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

TABLE 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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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

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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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

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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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

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 d

FIRSTCITY FINANCIAL CORP 10-Q