UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10 - Q

(Mark One)

Commission File Number       1-13610

PMC COMMERCIAL TRUST

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  ü   NO      

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES  ü   NO      

As of May 5, 2004, Registrant had outstanding 10,844,091 Common Shares of Beneficial Interest, par value $.01 per share.

PMC COMMERCIAL TRUST AND SUBSIDIARIES

INDEX

PART I

Financial Information

ITEM 1.

Financial Statements

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PMC COMMERCIAL TRUST AND SUBSIDIARIES

The accompanying notes are an integral part of these consolidated financial statements.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES

The accompanying notes are an integral part of these consolidated financial statements.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES

The accompanying notes are an integral part of these consolidated financial statements.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES

The accompanying notes are an integral part of these consolidated financial statements.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES

Note 1. Interim Financial Statements:

The accompanying consolidated balance sheet of PMC Commercial Trust (“PMC Commercial” or together with its wholly-owned subsidiaries, “we,” “us” or “our”) as of March 31, 2004 and the consolidated statements of income, comprehensive income and cash flows for the three months ended March 31, 2004 and 2003, have not been audited by independent accountants. In the opinion of management, the financial statements reflect all adjustments necessary to fairly present our financial position at March 31, 2004 and our results of operations for the three months ended March 31, 2004 and 2003. These adjustments are of a normal recurring nature.

Certain notes and other information have been omitted from the interim financial statements presented in this Quarterly Report on Form 10-Q. 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, 2003.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect (i) the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and (ii) the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. Our most sensitive estimates involved the valuation of our net assets acquired in connection with the merger and our retained interests in transferred assets and determining reserves on our loans receivable and assets acquired in liquidation.

The results for the three months ended March 31, 2004 are not necessarily indicative of future financial results.

Note 2. Business:

PMC Commercial is a real estate investment trust that primarily originates loans to small businesses collateralized by first liens on the real estate of the related business. We originate loans on commercial real estate primarily to borrowers in the hospitality industry. We also originate loans on commercial real estate to borrowers in the service, retail, multi-family and manufacturing industries. In addition, our investments include the ownership of commercial properties in the hospitality industry. Our common stock is traded on the American Stock Exchange under the symbol “PCC.”

PMC Capital, Inc. (“PMC Capital”), our affiliate through common management, was merged with and into PMC Commercial, with PMC Commercial continuing as the surviving entity, on February 29, 2004. Pursuant to the merger, each issued and outstanding share of PMC Capital common stock was converted into 0.37 of a common share of PMC Commercial. We now own and operate the businesses of PMC Capital and its subsidiaries, along with our existing operations and businesses.

Note 3. Consolidation:

The following subsidiaries were acquired in the merger with PMC Capital. First Western SBLC, Inc. (“First Western”) is licensed as a small business lending company that originates loans through the Small Business Administration (“SBA”) 7(a) guaranteed loan program. PMC Investment Corporation (“PMCIC”) is a licensed specialized small business investment company under the Small Business Investment Act of 1958, as amended (“SBIA”). Western Financial Capital Corporation (“Western Financial”) is a licensed small business investment company under the SBIA. PMC Funding Corp. (“PMC Funding”) and PMC Asset Holding, LLC (“Asset Holding”) hold assets on our behalf. References to PMC Capital within this quarterly report refer to PMC Capital and its subsidiaries.

The consolidated financial statements include the accounts of PMC Commercial and its wholly-owned subsidiaries, including PMC Commercial Trust, Ltd. 1998-1 (“PMCT Trust”), formed in conjunction with our 1998 structured loan financing transaction, First Western, PMCIC, Western Financial, PMC Funding and Asset Holding. All material intercompany balances and transactions have been eliminated.

In addition, we are the sole shareholder or partner of several non-consolidated subsidiaries. These are PMC Capital, L.P. 1998-1 (the “1998 Partnership”), PMC Capital, L.P. 1999-1 (the “1999 Partnership”), PMC Joint Venture, L.P. 2000 (the “2000 Joint Venture”), PMC Joint Venture, L.P. 2001 (the “2001 Joint Venture”), PMC Joint Venture, L.P. 2002-1 (the “2002 Joint Venture”) and PMC Joint Venture, L.P. 2003 (the “2003 Joint Venture”, and together with the 2000 Joint

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Venture, the 2001 Joint Venture and the 2002 Joint Venture, the “Joint Ventures” and together with the 1998 Partnership and the 1999 Partnership, the “SPEs”). The SPEs were created in connection with structured loan sale transactions.

Our ownership interest in SPEs created in conjunction with structured loan sale transactions are accounted for as retained interests in transferred assets (“Retained Interests”) in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities” (“SFAS No. 140”). Accordingly, the assets, liabilities, partners’ capital and results of operations of the SPEs are not included in our consolidated financial statements.

Note 4. Reclassifications:

Certain prior period amounts have been reclassified to conform to the current year presentation. These reclassifications had no effect on previously reported net income or total beneficiaries’ equity.

Note 5. Recently Issued Accounting Pronouncements:

The Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an interpretation of ARB 51 (“FIN 46”) in January 2003. In December 2003, FASB issued Interpretation No. 46R which replaced FIN 46 and clarified the application of ARB 51. Implementation of the provisions of FIN 46R is effective for the first reporting period after March 15, 2004. The primary objectives of FIN 46R are to provide guidance on (i) the identification of entities for which control is achieved through means other than voting rights, Variable Interest Entities (“VIEs”), and (ii) how to determine when and which business enterprise should consolidate the VIE (“the primary beneficiary”). This new model for consolidation applies to an entity which either (i) the equity investors, if any, do not have a controlling financial interest or (ii) the equity investment at risk is not considered sufficient (based on both quantitative and qualitative considerations) to finance the entity’s activities without receiving additional subordinated financial support from other parties, including the entity’s own equity investors. In addition, FIN 46R requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. FIN 46R will not impact our consolidated financial statements since it is not applicable to qualifying SPEs accounted for in accordance with SFAS No. 140.

Note 6. Stock-Based Compensation Plans:

At March 31, 2004, we had two stock-based compensation plans. Effective January 1, 2003, we adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” prospectively to all awards granted, modified or settled after January 1, 2003. Awards under the plans generally vest immediately. We did not grant any awards under the plans during the three months ended March 31, 2004 or 2003; therefore, we did not recognize any compensation expense for new grants.

We assumed unearned stock compensation in the merger with PMC Capital representing the intrinsic value of unvested stock options assumed that vest as the employees provide future services. Compensation expense is being recognized over the vesting period, and we recorded compensation expense of approximately $1,000 during the three months ended March 31, 2004.

Note 7. Merger:

PMC Capital, Inc. was merged with and into PMC Commercial on February 29, 2004. We believe that the merger will provide important strategic and financial benefits to us including larger market capitalization, stabilization of cash flow, support for our revenue stream and self-management. Each issued and outstanding share of PMC Capital common stock was converted into 0.37 of a common share of PMC Commercial. As a result, we issued 4,385,800 common shares of beneficial interest on February 29, 2004 valued at $13.10 per share, which was the average closing price of our common stock for the three days preceding the date of the announcement, adjusted by declared but unpaid dividends.

The merger was accounted for using the purchase method of accounting in accordance with SFAS No. 141, “Business Combinations” as we were not deemed to be under common control. Accordingly, our consolidated results of operations have

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

incorporated PMC Capital’s activity on a consolidated basis from the merger date. The cost of the merger was allocated to the assets acquired, liabilities assumed and preferred stock of subsidiary based on management’s estimates of their respective fair values at the date of merger. The fair value of the net assets acquired exceeded the cost of the merger, resulting in negative goodwill. The amount of negative goodwill was allocated proportionately to reduce the assigned values of the acquired assets excluding current assets, financial assets and assets held for sale. Substantially all of the assets acquired were considered to be financial assets or assets to be disposed of by sale. Accordingly, we recorded negative goodwill of $11,593,000 during the three months ended March 31, 2004 representing the excess of the fair value of net assets acquired over the cost of the merger.

The cost of the merger was as follows (dollars in thousands):

The following table summarizes the estimated fair values of assets acquired, liabilities assumed and preferred stock of subsidiary as of February 29, 2004 (in thousands):

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following pro forma results of operations are based on the financial statements of PMC Capital and assumed the merger occurred on January 1 of the respective years:

These pro forma results have been prepared for comparative purposes only. In the opinion of management, all material adjustments necessary to reflect the effects of the merger transaction have been made. This pro forma information is not necessarily indicative of what the actual results of operations would have been had the merger transaction occurred on the indicated dates, nor does it purport to represent PMC Commercial’s results of operations for future periods.

Note 8. Loans Receivable, net:

Loans receivable, net consisted of the following:

At March 31, 2004 and December 31, 2003, respectively, approximately $70.3 million (65%) and $21.2 million (42%) of our net loans receivable had a variable interest rate (reset on a quarterly basis) based upon either the 90-day LIBOR or the prime rate and $37.3 million (35%) and $29.3 million (58%) had a fixed interest rate, respectively. The weighted average interest rate of our variable-rate loans receivable was approximately 5.6% and 5.4% at March 31, 2004 and December 31, 2003, respectively. The weighted average interest rate of our fixed-rate loans receivable was approximately 10.0% and 10.1% at March 31, 2004 and December 31, 2003, respectively.

Our loans receivable were approximately 92% concentrated in the hospitality industry at March 31, 2004. Any economic factors that negatively impact the hospitality industry could have a material adverse effect on our financial condition or results of operations.

At March 31, 2004 and December 31, 2003, loans receivable of approximately $3.3 million and $1.8 million, respectively, were either greater than 60 days past due, the loans were identified as impaired or the loans were in the process of liquidation.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 9. Real Estate Investments:

As of March 31, 2004, our real estate investments consisted of 21 limited service hospitality properties (the “Hotel Properties”) that we purchased in 1998 and 1999 from Arlington Hospitality, Inc. (“Arlington”), under a sale/leaseback agreement (the “Lease Agreement”).

Pursuant to the Lease Agreement, we lease the Hotel Properties to Arlington Inns, Inc., a wholly-owned subsidiary of Arlington, for an initial 10-year period which expires in June 2008, with two renewal options of five years each and a third option for two years which expires in September 2020, and with consumer price index increases up to a maximum of 2% per year. Arlington guarantees the lease payment obligation of Arlington Inns, Inc. Arlington is a public entity that files periodic reports with the Securities and Exchange Commission (the “SEC”) and additional information about Arlington can be obtained from the SEC’s website at www.sec.gov.

At March 31, 2004, the annual base rent payment for the Hotel Properties was $5,338,000. In addition to our base rent we receive percentage rent equal to 4% of the gross room revenues of the Hotel Properties.

Our real estate investments consisted of the following:

The real estate investment held for sale at March 31, 2004 is under contract to Arlington for approximately $2.6 million pursuant to the Lease Agreement and is scheduled to be completed prior to June 2004.

We entered into a letter agreement with Arlington on March 12, 2004, pursuant to which we granted Arlington, among other things, reduced cash payments on the base rent due under the Lease Agreement. The letter agreement which originally terminated on April 30, 2004 was extended to May 31, 2004. Arlington is then required to pay the difference between the reduced rent payments made for March through May 2004 and the base rent for those three months provided for in the Lease Agreement. We anticipate that this difference will be collected prior to December 31, 2004.

We are currently in discussions with Arlington regarding a possible amendment to our Lease Agreement to allow for property sales, provide for additional rent deferments and adjust the timing and sales price for Arlington’s acquisition of our real estate investment held for sale. There can be no assurance that the Lease Agreement will be restructured on terms and conditions acceptable to us, or that any amendment will occur.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 10. Retained Interests:

In our structured loan sale transactions, we contributed loans receivable to an SPE in exchange for an ownership interest in that entity. The SPE issued notes payable (the “Structured Notes”) (usually through a private placement) to third parties (“Structured Noteholders”). The SPE then distributed a portion of the proceeds from the Structured Notes to us. The Structured Notes are collateralized solely by the assets of the SPE which means that should the SPE fail to make payments on the Structured Notes, the Structured Noteholders have no recourse against us. Upon the completion of our structured loan sale transactions, we recorded the transfer of loans receivable as a sale in accordance with SFAS No. 140. As a result, the loans receivable contributed to the SPE, the Structured Notes issued by the SPE, and the operating results of the SPE are not included in our consolidated financial statements. The difference between (i) the carrying value of the loans receivable sold and (ii) the relative fair value of the sum of (a) the cash received and (b) the present value of estimated future cash flows from the Retained Interests, constituted the gain or loss on sale. Retained Interests are carried at estimated fair value, with realized gains and losses recorded in net income and unrealized gains and losses recorded in beneficiaries’ equity.

Prior to the merger, we completed joint structured loan sale transactions with PMC Capital in 2000, 2001, 2002 and 2003 (the “Originated Structured Loan Sale Transactions”). As a result of the merger, we acquired the remaining ownership interests in the Joint Ventures and 100% of the 1998 Partnership and the 1999 Partnership (collectively, the “Acquired Structured Loan Sale Transactions”).

Information pertaining to the Originated Structured Loan Sale Transactions as of March 31, 2004 was as follows:

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Information pertaining to the Acquired Structured Loan Sale Transactions as of March 31, 2004 was as follows:

In addition, First Western has Retained Interests related to sale of loans originated pursuant to the SBA 7(a) loan program. First Western sold the unguaranteed portion of its loans receivable through a private placement in 1997 (“FW 97”) and has retained the right to service these loans receivable. Pursuant to the sale, First Western maintains a reserve fund and receives cash flow from the interest-only strip receivable established in connection with the sold loans receivable. At March 31, 2004, the principal balance outstanding on the sold loans of FW 97 was approximately $2.7 million and the reserve fund balance (currently at its minimum requirement) was $912,000.

The SBA guaranteed portions of First Western’s loans receivable are sold to either dealers in government guaranteed loans receivable or institutional investors (“Secondary Market Loan Sales”) as the loans are fully funded. On all Secondary Market Loan Sales, we retain an excess spread between the interest rate paid to us from our borrowers and the rate we pay to the purchaser of the guaranteed portion of the note. At March 31, 2004, the aggregate principal balance of First Western’s serviced loans receivable on which we have an excess spread was approximately $43.8 million and the weighted average excess spread (before servicing costs) was approximately 1.8%.

In determining the fair value of our Retained Interests related to First Western, our assumptions at March 31, 2004 included prepayment speeds ranging from 20% to 30% per annum, a loss rate of 0.2% per annum (relates only to FW 97) and discount rates ranging from 5.0% to 11.5%.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The components of our Retained Interests are as follows:

Our Retained Interests consisted of the following (percentages owned of the respective SPEs are shown in parentheses):

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following sensitivity analysis of our Retained Interests as of March 31, 2004 highlights the volatility that results when prepayments, losses and discount rates are different than our assumptions:

These sensitivities are hypothetical and should be used with caution. Values based on changes in these assumptions generally cannot be extrapolated since the relationship of the change in an assumption to the change in fair value is not linear. The effect of a variation in a particular assumption on the fair value of our Retained Interests is calculated without changing any other assumption. In reality, changes in one factor are not isolated from changes in another which might magnify or counteract the sensitivities.

The following information summarizes the financial position of the SPEs at March 31, 2004 and December 31, 2003. We owned 100% of the SPEs at March 31, 2004. We owned approximately 68% of the 2000 Joint Venture, 42% of the 2001 Joint Venture, 39% of the 2002 Joint Venture and 44% of the 2003 Joint Venture as of December 31, 2003. We did not own any of the 1998 Partnership or the 1999 Partnership as of December 31, 2003; however, the financial information is presented below for comparative purposes. The remaining interests in the Joint Ventures and 100% of the 1998 Partnership and the 1999 Partnership were owned by PMC Capital at December 31, 2003.

Summary of Financial Position (1):

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following information summarizes the results of operations of the SPEs.

Summary of Operations (1):

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

We owned 100% of the Joint Ventures as of March 31, 2004. Our limited partnership allocation of the net income of the Joint Ventures for the three months ended March 31, 2003 was as follows:

In accordance with SFAS No. 140, our consolidated financial statements do not include the assets, liabilities, partners’ capital, revenues or expenses of the SPEs. As a result, at March 31, 2004 and December 31, 2003 our consolidated balance sheets do not include the $370.1 million and $156.8 million of assets, respectively, and $308.5 million and $131.3 million of liabilities, respectively, related to our structured loan sale transactions recorded by our SPEs. Our Retained Interests related to these structured loan sale transactions were $73.4 million and $30.8 million at March 31, 2004 and December 31, 2003, respectively, including unrealized appreciation of $4.4 million and $3.6 million, respectively.

The income from our Retained Interests consists of the yield earned on our Retained Interests which is determined based on estimates of future cash flows and includes any fees collected (i.e., late fees, prepayment fees, etc.) by the SPEs in excess of anticipated fees. We update our cash flow assumptions on a quarterly basis and any changes to cash flow assumptions impact the yield on our Retained Interests. The annualized yield on our Retained Interests was 11.3% and 11.9% during the three months ended March 31, 2004 and 2003, respectively.

As a result of the merger, as of March 1, 2004, we are the servicer for all loans held by the SPEs. Servicing fee income for the three months ended March 31, 2004 was approximately $58,000 which represents one month of servicing fee income. Servicing fee income is included in other income, net, in our consolidated income statement. We have not established a servicing asset or liability as the servicing fees are considered adequate compensation. PMC Capital was the servicer for all loans receivable held by the SPEs prior to the merger; therefore, no servicing fees were earned or received by us for the three months ended March 31, 2003.

We received approximately $2.0 million and $220,000 in cash distributions from the SPEs during the three months ended March 31, 2004 and 2003, respectively. Our cash distributions were reduced during the three months ended March 31, 2003

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

due to the deferral of approximately $780,000 related to the 2000 Joint Venture. These funds were received in a future period.

In accordance with EITF 02-09, as a result of a delinquent loan which we were contractually allowed to repurchase from our SPE, we recorded a loan receivable and a corresponding due to affiliate at the estimated value of the loan receivable of approximately $800,000. The principal balance of this delinquent loan in the 2001 Joint Venture was approximately $1.1 million at March 31, 2004.

Note 11. Assets Acquired in Liquidation:

At March 31, 2004, our assets acquired in liquidation were approximately $1.9 million consisting primarily of a limited service hospitality property and additional collateral.

We acquired a limited service hospitality property in connection with the merger. We sold the limited service hospitality property to a third party in March 2004 for our cost of approximately $1.1 million. Accordingly, no gain or loss was recognized on the sale. We financed the sale through the origination of a loan of $900,000 at an interest rate of LIBOR plus 4.5%. The loan matures in 2006.

During March 2004, a limited service hospitality property with a cost of approximately $1.2 million was repurchased from PMCT Trust. The property was subsequently leased to a third party operator with an option to purchase. In April 2004, the property was sold to the third party for cash proceeds of approximately $1.5 million.

Note 12. Revolving Credit Facility and Notes and Debentures Payable:

Information on our revolving credit facility and notes and debentures payable at March 31, 2004 was as follows:

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Principal payments required on our notes and debentures payable at March 31, 2004 were as follows:

Revolving Credit Facility
We have a revolving credit facility which provides funds to originate loans collateralized by commercial real estate. The revolving credit facility matures in December 2004 and provides us with credit availability up to $40 million. We are charged interest on the balance outstanding under the revolving credit facility at our election of either the prime rate of the lender or 187.5 basis points over the 30, 60 or 90-day LIBOR. We did not have any amounts outstanding under the revolving credit facility at March 31, 2004 or December 31, 2003. The credit facility requires us to meet certain covenants, the most restrictive of which provides for an asset coverage test based on our cash and cash equivalents, loans receivable, Retained Interests and real estate investments as a ratio to our senior debt. At March 31, 2004, we were in compliance with the covenants of this facility.

Structured Notes Payable
In June 1998, we formed a bankruptcy remote partnership that completed a private placement of fixed-rate loan-backed notes (the “Trust Structured Notes”). The Trust Structured Notes mature in 2019; however, repayment of principal is based on collections of principal on the underlying loans receivable. The Trust Structured Notes bear interest at 6.37% per annum and are collateralized by the loans receivable that we contributed to the partnership. At March 31, 2004 and December 31, 2003, the principal amount of the underlying loans receivable was $19.1 million and $26.0 million, respectively. We have no obligation to pay the Trust Structured Notes, nor do the holders of the Trust Structured Notes have any recourse against our assets. Accordingly, if the partnership fails to pay the Trust Structured Notes, the sole recourse of the holders of the Trust Structured Notes is against the assets of the partnership. The principal amount of the Trust Structured Notes outstanding at March 31, 2004 and December 31, 2003 was $13.4 million and $18.7 million, respectively.

Mortgage Notes Payable
We have entered into seven mortgage notes payable, each collateralized by a Hotel Property. The mortgage notes payable have a weighted average interest rate of 6.6%, mature between June 2004 and August 2019 and have amortization periods of 20 years. At both March 31, 2004 and December 31, 2003, the aggregate balances outstanding on these obligations were $8.6 million. Of these mortgage notes payable, $1.5 million mature in June 2004 at an interest rate of 7.5% and $1.5 million mature in October 2004 at an interest rate of 8.0%.

In addition, our subsidiaries have entered into mortgage notes payable related to four Hotel Properties with a weighted average interest rate of approximately 8.0%. These mortgages are amortized over 20 years, mature from January 2010 to December 2017 and have restrictive provisions which provide for substantial prepayment penalties. At March 31, 2004 and December 31, 2003, the aggregate balances outstanding on these mortgage notes payable were $6.0 million and $6.1 million, respectively, of which $3.2 million and $3.3 million, respectively, were guaranteed by PMC Commercial.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Uncollateralized Notes Payable
Our uncollateralized notes payable outstanding at March 31, 2004 were assumed in connection with the merger and mature from April 2004 to July 2006 with a weighted average cost of funds of 3.9% at March 31, 2004. These notes payable require us to meet certain covenants (terms as defined in the agreement), the most restrictive of which require (i) that net loans receivable must exceed 150% of senior funded debt, (ii) loan losses for any twelve-month period must not exceed 3% of net loans receivable and (iii) our consolidated earnings plus interest expense must exceed 150% of interest expense. At March 31, 2004, we were in compliance with the covenants of these notes payable. During April 2004 (at maturity), we repaid $5.0 million of these notes payable using existing cash and our revolving credit facility.

Debentures Payable
Debentures payable, assumed in connection with the merger, represent amounts due to the SBA as a result of borrowings made pursuant to the SBIA. The debentures mature from September 2005 to September 2013 with a cost of funds at March 31, 2004 of 6.0%.

Note 13. Cumulative Preferred Stock of Subsidiary:

PMCIC has outstanding 30,000 shares of $100 par value, 3% cumulative preferred stock (the “3% Preferred Stock”) and 40,000 shares of $100 par value, 4% cumulative preferred stock (the “4% Preferred Stock”). The 3% Preferred Stock and the 4% Preferred Stock are held by the SBA pursuant to the SBIA.

PMCIC is entitled to redeem, in whole or part, the 3% Preferred Stock by paying the par value ($3.0 million) of these securities plus dividends accumulated and unpaid on the date of redemption. While the 3% Preferred Stock may be redeemed, redemption is not mandatory. Dividends of approximately $7,600 were recognized on the 3% Preferred Stock during the three months ended March 31, 2004, representing one month’s dividend requirement since the date of the merger, and are reflected in our consolidated statement of income as minority interest.

The 4% Preferred Stock was issued during 1994 ($2.0 million) and 1995 ($2.0 million) and must be redeemed at par no later than 15 years from the date of issuance. As such, SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” requires that the 4% Preferred Stock be classified as a liability on our consolidated balance sheet. Dividends of approximately $14,000 were recognized on the 4% Preferred Stock during the three months ended March 31, 2004, representing one month’s activity since the date of the merger, and are included as a component of interest expense in our consolidated statement of income.

Note 14. Earnings Per Share:

The computations of basic earnings per common share are based on our weighted average shares outstanding. The weighted average number of common shares outstanding was approximately 7,948,000 and 6,446,000 for the three months ended March 31, 2004 and 2003, respectively. For purposes of calculating diluted earnings per share, the weighted average shares outstanding were increased by approximately 31,000 and 8,000 shares, respectively, during the three months ended March 31, 2004 and 2003 for the dilutive effect of stock options.

Options to purchase 44,500 and 60,600 common shares were outstanding during the three months ended March 31, 2004 and 2003, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the stock.

Note 15. Dividends Paid and Declared:

On January 12, 2004, we paid a $0.38 per share quarterly dividend to common shareholders of record on December 31, 2003. On February 27, 2004, we paid a $0.243 per share quarterly dividend to common shareholders of record on February 23, 2004. The Board of Trust Managers declared the remaining $0.137 per share quarterly dividend (total of $0.38 per share for the first quarter of 2004) to common shareholders of record on March 31, 2004, which was paid on April 12, 2004.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 16. Taxable Income:

As a real estate investment trust (“REIT”), we generally will not be subject to corporate level Federal income tax on net income we currently distribute to shareholders provided we distribute at least 90% of our REIT taxable income. We may, however, be subject to certain Federal excise taxes and state and local taxes on our income and property. If we fail to qualify as a REIT in any taxable year, we will be subject to Federal income taxes at regular corporate rates (including any applicable alternative minimum tax) and will not be able to qualify as a REIT for four subsequent taxable years.

We have wholly-owned taxable REIT subsidiaries which are subject to Federal income taxes. Our taxable REIT subsidiaries are PMCIC, First Western and PMC Funding. The income generated from our taxable REIT subsidiaries is taxed at normal corporate rates. We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” Under SFAS 109, we account for income taxes using the asset and liability method, under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.

The following table reconciles net income to taxable income for PMC Commercial:

Income tax expense related to the taxable REIT subsidiaries consists of the following for the three months ended March 31, 2004 (in thousands):

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The provision for income taxes results in effective tax rates that differ from Federal statutory rates of 35%. The reconciliation of our taxable REIT subsidiaries income tax attributable to net income computed at Federal statutory rates to income tax expense was as follows for the three months ended March 31, 2004 (in thousands):

The components of the net deferred tax asset at March 31, 2004 were as follows (in thousands):

The net operating loss carryforwards were generated by PMC Funding. These net operating loss carryforwards are available to offset future taxable income of PMC Funding. However, based on PMC Funding’s historical and anticipated pretax earnings, management does not believe that we will realize the benefit of these net operating loss carryforwards. Accordingly, they were valued at zero at March 31, 2004. The net operating loss carryforwards expire from 2012 to 2022.

Note 17. Discontinued Operations:

Discontinued operations of our Hotel Properties (one hotel property and two hotel properties at March 31, 2004 and 2003, respectively) consisted of the following:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 18. Profit Sharing Plan:

Commencing with the merger on March 1, 2004, we have a profit sharing plan available to our full-time employees after one year of employment. Vesting increases ratably to 100% after the sixth year of employment. Pursuant to our profit sharing plan, approximately $18,000 was expensed during the three months ended March 31, 2004 representing one month’s activity since the date of the merger. Contributions to the profit sharing plan are at the discretion of our Board of Trust Managers.

Note 19. 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. At March 31, 2004, we had approximately $22.3 million of total loan commitments and approvals outstanding. Of these, approximately $0.8 million are for loans to be originated by First Western, a portion of which will be sold pursuant to SBA Guaranteed Sales. The majority of these commitments and approvals were for variable-rate loans based on the prime rate or the 90-day LIBOR at spreads over the prime rate generally ranging from 2.25% to 2.75% and over LIBOR generally ranging from 4.0% to 4.5%. The weighted average interest rate on our loan commitments and approvals at March 31, 2004 was approximately 5.5%. Commitments generally have fixed expiration dates and require payment of a fee to us. 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. Future minimum lease payments under this lease are as follows for the twelve-month periods ending March 31:

Rental expense, which is being recorded on a straight-line basis, amounted to approximately $13,000 during the three months ended March 31, 2004 representing expense for one month since the merger date.

Employment Agreements
In connection with the merger, we assumed employment agreements with certain of our officers. Annual base salary during the term of the contracts does not exceed $315,000 for any one individual. Future minimum payments under these contracts are $996,000, $934,000 and $467,000 for the twelve-month periods ending March 31, 2005, 2006 and 2007, respectively.

Structured Loan Financing Transaction
Our structured loan financing is not treated as a sale for financial reporting purposes. Distributions of the net assets from PMCT Trust, pursuant to its trust indenture, are limited and restricted. The reserve requirement (at its minimum of $1.4 million at March 31, 2004) is calculated as follows: the outstanding principal balance of PMCT Trust loans receivable which are delinquent 180 days or more plus 2% of our underlying loans receivable of PMCT Trust at inception ($1.4 million). As of March 31, 2004 and December 31, 2003, there were no loans receivable in PMCT Trust that were delinquent 180 days or more. At March 31, 2004, the cash balance in our reserve fund, included in restricted investments on our consolidated balance sheet, was approximately $1,438,000.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Structured Loan Sale Transactions
When our structured loan sale transactions were completed, the transaction documents of the SPE contained provisions (the “Credit Enhancement Provisions”) that govern the assets and the inflow and outflow of funds of the SPE formed as part of the structured loan sale transactions. The Credit Enhancement Provisions include specified limits on the delinquency, default and loss rates on the loans receivable included in each SPE. If, at any measurement date, the delinquency, default or loss rate with respect to any SPE were to exceed the specified limits, the Credit Enhancement Provisions would automatically increase the level of credit enhancement requirements for that SPE. During the period in which the specified delinquency, default or loss rate was exceeded, excess cash flow from the SPE, if any, would be used to fund the increased credit enhancement levels instead of being distributed, which would delay or reduce our distribution. During the first quarter of 2004, as a result of delinquent loans with a principal balance of $1.9 million related to two structured loans sale transactions, certain Credit Enhancement Provisions were triggered. As a consequence, cash flows of approximately $840,000 have been deferred and utilized to fund the increased reserve requirements. As a result of the $1.9 million of delinquent loans, management expects that approximately $1.0 million of additional cash flows will be deferred and used to fund the increased reserve requirements. Management believes that these funds, used to build the reserve fund, will be distributed to us in future periods. In general, there can be no assurance that amounts deferred under Credit Enhancement Provisions will be received in future periods or that future deferrals or losses will not occur.

Environmental
PMC Funding has recorded a liability of approximately $100,000 for the estimated remaining costs to remediate an environmental obligation related to an asset acquired through liquidation and subsequently sold during 1999 by PMC Funding. We cannot currently estimate when or if the full obligation may be required to be paid. There can be no assurance of the accuracy of this estimate. While not anticipated, if the underlying environmental remediation required increases as a result of a change in the effectiveness of the current remediation, additional costs will be incurred and such costs could be material.

Litigation
In the normal course of business, including our assets acquired in liquidation, we are subject to various proceedings and claims, the resolution of which will not, in management’s opinion, have a material adverse effect on our financial position or results of operations.

Note 20. Business Segments:

Operating results and other financial data are presented for our principal business segments. These segments are categorized by line of business which also corresponds to how they are operated. The segments include (i) the Lending Division, which originates loans to small businesses primarily in the hospitality industry and (ii) the Property Division which owns our Hotel Properties.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Our business segment data for the three months ended March 31, 2004 and 2003 was as follows: