’s management, including the principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Controls

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

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PART II

OTHER INFORMATION

Item 1. Legal Proceedings.

On January 15, 2013, a putative class action lawsuit was filed in the District Court in McLennan County, Texas against the Company, its directors, Parent, Merger Subsidiary and Värde purportedly on behalf of the Company's stockholders, under the caption Eric J. Drayer v. James T. Sartain, et. al. , Cause No. 2013-246-5. The lawsuit alleged, among other things, that the director defendants breached their fiduciary duties to the Company's stockholders in connection with Värde's proposal and that Värde, Parent and Merger Subsidiary have aided and abetted such breaches. The plaintiff sought declaratory and injunctive relief, reasonable attorneys' and experts' fees and in the event the transaction is consummated, rescission of the transaction, rescissory damages and an accounting of all damages, profits and special benefits. On February 13, 2013, a first amended petition was filed. The amended petition alleged that the director defendants breached their fiduciary duties by (i) failing to maximize the value of the Company, (ii) taking steps to avoid competitive bidding, (iii) failing to properly value the Company and (iv) omitting material information and providing materially misleading information in the preliminary proxy statement, and sought the same relief and asserted the same claims as the original petition.

On January 29, 2013, a putative class action lawsuit was filed in the Court of Chancery of the State of Delaware against the Company, its directors, Parent, Merger Subsidiary and Värde purportedly on behalf of the Company's stockholders, under the caption Paul Perry v. FirstCity Financial Corporation, et. al., Case No. 8259-VCG. The lawsuit alleged, among other things, that the director defendants breached their fiduciary duties to the Company's stockholders by entering into the merger agreement and that the Company, Värde, Parent and Merger Subsidiary aided and abetted such breaches. The plaintiff sought declaratory and injunctive relief, reasonable attorneys' and experts' fees and in the event the transaction is consummated, rescission of the transaction and an accounting of all damages, profits and special benefits. On February 15, 2013, a first amended complaint was filed adding Värde Management, L.P. as a defendant. The amended complaint alleged that the director defendants breached their fiduciary duties by (i) agreeing to the merger consideration which undervalues the Company, (ii) agreeing to the terms of the merger agreement which deter other bidders and (iii) omitting material information and providing materially misleading information in the preliminary proxy statement, and sought the same relief and asserted the same claims as the original complaint.

On April 10, 2013, the Company, its directors, Parent, Merger Subsidiary, Värde and Värde Management, L.P., as defendants in the Perry lawsuit and the Drayer lawsuit, reached an agreement in principle with the plaintiffs in such actions providing for the settlement of the actions on the terms and subject to the conditions set forth in the memorandum of understanding dated April 10, 2013, which was amended on April 22, 2013 (the "MOU"), which terms included, but are not limited to, an obligation by the Company to make certain additional disclosures in the proxy statement regarding the proposed transaction. If the settlement becomes effective, the attorneys for the plaintiff class will seek an award of attorney's fees and expenses. The settlement is subject to, among other things, the execution of definitive settlement documentation, the completion of confirmatory discovery, dismissal of the actions, consummation of the proposed transaction and the approval of the Texas and Delaware courts. Upon effectiveness of the settlement, the Perry and Drayer lawsuits will be dismissed with prejudice and all claims under federal and state law that were or could have been asserted in such suits or which arise out of or relate to the proposed transaction will be released by the plaintiff class. The defendants entered into the MOU to eliminate the uncertainty, burden, risk, expense and distraction of further litigation.

Item 1A. Risk Factors.

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

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

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Item 6. Exhibits.

Exhibit Number		Description of Exhibit

31.1*	—	Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2*	—	Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1*	—	Certification of the Chief Executive Officer pursuant to 18 U.S.C Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2*	—	Certification of the Chief Financial Officer pursuant to 18 U.S.C Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS**	—	XBRL Instance Document

101.SCH**	—	XBRL Taxonomy Extension Schema Document

101.CAL**	—	XBRL Taxonomy Calculation Linkbase Document

101.LAB**	—	XBRL Taxonomy Label Linkbase Document

101.PRE**	—	XBRL Taxonomy Presentation Linkbase Document

101.DEF**	—	XBRL Taxonomy Definition Linkbase Document

* Filed herewith.

** In accordance with Rule 406T of Regulation S-T, the XBRL information in Exhibit 101 to this quarterly report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (Exchange Act), or otherwise subject to the liability of that section, and shall not be incorporated by reference into any registration statement or other document filed under the Securities Act of 1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

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SIGNATURES

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

	FIRSTCITY FINANCIAL CORPORATION
Dated: May 13, 2013


	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 and
		Accounting Officer)

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