PMC COMMERCIAL TRUST AND SUBSIDIARIES

INDEX

PART I

Financial Information

ITEM 1.

Financial Statements

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

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

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

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

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

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

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF BENEFICIARIES’ EQUITY

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

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

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

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 June 30, 2005 and the consolidated statements of income and comprehensive income for the three and six months ended June 30, 2005 and 2004 and beneficiaries’ equity and cash flows for the six months ended June 30, 2005 and 2004, 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 June 30, 2005 and our results of operations for the three and six months ended June 30, 2005 and 2004. 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, 2004.

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 involved the valuation of our net assets acquired in connection with the merger, the valuation of our retained interests in transferred assets, determination of reserves on our receivables and impairment analyses on our long-lived assets.

The results for the three and six months ended June 30, 2005 are not necessarily indicative of future financial results.

Note 2. Business:

PMC Commercial is a real estate investment trust (“REIT”) that either directly or through its subsidiaries, 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 shares are traded on the American Stock Exchange under the symbol “PCC.” On February 29, 2004, PMC Capital, Inc. (“PMC Capital”), a regulated investment company related to us through common management, was merged with and into PMC Commercial. As a result of the merger, we own and operate the businesses of PMC Capital and its subsidiaries, along with our existing operations and businesses.

Note 3. Consolidation:

We consolidate entities that we control by ownership of a majority voting interest as well as variable interest entities for which we are the primary beneficiary. To the extent we do not have a majority voting interest, we use the equity method to account for investments for which we have the ability to exercise significant influence over operating and financial policies. Consolidated net income includes our share of the net earnings of the entity accounted for using the equity method. The difference between consolidation and the equity method impacts certain financial ratios because of the presentation of the detailed line items reported in the financial statements. All material intercompany balances and transactions have been eliminated.

The consolidated financial statements include the accounts of PMC Commercial, First Western SBLC, Inc. (“First Western”), PMC Investment Corporation (“PMCIC”), Western Financial Capital Corporation (“Western Financial”), PMC Commercial Trust, Ltd. 1998-1 (“PMCT Trust”), PMC Funding Corp. (“PMC Funding”), PMC Asset Holding, LLC (“Asset Holding”), PMC Conduit, L.P. (“PMC Conduit”), PMC Properties, Inc. (“PMC Properties”) and four separate subsidiaries created in conjunction with the purchase of four hotel properties in 1999.

First Western is licensed as a small business lending company that originates loans through the Small Business Administration (“SBA”) 7(a) Guaranteed Loan Program. PMCIC is a licensed specialized small business investment company under the Small Business Investment Act of 1958, as amended (“SBIA”). Western Financial is a licensed small business investment company under the SBIA. PMCT Trust was formed in conjunction with our 1998 structured loan financing transaction.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

PMC Funding, Asset Holding and PMC Conduit hold assets on our behalf. PMC Properties is the operator, through third party managers, of certain limited service hotel properties.

In addition, we own subordinate financial interests in several non-consolidated special purpose entities. 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 Venture, the 2001 Joint Venture and the 2002 Joint Venture, the “Joint Ventures,” and the Joint Ventures together with the 1998 Partnership and the 1999 Partnership, the “QSPEs”). The QSPEs were created in connection with structured loan sale transactions.

We account for our 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 QSPEs are not included in our consolidated financial statements.

Note 4. Variable Interest Entities:

General Information
In December 2003, the Financial Accounting Standards Board issued Interpretation No. 46R (“FIN 46R”). The primary objectives of FIN 46R are to provide guidance on (1) the identification of entities for which control is achieved through means other than voting rights (Variable Interest Entities (“VIEs”)), and (2) how to determine when and which business enterprise should consolidate the VIE (the “primary beneficiary”). This model for consolidation applies to an entity which either (1) the equity investors, if any, do not have a controlling financial interest or (2) 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.

An entity should consolidate a VIE if that entity will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or both.

Conduit Warehouse Facility
On February 7, 2005, we entered into a $100.0 million conduit warehouse facility (the “Conduit Facility”). In conjunction with the Conduit Facility, we created a new subsidiary, PMC Conduit, a bankruptcy remote entity, which holds the assets and liabilities of the Conduit Facility. The Conduit Facility operates as a revolving line of credit, collateralized by loans originated by us, which have been or will be sold to PMC Conduit. The transfer of the loans to PMC Conduit did not meet the requirements of SFAS No. 140 for gain on sale treatment. PMC Commercial has not guaranteed the repayment of the obligations of the Conduit Facility.

PMC Conduit was determined to be a VIE and PMC Commercial is the primary beneficiary of PMC Conduit; therefore, PMC Conduit is consolidated in the financial statements of PMC Commercial.

Junior Subordinated Notes
On March 15, 2005, PMC Commercial issued notes payable (the “Junior Subordinated Notes”) of approximately $27.1 million due March 30, 2035 to a special purpose subsidiary, PMC Preferred Capital Trust-A, a Delaware statutory trust (the “Preferred Trust”). The Junior Subordinated Notes are subordinated to PMC Commercial’s existing debt.

The Preferred Trust was determined to be a VIE but PMC Commercial is not considered to be the primary beneficiary of the Preferred Trust; therefore, the Preferred Trust is not consolidated in PMC Commercial’s financial statements. The equity method is used to account for our investment in the Preferred Trust.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 5. 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 6. Share-Based Compensation Plans:

At June 30, 2005, we have options outstanding under share-based compensation plans. The 1993 Employee Share Option Plan and the Trust Manager Share Option Plan expired in December 2003; thus, no additional options will be issued under these two plans.

The 2005 Equity Incentive Plan was approved by our shareholders on June 11, 2005 and permits the grant of options to our employees, executive officers and Board of Trust Managers and restricted shares to our executive officers and Board of Trust Managers for up to 500,000 common shares. We believe that these awards better align the interests of our employees, executive officers and Board of Trust Managers with those of our shareholders.

We use the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” to account for all awards granted, modified or settled.

Option awards were granted with an exercise price equal to the market price of our common shares at the date of grant and vest immediately upon grant with five-year contractual terms. The restricted share awards 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).

We granted 36,700 option awards on June 11, 2005 at an exercise price of $14.54. The fair value of this option award was estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:

The expected term of the options granted represents the period of time that the options are expected to be outstanding and was determined based on our 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 volatility to determine our expected volatility. We recorded compensation expense of approximately $23,000 during the three and six months ended June 30, 2005 related to the option grant.

In addition, we issued an aggregate of 9,060 restricted shares to executive officers and our Board of Trust Managers on June 11, 2005 with the current market price of the shares at $14.54. Compensation expense is being recognized over the vesting period. We recorded compensation expense of approximately $49,000 during the three and six months ended June 30, 2005 for the vested portion of our restricted share issuance. As of June 30, 2005, there was approximately $82,000 of total unrecognized compensation expense related to the unvested restricted shares which will be recognized over the next two years.

We assumed unearned stock compensation in the merger with PMC Capital representing the intrinsic value of unvested options assumed that vest as the employees provide future services. Compensation expense was recognized over the vesting period. We recorded compensation expense of approximately $4,000 and $5,000 during the three and six months ended June 30, 2004, respectively, related to these unvested options.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 7. Merger:

PMC Capital merged with and into PMC Commercial on February 29, 2004. Benefits from the merger included a larger equity market capitalization that helps create new business flexibility and earnings stability. As a result of the larger equity base, our ability to meet our liquidity needs has been enhanced through access to larger credit facilities and alternative capital sources such as our Conduit Facility and Junior Subordinated Notes. 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 of the closing prices of our common shares for the six 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 incorporated PMC Capital’s activities 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 six months ended June 30, 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 our financial statements and the financial statements of PMC Capital and assumed the merger occurred on January 1, 2004:

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.

Note 8. Loans Receivable, net:

Loans receivable, net, consisted of the following:

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Additional information on our loans receivable, net, was as follows:

Our loans receivable were approximately 95% concentrated in the hospitality industry at June 30, 2005. Any economic factors that negatively impact the hospitality industry could have a material adverse effect on our financial condition or results of operations.

The activity in our loan loss reserves was as follows:

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Impaired loans are defined by generally accepted accounting principles as loans for which it is probable that the lender will be unable to collect all amounts due based on the original contractual terms of the loan. Information on those loans considered to be impaired loans was as follows:

Note 9. Real Estate Investments and Rent and Related Receivables:

As of June 30, 2005, we owned 16 hotel properties (the “Hotel Properties”). These properties were part of a sale and leaseback transaction commencing in 1998 with Arlington Hospitality, Inc. (“AHI”) whereby we purchased the properties from AHI and then leased the properties to a wholly-owned subsidiary of AHI, Arlington Inns, Inc. (“AII” and together with AHI, “Arlington”). We concurrently entered into a Master Lease Agreement with AHI and AII covering all the properties and entered into a guaranty agreement with AHI whereby AHI guaranteed all obligations of AII under the individual property lease agreements. The Master Lease Agreement, as amended, with the individual property lease agreements being known as the “Lease Agreement.”

The Lease Agreement expires in June 2008, but can be extended by either Arlington or us for one five-year period, and thereafter by Arlington for a five-year period and a subsequent two-year period. This initial five-year extension period must be exercised on an “all-or-none” basis. If fully extended, the term of the Lease Agreement would continue until September 2020. AHI guarantees the obligations of AII under the Lease Agreement. AHI 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.

The Lease Agreement (1) allows for the disposition of the Hotel Properties prior to October 1, 2008 and (2) provides for annual rent of 8.5% of the Stated Value established for the Hotel Properties. The Stated Value of each Hotel Property (currently an aggregate of $39.2 million) is the value attributed to each Hotel Property at inception of the Lease Agreement for purposes of determining the lease payment. The Lease Agreement provides for rent increases to approximately 10.5% and ultimately 15% of the Stated Value established for the Hotel Properties unless Hotel Properties are sold prior to October 1, 2008 and sales occur so that we own less than 16, 11 and six Hotel Properties at October 1, 2005, 2006 and 2007, respectively. In addition, the annual rent increases to 15% of the Stated Value established for the Hotel Properties in the event of a monetary default.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Lease income was recorded on a straight-line basis over the remaining fixed non-cancelable term of the Lease Agreement. Due to the initial five-year lease extension being controlled by PMC Commercial, the fixed non-cancelable lease term was through June 2013. During the three and six months ended June 30, 2005, we recorded approximately $543,000 and $1,137,000, respectively, in straight-line rent.

Lease Agreement Default
The May and June 2005 lease payments due from AII were not paid. As a result, we declared an event of default under the Lease Agreement, requested payment from AHI as the guarantor and asserted our right to terminate AII’s possession of the properties without terminating the individual lease agreements. We obtained possession of one property which we currently operate; however, on June 22, 2005, AII filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code which prevented us from any further attempts to terminate possession of any of the remaining properties without termination of the leases. AHI has not filed for bankruptcy although to date, AHI has not performed pursuant to the guaranty. On June 28, 2005, the Bankruptcy Court approved the rejection (i.e., termination) of two of the individual property leases under the Lease Agreement. As a result of the lease rejection, we were given possession of the two properties.

For the three properties we currently operate, we have retained third party management companies to operate the properties. There can be no assurance that AII will not reject either additional or all of the remaining individual property leases. It is our intention to sell these properties in an orderly and efficient manner. However, due to the bankruptcy of AII, there is an uncertainty as to the ultimate timing for the sale of these properties.

AII made its July and August rent payments (at 8.5% of the Stated Value established for the 13 Hotel Properties operated by AII) of approximately $224,000 each month during July and August 2005.

Real Estate Investments
Our real estate investments consisted of the following:

For our 16 Hotel Properties to be held and used, we performed a recoverability test to determine if the future undiscounted cash flows over our expected holding period for the Hotel Properties exceeded the carrying value of the Hotel Properties. Based on this analysis, we recorded impairment losses of approximately $1.9 million during the three and six months ended June 30, 2005 related to our Hotel Properties included in our property segment. Impaired assets identified were furniture, fixtures and equipment and buildings and improvements. Future cash flows are based on estimated future rent payments to be received on the Hotel Properties, proceeds from the sale and/or termination fees and property operations, if applicable. Management’s estimates of the values for property sales are based on current market conditions. These values may change based on the numerous factors that impact the (1) local and national economy, (2) prospects for the hospitality industry, (3) timing of particular sales, (4) franchise affiliation and (5) particular operating results of the property.

We have mortgage notes on 10 of our Hotel Properties. The net book value and mortgage payables of our mortgaged real estate investments was approximately $18.9 million and $12.6 million, respectively, at June 30, 2005.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Lease Payments
As a result of a monetary default, the Lease Agreement provides for rent to be at the default rate of 15% of the Stated Value established for the Hotel Properties; however, due to the uncertainty of collection we have not recorded this additional rent. For 2005, the annual rent payment for the 13 Hotel Properties operated by AII is approximately $2,686,000 based on 8.5% of the Stated Value established for the Hotel Properties (notwithstanding Arlington’s default).

In addition to our rent payment, we historically received percentage rent equal to 4% of the gross room revenues of the Hotel Properties which was deposited into an escrow account for future capital expenditures. Effective April 14, 2005, we signed a letter agreement with Arlington waiving the requirement for percentage rent on 12 of the 16 Hotel Properties during the three months ended March 31, 2005. AII did not pay the percentage rent due for May and June. In addition, the April payment was not made for 12 of the 16 Hotel Properties. For the six months ended June 30, 2005 and 2004, our percentage rent was approximately $30,000 and $280,000, respectively. For the three months ended June 30, 2005 and 2004, our percentage rent was approximately $8,000 and $156,000, respectively.

Minimum future lease payments receivable on the 13 remaining individual property leases, as amended, notwithstanding Arlington’s default, were as follows at June 30, 2005:

Rent and Related Receivables
Our rent and related receivables were as follows:

We evaluated the recoverability of these net assets based on a probability weighted analysis of the future cash flows expected to be received and determined that no allowance was necessary on these assets as of June 30, 2005. We currently anticipate that future rent and rent related income will be recorded on a cash basis due to the uncertainty surrounding collection and based on the results of our recoverability analysis. To the extent there is a reduction of estimated future cash flows, we would record an allowance against these receivables. Conversely, if we were to collect proceeds above our estimates, any excess would be recorded as lease income.

In addition to the rent and related receivables above, we maintain a capital expenditures account for future capital expenditures required to maintain the real estate investments. Funds are released from this account when capital expenditures are incurred. As of June 30, 2005, the balance in our capital expenditure account is approximately $1.1 million and is included in restricted investments on our consolidated balance sheet.

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Property Sales
Upon the sale of each of the Hotel Properties, AHI is required to provide us consideration equal to the Stated Value established for the Hotel Property being sold, through cash proceeds from a third party purchaser and an unsecured note from Arlington if the cash proceeds are less than the Stated Value established for the Hotel Property (a “Shortfall”). The Shortfall note receivable is unsecured, evidences the aggregate of all Shortfalls, originally matured in 2011 and had a fixed interest rate of 8.5%. At June 30, 2005, the Shortfall note receivable was approximately $776,000 (prior to discounts), had a default interest rate of 15% and is currently due since Arlington is now in default under the Lease Agreement. If, at any time, the aggregate Shortfall exceeds $4.0 million, AHI is immediately required to pay the excess. Any sales proceeds received in excess of the Stated Value established for the Hotel Property sold will be applied as a reduction of the balance outstanding on any Shortfall or if none are outstanding, then allocated to reduce the Stated Value established for the remaining Hotel Properties to be sold.

A Shortfall note receivable from AHI is recorded as a deferred liability at the estimated fair value of the note received since an uncertainty exists as to whether the note receivable will ultimately be collected from AHI or third party sales proceeds from the sale of the remaining properties. If principal payments are made on the Shortfall note such that the face amount of the Shortfall note is less than the deferred liability, income will be recorded. No later than the disposition of the final property, any remaining deferred liability will be considered earned and accordingly, will be recorded as income. We received fees of approximately $293,000 during the six months ended June 30, 2005 related to the sale of two hotel properties (one during the fourth quarter of 2004 and one during the first quarter of 2005) of which approximately $146,000 was recognized as income.

We sold a hotel property during March 2005, previously included in real estate investment held for sale, for $2.1 million and recognized a gain of approximately $127,000. AHI provided us with a Shortfall note receivable with an estimated fair value of $267,000 and we recorded a corresponding deferred liability which was included in other liabilities on our consolidated balance sheet.

During June 2005, we sold two hotel properties for approximately $4.9 million and recorded gains totaling approximately $978,000. In conjunction with these sales, the Shortfall note receivable was reduced by approximately $70,000 representing the sales proceeds received from third parties in excess of the Stated Value of the hotel properties.

Property Taxes
Per the Lease Agreement, Arlington is obligated to pay all property taxes on the Hotel Properties. As of June 30, 2005, property taxes due for 2004 but not yet paid by Arlington totaled approximately $250,000. We paid these property taxes during July 2005. As a result, we recorded general and administrative expense and accounts payable and accrued expenses of approximately $250,000 on our consolidated balance sheet for these taxes during the three and six months ended June 30, 2005. Since these taxes are the responsibility of Arlington under the Lease Agreement, we also recorded rent and related receivables on our consolidated balance sheet and lease income of approximately $250,000 during the three and six months ended June 30, 2005. Additional unpaid property taxes which are Arlington’s responsibility at June 30, 2005 totaled approximately $400,000. To the extent Arlington does not make these required tax payments, these property taxes are our responsibility, although we will pursue recovery from Arlington. Estimated annual tax assessments for 2005 on our 16 Hotel Properties total approximately $667,000.

Note 10. Retained Interests:

In our structured loan sale transactions, we contributed loans receivable to a QSPE in exchange for cash and beneficial interests in that entity. The QSPE issued notes payable (the “Structured Notes”) (usually through a private placement) to unaffiliated parties (“Structured Noteholders”). The QSPE then distributed a portion of the proceeds from the Structured Notes to us. The Structured Notes are collateralized solely by the assets of the QSPE which means that should the financial assets in the QSPE be insufficient for the trustee 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 QSPE, the Structured Notes issued by the QSPE, and the operating results of the QSPE are not included in our consolidated financial statements. The difference between (1) the carrying value of the loans receivable sold and (2) the sum of (a) the cash

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

received and (b) the relative fair value of our 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.

We completed joint structured loan sale transactions with PMC Capital during 2000, 2001, 2002 and 2003. Our interests related to the loans receivable we contributed to these structured loan sale transactions are the “Originated Structured Loan Sale Transactions.” As a result of the merger, on February 29, 2004, we acquired PMC Capital’s Retained 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 our Originated Structured Loan Sale Transactions as of June 30, 2005 was as follows:

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Information pertaining to our Acquired Structured Loan Sale Transactions as of June 30, 2005 was as follows:

None of the loans within our Originated or Acquired Structured Loan Sale Transactions were delinquent over 60 days as to principal and interest. However, we have identified one loan ($1.4 million) within our Acquired Structured Loan Sale Transactions (the 2002 Joint Venture) that we consider a problem loan. Problem loans are loans which are not complying with their contractual terms, the collection of the balance of the principal is considered impaired and on which the fair value of the collateral is less than the remaining unamortized principal balance. If we had to liquidate this loan, the loss could exceed estimates and the estimated fair value of our Retained Interests would decline.

In addition, First Western has Retained Interests related to the sale of loans originated pursuant to the SBA 7(a) Guaranteed Loan Program. 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 Secondary Market Loan Sales, we may 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 and servicing costs. At June 30, 2005, the aggregate principal balance of First Western’s serviced loans receivable on which we had an excess spread was approximately $39.2 million and the weighted average excess spread was approximately 0.7%. In determining the fair value of our Retained Interests related to Secondary Market Loan Sales, our assumptions at June 30, 2005 included a prepayment speed of 20% per annum and a discount rate of 11.6%.

First Western previously had Retained Interests related to the sale of the unguaranteed portion of its loans receivable through a private placement in 1997. On April 15, 2005, we acquired, through exercise of our option, the $2.2 million in loans

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

receivable remaining in the securitization for approximately $2.2 million using existing cash and the reserve fund balance of $912,000.

The estimated fair value of our Retained Interests is based upon an estimate of the discounted future cash flows we will receive. In determining the present value of expected future cash flows, estimates are made in determining the amount and timing of those cash flows and the discount rates. The amount and timing of cash flows is generally determined based on estimates of loan losses and anticipated prepayment speeds relating to the loans receivable contributed to the QSPE. Actual loan losses and prepayments may vary significantly from assumptions. The discount rates that we utilize in computing the estimated fair value are based upon estimates of the inherent risks associated with each cash flow stream. Due to the limited number of entities that conduct transactions with similar assets, the relatively small size of our Retained Interests and the limited number of buyers for such assets, no readily ascertainable market exists. Therefore, our estimate of the fair value may or may not vary from what a willing buyer would pay for these assets.

The components of our Retained Interests are as follows:

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Our Retained Interests consisted of the following:

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PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following sensitivity analysis of our Retained Interests as of June 30, 2005 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.

In accordance with SFAS No. 140, our consolidated financial statements do not include the assets, liabilities, partners’ capital, revenues or expenses of the QSPEs. As a result, at June 30, 2005 and December 31, 2004 our consolidated balance sheets do not include the $294.6 million and $321.4 million of assets, respectively, and $238.7 million and $263.4 million of liabilities, respectively, related to our structured loan sale transactions recorded by our QSPEs.

The following information summarizes the financial position of the QSPEs at June 30, 2005 and December 31, 2004.

Summary of Financial Position: