UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

(Mark One)

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

For the Quarterly Period Ended September 30, 2004 or

[  ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 033-19694

FirstCity Financial Corporation

(254) 751-1750
(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 [  ]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

     The number of shares of common stock, par value $.01 per share, outstanding at November 9, 2004 was 11,260,687.

Table of Contents

PART I

FINANCIAL INFORMATION

Item 1. Financial Statements

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

2

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)

See accompanying notes to consolidated financial statements.

3

FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
AND COMPREHENSIVE INCOME
(Dollars in thousands)
(Unaudited)

See accompanying notes to consolidated financial statements.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

See accompanying notes to consolidated financial statements.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Dollars in thousands, except per share data)

(1) Basis of Presentation, Earnings per Common Share and Stock-Based Compensation

     FirstCity Financial Corporation (the “Company” or “FirstCity”) is a financial services company with offices throughout the United States and Mexico, with a presence in France and South America. At September 30, 2004, the Company was engaged in one principal reportable segment — portfolio asset acquisition and resolution. The portfolio asset acquisition and resolution business involves acquiring portfolios of loans, real estate and other assets or single assets (collectively referred to as “Portfolios” or “Portfolio Assets”) at a discount to face value and servicing and resolving such portfolios in an effort to maximize the present value of the ultimate cash recoveries. On September 21, 2004, FirstCity and certain of its subsidiaries entered into a Securities Purchase Agreement relating to the sale of a 31% beneficial ownership interest in Drive Financial Services LP (“Drive”) and its general partner, Drive GP LLC, to IFA Drive GP Holdings LLC (“IFA-GP”), IFA Drive LP Holdings LLC (“IFA-LP”) and Drive Management LP (“MG-LP”). As a result of the execution of the sale agreement, the consumer lending segment conducted through Drive was no longer considered a principal reportable segment and is treated as a discontinued operation.

     The unaudited consolidated financial statements of FirstCity reflect, in the opinion of management, all adjustments, consisting only of normal and recurring adjustments, necessary to present fairly FirstCity’s consolidated financial position at September 30, 2004, its results of operations for the three and nine month periods ended September 30, 2004 and 2003 and cash flows for the nine month periods ended September 30, 2004 and 2003.

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates include the estimation of future collections on purchased portfolio assets used in the calculation of net gain on resolution of portfolio assets, interest rate environments, valuation of the deferred tax asset, and prepayment speeds and collectibility of loans held in inventory, in securitization trusts and held for investment. Actual results could differ materially from those estimates.

     Basic net earnings per common share calculations are based upon the weighted average number of common shares outstanding. Earnings included in the earnings per common share calculation are reduced by minority interest and increased for preferred stock dividends. Potentially dilutive common share equivalents include warrants and stock options in the diluted earnings per common share calculations.

     At September 30, 2004, the Company has three stock-based employee compensation plans. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in the consolidated statements of operations, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. As required by FASB Statement No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, the following table represents the effect on net earnings and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

(2) Liquidity and Capital Resources

     The Company requires liquidity to fund its operations, working capital, payment of debt, equity for acquisition of Portfolio Assets, investments in and advances to entities formed to acquire Portfolios (“Acquisition Partnerships”), retirement of and dividends on preferred stock, and other investments. The potential sources of liquidity are funds generated from operations, equity distributions from the Acquisition Partnerships, interest and principal payments on subordinated intercompany debt, dividends from the Company’s subsidiaries, borrowings from revolving lines of credit and other credit facilities, proceeds from equity market transactions, securitization and other structured finance transactions and other special purpose short-term borrowings.

     At September 30, 2004, FirstCity had $95 million total debt outstanding with Bank of Scotland and BoS(USA) Inc. (the “Senior Lenders”). This debt was comprised of $53 million in term loans, $4 million under a $5 million revolving credit loan and a $38 million under a $45 million revolving portfolio acquisition loan facility. As discussed in note 4, on November 1, 2004, FirstCity completed the sale of the Company’s 31% beneficial ownership interest in Drive and its general partner, Drive GP LLC, which resulted in net proceeds of $86.8 million. A portion of the proceeds was used to pay off the $53 million in term loans and the $4 million revolving credit loan.

     On November 12, 2004, FirstCity and Bank of Scotland restructured the $5 million revolving credit loan and the $45 million revolving portfolio acquisition facility into a $96 million revolving acquisition facility that matures in November 2008. This new facility will be used to finance the senior debt and equity portion of distressed asset pool purchases and to provide for the issuance of Letters of Credit and working capital loans. The $96 million facility (i) allows loans to be made in Euros up to a maximum amount in Euros that is equivalent to $35 million U.S. dollars, (ii) allows loans to be made for acquisition of Portfolio Assets in Latin America of up to $35 million, (iii) provides for an interest rate of Libor plus 2.50% to 2.75%, (iv) provides for a commitment fee of 0.20% of the unused balance of the revolving acquisition facility, and (v) provides that the aggregate borrowings under the facility does not exceed 60% of the net present value of FirstCity’s interest in Portfolio Assets in Acquisition Partnerships pledged to secure the acquisition facility.

     BoS (USA) Inc. (“BoS (USA)”) has a warrant to purchase 425,000 shares of the Company’s voting Common Stock at $2.3125 per share. BoS (USA) is entitled to additional warrants in connection with this existing warrant for 425,000 shares under certain specific situations to retain its ability to acquire approximately 4.86% of the Company’s voting Common Stock. The warrant will expire on August 31, 2010, if it is not exercised prior to that date.

     There are currently 126,291 shares of New Preferred Stock outstanding. The issue, which matures in September 2005, has a $21.00 per share liquidation preference and $2.10 per share annual dividend rate. The Company expects to make quarterly dividend payments of $.525 per share until the shares are retired.

     The Company has a $35 million loan facility with CFSC Capital Corp. XXX, a subsidiary of Cargill (the “Cargill Facility”). This facility is being used exclusively to provide equity in new Portfolio acquisitions in partnerships with Cargill and its affiliates and matures in March 2005. At September 30, 2004, approximately $23.2 million was outstanding under this facility. On November 12, 2004, the outstanding balance on the Cargill Facility was paid down to zero out of a portion on the proceeds received on the sale of Drive.

     Management believes that the loan facilities provided by the Senior Lenders along with the liquidity from the Cargill Facility, the related fees generated from the servicing of assets and equity distributions from existing Acquisition Partnerships and wholly-owned portfolios will allow the Company to meet its obligations as they come due during the next twelve months.

(3) New Accounting Pronouncements

     In November 2003, the FASB issued Staff Position, No. 150-3, Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity (“Staff Position 150-3”). Staff Position 150-3 defers the application of various provisions of SFAS 150 for specified mandatorily redeemable noncontrolling interests in consolidated limited-life entities. FirstCity has minority interests in various limited-life partnerships with a carrying value of $1.3 million at September 30, 2004. The estimated amount that would be paid to the minority interest holder if the instruments were to be settled at September 30, 2004 is $.7 million.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

     In December 2003, the Accounting Standards Executive Committee issued Statement of Position No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (“SOP 03-3”). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. SOP 03-3 limits the yield that may be accreted on a loan portfolio to the excess of undiscounted expected cash flows over the initial investment in the loan portfolio. FirstCity will be required to account for all loans acquired after 2004 in accordance with SOP 03-3. For loans acquired prior to January 1, 2005, FirstCity will adopt the provisions of SOP 03-3 on a prospective basis.

     In December 2003, the FASB issued a revision to Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46R”), which was originally issued in January 2003. FIN 46R provides guidance on the consolidation of certain entities when control exists through other than voting (or similar) interests and was effective immediately with respect to entities created after January 31, 2003. For certain special purpose entities created prior to February 1, 2003, FIN 46R became effective for financial statements issued after December 15, 2003. For all other entities created prior to February 1, 2003, FIN 46R became effective January 1, 2004.

     FIN 46R requires consolidation by the majority holder of expected residual gains and losses of the activities of a variable interest entity (“VIE”). FirstCity holds significant variable interests in certain Acquisition Partnerships, which would be characterized as VIE’s. However, FirstCity is not deemed to be the primary beneficiary of any of these entities based on the criteria set forth in FIN46R. At September 30, 2004, FirstCity’s maximum exposure to loss as a result of its involvement with the VIE’s is $33 million.

(4) Discontinued Operations

     Discontinued operations are comprised of two components previously reported as the Company’s residential and commercial mortgage banking business (“Mortgage”) and the consumer lending business conducted through the Company’s minority interest investment in Drive (“Consumer”). Earnings from discontinued operations is summarized as follows:

     Mortgage

     The Company recorded a provision of $1.2 million in the first nine months of 2004 and $.4 million in the first nine months of 2003 for additional losses from discontinued mortgage operations. The provisions primarily relate to reductions in anticipated future cash flows from securitization trusts due to increased prepayment speeds and losses, and a higher projected interest cost of the underlying bonds. The net assets from discontinued mortgage operations consist of the following:

     The only assets remaining from discontinued mortgage operations are the investment securities resulting from the retention of residual interests in securitization transactions. Although the liquidation or run-off of these investment securities will last longer than one year, the Company is contractually obligated to service the securitized assets. The Company has considered the estimated future gross cash receipts for such investment securities in the computation of the value of such investment securities. The cash flows are collected over a period of time and are valued using prepayment assumptions of 32% to 50% for fixed rate loans and 35% to 36% for variable rate loans. Overall loss rates are estimated from 3% to 13% of collateral.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

     Consumer

     On September 21, 2004, FirstCity and certain of its subsidiaries entered into a definitive agreement to sell a 31% beneficial ownership interest in Drive and its general partner, Drive GP LLC, to IFA-GP, IFA-LP and MG-LP for a total purchase price of $108.5 million in cash, resulting in distributions and payments to FirstCity in the aggregate amount of $86.8 million in cash, from various sources. The sale was completed on November 1, 2004, and net cash proceeds from these transactions were primarily used to pay off debt.

     Pursuant to SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the consolidated financial statements have been reclassified for all periods presented to reflect the operations, assets and liabilities of the consumer business segment as discontinued operations. The assets and liabilities of such operations have been classified as “Consumer assets held for sale” and “Liabilities from discontinued consumer operations,” respectively on the September 30, 2004 and December 31, 2003 balance sheets and consist of the following:

     The net earnings from discontinued consumer operations were classified on the consolidated statements of operations for the three and nine months ended September 30, 2004 and 2003 as “Earnings from discontinued operations.” Summarized results of discontinued consumer operations are as follows:

     The pro forma consolidated balance sheet as of September 30, 2004 and the statements of operations for the three and nine months ended September 30, 2004 and 2003 and the year ended December 31, 2003 illustrating the effects of the Drive sale as if it has occurred as of the beginning of the periods are as follows:

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

Pro Forma Condensed Consolidated Balance Sheet at September 30, 2004
(Dollars in thousands)
(Unaudited)

(A)		Record proceeds of sale of FirstCity’s 31% interest in Drive.
(B)		Record $83.8 million pay down of debt and interest, payment of $1.3 million of debt fees to Bank of Scotland and write-off $1.3 million of unamortized loan fees relating to the paid off debt (net of $.7 million of new loan fees capitalized).
(C)		Record $204 thousand estimated closing costs less $27 thousand fees prepaid.
(D)		Record write-off remaining $6.3 million unamortized loan discount relating to $8.0 million accrued participation liability owed to Bank of Scotland.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

Pro Forma Condensed Consolidated Statements of Operations
(Dollars in thousands except per share data)
(Unaudited)

(A)

To eliminate additional interest and fees on notes payable that would not have been incurred if the transaction had been completed at the beginning of the period: 2004 interest savings from paydown of $67.8 million x average rate of 7.74% ÷ 4 = $1.3 million and amortization of loan fees of $.2 million; 2003 interest savings from paydown of $67.8 million x average rate of 7.50% ÷ 4 = $1.3 million and amortization of loan fees of $.2 million.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

Pro Forma Condensed Consolidated Statements of Operations
(Dollars in thousands except per share data)
(Unaudited)

(A)		To eliminate additional interest and fees on notes payable that would not have been incurred if the transaction had been completed at the beginning of the period: 2004 interest savings from paydown of $67.8 million x average rate of 7.62% x .75 = $3.9 million and amortization of loan fees of $.6 million; 2003 interest savings from paydown of $67.8 million x average rate of 7.60% x .75 = $3.9 million and amortization of loan fees of $.6 million.
(B)		Earnings from continuing operations per common share for the nine months ended September 30, 2003 include the effects of $133 thousand accumulated preferred dividends.

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

Pro Forma Condensed Consolidated Statements of Operations
For the Year Ended December 31, 2003
(Dollars in thousands except per share data)
(Unaudited)

(A)		To eliminate the results of operations from the discontinued consumer business segment that would not have been incurred if the transaction had been completed at the beginning of the period. The elimination of $6.4 million of additional interest and fees on notes payable includes interest savings from paydown of $83.8 million x average rate of 6.66% = $5.6 million and amortization of loan fees of $.8 million.
(B)		Earnings from continuing operations per common share include the effects of $133 thousand accumulated preferred dividends in arrears.

(5) Portfolio Assets

     Portfolio Assets are summarized as follows:

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

     Portfolio Assets are pledged to secure notes payable that are non-recourse to FirstCity or any affiliate other than the entity that incurred the debt.

(6) Loans Receivable from Acquisition Partnerships Held for Investment

     Loans receivable from Acquisition Partnerships held for investment consist primarily of loans from certain partnerships located in Mexico and are summarized as follows:

     There were no provisions recorded on these loans during the third quarter of 2004 and 2003. The loans receivable from Acquisition Partnerships are secured by the assets/loans acquired by the partnerships with purchase money loans provided by affiliates of the investors to the partnerships to purchase the asset pools held in those entities. These loans are evaluated for impairment by analyzing the expected future cash flows from the underlying assets within each pool to determine that the cash flows were sufficient to repay these notes. The Company applies the asset valuation methodology consistently in all venues and uses the same proprietary asset management system to evaluate impairment on all asset pools. The results of this evaluation indicated that cash flows from the pools will be sufficient to repay the loans and no allowances for impairment were necessary.

     Equity method losses which were recorded to reduce the loans and interest receivable from the Mexican partnerships were $.4 million and $1.8 million during the first nine months of 2004 and 2003, respectively, in compliance with EITF 98-13, Accounting by an Equity Method Investor for Investee Losses When the Investor Has Loans to and Investments in Other Securities of the Investee.

(7) Equity Investments

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

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FIRSTCITY FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (continued)

Condensed Combined Balance Sheets

Condensed Combined Summary of Operations