Form 10-Q
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One);
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2011
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     .
Commission File Number 1-13610
PMC COMMERCIAL TRUST
(Exact name of registrant as specified in its charter)
     
TEXAS   75-6446078
     
(State or other jurisdiction   (I.R.S. Employer Identification No.)
of incorporation or organization)    
     
17950 Preston Road, Suite 600, Dallas, TX 75252   (972) 349-3200
     
(Address of principal executive offices)   (Registrant’s telephone number)
Indicate by check mark whether the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. YES o NO þ
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 whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). YES þ NO o
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o
  Accelerated filer þ   Non-accelerated filer o   Smaller reporting company o
 
      (Do not check if a smaller reporting company)    
Indicate by check mark whether the Registrant is a shell company (as defined in Exchange Act Rule 12b-2). YES o NO þ
As of August 3, 2011, the Registrant had outstanding 10,574,554 Common Shares of Beneficial Interest, par value $.01 per share.
 
 

 

 


 

PMC COMMERCIAL TRUST AND SUBSIDIARIES
INDEX
         
    PAGE NO.  
       
 
       
       
 
       
    2  
 
       
    3  
 
       
    4  
 
       
    5  
 
       
    6  
 
       
    7  
 
       
    21  
 
       
    37  
 
       
    41  
 
       
       
 
       
    42  
 
       
    42  
 
       
    42  
 
       
    42  
 
       
    42  
 
       
    42  
 
       
    43  
 
       
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

 

 


Table of Contents

PART I
Financial Information
ITEM 1.
Financial Statements

 

1


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)
                 
    June 30,     December 31,  
    2011     2010  
    (Unaudited)  
ASSETS
               
Loans receivable, net:
               
Commercial mortgage loans receivable
  $ 121,131     $ 122,581  
Commercial mortage loans receivable, subject to structured notes payable
    36,457       40,421  
SBIC commercial mortgage loans receivable
    29,653       31,113  
SBA 7(a) loans receivable, subject to secured borrowings
    26,012       20,533  
SBA 7(a) loans receivable
    19,039       18,570  
 
           
Loans receivable, net
    232,292       233,218  
Restricted cash and cash equivalents
    7,211       5,786  
Cash and cash equivalents
    4,709       2,642  
Real estate owned
    1,914       3,477  
Other assets
    6,675       7,004  
 
           
 
               
Total assets
  $ 252,801     $ 252,127  
 
           
 
               
LIABILITIES AND EQUITY
               
Liabilities:
               
Debt:
               
Secured borrowings — government guaranteed loans
  $ 28,009     $ 21,765  
Junior subordinated notes
    27,070       27,070  
Structured notes payable
    19,452       22,157  
Revolving credit facility
    12,800       13,800  
SBIC debentures payable
    8,179       8,177  
 
           
Debt
    95,510       92,969  
Borrower advances
    3,640       3,462  
Accounts payable and accrued expenses
    2,285       2,739  
Dividends payable
    1,714       1,712  
Deferred gains on property sales
          685  
 
           
 
               
Total liabilities
    103,149       101,567  
 
           
 
               
Commitments and contingencies
               
 
               
Beneficiaries’ equity:
               
Common shares of beneficial interest; authorized 100,000,000 shares of $0.01 par value; 11,110,883 and 11,095,883 shares issued at June 30, 2011 and December 31, 2010, respectively; 10,574,554 and 10,559,554 shares outstanding at June 30, 2011 and December 31, 2010, respectively
    111       111  
Additional paid-in capital
    152,903       152,756  
Net unrealized appreciation of retained interests in transferred assets
    349       276  
Cumulative net income
    174,704       172,449  
Cumulative dividends
    (174,414 )     (171,031 )
 
           
 
               
 
    153,653       154,561  
 
               
Less: Treasury stock; at cost, 536,329 shares at June 30, 2011 and December 31, 2010
    (4,901 )     (4,901 )
 
           
 
               
Total beneficiaries’ equity
    148,752       149,660  
 
               
Noncontrolling interests — cumulative preferred stock of subsidiary
    900       900  
 
           
 
               
Total equity
    149,652       150,560  
 
           
 
               
Total liabilities and equity
  $ 252,801     $ 252,127  
 
           
The accompanying notes are an integral part of these consolidated financial statements.

 

2


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)
                                 
    Six Months Ended     Three Months Ended  
    June 30,     June 30,  
    2011     2010     2011     2010  
    (Unaudited)  
Revenues:
                               
Interest income
  $ 6,756     $ 6,715     $ 3,389     $ 3,498  
Other income
    1,147       675       458       437  
 
                       
 
                               
Total revenues
    7,903       7,390       3,847       3,935  
 
                       
 
                               
Expenses:
                               
Salaries and related benefits
    2,216       1,911       1,099       970  
Interest
    1,930       2,000       957       1,011  
General and administrative
    1,048       1,212       544       644  
Provision for (reduction of) loan losses, net
    379       (98 )     66       104  
 
                       
 
                               
Total expenses
    5,573       5,025       2,666       2,729  
 
                       
 
                               
Income before income tax benefit and discontinued operations
    2,330       2,365       1,181       1,206  
 
                               
Income tax benefit
    29       128       54       20  
 
                       
 
                               
Income from continuing operations
    2,359       2,493       1,235       1,226  
 
                               
Discontinued operations
    (104 )     8       104       (3 )
 
                       
 
                               
Net income
  $ 2,255     $ 2,501     $ 1,339     $ 1,223  
 
                       
 
                               
Weighted average shares outstanding:
                               
Basic
    10,566       10,549       10,570       10,550  
 
                       
Diluted
    10,621       10,565       10,626       10,566  
 
                       
 
                               
Basic and diluted earnings per share:
                               
Income from continuing operations
  $ 0.22     $ 0.24     $ 0.12     $ 0.12  
Discontinued operations
    (0.01 )           0.01        
 
                       
Net income
  $ 0.21     $ 0.24     $ 0.13     $ 0.12  
 
                       
The accompanying notes are an integral part of these consolidated financial statements.

 

3


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)
                                 
    Six Months Ended     Three Months Ended  
    June 30,     June 30,  
    2011     2010     2011     2010  
    (Unaudited)  
Net income
  $ 2,255     $ 2,501     $ 1,339     $ 1,223  
 
                       
 
                               
Change in unrealized appreciation of retained interests in transferred assets:
                               
 
                               
Net unrealized appreciation arising during period
    118       20       51       49  
Net realized gains included in net income
    (45 )     (4 )     (25 )     (1 )
 
                       
 
    73       16       26       48  
 
                       
 
                               
Comprehensive income
  $ 2,328     $ 2,517     $ 1,365     $ 1,271  
 
                       
The accompanying notes are an integral part of these consolidated financial statements.

 

4


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY

(In thousands, except share and per share data)
                                                                         
    Six Months Ended June 30, 2010  
    (Unaudited)  
                            Net                                      
                            Unrealized                                      
    Common                     Appreciation                                      
    Shares of                     of Retained                             Cumulative        
    Beneficial             Additional     Interests in     Cumulative                     Preferred        
    Interest     Par     Paid-in     Transferred     Net     Cumulative     Treasury     Stock of     Total  
    Outstanding     Value     Capital     Assets     Income     Dividends     Stock     Subsidiary     Equity  
 
Balances, January 1, 2010
    10,548,354     $ 111     $ 152,611     $ 325     $ 167,686     $ (164,274 )   $ (4,901 )   $ 900     $ 152,458  
Cumulative effect adjustment
                    $ (265 )     466                         201  
Net unrealized appreciation
                      16                               16  
Share-based compensation expense
    9,700             99                                     99  
Dividends ($0.32 per share)
                                  (3,378 )                 (3,378 )
Net income
                            2,501                         2,501  
 
                                                     
Balances, June 30, 2010
    10,558,054     $ 111     $ 152,710     $ 76     $ 170,653     $ (167,652 )   $ (4,901 )   $ 900     $ 151,897  
 
                                                     
CONSOLIDATED STATEMENTS OF EQUITY
                                                                         
    Six Months Ended June 30, 2011  
    (Unaudited)  
                            Net                                      
                            Unrealized                                      
    Common                     Appreciation                                      
    Shares of                     of Retained                             Cumulative        
    Beneficial             Additional     Interests in     Cumulative                     Preferred        
    Interest     Par     Paid-in     Transferred     Net     Cumulative     Treasury     Stock of     Total  
    Outstanding     Value     Capital     Assets     Income     Dividends     Stock     Subsidiary     Equity  
 
Balances, January 1, 2011
    10,559,554     $ 111     $ 152,756     $ 276     $ 172,449     $ (171,031 )   $ (4,901 )   $ 900     $ 150,560  
Net unrealized appreciation
                      73                               73  
Share-based compensation expense
    15,000             147                                     147  
Dividends ($0.32 per share)
                                  (3,383 )                 (3,383 )
Net income
                            2,255                         2,255  
 
                                                     
Balances, June 30, 2011
    10,574,554     $ 111     $ 152,903     $ 349     $ 174,704     $ (174,414 )   $ (4,901 )   $ 900     $ 149,652  
 
                                                     
The accompanying notes are an integral part of these consolidated financial statements.

 

5


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)
                 
    Six Months Ended  
    June 30,  
    2011     2010  
    (Unaudited)  
Cash flows from operating activities:
               
Net income
  $ 2,255     $ 2,501  
Adjustments to reconcile net income to net cash used in operating activities:
               
Depreciation
    4       9  
Impairment losses
    232        
Net gains on sales of real estate
    (570 )     (78 )
Deferred income taxes
    (231 )     (502 )
Provision for (reduction of) loan losses, net
    379       (98 )
Unrealized premium adjustment
    642       1,082  
Amortization and accretion, net
    (23 )     30  
Share-based compensation
    147       99  
Capitalized loan origination costs
    (96 )     (183 )
Loans funded, held for sale
    (10,743 )     (19,826 )
Proceeds from sale of guaranteed loans
    6,015        
Principal collected on loans
    294       64  
Loan fees remitted, net
    (78 )     (37 )
Change in operating assets and liabilities:
               
Other assets
    (533 )     (81 )
Borrower advances
    178       1,026  
Accounts payable and accrued expenses
    (485 )     249  
Other liabilities
    (32 )     (28 )
 
           
Net cash used in operating activities
    (2,645 )     (15,773 )
 
           
 
               
Cash flows from investing activities:
               
Loans funded
    (3,233 )     (3,118 )
Principal collected on loans
    9,429       8,677  
Principal collected on retained interests in transferred assets
    70       109  
Purchase of furniture, fixtures, and equipment
    (31 )      
Proceeds from sales of real estate owned, net
    111       2,291  
Proceeds from unconsolidated subsidiary
    1,373        
Investment in restricted cash and cash equivalents, net
    (1,425 )     (404 )
 
               
 
           
Net cash provided by investing activities
    6,294       7,555  
 
           
 
               
Cash flows from financing activities:
               
Repayment of revolving credit facility, net
    (1,000 )     (4,100 )
Payment of principal on structured notes payable
    (2,705 )     (2,289 )
Proceeds from secured borrowings — government guaranteed loans
    5,980       18,639  
Payment of principal on secured borrowings — government guaranteed loans
    (294 )     (64 )
Redemption of redeemable preferred stock of subsidiary
          (2,000 )
Payment of borrowing costs
    (182 )      
Payment of dividends
    (3,381 )     (3,397 )
 
           
Net cash provided by (used in) financing activities
    (1,582 )     6,789  
 
           
 
               
Net increase (decrease) in cash and cash equivalents
    2,067       (1,429 )
 
               
Cash and cash equivalents, beginning of year
    2,642       7,838  
 
           
 
               
Cash and cash equivalents, end of period
  $ 4,709     $ 6,409  
 
           
The accompanying notes are an integral part of these consolidated financial statements.

 

6


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
Note 1. Basis of Presentation:
The accompanying interim financial statements of PMC Commercial Trust (“PMC Commercial” or together with its wholly-owned subsidiaries, “we,” “us” or “our”) have not been audited by independent accountants. These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statement presentation. In the opinion of management, the financial statements include all normal recurring adjustments necessary for a fair statement of the results for the interim period. All material intercompany balances and transactions have been eliminated. The results for the three and six months ended June 30, 2011 are not necessarily indicative of future financial results. Therefore, these financial statements should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect (1) the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and (2) the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. Our most sensitive estimates involve the valuation of our real estate owned and determination of loan loss reserves.
Note 2. Recently Issued Accounting Pronouncements:
ASC topic 310 Update 2011-02 (“2011-02”) was issued in April 2011. 2011-02 clarified guidance on a creditor’s evaluation of whether (1) it has granted a concession and (2) a debtor is experiencing financial difficulties. 2011-02 is effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. Early adoption is permitted. We are currently evaluating the impact of this update on our financial statements; however, we anticipate that our loans identified as troubled debt restructurings, and as a result deemed impaired, will increase.
ASU 2011-04, Fair Value Measurement (Topic 820); Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP was issued in May 2011. This ASU provides additional guidance on fair value measurements and requires additional fair value disclosures including quantitative and qualitative information for recurring Level 3 fair value measurements. In addition, entities must report the level in the fair value hierarchy of assets and liabilities not recorded at fair value but where fair value is disclosed. This ASU is effective for interim and annual periods beginning on or after December 15, 2011, with early adoption prohibited. We are currently evaluating the impact of this ASU on our financial statements.
Note 3. Reclassifications:
Certain prior period amounts have been reclassified to conform with the current period presentation. These reclassifications had no effect on previously reported net income, cash flows or beneficiaries’ equity.

 

7


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
Note 4. Loans Receivable, net:
Loans receivable, net, consisted of the following:
                 
    June 30,     December 31,  
    2011     2010  
    (In thousands)  
Commercial mortgage loans (1)
  $ 122,751     $ 124,065  
Commercial mortgage loans, subject to structured notes payable
    36,537       40,514  
SBIC commercial mortgage loans
    29,897       31,289  
SBA 7(a) loans, subject to secured borrowings
    26,012       20,326  
SBA 7(a) loans
    18,908       18,673  
 
           
Total loans receivable
    234,105       234,867  
Adjusted by:
               
Deferred capitalized costs (commitment fees), net
    47       (40 )
Loan loss reserves
    (1,860 )     (1,609 )
 
           
Loans receivable, net
  $ 232,292     $ 233,218  
 
           
 
     
(1)  
At December 31, 2010, these loans were pledged to our revolving credit facility.
Commercial mortgage loans
Represents all of the loans of PMC Commercial Trust.
Commercial mortgage loans, subject to structured notes payable
Represents loans contributed to special purpose entities in exchange for a subordinated financial interest in that entity. The collateral of the structured notes payable includes these loans.
SBIC commercial mortgage loans
Loans originated by our Small Business Investment Company (“SBIC”) subsidiaries.
SBA 7(a) loans, subject to secured borrowings
Represents the government guaranteed portion of loans which were sold with the proceeds received from the sale reflected as secured borrowings — government guaranteed loans (a liability on our consolidated balance sheet). There is no credit risk associated with these loans since the SBA has guaranteed payment of the principal.
SBA 7(a) loans
Represents (1) the non-government guaranteed retained portion of loans originated under the SBA 7(a) program and (2) the government guaranteed portion of loans that have not yet been fully funded or legally sold. The balance is net of retained loan discounts of $1.3 million at both June 30, 2011 and December 31, 2010.
Concentration Risks
We have certain concentrations of investments. Substantially all of our revenue is generated from loans collateralized by hospitality properties. At both June 30, 2011 and December 31, 2010, our loans were 94% concentrated in the hospitality industry. Any economic factors that negatively impact the hospitality industry, including recessions, depressed commercial real estate markets, travel restrictions, gasoline prices, bankruptcies or other political or geopolitical events, could have a material adverse effect on our financial condition and results of operations.
At both June 30, 2011 and December 31, 2010, 19% of our loans were collateralized by properties in Texas. No other state had a concentration of 10% or greater of our loans receivable at June 30, 2011. A decline in economic conditions in any state in which we have a concentration of investments could have a material adverse effect on our financial condition and results of operations.

 

8


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
We have not loaned more than 10% of our assets to any single borrower; however, we have an affiliated group of obligors representing greater than 5% of our loans receivable (approximately 6%) at both June 30, 2011 and December 31, 2010. Any decline in the financial status of this group could have a material adverse effect on our financial condition and results of operations.
Aging
The following tables represent an aging of our loans receivable. These tables do not include our SBA 7(a) loans receivable, subject to secured borrowings since the SBA has guaranteed payment of the principal.
                                                 
June 30, 2011  
                    Commercial        
                    Mortgage     SBA 7(a)  
Category   Totals     Loans     Loans  
    (Dollars in thousands)  
Current
  $ 204,955       98.5 %   $ 186,340       98.5 %   $ 18,615       98.5 %
Between 30 and 59 days delinquent
    18                         18        
Between 60 and 89 days delinquent
    774       0.4 %     774       0.4 %            
Over 89 days delinquent (1)
    2,346       1.1 %     2,071       1.1 %     275       1.5 %
 
                                   
 
  $ 208,093       100.0 %   $ 189,185       100.0 %   $ 18,908       100.0 %
 
                                   
 
     
(1)  
Includes $1.5 million of loans on which the borrowers have filed for Chapter 11 Bankruptcy. We are classified as a secured creditor in the bankruptcy proceedings. In addition, the collateral underlying $0.7 million of loans included in the over 89 days delinquent category was in the foreclosure process.
                                                 
December 31, 2010  
                    Commercial        
                    Mortgage     SBA 7(a)  
Category   Totals     Loans     Loans  
    (Dollars in thousands)  
Current (1)
  $ 196,539       91.6 %   $ 178,592       91.2 %   $ 17,947       96.1 %
Between 30 and 59 days delinquent
    4,877       2.3 %     4,664       2.4 %     213       1.1 %
Between 60 and 89 days delinquent
    5,576       2.6 %     5,253       2.7 %     323       1.7 %
Over 89 days delinquent (2)
    7,549       3.5 %     7,359       3.8 %     190       1.0 %
 
                                   
 
  $ 214,541       100.0 %   $ 195,868       100.0 %   $ 18,673       100.0 %
 
                                   
 
     
(1)  
Includes $9.0 million of loans which are current under agreements which provide for interest only payments during a short period of time in exchange for additional collateral. Of this, $7.2 million relates to an affiliated group of obligors described above.
 
(2)  
Includes $6.3 million of loans on which the borrowers have filed for Chapter 11 Bankruptcy. We are classified as a secured creditor in the bankruptcy proceedings. In addition, the collateral underlying $1.1 million of loans included in the over 89 days delinquent category was in the foreclosure process.
Loan Loss Reserves
We have a quarterly review process to identify and evaluate potential exposure to loan losses. Loans that require specific identification review are identified based on one or more negative characteristics including, but not limited to, non-payment or lack of timely payment of interest and/or principal, non-payment or lack of timely payment of property taxes for an extended period of time, insurance defaults and/or franchise defaults. The specific identification evaluation begins with an estimation of underlying collateral values using appraisals, broker price opinions, tax assessed value and/or revenue analysis. Management uses appraisals as tools in conjunction with other determinants of collateral value to estimate collateral values, not as the sole determinant of value due to the current economic environment. The property valuation takes into consideration current information on property values in general and value changes in commercial real estate and/or hospitality properties. The probability of liquidation is then determined. These probability determinations include macroeconomic factors, the location of the property and economic environment where the property is located, industry specific factors relating primarily to the hospitality industry, our historical experience with similar borrowers and/or individual borrower or collateral characteristics, and in certain circumstances, the strength of the guarantors. The liquidation probability is then applied to the specifically identified loss exposure to establish the specifically identified reserve for that loan.

 

9


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
Management closely monitors our loans which require evaluation for loan loss reserves based on specific identification which are classified into three categories: Doubtful, Substandard and Other Assets Especially Mentioned (“OAEM”) (together “Specific Identification Loans”). Loans classified as Doubtful are generally loans which are not complying with their contractual terms, the collection of the balance of the principal is considered impaired and liquidation of the collateral securing the loan is probable. These loans are typically placed on non-accrual status and are generally in the foreclosure process. Loans classified as Substandard are generally those loans that are either not complying or had previously not complied with their contractual terms and have other credit weaknesses which may make payment default or principal exposure likely but not yet certain. Loans classified as OAEM are generally loans for which the credit quality of the borrowers has temporarily deteriorated. Typically these borrowers, whose loans are classified as OAEM, are current on their payments; however, they may be delinquent on their property taxes, insurance, or franchise fees or may be under agreements which provided for interest only payments during a short period of time. In addition, included in OAEM are loans for which the borrowers have filed for Chapter 11 Bankruptcy and we are classified as a secured creditor in the bankruptcy proceedings. Until bankruptcy plans are confirmed, the loans are typically delinquent.
Management has classified our loans receivable (excluding our SBA 7(a) loans receivable, subject to secured borrowings since the SBA has guaranteed payment of the principal) as follows (balances represent our investment in the loans prior to loan loss reserves and deferred commitment fees):
                                                 
    June 30, 2011  
                    Commercial                      
                    Mortgage             SBA 7(a)        
    Totals     %     Loans     %     Loans     %  
    (Dollars in thousands)  
Satisfactory
  $ 178,190       85.6 %   $ 160,110       84.6 %   $ 18,080       95.6 %
OAEM
    21,992       10.6 %     21,981       11.6 %     11       0.1 %
Substandard
    5,384       2.6 %     5,023       2.7 %     361       1.9 %
Doubtful
    2,527       1.2 %     2,071       1.1 %     456       2.4 %
 
                                   
 
  $ 208,093       100.0 %   $ 189,185       100.0 %   $ 18,908       100.0 %
 
                                   
                                                 
    December 31, 2010  
                    Commercial                      
                    Mortgage             SBA 7(a)        
    Totals     %     Loans     %     Loans     %  
    (Dollars in thousands)  
Satisfactory
  $ 187,630       87.5 %   $ 169,880       86.7 %   $ 17,750       95.1 %
OAEM
    16,886       7.9 %     16,872       8.6 %     14       0.1 %
Substandard
    9,113       4.2 %     8,469       4.3 %     644       3.4 %
Doubtful
    912       0.4 %     647       0.3 %     265       1.4 %
 
                                   
 
  $ 214,541       100.0 %   $ 195,868       100.0 %   $ 18,673       100.0 %
 
                                   
At June 30, 2011 and December 31, 2010, we had loan loss reserves of $1,860,000 and $1,609,000, respectively, including general loan loss reserves of $1,270,000 and $1,100,000, respectively. Our total loan loss reserves and general loan loss reserves as a percentage of our outstanding portfolio (excluding SBA 7(a) loans receivable, subject to secured borrowings) were 89 basis points and 61 basis points, respectively, at June 30, 2011 and 54 basis points and 38 basis points, respectively, at June 30, 2010. Our provision for loan losses (excluding reductions of loan losses) as a percentage of our weighted average outstanding loans receivable (excluding SBA 7(a) loans receivable, subject to secured borrowings) was 0.25% and 0.14% during the six months ended June 30, 2011 and 2010, respectively. To the extent one or several of our loans experience significant operating difficulties and we are forced to liquidate the loans, future losses may be substantial.

 

10


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
The activity in our loan loss reserves was as follows:
                                 
    Six Months Ended June 30,  
    2011        
            Commercial              
            Mortgage     SBA 7(a)        
    Total     Loans     Loans     2010  
    (In thousands)  
Balance, beginning of year
  $ 1,609     $ 1,303     $ 306     $ 1,257  
Provision for loan losses
    520       332       188       306  
Reduction of loan losses
    (141 )     (118 )     (23 )     (404 )
Consolidation of the 2000 Joint Venture and the 1998 Partnership reserves
                      184  
Principal balances written-off
    (128 )           (128 )     (143 )
 
                       
Balance, end of period
  $ 1,860     $ 1,517     $ 343     $ 1,200  
 
                       
Information on those loans considered to be impaired loans (loans for which it is probable that the lender will be unable to collect all amounts due according to the original contractual terms of the loan) was as follows:
                                                 
    June 30, 2011     December 31, 2010  
            Commercial                     Commercial        
            Mortgage     SBA 7(a)             Mortgage     SBA 7(a)  
    Total     Loans     Loans     Total     Loans     Loans  
    (In thousands)  
Impaired loans requiring reserves
  $ 1,704     $ 1,411     $ 293     $ 687     $ 419     $ 268  
Impaired loans expected to be fully recoverable
    817       654       163       228       228        
 
                                   
Total impaired loans
  $ 2,521     $ 2,065     $ 456     $ 915     $ 647     $ 268  
 
                                   
                                 
    Three Months Ended June 30,  
    2011          
            Commercial              
            Mortgage     SBA 7(a)        
    Total     Loans     Loans     2010  
    (In thousands)  
Average impaired loans
  $ 2,646     $ 2,061     $ 585     $ 3,915  
 
                       
 
                               
Interest income on impaired loans
  $ 2     $     $ 2     $ 57  
 
                       

 

11


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
                                 
    Six Months Ended June 30,  
    2011          
            Commercial              
            Mortgage     SBA 7(a)        
    Total     Loans     Loans     2010  
    (In thousands)  
Average impaired loans
  $ 2,548     $ 2,059     $ 489     $ 4,190  
 
                       
 
                               
Interest income on impaired loans
  $ 4     $     $ 4     $ 71  
 
                       
Our recorded investment in Non-Accrual Loans at June 30, 2011 of $4,585,000 was comprised of $293,000 of SBA 7(a) loans and $4,292,000 of commercial mortgage loans. Our recorded investment in Non-Accrual Loans at December 31, 2010 of $12,275,000 was comprised of $519,000 of SBA 7(a) loans and $11,756,000 of commercial mortgage loans. Our Non-Accrual Loans were primarily in bankruptcy proceedings or the collateral securing our Non-Accrual Loans was in the process of foreclosure at June 30, 2011 and December 31, 2010. We did not have any loans receivable past due 90 days or more which were accruing interest at June 30, 2011 or December 31, 2010.
Additional Credit Quality Indicator
We consider loan origination dates to be a credit quality indicator of our portfolio. Loans originated from 1991 to 1999 are heavily seasoned; thus typically representing a smaller risk in terms of loss upon liquidation due to paydowns of principal. For loans originated during 2005 to 2007, the businesses collateralizing these loans (within a short period of time following closing of the loans) were subject to extreme conditions including a recession and resulting decrease in property values and performance. While we believe that industry performance is improving, it has not yet reached pre-recession levels. The majority of our loans receivable which were over 89 days delinquent at June 30, 2011 and December 31, 2010 were originated from 2005 to 2007.
The years of origination for our loans receivable outstanding (excluding our SBA 7(a) loans receivable, subject to secured borrowings since the SBA has guaranteed payment of the principal) were as follows:
                                                 
June 30, 2011  
                    Commercial        
                    Mortgage     SBA 7(a)  
Year of Origination   Totals     Loans     Loans  
    (Dollars in thousands)  
1991 to 1999
  $ 33,120       15.9 %   $ 31,833       16.8 %   $ 1,287       6.8 %
2000 to 2004
    54,114       26.0 %     51,544       27.2 %     2,570       13.6 %
2005 to 2007
    77,029       37.0 %     75,734       40.0 %     1,295       6.8 %
2008 to 2011
    43,830       21.1 %     30,074       15.9 %     13,756       72.8 %
 
                                   
 
  $ 208,093       100.0 %   $ 189,185       100.0 %   $ 18,908       100.0 %
 
                                   

 

12


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
                                                 
December 31, 2010  
                    Commercial        
                    Mortgage     SBA 7(a)  
Year of Origination   Totals     Loans     Loans  
    (Dollars in thousands)  
1991 to 1999
  $ 36,405       17.0 %   $ 35,057       17.9 %   $ 1,348       7.2 %
2000 to 2004
    56,497       26.3 %     53,739       27.4 %     2,758       14.8 %
2005 to 2007
    79,118       36.9 %     77,773       39.7 %     1,345       7.2 %
2008 to 2010
    42,521       19.8 %     29,299       15.0 %     13,222       70.8 %
 
                                   
 
  $ 214,541       100.0 %   $ 195,868       100.0 %   $ 18,673       100.0 %
 
                                   
Note 5. Other Assets:
Other assets consisted of the following:
                 
    June 30,     December 31,  
    2011     2010  
    (In thousands)  
Deferred tax asset, net
  $ 1,270     $ 1,039  
Retained interests in transferred assets
    1,014       1,010  
Deferred borrowing costs, net
    1,007       836  
Servicing asset, net
    830       758  
Investment in variable interest entities (1)
    820       2,183  
Interest receivable
    689       691  
Prepaid expenses and deposits
    550       286  
Other
    495       201  
 
           
 
  $ 6,675     $ 7,004  
 
           
 
     
(1)  
During January 2011, our lessee exercised the fixed purchase option related to one of our unconsolidated variable interest entities. No gain or loss was recorded on the transaction.

 

13


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
Note 6. Debt:
Information on our debt was as follows:
                                         
                                    Weighted  
                                    Average  
                                    Interest Rate  
                    Weighted Average     on Underlying  
    Carrying Value (1)     Coupon Rate at     Loans at  
    June 30,     December 31,     June 30,     December 31,     June 30,  
    2011     2010     2011     2010     2011  
    (Dollars in thousands, except footnotes)                          
Structured notes payable:
                                       
2003 Joint Venture
  $ 5,989     $ 7,094       2.75 %     2.80 %     4.30 %
2000 Joint Venture
    10,330       11,724       7.28 %     7.28 %     9.56 %
1998 Partnership
    3,133       3,339       2.25 %     2.25 %     4.99 %
 
                                   
 
    19,452       22,157                          
 
                                   
 
                                       
Junior subordinated notes
    27,070       27,070       3.56 %     3.54 %   NA  
 
                                   
 
                                       
Revolving credit facility (2)
    12,800       13,800       2.42 %     3.25 %   NA  
 
                                   
 
                                       
Debentures payable
    8,179       8,177       5.90 %     5.90 %   NA  
 
                                   
 
                                       
Secured borrowings — government guaranteed loans:
                                       
Loans sold for a premium and excess spread
    21,970       15,664       3.82 %     3.87 %     5.95 %
Loans sold for excess spread
    6,039       6,101       1.58 %     1.58 %     5.96 %
 
                                   
 
    28,009       21,765                          
 
                                   
 
                                       
Debt
  $ 95,510     $ 92,969                          
 
                                   
 
     
(1)  
The face amount of debt as of June 30, 2011 and December 31, 2010 was $95,521,000 and $92,982,000, respectively.
 
(2)  
We amended our revolving credit facility in June 2011. The maturity date was extended to June 30, 2014 and our interest rate was reduced to prime less 50 basis points or the 30 day LIBOR plus 2%, at our option.

 

14


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
Principal payments on our debt at June 30, 2011 were as follows:
                         
            Structured        
            Notes and        
          Secured     All Other  
Years Ending June 30,   Total     Borrowings (1)     Debt (2)  
    (In thousands)  
2012
  $ 3,984     $ 3,984     $  
2013
    4,266       4,266        
2014
    21,255       4,265       16,990  
2015
    8,494       4,494       4,000  
2016
    3,754       3,754        
Thereafter
    53,768       26,698       27,070  
 
                 
 
  $ 95,521     $ 47,461     $ 48,060  
 
                 
 
     
(1)  
Principal payments are generally dependent upon cash flows received from the underlying loans. Our estimate of their repayment is based on scheduled principal payments on the underlying loans. Our estimate will differ from actual amounts to the extent we experience prepayments and/or loan losses. No payment is due on the structured notes or secured borrowings unless payments are received from the borrowers on the loans underlying them.
 
(2)  
Represents the revolving credit facility, junior subordinated notes and debentures payable.
Note 7. Share-Based Compensation Plans:
We granted 27,000 option awards on June 10, 2011 at an exercise price of $8.75 (the then current market price). The fair value of this option award was estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions:
         
Assumption        
Expected Term (years)
    3.0  
Risk-Free Interest Rate
    0.71 %
Expected Dividend Yield
    7.31 %
Expected Volatility
    33.58 %
Expected Forfeiture Rate
    2.0 %
The expected term of the options granted represents the period of time that the options are expected to be outstanding and was based on historical data. The risk-free rate was based on the three-year U.S. Treasury rate corresponding to the expected term of the options. We used historical information to determine our expected volatility and forfeiture rates. We recorded compensation expense of $30,000 during the three and six months ended June 30, 2011 related to this option grant. We granted 26,500 option awards on June 12, 2010 at an exercise price of $8.35 (the closing price on June 11, 2010) and recorded compensation expense of approximately $33,000 during the three and six months ended June 30, 2010.
We issued an aggregate of 5,000 shares to the Board of Trust Managers on June 10, 2011 at the then current market price of the shares of $8.75. These shares vested immediately upon issuance. We recorded compensation expense of $44,000 during the three and six months ended June 30, 2011 related to these shares.
We issued an aggregate of 10,000 restricted shares to executive officers on March 13, 2011 at the then current market price of the shares of $8.72. We issued an aggregate of 13,100 restricted shares to executive officers and our Board of Trust Managers on June 12, 2010 at the then current market price of the shares of $8.35. There were forfeitures of 3,400 restricted shares during June 2010. The restricted shares vest based on two years of continuous service with one-third of the shares vesting immediately upon issuance of the shares and one-third vesting at the end of each of the next two years. Restricted share awards provide for accelerated vesting if there is a change in control (as defined in the plan). Compensation expense related to the restricted shares is being recognized over the vesting periods. We recorded compensation expense of $24,000 and $42,000 during the three months ended June 30, 2011 and 2010, respectively, and $73,000 and $66,000 during the six months ended June 30, 2011 and 2010, respectively, related to these restricted shares. As of June 30, 2011, there was $60,000 of total unrecognized compensation expense related to restricted shares which will be recognized over the next two years.

 

15


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
Note 8. Other Income:
Other income consisted of the following:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2011     2010     2011     2010  
    (In thousands)  
Premium income
  $ 128     $ 167     $ 559     $ 167  
Prepayment fees
    110       93       110       135  
Servicing income
    103       86       200       164  
Retained interests in transferred assets
    53       34       106       75  
Loan related income — other
    46       38       92       96  
Other
    18       19       80       38  
 
                       
 
  $ 458     $ 437     $ 1,147     $ 675  
 
                       
Note 9. Income Taxes:
PMC Commercial has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). To qualify as a REIT, PMC Commercial must meet a number of organizational and operational requirements, including a requirement that we distribute at least 90% of our REIT taxable income to our shareholders. As a REIT, PMC Commercial generally will not be subject to corporate level Federal income tax on net income that is currently distributed to shareholders.
PMC Commercial has wholly-owned taxable REIT subsidiaries (“TRS’s”) which are subject to Federal income taxes. The income generated from the TRS’s is taxed at normal corporate rates.
Note 10. Discontinued Operations:
Discontinued operations consisted of the following:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2011     2010     2011     2010  
    (In thousands)  
Net gains on sales of real estate
  $ 568     $ 2     $ 570     $ 78  
Net operating losses
    (232 )     (5 )     (442 )     (70 )
Impairment losses
    (232 )           (232 )      
 
                       
Discontinued operations
  $ 104     $ (3 )   $ (104 )   $ 8  
 
                       

 

16


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
During the second quarter of 2011, previously deferred gains of $683,000 from property sales we financed were recognized as gains due to principal reductions on the underlying loans. During June 2011, we sold an asset acquired through foreclosure for $1.3 million, received cash proceeds of $128,000 and financed the remainder. A loss of $115,000 was recorded on the transaction.
During the second quarter of 2011, we recorded impairment losses due to declines in the estimated fair value of our real estate owned, primarily a full service hospitality property owned by the 2003 Joint Venture.
Note 11. Earnings Per Share:
The computations of basic earnings per common share are based on our weighted average shares outstanding. For purposes of calculating diluted earnings per share, the weighted average shares outstanding were increased by 55,000 shares to reflect the dilutive effect of stock options during the three and six months ended June 30, 2011. During both the three and six months ended June 30, 2010, the weighted average shares outstanding were increased by 16,000 shares to reflect the dilutive effect of stock options.
Not included in the computation of diluted earnings per share were outstanding options to purchase 39,000 and 77,000 common shares during the three and six months ended June 30, 2011 and 2010, respectively, because the options’ exercise prices were greater than the average market price of the shares.
Note 12. Fair Value Measurements:
For impaired loans measured at fair value on a nonrecurring basis during the six months ended June 30, 2011 and 2010, the following table provides the carrying value of the related individual assets at quarter end. We used Level 3 inputs to determine the estimated fair value of our impaired loans.
                                 
                    Provision for  
                    Loan Losses  
    Carrying Value at     Six Months Ended  
    June 30,     June 30, (2)  
    2011     2010     2011     2010  
    (In thousands)  
Impaired loans (1)
  $ 2,269     $ 2,053     $ 124     $ 101  
 
                       
 
     
(1)  
Carrying value represents our impaired loans net of loan loss reserves. Our carrying value is determined based on management’s assessment of the fair value of the collateral based on numerous factors including operating statistics to the extent available, appraised value of the collateral, tax assessed value and market environment.
 
(2)  
Represents the net change in the provision for loan losses included in our consolidated statements of income related specifically to these loans during the periods presented.
For real estate owned, our carrying value approximates the estimated fair value at the time of foreclosure and the lower of cost or fair value thereafter. We use Level 3 inputs to determine the estimated fair value of our real estate owned. The carrying value of our real estate owned is established at the time of foreclosure based upon management’s assessment of its fair value based on numerous factors including operating statistics to the extent available, the appraised value, tax assessed value and market environment. At June 30, 2011 and December 31, 2010, both the carrying value and estimated fair value of our real estate owned was $1,914,000 and $3,477,000, respectively.

 

17


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
The estimated fair values of our financial and non-financial instruments were as follows:
                                 
    June 30,     December 31,  
    2011     2010  
            Estimated             Estimated  
    Carrying     Fair     Carrying     Fair  
    Amount     Value     Amount     Value  
    (In thousands)  
Assets:
                               
Loans receivable, net
  $ 232,292     $ 230,584     $ 233,218     $ 228,821  
Cash and cash equivalents
    4,709       4,709       2,642       2,642  
Restricted cash and cash equivalents
    7,211       7,211       5,786       5,786  
 
                               
Liabilities:
                               
Structured notes and SBIC debentures payable
    27,631       28,040       30,334       30,781  
Secured borrowings — government guaranteed loans
    28,009       28,009       21,765       21,765  
Revolving credit facility
    12,800       12,800       13,800       13,800  
Junior subordinated notes
    27,070       22,334       27,070       22,310  
In general, estimates of fair value may differ from the carrying amounts of the financial assets and liabilities primarily as a result of the effects of discounting future cash flows. Considerable judgment is required to interpret market data and develop estimates of fair value. Accordingly, the estimates presented may not be indicative of the amounts we could realize in a current market exchange.
Loans receivable, net: Our loans receivable are recorded at cost and adjusted by net loan origination fees and discounts. In order to determine the estimated fair value of our loans receivable, we use a present value technique for the anticipated future cash flows using certain assumptions including a current discount rate, prepayment tendencies and potential loan losses. Reserves are established based on numerous factors including, but not limited to, the creditor’s payment history, collateral value, guarantor support and other factors. In the absence of a readily ascertainable market value, the estimated value of our loans receivable may differ from the values that would be placed on the portfolio if a ready market for the loans receivable existed.
Cash and cash equivalents: The carrying amount is considered to be reasonable estimates of fair value due to the short maturity of these funds.
Restricted cash and cash equivalents: Restricted cash and cash equivalents are comprised of our collection and reserve accounts of the securitizations. The carrying amount is considered to be a reasonable estimate of their fair value due to (1) the short maturity of the collection account, (2) the majority of our reserve accounts can be used at any time in conjunction with the exercise of our “clean-up call” options and (3) the reserve accounts providing collateral value at their current carrying amounts to the structured noteholders.
Structured notes and SBIC debentures payable and junior subordinated notes: The estimated fair value is based on a present value calculation based on prices of the same or similar instruments after considering market risks, current interest rates and remaining maturities.
Secured borrowings — government guaranteed loans: The estimated fair value approximates cost as the value of the loans that were sold approximates the value we would be able to attain in similar current third-party transactions.
Revolving credit facility: The carrying amount is a reasonable estimation of fair value as the interest rate on this instrument is variable and was set in a current third-party transaction.

 

18


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
Note 13. Supplemental Disclosure of Cash Flow Information:
Information regarding our non-cash activities was as follows:
                 
    Six Months Ended  
    June 30,  
    2011     2010  
    (In thousands)  
Loans receivable reclassified to real estate owned
  $     $ 2,380  
 
           
 
               
Reclassification from secured borrowings — government guaranteed loans to loans receivable, net
  $     $ 2,007  
 
           
 
               
Loans receivable originated to facilitate sales of real estate owned
  $ 1,172     $ 3,325  
 
           
 
               
Consolidation of off-balance sheet securitizations:
               
Loans receivable, net
  $     $ 27,752  
 
           
Restricted cash and cash equivalents
  $     $ 3,396  
 
           
Structured notes payable
  $     $ 19,524  
 
           
Note 14. Commitments and Contingencies:
Loan Commitments
Commitments to extend credit are agreements to lend to a customer provided the terms established in the contract are met. Our outstanding loan commitments and approvals to fund loans were approximately $18.7 million at June 30, 2011, the majority of which were for prime-based loans to be originated by First Western, the government guaranteed portion of which is intended to be sold. Commitments generally have fixed expiration dates. Since some commitments are expected to expire without being drawn upon, total commitment amounts do not necessarily represent future cash requirements.
Operating Lease
We lease office space in Dallas, Texas under a lease which expires in October 2011. During April 2011, we signed an amendment extending this lease to February 2015. Future minimum lease payments are as follows:
         
Twelve Months Ending June 30,   Total  
    (In thousands)  
2012
  $ 85  
2013
    208  
2014
    214  
2015
    146  
 
     
 
  $ 653  
 
     
Employment Agreements
We have employment agreements with our executive officers for terms expiring June 30, 2014. Under certain circumstances, as defined within the agreements, the agreements provide for (1) severance compensation or change in control payments to the executive officer in an amount equal to 2.99 times the average of the last three years annual compensation paid to the executive officer and (2) death and disability payments in an amount equal to two times and one time, respectively, the annual compensation paid to the executive officer.

 

19


Table of Contents

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
Structured Loan Sale Transactions
The documents of the structured loan sale transactions contain provisions (the “Credit Enhancement Provisions”) that govern the assets and the inflow and outflow of funds of the entities originally formed as part of the structured loan sale transactions. The Credit Enhancement Provisions include specified increased reserve requirements. If, at any measurement date, the loans in structured loan transactions were delinquent in excess of specified limits or were considered “charged-off” loans in accordance with the transaction documents, the Credit Enhancement Provisions would require an increase in the level of credit enhancement (reserve fund). During the period in which the Credit Enhancement Provisions were in effect, excess cash flow from the entity, if any, which would otherwise be distributable to us, would be used to fund the increased credit enhancement levels until the specified reserve requirement was met and would delay or reduce our distribution. In general, there can be no assurance that amounts deferred under Credit Enhancement Provisions would be received in future periods or that future deferrals or losses would not occur.
Litigation
We had significant outstanding claims against Arlington Hospitality, Inc.’s and its subsidiary, Arlington Inns, Inc.’s (together “Arlington”) bankruptcy estates. Arlington objected to our claims and initiated a complaint in the bankruptcy seeking, among other things, the return of payments Arlington made pursuant to the property leases and the master lease agreement. While confident that a substantial portion of our claims would have been allowed and the claims against us would have been disallowed, due to the exorbitant cost of defense coupled with the likelihood of reduced available assets in the debtors’ estates to pay claims, we executed an agreement with Arlington to settle our claims against Arlington and Arlington’s claims against us. The settlement provides that Arlington will dismiss its claims seeking the return of certain payments made pursuant to the property leases and master lease agreement and substantially reduces our claims against the Arlington estates. The settlement further provides for mutual releases among the parties. The Bankruptcy Court approved the settlement. Accordingly, there are no remaining assets or liabilities recorded in the accompanying consolidated financial statements related to this matter. However, the settlement will only become final upon the Bankruptcy Court’s approval of Arlington’s liquidation plan which was filed during the third quarter of 2007. We currently anticipate that the bankruptcy will be dismissed during the third quarter of 2011 based on a dismissal motion filed with the Bankruptcy Court.
In the normal course of business we are periodically party to certain legal actions and proceedings involving matters that are generally incidental to our business (i.e., collection of loans receivable). In management’s opinion, the resolution of these legal actions and proceedings will not have a material adverse effect on our consolidated financial statements.
Other
If the SBA establishes that a loss on an SBA guaranteed loan is attributable to significant technical deficiencies in the manner in which the loan was originated, funded or serviced by us, the SBA may seek recovery of the principal loss related to the deficiency from us. With respect to the guaranteed portion of SBA loans that have been sold, the SBA will first honor its guarantee and then seek compensation from us in the event that a loss is deemed to be attributable to technical deficiencies. Based on historical experience, we do not expect that this contingency would be material to the financial statements if asserted.

 

20


Table of Contents

ITEM 2.
Management’s Discussion and Analysis of Financial Condition
and Results of Operations
This Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created thereby. Such forward-looking statements can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “believe,” “anticipate,” “estimate,” or “continue,” or the negative thereof or other variations or similar words or phrases. These statements include the plans and objectives of management for future operations, including, but not limited to, plans and objectives relating to future growth of the loan portfolio and availability of funds. The forward-looking statements included herein are based on current expectations and there can be no assurance that these expectations will be attained. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this Form 10-Q will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. Readers are cautioned not to place undue reliance on forward-looking statements. Forward-looking statements speak only as of the date they are made. We do not undertake to update them to reflect changes that occur after the date they are made.
The following discussion of our financial condition at June 30, 2011 and results of operations for the three and six months ended June 30, 2011 and 2010 should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2010. For a more detailed description of the risks affecting our financial condition and results of operations, see “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010.
EXECUTIVE SUMMARY
General Economic Environment
Commercial Real Estate and Lodging Industry
Economic conditions have subjected our borrowers to financial stress. The operations of the limited service hospitality properties collateralizing our loans were negatively impacted by the recent recessionary economic environment. As a result, we have experienced, and continue to experience, a significant number of issues related to our borrowers including payment delinquencies, slow pays, insufficient funds payments, non-payment or lack of timely payment of real estate taxes and franchise fees, requests for payment deferrals, lack of cash flow, shortage of funds for franchise required improvements or maintenance issues jeopardizing continuation of franchises, terminating franchises, conversion to lesser franchises, deterioration of the physical property (our collateral) and declining property values. As such, our litigation and foreclosure activity and related costs have increased.
As part of our efforts to assist those borrowers who are experiencing negative cash flows, we temporarily or permanently modified the terms of certain loans receivable or we have allowed reduced payments during the off season. We are not yet able to determine if these concessions were sufficient to improve these borrowers’ cash flows such that future modifications will not be necessary. Recently, we believe that economic conditions have improved, including those associated with the hospitality industry. However, there can be no certainty that these improved economic conditions will benefit borrowers whose cash flow was not sufficient to cover their debt service without capital investment to continue to be able to make payments in accordance with their loan documents.
There has been an increase in mortgage defaults and foreclosures in the broader commercial real estate market and these defaults may continue. This increase was due in part to credit market turmoil and declining property cash flows and values. In addition, when foreclosures on commercial real estate properties increase, the property values typically decline even further as supply exceeds demand. We have experienced an increase in litigation (including borrowers who have filed for bankruptcy reorganization) and foreclosure activity. In conjunction with this increase in foreclosure activity, we have experienced, and will likely continue to

 

21


Table of Contents

experience, an increase in expenses, including general and administrative, provision for loan losses and impairment losses. Further, our ability to sell our real estate owned (“REO”) and the prices we receive on sale are affected by many factors, including but not limited to, the number of potential buyers, the number of competing properties on the market and other market conditions. Our impairment losses on our REO during the six months ended June 30, 2011 totaled $232,000 and are included in discontinued operations. As a result of the challenging economic conditions, the holding periods for our REO have increased. The lagging impact of the adverse economic conditions may continue to have an adverse effect of our REO and the limited service hospitality industry which may require additional impairment losses and the effect on our results of operations and financial condition may be material.
Historically, we have not experienced significant losses on real estate secured loans due to our borrowers’ equity in their properties, the value of the underlying collateral, the cash flows from operations of the businesses and other factors, such as having recourse to the guarantors. However, if the economy or the commercial real estate market does not continue to improve, we could experience an increase in credit losses. In addition, due to the prolonged economic downturn and the current economic environment, we believe that in general, our borrowers’ equity in their properties has been eroded and may further erode which may result in an increase in foreclosure activity and credit losses. The lagging impact of the adverse economic conditions may continue to have an adverse effect on the financial condition of individual borrowers and the limited service hospitality industry which may require the establishment of significant additional loan loss reserves and the effect on our results of operations and financial condition may be material.
Liquidity
Our $30 million revolving credit facility (the “Revolver”) was amended and as extended matures on June 30, 2014. Borrowings under the Revolver are unsecured. Previously all amounts borrowed were secured by the loans of PMC Commercial Trust and the stock of our SBLC subsidiary. The interest rate was reduced to prime less 50 basis points or the 30 day LIBOR plus 2%, at our option. The total amount available under the Revolver of initially $30 million is subject to increase as follows: (1) on January 1, 2012, the $30 million would automatically increase by $5 million to $35 million and (2) on January 1, 2013, the $30 million or $35 million (as applicable at the time) would automatically increase by $5 million to $35 million or $40 million, as applicable, provided there is no event of default or potential default on these dates and the non-performing loan ratio, as defined, is not more than 20% on these dates.
During June 2011 we received commitments from the SBA for the issuance of up to $15 million in SBIC debentures. We are currently marketing SBIC loans and anticipate drawing down these debentures, subject to SBA approval, as these loans are funded.
As a result of the prolonged downturn in the real estate markets, the availability of capital for providers of real estate financing was severely restricted. As a result, capital providers (including banks and insurance companies) substantially reduced the availability and increased the cost of debt capital for many companies originating commercial mortgages. These challenges continue to impact our ability to fully utilize our lending platform and have reduced yields on our assets as interest rates declined and remained at low levels. At this time, there is uncertainty as to how long we will continue to be impacted by the current lack of long-term liquidity and what shape the economy will take in the future.
Strategic Alternatives
The current credit and capital market environment remains unstable for commercial real estate lenders. While we continue to explore and evaluate strategic opportunities, our primary focus is on maximizing the value of our current investment portfolio and business strategy and exploring opportunities for alternative liquidity sources.
Secondary Market Loan Sales
We continue to focus on the origination of SBA 7(a) loans which require less capital due to the ability to sell the government guaranteed portion of such loans. We utilize the SBA 7(a) program to originate small business loans, primarily secured by real estate, and then sell the government guaranteed portion to investors.
During the first six months of 2011, we sold $12.0 million of the guaranteed portion of SBA 7(a) loans for either (1) cash premiums and 100 basis points (1%) (the minimum spread required to be retained pursuant to SBA regulations) as the servicing spread on the sold portion of the loan or (2) future servicing spreads averaging 189 basis points (including the 100 basis points required to be retained) and cash premiums of 10% (i.e., “hybrid loan sales”). For hybrid loan sales, gains are not recognized at the time of sale due to accounting rules. The cash premium will instead be amortized as a reduction to interest expense over the life of the loan.

 

22


Table of Contents

Our secondary market loan sale activity was as follows during the six months ended June 30, 2011:
                                 
    Principal     Premium     Gain Recognized Upon Sale  
Type of Sale   Sold     Received     Book     Tax  
Cash premium
  $ 6,015,000     $ 603,000     $ 559,000     $ 627,000  
Hybrid
    5,980,000       598,000             730,000  
 
                       
 
  $ 11,995,000     $ 1,201,000     $ 559,000     $ 1,357,000  
 
                       
LOAN PORTFOLIO INFORMATION
Loan Activity
During the first six months of 2011 we funded $12.9 million of SBA 7(a) loans. At June 30, 2011, December 31, 2010 and June 30, 2010, our outstanding commitments to fund loans were approximately $18.7 million, $16.5 million and $9.5 million, respectively. We expect that fundings during 2011 will be between $40 million and $50 million predominantly through the SBA 7(a) program.
In addition to our retained portfolio of $234.1 million at June 30, 2011, we service $53.4 million of aggregate principal balance of loans sold pursuant to Secondary Market Loan Sales. In addition, due to a change in accounting rules, beginning January 1, 2010, the aggregate principal balance remaining on loans that were sold in structured loan sale transactions were consolidated and included in our retained portfolio. Since we retained a residual interest in the cash flows from these loans, the performance of these loans impacted our profitability and our cash available for dividend distributions. Therefore, we provide information on both our loans retained (the “Retained Portfolio”) and combined with sold loans that we service (the “Aggregate Portfolio”).
Information on our Aggregate Portfolio, including prepayments, was as follows:
                                                 
    June 30,     December 31,  
    2011     2010     2009     2008     2007     2006  
    (Dollars in thousands)  
Aggregate Portfolio (1)
  $ 287,524     $ 284,451     $ 273,687     $ 275,530     $ 326,368     $ 397,567  
Loans funded (2)
  $ 13,976     $ 38,440     $ 30,435     $ 34,587     $ 33,756     $ 51,686  
Prepayments (2)
  $ 4,615     $ 10,830     $ 12,795     $ 68,556     $ 84,137     $ 91,710  
% Prepayments (3)
    3.2 %     4.0 %     4.6 %     21.0 %     21.2 %     20.5 %
 
     
(1)  
Serviced Portfolio outstanding at the period ended before loan loss reserves and deferred commitment fees.
 
(2)  
During the years ended December 31 and the six months ended June 30, 2011.
 
(3)  
Represents prepayments as a percentage of the Aggregate Portfolio outstanding as of the beginning of the applicable year. For the six months ended June 30, 2011, represents annualized prepayments as a percentage of our Aggregate Portfolio outstanding.

 

23


Table of Contents

Loans originated and principal repayments on our Retained Portfolio were as follows:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2011     2010     2011     2010  
  (In thousands)
Loans Originated:
                               
Loans Funded:
                               
SBA 7(a) loans
  $ 5,074     $ 11,933     $ 12,940     $ 22,715  
Commercial mortgage loans
    830       189       1,036       229  
 
                       
Total loans funded
    5,904       12,122       13,976       22,944  
 
                               
Other Loan Transactions:
                               
2000 Joint Venture (1)
                      22,912  
1998 Partnership (1)
                      5,024  
Loans originated to facilitate sales of real estate owned
    1,172       1,050       1,172       3,325  
 
                       
Total loans originated
  $ 7,076     $ 13,172     $ 15,148     $ 54,205  
 
                       
 
                               
Principal Reductions:
                               
Scheduled principal payments
  $ 2,894     $ 2,877     $ 5,593     $ 5,683  
Prepayments
    3,968       841       4,130       3,058  
Proceeds from sale of SBA 7(a) guaranteed loans (2)
    1,335       2,007       6,015       2,007  
 
                       
Total principal reductions
  $ 8,197     $ 5,725     $ 15,738     $ 10,748  
 
                       
 
     
(1)  
The 2000 Joint Venture and the 1998 Partnership were consolidated effective January 1, 2010 due to a change in accounting rules.
 
(2)  
For the three and six months ended June 30, 2010, represents reclassifications from secured borrowings — government guaranteed loans to loans receivable.
Retained Portfolio
Our Retained Portfolio was comprised of the following:
                                                 
    June 30, 2011     December 31, 2010  
                    Weighted                     Weighted  
                    Average                     Average  
    Retained Portfolio     Interest     Retained Portfolio     Interest  
    Amount     %     Rate     Amount     %     Rate  
    (Dollars in thousands)  
Variable-rate — LIBOR
  $ 134,821       58.0 %     4.2 %   $ 125,606       53.9 %     4.2 %
Fixed-rate
    47,569       20.5 %     9.3 %     63,263       27.1 %     9.1 %
Variable-rate — prime
    49,902       21.5 %     5.7 %     44,349       19.0 %     5.7 %
 
                                   
 
  $ 232,292       100.0 %     5.6 %   $ 233,218       100.0 %     5.8 %
 
                                   
As the majority of our loans have variable interest rates, during the current low interest rate environment, our interest income has been negatively impacted. To the extent LIBOR or the prime rate changes, we will have changes in interest income from our variable-rate loans.

 

24


Table of Contents

Portfolio Quality
At June 30, 2011 and December 31, 2010, we had loan loss reserves of $1,860,000 and $1,609,000, respectively, including general reserves of $1,270,000 and $1,100,000, respectively. Our provision for loan losses (excluding reductions of loan losses) as a percentage of our weighted average outstanding loans receivable (excluding our SBA 7(a) loans receivable, subject to secured borrowings) was 0.25% and 0.14% during the six months ended June 30, 2011 and 2010, respectively. To the extent one or several of our loans experience significant operating difficulties and we are forced to liquidate the loans, future losses may be substantial.
Management closely monitors our loans which require evaluation for loan loss reserves based on specific identification which are classified into three categories: Doubtful, Substandard and Other Assets Especially Mentioned (“OAEM”) (together “Specific Identification Loans”). Loans classified as Doubtful are generally loans which are not complying with their contractual terms, the collection of the balance of the principal is considered impaired and liquidation of the collateral securing the loan is probable. These loans are typically placed on non-accrual status and are generally in the foreclosure process. Loans classified as Substandard are generally those loans that are either not complying or had previously not complied with their contractual terms and have other credit weaknesses which may make payment default or principal exposure likely but not yet certain. Loans classified as OAEM are generally loans for which the credit quality of the borrowers has temporarily deteriorated. Typically the borrowers are current on their payments; however, they may be delinquent on their property taxes, insurance, or franchise fees or may be under agreements which provided for interest only payments during a short period of time. In addition, included in OAEM are loans for which the borrowers have filed for Chapter 11 Bankruptcy and we are classified as a secured creditor in the bankruptcy proceedings. Until bankruptcy plans are confirmed, the loans are typically delinquent.
Management has classified our loans receivable (excluding our SBA 7(a) loans receivable, subject to secured borrowings since the SBA has guaranteed payment of the principal) as follows (balances represent our investment in the loans prior to loan loss reserves and deferred commitment fees):
                                                 
    June 30, 2011  
                    Commercial                      
                    Mortgage             SBA 7(a)        
    Totals     %     Loans     %     Loans     %  
    (Dollars in thousands)  
Satisfactory
  $ 178,190       85.6 %   $ 160,110       84.6 %   $ 18,080       95.6 %
OAEM
    21,992       10.6 %     21,981       11.6 %     11       0.1 %
Substandard
    5,384       2.6 %     5,023       2.7 %     361       1.9 %
Doubtful
    2,527       1.2 %     2,071       1.1 %     456       2.4 %
 
                                   
 
  $ 208,093       100.0 %   $ 189,185       100.0 %   $ 18,908       100.0 %
 
                                   
                                                 
    December 31, 2010  
                    Commercial                      
                    Mortgage             SBA 7(a)        
    Totals     %     Loans     %     Loans     %  
    (Dollars in thousands)  
Satisfactory
  $ 187,630       87.5 %   $ 169,880       86.7 %   $ 17,750       95.1 %
OAEM
    16,886       7.9 %     16,872       8.6 %     14       0.1 %
Substandard
    9,113       4.2 %     8,469       4.3 %     644       3.4 %
Doubtful
    912       0.4 %     647       0.3 %     265       1.4 %
 
                                   
 
  $ 214,541       100.0 %   $ 195,868       100.0 %   $ 18,673       100.0 %
 
                                   

 

25


Table of Contents

We begin foreclosure and liquidation proceedings when we determine the pursuit of these remedies is the most appropriate course of action. Foreclosure and bankruptcy are complex and sometimes lengthy processes that are subject to Federal and state laws and regulations.
We are currently in the process of foreclosure proceedings on several properties collateralizing our loans. Historically, subsequent to commencement of the foreclosure process, many borrowers brought their loans current; thus, we stopped the foreclosure process. However, in general, we believe that our borrowers’ equity in their properties has eroded and may further erode which may result in an increase in foreclosure activity and credit losses. Borrowers have the option of seeking Federal bankruptcy protection which could delay the foreclosure process. In conjunction with bankruptcy process, the terms of the loan agreement may be modified. Typically, delays in the foreclosure process will have a negative impact on our results of operations and/or financial condition due to direct and indirect costs incurred and possible deterioration of the collateral. It is difficult to determine what impact the market disruptions will have on our borrowers whose collateral is in the process of foreclosure and the borrowers’ ability to become current on their loans.
Properties being foreclosed upon typically have deteriorated both physically (requiring certain repairs and maintenance and discretionary capital spending) and in their market (i.e., issues with the properties’ vendors and reputation requiring rebuilding of its customer and vendor base). To the extent properties are acquired through foreclosure, we will incur holding costs including, but not limited to, taxes, legal fees and insurance. In many cases, (1) cash flows have been reduced such that expenses exceed revenues and (2) franchise issues must be addressed (i.e., quality and brand standards and non-payment of franchise fees). Notwithstanding the foregoing, we believe that in most cases it is prudent to continue to have the business operate until the property can be sold because of a property’s increased marketability as an operating entity compared to non-operating (demonstrated historically through our sales efforts and from information received from third-party brokers). We will hire third-party management companies to operate the properties until they are sold.
RESULTS OF OPERATIONS
Three Months Ended June 30, 2011 Compared to the Three Months Ended June 30, 2010
Overview
                                 
    Three Months Ended        
    June 30,     Change  
    2011     2010     $     %  
    (Dollars in thousands)  
Total revenues
  $ 3,847     $ 3,935     $ (88 )     (2.2 )%
Total expenses
  $ 2,666     $ 2,729     $ (63 )     (2.3 )%
 
                               
Income from continuing operations
  $ 1,235     $ 1,226     $ 9       0.7 %
Net income
  $ 1,339     $ 1,223     $ 116       9.5 %
Revenues
We had a decrease in interest income of $109,000 which was primarily attributable to a decrease in our weighted average loans receivable from $235.9 million during the three months ended June 30, 2010 to $232.4 million during the three months ended June 30, 2011 and an increase in non-accrual loans. Our non-accrual loans increased to $4.6 million at June 30, 2011 compared to $1.2 million at June 30, 2010.

 

26


Table of Contents

Other income consisted of the following:
                 
    Three Months Ended  
    June 30,  
    2011     2010  
    (In thousands)  
Premium income
  $ 128     $ 167  
Prepayment fees
    110       93  
Servicing income
    103       86  
Retained interests in transferred assets
    53       34  
Loan related income — other
    46       38  
Other
    18       19  
 
           
 
  $ 458     $ 437  
 
           
Premium income results from certain sales of the government guaranteed portion of SBA 7(a) loans into the secondary market. Beginning January 1, 2010, due to a change in accounting rules, premium income to be recognized was deferred for a period of at least 90 days until any potential contingency period for having to refund these premiums was satisfied. However, contingency periods were eliminated during the first quarter of 2011; therefore, we record premium income for those sales for solely cash premiums and the required 1% servicing spread.
Interest Expense
Interest expense consisted of the following:
                 
    Three Months Ended  
    June 30,  
    2011     2010  
    (In thousands)  
Structured notes payable
  $ 253     $ 335  
Junior subordinated notes
    246       245  
Secured borrowings
    200       86  
Revolver
    111       198  
Debentures payable
    124       124  
Other
    23       23  
 
           
 
  $ 957     $ 1,011  
 
           
The weighted average cost of our funds decreased to 3.9% during the three months ended June 30, 2011 compared to 4.1% during the three months ended June 30, 2010.
Interest expense on our structured notes payable has decreased due to principal payments received from the underlying loans. The weighted average balance outstanding on our structured notes during the three months ended June 30, 2011 decreased to $19.8 million from $26.0 during the three months ended June 30, 2010.
Secured borrowings increase as we sell SBA 7(a) loans solely for excess servicing spreads. Interest expense on our secured borrowings will continue to increase unless we sell loans solely for cash and the 1% required servicing spread or we experience significant prepayments. The weighted average balance outstanding on our secured borrowings was $27.0 million during three months ended June 30, 2011 compared to $12.2 million during the three months ended June 30, 2010.
Our Revolver was amended during June 2011. The interest rate was reduced to prime less 50 basis points or the 30 day LIBOR plus 2%, at our option. The weighted average balance outstanding on our Revolver was $12.6 million during the three months ended June 30, 2011 compared to $22.0 million during the three months ended June 30, 2010.

 

27


Table of Contents

Other Expenses
Salaries and related benefits expense increased $129,000 during the three months ended June 30, 2011 compared to the three months ended June 30, 2010 due to cost of living increases, an increase in employees, a reduction in the number of loans funded which decreased capitalized loan origination costs and an increase in expense related to issuance of restricted shares.
General and administrative expense decreased $100,000 during the three months ended June 30, 2011 compared to the three months ended June 30, 2010. General and administrative expenses are comprised of (1) corporate overhead including legal and other professional expenses, sales and marketing expenses, public company and regulatory costs and (2) expenses related to assets currently in the process of foreclosure. Our corporate overhead decreased slightly to $508,000 during the three months ended June 30, 2011 compared to $527,000 during the three months ended June 30, 2010 primarily due to decreased professional fees. Expenses related to assets currently in the process of foreclosure decreased to $36,000 during the three months ended June 30, 2011 compared to $117,000 during the three months ended June 30, 2010. We expect to continue to incur general and administrative expenses related to collateral dependent loans until the foreclosure processes are completed; however, these expenses are difficult to estimate, may increase and may be material.
Discontinued Operations
                 
    Three Months Ended  
    June 30,  
    2011     2010  
    (In thousands)  
Net gains on sales of real estate
  $ 568     $ 2  
Net operating losses
    (232 )     (5 )
Impairment losses
    (232 )      
 
           
Discontinued operations
  $ 104     $ (3 )
 
           
During the three months ended June 30, 2011, previously deferred gains of $683,000 from property sales we financed were recorded as gains due to principal reductions on the underlying loans. In addition, during June 2011, we sold an asset acquired through foreclosure for $1.3 million, received cash proceeds of $128,000 and financed the remainder. A loss of $115,000 was recorded on the transaction.
Our net operating losses from discontinued operations arose from the operations and holding costs of our REO. The majority of our operating REO was acquired subsequent to the second quarter of 2010.
Impairment losses represent declines in the estimated fair value of our REO subsequent to initial valuation. During the three months ended June 30, 2011, our losses are primarily related to a full service hospitality property.

 

28


Table of Contents

Six Months Ended June 30, 2011 Compared to the Six Months Ended June 30, 2010
Overview
                                 
    Six Months Ended                
    June 30,     Change  
    2011     2010     $     %  
    (Dollars in thousands)  
Total revenues
  $ 7,903     $ 7,390     $ 513       6.9 %
Total expenses
  $ 5,573     $ 5,025     $ 548       10.9 %
 
                               
Income from continuing operations
  $ 2,359     $ 2,493     $ (134 )     (5.4 )%
Net income
  $ 2,255     $ 2,501     $ (246 )     (9.8 )%
Revenues increased primarily due to an increase in premium income while the increase in our expenses related primarily to an increase in provision for (reduction of) loan losses, net. We had a provision of $379,000 during the six months ended June 30, 2011 compared to a reduction of $98,000 during the six months ended June 30, 2010.
Our net income also decreased as result of a change in discontinued operations which generated a loss of $104,000 during the six months ended June 30, 2011 compared to income of $8,000 during the six months ended June 30, 2010. During 2011, we are experiencing significant operating losses from our REO primarily related to those properties we acquired through foreclosure subsequent to the second quarter of 2010.
More detailed information on the composition of and changes in certain of our revenues and expenses is provided below.
Revenues
Other income consisted of the following:
                 
    Six Months Ended  
    June 30,  
    2011     2010  
    (In thousands)  
Premium income
  $ 559     $ 167  
Servicing income
    200       164  
Prepayment fees
    110       135  
Retained interests in transferred assets
    106       75  
Loan related income — other
    92       96  
Other
    80       38  
 
           
 
  $ 1,147     $ 675  
 
           
Premium income results from certain sales of the government guaranteed portion of SBA 7(a) loans into the secondary market. Beginning January 1, 2010, due to a change in accounting rules, premium income to be recognized was deferred for a period of at least 90 days until any potential contingency period for having to refund these premiums was satisfied. However, contingency periods were eliminated during the first quarter of 2011; therefore, we recorded premium income for those sales for solely cash premiums and the required 1% servicing spread.

 

29


Table of Contents

Interest Expense
Interest expense consisted of the following:
                 
    Six Months Ended  
    June 30,  
    2011     2010  
    (In thousands)  
Structured notes payable
  $ 526     $ 681  
Junior subordinated notes
    489       484  
Secured borrowings
    386       105  
Revolver
    238       398  
Debentures payable
    246       247  
Other
    45       85  
 
           
 
  $ 1,930     $ 2,000  
 
           
The weighted average cost of our funds was 3.9% during both the six months ended June 30, 2011 and 2010.
Our weighted average secured borrowings increased to $25.2 million during the six months ended June 30, 2011 compared to $8.1 million during the six months ended June 30, 2010. Interest expense on our secured borrowings will continue to increase unless we sell loans solely for cash and the 1% required servicing spread or we experience significant prepayments.
We amended our Revolver during June 2011. The interest rate was reduced to prime less 50 basis points or the 30 day LIBOR plus 2%, at our option. The weighted average balance outstanding on our Revolver was $12.7 million during the six months ended June 30, 2011 compared to $22.1 million during the six months ended June 30, 2010.
Other Expenses
Salaries and related benefits expense increased $305,000 during the six months ended June 30, 2011 compared to the six months ended June 30, 2010 due to cost of living increases, an increase in employees, a reduction in the number of loans funded which decreased capitalized loan origination costs and an increase in expense related to issuance of restricted shares.
General and administrative expense decreased $164,000 during the six months ended June 30, 2011 compared to the six months ended June 30, 2010. General and administrative expenses are comprised of (1) corporate overhead including legal and other professional expenses, sales and marketing expenses, public company and regulatory costs and (2) expenses related to assets currently in the process of foreclosure. Our corporate overhead increased slightly to $936,000 during the six months ended June 30, 2011 compared to $907,000 during the six months ended June 30, 2010. Expenses related to assets currently in the process of foreclosure totaled $305,000 during the six months ended June 30, 2010 compared to $112,000 during the six months ended June 30, 2011. We expect to continue to incur general and administrative expenses related to collateral dependent loans until the foreclosure processes are completed; however, these expenses are difficult to estimate, may increase and may be material.
We had a provision for loan losses, net, of $379,000 during the six months ended June 30, 2011 compared to a reduction of loan losses, net, of $98,000 during the six months ended June 30, 2010. The increase during the six months ended June 30, 2011 was comprised of $170,000 related to an increase in general reserves and $209,000 in specific identification reserves. The reduction of loan losses during the six months ended June 30, 2010 was related to specific identification reserves primarily related to positive changes in (1) the financial condition of certain borrowers and (2) collateral valuation on a limited service hospitality loan.
We recorded income tax benefits of $29,000 and $128,000 during the six months ended June 30, 2011 and 2010, respectively, related to our taxable REIT subsidiaries which had a loss of $293,000 during 2010 compared to a loss of $100,000 during 2011. See — “REIT Taxable Income.”

 

30


Table of Contents

Discontinued Operations
                 
    Six Months Ended  
    June 30,  
    2011     2010  
    (In thousands)  
Net gains on sales of real estate
  $ 570     $ 78  
Net operating losses
    (442 )     (70 )
Impairment losses
    (232 )      
 
           
Discontinued operations
  $ (104 )   $ 8  
 
           
During the six months ended June 30, 2011, previously deferred gains of $685,000 from property sales we financed were recorded as gains due to principal reductions on the underlying loans. In addition, during June 2011, we sold an asset acquired through foreclosure for $1.3 million, received cash proceeds of $128,000 and financed the remainder. A loss of $115,000 was recorded on the transaction. We recorded a gain on the sale of an asset acquired through foreclosure of $76,000 during the six months ended June 30, 2010.
Our net operating losses from discontinued operations arose from the operations and holding costs of our REO. The majority of our REO was acquired during June 2010 and the fourth quarter of 2010; thus, net losses for our three hospitality properties are not included in the three months ended June 30, 2010.
Impairment losses represent declines in the estimated fair value of our REO subsequent to initial valuation. During the three months ended June 30, 2011, our losses are primarily related to a full service hospitality property.
LIQUIDITY AND CAPITAL RESOURCES
Cash Flow Analysis
Information on our cash flow was as follows:
                         
    Six Months Ended        
    June 30,        
    2011     2010     Change  
    (In thousands)  
Cash used in operating activities
  $ (2,645 )   $ (15,773 )   $ 13,128  
Cash provided by investing activities
    6,294       7,555       (1,261 )
Cash provided by (used in) financing activities
    (1,582 )     6,789       (8,371 )
 
                 
Net cash flow
  $ 2,067     $ (1,429 )   $ 3,496  
 
                 
Operating Activities
As a REIT, our earnings are typically used to fund our dividends. Since operating cash flows also include lending activities, it is necessary to adjust our cash flow from operating activities for our lending activities to determine coverage of our dividends from operations. Therefore, we adjust net cash flow from operating activities to “Modified Cash.” Management believes that our modified cash available for dividend distributions (“Modified Cash”) is a more appropriate indicator of operating cash coverage of our dividend payments than cash flow from operating activities. Modified Cash is calculated by adjusting our cash flow from operating activities by (1) the change in operating assets and liabilities and (2) loans funded, held for sale, net of proceeds from sale of guaranteed loans and principal collected on loans (“Operating Loan Activity”). Modified Cash, a non-GAAP financial measurement, is one of the factors used by our Board of Trust Managers (the “Board”) in its determination of dividends and their timing. In respect to our dividend policy, we believe that the disclosure of Modified Cash adds additional transparency to our dividend calculation and intentions. However, Modified Cash may differ significantly from dividends paid due to timing differences between book income and taxable income and timing of payment of dividends to eliminate or reduce Federal income taxes or excise taxes at the REIT level.

 

31


Table of Contents

The following reconciles net cash used in operating activities to Modified Cash:
                 
    Six Months Ended  
    June 30,  
    2011     2010  
    (In thousands)  
Net cash used in operating activities
  $ (2,645 )   $ (15,773 )
Change in operating assets and liabilities
    872       (1,166 )
Operating Loan Activity
    4,728       19,826  
 
           
Modified Cash
  $ 2,955     $ 2,887  
 
           
To the extent Modified Cash does not cover the current dividend distribution rate or if additional cash is needed based on our working capital needs, the Board may choose to modify its current dividend policy. During the six months ended June 30, 2011 and 2010, dividend distributions were greater than our Modified Cash by $426,000 and $510,000, respectively. To the extent we need working capital to fund any shortfall in operating cash flows to cover our dividend distributions, we would need to borrow the funds from our Revolver or use funds from the repayment of principal on loans receivable.
Investing Activities
Our primary investing activity is the origination of loans and collections on our investment portfolio. During the six months ended June 30, 2011 and 2010, the primary source of funds was principal collected on loans, net of loans funded of $6,196,000 and $5,559,000, respectively. We expect that this will continue to be our primary source of funds from investing activities. During the six months ended June 30, 2011, we also received cash proceeds from our unconsolidated subsidiary of $1,373,000 when our lessee exercised their fixed purchase option. In addition, during the six months ended June 30, 2010, we sold assets included in REO and collected cash proceeds of $2,291,000.
Based on our outstanding loan portfolio at June 30, 2011, our estimated principal payments during the next twelve months are approximately $11.9 million. Of this, approximately $7.3 million could be available to repay a portion of the existing balance under the Revolver. The remaining $4.6 million would be used to repay structured notes payable, secured borrowings and for working capital of our SBICs.
Financing Activities
We used funds from financing activities during the six months ended June 30, 2011 and 2010 primarily (1) to pay dividends of $3,381,000 and $3,397,000, respectively, and (2) for net repayment on our Revolver of $1,000,000 and $4,100,000, respectively. Proceeds from Secondary Market Loans Sales recorded as secured borrowings during the six months ended June 30, 2011 and 2010 were $5,980,000 and $18,639,000, respectively. In addition, during the six months ended June 30, 2010, we redeemed $2,000,000 of redeemable preferred stock of subsidiary due in May 2010 using cash on hand of one of our SBIC subsidiaries.
Sources and Uses of Funds
Liquidity Overview
Liquidity is a measure of our ability to meet potential cash requirements, including ongoing commitments to repay borrowings, fund loans and other investments, pay dividends, fund debt service and for other general corporate purposes. Our primary sources of funds to meet our short-term liquidity needs, including working capital, dividends, debt service and additional investments, if any, consist of (1) Secondary Market Loan Sales, (2) proceeds from principal and interest payments, including prepayments, and (3) borrowings under any credit facilities. We believe these sources of funds will be sufficient to meet our liquidity requirements in the short-term.

 

32


Table of Contents

Our Revolver was amended and as extended matures on June 30, 2014. Borrowings under the Revolver are unsecured. Previously all amounts borrowed were secured by the loans of PMC Commercial Trust and the stock of our SBLC subsidiary. The interest rate was reduced to prime less 50 basis points or the 30-day LIBOR plus 2%, at our option. The total amount available under the Revolver is initially $30 million, which is subject to increase as follows: (1) on January 1, 2012, the $30 million would automatically increase by $5 million to $35 million and (2) on January 1, 2013, the $30 million or $35 million (as applicable at the time) would automatically increase by $5 million to $35 million or $40 million, as applicable, provided there is no event of default or potential default on these dates and the non-performing loan ratio, as defined, is not more than 20% on these dates. Certain covenants, among other things, limit our ability to incur indebtedness, grant liens, make investments and sell assets. The amendment modifies certain of these covenants and deletes certain financial covenants including, the maximum leverage ratio, maximum non-performing loan ratio, maximum charge-off ratio and minimum asset coverage ratio.
Currently we believe that access to debt capital through new warehouse lines, trust preferred securities or securitization issuances is not available to us or, to the extent available, with terms that would be unacceptable to us. During the recession that commenced in 2008, banks and other lending institutions tightened lending standards and restricted credit to long-term real estate lenders like ourselves as they rebuilt their capital bases. The structured credit markets, including the asset-backed securities (“ABS”) markets, and warehouse credit facilities were severely curtailed. These sources of funds are currently not available to us due to, among other things, (1) the market conditions described above, (2) the long-term maturities of our loans, (3) our concentration in the hospitality industry and (4) our relatively small size. In addition, there is currently no market for issuance of trust preferred securities (junior subordinated notes) for real estate companies and we do not anticipate this market to be available in the future. The lack of liquidity in ABS, commercial mortgage-backed securities and other commercial mortgage markets continues today and has negatively impacted commercial real estate sales and financing activity since 2009. While we believe these conditions have improved and will continue to improve since commercial real estate market fundamentals should return over the long-term, we are unable to predict how long these conditions will continue and what long-term impact this will have on these markets.
If we are unable to make required payments under our borrowings, breach any representation or warranty of our borrowings or violate any covenant, our lenders may accelerate the maturity of our debt or force us to take other actions. In connection with an event of default under our Revolver, the lender is permitted to accelerate repayment of all amounts due and terminate commitments thereunder to satisfy any balance outstanding and due pursuant to the Revolver. Any such event may have a material adverse effect on our liquidity, the value of our common shares and the ability to pay dividends to our shareholders. In the event of a default on our Revolver, we will rely on Modified Cash, principal payments (including prepayments), and (if necessary) proceeds from asset and loan sales to satisfy our liquidity requirements.
Sources of Funds
In general, we need liquidity to originate new loans and repay principal on our debt. Our operating revenues are typically utilized to pay our operating expenses, interest and dividends. We have been utilizing principal collections on loans receivable, proceeds from Secondary Market Loan Sales and borrowings under our Revolver as our primary sources of funds.
In addition, historically we utilized a combination of the following sources, among others, to generate funds:
   
Issuance of SBIC debentures;
 
   
Issuance of junior subordinated notes; or
 
   
Structured loan financings or sales.
At June 30, 2011, the issuance of junior subordinated notes and structured loan financings or sales were not available to us and there can be no assurance that they will be available in the future. Since 2004, our working capital has primarily been provided through credit facilities, the issuance of junior subordinated notes and principal payments (including prepayments) on loans receivable. Prior to 2004, our primary source of long-term funds was structured loan sale transactions. At the current time, there is a limited market for commercial loan asset-backed securitizations. We cannot anticipate when, or if, this market will be available to us in the future. Until this market becomes more readily available, our ability to grow is limited.

 

33


Table of Contents

The relatively limited amount of capital available to originate new loans has caused us to restrict non-SBA 7(a) loan origination activity. A reduction in the availability of the above sources of funds could have a material adverse effect on our financial condition and results of operations. If these sources are not available in the future, we may have to originate loans at further reduced levels or sell assets, potentially on unfavorable terms.
Our Revolver, which currently has aggregate availability of $30 million, matures June 30, 2014. To the extent we need additional capital for unanticipated items, there can be no assurance that we would be able to increase the amount available under any credit facilities or identify other sources of funds at an acceptable cost, if at all.
During June 2011 we received commitments from the SBA for the issuance of up to $15 million in SBIC debentures. We are currently marketing SBIC loans and anticipate drawing down these debentures, subject to SBA approval, as these loans are funded. The interest rate on the debentures will be set within six months of the issuance of the debenture.
We rely on Secondary Market Loan Sales to create availability and/or repay principal due on our Revolver. Once fully funded, we typically sell the government guaranteed portion of our SBA 7(a) program loans. The market demand for Secondary Market Loan Sales may decline or be temporarily suspended. To the extent we are unable to execute Secondary Market Loan Sales in the normal course of business, our financial condition and results of operations could be adversely affected.
As a REIT, we must distribute to our shareholders at least 90% of our REIT taxable income to maintain our tax status under the Code. Accordingly, to the extent the sources above represent taxable income, such amounts have historically been distributed to our shareholders. In general, should we receive less cash from our portfolio of investments, we can lower the dividend so as not to cause any material cash shortfall. During 2011, we anticipate that our Modified Cash will be utilized to fund our expected 2011 dividend distributions and generally will not be available to fund portfolio growth or for the repayment of principal due on our debt.
The Revolver requires us to meet certain covenants. At June 30, 2011, we were in compliance with the covenants of this facility. While we anticipate maintaining compliance with these covenants, there can be no assurance that we will be able to do so.
Uses of Funds
Currently, the primary use of our funds is to originate loans and for repayment of principal and interest on our debt. Our outstanding commitments to fund new loans were $18.7 million at June 30, 2011, the majority of which were for prime-rate based loans to be originated under the SBA 7(a) program, the government guaranteed portion of which is intended to be sold pursuant to Secondary Market Loan Sales. Our net working capital outlay would be approximately $5.6 million related to these loans; however, the guaranteed portion of our SBA 7(a) loans cannot be sold until they are fully funded. Commitments have fixed expiration dates. Since some commitments expire without the proposed loan closing, total committed amounts do not necessarily represent future cash requirements. During 2011, we anticipate loan fundings will range from $40 million to $50 million. In addition, we use funds for operating deficits and holding costs of our REO and properties in the process of foreclosure.
There may be several months between when the initial balance of an SBA 7(a) loan is funded and it is fully funded and can be sold. In these instances, our liquidity would be affected in the short-term.
We may repurchase loans from the securitizations which have become “charged-off” as defined in the transaction documents either through delinquency or initiation of foreclosure or we may repurchase all of the loans from a securitization once “clean-up call” options have been achieved. We have achieved “clean-up call” options on our 2003 Joint Venture and 1998 Partnership. If we choose to repurchase a loan from a securitization or exercise our “clean-up call” option and repurchase all of the loans from a securitization using our Revolver, the balance due on our structured notes payable would decrease and the balance due under our Revolver would increase. We may also be required to use restricted cash collateralizing one of our securitizations to repay to the structured noteholders a loan within such securitization if it is deemed “charged-off” per the transaction documents.
We may pay dividends in excess of our Modified Cash to maintain our REIT status or as approved by our Board. During the six months ended June 30, 2011, the sources of funds for our dividend distributions of $3.4 million were Modified Cash of $2.9 million and principal collections on our loans receivable of $0.5 million.

 

34


Table of Contents

DIVIDENDS
Our shareholders are entitled to receive dividends when and as declared by the Board. In determining dividend policy, the Board considers many factors including, but not limited to, actual and anticipated Modified Cash, expectations for future earnings, REIT taxable income and maintenance of REIT status, TRS taxable income, the economic environment, our ability to obtain leverage and our loan portfolio performance. In order to maintain REIT status, PMC Commercial is required to pay out 90% of REIT taxable income. Consequently, the dividend rate on a quarterly basis does not necessarily correlate directly to any individual factor.
Dividends declared during 2011 were as follows:
                 
            Amount  
Date Paid   Record Date   Per Share  
April 11, 2011
  March 31, 2011   $ 0.16  
July 11, 2011
  June 30, 2011     0.16  
 
             
 
          $ 0.32  
 
             
We have a minimum net worth covenant ($142.0 million) within our Revolver that may limit our ability to pay out returns of capital as part of our dividends. This covenant has not historically limited the amount of dividends we have paid and management does not believe that this covenant will restrict future dividend payments.
REIT TAXABLE INCOME
REIT taxable income is a financial measure that is presented quarterly to assist investors in analyzing our performance and is one of the factors utilized by our Board in determining the level of dividends to be paid to our shareholders. Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied and are not audited. These non-GAAP measures have limitations as analytical tools and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP.
The following reconciles net income to REIT taxable income:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2011     2010     2011     2010  
    (In thousands)    
Net income
  $ 1,339     $ 1,223     $ 2,255     $ 2,501  
Gains related to real estate
    (683 )     (2 )     (235 )     387  
Amortization and accretion
    (17 )     (25 )     (33 )     (51 )
Loan valuation
    (41 )     (361 )     147       (558 )
Impairment losses
    209             209        
Other, net
    4       (100 )     34       (154 )
 
                       
Subtotal
    811       735       2,377       2,125  
 
                               
Adjustment for TRS net loss, net of tax
    128       60       100       293  
 
                       
REIT taxable income
  $ 939     $ 795     $ 2,477     $ 2,418  
 
                       
 
                               
Distributions declared
  $ 1,692     $ 1,690     $ 3,383     $ 3,378  
 
                       
 
                               
Weighted average common shares outstanding
    10,571       10,550       10,566       10,549  
 
                       

 

35


Table of Contents

As a REIT, PMC Commercial generally will not be subject to corporate level Federal income tax on net income that is currently distributed to shareholders provided the distribution exceeds 90% of REIT taxable income.
Primarily as a result of the timing differences for gain recognition on Secondary Market Loan Sales, our combined REIT taxable income and TRS’s taxable income (net of current income tax expense) is materially different than our net income. The following table reconciles our net income to our Adjusted Taxable Income, Net of Current Tax Expense:
                         
    Six Months Ended June 30, 2011  
    Combined     REIT     TRS’s  
    (In thousands, except footnotes)  
Net income (loss)
  $ 2,255     $ 2,355     $ (100 )
Book vs. tax timing differences
    815       122       693 (1)
 
                 
Taxable income
    3,070       2,477       593  
Special item (2)
    (448 )     (448 )      
 
                 
Taxable Income, adjusted for special item
    2,622       2,029       593  
Current income tax expense
    (202 )           (202 )
 
                 
Adjusted Taxable Income, Net of Current Tax Expense
  $ 2,420     $ 2,029     $ 391  
 
                 
                         
    Six Months Ended June 30, 2010  
    Combined     REIT     TRS’s  
    (In thousands, except footnotes)  
Net income (loss)
  $ 2,501     $ 2,794     $ (293 )
Book vs. tax timing differences
    1,011       (376 )     1,387 (1)
 
                 
Taxable income
    3,512       2,418       1,094  
Current income tax expense
    (374 )           (374 )
 
                 
Adjusted Taxable Income, Net of Current Tax Expense
  $ 3,138     $ 2,418     $ 720  
 
                 
 
     
(1)  
Includes $690,000 and $1,858,000 of timing differences during 2011 and 2010, respectively, related to Secondary Market Loan Sales.
 
(2)  
Recognition of deferred gain for tax purposes on a property previously owned by our off-balance sheet variable interest entity.
Adjusted Taxable Income, Net of Current Tax Expense is defined as reported net income, adjusted for book versus tax timing differences and special items. Special items may include, but are not limited to, unusual and infrequent non-operating items. Among other items, we use Adjusted Taxable Income, Net of Current Tax Expense to measure and evaluate our operations. We believe that the results provide a useful analysis of ongoing operating trends.

 

36


Table of Contents

ITEM 3.
Quantitative and Qualitative Disclosures About Market Risk
Market risk is the exposure to loss resulting from changes in various market metrics. We are subject to market risk including liquidity risk, real estate risk and interest rate risk as described below. Although management believes that the quantitative analysis on interest rate risk below is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size and composition of our balance sheet and other business developments that could affect our financial position and net income. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by these estimates.
Liquidity Risk
Liquidity risk is the potential that we would be unable to meet our obligations as they come due because of an inability to liquidate assets or obtain funding. We are subject to changes in the debt and collateralized mortgage markets. These markets are experiencing disruptions, which could continue to have an adverse impact on our earnings and financial condition.
Current conditions in the debt markets include reduced liquidity and increased risk adjusted premiums. These conditions have increased the cost and reduced the availability of financing sources. The market for trading and issuance in asset-backed securities continues to experience disruptions resulting from reduced investor demand for these securities and increased investor yield requirements. In light of these market conditions, we expect to finance our loan portfolio in the short-term with our current capital and any available credit facilities.
Real Estate Risk
The value of our commercial mortgage loans and our ability to sell such loans, if necessary, are impacted by market conditions that affect the properties that are the primary collateral for our loans. Property values and operating income from the properties may be affected adversely by a number of factors, including, but not limited to:
   
national, regional and local economic conditions;
 
   
rises in gasoline prices if there is a concurrent decrease in business and leisure travel;
 
   
local real estate conditions (including an oversupply of commercial real estate);
 
   
natural disasters including hurricanes and earthquakes, acts of war and/or terrorism and other events that may cause performance declines and/or losses to the owners and operators of the real estate securing our loans;
 
   
changes or continued weakness in the underlying value of limited service hospitality properties;
 
   
construction quality, construction cost, age and design;
 
   
demographic factors;
 
   
uninsured losses;
 
   
environmental, zoning and other governmental laws and regulations;
 
   
increases in operating expenses (such as energy costs) for the owners of the properties; and
 
   
limitations in the availability and cost of leverage.
In the event property cash flows decrease, a borrower may have difficulty repaying our loan, which could result in losses to us. In addition, decreases in property values reduce the value of the collateral and the potential proceeds available to borrowers to repay our loans, which could also cause us to suffer losses. Decreases in property values could reduce the value of our REO which could cause us to suffer losses.

 

37


Table of Contents

The following analysis of our provision for loan losses quantifies the negative impact to our net income from increased losses on our Retained Portfolio:
                         
    Six Months     Year Ended     Six Months  
    Ended     December 31,     Ended  
Provision for loan losses   June 30, 2011     2010     June 30, 2010  
    (In thousands)  
As reported (1)
  $ 520     $ 1,019     $ 306  
Annual loan losses increase by 50 basis points (2)
    1,042       2,117       884  
Annual loan losses increase by 100 basis points (2)
    1,564       3,214       1,462  
 
     
(1)  
Excludes reductions of loan losses
 
(2)  
Represents provision for loan losses based on increases in losses as a percentage of our weighted average loans receivable for the periods indicated
Interest Rate Risk
Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors.
Since our loans are predominantly variable-rate, based on LIBOR or the prime rate, our operating results will depend in large part on LIBOR or the prime rate. One of the determinants of our operating results is differences between the income from our loans and our borrowing costs. Most of our borrowings are also based on LIBOR or the prime rate. The objective of this strategy is to minimize the impact of interest rate changes on our net interest income.
VALUATION OF LOANS
Our loans are recorded at cost and adjusted by net loan origination fees and discounts (which are recognized as adjustments of yield over the life of the loan) and loan loss reserves. In order to determine the estimated fair value of our loans, we use a present value technique for the anticipated future cash flows using certain assumptions including a current market discount rate, potential prepayment risks and loan losses. If we were required to sell our loans at a time we would not otherwise do so, there can be no assurance that management’s estimates of fair values would be obtained and losses could be incurred.
At June 30, 2011, our loans are 80% variable-rate at spreads over LIBOR or the prime rate. Increases or decreases in interest rates will generally not have a material impact on the fair value of our variable-rate loans. We had $184.7 million of variable-rate loans at June 30, 2011. The estimated fair value of our variable-rate loans ($181.8 million at June 30, 2011) is dependent upon several factors including changes in interest rates and the market for the type of loans we have originated.
We had $47.6 million and $63.2 million of fixed-rate loans at June 30, 2011 and December 31, 2010, respectively. The estimated fair value of these fixed-rate loans approximates their cost and is dependent upon several factors including changes in interest rates and the market for the types of loans that we have originated. Since changes in market interest rates do not affect the interest rates on our fixed-rate loans, any changes in these rates do not have an immediate impact on our interest income. Our interest rate risk on our fixed-rate loans is primarily related to loan prepayments and maturities.
The average maturity of our loan portfolio is less than its average contractual terms because of prepayments. Assuming market liquidity, the average life of mortgage loans tends to increase when the current mortgage rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when the current mortgage rates are substantially lower than rates on existing mortgage loans (due to refinancing of fixed-rate loans).
INTEREST RATE SENSITIVITY
At June 30, 2011 and December 31, 2010, we had $184.7 million and $170.0 million of variable-rate loans, respectively, and $77.0 million and $73.1 million of variable-rate debt, respectively. On the difference between our variable-rate loans and our variable-rate debt ($107.7 million and $96.9 million at June 30, 2011 and December 31, 2010, respectively) we have interest rate risk. To the extent variable rates decrease, our interest income net of interest expense would decrease.

 

38


Table of Contents

The sensitivity of our variable-rate loans and debt to changes in interest rates is regularly monitored and analyzed by measuring the characteristics of our assets and liabilities. We assess interest rate risk in terms of the potential effect on interest income net of interest expense in an effort to ensure that we are insulated from any significant adverse effects from changes in interest rates. As a result of our predominately variable-rate portfolio, our earnings are susceptible to being reduced during periods of lower interest rates. Based on a sensitivity analysis of interest income and interest expense at June 30, 2011 and December 31, 2010, if the consolidated balance sheet were to remain constant and no actions were taken to alter the existing interest rate sensitivity, each hypothetical 25 basis point reduction in interest rates would reduce net income by approximately $269,000 and $242,000, respectively, on an annual basis. Since LIBOR has already been reduced to historically low levels, further significant negative impacts from lower LIBOR interest rates are not anticipated. In addition, as a REIT, the use of hedging interest rate risk is typically only provided on debt instruments due to potential REIT compliance issues. Benefits derived from hedging strategies not based on debt instruments (i.e., investments) may be deemed bad income for REIT qualification purposes. The use of a hedge strategy (on our debt instruments) would only be beneficial to fix our cost of funds and hedge against rising interest rates.
DEBT
Our debt is comprised of SBA debentures, junior subordinated notes, the Revolver, structured notes and secured borrowings — government guaranteed loans. At June 30, 2011 and December 31, 2010, approximately $18.5 million and $19.9 million, respectively, of our debt had fixed rates of interest and was therefore not affected by changes in interest rates. Our variable-rate debt is based on LIBOR or the prime rate and thus subject to adverse changes in market interest rates. Assuming there were no increases or decreases in the balance outstanding under our variable-rate debt at June 30, 2011, each hypothetical 100 basis points increase in interest rates would increase interest expense and decrease net income by approximately $770,000.
Our fixed-rate debt at June 30, 2011 was comprised of SBA debentures and structured notes of the 2000 Joint Venture.
The following tables present the principal amounts by year of expected maturity, weighted average interest rates and estimated fair values to evaluate the expected cash flows and sensitivity to interest rate changes of our outstanding debt at June 30, 2011 and December 31, 2010:
                                                                 
    Twelve Month Periods Ending June 30,         Carrying     Fair  
    2012     2013     2014     2015     2016     Thereafter     Value     Value (1)  
    (Dollars in thousands)  
Fixed-rate debt (2)
  $ 1,507     $ 1,727     $ 5,824     $ 5,807     $ 1,985     $ 1,658     $ 18,508     $ 19,065  
Variable-rate debt (LIBOR and prime based) (3) (4)
    2,477       2,539       15,420       2,687       1,769       52,110       77,002       72,118  
 
                                               
Totals
  $ 3,984     $ 4,266     $ 21,244     $ 8,494     $ 3,754     $ 53,768     $ 95,510     $ 91,183  
 
                                               
 
     
(1)  
The estimated fair value is based on a present value calculation based on prices of the same or similar instruments after considering risk, current interest rates and remaining maturities.
 
(2)  
The weighted average interest rate of our fixed-rate debt at June 30, 2011 was 6.7%.
 
(3)  
Principal payments on the structured notes and secured borrowings are dependent upon cash flows received from the underlying loans. Our estimate of their repayment is based upon scheduled principal payments on the underlying loans. Our estimate will differ from actual amounts to the extent we experience prepayments and/or loan losses.
 
(4)  
The weighted average interest rate of our variable-rate debt at June 30, 2011 was 3.2%.

 

39


Table of Contents

                                                                 
    Years Ending December 31,             Carrying     Fair  
    2011     2012     2013     2014     2015     Thereafter     Value     Value (1)  
    (Dollars in thousands)  
Fixed-rate debt (2)
  $ 1,652     $ 1,815     $ 6,155     $ 2,008     $ 6,205     $ 2,066     $ 19,901     $ 20,514  
Variable-rate debt (LIBOR and prime rate based) (3) (4)
    16,123       2,414       2,463       2,570       2,534       46,964       73,068       68,142  
 
                                               
Totals
  $ 17,775     $ 4,229     $ 8,618     $ 4,578     $ 8,739     $ 49,030     $ 92,969     $ 88,656  
 
                                               
 
     
(1)  
The estimated fair value is based on a present value calculation based on prices of the same or similar instruments after considering risk, current interest rates and remaining maturities.
 
(2)  
The weighted average interest rate of our fixed-rate debt at December 31, 2010 was 6.7%.
 
(3)  
Principal payments on the structured notes and secured borrowings are dependent upon cash flows received from the underlying loans. Our estimate of their repayment is based upon scheduled principal payments on the underlying loans. Our estimate will differ from actual amounts to the extent we experience prepayments and/or loan losses.
 
(4)  
The weighted average interest rate of our variable-rate debt at December 31, 2010 was 3.3%.

 

40


Table of Contents

ITEM 4.
Controls and Procedures
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, management has evaluated the effectiveness of our disclosure controls and procedures (as defined under rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of June 30, 2011. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There have been no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

41


Table of Contents

PART II
Other Information
ITEM 1. Legal Proceedings
In the normal course of business we are periodically party to certain legal actions and proceedings involving matters that are generally incidental to our business (i.e., collection of loans receivable). In management’s opinion, the resolution of these legal actions and proceedings will not have a material adverse effect on our consolidated financial statements.
ITEM 1A. Risk Factors
There have been no material changes to the factors disclosed in Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2010, other than the following.
Investment Risks — Lending Activities
Recent delays by U.S. lawmakers in reaching an agreement to raise the national debt ceiling, the resulting uncertainty about whether lawmakers will be able to implement a deficit reduction plan and any downgrade in the U.S.’s credit rating could materially adversely affect our business, financial condition, results of operations and share price.
The current U.S. debt ceiling and budget deficit concerns caused a credit rating agency downgrade to the U.S.’s credit rating for the first time in history. In addition, there potentially may be future downgrades. While U.S. lawmakers were able to reach an agreement and raise the national debt ceiling, there is still uncertainty about whether the U.S. can implement the deficit reduction plan or avoid having additional credit rating downgrades by one or more of the rating agencies. Any default by the U.S. on its obligations, the perceived risk of such a default or any downgrade of the U.S.’s credit rating could have a material adverse affect on the financial markets and economic conditions in the U.S. and throughout the world which could negatively affect our business, financial condition, results of operations and share price.
These economic and market conditions could negatively impart the value of the government guaranteed portion of our SBA 7(a) program loans or the interest rates that we may be charged on future SBIC debenture issuances. In addition, these economic and market conditions could adversely affect our business in many ways, including but not limited to, adversely impacting our ability to obtain financing for our investments or increasing the cost of such financing if it is obtained.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
ITEM 3. Defaults upon Senior Securities
None.
ITEM 4. Reserved
ITEM 5. Other Information
None.

 

42


Table of Contents

ITEM 6. Exhibits
A. Exhibits
     
3.1
  Declaration of Trust (incorporated by reference to the exhibits to the Registrant’s Registration Statement on Form S-11 filed with the Securities and Exchange Commission (“SEC”) on June 25, 1993, as amended (Registration No. 33-65910)).
 
   
3.1(a)
  Amendment No. 1 to Declaration of Trust (incorporated by reference to the Registrant’s Registration Statement on Form S-11 filed with the SEC on June 25, 1993, as amended (Registration No. 33-65910)).
 
   
3.1(b)
  Amendment No. 2 to Declaration of Trust (incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 1993).
 
   
3.1(c)
  Amendment No. 3 to Declaration of Trust (incorporated by reference to the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2003).
 
   
3.2
  Bylaws (incorporated by reference to the exhibits to the Registrant’s Registration Statement on Form S-11 filed with the SEC on June 25, 1993, as amended (Registration No. 33-65910)).
 
   
3.3
  Amendment No. 1 to Bylaws (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on April 16, 2009).
 
   
10.1
  Form of Executive Employment Contract (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on June 29, 2011).
 
   
10.2
  First Amendment to Amended and Restated Credit Agreement among PMC Commercial Trust, First Western SBLC, Inc., and JPMorgan Chase Bank, National Association, as Administrative Agent, and the lenders named therein, dated June 8, 2011 (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on June 10, 2011).
 
   
10.3
  Second Amended and Restated Revolving Note executed by PMC Commercial Trust (incorporated by reference to Exhibit 10.2 to the Registrant’s Current Report on Form 8-K filed with the SEC on June 10, 2011).
 
   
10.4
  First Amended and Restated Revolving Note executive by First Western SBLC, Inc. (incorporated by reference to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K filed with the SEC on June 10, 2011).
 
   
*31.1
  Section 302 Officer Certification — Chief Executive Officer
 
   
*31.2
  Section 302 Officer Certification — Chief Financial Officer
 
   
**32.1
  Section 906 Officer Certification — Chief Executive Officer
 
   
**32.2
  Section 906 Officer Certification — Chief Financial Officer
 
   
***101.INS
  XBRL Instance Document
 
   
***101.SCH
  XBRL Taxonomy Extension Schema Document
 
   
***101.CAL
  XBRL Taxonomy Extension Calculation Linkbase Document
 
   
***101.DEF
  XBRL Taxonomy Extension Definition Linkbase Document
 
   
***101.LAB
  XBRL Taxonomy Extension Label Linkbase Document
 
   
***101.PRE
  XBRL Taxonomy Extension Presentation Linkbase Document
 
     
*  
Filed herewith.
 
**  
Furnished herewith
 
***  
In accordance with Regulation S-T, the XBRL-related information in Exhibit No. 101 shall be deemed “furnished” and not “filed” under sections 11 or 12 of the Securities Act of 1933 and/or under section 18 of the Securities and Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

43


Table of Contents

Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
 
  PMC Commercial Trust    
 
       
Date: 08/09/11
  /s/ Lance B. Rosemore
 
Lance B. Rosemore
   
 
  President and Chief Executive Officer    
 
       
Date: 08/09/11
  /s/ Barry N. Berlin    
 
       
 
  Barry N. Berlin    
 
  Executive Vice President and    
 
  Chief Financial Officer    
 
  (Principal Accounting Officer)    

 

44