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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number 033-19694

FirstCity Financial Corporation

(254) 751-1750

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

      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 þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     þ

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

      The number of shares of common stock outstanding at March 17, 2004 was 11,193,687. As of such date, the aggregate market value of the voting and non-voting common equity held by non-affiliates, based upon the closing price of the common stock on the Nasdaq National Market System, was approximately $56,619,552.

FIRSTCITY FINANCIAL CORPORATION

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FORWARD LOOKING INFORMATION

      This Annual Report on Form 10-K may contain forward-looking statements. The factors identified under “Risk Factors” contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are important factors (but not necessarily all of the important factors) that could cause actual results to differ materially from those expressed in any forward-looking statement made by, or on behalf of, FirstCity Financial Corporation (the “Company” or “FirstCity”).

      When any such forward-looking statement includes a statement of the assumptions or bases underlying such forward-looking statement, the Company cautions that, while such assumptions or bases are believed to be reasonable and are made in good faith, assumed facts or bases almost always vary from actual results, and the differences between assumed facts or bases and actual results can be material, depending upon the circumstances. When, in any forward-looking statement, the Company, or its management, expresses an expectation or belief as to future results, such expectation or belief is expressed in good faith and is believed to have a reasonable basis, but there can be no assurance that the statement of expectation or belief will result or be achieved or accomplished. The words “believe,” “expect,” “estimate,” “project,” “anticipate” and similar expressions identify forward-looking statements.

PART I

General

      FirstCity, a Delaware corporation, is a financial services company headquartered in Waco, Texas with offices throughout the United States and Mexico and a presence in France and South America. The Company began operating in 1986 as a specialty financial services company focused on acquiring and resolving distressed loans and other assets purchased at a discount relative to the aggregate unpaid principal balance of the loans or the appraised value of the other assets (“Face Value”). To date the Company has acquired, for its own account and through various affiliated partnerships, pools of assets or single assets (collectively referred to as “Portfolio Assets” or “Portfolios”) with a Face Value of approximately $7.5 billion. The Company’s servicing expertise, which it has developed largely through the resolution of distressed assets, is a cornerstone of its growth strategy. Today the Company is engaged in two principal businesses: (i) Portfolio Asset acquisition and resolution and (ii) consumer lending through the Company’s minority investment in Drive Financial Services, LP (“Drive”). See Note 8 of the Company’s Consolidated Financial Statements for certain financial information about these two segments of the Company.

Business Strategy

      The Company’s core business is the acquisition, management, servicing and resolution of Portfolio Assets. Key elements of the Company’s overall business strategy include:

	•	Increasing the Company’s investments in Portfolio Assets acquired from financial institutions and government agencies, both for its own account or through investment entities formed with Cargill Financial Services Corporation (“Cargill”, “CFSC” or “Cargill Financial”) or one or more other co-investors, thereby capitalizing on the expertise of partners whose skills complement those of the Company.
	•	Identifying and acquiring, through non-traditional niche sources, distressed assets that meet the Company’s investment criteria, which may involve the utilization of special acquisition structures.
	•	Acquiring, managing, servicing and resolving Portfolio Assets in certain international markets, either separately or in partnership with others, including Cargill.
	•	Capitalizing on the Company’s servicing expertise to enter into new markets with servicing agreements that provide for reimbursement of costs of entry and operations plus an incentive servicing fee after certain thresholds are met without requiring substantial equity investments.

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	•	Retaining a minority interest investment in Drive.
	•	Maximizing growth in operations, thereby permitting the utilization of the Company’s net operating loss carryforwards (“NOLs”).

Background

      The Company began operating in the financial service business in 1986 as a purchaser of distressed assets from the Federal Deposit Insurance Corporation (“FDIC”) and the Resolution Trust Corporation (“RTC”). From its original office in Waco, Texas, with a staff of four professionals, the Company’s asset acquisition and resolution business grew to become a significant participant in an industry fueled by the problems experienced by banks and thrifts throughout the United States. In the late 1980s, the Company also began acquiring assets from healthy financial institutions interested in eliminating nonperforming assets from their portfolios. The Company began its relationship with Cargill in 1991. Since that time, the Company and Cargill have formed a series of acquisition partnerships through which they have jointly acquired over $6.6 billion in face value of Portfolio Assets.

      In July 1995, the Company acquired by merger (the “Merger”) First City Bancorporation of Texas, Inc. (“FCBOT”), a former bank holding company that had been engaged in a proceeding under Chapter 11 of the United States Bankruptcy Code since November 1992. As a result of the Merger, the common stock of the Company became publicly held and the Company received $20 million of additional equity capital and entered into an incentive-based servicing agreement to manage approximately $300 million in assets for the benefit of the former equity holders of FCBOT. In addition, as a result of the Merger, the Company retained FCBOT’s rights to approximately $596 million in net operating loss carry forwards (“NOLs”), which the Company believes it can use to offset taxable income generated by the Company and its consolidated subsidiaries.

      Following the Merger, the Company adopted a growth and diversification strategy designed to capitalize on its servicing and credit expertise to expand into additional financial service businesses. To that end, in July 1997 the Company acquired Harbor Financial Group, Inc. and its subsidiaries (collectively referred to as “Mortgage Corp.”), a company engaged in the residential and commercial mortgage banking business since 1983. During 1997, the Company also expanded into related niche financial services markets, such as mortgage conduit banking, conducted through FC Capital Corp. (“Capital Corp.”), a subsidiary of the Company, and consumer finance, conducted through FirstCity Consumer Lending Corporation (“Consumer Corp.”), a subsidiary of the Company.

      Effective during the third quarter of 1999, management of the Company adopted formal plans to discontinue the operations of Mortgage Corp. and Capital Corp. These entities comprised the operations that were previously reported as the Company’s mortgage banking operations. Because the Company formally adopted plans to discontinue the operations of Mortgage Corp. and Capital Corp., and operations at each such entity have ceased, the results of historical operations have been reflected as discontinued operations.

      On October 14, 1999, Harbor Financial Group, Inc. (“Harbor Parent”), Harbor Financial Mortgage Corporation (“Harbor”) and four subsidiaries of Harbor filed voluntary petitions under Chapter 11 of the United States Bankruptcy Code. On December 14, 1999, these bankruptcy proceedings were converted to liquidation proceedings under Chapter 7 of the United States Bankruptcy Code. John H. Litzler, the Chapter 7 Trustee in the bankruptcy proceedings (the “Trustee”), initiated adversary proceedings on May 25, 2001 against FirstCity and various current and former directors and officers of FirstCity and Mortgage Corp. alleging breach of fiduciary duties, mismanagement, and self-dealing by FirstCity and Harbor directors and officers, and improper transfer of funds from the Harbor related entities to FirstCity. The claims also included fraudulent and preferential transfer of assets of the Harbor entities, fraud and conspiracy. The Trustee, FirstCity, the other defendants and the insurers providing Director’s and Officer’s Insurance coverage for FirstCity and its subsidiaries (the “Insurers”) settled the claims brought in the adversary proceedings with the approval of the Bankruptcy Court. Under the terms of the settlement agreement, the Trustee released the defendants, their affiliates and subsidiaries from any and all claims which were brought or could have been

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      As a result of the liquidity constraints created by the discontinued operations of Mortgage Corp. and Capital Corp., in the third quarter of 2000, Consumer Corp. completed the sale of a 49% equity interest in its automobile finance operation to IFA Drive GP Holdings LLC (“IFA-GP”) and IFA Drive LP Holdings LLC (“IFA-LP”), wholly-owned subsidiaries of BoS(USA), Inc. (“BoS(USA)”), a wholly-owned subsidiary of Bank of Scotland (together with BoS(USA), the “Senior Lenders”), for a purchase price of $15 million cash. The transaction generated $75 million in cash and resulted in a gain of $12.1 million ($4 million was deferred and recognized in the December 2002 recapitalization discussed below). Simultaneously, the Senior Lenders and the Company completed a debt restructure whereby the Company reduced the outstanding debt under its senior and subordinate facilities from $113 million to approximately $44 million. The Company also retired approximately $6.4 million of debt owed to other lenders.

      In December 2002, FirstCity completed a recapitalization in which holders of FirstCity’s redeemable preferred stock, par value $.01 per share (“New Preferred Stock”), representing 89.3% of the 1,222,901 shares previously outstanding, exchanged 1,092,210 shares of New Preferred Stock for 2,417,388 shares of common stock and $10.5 million. Upon the completion of the recapitalization, 130,691 shares of New Preferred Stock remained outstanding. As a result, common equity was increased by $18.9 million. FirstCity also recognized the $4 million gain (previously deferred) from the release of its guaranty of Drive’s indebtedness to BoS(USA). BoS(USA)’s warrant to purchase 1,975,000 shares of non-voting common stock was cancelled. FirstCity also acquired the minority interest in FirstCity Holdings held by Terry R. DeWitt, G. Stephen Fillip and James C. Holmes, each of whom are Senior Vice Presidents of FirstCity, by issuing 400,000 shares of common stock of the Company and a note payable with an imputed balance of $1.3 million at December 31, 2003. This note is to be paid from incentive servicing fees received from the Mexican Acquisition Partnerships, with an aggregate payout to the note holders not to exceed $3.2 million.

      As a part of the recapitalization, BoS(USA) provided a non-recourse loan in the amount of $16 million to FirstCity which was used to pay the cash portion of the exchange offer to the holders of the New Preferred Stock, to pay expenses of the exchange offer and recapitalization, and to reduce FirstCity’s debt to the Senior Lenders. The $16 million loan is secured by a 20% interest in Drive (64.51% of FirstCity’s remaining 31% interest in Drive) and certain other assets of Consumer Corp. for the sole purpose of allowing BoS(USA) to realize upon the 20% Drive interest in the event of default by FirstCity. In connection with the $16 million loan, FirstCity is obligated to pay an arrangement fee to BoS(USA) equal to 20% of all amounts received by FirstCity in excess of $16 million from any sale or other disposition of FirstCity’s 20% interest in Drive and all dividends and other distributions paid by Drive or its general partner on FirstCity’s 20% interest in Drive.

Portfolio Asset Acquisition and Resolution

      In the Portfolio Asset acquisition and resolution business, FirstCity acquires and resolves portfolios of performing and nonperforming commercial and consumer loans and other assets that are generally acquired at a discount to Face Value. Purchases may be in the form of pools of assets or single assets. Performing assets are those as to which debt service payments are being made in accordance with the original or restructured terms of such assets. Nonperforming assets are those as to which debt service payments are not being made in accordance with the original or restructured terms of such assets, or as to which no debt service payments are being made. Portfolios are designated as nonperforming unless substantially all of the assets comprising the Portfolio are performing. Once a Portfolio has been designated as either performing or nonperforming, such designation is generally not changed for accounting purposes regardless of the performance of the assets comprising the Portfolio. Portfolios are either acquired for FirstCity’s own account or through investment entities formed with Cargill or one or more other co-investors (each such entity, an “Acquisition Partnership”). See “— Relationship with Cargill”. To date, FirstCity and the Acquisition Partnerships have acquired over $7.5 billion in Face Value of assets, with FirstCity’s equity investment being $258 million.

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      In the early 1990s large quantities of nonperforming assets were available for acquisition from the RTC and the FDIC. Since 1993, sellers of nonperforming assets have included private sellers as well as government agencies such as the Small Business Administration. Private sellers include financial institutions, insurance companies, and other institutional lenders, both in the United States and in various foreign countries. As a result of mergers, acquisitions and corporate downsizing efforts, other business entities frequently seek to dispose of excess real estate or other financial assets not meeting the strategic needs of a seller. Sales of such assets improve the seller’s balance sheet, reduce overhead costs, reduce staffing requirements and avoid management and personnel distractions associated with the intensive and time-consuming task of resolving loans and disposing of real estate. Consolidations within a broad range of industries, especially banking, have augmented the trend of financial institutions and other sellers packaging and selling asset portfolios to investors as a means of disposing of nonperforming loans or other surplus or non-strategic assets.

      FirstCity acquires and manages Portfolio Assets, which are generally purchased at a discount to Face Value by FirstCity or through Acquisition Partnerships. The Portfolio Assets are generally nonhomogeneous assets, including loans of varying qualities that are unsecured or secured by diverse collateral types and real estate. Some of the secured 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 either on real estate, business assets or other collateral cash flow. Consumer loans may be secured (by real or personal property) or unsecured. Portfolio Assets may be designated as performing or nonperforming. FirstCity generally expects to resolve Portfolio Assets within five years after purchase.

      To date, a substantial majority of the Portfolio Assets acquired by FirstCity have been designated as nonperforming. FirstCity seeks to resolve nonperforming Portfolio Assets through (i) a negotiated settlement with the borrower in which the borrower pays all or a discounted amount of the loan, (ii) conversion of the loan into a performing asset through extensive servicing efforts followed by either a sale of the loan to a third party or retention of the loan by FirstCity or the Acquisition Partnership or (iii) foreclosure and sale of the collateral securing the loan.

      FirstCity has substantial experience acquiring, managing and resolving a wide variety of asset types and classes. As a result, it does not limit itself as to the types of Portfolios it will evaluate and purchase. FirstCity’s willingness to acquire Portfolio Assets is generally determined by factors including the information that is available regarding the assets in a Portfolio, the price at which the Portfolio can be acquired and the expected net cash flows from the resolution of such assets. FirstCity and the Acquisition Partnerships have acquired Portfolio Assets in virtually all 50 states, the Virgin Islands, Puerto Rico, Chile, France, Germany, Japan and Mexico. FirstCity believes that its willingness to acquire nonhomogeneous Portfolio Assets without regard to geographic location provides it with an advantage over certain competitors that limit their activities to either a specific asset type or geographic location.

      FirstCity also seeks to capitalize on emerging opportunities in foreign countries in which the market for nonperforming loans of the type generally purchased by FirstCity is less efficient than the market for such assets in the United States. Through December 31, 2003, FirstCity has acquired, with Cargill and a local French partner, eighteen Portfolios in France consisting of approximately 32,000 assets for an aggregate purchase price of approximately $389 million. These assets had a Face Value of approximately $1.6 billion. FirstCity’s share of the equity interest in the Portfolios acquired in France ranges from 10% to 33.5% and FirstCity has made a total equity investment in these Portfolios of approximately $38 million. FirstCity owns a 10% interest in MCS et Associates (“MCS”), a French asset servicing company, and FirstCity is, in conjunction with MCS and Cargill, actively pursuing opportunities to purchase additional pools of Portfolio Assets in France and other areas of Western Europe. In addition, FirstCity owns 100% of a Mexican asset servicing company, which has offices in Guadalajara and Mexico City, Mexico, that facilitates FirstCity’s participation in acquisition of Portfolios in Mexico. Through December 31, 2003, FirstCity and its various partners have acquired ten Portfolios in Mexico consisting of an aggregate of approximately 51,000 assets for

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      The following table presents selected data for the Portfolio Assets acquired by FirstCity

Portfolio Assets

(1)	Includes investments made in the form of equity and notes receivable from the Acquisition Partnerships payable to affiliates of the Company.

      FirstCity develops its Portfolio Asset opportunities through a variety of sources. The activities or contemplated activities of expected sellers are publicized in industry publications and through other similar sources. FirstCity also maintains relationships with a variety of parties involved as sellers or as brokers or agents for sellers. Many of the brokers and agents concentrate by asset type and have become familiar with FirstCity’s acquisition criteria and periodically approach FirstCity with identified opportunities. In addition, repeat business referrals from Cargill or other co-investors in Acquisition Partnerships, repeat business from previous sellers, focused marketing by FirstCity and the nationwide presence of FirstCity are important sources of business.

      FirstCity identifies investment opportunities in foreign markets in much the same manner as in the United States. In varying degrees of volume and efficiency, the markets of Europe, Asia, and Latin America all include sellers of nonperforming assets. In some countries, such as Mexico, the government has taken a very active role in the management and orderly disposition of these types of assets. FirstCity’s established presence in Mexico and France provides a strong base for the identification, valuation, and acquisition of assets in those countries, as well as in adjacent markets. FirstCity continues to identify partners who have contacts within various foreign markets and or can assist in locating Portfolio Asset opportunities with FirstCity.

      Prior to making an offer to acquire any Portfolio, FirstCity performs an extensive evaluation of the assets that comprise the Portfolio. If, as is often the case, the Portfolio Assets are nonhomogeneous, FirstCity will evaluate all individual assets determined to be significant to the total of the proposed purchase. If the Portfolio Assets are homogenous in nature, a sample of the assets comprising the Portfolio may be selected for evaluation. The evaluation of individual assets generally includes analyzing the credit and collateral file or other due diligence information supplied by the seller. Based upon such seller-provided information, FirstCity will undertake additional evaluations of the asset, that, to the extent permitted by the seller, will include site visits to, and environmental reviews of the property securing the loan or the asset proposed to be purchased. FirstCity will also analyze relevant local economic and market conditions based on information obtained from its prior experience in the market or from other sources, such as local appraisers, real estate principals, realtors and brokers.

      The evaluation further includes an analysis of an asset’s projected cash flow and sources of repayment, including the availability of third party guarantees. FirstCity values loans (and other assets included in a

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      The analysis and underwriting procedure in foreign markets follows the same extensive diligence philosophy as that employed by the Company domestically. Additional risks are evaluated in foreign markets, including property value economic factors (inflation or deflation), currency strength, short and long-term market stability and political concerns. These risks are evaluated and priced into the cost of the acquisition.

      After a Portfolio is acquired, FirstCity assigns the Portfolio Assets to account servicing officers who are independent of the personnel that performed the due diligence evaluation in connection with the purchase of the Portfolio. Portfolio Assets are serviced either at the Company’s headquarters or in one of FirstCity’s other offices. FirstCity may establish servicing operations in locations in close proximity to significant concentrations of Portfolio Assets. Such offices are reviewed for closing after the assets in the geographic region surrounding the office are substantially resolved. The assigned account servicing officer develops a business plan and budget for each asset based upon an independent review of the cash flow projections developed during the investment evaluation, physical inspections of assets or collateral underlying the related loans, evaluation of local market conditions and discussions with the relevant borrower. Budgets are periodically reviewed and revised as necessary. FirstCity employs loan-tracking software and other operational systems that are generally similar to systems used by commercial banks, but which have been enhanced to track both the collected and the projected cash flows from Portfolio Assets.

      FirstCity services all of the Portfolio Assets owned for its own account, all of 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, FirstCity generally earns a servicing fee, which is a percentage of gross cash collections generated rather than a management fee based on the Face Value of the asset being serviced. 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 on each asset. For the Mexican Acquisition Partnerships, FirstCity earns a servicing fee based on costs of servicing plus a profit margin. The Company also has certain consulting contracts with its Mexican investment entities pursuant to which the Company is entitled to additional compensation for servicing once a specified return to the investors has been achieved. The Acquisition Partnerships in France are serviced by MCS in which the Company maintains a 10% equity interest.

      Portfolio Assets are either acquired for the account of a subsidiary of FirstCity or through the Acquisition Partnerships. Portfolio Assets owned directly by a subsidiary of FirstCity may be funded with loans made by FirstCity to its subsidiaries, equity financing provided by an affiliate of Cargill, BoS(USA) or other third parties and secured debt that is recourse only to the Acquisition Partnership.

      Each Acquisition Partnership is a separate legal entity, (generally a limited partnership, but may instead be a limited liability company, trust, corporation or other type of entity). FirstCity and an investor typically form a corporation to serve as the corporate general partner of each Acquisition Partnership. Generally, for domestic Acquisition Partnerships, FirstCity and another investor each own 50% of the general partner and a 49.5% limited partnership interest in the domestic Acquisition Partnership (the general partner owns the other 1% interest). Cargill or its affiliates are the investor in the vast majority of the Acquisition Partnerships currently in existence. See “— Relationship with Cargill.” Certain institutional investors have also held limited partnership interests in the Acquisition Partnerships and may hold interests in the related corporate general partners.

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      The Acquisition Partnerships are generally financed by debt, secured only by the assets of the individual entity, and are nonrecourse to the Company, its co-investors and the other Acquisition Partnerships. FirstCity believes that this legal structure insulates the Company and the other Acquisition Partnerships from certain potential risks, while permitting FirstCity to share in the economic benefits of each Acquisition Partnership.

      Senior secured acquisition financing currently provides the majority of the funding for the purchase of Portfolios. FirstCity and the Acquisition Partnerships have relationships with a number of senior lenders including Cargill. Senior acquisition financing is obtained at variable interest rates ranging from LIBOR to prime based pricing with negotiated spreads to the base rates. The final maturity of the senior secured acquisition debt is normally two years from the date of funding of each advance under the facility. The terms of the senior acquisition debt of the Acquisition Partnerships often allow, under certain conditions, distributions to equity partners before the debt is repaid in full.

      Prior to maturity of the senior acquisition debt, the Acquisition Partnerships typically refinance the senior acquisition debt with long-term debt secured by the assets of the partnership. Such long-term debt generally accrues interest at a lower rate than the senior acquisition debt, has collateral terms similar to the senior acquisition debt, and permits distributions of excess cash flow generated by the Acquisition Partnership to the equity partners so long as the partnership is in compliance with applicable financial covenants.

      In foreign markets, FirstCity conducts analysis with respect to the establishment of ownership structures. Prior to investment, FirstCity, in conjunction with its co-investors, performs significant due diligence and planning on the tax, licensing, and other ownership issues of the particular country. As in the United States, each foreign Acquisition Partnership is a separate legal entity, generally formed as the equivalent of a limited liability company or a liquidating trust. Over the years, FirstCity has cultivated successful relationships with several investors in its international acquisitions.

      Cargill, a diversified financial services company, is a wholly owned subsidiary of Cargill, Incorporated, which is generally regarded as one of the world’s largest privately held corporations and has offices worldwide. Cargill and its affiliates provide significant debt and equity financing to the Acquisition Partnerships. In addition, FirstCity believes its relationship with Cargill significantly enhances FirstCity’s credibility as a purchaser of Portfolio Assets and facilitates its ability to expand into related businesses and foreign markets.

      Under a Right of First Refusal Agreement and Due Diligence Reimbursement Agreement effective as of January 1, 1998, as amended (the “Right of First Refusal Agreement”) among the Company, FirstCity Servicing Corporation, Cargill and its wholly owned subsidiary CFSC Capital Corp. II (“CFSC”), if the Company receives an invitation to bid on or otherwise obtains an opportunity to acquire interests in loans, receivables, real estate or other assets located in the United States, Canada, Latin America, or the Caribbean in which the aggregate amount to be bid exceeds $4 million, or $500 thousand for consumer assets, the Company is required to follow a prescribed notice procedure pursuant to which CFSC has the option to participate in the proposed purchase by requiring that such purchase or acquisition be effected through an Acquisition Partnership formed by the Company and Cargill (or an affiliate). The Right of First Refusal Agreement does not prohibit the Company from holding discussions with entities other than CFSC regarding potential joint purchases of interests in loans, receivables, real estate or other assets, provided that any such purchase is subject to CFSC’s right to participate in the Company’s share of the investment. The Right of First Refusal Agreement further provides that, subject to certain conditions, CFSC will pay to the Company a monthly amount to cover due diligence expense, plus 50% of the third party due diligence expenses incurred by the Company in connection with proposed asset purchases. The Right of First Refusal Agreement is a restatement and extension of a similar agreement entered into among the Company, certain members of the Company’s management and Cargill in 1992. The Right of First Refusal Agreement has a termination date of February 1, 2006 and will renew automatically for an additional year on an annual basis thereafter unless either party gives notice to the other of its desire to discontinue the arrangement six months prior to the termination date.

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      Future increases in the Company’s investments in Portfolio Assets acquired from institutions and government agencies may be obtained through investment entities formed with Cargill, whereby Cargill shares a general partner interest, thereby capitalizing on the expertise of Cargill whose skills complement those of the Company.

      Historically, FirstCity has leveraged its expertise in asset resolution and servicing by investing in a wide variety of asset types across a broad geographic scope. FirstCity continues to follow this investment strategy and seeks expansion opportunities into new asset classes and geographic areas when it believes it can achieve attractive risk adjusted returns. The following items are significant elements of FirstCity’s business strategy in the portfolio acquisition and resolution business:

	•	Traditional markets. FirstCity believes it will continue to invest in Portfolio Assets acquired from financial institutions and government agencies, both for its own account or through investment entities formed with Cargill or one or more other co-investors.
	•	Niche markets. FirstCity believes it will continue to pursue profitable private market niches in which to invest. The niche investment opportunities that FirstCity has pursued to date include (i) the acquisition of improved or unimproved real estate, including excess retail sites, and (ii) periodic purchases of single financial or real estate assets from banks and other financial institutions with which FirstCity has established relationships, and from a variety of other sellers that are familiar with the Company’s reputation for acting quickly and efficiently.
	•	Foreign markets. FirstCity believes that the foreign markets for Portfolio Assets are less developed than the U.S. market, and therefore provide a greater opportunity to achieve attractive risk adjusted returns. FirstCity has purchased Portfolio Assets in France, Japan (sold in 1999) and Mexico and expects to continue to seek purchase opportunities outside of the United States.

Consumer Lending

      The Company historically conducted all of its consumer receivable origination activities through Consumer Corp. Consumer Corp.’s focus had been on the origination and servicing of sub-prime consumer automobile loans. Such loans are extended to borrowers who evidence an ability and willingness to repay credit, but have experienced an adverse event, such as a job loss, illness or divorce, or have had past credit problems, such as delinquency, bankruptcy, repossession or charge-offs. In the third quarter of 2000, Consumer Corp. formed Drive and transferred the entire operations of its automobile finance platform to Drive. Consumer Corp. sold a 49% equity interest in Drive to IFA-GP and IFA-LP, subsidiaries of BoS(USA), a wholly owned subsidiary of Bank of Scotland. See “Background” for additional information related to formation and structure of Drive. As a result of the sale, the majority of Consumer Corp.’s operations have been accounted for under the equity method since August 1, 2000.

      Drive is a specialized consumer finance company engaged in the purchase, securitization, and servicing of retail installment contracts originated by automobile dealers. Drive acquires retail installment contracts principally from manufacturer-franchised dealers in connection with their sale of used and new automobiles and light duty trucks to “sub-prime” customers with limited credit histories or past credit problems. At the present, Drive does not extend credit directly to consumers, nor does it purchase retail installment contracts from other financial institutions.

      During 2002, Drive elected not to use gain on sale treatment when assets were securitized. Instead, Drive pursued a strategy to grow the balance sheet and record interest income from loans and interest expense on the related debt as incurred to build an earnings stream over time.

Government Regulation

      Portfolio Asset Acquisition and Resolution — Certain aspects of the Company’s Portfolio Asset acquisition and resolution business are subject to regulation under various federal, state and local statutes and

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      Consumer Lending — Numerous federal and state consumer protection laws and related regulations impose substantial requirements upon lenders and servicers involved in consumer finance. These laws include the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Federal Trade Commission Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Magnuson-Moss Warranty Act, the Federal Reserve Board’s Regulations B and Z, state adaptations of the National Consumer Act and of the Uniform Consumer Credit Code, and state motor vehicle retail installment sales acts, retail installment sales acts and other similar laws. Also, state laws impose finance charge ceilings and other restrictions on consumer transactions and require contract disclosures in addition to those required under federal law. These requirements impose specific statutory liabilities upon creditors who fail to comply with their provisions.

      In addition, as an affiliate of BoS(USA), Drive is subject to regulatory oversight by the Federal Reserve Bank and the Office of the Comptroller of Currency, who may periodically review the operations of Drive when examining the safety and soundness of BOS(USA)’s and Bank of Scotland’s operations in the United States.

Competition

      Portfolio Asset Acquisition and Resolution — The Portfolio Asset acquisition business is highly competitive. Some of the Company’s principal competitors are substantially larger and better capitalized than the Company. Because of these resources, these companies may be better able than the Company to acquire Portfolio Assets, to pursue new business opportunities or to survive periods of industry consolidation. Generally, there are three aspects of the distressed asset business: due diligence, Portfolio management, and servicing. The Company is a major participant in all three areas. In comparison, certain of its competitors (including certain securities and banking firms) have historically competed primarily as portfolio purchasers and have customarily engaged other parties to conduct due diligence on potential Portfolio purchases and to service acquired assets, and certain other competitors (including certain banking and other firms) have historically competed primarily as servicing companies.

      The Company believes that its ability to acquire Portfolios for its own account and through Acquisition Partnerships will be an important component of the Company’s overall future growth. Acquisitions of Portfolios are often based on competitive bidding, which involves the danger of bidding too low (which generates no business), or bidding too high (which could result in the purchase of a Portfolio at an economically unattractive price).

      Consumer Lending — The automobile finance industry is the second largest consumer finance market in the United States. The vast majority of automobile financing is provided by captive finance subsidiaries of major auto manufacturers, banks, and credit unions for vehicles purchased by “A” credit consumers or “prime” consumers. Primary lenders tend to avoid or do not consistently serve the sub-prime market, in which predominantly used automobiles are purchased by borrowers with “B,” “C,” or “D” credit. The sub-prime consumer market estimated at approximately $100 billion per year is served mainly by independent finance companies such as Drive.

      The Company believes that the sub-prime, consumer automobile market is growing because of a number of factors including (i) economic trends, (ii) the extension of the average useful life of automobiles, and (iii) the increasing number of late model used automobiles being offered for sale including former rental cars and off-lease vehicles.

      The Company believes Drive is well positioned to maximize on this opportunity due to its talented management team, strong financial partner in BoS(USA), growth of market saturation, consistent record of success of its business model and an attractive net margin environment, assisted by the low wholesale interest market.

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      Drive is currently represented in 28 states with concentrations in the Texas, California, Georgia and North Carolina markets. Drive originated $485 million in receivable contracts in 2003, which represents a fraction of 1% of the potential market. The Company believes there is ample room to grow both in current markets and in new markets not yet serviced. Sub-prime competition varies from market to market, but the largest competitors seen in most markets include Americredit Corporation, Household Finance, WFS Finance and Capital One. Each of these competes in a different credit sector within Drive’s market and all are currently moving upwards in the credit cycle as the economy changes. Drive believes it has opportunities to grow its market share, at the lowest end of the credit spectrum, through controlled use of its business model.

Employees

      The Company had 267 employees as of December 31, 2003. No employee is a member of a labor union or party to a collective bargaining agreement. The Company believes that its employee relations are good.

Relationship with the Bank of Scotland

      FirstCity has had a significant relationship with the Bank of Scotland or its subsidiaries since September 1997. In connection with the recapitalization, FirstCity and the Senior Lenders entered into a loan agreement that refinanced the Company’s existing debt with the Senior Lenders ($40 million outstanding at December 31, 2003). The Senior Lenders also provided new financing to FirstCity, with a total commitment of up to $59 million, consisting of (a) a $5 million revolving credit loan and (b) an acquisition term loan in an amount up to $54 million. The outstanding balances at December 31, 2003 on the new financings were $1.1 million and $3.0 million, respectively. The aggregate amount of outstanding loans under the total commitment by the Senior Lenders for the refinancing and the new financing at any time may not exceed $77 million.

      As a part of the recapitalization, BoS(USA) provided a non-recourse loan in the amount of $16 million to FirstCity which was used to pay the cash portion of the exchange offer to the holders of the New Preferred Stock, to pay expenses of the exchange offer and recapitalization, and to reduce FirstCity’s debt to the Senior Lenders. The $16 million loan is secured by a 20% interest in Drive (64.51% of FirstCity’s remaining 31% interest in Drive) and other assets of Consumer Corp. In connection with the $16 million loan, FirstCity is obligated to pay an arrangement fee to BoS(USA) equal to 20% of all amounts received by FirstCity in excess of $16 million from any sale or other disposition of FirstCity’s 20% interest in Drive and all dividends and other distributions paid by Drive or its general partner on FirstCity’s 20% interest in Drive. Management of the Company believes the value of FirstCity’s 20% ownership interest of Drive does not exceed $16 million as of December 31, 2003.

      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 under certain circumstances to additional warrants in connection with the existing warrant for 425,000 shares to retain its ability to acquire approximately 4.86% of the Company’s voting Common Stock.

      Drive has a warehouse line of credit with BoS(USA), which provides borrowings up to $300 million (increased from $250 million in February 2004). Drive’s obligation under this arrangement at December 31, 2003 was $178 million. The debt is secured by Drive’s retail installment contracts and has been extended to February 2005.

      In addition, with respect to Drive, BoS(USA) has entered into certain agreements with Drive (the “Sponsor Agreements”) that require BoS(USA), under certain circumstances to (a) purchase nonconforming contracts in the event that the seller, the servicer, or the related originator fails to repurchase any contract that is required to be repurchased, (b) pay certain premiums and other expenses, (c) indemnify the collateral agent and the insurance provider from certain types of losses, and (d) to make certain secondary servicer advances. BoS(USA) has required FirstCity to indemnify BoS(USA) for 31% (the amount of its direct and indirect ownership in Drive) of any losses resulting under the terms of the Sponsor Agreements. To date, FirstCity has not paid any amounts in connection with its obligations pursuant to the Sponsor Agreements.

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      The Company leases all its office locations. The Company leases its current headquarters building from a related party under a noncancellable operating lease, which expires December 31, 2006. All leases of the other offices of the Company and subsidiaries expire prior to 2005. The following is a list of the Company’s principal physical properties leased as of December 31, 2003.

      Periodically, FirstCity, its subsidiaries, its affiliates and the Acquisition Partnerships are parties to or otherwise involved in legal proceedings arising in the normal course of business. FirstCity does not believe that there is any proceeding threatened or pending against it, its subsidiaries, its affiliates or the Acquisition Partnerships which, if determined adversely, would have a material adverse effect on the consolidated financial position, results of operations or liquidity of FirstCity, its subsidiaries, its affiliates or the Acquisition Partnerships.

      The Company held its annual meeting of stockholders (the “Annual Meeting”) on November 18, 2003. The following items for business were considered at the Annual Meeting.

      The following were elected as directors to serve as members of the Company’s Board of Directors until the Company’s 2004 annual meeting of stockholders. The number of votes cast for each nominee was as follows:

      The stockholders approved the Company’s 2004 Stock Option and Award Plan. The number of votes for the proposal: 4,916,901; votes against: 314,841; abstentions: 89,123.

      A proposal to ratify the Board of Directors’ appointment of KPMG LLP as the Company’s independent auditors for 2003 was approved by the stockholders. The number of votes for the proposal: 9,264,440; votes against: 16,023; abstentions: 19,555.

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PART II

Common and Preferred Stock Data

      The Company’s common stock, $.01 par value per share (“Common Stock”), and redeemable preferred stock, par value $.01 per share (“New Preferred Stock”) are listed on the Nasdaq National Market System under the symbols FCFC and FCFCO, respectively. The number of holders of record of Common Stock on March 19, 2004 was approximately 491. High and low stock prices for the Common Stock and New Preferred Stock in 2003 and 2002 are displayed in the following table:

      The Company has never declared or paid a dividend on the Common Stock. The Company currently intends to retain future earnings to finance its growth and development and therefore does not anticipate that it will declare or pay any dividends on the Common Stock in the foreseeable future. Any future determination as to payment of dividends will be made at the discretion of the Board of Directors of the Company and will depend upon the Company’s operating results, financial condition, capital requirements, general business conditions and such other factors that the Board of Directors deems relevant. The Company’s loan facilities with the Senior Lenders and certain other credit facilities to which the Company and its subsidiaries are parties contain restrictions relating to the payment of dividends and other distributions. In the third quarter of 1999, dividends on the New Preferred Stock were suspended. Given the continued high debt levels of the Company, and management’s priority of assuring adequate levels of liquidity, the Company does not anticipate that dividends on shares of New Preferred Stock will be paid in the foreseeable future.

      During 2002, FirstCity also acquired the minority interest in FirstCity Holdings held by Terry R. DeWitt, G. Stephen Fillip and James C. Holmes, each of whom are Senior Vice Presidents of FirstCity by issuing 400,000 shares of unregistered common stock of the Company and a note payable with an imputed balance of $1.3 million at December 31, 2003. This note is to be paid down out of incentive servicing fees received from the Mexican Acquisition Partnerships, with an aggregate payout to the note holders not to exceed $3.2 million. The sale of the 400,000 shares of Common Stock was an exempt transaction pursuant to Section 4(2) of the Securities Act of 1933, as amended.

      In December 2002, FirstCity completed a recapitalization in which holders of the New Preferred Stock exchanged 1,092,210 shares of New Preferred Stock, representing 89.3% of the 1,222,901 shares previously outstanding, for 2,417,388 shares of common stock and $10.5 million. As a result, common equity was increased by $18.9 million. Upon the completion of the recapitalization, 130,691 shares of New Preferred Stock remained outstanding. During the first quarter of 2003, 4,400 shares of New Preferred Stock were redeemed for 8,200 shares of common stock and $50,000 in cash, leaving 126,291 shares outstanding at

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      Simultaneously with the closing of the exchange offer for New Preferred Stock in December 2002 and the other transactions contemplated by the recapitalization, FirstCity and the Senior Lenders entered into a loan agreement that refinanced the Company’s existing financings with the Senior Lenders. The Senior Lenders also provided new financing to FirstCity, with a total commitment by Bank of Scotland of up to $59 million, consisting of (a) a $5 million revolving credit loan and (b) an acquisition term loan in an amount up to $54 million. The aggregate amount of outstanding loans under the total commitment by the Senior Lenders for the refinancing and the new financing at any time may not exceed $77 million.

      In the third quarter of 2000, Consumer Corp. completed a sale of a 49% equity interest in its automobile finance operation to IFA-GP and IFA-LP. As a result of this sale, the Company no longer consolidates the financial statements of its automobile finance operation since August 1, 2000, but instead records its investment under the equity method of accounting.

      Effective during the third quarter of 1999, management of the Company adopted formal plans to discontinue the operations of Mortgage Corp and Capital Corp. These entities comprise the operations that were previously reported as the Company’s residential and commercial mortgage banking business. Because the Company formally adopted plans to discontinue the operations of Mortgage Corp. and Capital Corp., and operations at each such entity have ceased, the results of historical operations have been reflected as discontinued operations.

      On October 14, 1999, Harbor Financial Group, Inc. (“Harbor Parent”), Harbor Financial Mortgage Corporation (“Harbor”) and four subsidiaries of Harbor filed voluntary petitions under Chapter 11 of the United States Bankruptcy Code. On December 14, 1999, these bankruptcy proceedings were converted to liquidation proceedings under Chapter 7 of the United States Bankruptcy Code. John H. Litzler, the Chapter 7 Trustee in the bankruptcy proceedings (the “Trustee”), initiated adversary proceedings on May 25, 2001 alleging various claims against FirstCity and various current and former directors and officers of FirstCity and Mortgage Corp. The Trustee, FirstCity, the other defendants and the insurers providing Director’s and Officer’s Insurance coverage for FirstCity and its subsidiaries (the “Insurers”) settled the all claims brought in the adversary proceedings with the approval of the Bankruptcy Court. Under the terms of the settlement agreement, the Trustee released the defendants, their affiliates and subsidiaries from any and all claims which were brought or could have been brought by the Trustee against any of the defendants, any past and present officers and directors of FirstCity or any affiliates or subsidiaries of FirstCity. FirstCity did not guarantee the indebtedness of Mortgage Corp. and has previously reached agreement with its Senior lenders to permanently waive any events of default related to Mortgage Corp., including bankruptcy.

      The Selected Financial Data presented below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Item 7 and with the related Consolidated Financial Statements and Notes thereto under Item 8 of this Annual Report on Form 10-K, respectively.

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Selected Financial Data

(1)	Includes deferred tax provisions of $7.0 million and $4.9 million, respectively, in 2000 and 1999 related to the reduction of benefits to be realized from NOLs.

      The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements of the Company (including the Notes thereto) included elsewhere in this Annual Report on Form 10-K.

Overview

      The Company is a financial services company engaged in Portfolio Asset acquisition and resolution, conducted through FirstCity, and in consumer lending, through its investment in Drive.

      During 2003 the Company continued to build on the positive foundation of the recapitalization which was completed in December 2002 which provided needed investment liquidity to the Portfolio Asset acquisition and resolution business allowing the Company to invest $22.9 million during the year up from $16.7 million in 2002. Of the total invested during 2003, $12.4 million was invested domestically, $9.4 million was invested in France and $1.1 million was invested in Mexico. It is the goal of management to increase the volume of acquisitions each year and invest in a disciplined manner larger amounts of equity as opportunities arise utilizing the new liquidity currently available. The Portfolio Asset acquisition and resolution business is the primary source of cash flow for the Company and its subsidiaries for the repayment of debt and operating expenses.

      The gradual improvement in the domestic economy during 2003 is reflected in the results of the Portfolio Asset acquisition and resolution business and through the Company’s 31% investment in Drive, both segments

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      Although the Company’s primary revenues are generated by the Portfolio Asset acquisition and resolution business and the Company’s investment in Drive, other items such as interest expense, and the effects of discontinued operations also have a significant impact on net income. During 2003 corporate interest and dividend expense declined to $4.7 million down from $6.3 million during 2002 as a result of lower interest rates and reduced levels of debt. The Company also had reduced provisions from discontinued operations of $520 thousand, down from $9.7 million in 2002. Additionally, the Company received cash flow from the residual interests held in discontinued operations of $1.5 million during 2003.

      Overall the Company’s financial results reflect renewed strength and positive growth trends while operating in an environment of nationwide recession, high unemployment, weak wholesale auction values, record personal bankruptcies and record low interest rates all of which created a challenging operating landscape during 2003.

      The Company’s financial results are affected by many factors including levels of and fluctuations in interest rates, fluctuations in the underlying values of real estate and other assets, the timing of and ability to liquidate assets, and the availability and prices for loans and assets acquired in all of the Company’s businesses. The Company’s business and results of operations are also affected by the availability of financing with terms acceptable to the Company and the Company’s access to capital markets, including the securitization markets.

      As a result of the significant period to period fluctuations in the revenues and earnings of the Company’s Portfolio Asset acquisition and resolution business, the sale of the interest in the automobile finance operation, and the timing of securitization transactions and structuring of Drive, period to period comparisons of the Company’s results of continuing operations may not be meaningful.

Results of Operations

      The Company reported earnings from continuing operations of $9.7 million in 2003 compared to $5.9 million in 2002. Loss from discontinued operations was $.5 million in 2003 and $9.7 million in 2002. Net earnings to common stockholders were $9.1 million in 2003 compared to a loss of $6.2 million in 2002. On a per share basis, diluted net earnings to common stockholders were $.80 in 2003 compared to a loss of $.74 in 2002.

      The operating contribution of $14.5 million in 2003 increased by $3.3 million, or 29%, compared with 2002. FirstCity purchased $129 million of Portfolio Assets during 2003 ($128 million through the Acquisition Partnerships) compared to $172 million in acquisitions in 2002. FirstCity’s investment in these acquisitions was $22.9 million and $16.7 million in 2003 and 2002, respectively. FirstCity’s year-end investment in wholly-owned Portfolio Assets decreased to $4.5 million from $9.8 million at December 31, 2003 and 2002, respectively, as a result of normal liquidation.

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      Servicing fee revenues. Servicing fee revenues increased by 19% to $15.1 million in 2003 from $12.7 million in 2002. Service fees from the Mexican partnerships (including incentive service fees) increased $3.0 million or 42% from $7.2 million in 2002 to $10.2 million in 2003 due to increased servicing responsibilities in Mexico as a result of bringing the majority of the servicing in-house and not using third-party servicers to provide the servicing function for the Mexican partnerships. For the Mexican Acquisition Partnerships, FirstCity earns a servicing fee based on costs of servicing plus a profit margin. Service Fees from the domestic Acquisition Partnerships decreased $.6 million or 11% from $5.5 million in 2002 to $4.9 million in 2003. In June 2002, three domestic Acquisition Partnerships completed a bulk loan sale of performing and non-performing Portfolio Assets with a carrying value of $59 million for proceeds of $71 million. As a result of the sale, the Company recorded servicing fee revenues of $.9 million. In June 2003, FirstCity and several Acquisition Partnerships completed another loan sale of performing and non-performing Portfolio Assets with a carrying value of $8.3 million for proceeds of $10.0 million, resulting in $.3 million of service fees.

      Gain on resolution of Portfolio Assets. The net gain on resolution of Portfolio Assets increased from $1.1 million in 2002 to $1.4 million in 2003. The gross profit percentage on the resolution of Portfolio Assets in 2003 was 18% as compared to 27% in 2002 primarily as a result of a payoff of three performing loans in July 2003 generating proceeds of $1.5 million and no gain.

      Equity in earnings of investments. Equity in earnings of Acquisition Partnerships increased 61% to $13.6 million in 2003 compared to $8.4 million in 2002. The Acquisition Partnerships reflected net earnings of $15.1 million in 2003 compared to a net loss of $13.2 million in 2002. Following is a discussion of equity earnings by geographic region.

	•	Domestic — Equity in earnings of domestic Acquisition Partnerships was $13.5 million in 2003 compared to $10.0 million in 2002. Equity in earnings in MinnTex Investment Partners LP, which began operations in April 2002, was $3.7 million in 2003 compared to $1.8 million in 2002. Also, one real estate partnership realized a $2.9 million gain on sale in the fourth quarter of 2003.
	•	Mexico — Equity in loss of Mexican Acquisition Partnerships was $4.0 million in 2003 compared to $3.5 million in 2002. These partnerships reflected a loss of $41.2 million in 2003 compared to $56.5 million in 2002. The partnerships recorded foreign exchange losses of $30.0 million in 2003 compared to $24.9 million in 2002. Interest expense of $17.0 million and $54.9 million were recorded 2003 and 2002, respectively. This interest is owed to the investors of these partnerships, of which FirstCity recorded $2.5 million and $3.9 million, respectively, as interest income. Excluding effects of foreign currency transactions and interest expense, these partnerships reflected adjusted net earnings of $5.8 million in 2003 compared to $23.3 million in 2002, which is primarily due to the Mexican partnerships receiving $28.9 million or 34% less collections in 2003 compared to 2002. The Company continues to see opportunities to invest in Mexico that are favorable taking into consideration the currency risk and continues to monitor the foreign currency exposure on a daily basis and evaluate the advisability of hedging these investments through analysis of currency forecasts, the cost of hedging those investments and the available liquidity to do so.
	•	France — Equity in earnings of Acquisition Partnerships located in France increased 100% to $4.1 million in 2003 compared to $1.9 million in 2002. This increase is principally due to the addition of three French Partnerships during 2002 and two in 2003, which accounted for $2.4 million in equity in earnings in 2003. In addition, the Company sold in June 2002 its investment in eight French Partnerships, which accounted for $.4 million in equity in earnings in 2002. During 2003, FirstCity also recorded $1.2 million in foreign currency transaction gains (included in other expenses) relating to investments in France as the euro relative to the dollar appreciated from 1.05 at December 31, 2002 to 1.26 at December 31, 2003.

      Interest income. Interest income decreased 35% from $5.1 million in 2002 to $3.3 million in 2003 primarily due to the Company amending three loan agreements with Acquisition Partnerships located in Mexico to provide for no interest to be payable with respect to periods after the effective date of the amendments. This change had no impact on the consolidated net earnings as the effect is offset through equity

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      Gain on sale of interest in equity investments. During 2002, the Company sold its investment in eight French Acquisition Partnerships to existing investors in those entities. FirstCity received proceeds of $3.4 million on the sale resulting in a gain of $1.8 million.

      Other income. Other income decreased 45% from $2.2 million in 2002 to $1.2 million in 2003 primarily due to a $.7 million gain on the early extinguishment of debt recorded in 2002.

      Expenses. Operating expenses decreased $.2 million or 1%, primarily due to reductions in minority interest expense, interest and other expenses, offset by increases in salaries and benefits in Mexico.

      Interest and fees on notes payable was flat from year to year.

      Salaries and benefits increased $2.9 million, or 30%, due to increased servicing personnel in Mexico. Total personnel within the Portfolio Asset acquisition and resolution segment increased from 212 to 237 at December 31, 2002 and 2003, respectively, with the personnel in Mexico increasing from 137 to 170. FirstCity also recorded additional servicing fee revenues with the increased servicing responsibilities in Mexico.

      The provision for loan and impairment losses was $98,000 in 2003 and includes a $61,000 recovery on one real estate Portfolio. The provision for loan and impairment losses totaled $295,000 in 2002.

      Minimal provisions were recorded in 2003 and 2002 for performing or non-performing Portfolios as the economic conditions during that period did not negatively impact the Company’s expectation of future cash flows. Impairment on performing Portfolio Assets is measured based on the present value of the expected future cash flows in the aggregate discounted at the loan’s risk adjusted rates, which approximates the effective interest rates, or the fair value of the collateral, less estimated selling costs, if any loans are collateral dependent and foreclosure is probable. Impairment on nonperforming Portfolios is evaluated by analyzing the expected future cash flows from the underlying assets within each Portfolio. The expected future cash flows are reviewed monthly and adjusted as deemed necessary. Changes in various factors including, but not limited to, economic conditions, deterioration of collateral values, deterioration in the borrower’s financial condition and other conditions described in the risk factors discussed later in this document, could have a negative impact on the estimated future cash flows of the Portfolio. Significant decreases in estimated future cash flows can reduce a Portfolio’s present value to below the Company’s carrying value of that Portfolio, causing impairment.

      The Company recorded permanent valuation impairments of $.2 million in 2002 on two real estate Portfolios due to deterioration of property values and market conditions, as well as additional expected disposal costs. For real estate Portfolios, the evaluation of impairment is determined quarterly based on the review of the estimated future cash receipts less estimated costs to sell, which represents the net realizable value of the real estate Portfolio. A valuation allowance is established for any impairment identified through provisions charged to operations in the period the impairment is identified.

      There were no provisions recorded on loans receivable from Acquisition Partnerships during the third quarter of 2003 and 2002. The loans receivable from the Mexican partnerships are secured by the assets/loans acquired by the Mexican partnerships with purchase money loans provided by affiliates of the investors in the Mexican 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.

      Occupancy, data processing and other expenses declined $1.6 million or 24% primarily due to net foreign currency gains of $1.1 million in 2003 compared to $146,000 in 2002.

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      Minority interest expense was $1.3 million in 2002. In December 2002, FirstCity acquired the minority interest in FirstCity Holdings as part of a recapitalization, and in April 2003, acquired the minority interest of MCSFC LP.

      FirstCity’s consumer lending segment consists of the Company’s net investment in Drive. The operating contribution for 2003 was $5.3 million compared to $3.5 million in 2002.

      Equity in earnings of investment. FirstCity recorded equity in earnings of Drive of $7.2 million in 2003 compared to equity in loss of $.5 million in 2002. Drive recorded net income of $19.0 million in 2003 compared to a loss of $1.6 million in 2002. Drive’s inventory of retail installments contracts has grown from $368 million at December 31, 2002 to $623 million at December 31, 2003. Consequently, net interest margin after provision for credit losses and impairments at Drive rose from $52.8 million to $86.2 million during 2002 and 2003, respectively. The provisions for impairment on residual assets of $8.4 million were related to higher losses and delinquencies as a result of market and general economic conditions and are more prevalent in pools of loans originated prior to 2002. Drive’s management believes that recent market conditions indicate initial signs of improvement and Drive Management continues to monitor trends in cash flow and performance to determine the impact upon the need for additional provisions. Net income from Drive continues to be positive as originations and the volume of portfolio assets grow over time. Based on information provided by Drive, the Company expects that this positive trend will continue.

      Gain on sale of interest in Drive. FirstCity recognized a $4 million deferred gain in the fourth quarter of 2002 as a result of the release of FirstCity’s guaranty of a $60 million loan to Drive by BoS(USA). The guaranty was released in connection with the closing of the Company’s recapitalization in December 2002.

      The following items affect the Company’s overall results of operations and are not directly allocated to any one of the Company’s businesses discussed above.

      Corporate interest and overhead. Company level interest expense increased by 19% to $4.6 million in 2003 from $3.9 million in 2002 due to increased effective interest costs. Other corporate overhead expenses increased 10% to $5.9 million in 2003 from $5.4 million in 2002 primarily due to increased salaries and benefits and other operating expenses at the corporate level.

      Income taxes. Provision for income taxes was $240,000 in 2003 and $153,000 in 2002 and related primarily to state income taxes. Federal income taxes are provided at a 35% rate applied to taxable income or loss and are offset by NOLs that the Company believes are available. The tax benefit of the NOLs is recorded in the period during which the benefit is realized. The Company recorded no deferred tax provision in 2003 and 2002.

      Discontinued Operations. The Company recorded a provision of $.5 million in 2003 for additional losses from discontinued operations compared to $9.7 million in 2002. The additional provisions primarily relate to a decrease in the estimated future gross cash receipts on residual interests in securitizations. These securities are in “run-off,” and the Company is contractually obligated to service these assets. The assumptions used in the valuation model consider both industry as well as the Company’s historical experience. The decrease in the estimated future gross cash receipts is partially a result of the actual losses exceeding the losses projected by the valuation model. In addition, prepayment assumptions have increased to take into consideration the lower market rates and higher than predicted actual prepayments over the past quarter. As the securities “run off,” assumptions are reviewed in light of historical evidence in revising the prospective results of the model. These revised assumptions could potentially result in either an increase or decrease in the estimated cash receipts. An additional provision is booked based on the output of the valuation model if deemed necessary.

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      The Company reported earnings from continuing operations of $5.9 million, including a $4 million gain from the release of its guaranty of Drive’s indebtedness, in 2002 compared to $2.2 million in 2001. Loss from discontinued operations was $9.7 million in 2002 and $5.2 million in 2001. Net loss to common stockholders was $6.2 million in 2002 compared to $5.6 million in 2001. On a per share basis, basic and diluted net loss attributable to common stockholders was $.74 in 2002 compared to $.67 in 2001.

      The operating contribution of $11.2 million in 2002 increased by $3.5 million, or 45%, compared with 2001. FirstCity purchased $172 million of Portfolio Assets during 2002 through the Acquisition Partnerships compared to $225 million in acquisitions in 2001. FirstCity’s investment in Portfolio Assets decreased to $9.8 million in 2002 from $14.2 million in 2001 as a result of normal liquidation. FirstCity invested $16.7 million in equity in Portfolio Assets in 2002 compared to $24.3 million in 2001.

      Servicing fee revenues. Servicing fee revenues increased by 32% to $12.7 million in 2002 from $9.6 million in 2001 primarily as a result of increased collections in domestic Acquisition Partnerships. In June 2002, three domestic Acquisition Partnerships completed a bulk loan sale of performing and non-performing Portfolio Assets with a carrying value of $59 million for proceeds of $71 million. As a result of the sale, the Company recorded servicing fee revenues of $.9 million. Also, FirstCity received higher service fees on one portfolio acquired in 2002 due to the type of assets and level of servicing required on each asset.

      Gain on resolution of Portfolio Assets. The net gain on resolution of Portfolio Assets was flat from year to year.

      Equity in earnings of investments. Equity in earnings of Acquisition Partnerships decreased 14% to $8.4 million in 2002 compared to $9.7 million in 2001. Net loss in the combined Acquisition Partnerships was $13.2 million in 2002 compared to earnings of $14.2 million in 2001 due to significant losses in Mexico, in which the Company has smaller equity investments compared to investments in the United States and France. See Note 6 of the Company’s consolidated financial statements for a comparison of earnings of the Acquisition Partnerships and equity in earnings of those entities summarized by geographic region. Equity in earnings of Servicing Entities was $.8 million in 2002 compared to $1.0 million in 2001.

      Interest income. Interest income decreased $.7 million or 12% due to average balances in Portfolio Assets and loans receivable decreasing to $31.6 million in 2002 from $40.7 million in 2001.

      Gain on sale of interest in equity investments. During 2002, the Company sold its investment in eight French Acquisition Partnerships to existing investors in those entities. FirstCity received proceeds of $3.4 million on the sale resulting in a gain of $1.8 million. During 2001, the Company sold equity investments in two domestic Acquisition Partnerships for $7.6 million resulting in a gain of $3.3 million.

      Operating expenses. Operating expenses decreased $3.9 million or 16% primarily as a result of decreased debt costs and lower write-downs of Portfolio Assets, offset by increased operating costs in Mexico.

      Interest and fees on notes payable decreased $1.2 million or 29% due to average debt for 2002 decreasing to $28.9 million from $42.3 million in 2001. Also, the average cost of borrowing decreased from 9.8% in 2001 to 9.2% in 2002.

      Salaries and benefits increased $1.9 million or 25% primarily due to increased servicing personnel in Mexico. Total personnel within the Portfolio Asset acquisition and resolution segment increased from 150 at year end 2001 to 212 at year end 2002, with the personnel in Mexico increasing from 81 at year end 2001 to 137 at year end 2002.

      The provision for loan and impairment losses was $.3 million in 2002 compared to $3.3 million in 2001. Minimal provisions were recorded in 2002 for performing and non-performing Portfolios, as the economic conditions during that period did not negatively impact the Company’s expectation of future cash flows. In 2001, provisions of $1.6 million in four non-performing Portfolios and $.6 million in two performing Portfolios

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      Occupancy, data processing and other expenses decreased $2.1 million or 24% during the period due to a decrease in servicing fee expense in Mexico of $2.9 million offset by increases in foreign currency exchange rate expense of $.5 million, occupancy expense of $.3 million and travel expense of $.1 million. In 2001 fees to third party servicers in Mexico were paid by the Company through August of 2001 from September 2001 to the present the Mexican Acquisition Partnerships have paid third party servicers directly.

      Minority interest expense increased 39% from $.9 million in 2001 to $1.3 million in 2002 due primarily to increased earnings in FirstCity Holdings, which was 80% owned by the Company. In December 2002, FirstCity acquired the minority interest in FirstCity Holdings as part of a recapitalization.

      The operating contribution for 2002 was $3.5 million compared to $4.4 million (net of a $.3 million cumulative effect of accounting change) during 2001.

      Equity in earnings of investment. FirstCity recorded equity in loss of Drive of $.5 million in 2002 compared to equity in earnings of $5.9 million in 2001. Drive recorded a net loss of $1.6 million in 2002 compared to earnings of $14.5 million in 2001. In 2002, Drive structured its securitizations as financings and did not use gain on sale treatment when assets were securitized. Drive pursued a strategy to grow the balance sheet and record interest income from loans and interest expense on the related debt as incurred to build an earnings stream over time.

      Gain on sale of interest in Drive. FirstCity recognized a $4 million deferred gain in the fourth quarter of 2002 as a result of the release of FirstCity’s guaranty of a $60 million loan to Drive by BoS(USA). The guaranty was released in connection with the closing of the Company’s recapitalization in December 2002.

      Operating expenses. Total operating expenses declined primarily as a result of minority interest income of $.1 million in 2002 compared to minority interest expense of $1.1 million in 2001. Minority interest expense is directly attributable to earnings and losses of Drive.

      The following items affect the Company’s overall results of operations and are not directly allocated to any one of the Company’s businesses discussed above.

      Corporate overhead. Company level interest expense decreased by 17% to $3.9 million in 2002 from $4.6 million in 2001 as a result of lower levels of debt. Other corporate overhead expenses were flat from year to year.

      Income taxes. Federal income taxes are provided at a 35% rate applied to taxable income or loss and are offset by NOLs that the Company believes are available. The tax benefit of the NOLs is recorded in the period during which the benefit is realized. The Company recorded no deferred tax provision in 2002 and 2001.

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Analysis of Revenues and Expenses

      The following table summarizes the revenues and expenses of each of the Company’s business segments and presents the contribution that each business makes to the Company’s operating margin.

Analysis of Revenues and Expenses

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Fourth Quarter

      Net earnings for the fourth quarter of 2003 were $3.5 million, or $.31 per share on a diluted basis. The following table presents a summary of operations for the fourth quarters of 2003 and 2002.

Condensed Consolidated Summary of Operations

Portfolio Asset Acquisition and Resolution

      In 2003 the Company invested $23 million in portfolios acquired through Acquisition Partnerships and subsidiaries. Acquisitions by the Company over the last five years are summarized as follows:

      The Company believes that prospects for investment in distressed assets in 2004 continue to be positive. In the U.S., opportunities remain strong as many sellers use the sale of distressed assets as an ongoing balance sheet management tool. Additionally, with the bank merger activity, acquiring banks are using the sale of portfolios to facilitate their acquisition activities. Additionally, in the foreign markets, the availability of distressed assets in France and Mexico remains strong. The Company is looking to expand its franchise base into Central and South America as well as other parts of Europe. To capitalize on these opportunities, FirstCity has implemented marketing programs to identify new opportunities for investment in Portfolio assets, both on a bid and negotiated basis.

      Revenues with respect to the Company’s Portfolio Asset acquisition and resolution segment consist primarily of (i) servicing fees from Acquisition Partnerships for the servicing activities performed related to the assets held in the Acquisition Partnerships, (ii) equity in earnings of affiliated Acquisition Partnerships and servicing entities, (iii) interest income on performing Portfolio Assets and loans receivable, and (iv) gains

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Analysis of Selected Revenues and Expenses

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