SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10 – K

þ		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2006

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 of incorporation or organization)		(I.R.S. Employer Identification No.)
17950 Preston Road, Suite 600, Dallas, TX 75252		(972) 349-3200
(Address of principal executive offices)		(Registrant’s telephone number)

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

Title of Each Class		Name of Each Exchange on Which Registered
Common Shares of beneficial interest, $.01 par value		American Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:
None

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES þ NO o

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

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

Indicate by check mark whether the Registrant is a shell company (as defined in Exchange Act Rule 12b-2).
YES o NO þ

Indicate by check mark whether the Registrant is a well-known seasoned issuer (as defined in Rule 405 of the Securities Act).
YES o NO þ

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

The aggregate market value of the voting stock held by non-affiliates of the Registrant, based upon the closing sale price of the Common Shares of Beneficial Interest on June 30, 2006 as reported on the American Stock Exchange, was approximately $121 million. Common Shares of Beneficial Interest held by each officer and trust manager and by each person who owns 10% or more of the outstanding Common Shares of Beneficial Interest have been excluded because such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of March 2, 2007, the Registrant had outstanding 10,753,803 Common Shares of Beneficial Interest.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the Registrant’s Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the year covered by this Form 10-K with respect to the Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.

 

 

PMC COMMERCIAL TRUST

Form 10-K
For the Year Ended December 31, 2006

TABLE OF CONTENTS

ITEM				PAGE
PART I
1.		Business			2
1A.		Risk Factors			14
1B.		Unresolved Staff Comments			22
2.		Properties			23
3.		Legal Proceedings			23
4.		Submission of Matters to a Vote of Security Holders			23
PART II
5.		Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities			24
6.		Selected Consolidated Financial Data			25
7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			26
7A.		Quantitative and Qualitative Disclosures About Market Risk			56
8.		Consolidated Financial Statements and Supplementary Data			58
9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			58
9A.		Controls and Procedures			58
9B.		Other Information			58
PART III
10.		Directors and Executive Officers of the Registrant			59
11.		Executive Compensation			59
12.		Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters			60
13.		Certain Relationships and Related Transactions			60
14.		Principal Accountant Fees and Services			60
PART IV
15. Exhibits and Financial Statement Schedules					61
Signatures					62
Consolidated Financial Statements					F-1
Exhibits					E-1
Amendment No. 2 to Credit and Security Agreement
Subsidiaries of the Registrant
Consent of PricewaterhouseCoopers LLP
Section 302 Officer Certification - Chief Executive Officer
Section 302 Officer Certification - Chief Financial Officer
Section 906 Officer Certification - Chief Executive Officer
Section 906 Officer Certification - Chief Financial Officer

Forward-Looking Statements

     This Form 10-K 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. These statements include the plans and objectives of management for future operations, including plans and objectives relating to future growth of our loans receivable and availability of funds. 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. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties identified in this Form 10-K, including, without limitation, the risks identified under the caption “Item 1A. Risk Factors.” 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-K 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.

PART I

Item 1. BUSINESS

INTRODUCTION

     PMC Commercial Trust (“PMC Commercial” and together with its wholly-owned subsidiaries, the “Company,” “our” or “we”) is a real estate investment trust (“REIT”) that primarily originates loans to small businesses collateralized by first liens on the real estate of the related business. Our loans are primarily to borrowers in the limited service hospitality industry. We also originate loans for commercial real estate primarily in the service, retail, multi-family and manufacturing industries. In addition, our investments include the ownership of commercial properties in the hospitality industry. As a REIT, we seek to maximize shareholder value through long-term growth in dividends paid to our shareholders. We must distribute at least 90% of our REIT taxable income to shareholders to maintain our REIT status. See “Tax Status.” We pay dividends from the cash flow generated from operations. Our common shares are traded on the American Stock Exchange under the symbol “PCC.”

     Our mission is to derive income primarily from the origination of real estate collateralized loans and from ownership in income producing real estate. Through conservative underwriting and exceptional service, we strive to provide our shareholders with the highest dividend, consistent with the focus on preservation of investment capital.

     We generate revenue primarily from the yield and other fee income earned on our investments. Our operations are centralized in Dallas, Texas and include originating, servicing and selling commercial loans and to a lesser extent, property ownership. During the years ended December 31, 2006 and 2005, our total revenues were approximately $30.7 million and $25.1 million, respectively, and our net income was approximately $15.7 million and $11.3 million, respectively. See “Item 8. Consolidated Financial Statements and Supplementary Data” for additional financial information.

     In addition to loans originated by PMC Commercial, we also originate loans through our subsidiaries. Our wholly-owned lending subsidiaries are: First Western SBLC, Inc. (“First Western”), PMC Investment Corporation (“PMCIC”) and Western Financial Capital Corporation (“Western Financial”). First Western is licensed as a small business lending company (“SBLC”) that originates loans through the Small Business Administration’s (“SBA”) 7(a) Guaranteed Loan Program (“SBA 7(a) Program”). PMCIC and Western Financial are small business investment companies (“SBICs”). These subsidiaries were acquired in the merger with PMC Capital, Inc. (“PMC Capital”), our affiliate through common management, on February 29, 2004.

     First Western is currently a “Preferred Lender” nationwide, as designated by the SBA, and originates, sells and services small business loans throughout the continental United States. As a non-bank SBA 7(a) Program lender, First Western is able to originate loans on which a substantial portion of the loan (generally 75%) is

guaranteed as to payment of principal and interest by the SBA. A market exists for the sale of the guaranteed portion of First Western’s loans and we receive cash premiums at the time of sale that approximate up to 10% of the principal amount of the loan sold. To the extent we are able to increase our volume of loans originated by our SBLC, there should be a corresponding increase in premiums received. In addition, due to the existence of the SBA guarantee, we are able to originate loans that would not typically meet our underwriting criteria due to the profitability of the loan including the premium received. See “Lending Activities – SBA Programs.”

     Our ability to generate interest income, as well as other loan related fees, is dependent upon economic, regulatory and competitive factors that influence interest rates and loan originations and our ability to secure financing for our investment activities. The amount of income earned varies based on the volume of loans funded, the timing and amount of structured loan transactions, the volume of loans which prepay and the resultant applicable prepayment fees, if any, the mix of loans (construction versus non-construction), the interest rate on loans originated and the general level of interest rates.

     Generally, in order to fund new loans, we need to borrow funds or sell loans. From 1996 to 2003, our primary source of funds was structured loan transactions. In a structured loan transaction, we contribute loans receivable to a special purpose entity (“SPE”) in exchange for cash and a subordinate financial interest in that entity. If the SPE meets the definition of a qualifying special purpose entity (“QSPE”), we account for the transaction as a sale of our loans receivable; and as a result, neither the loans receivable contributed to the QSPE nor the notes payable issued by the QSPE are included in our consolidated financial statements. See “Structured Loan Transactions.” Since the completion of our last securitization in October 2003, our working capital has been provided through credit facilities and the issuance of junior subordinated notes in March 2005.

     We have historically operated in two identifiable reportable segments: (1) the lending division, which originates loans to small businesses primarily in the hospitality industry and (2) the property division, which owns and operates certain of our hotel properties. As a result of sales of a majority of our hotel properties, at December 31, 2006, the lending division comprised approximately 98% of our total assets. See detailed financial information regarding our segments in “Item 8. Consolidated Financial Statements and Supplementary Data.”

LENDING ACTIVITIES

Overview

     Our lending division originates loans to small businesses, primarily in the hospitality industry. For the year ended December 31, 2006, total revenues and income from continuing operations of our lending division were approximately $28.5 million (approximately 93% of our total revenues) and $15.0 million, respectively. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Executive Summary.”

     We are a national lender that primarily originates small business loans in the limited service sector of the hospitality industry. In addition to first liens on real estate of the related business, our loans are generally personally guaranteed by the principals of the entities obligated on the loans.

     We identify loan origination opportunities through personal contacts, internet referrals, attendance at trade shows and meetings, correspondence with local chambers of commerce, direct mailings, advertisements in trade publications and other marketing methods. We also generate loans through referrals from lawyers, accountants, real estate and loan brokers and existing borrowers. Payments are often made to non-affiliated individuals who assist in generating loan applications, with such payments generally not exceeding 1% of the principal amount of the originated loan.

Limited Service Hospitality Industry

     Our loans are generally collateralized by first liens on limited service hospitality properties and are typically made for owner-operated facilities operating under national franchises. We believe that franchise operations offer attractive lending opportunities because such businesses generally employ proven business concepts, have national reservation systems, have consistent product quality, are screened and monitored by franchisors and generally have a higher rate of success when compared to other independently operated hospitality businesses.

     Lodging demand in the United States appears to correlate to changes in the United States Gross Domestic Product (“U.S. GDP”), with typically a two to three quarter lag. Given the relatively strong U.S. GDP growth over the past several years, continued improvement in 2007 lodging demand has been predicted by industry analysts. Such improvement will be dependent upon several factors including: the strength of the economy, the correlation of hotel demand to new hotel supply and the impact of global or domestic events on travel and the hotel industry. Leading industry analysts, including PricewaterhouseCoopers LLP, have published reports that predict the industry’s results will continue to improve in 2007.

Loan Originations and Underwriting

     We originate mortgage loans to small businesses primarily collateralized by commercial real estate. We believe that we successfully compete in certain sectors of the commercial real estate finance market due to our understanding of our borrowers’ businesses, the flexible loan terms that we offer and our responsive customer service. Our approach to assessing new commercial mortgage loans requires an analysis of the property operator, the replacement cost of the collateral, its liquidation value and an analysis of local market conditions.

     We consider the underlying cash flow of the tenant or owner-occupant as well as more traditional real estate underwriting criteria such as:

	•		The components and value of the borrower’s collateral (primarily real estate);
	•		The ease with which the collateral can be liquidated;
	•		The industry and competitive environment in which the borrower operates;
	•		The financial strength of the guarantors;
	•		The existence of any secondary repayment sources; and
	•		The existence of a franchise relationship.

     Upon receipt of a completed loan application, our credit department conducts: (1) a detailed analysis of the potential loan, which typically includes an appraisal and a valuation by our credit department of the property that will collateralize the loan to ensure compliance with loan-to-value percentages, (2) a site inspection for real estate collateralized loans, (3) a review of the borrower’s business experience, (4) a review of the borrower’s credit history, and (5) an analysis of the borrower’s debt-service-coverage, debt-to-equity and other applicable ratios. All appraisals are performed by an approved, licensed third party appraiser and based on the market value, replacement cost and cash flow value approaches. We utilize nationwide independent appraisal firms and local market economic information to the extent available.

     We believe that our typical non SBA 7(a) Program loan is distinguished from those of some of our competitors by the following characteristics:

	•		Substantial down payments are required. We usually require an initial down payment of not less than 20% of the value of the property which is collateral for the loan at the time of such loan. Our experience has shown that the likelihood of full repayment of a loan increases if the owner/operator is required to make an initial and substantial financial commitment to the property which is collateral for the loan.
	•		“Cash outs” are typically not permitted. Generally, we will not make a loan in an amount greater than the lesser of either the replacement cost of the property which is collateral for the loan or the current appraised value of the property which is collateral for the loan. For example, a hotel property may have been originally constructed for a cost of $2,000,000, with the owner/operator borrowing $1,600,000 of that amount. At the time of the borrower’s loan refinancing request, the property securing the loan is appraised at $4,000,000. Some of our competitors might loan from 70% to 90% or more of the new appraised value of the property and permit the owner/operator to receive a cash distribution from the proceeds. Generally, we would not permit this type of “cash-out” distribution.
	•		The obligor is personally liable for the loan. We generally require the principals of the borrower to personally guarantee the loan.

     We are currently originating primarily variable-rate loans. Our variable-rate loans are based on (1) LIBOR or (2) the prime rate (primarily related to our SBA 7(a) Program). Many of our competitors are presently pricing fixed-rate loans based on a spread over the interest rate swap market. We are currently offering fixed-rate loans to borrowers at approximately 3.5% over the 5-year treasury rate and anticipate the maximum amount of fixed-rate loans we will originate under this program to be approximately $30.0 million. We are continually evaluating the feasibility of utilizing the swap market or interest rate caps to lock in a fixed cost of funds so that we can offer a more competitive fixed-rate product. Based on the current interest rate environment, these alternative sources of pricing are not viable for us since there is significant exposure of loss of capital in the event of loan liquidation or

prepayment. To the extent we are able to use the swap market or interest rate caps to lock in a fixed cost of funds, we believe our originations of fixed-rate loans would increase. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Current Operating Overview and Economic Factors – Lending Division.”

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

		At December 31,
		2006												2005
										Weighted												Weighted
										Average												Average
		Loans Receivable, net								Interest				Loans Receivable, net								Interest
		Amount				%				Rate				Amount				%				Rate
		(Dollars in thousands)
Variable-rate — LIBOR		$	127,931				75.6	%			9.4	%		$	120,645				76.6	%			8.3	%
Fixed-rate			23,419				13.9	%			8.8	%			18,651				11.8	%			9.4	%
Variable rate — prime			17,831				10.5	%			10.2	%			18,278				11.6	%			8.7	%
Total		$	169,181				100.0	%			9.4	%		$	157,574				100.0	%			8.5	%

     Our variable-rate loans receivable generally require monthly payments of principal and interest, reset on a quarterly basis, to amortize the principal over the remaining life of the loan. Fixed-rate loans receivable generally require level monthly payments of principal and interest calculated to amortize the principal over the remaining life of the loan.

Loan Activity

     The following table details our loan activity for the years indicated:

		Years Ended December 31,
		2006				2005				2004				2003				2002
		(In thousands)
Loans receivable, net — beginning of year		$	157,574			$	128,234			$	50,534			$	71,992			$	78,486
Loans originated			71,530				58,852				53,659				31,320				32,776
Loans acquired in the merger (1)			—				—				55,144				—				—
Principal collections (2)			(47,240	)			(13,826	)			(23,196	)			(5,655	)			(11,637	)
Repayments of SBA 504 program loans (3)			(2,342	)			(2,180	)			(1,621	)			(1,963	)			(631	)
Loans sold (4)			(6,373	)			(7,785	)			(6,222	)			—				—
Loans transferred to AAL (5)			(3,730	)			(5,657	)			(2,115	)			—				—
Structured loan sales (6)			—				—				—				(45,456	)			(27,286	)
Loan deemed to be repurchased from QSPE (7)			—				—				2,126				—				—
Other adjustments (8)			(238	)			(64	)			(75	)			296				284
Loans receivable, net — end of year		$	169,181			$	157,574			$	128,234			$	50,534			$	71,992

Quarterly Loan Originations

     The following table is a breakdown of loans originated on a quarterly basis during the years indicated:

		Years Ended December 31,
		2006				2005				2004				2003				2002
		(In thousands)
First Quarter		$	17,630			$	8,251			$	6,609			$	9,009			$	6,346
Second Quarter			13,536				11,236				17,255				12,103				6,506
Third Quarter			5,710				15,010				14,998				5,557				10,044
Fourth Quarter			34,654				24,355				14,797				4,651				9,880
Total		$	71,530			$	58,852			$	53,659			$	31,320			$	32,776

Loan Portfolio Statistics

     Information on our loans receivable, loans which have been sold (either to our QSPEs or secondary market sales of SBA 7(a) Program loans) and on which we have retained interests (the “Sold Loans”) and our loans receivable combined with our Sold Loans (the “Aggregate Portfolio”) was as follows:

		At December 31,
		2006												2005
		Aggregate				Sold Loans				Loans				Aggregate				Sold Loans				Loans
		Portfolio				(1)				Receivable				Portfolio				(1)				Receivable
		(Dollars in thousands)
Portfolio outstanding (2)		$	397,567			$	227,874			$	169,693			$	447,220			$	288,652			$	158,568
Weighted average interest rate			9.5	%			9.6	%			9.4	%			8.8	%			8.9	%			8.5	%
Annualized average yield (3)			10.5	%			10.1	%			11.0	%			9.4	%			9.6	%			8.9	%
Weighted average contractual maturity (in years)			15.0				13.6				16.7				15.3				14.6				16.8
Impaired loans (4)		$	5,415			$	3,496			$	1,919			$	12,780			$	5,558			$	7,222
Hospitality industry concentration %			91.7	%			90.0	%			93.9	%			91.5	%			89.6	%			94.9	%
Texas concentration % (5)			24.7	%			26.5	%			22.3	%			24.0	%			28.9	%			14.9	%

Industry Concentration

     The distribution of our loan portfolio by industry was as follows at December 31, 2006:

		Loans Receivable												Aggregate Portfolio
		Number								% of				Number								% of
		of								Total				of								Total
		Loans				Cost (1)				Cost				Loans				Cost (1)				Cost
		(Dollars in thousands)
Hotels and motels			161			$	159,417				93.9	%			311			$	364,530				91.7	%
Gasoline/service stations			16				6,638				3.9	%			23				14,051				3.5	%
Restaurants			15				1,219				0.7	%			15				2,894				0.7	%
Apartments/RV Parks			3				771				0.5	%			7				4,532				1.1	%
Retail, other			9				556				0.3	%			9				1,601				0.4	%
Services			10				364				0.2	%			18				3,486				0.9	%
Other			13				728				0.5	%			16				6,473				1.7	%
			227			$	169,693				100.0	%			399			$	397,567				100.0	%

SBA Programs

General

     We utilize programs established by the SBA to generate loan origination opportunities and provide us with a funding source as follows:

	•		We have an SBLC that originates loans through the SBA’s 7(a) Program;
	•		We participate as a private lender in the SBA 504 Program which allows us to originate first mortgage loans with lower loan-to-value ratios;
	•		We have two licensed SBICs regulated under the Small Business Investment Act of 1958, as amended (“SBIA”). Our SBICs use long-term funds provided by the SBA, together with their own capital, to provide long-term collateralized loans to eligible small businesses, as defined under SBA regulations.

     Our regulated SBA subsidiaries are periodically examined and audited by the SBA to determine compliance with SBA regulations.

SBA 7(a) Program

     Under the SBA 7(a) Program, the SBA typically guarantees 75% of qualified loans over $150,000 with such guarantees to an individual not exceeding $1.5 million. While the eligibility requirements of the SBA 7(a) Program vary by the industry of the borrower and other factors, the general eligibility requirements are that: (1) gross sales of the borrower cannot exceed $6.5 million, (2) liquid assets of the borrower and affiliates cannot exceed specified limits, and (3) the maximum aggregate SBA loan guarantees to a borrower cannot exceed $1.5 million. Maximum maturities for SBA 7(a) Program loans are 25 years for real estate and between seven and 15 years for the purchase of machinery, furniture, fixtures and/or equipment. In order to operate as an SBLC, a licensee is required to maintain a minimum net worth (as defined by SBA regulations) of the greater of (1) 10% of the outstanding loans receivable and other investments or (2) $1.0 million, as well as certain other regulatory restrictions such as change in control provisions. See “Item 1A. Risk Factors.”

SBA 504 Program

     The SBA 504 Program assists small businesses in obtaining subordinated, long-term financing by guaranteeing debentures available through certified development companies for the purpose of acquiring land, building, machinery and equipment and for modernizing, renovating or restoring existing facilities and sites. A typical finance structure for an SBA 504 Program project would include a first mortgage covering 50% of the project cost from a private lender, a second mortgage obtained through the SBA 504 Program covering up to 40% of the project cost and a contribution of at least 10% of the project cost by the principals of the small businesses being assisted. We typically require at least a 20% contribution of the equity in a project by our borrowers. The SBA

does not guarantee the first mortgage. Although the total sizes of projects utilizing the SBA 504 Program are unlimited, currently the maximum amount of subordinated debt in any individual project is generally $1.5 million (or $2 million for certain projects). Typical project costs range in size from $1 million to $6 million.

SBIC Program

     We originate loans to small businesses through our SBICs. According to SBA regulations, SBICs may make long-term loans to small businesses and invest in the equity securities of such businesses. Under present SBA regulations, eligible small businesses include businesses that have a net worth not exceeding $18 million and have average annual fully taxable net income not exceeding $6 million for the most recent two fiscal years. An SBIC can issue debentures whose principal and interest is guaranteed to be paid to the debt holder in the event of non-payment by the SBIC. As a result, the debentures’ costs of funds are usually lower compared to alternative fixed-rate sources of funds available to us.

PROPERTY DIVISION

     We originally purchased a total of 30 properties, operated as Amerihost Inns, during 1998 and 1999. These properties were part of a sale and leaseback transaction 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. AII filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code (“Chapter 11”) on June 22, 2005. AHI filed for bankruptcy protection under Chapter 11 on August 31, 2005.

     We commenced selling properties during 2000, and we began 2006 with 13 owned Amerihost Inns and two Amerihost Inns acquired in liquidation of loans for a total of 15 properties. On January 13, 2006, AII rejected the leases and turned over property operations to us. We sold 12 of these properties during the first half of 2006. Our property division owns and operates our limited service hospitality properties through third party management companies. For the year ended December 31, 2006, total revenues and loss from continuing operations of our property division were approximately $2.2 million (approximately 7% of our total revenues) and $1.3 million, respectively.

     At December 31, 2006, two of the three limited service hospitality properties that we own were included in our consolidated financial statements. We leased one of our three remaining hotel properties during the third quarter of 2006 and as a result of the lease structure, have deconsolidated the ownership and operations of the property. We are currently marketing to lease the remaining two properties. As a REIT, we cannot directly operate hotel properties; therefore, the properties are being operated by third party management companies.

STRUCTURED LOAN TRANSACTIONS

General

     Structured loan transactions have historically been our primary method of obtaining funds for new loan originations. In a structured loan transaction, we contribute loans receivable to an SPE in exchange for a subordinate financial interest in that entity and obtain an opinion of counsel that the contribution of the loans receivable to the SPE constitutes a “true sale” of the loans receivable. The SPE issues notes payable (usually through a private placement) to third parties and then distributes a portion of the notes payable proceeds to us. The notes payable are collateralized solely by the assets of the SPE. If the SPE meets the definition of a QSPE, we account for the structured loan transaction as a sale of our loans receivable; and as a result, neither the loans receivable contributed to the QSPE nor the notes payable issued by the QSPE are included in our consolidated financial statements. The terms of the notes payable issued by the QSPEs provide that the partners of these QSPEs are not liable for any payment on the notes. Accordingly, if the QSPEs fail to pay the principal or interest due on the notes, the sole recourse of the holders of the notes is against the assets of the QSPEs. We have no obligation to pay the notes, nor do the holders of the notes have any recourse against our assets. We are the servicer of the loans pursuant to the transaction documents and are paid a fee of 30 basis points per year based on the principal outstanding.

     When a structured loan sale transaction is completed our ownership interests in the QSPEs are accounted for as retained interests in transferred assets (“Retained Interests”) and recorded at the present value of the estimated

future cash flows to be received from the QSPE. The difference between (1) the carrying value of the loans receivable sold and (2) the sum of (a) the cash received and (b) the relative fair value of our Retained Interests, constitutes the gain or loss on sale. Gains or losses on these sales may represent a material portion of our net income in the period in which the transactions occur.

     All of our securitization transactions provide a clean-up call. A clean-up call is an option allowed by the transaction documents to repurchase the transferred assets when the amount of the outstanding assets (or corresponding notes payable outstanding) falls to a level at which the cost of servicing those assets becomes burdensome. The clean-up call option regarding a loan in a QSPE or SPE is exercised by the party that contributed the loan to the QSPE or SPE.

     Since we have historically relied on structured loan transactions as our primary source of operating capital to fund new loan originations, any adverse changes in our ability to complete this type of transaction, including any negative impact on the asset-backed securities market for the type of product we generate, could have a detrimental effect on our ability to generate funds to originate loans. See “Item 1A — Risk Factors.”

Structured Loan Sale Transactions

General

     As of December 31, 2006, the QSPEs consisted of:

	•		PMC Capital, L.P. 1998-1 (the “1998 Partnership”) and its related general partner;
	•		PMC Capital, L.P. 1999-1 (the “1999 Partnership) and its related general partner;
	•		PMC Joint Venture, L.P. 2000 (the “2000 Joint Venture”) and its related general partner;
	•		PMC Joint Venture, L.P. 2001 (the “2001 Joint Venture”) and its related general partner;
	•		PMC Joint Venture, L.P. 2002-1 (the “2002 Joint Venture”) and its related general partner; and,
	•		PMC Joint Venture, L.P. 2003-1 (the “2003 Joint Venture,” and together with the 2000 Joint Venture, the 2001 Joint Venture and the 2002 Joint Venture, the “Joint Ventures”) and its related general partner.

     As a result of the merger, we acquired PMC Capital’s subordinate interests in the Joint Ventures and 100% of the subordinate interests in the 1998 Partnership and the 1999 Partnership (collectively, the “Acquired Structured Loan Sale Transactions”). We previously owned subordinate interests in the Joint Ventures (the “Originated Structured Loan Sale Transactions”). Even though we own 100% of the subordinate interest in each of the Joint Ventures, since a portion was obtained through acquisition, we recorded these investments separately. At the date of acquisition, the fair value of the Acquired Structured Loan Sale Transactions became our cost.

     In addition, First Western has Retained Interests related to the sale of loans originated pursuant to the SBA 7(a) Program.

Originated Structured Loan Sale Transactions

     Information relating to our Originated Structured Loan Sale Transactions was as follows:

		2000 Joint				2001 Joint				2002 Joint				2003 Joint
		Venture				Venture				Venture				Venture
		(Dollars in thousands)
Transaction date			12/18/00				06/27/01				04/12/02				10/07/03
Principal amount of loans sold:
At time of sale		$	55,675			$	32,662			$	27,286			$	45,456
At December 31, 2006		$	29,018			$	9,161			$	15,510			$	25,480
Structured notes:
At time of sale		$	49,550			$	30,063			$	24,557			$	40,910
At December 31, 2006		$	23,597			$	6,562			$	12,740			$	22,182
Weighted average interest rate on loans (1):
At time of sale			9.63	%			9.62	%			9.23	%			L+4.02	%
At December 31, 2006			9.54	%			9.70	%			9.55	%			L+4.02	%
Required overcollateralization:
At time of sale (2)			11.0	%			8.0	%			10.0	%			10.0	%
At December 31, 2006 (3)			19.1	%			28.5	%			17.7	%			17.8	%
Interest rate on the structured notes payable (1)			7.28	%			6.36	%			6.67	%			L+1.25	%
Rating of structured notes (4)		“Aaa”				“Aaa”				“Aaa”				“Aaa”
Cash reserve requirement (5)			6.0	%			6.0	%			6.0	%			6.0	%

Acquired Structured Loan Sale Transactions

     Information relating to our Acquired Structured Loan Sale Transactions was as follows:

		1998				1999				2000 Joint				2001 Joint				2002 Joint				2003 Joint
		Partnership				Partnership				Venture				Venture				Venture				Venture
		(Dollars in thousands)
Principal amount of loans sold:
At February 29, 2004		$	21,702			$	29,800			$	17,345			$	37,191			$	36,102			$	56,424
At December 31, 2006		$	11,795			$	15,060			$	8,561			$	17,931			$	17,133			$	38,631
Structured notes:
At February 29, 2004		$	21,221			$	26,394			$	15,636			$	33,324			$	32,932			$	50,774
At December 31, 2006		$	11,757			$	11,579			$	5,860			$	15,875			$	12,877			$	32,954
Weighted average interest rate on loans (1):
At February 29, 2004			P+1.22	%			9.40	%			9.20	%			9.64	%			9.58	%			L+4.02	%
At December 31, 2006			P+0.96	%			9.07	%			9.00	%			9.67	%			9.52	%			L+4.02	%
Required overcollateralization (2) (3):
At February 29, 2004			10.5	%			12.0	%			15.7	%			10.6	%			12.0	%			10.2	%
At December 31, 2006			10.5	%			23.8	%			31.9	%			22.0	%			25.2	%			15.0	%
Mortgage-backed security (4)			5.0	%			—				—				—				—				—
Interest rate on structured notes (1)			P-1.00	%			6.60	%			7.28	%			6.36	%			6.67	%			L+1.25	%
Rating of structured notes (5)		“Aaa”				“Aaa”				“Aaa”				“Aaa”				“Aaa”				“Aaa”
Cash reserve requirement (6)		$	1,329			$	1,210				6.0	%			6.0	%			6.0	%			6.0	%

Retained Interests

     As a result of our structured loan sale transactions, we have Retained Interests representing our residual interest in the loans sold to the QSPEs. When we securitize loans, we are required to recognize Retained Interests, which represent our right to receive net future cash flows, at their fair value. Our Retained Interests consist of (1) the required overcollateralization, which is the retention of a portion of each of the Sold Loans, (2) the reserve fund, which represents the required cash balance owned by the QSPE and (3) the interest-only strip receivable, which represents the future excess funds to be generated by the QSPE after payment of all obligations of the QSPE. Our Retained Interests are subject to credit, prepayment and interest rate risks. The estimated fair value of our Retained Interests is determined based on the present value of estimated future cash flows that we will receive from the QSPEs. The estimated future cash flows are calculated based on assumptions concerning, among other things, loan losses and prepayment speeds. On a quarterly basis, we measure the fair value of, and record income relating to, the Retained Interests based upon the future anticipated cash flows discounted based on an estimate of market interest rates for investments of this type. Any appreciation of the Retained Interests is included in our balance sheet in beneficiaries’ equity. Any depreciation of Retained Interests is either included in our statement of income as either a permanent impairment (if there is a reduction in expected future cash flows) or on the balance sheet in beneficiaries’ equity as an unrealized loss.

     We retain a portion of the default and prepayment risk associated with the underlying loans of our Retained Interests. Actual defaults and prepayments, with respect to estimating future cash flows for purposes of valuing our

Retained Interests will vary from our assumptions, possibly to a material degree, and slower (faster) than anticipated prepayments of principal or lower (higher) than anticipated loan losses will increase (decrease) the fair value of our Retained Interests and related cash flows. We regularly measure our loan loss, prepayment and other assumptions against the actual performance of the loans sold. Although we believe that assumptions made as to the future cash flows are reasonable, actual rates of loss or prepayments will vary from those assumed and the assumptions may be revised based upon changes in facts or circumstances. See “Item 1A – Risk Factors – Investments General – There is no market for our Retained Interests and the value is volatile.”

     In accordance with generally accepted accounting principles, our consolidated financial statements do not include the assets, liabilities, partners’ capital, revenues or expenses of the QSPEs. As a result, at December 31, 2006 and 2005, our consolidated balance sheets do not include $207.7 million and $276.1 million in assets, respectively, and $156.5 million and $220.8 million in liabilities, respectively, related to these structured loan sale transactions recorded by the QSPEs. At December 31, 2006, the partners’ capital of the QSPEs was approximately $51.2 million compared to the estimated value of the associated Retained Interests of approximately $55.1 million.

TAX STATUS

     PMC Commercial has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”). As a REIT, PMC Commercial is generally not subject to Federal income tax (including any applicable alternative minimum tax) to the extent that it distributes at least 90% of its REIT taxable income to shareholders. Certain of PMC Commercial’s subsidiaries, including First Western and PMCIC, have elected to be treated as taxable REIT subsidiaries; thus, their earnings are subject to U.S. Federal income tax. To the extent PMC Commercial’s taxable REIT subsidiaries retain their earnings and profits, these earnings and profits will be unavailable for distribution to our shareholders.

     PMC Commercial may, however, be subject to certain Federal excise taxes and state and local taxes on its income and property. If PMC Commercial fails to qualify as a REIT in any taxable year, it 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. REITs are subject to a number of organizational and operational requirements under the Code. See “Item 1A – Risk Factors – REIT Related Risks” for additional tax status information.

EMPLOYEES

     We employed 45 individuals including marketing professionals, investment professionals, operations professionals and administrative staff as of December 31, 2006. In addition, we have employment agreements with our executive officers. Annual base salary during the terms of the contracts does not exceed $375,000 for any one individual. Our operations are conducted from our Dallas, Texas office. We believe the relationship with our employees is good.

COMPETITION

     In originating loans we compete with other specialty commercial lenders, banks, broker dealers, other REITs, savings and loan associations, insurance companies and other entities that originate loans. Many of these competitors have greater financial and managerial resources than us, are able to provide services we are not able to provide (i.e., depository services), and may be better able to withstand the impact of economic downturns than we are. In addition, the yield curve combined with increased competition has caused margin compression.

     Fixed-rate lending: As a result of the prolonged period in which the yield curve has been inverted or flat (i.e., compression of long-term and short-term interest rates) combined with increased competition from fixed-rate lenders, our margins for fixed-rate loans contracted to the point where it is no longer economically viable for us to compete for fixed-rate loans. In addition, the market has changed where borrowers are looking predominately for fixed-rate loans; however, our ability to offer fixed-rate loans is constrained by our cost of funds. Local banks offer a five-year maturity, 20-year amortization loan (“mini-perm loan”) at a more attractive rate than we can offer based on our current sources of funds. Consequently, we are currently predominately committing to loans with a variable rate.

     We continue to actively pursue alternative sources of funds and evaluate interest rate hedges to reduce our cost of funds and/or reduce interest rate risk, which may allow us to originate fixed-rate loans at more competitive rates.

     Variable-rate lending: For our variable-rate loan product, we believe we compete effectively on the basis of interest rates, our long-term maturities and payment schedules, the quality of our service, our reputation as a lender, timely credit analysis and greater responsiveness to renewal and refinancing requests from borrowers.

CUSTOMERS

     In relation to our lending division, we are not dependent upon a single borrower, or a few borrowers, whose loss would have a material adverse effect on us. In addition, we have not loaned more than 10% of our assets to any single borrower.

SECURITIES EXCHANGE ACT REPORTS

     The Company maintains an internet site at the following address: www.pmctrust.com. The information on the Company’s website is not incorporated by reference in this annual report on Form 10-K.

     We make available on or through our website certain reports and amendments to those reports that we file with or furnish to the Securities and Exchange Commission (“SEC”) in accordance with the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These include our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K. We make this information available on our website free of charge as soon as reasonably practicable after we electronically file the information with, or furnish it to, the SEC.

Item 1A. RISK FACTORS

     Management has identified the following important factors that could cause actual results to differ materially from those reflected in forward-looking statements or from our historical results. These factors, which are not all-inclusive, could have a material impact on our asset valuations, results of operations or financial condition. In addition, these factors could impair our ability to maintain dividend distributions at current levels.

Investment Risks — Lending Activities

Competition might prevent us from originating loans at favorable yields, which would harm our results of operations and our ability to continue paying dividends at current levels.

     Our net income depends on our ability to originate loans at favorable spreads over our borrowing costs. In originating loans, we compete with other specialty commercial lenders, banks, broker dealers, other REITs, savings and loan associations, insurance companies and other entities that originate loans, many of which have greater financial resources than us. As a result, we may not be able to originate sufficient loans at favorable spreads over our borrowing costs, which would harm our results of operations and consequently, our ability to continue paying dividends at current levels.

There are significant risks in lending to small businesses.

     Our loans receivable consist primarily of loans to small, privately-owned businesses. There is no publicly available information about these businesses; therefore, we must rely on our own due diligence to obtain information in connection with our investment decisions. Our borrowers may not meet net income, cash flow and other coverage tests typically imposed by banks. A borrower’s ability to repay its loan may be adversely impacted by numerous factors, including a downturn in its industry or other negative economic conditions. Deterioration in a borrower’s financial condition and prospects may be accompanied by deterioration in the collateral for the loan. In addition, small businesses typically depend on the management talents and efforts of one person or a small group of people for their success. The loss of services of one or more of these persons could have an adverse impact on the operations of the small business. Small companies are typically more vulnerable to customer preferences, market conditions and economic downturns and often need additional capital to expand or compete. These factors may have an impact on the ultimate recovery of our loans receivable from such businesses. Loans to small businesses, therefore, involve a high degree of business and financial risk, which can result in substantial losses and accordingly should be considered speculative.

There is volatility in the valuation of our loans receivable which can require the establishment of loan loss reserves.

     There is typically no public market or established trading market for the loans we originate. The illiquid nature of our loans may adversely affect our ability to dispose of such loans at times when it may be advantageous for us to liquidate such investments.

     To the extent one or several of our borrowers experience significant operating difficulties and we are forced to liquidate the collateral underlying the loan, future losses may be substantial. The determination of whether significant doubt exists and whether a loan loss reserve is necessary for each loan requires judgment and consideration of the facts and circumstances existing at the evaluation date. Changes to the facts and circumstances of the borrower and/or the physical condition of the collateral underlying the loan, the hospitality industry and the economy may require the establishment of significant additional loan loss reserves.

Changes in interest rates could negatively affect lending operations, which could result in reduced earnings.

     The net income of our lending operations is materially dependent upon the “spread” between the rate at which we borrow funds and the rate at which we loan these funds. During periods of changing interest rates, interest rate mismatches could negatively impact our net income, dividend yield, and the market price of our common shares.

     At the present time, we primarily originate variable-rate loans and have certain debt which is long-term and at fixed interest rates and preferred stock which is long-term with a fixed dividend yield. If the yield on loans originated with funds obtained from fixed-rate borrowings or preferred stock fails to cover the cost of such funds, our cash flow will be reduced.

     As a result of our current dependence on variable-rate loans, our interest income will be reduced during low interest rate environments. To the extent that LIBOR or the prime rate decreases from current levels, interest income on our currently outstanding loans receivable will decline.

     Changes in interest rates do not have an immediate impact on the interest income of our fixed-rate loans receivable. Our interest rate risk on our fixed-rate loans receivable is primarily due to loan prepayments and maturities. The average maturity of our loan portfolio is less than their average contractual terms because of prepayments. The average life of mortgage loans receivable tends to increase when the current mortgage rates are substantially higher than rates on existing mortgage loans receivable and, conversely, decrease when the current mortgage rates are substantially lower than rates on existing mortgage loans receivable (due to refinancings of fixed-rate loans receivable at lower rates).

We depend on the accuracy and completeness of information about potential borrowers and guarantors.

     In deciding whether or not to extend credit or enter into transactions with potential borrowers and/or their guarantors, we rely on information furnished to us by or on behalf of potential borrowers and/or guarantors, including financial statements, construction invoices and other financial information. We also rely on representations of potential borrowers and/or guarantors as to the accuracy and completeness of that information. Our financial condition and results of operations could be negatively impacted to the extent we rely on financial statements that are materially misleading.

Investment Risks — General

There is no market for our Retained Interests and the value is volatile.

     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 for our Retained Interests. Therefore, our estimate of the fair value may vary significantly from what a willing buyer would pay for these assets. If a ready market existed for our Retained Interests, the value would be different and the difference may be significant.

     The following is a sensitivity analysis of our Retained Interests as of December 31, 2006 to highlight the volatility that results when prepayments, loan losses and discount rates are different than our assumptions:

		Estimated
		Fair
Changed Assumption		Value				Asset Change (1)
		(In thousands)
Losses increase by 50 basis points per annum (2)		$	54,157				($1,567	)
Losses increase by 100 basis points per annum (2)		$	52,583				($3,141	)
Rate of prepayment increases by 5% per annum (3)		$	55,136				($   588	)
Rate of prepayment increases by 10% per annum (3)		$	54,709				($1,015	)
Discount rates increase by 100 basis points		$	54,127				($1,597	)
Discount rates increase by 200 basis points		$	52,595				($3,129	)

     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 assumptions to the change in value may not be linear. The effect of a variation in a particular assumption on the estimated 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.

     Changes in any of these assumptions or actual results which deviate from assumptions will affect the estimated fair value of our Retained Interests, possibly to a material degree. There can be no assurance as to the accuracy of these estimates.

We have a concentration of investments in the hospitality industry and in certain states, which may negatively impact our financial condition and results of operations.

     Substantially all of our revenue is generated from loans collateralized by hospitality properties. At December 31, 2006, our loans receivable were approximately 94% concentrated in the hospitality industry and approximately 94% of the loans sold to our QSPEs were concentrated in the hospitality industry. Any economic factors that negatively impact the hospitality industry, including terrorism, travel restrictions, bankruptcies or other political or geopolitical events, could have a material adverse effect on our financial condition and results of operations.

     At December 31, 2006, approximately 22% of our loans receivable were collateralized by properties in Texas, approximately 10% were collateralized by properties in Ohio and approximately 24% of the loans sold to our QSPEs were collateralized by properties in Texas. No other state had a concentration of 10% or greater of our loans receivable, loans sold to our QSPEs or Aggregate Portfolio at December 31, 2006. 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.

We are subject to prepayment risk on our Retained Interests and loans receivable which could result in losses or reduced earnings and negatively affect our cash available for distribution to shareholders.

     Our prepayment activity has increased. Prepayment activity on our aggregate fixed-rate loans receivable has remained at high levels as a result of the continued low long-term interest rate environment combined with increased competition and the reduction or expiration of prepayment fees. In addition, prepayment activity for our aggregate variable-rate loans has increased since borrowers with variable-rate loans are generally seeking fixed-rate loans due to currently marketed fixed-rate interest rates being lower than the current interest rate on their loan and/or concerns of possible rising interest rates.

     The proceeds from the prepayments we receive are either used to repay debt or invested initially in temporary investments. During decreasing interest rate environments and when competition is greater, prepayments of our fixed-rate loans have generally been re-loaned or committed to be re-loaned at lower interest rates than the prepaid loans receivable. For prepayments on variable-rate loans, if the spread we charge over LIBOR or the prime rate were to decrease, the lower interest rates we would receive on these new loans receivable would have an adverse effect on our results of operations and depending upon the rate of future prepayments may further impact our results of operations.

     Prepayments on loans sold to the QSPEs may have a negative impact on our financial condition or results of operations. Prepayments of loans receivable with higher interest rates negatively impact the value of our Retained Interests to a greater extent than prepayments of loans receivable with lower interest rates. Prepayments in excess of assumptions will cause a decline in the fair value of our Retained Interests primarily relating to a reduction in the excess funds (our interest-only strip receivable) expected from our structured loan sale transactions. For example, if a $1.0 million loan with an interest rate of 10% prepays and the “all-in cost” of that QSPE’s structured notes was 7%, we would lose the 3% spread we had expected to receive on that loan in future periods. Our “all-in costs” include interest, servicing, trustee and other ongoing costs. The “spread” that is lost may be offset in part or in whole by any prepayment fee that we collect.

     Our SBLC sells the guaranteed portion of most of its originated loans through private placements (“Secondary Market Sales”). These sales are particularly sensitive to prepayments. Our Retained Interests in these loan sales consists only of the spread between the interest collected from the borrower and the interest paid to the purchaser of the guaranteed portion of the loan. Therefore, to the extent the prepayments of these loans exceed estimates, we lose the estimated fair value of the associated Retained Interests.

Our Board of Trust Managers may change operating policies and strategies without shareholder approval or prior notice and such change could harm our business and results of operations and the value of our stock.

     Our Board of Trust Managers has the authority to modify or waive our current operating policies and strategies, including PMC Commercial’s election to operate as a REIT, without prior notice and without shareholder

approval. We cannot predict the effect any changes to our current operating policies and strategies would have on our business, operating results and value of our stock; however, the effect could be adverse.

Liquidity and Capital Resources Risks

Our operating results could be negatively impacted by our inability to access certain financial markets.

     We rely upon access to capital markets as a source of liquidity to satisfy our working capital needs, grow our business and invest in loans. Although we believe that we maintain sufficient access to these financial markets, adverse changes in the economy, the overall health of the limited service hospitality industry and increased loan losses could limit access to these markets and restrict us from continuing our current operating strategy or implementing new operating strategies.

The market for structured loan transactions may decline, which would decrease the availability of, and/or increase the cost of, working capital and negatively affect the potential for growth.

     We will continue to need capital to fund loans. Historically, we have sold loans receivable as part of structured loan transactions, borrowed from financial institutions and issued equity securities to raise capital. A reduction in the availability of funds from financial institutions or the asset-backed securities market could have a material adverse effect on our financial condition and our results of operations. Our long-term ability to continue to grow depends, to a large extent, on our ability to sell asset-backed securities through structured loan transactions. In certain economic markets the availability of funds may be diminished or the “spread” charged for funds may increase causing us to delay a structured loan transaction. In addition, terrorist attacks or political or geopolitical events could impact the availability and cost of capital.

     A number of factors could impair our ability, or alter our decision, to complete a structured loan transaction. These factors include, but are not limited to:

	•		As a result of certain economic conditions, investors in the type of asset-backed securities that we place may increase our cost of capital by widening the “spreads” (over a benchmark such as LIBOR or treasury rates) they require in order to purchase the asset-backed securities or cease acquiring our type of asset-backed security;
	•		A deterioration in the performance of our loans receivable or the loans receivable of our prior transactions (for example, higher than expected loan losses or delinquencies) may deter potential investors from purchasing our asset-backed securities;
	•		A deterioration in the operations or market perception of the limited service sector of the hospitality industry may deter potential investors from purchasing our asset-backed securities or lower the available rating from the rating agencies; and
	•		A change in the underlying criteria utilized by the rating agencies may cause transactions to receive lower ratings than previously issued thereby increasing the cost on our transactions.

     Significant changes in any of these criteria may result in us temporarily suspending the use of structured loan transactions and we may seek other sources of financing. A reduction in the availability or an increased cost of this source of funds could have a material adverse effect on our financial condition and results of operations since working capital may not be available or available at acceptable “spreads” to fund future loan originations or to acquire real estate.

We use leverage to fund our capital needs which magnifies the effect of changing interest rates on our earnings.

     We have borrowed funds and intend to borrow additional funds. As a result, we use leverage to fund our capital needs. Private lenders and the SBA have fixed dollar claims on our assets superior to the claims of the holders of our common shares. Leverage magnifies the effect that rising or falling interest rates have on our earnings. Any increase in the interest rate earned by us on investments in excess of the interest rate on the funds obtained from borrowings would cause our net income and earnings per share to increase more than they would without leverage, while any decrease in the interest rate earned by us on investments would cause net income and earnings per share to decline by a greater amount than they would without leverage. Leverage is thus generally considered a speculative investment technique. In order for us to repay indebtedness on a timely basis, we may be required to dispose of assets when we would not otherwise do so and at prices which may be below the net book value of such assets. Dispositions of assets could have a material adverse effect on our financial condition and results of operations.

Operating Risks

Economic slowdowns, negative political events and changes in the competitive environment could adversely affect operating results.

     Several factors may impact the hospitality industry. Many of the businesses to which we have made, or will make, loans may be susceptible to economic slowdowns or recessions. During economic downturns, there may be reductions in business travel and consumers generally take fewer vacations. Terrorism, bankruptcies or other political or geopolitical events could negatively affect our borrowers. Our non-performing assets are likely to increase during these periods. These conditions could lead to losses in our portfolio and a decrease in our interest income, net income and assets.

     Another factor which affects the limited service sector of the hospitality industry is a significant rise in gasoline prices within a short period of time. A significant portion of the limited service hospitality properties collateralizing our loans are located on interstate highways. When gas prices sharply increase, occupancy rates for properties located on interstate highways may decrease. These factors may cause a reduction in revenue per available room. If revenue for the limited service sector of the hospitality industry were to experience significant sustained reductions, the ability of our borrowers to meet their obligations could be impaired and loan losses could increase.

     Many of our competitors have greater financial and managerial resources than us and are able to provide services we are not able to provide (i.e., depository services). As a result of these competitors’ size and diversified income resources, they may be better able to withstand the impact of economic downturns.

There may be significant fluctuations in our quarterly results which may adversely affect our stock price.

     Our quarterly operating results fluctuate based on a number of factors, including, among others:

	•		Interest rate changes;
	•		The volume and timing of loan originations and prepayments of our loans receivable;
	•		The recognition of gains or losses on investments;
	•		The level of competition in our markets; and
	•		General economic conditions, especially those which affect the hospitality industry.

     As a result of the above factors, quarterly results should not be relied upon as being indicative of performance in future quarters.

We depend on our key personnel, and the loss of any of our key personnel could adversely affect our operations.

     We depend on the diligence, experience and skill of our key personnel (executive officers) who provide management services to us for the selection, acquisition, structuring, monitoring and sale of our portfolio assets and the borrowings used to acquire these assets. We have entered into employment agreements with our executive officers. The loss of any executive officer could harm our business, financial condition, cash flow and results of operations.

We operate in a highly regulated environment, changes in which could adversely affect our financial condition or results of operations.

     As a company whose common shares are publicly traded, we are subject to the rules and regulations of the SEC. In addition, we are regulated by the SBA. Changes in laws that govern our entities may significantly affect our business. Laws and regulations may be changed from time to time, and the interpretations of the relevant laws and regulations are also subject to change. Any change in the laws or regulations governing our business could have a material impact on our financial condition or results of operations.

     At any time, U.S. Federal income tax laws governing REITs or the administrative interpretations of those laws may be amended. Any of those new laws or interpretations thereof may take effect retroactively and could adversely affect us. The Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced the tax rate on both dividends and long-term capital gains for most non-corporate taxpayers to 15% until 2008. This reduced maximum tax rate generally does not apply to ordinary REIT dividends, which continue to be subject to tax at the higher tax rates applicable to ordinary income (a maximum rate of 35%). However, the 15% maximum tax rate does apply to

certain REIT distributions. This legislation may cause shares in non-REIT corporations to be a more attractive investment to individual investors than shares in REITs and may adversely affect the market price of our common shares.

     To the extent a loan becomes a problem loan, we will deliver a default notice and begin foreclosure and liquidation proceedings when we determine that pursuit of these remedies is the most appropriate course of action. Foreclosure and bankruptcy are complex and sometimes time consuming processes that are subject to Federal and state laws and regulations, as well as various guidelines imposed by mortgage investors.

     In conjunction with the operations of our assets acquired in liquidation and hotel properties, we are subject to numerous Federal, state and local laws and government regulations including environmental, occupational health and safety, state and local taxes and laws relating to access for disabled persons.

     Regarding our owned properties, under various Federal, state and local laws, ordinances and regulations, a current or former owner or operator of real estate may be considered liable for the costs of remediating or removing hazardous substances found on its property, regardless of whether or not the property owner or operator was responsible for its presence. Such liability may be imposed by the Environmental Protection Agency or any state or local government authority regardless of fault. The ultimate costs under environmental laws and the timing of these costs are difficult to predict, and the liability under some environmental laws related to contaminated sites can be imposed retroactively, may be on a joint and several basis and could be material to our financial statements or results of operations.

     The Americans with Disabilities Act of 1990 (“ADA”) requires all public accommodations and commercial facilities to meet federal requirements related to access and use by disabled persons. Compliance with the ADA requirements could require removal of access barriers. Although we believe that the properties that we own or finance are substantially in compliance with these requirements, a determination that the properties are not in compliance with the ADA could result in the imposition of fines by the U.S. Government or an award of damages to private litigants.

REIT Related Risks

Failure to qualify as a REIT would subject PMC Commercial to U.S. Federal income tax.

     If a company meets certain income and asset diversification and income distribution requirements under the Code, it can qualify as a REIT and be entitled to pass-through tax treatment. We would cease to qualify for pass-through tax treatment if we were unable to comply with these requirements. PMC Commercial is also subject to a non-deductible 4% excise tax (and, in certain cases, corporate level income tax) if we fail to make certain distributions. Failure to qualify as a REIT would subject us to Federal income tax as if we were an ordinary corporation, resulting in a substantial reduction in both our net assets and the amount of income available for distribution to our shareholders.

     We believe that we have operated in a manner that allows us to qualify as a REIT under the Code and intend to continue to so operate. Although we believe that we are organized and operate as a REIT, no assurance can be given that we will continue to remain qualified as a REIT. Qualification as a REIT involves the application of technical and complex provisions of the Code for which there are limited judicial or administrative interpretations and involves the determination of various factual matters and circumstances not entirely within our control. In addition, no assurance can be given that new legislation, regulations, administrative interpretations or court decisions will not significantly change the tax laws with respect to qualification as a REIT or the Federal income tax consequences of such qualification.

     In addition, compliance with the REIT qualification tests could restrict our ability to take advantage of attractive investment opportunities in non-qualifying assets, which would negatively affect the cash available for distribution to our shareholders.

     If PMC Commercial fails to qualify as a REIT, we may, among other things:

	•		not be allowed a deduction for distributions to our shareholders in computing our taxable income;
	•		be subject to U.S. Federal income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates;
	•		be subject to increased state and local taxes; and,
	•		unless entitled to relief under certain statutory provisions, be disqualified from treatment as a REIT for the taxable year in which we lost our qualification and the four taxable years following the year during which we lost our qualification.

     As a result of these factors, failure to qualify as a REIT could also impair our ability to expand our business and raise capital, substantially reduce the funds available for distribution to our shareholders and may reduce the market price of our common shares.

Ownership limitation associated with our REIT status may restrict change of control or business combination opportunities.

     In order for PMC Commercial to qualify as a REIT, no more than 50% in value of our outstanding capital shares may be owned, directly or indirectly, by five or fewer individuals during the last half of any calendar year. “Individuals” include natural persons, private foundations, some employee benefit plans and trusts, and some charitable trusts.

     To preserve PMC Commercial’s REIT status, our declaration of trust generally prohibits any shareholder from directly or indirectly owning more than 9.8% of any class or series of our outstanding common shares or preferred shares without specific waiver from our Board of Trust Managers. The ownership limitation could have the effect of discouraging a takeover or other transaction in which holders of our common shares might receive a premium for their shares over the then prevailing market price or which holders might believe to be otherwise in their best interests.

Failure to make required distributions to our shareholders would subject us to tax.

     In order to qualify as a REIT, an entity generally must distribute to its shareholders, each taxable year, at least 90% of its taxable income, other than any net capital gain and excluding the non-distributed taxable income of taxable REIT subsidiaries. As a result, our shareholders receive periodic distributions from us. Such distributions are taxable as ordinary income to the extent that they are made out of current or accumulated earnings and profits. To the extent that a REIT satisfies the 90% distribution requirement, but distributes less than 100% of its taxable income, it will be subject to federal corporate income tax on its undistributed income. In addition, the REIT will incur a 4% nondeductible excise tax on the amount, if any, by which its distributions in any calendar year are less than the sum of:

	•		85% of its ordinary income for that year;
	•		95% of its capital gain net income for that year; and
	•		100% of its undistributed taxable income from prior years.

     We have paid out, and intend to continue to pay out, our REIT taxable income to shareholders in a manner intended to satisfy the 90% distribution requirement and to avoid Federal corporate income tax.

     Our taxable income may substantially exceed our net income as determined based on generally accepted accounting principles (“GAAP”) because, for example, capital losses will be deducted in determining GAAP income, but may not be deductible in computing taxable income. In addition, we may invest in assets that generate taxable income in excess of economic income or in advance of the corresponding cash flow from the assets, referred to as excess non-cash income. Although some types of non-cash income are excluded in determining the 90% distribution requirement, we will incur Federal corporate income tax and the 4% excise tax with respect to any non-cash income items if we do not distribute those items on an annual basis. As a result of the foregoing, we may generate less cash flow than taxable income in a particular year. In that event, we may be required to use cash reserves, incur debt, or liquidate non-cash assets at rates or times that we regard as unfavorable in order to satisfy the distribution requirement and to avoid federal corporate income tax and the 4% excise tax in that year.

Our ownership of and relationship with our taxable REIT subsidiaries will be limited, and a failure to comply with the limits would jeopardize our REIT status and may result in the application of a 100% excise tax.

     Subject to certain restrictions, a REIT may own up to 100% of the stock of one or more taxable REIT subsidiaries. A taxable REIT subsidiary may earn income that would not be qualifying income if earned directly by the parent REIT. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a taxable REIT subsidiary. A corporation of which a taxable REIT subsidiary directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a taxable REIT subsidiary. Overall, no more than 20% of the value of a REIT’s assets may consist of stock or securities of one or more taxable REIT subsidiaries. A taxable REIT subsidiary generally will pay income tax at regular corporate rates on any taxable income that it earns. In addition, the taxable REIT subsidiary rules limit the deductibility of interest paid or accrued by a taxable REIT subsidiary to its parent REIT to assure that the taxable REIT subsidiary is subject to an appropriate level of corporate taxation. The rules also impose a 100% excise tax on certain transactions between a taxable REIT subsidiary and its parent REIT that are not conducted on an arm’s-length basis.

     Our taxable REIT subsidiaries are PMCIC, First Western, PMC Funding Corp. and PMC Properties, Inc. (“PMC Properties”). PMC Funding Corp. holds assets on our behalf. PMC Properties is the operator, through third party management companies, of our hotel properties.

     Our taxable REIT subsidiaries are subject to normal corporate income taxes. We continuously monitor the value of our investments in taxable REIT subsidiaries for the purpose of ensuring compliance with the rule that no more than 20% of the value of our assets may consist of taxable REIT subsidiary stock and securities (which is applied at the end of each calendar quarter). The aggregate value of our taxable REIT subsidiary stock and securities is less than 20% of the value of our total assets (including our taxable REIT subsidiary stock and securities). In addition, we will scrutinize all of our transactions with our taxable REIT subsidiaries for the purpose of ensuring that they are entered into on arm’s-length terms in order to avoid incurring the 100% excise tax described above. There are no distribution requirements applicable to the taxable REIT subsidiaries and after-tax earnings may be retained. There can be no assurance, however, that we will be able to comply with the 20% limitation on ownership of taxable REIT subsidiary stock and securities on an ongoing basis so as to maintain REIT status or to avoid application of the 100% excise tax imposed on certain non-arm’s-length transactions.

Hotel Property Ownership Risks

We are dependent on third party management for the operation and management of our hotel
properties and we are subject to operating risks of hotel properties.

     We are dependent upon third party managers to operate and manage our hotel properties. As a REIT, PMC Commercial cannot directly operate the hotel properties. The operating results of our hotel properties are subject to a variety of risks which could negatively impact their cash flows.

     We are incurring costs including holding costs and operating costs until the remaining two properties are leased. There can be no assurance that we will be able to find new tenants for our hotel properties or negotiate to receive the same amount of historical lease income.

We could encounter risks that adversely affect real estate ownership.

     Our real estate investments are subject to a variety of risks including, but not limited to:

	•		adverse changes in general or local economic or real estate market conditions;
	•		changes in zoning laws;
	•		changes in traffic patterns and neighborhood characteristics;
	•		increases in assessed valuation and real estate tax rates;
	•		increases in the cost of property insurance;
	•		governmental regulations and fiscal policies;
	•		the potential for uninsured or underinsured property losses; and
	•		the impact of environmental laws and regulations.

     Materialization of any of these risks could cause us to incur losses, and our results of operations and financial condition could be adversely impacted.

We may be required to make significant capital improvements to maintain our hotel properties and their flags.

     We may be required to replace furniture, fixtures and equipment or to make other capital improvements or renovations to the hotel properties which could affect our liquidity. We could also need periodic capital improvements to comply with standards associated with any flag under franchise agreements. These capital improvements may cause a disruption of operations and potential lost room revenue to the extent not covered by insurance and/or a reduction of return on our investment in these hotel properties.

Item 1B. UNRESOLVED STAFF COMMENTS

     None.

Item 2. PROPERTIES

     We lease office space for our corporate headquarters in Dallas, Texas under an operating lease which expires in October 2011.

     At December 31, 2006, two of the three limited service hospitality properties that we own were included in our consolidated financial statements. Of our consolidated properties, one property is located in Illinois and one is in Ohio. The Illinois property has 60 rooms and was built in 1995. The Ohio property has 79 rooms and was built in 1990. We are currently marketing to lease these two properties. The remaining property owned by our unconsolidated subsidiary is located in Indiana, was built in 1992 and has 60 rooms.

Item 3. 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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     There were no matters submitted to a vote of security holders during the fourth quarter of 2006.

PART II

Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

     The Common Shares are traded on the American Stock Exchange (the “AMEX”) under the symbol “PCC.” The following table sets forth, for the periods indicated, the high and low sales prices as reported on the AMEX and the regular and special dividends per share declared by us for each such period.

										Regular				Special
										Dividends Per				Dividends Per
Quarter Ended		High				Low				Share				Share
December 31, 2006		$	15.43			$	13.65			$	0.30			$	0.10
September 30, 2006		$	14.72			$	12.68			$	0.30				—
June 30, 2006		$	13.59			$	12.40			$	0.30				—
March 31, 2006		$	13.80			$	12.19			$	0.30				—
December 31, 2005		$	13.48			$	11.26			$	0.30				—
September 30, 2005		$	13.67			$	11.30			$	0.30				—
June 30, 2005		$	15.44			$	12.80			$	0.30				—
March 31, 2005		$	15.65			$	14.64			$	0.35				—
December 31, 2004		$	15.98			$	14.40			$	0.34				—
September 30, 2004		$	15.44			$	14.00			$	0.34				—
June 30, 2004		$	15.55			$	13.03			$	0.34				—
March 31, 2004		$	17.20			$	14.77			$	0.38				—

     On March 2, 2007, there were approximately 1,250 holders of record of Common Shares and the last reported sales price of the Common Shares was $14.87.

     Our shareholders are entitled to receive dividends when and as declared by our Board of Trust Managers (the “Board”). Our Board considers many factors in determining dividend policy including, but not limited to, expectations for future earnings, REIT taxable income, the interest rate environment, competition, our ability to obtain leverage and our loan portfolio activity. The Board also uses REIT taxable income plus tax depreciation in determining the amount of dividends declared. In addition, as a REIT we are required to pay out 90% of taxable income. Consequently, the dividend rate on a quarterly basis will not necessarily correlate directly to any single factor such as REIT taxable income or earnings expectations. We anticipate, as a result of earnings from our core business and gains generated on our property sales, that we will maintain our current regular quarterly dividend of $0.30 per share through the end of 2007.

     We have certain covenants within our debt facilities that limit our ability to pay out returns of capital as part of our dividends. These restrictions have not historically limited the amount of dividends we have paid and management does not believe that they will restrict future dividend payments. See “Selected Consolidated Financial Data” in Item 6, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in Item 7 and “Consolidated Financial Statements and Supplementary Data” in Item 8 for additional information concerning dividends.

     We have not had any sales of unregistered securities during the last three years.

     See Item 12 in this Form 10-K for information regarding our equity compensation plans.

Item 6. SELECTED CONSOLIDATED FINANCIAL DATA

     The following is a summary of our Selected Consolidated Financial Data as of and for the five years in the period ended December 31, 2006. The following data should be read in conjunction with our consolidated financial statements and the notes thereto and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this Form 10-K. The selected financial data presented below has been derived from our consolidated financial statements.

		Years Ended December 31,
		2006				2005				2004 (1)				2003				2002
		(In thousands, except per share information)
Total revenues		$	30,677			$	25,099			$	20,916			$	9,983			$	11,212
Income from continuing operations (2)		$	13,648			$	9,378			$	9,923			$	4,763			$	6,194
Discontinued operations (2)		$	2,036			$	1,919			$	3,265			$	2,700			$	3,180
Gain on sale of loans receivable		$	—			$	—			$	—			$	711			$	562
Extraordinary item: negative goodwill		$	—			$	—			$	11,593			$	—			$	—
Net income		$	15,684			$	11,297			$	24,781			$	8,174			$	9,936
Basic weighted average common shares outstanding			10,748				10,874				10,134				6,448				6,444
Basic and diluted earnings per common share:
Income from continuing operations and gain on sale of loans receivable (2)		$	1.27			$	0.86			$	0.98			$	0.85			$	1.05
Extraordinary item: negative goodwill		$	—			$	—			$	1.14			$	—			$	—
Net income		$	1.46			$	1.04			$	2.44			$	1.27			$	1.54
Dividends declared, common		$	13,975			$	13,569			$	14,140			$	9,932			$	10,440
Dividends per common share		$	1.30			$	1.25			$	1.40			$	1.54			$	1.62

		At December 31,
		2006				2005				2004 (1)				2003				2002
		(In thousands)
Loans receivable, net		$	169,181			$	157,574			$	128,234			$	50,534			$	71,992
Retained Interests		$	55,724			$	62,991			$	70,523			$	30,798			$	23,532
Real estate investments, net		$	4,414			$	8,080			$	36,223			$	41,205			$	44,928
Real estate investments, held for sale, net		$	—			$	15,470			$	1,859			$	2,134			$	1,877
Total assets		$	240,404			$	259,192			$	253,840			$	131,736			$	149,698
Debt		$	64,841			$	84,040			$	75,349			$	33,380			$	48,491
Redeemable preferred stock of subsidiary		$	3,668			$	3,575			$	3,488			$	—			$	—

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following discussion should be read in conjunction with our Consolidated Financial Statements and the related notes that appear elsewhere in this document.

BUSINESS

     We are primarily a commercial lender that originates loans to small businesses that are principally collateralized by first liens on the real estate of the related business. We then sell certain of our loans receivable through privately-placed structured loan transactions. Historically, we have retained residual interests in all loans receivable sold through our subordinate financial interest in the related qualifying special purpose entities (“QSPEs”).

     Our revenues have historically included the following:

	•		Interest earned on our loans receivable;
	•		Lease and operating income on our hotel properties;
	•		Income on our Retained Interests; and
	•		Other related loan fees, including servicing fees, late fees, prepayment fees, assumption fees and construction monitoring fees.

     Our ability to generate interest income, as well as other revenue sources, is dependent on economic, regulatory and competitive factors that influence interest rates and loan originations, and our ability to secure financing for our investment activities. The amount of income earned will vary based on the volume of loans funded, the timing and amount of structured loan transactions, the volume of loans receivable which prepay, the mix of loans (construction versus non-construction), the interest rate and type of loans originated (whether fixed or variable) as well as the general level of interest rates. For a more detailed description of the risks affecting our financial condition and results of operations, see “Risk Factors” in Item 1A of this Form 10-K.

EXECUTIVE SUMMARY

Lending

     During 2006, our loan originations were approximately $71.5 million, of which approximately $19.8 million were originated in connection with sales of our Amerihost hotel properties and assets acquired in liquidation. While we were able to originate our highest quarterly loan volume in our history during the fourth quarter of 2006, we continue to be faced with many challenges in 2007.

     The competitive marketing challenges that we are facing have impacted our financial position through the significant amount of prepayments of our outstanding portfolio and are expected to impact future operating results. These challenges include:

	•		The loan products we offer do not include a competitive fixed-rate loan product and our volume of origination for variable-rate loans has diminished as many potential customers have sought a fixed-rate loan product;
	•		The margins we currently receive between the interest rate we charge our borrowers and the interest rate we are charged by our lenders have compressed;
	•		Prepayments have been at all time highs and caused significant reductions in both our serviced and retained portfolios;
	•		The differential between short-term interest rates (the prime rate is currently 8.25%) and long-term interest rates (5-year treasury rates are approximately 4.7%) has resulted in fixed-rate loans being more attractive than higher priced variable-rate loans; and
	•		An inverse/flat yield curve has eliminated the premium we historically achieved for providing a longer term (typically 20 years) fully amortizing loan.

     As a result of these loan origination challenges and our goal to expand our portfolio, we are exploring additional investment opportunities. We expect to identify and invest in opportunities in the real estate market that are natural additions to supplement our core business. Currently, we are evaluating investments including, but not limited to, ownership of office buildings, retail centers, office warehouses and other real estate, convenience and service stations, restaurants, joint venture ownership of hotels and acquisitions of real estate related businesses. We

are also evaluating opportunities with banks (or internet banks) which may provide alternative and/or lower costs of funds that will allow us to lend against real estate collateral. In order to finance these investments, we anticipate utilization of our credit facilities. While we are using resources to evaluate these opportunities, there can be no assurance that we will ultimately invest in any of these alternatives. In addition, some of these alternatives may initially generate negative cash flow and could impact our ability to maintain our dividend payments at their current levels. However, we anticipate, that as a result of earnings from our core business and gains generated on our property sales, that we will maintain our current regular quarterly dividend of $0.30 per share through the end of 2007.

     We also anticipate expansion of our Small Business Administration’s (“SBA”) 7(a) Guaranteed Loan Program (“SBA 7(a) Program”). Our wholly-owned subsidiary, First Western SBLC, Inc. (“First Western”), is licensed as a small business lending company that originates loans through the SBA 7(a) Program. First Western is a “Preferred Lender” nationwide, as designated by the SBA. This Preferred Lender status should shorten the time period necessary to originate SBA 7(a) Program loans. While we anticipate that as a result of this change, our originations under the SBA 7(a) Program will increase, to date we have not realized a significant increase in origination volume or commitments since our marketing efforts generally take time to provide benefits. We recently expanded our marketing initiatives for origination of SBA 7(a) Program loans and anticipate increased volume as a result.

Competition

     The number of lenders who compete with us for limited service hospitality loans has increased and many of these competitors have a lower cost of funds and are therefore able to offer rates below what we can offer. The yield curve combined with increased competition has caused margin compression.

     Fixed-rate lending: As a result of the prolonged period in which the yield curve has been inverted or flat (i.e., compression of long-term and short-term interest rates) combined with increased competition from fixed-rate lenders, our margins for fixed-rate loans contracted to the point where it is no longer economically viable for us to compete for fixed-rate loans. In addition, the market has changed where borrowers are looking predominately for fixed-rate loans; however, our ability to offer fixed-rate loans is constrained by our cost of funds. Local banks offer a five-year maturity, 20-year amortization loan (“mini-perm loan”) at a more attractive rate than we can offer based on our current sources of funds. Consequently, we are currently predominately committing to loans with a variable rate.

     If we reduce our rates in order to originate fixed-rate loans, it is likely that the spread on our next fixed-rate securitization would be significantly lower than we have historically achieved on our fixed-rate securitizations. In addition, there is a risk that during the interim period between when we make loans with fixed interest rates and when we complete a fixed-rate structured loan transaction, if rates were to rise, we would be negatively affected by interest rate spread compression. We continue to actively pursue alternative sources of funds and evaluate interest rate hedges to reduce our cost of funds and/or reduce interest rate risk, which may allow us to originate fixed-rate loans at more competitive rates.

     Variable-rate lending: Due to increased competition from variable-rate lenders, our margins for variable-rate loans have also contracted. Whereas historically we originated variable-rate loans at 3.5% to 4.5% over LIBOR, currently we are offering rates between 3.0% to 4.0% over LIBOR.

     In addition, as a result of our weighted average spread over LIBOR being reduced on our variable-rate loan originations, we anticipate that the spread between the interest rate on new loan originations and the cost of funds may be less than the spread of 2.77% on our variable-rate securitization completed during 2003.

Prepayments

     During 2006, we experienced significant prepayment activity. Prepayments of our retained portfolio were approximately $40.7 million during 2006 compared to approximately $9.4 million during 2005. In addition, during 2006 we had prepayments of approximately $46.8 million in loans sold as part of securitizations compared to approximately $31.7 million during 2005. This increased activity is primarily a result of competitors providing refinance opportunities for our borrowers combined with the effect of the reduction or expiration of our prepayment fees on certain of our loans due to the structure of the fees (i.e., expiration of lock out or yield maintenance provisions). We believe that we will continue to see high levels of prepayment activity during 2007. During January and February 2007, prepayments of our retained portfolio and our loans sold as part of securitizations were

approximately $7.6 million and $10.8 million, respectively.

Property Ownership

     We originally purchased a total of 30 properties, operated as Amerihost Inns, during 1998 and 1999. In June 2005, Arlington Inns, Inc. (“AII”) filed for bankruptcy protection. This was followed in August 2005 with the bankruptcy filing of Arlington Hospitality, Inc. (“AHI” and together with AII, “Arlington”), the parent of AII and the guarantor of all lease obligations.

     We commenced selling properties during 2000, and we began 2006 with 13 owned Amerihost Inns and two Amerihost Inns acquired in liquidation of loans for a total of 15 properties. On January 13, 2006, AII rejected the leases and turned over property operations to us. We sold 12 of these properties during the first half of 2006.

     At December 31, 2006, two of the three hotel properties that we own were included in our consolidated financial statements. As a REIT, PMC Commercial cannot directly operate these properties; therefore, we are dependent upon third party management companies to operate and manage our hotel properties. As these properties have mortgages (which were assumed in the original purchase from AHI) with significant prepayment penalties, we do not anticipate selling these properties until the properties’ market values increase or the prepayment penalties decrease.

     One hotel property is owned by our non-consolidated subsidiary and was leased effective September 29, 2006. The lessee has the option, and is expected to exercise this option, to purchase the property for $1,825,000 at termination of the lease in January 2011, or earlier if certain events occur. Due to the nature of the lease, the subsidiary that owns the hotel property is no longer consolidated in our financial statements and the equity method is used to account for our investment in the subsidiary effective September 29, 2006. We are currently marketing to lease the remaining two properties.

     We have significant outstanding claims against Arlington’s bankruptcy estate. Based on information provided through the bankruptcy proceedings and an estimate of net cash proceeds available to the unsecured creditors, we recorded impairments on these claims during 2005 and 2006 and valued those claims at approximately $0.6 million at December 31, 2006. Arlington has objected to our claims and initiated a complaint in the bankruptcy seeking, among other things, the return of payments Arlington made pursuant to the leases and the Master Lease Agreement. Although the value of our claims against Arlington is significantly higher than Arlington’s claims against us, there is no assurance that we will collect our claims from Arlington nor is there any assurance we will not be required to make payments to the bankruptcy estate in connection with Arlington’s initiated claim.

CURRENT OPERATING OVERVIEW AND ECONOMIC FACTORS

     The following provides a summary of our current operating overview and significant economic factors that may have an impact on our financial condition and results of operations. The factors described below could impact the volume of loan originations, the income we earn on our assets, our ability to complete a securitization, the performance of our loans, the operations of our properties and/or the performance of the QSPEs.

Lending Division

     Loans originated during 2006 were $71.5 million (of which approximately $19.8 million were originated in conjunction with sales of our Amerihost hotel properties and assets acquired in liquidation) which is greater than the $58.9 million of loans we originated during 2005. We currently anticipate loan originations to be between $55 million and $70 million during 2007. At December 31, 2006 and 2005, our outstanding commitments to fund new loans were approximately $32.6 million and $50.5 million, respectively. The majority of our current commitments are for variable-rate loans which provide an interest rate match with our present sources of funds.

     Several key factors (as described both in “Executive Summary” and in more detail below) that affect our estimates of future loan originations are as follows:

	•		our current inability to originate fixed-rate loans with an adequate spread;
	•		borrowers looking to fix their cost of capital (borrow at fixed rates);
	•		uncertainty as to the cost of funds of future securitizations; and
	•		increased competition from local banks and other lenders, who are willing to lend at lower rates.

     We believe that in this interest rate environment borrowers are looking predominately for fixed-rate loans; however, to the extent we originate fixed-rate loans, we have potential exposure to interest rate risk. Local bank competitors offer, among other things, five-year fixed-rate loans with rates that are below the long-term interest rates that we can presently offer. Historically, the rate for our fixed-rate product needed to be around 3.75% to 4.00% over the 10-year treasury rate in order to provide us with what management believed was a reasonable spread. With the 10-year treasury rate at approximately 4.7%, historically the rate we needed to obtain was approximately 8.50% to 8.75% for a quality loan with a 20-year amortization and maturity. The local banks currently offer a five-year maturity, 20-year amortization loan at approximately 7.25% to 8.00%. Management believes that the difference between our competitor’s fixed rate products and our variable-rate products is causing a greater percentage of borrowers to take on the refinancing risk that rates will not rise significantly or be unavailable in five years and they are therefore accepting refinancing with our competitor’s mini-perm loans. Many of our competitors are presently pricing fixed-rate loans based on a spread over the interest rate swap market. We are currently offering fixed-rate loans to borrowers at approximately 3.5% over 5-year treasury rates and anticipate the maximum amount of fixed-rate loans we will originate under this program to be approximately $30.0 million. We are continually evaluating the feasibility of utilizing the swap market or interest rate caps to lock in a fixed cost of funds so that we can offer a more competitive fixed-rate product. Based on the current interest rate environment, these alternative sources of pricing are not viable for us since there is significant exposure of loss of capital in the event of loan liquidation or prepayment. To the extent we are able to use the swap market or interest rate caps to lock in a fixed cost of funds, we believe our originations of fixed-rate loans would increase.

     The net interest margin for our leveraged portfolio is dependent upon the difference between the cost of our borrowed funds and the rate at which we invest these funds (the “net interest spread.”) In general, a significant reduction in net interest spread may have a material adverse effect on our results of operations and may cause us to re-evaluate our lending focus. See “Executive Summary.” In addition, the weighted average spread over LIBOR for our variable-rate loans has decreased to 4.0% at December 31, 2006 from 4.2% at December 31, 2005.

     While we have been unable to effectively compete for fixed-rate loans, we believe that our LIBOR-based loan program (1) allows us to compete more effectively with the diminishing market share of variable-rate products, (2) provides us with a more attractive securitization product and (3) provides us with a net interest spread that is less susceptible to interest rate risk than fixed-rate loan programs.

Lodging Industry

     Lodging demand in the United States appears to correlate to changes in U.S. GDP, with typically a two to three quarter lag. Given the relatively strong U.S. GDP growth over the past several years, continued improvement in 2007 lodging demand has been predicted by industry analysts. Such improvement will be dependent upon several factors including the strength of the economy, the correlation of hotel demand to new hotel supply and the impact of global or domestic events on travel and the hotel industry. Leading industry analysts, including PricewaterhouseCoopers LLP, have published reports that predict the industry’s results will continue to improve in 2007.

PORTFOLIO INFORMATION

Lending Activities

General

     Our lending activities consist primarily of originating loans to borrowers who operate properties in the hospitality industry.

     Loans originated and principal repayments of our loans receivable were as follows:

		Years Ended
		December 31,
		2006				2005
		(In millions)
Loan Originations:
Commercial mortgage loans		$	36.9			$	35.9
SBA 7(a) Program loans			8.5				10.7
Loans originated in connection with sale of assets acquired in liquidation and hotel properties			19.8				8.5
SBA 504 program loans (1)			6.3				3.8
Total loans originated		$	71.5			$	58.9
Principal Repayments:
Prepayments		$	40.7			$	9.4
Proceeds from the sale of SBA 7(a) guaranteed loans			6.4				7.8
Scheduled principal payments			5.3				3.8
Balloon maturities or SBA 504 program loans			3.6				2.8
Total principal repayments		$	56.0			$	23.8

     At December 31, 2006, approximately $145.8 million of our loans receivable had a variable interest rate (reset on a quarterly basis) based primarily on the 90-day LIBOR, or the prime rate (primarily related to our SBA 7(a) Program) with a weighted average interest rate of approximately 9.5%. The spread that we charge over LIBOR generally ranges from 3.0% to 4.0% and the spread we charge over the prime rate generally ranges from 1.25% to 2.50%. The LIBOR and prime rate used in determining interest rates during the first quarter of 2007 (set on January 1, 2007) was 5.36% and 8.25%, respectively. Changes in LIBOR or the prime rate will have an impact on our interest income from our variable-rate loans receivable. In addition, at December 31, 2006, approximately $23.4 million of our loans receivable had a fixed interest rate with a weighted average interest rate of approximately 8.8%. See “Item 7A. — Quantitative and Qualitative Disclosures About Market Risk.”

Prepayment Activity

     Our prepayment activity has increased. Prepayment activity for our aggregate fixed-rate loans receivable has remained at high levels as a result of the continued low long-term interest rate environment combined with increased competition and the reduction or expiration of prepayment fees. Prepayment activity for our aggregate variable-rate loans receivable has increased since borrowers with variable-rate loans are generally seeking fixed-rate loans due to currently marketed fixed-rate interest rates being lower than the current interest rate on their loan and/or concerns of possible rising interest rates. We believe that we will continue to see prepayment activity at these higher levels during 2007.

     The timing and volume of our prepayment activity for both our variable and fixed-rate loans receivable fluctuate and are impacted by numerous factors including the following:

	•		The competitive lending environment (i.e., availability of alternative financing);
	•		The current and anticipated interest rate environment;
	•		The market value of limited service hospitality properties; and
	•		The amount of the prepayment fee and the length of prepayment prohibition, if any.

     When loans receivable are repaid prior to their maturity, we generally receive prepayment fees. Prepayment fees result in one-time increases in our income. In addition, prepayments of Sold Loans will have an impact on our financial condition and results of operations. Prepayments of Sold Loans with higher interest rates negatively impact the value of our Retained Interests to a greater extent than prepayments of Sold Loans with lower interest rates. Prepayments in excess of our assumptions will cause a decline in the value of our Retained Interests primarily relating to a reduction in the excess funds (our interest-only strip receivable) expected from our structured loan sale

transactions. The “spread” that is lost may be offset in part or in whole by the prepayment fee that we collect. Many of the prepayment fees for our aggregate fixed-rate loans receivable are based upon a yield maintenance premium which provides for greater prepayment fees as interest rates decrease. For our aggregate fixed-rate loans receivable, these fees are generally greater for those loans with higher interest rates although the prepayment fees also decline as the loans get closer to their maturity. In addition, certain loans receivable have prepayment prohibitions of up to five years. Prepayment fees for our aggregate variable-rate loans receivable and fixed-rate loans receivable whose prepayment prohibition have expired are generally not significant. For our loans receivable, the proceeds from the prepayments we receive are either used to repay debt or invested initially in temporary investments. It is difficult for us to accurately predict the volume or timing of prepayments since the factors listed above are not all-inclusive and changes in one factor are not isolated from changes in another which might magnify or counteract the rate or volume of prepayment activity.

     Our SBLC sells the guaranteed portion of most of its originated loans through private placements. These sales are especially sensitive to prepayments. Our Retained Interests in these loan sales consist only of the spread between the interest collected from the borrower and the interest paid to the purchaser of the guaranteed portion of the loan. Therefore, to the extent the prepayments of these loans exceed estimates, there is a significant impact on the value of the associated Retained Interests. In addition, loans originated under the SBA 7(a) Program do not have prepayment fees which are retained by us.

Impaired Loans

     Our policy with respect to loans receivable which are in arrears as to interest payments for a period in excess of 60 days is generally to discontinue the accrual of interest income. To the extent a loan becomes a Problem Loan (as defined below), we will deliver a default notice and begin foreclosure and liquidation proceedings when we determine that pursuit of these remedies is the most appropriate course of action.

     Senior management closely monitors our impaired loans which are classified into two categories: Problem Loans and Special Mention Loans (together, “Impaired Loans”). Our 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. Our Special Mention Loans are those loans receivable that are either not complying or had previously not complied with their contractual terms but we expect a full recovery of the principal balance through either collection efforts or liquidation of collateral.

     Historically, we have not had a significant amount of Impaired Loans or delinquent loans nor have we had a significant amount of charged-off loans. Our Impaired Loans were as follows (balances represent our investment in the loans prior to loan loss reserves and deferred commitment fees):

		At December 31,
		2006				2005
		(Dollars in thousands)
Problem Loans:
Loans receivable		$	1,887			$	1,587
Sold loans of QSPEs (1)			—				—
		$	1,887			$	1,587
Special Mention Loans:
Loans receivable (2)		$	32			$	5,635
Sold loans of QSPEs (1)			3,496				5,558
		$	3,528			$	11,193
Percentage Problem Loans:
Loans receivable			1.1	%			1.0	%
Sold loans of QSPEs (1)			—				—
Percentage Special Mention Loans:
Loans receivable			—				3.6	%
Sold loans of QSPEs (1)			1.9	%			2.3	%

     At December 31, 2006 and 2005, we had reserves of approximately $63,000 and $427,000, respectively, against loans receivable that we have deemed to be Impaired Loans. Our provision for loan losses (excluding reductions of loan losses) as a percentage of our weighted average outstanding loans receivable was 0.11% and 0.24% during 2006 and 2005, 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. The decrease in our total Impaired Loans from 2005 to 2006 is due primarily to foreclosure of the underlying collateral of three limited service hospitality properties, repayment in full and assumption of certain loans and improved performance of a sold loan which is no longer considered to be an Impaired Loan.

Retained Interests

     At December 31, 2006 and 2005, the estimated fair value of our Retained Interests was approximately $55.7 million and $63.0 million, respectively. As a result of our structured loan sale transactions, we have Retained Interests representing the subordinate interest in loans receivable that have been contributed to QSPEs and have been recorded as sold. When we securitize loans receivable, we are required to recognize Retained Interests, which represents our right to receive net future cash flows, at their estimated fair value. Our Retained Interests consist of (1) the retention of a portion of each of the Sold Loans (the “required overcollateralization”), (2) contractually required cash balances owned by the QSPE (the “reserve fund”) and (3) future excess funds to be generated by the QSPE after payment of all obligations of the QSPE (the “interest-only strip receivable”). Retained Interests are subject to credit, prepayment and interest rate risks.

     The estimated fair value of our Retained Interests is based on estimates of the present value of future cash flows we expect to receive from the QSPEs. Estimated future cash flows are based in part upon estimates of prepayment speeds and loan losses. Prepayment speeds and loan losses are estimated based on the current and

anticipated interest rate and competitive environments and our historical experience with these and similar loans receivable. The discount rates utilized are determined for each of the components of Retained Interests as estimates of market rates based on interest rate levels considering the risks inherent in the transaction. Changes in any of our assumptions, or actual results which deviate from our assumptions, may materially affect the value of our Retained Interests.

     The net unrealized appreciation on our Retained Interests at December 31, 2006 and 2005 was approximately $3.3 million and $4.5 million, respectively. The primary reason for the decrease in unrealized appreciation on our Retained Interests was prepayments. Any appreciation of our Retained Interests is included on our consolidated balance sheets in beneficiaries’ equity. Any depreciation of our Retained Interests is either included in the consolidated statements of income as a permanent impairment (if there is a reduction in expected future cash flows) or on our consolidated balance sheet in beneficiaries’ equity as an unrealized loss. Reductions in expected future cash flows generally occur as a result of decreases in expected yields, increases in anticipated loan losses or increases in prepayment speed assumptions. Any unrealized appreciation of our Retained Interests will be recognized as income over the estimated remaining life of the Retained Interests through a higher effective yield.

Assets Acquired in Liquidation

     We have not historically had a significant amount of assets acquired in liquidation. With regard to properties acquired through foreclosure, deferred maintenance issues may have to be addressed as part of the operation of the property or it may not be economically justifiable to operate the property prior to its sale. To the extent keeping the property in operation is deemed to assist in attaining a higher value upon sale, we will take steps to do so including hiring third party management companies to operate the property.

     In connection with the sale of our assets acquired in liquidation to third parties, we may finance a portion of the purchase price of the property. These loans will typically bear market rates of interest. While these loans are evaluated using the same methodology as our loans receivable, certain lending criteria may not be able to be achieved.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

     Our discussion and analysis of our financial condition and our results of operations is based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Our management has discussed the development and selection of these critical accounting policies and estimates with the audit committee of our Board of Trust Managers, and the audit committee has reviewed the disclosures relating to these policies and estimates included in this annual report.

     We believe the following critical accounting considerations and significant accounting policies represent our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Valuation of Loans Receivable

     Loan loss reserves are established based on a determination, through an evaluation of the recoverability of individual loans receivable, that significant doubt exists as to the ultimate realization of the loan receivable. We monitor the loan portfolio on an ongoing basis and evaluate the adequacy of our loan loss reserves. In our analysis, we review various factors, including the value of the collateral underlying the loan receivable and the borrower’s payment history. The determination of whether significant doubt exists and whether a loan loss reserve is necessary for each loan requires judgment and consideration of the facts and circumstances existing at the evaluation date. Changes to the facts and circumstances of the borrower, the hospitality industry and the economy may require the establishment of significant additional loan loss reserves. If a determination is made that significant doubt exists as to the ultimate collection of our loans receivable, the effect on our results of operations may be material.

     At December 31, 2006 and 2005, we had reserves of approximately $63,000 and $427,000, respectively, against loans receivable that we have deemed to be Impaired Loans. Our provision for loan losses (excluding reductions of loan losses) as a percentage of our weighted average outstanding loans receivable was 0.11% and 0.24% during 2006 and 2005, respectively.

     The limited service hospitality industry experienced difficult operating periods from 2001 through 2003;

however, this trend reversed with subsequent years experiencing positive trends. In addition, theses positive trends are expected to continue during 2007. This positive trend along with our experience with liquidations of properties underlying impaired loans and the knowledge gained from such liquidations has benefited us in achieving lower losses from loan liquidations. As a result, our reserves have decreased. 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.

Valuation of Retained Interests

     Due to the limited number of entities that conduct structured loan sale 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 for our Retained Interests. Therefore, our estimate of fair value may vary significantly from what a willing buyer would pay for these assets.

     The estimated fair value of our Retained Interests is determined based on the present value of estimated future cash flows from the QSPEs. This valuation is our most volatile critical accounting estimate since it is dependent upon estimates of future cash flows that are based on the performance of the underlying loans receivable and estimates of discount rates. Prepayments or losses in excess of estimates will cause unrealized depreciation and ultimately permanent impairments. The estimated future cash flows are calculated based on assumptions including, among other things, prepayment speeds and loan losses. We regularly measure loan loss and prepayment assumptions against the actual performance of the loans receivable sold and to the extent adjustments to our assumptions are deemed necessary, they are made on a quarterly basis. If prepayment speeds occur at a faster rate than anticipated, or future loan losses either occur quicker, or in amounts greater than expected, the fair value of the Retained Interests will decline and total income in future periods would be reduced. For example, if a $1.0 million loan with an interest rate of 10% prepays and the “all-in cost” of that QSPE’s structured notes was 7%, we would lose the 3% spread we had expected to receive on that loan in future periods. The “spread” that is lost may be offset in part or in whole by any prepayment fee that we collect. If prepayments occur slower than anticipated, or future loan losses are either slower than or less than expected, cash flows would exceed estimated amounts, the estimated fair value of our Retained Interests would increase and total income in future periods would be enhanced. Although we believe that assumptions as to the future cash flows of the structured loan sale transactions are reasonable, actual rates of loss or prepayments may vary significantly from those assumed and other assumptions may be revised based upon anticipated future events. Over the past three years, there has been no significant change in the methodology employed in valuing these assets. The discount rates utilized in computing the net present value of future cash flows are based on an estimate of the inherent risks associated with each cash flow stream. Purchasers of these types of investments may utilize different discount rates in determining the fair value of the estimated future cash flows.

     As a result of the merger, we acquired PMC Capital’s subordinate interests in the Joint Ventures and 100% of the subordinate interests in the 1998 Partnership and the 1999 Partnership (collectively, the “Acquired Structured Loan Sale Transactions”). We previously owned subordinate interests in the Joint Ventures (the “Originated Structured Loan Sale Transactions”).

     Constant prepayment rates and aggregate losses assumed were as follows for our Originated Structured Loan Sale Transactions (“Originated”) and Acquired Structured Loan Sale Transactions (“Acquired”):

		Constant Prepayment Rate								Aggregate Losses Assumed
		At December 31,								At December 31,
		2006				2005				2006				2005
Originated:
2000 Joint Venture			18.0	%			11.0	%			1.45	%			2.74	%
2001 Joint Venture			18.0	%			12.0	%			—				2.63	%
2002 Joint Venture			18.0	%			12.0	%			1.42	%			3.72	%
2003 Joint Venture			16.0	%			12.0	%			1.36	%			2.51	%
Acquired:
Secondary Market Sales (1)			20.0	%			20.0	%			—				—
1998 Partnership			16.0	%			12.5	%			1.71	%			3.12	%
1999 Partnership			18.0	%			14.0	%			1.82	%			2.43	%
2000 Joint Venture			18.0	%			14.0	%			1.39	%			3.28	%
2001 Joint Venture			18.0	%			12.0	%			1.20	%			2.06	%
2002 Joint Venture			18.0	%			12.0	%			1.79	%			2.68	%
2003 Joint Venture			16.0	%			12.0	%			1.48	%			2.77	%

     Constant prepayment rates have generally increased from 2005 to 2006 primarily due to increased historical prepayments and the anticipated continuation of high levels of prepayments due to increased competition and the reduction or expiration of prepayment fees in a significant portion of the underlying portfolio.

     Aggregate losses assumed have generally decreased from December 31, 2005 to December 31, 2006 primarily based on decreased portfolio outstanding, historical losses being significantly below original estimates and the continued positive performance of our securitized loans and the limited service hospitality industry.

     Discount rates utilized from December 31, 2005 to December 31, 2006 have increased by approximately 20 basis points (0.20%) due primarily to rising interest rates.

     The following is a sensitivity analysis of our Retained Interests as of December 31, 2006 to highlight the volatility that results when prepayments, loan losses and discount rates are different than our assumptions:

		Estimated
		Fair
Changed Assumption		Value				Asset Change (1)
		(In thousands)
Losses increase by 50 basis points per annum (2)		$	54,157				($1,567	)
Losses increase by 100 basis points per annum (2)		$	52,583				($3,141	)
Rate of prepayment increases by 5% per annum (3)		$	55,136				($   588	)
Rate of prepayment increases by 10% per annum (3)		$	54,709				($1,015	)
Discount rates increase by 100 basis points		$	54,127				($1,597	)
Discount rates increase by 200 basis points		$	52,595				($3,129	)

     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 assumptions to the change in value may not be linear. The effect of a variation in a particular assumption on the estimated 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.

Valuation of Rent and Related Receivables

     At December 31, 2006, our rent and related receivables consisted of unpaid rent, property taxes, legal fees incurred, termination damages, notes receivable and other charges (the “Arlington Claims”) of approximately $2,747,000 before reserves. As a result of the uncertainty of collection, our claim in the Arlington bankruptcy is well in excess of our recorded investment in the Arlington Claims.

     We performed an analysis of our anticipated future proceeds related to the Arlington bankruptcy to determine the collectibility of our investment in the rent and related receivables based on best available information provided to us through the bankruptcy proceedings. As a result, we established an allowance of $1,255,000 during 2005. We recorded additional allowances of $925,000 during 2006. Accordingly, our net recorded investment was $567,000 at December 31, 2006. To the extent there is a reduction of the anticipated future proceeds, we would record an additional allowance against these receivables.

Valuation of Real Estate Investments

     At December 31, 2006, two of the three hotel properties that we own were included in our consolidated financial statements. As these properties have mortgages (which were assumed in the original purchase from AHI) with significant prepayment penalties, we do not anticipate selling these properties until the properties’ market values increase or the prepayment penalties decrease. We are currently marketing to lease these two properties.

     In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment of or Disposal of Long-Lived Assets,” (“SFAS No. 144”) our hotel properties are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. We consider each hotel property to be an identifiable component of our business. In accordance with SFAS No. 144, we do not consider hotels as “held for sale” until it is probable that the sale will be completed within one year. The determination of “held for sale” status is assessed based on all available facts and circumstances, including management’s intent and ability to eliminate the cash flows of the property from the Company’s operations and management’s intent and ability not to have significant continuing involvement in the operations of the property.

     We discontinue depreciation on hotel properties if they are classified as “held for sale.” Upon designation of a hotel property as “held for sale,” we compare the carrying value of the hotel property to its estimated fair value, less costs to sell. We will reclassify the hotel property to real estate investment held for sale on our consolidated balance sheet at the lesser of its carrying value or its estimated fair value, less costs to sell. Any adjustment to the carrying value of a hotel property classified as “held for sale” is reflected in discontinued operations in our consolidated statements of income as impairment losses. In addition, the operating results of those properties classified as “held for sale” or that have been sold are included in discontinued operations.

     We periodically review our real estate investments for impairment. If facts or circumstances support the possibility of impairment, we will prepare a projection of the undiscounted future cash flows without interest charges for the specific property. Impairment exists if the estimate of future cash flows expected to result from the use and ultimate disposition of the specific property is less than its carrying value. If impairment is indicated, an adjustment will be made to the carrying value of the property based on the difference between the current estimated fair value and the depreciated cost of the asset.

Revenue Recognition Policies

Interest Income

     Interest income includes interest earned on loans and our short-term investments and the amortization of net loan origination fees and discounts. Interest income on loans is accrued as earned with the accrual of interest generally suspended when the related loan becomes a non-accrual loan. A loan receivable is generally classified as non-accrual (a “Non-Accrual Loan”) if (1) it is past due as to payment of principal or interest for a period of more than 60 days, (2) any portion of the loan is classified as doubtful or is charged-off or (3) if the repayment in full of the principal and/or interest is in doubt. Generally, loans are charged-off when management determines that we will be unable to collect any remaining amounts due under the loan agreement, either through liquidation of collateral or other means. Interest income on a Non-Accrual Loan is recognized on either the cash basis or the cost recovery basis.

     When originating a loan receivable, we generally charge a commitment fee. These fees, net of costs, are deferred and recognized as an adjustment of yield over the life of the related loan receivable using a method which approximates the effective interest method.

     For purchased loans, we may have discounts representing the difference between the unamortized principal balance of the loan and its estimated fair value at the date of purchase. For performing loans, these discounts are recognized as an adjustment of yield over the life of the related loan receivable using a method which approximates the effective interest method.

     For loans originated under the SBA 7(a) Program, when we sell the SBA guaranteed portion of the loans, a portion of the sale proceeds representing the difference in the face amount of the unguaranteed portion of the loans and the value of the loans (the “Retained Loan Discount”) is determined on a relative fair value basis and is recorded as a reduction in basis of the retained portion of the loan rather than premium income. The Retained Loan Discount is amortized to interest income over the life of the underlying loan using the effective interest method unless the underlying loan receivable is prepaid or sold.

Income from Retained Interests

     The income from our Retained Interests represents the accretion (recognized using the effective interest method) 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 QSPEs 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.

Lease Income

     Lease income consists primarily of base rent on our properties and when applicable, straight-line rental income. We record lease income on a straight-line basis (when applicable) over the estimated lease term to the extent collectibility is reasonably assured.

RESULTS OF OPERATIONS

Year Ended December 31, 2006 Compared to the Year Ended December 31, 2005

Overview

     Our income from continuing operations increased by $4,270,000 to $13,648,000 ($1.27 per share) during 2006 from $9,378,000 ($0.86 per share) during 2005. The lending division’s income from continuing operations increased to $14,977,000 during 2006 from $11,807,000 during 2005. Our property division’s loss from continuing operations decreased to $1,329,000 during 2006 from $2,429,000 during 2005. As described in more detail below, significant changes between these periods were:

	•		An increase in interest income of $3,882,000 due primarily to increases in variable interest rates and our weighted average loans outstanding;
	•		A gain from early extinguishment of debt of $563,000 resulting from the repayment of $7,310,000 of debentures with unamortized premiums; and
	•		An increase in other income of $535,000 due primarily to prepayment fees received; partially offset by

	•		An increase in interest expense of $747,000 due primarily to increases in variable interest rates and borrowings under our conduit facility, and
	•		A net decrease in hotel property related income of $385,000 as a result of the rejection in January 2006 of our hotel property leases by our tenant and the subsequent operation of the properties by third party management companies.

     Discontinued operations increased by $117,000 to $2,036,000 ($0.19 per share) during 2006 from $1,919,000 ($0.18 per share) during 2005. As described in more detail below, significant changes between these periods were:

	•		Impairment losses decreased by $1,680,000; partially offset by
	•		Net gains on property sales decreased by $192,000; and
	•		Net earnings from our hotel properties decreased by $1,371,000.

     More detailed comparative information on the composition of and changes in our revenues and expenses is provided below.

Revenues

     Interest income consisted of the following:

		Years Ended December 31,
		2006				2005				Increase
		(In thousands)
Interest income — loans		$	14,781			$	11,106			$	3,675
Accretion of loan fees and discounts			437				297				140
Interest income — idle funds			242				175				67
		$	15,460			$	11,578			$	3,882

     The increase in interest income – loans was primarily attributable to increases in (1) variable interest rates (both prime and LIBOR) and (2) our weighted average loans receivable outstanding of $18.7 million (14%) to $155.6 million during 2006 from $136.9 million during 2005. The weighted average LIBOR and prime rate used in the determination of interest rates charged to our borrowers increased by approximately 180 basis points and 190 basis points, respectively from 2005 to 2006. Our weighted average interest rate increased from 8.5% at December 31, 2005 to 9.4% at December 31, 2006. As of December 31, 2006, approximately 86% of our loans receivable had variable interest rates.

     Income from Retained Interests decreased $68,000 primarily due to (1) a decrease in the weighted average balance of our Retained Interests outstanding of $6.9 million to $58.3 million during 2006 compared to $65.2 million during 2005 and (2) a decrease in unanticipated prepayment fees of $242,000. Partially offsetting these decreases was an increase in accretion income primarily due to an increase in anticipated future cash flows resulting mainly from a reduction in future anticipated losses. The income from our Retained Interests consists of the accretion on our Retained Interests which is determined based on estimates of future cash flows and includes any fees collected by the QSPEs in excess of anticipated fees. The yield on our Retained Interests, which is comprised of the income earned less permanent impairments, increased to 14.1% during 2006 from 13.8% during 2005. Excluding the impact of permanent impairments, the yield on our Retained Interests increased to 16.1% during 2006 from 14.5% during 2005.

     Other income consisted of the following:

		Years Ended
		December 31,								Increase
		2006				2005				(Decrease)
		(In thousands)
Prepayment fees		$	1,653			$	590			$	1,063
Servicing income			1,025				1,222				(197	)
Premium income			499				618				(119	)
Other loan related income			403				646				(243	)
Equity in earnings of unconsolidated subsidiaries			76				45				31
		$	3,656			$	3,121			$	535

     Prepayment activity has remained at high levels and we believe that we will continue to see prepayment activity at these higher levels during 2007. Prepayment activity for our fixed-rate loans receivable has remained at high levels as a result of the continued low long-term interest rate environment combined with increased competition and the effect of the reduction or expiration of prepayment fees. In addition, prepayment activity for our variable-rate loans receivable has increased since borrowers with variable-rate loans are generally seeking fixed-rate loans due to currently marketed fixed interest rates being lower than the current interest rate on their loan and/or concerns of rising interest rates. To the extent that prepayments are for variable-rate loans, the prepayment fees will generally not be as great as the fees on our fixed-rate loans.

     We earn fees for servicing all loans held by the QSPEs and loans sold into the secondary market by First Western. As these fees are based on the principal balances of sold loans outstanding, until we complete our next securitization, they will decrease over time as scheduled principal payments and prepayments occur.

     Premium income results from the sale of First Western’s loans into the secondary market. We sold 14 loans during both 2006 and 2005 and collected cash premiums of $615,000 and $700,000 during 2006 and 2005, respectively. Effective in May 2006, First Western is a Preferred Lender nationwide. In addition, we recently expanded our marketing initiatives for origination of SBA 7(a) Program loans. As a result, we anticipate that our originations under the SBA 7(a) Program should increase; however, to date we have not realized a significant increase in origination volume or commitments since our marketing efforts generally take time to provide benefits. To the extent we are able to increase our volume of loans originated by First Western, there should be a corresponding increase in premiums received.

     Other loan related income includes late fees, assumption fees, forfeited commitment fees and other fees. These fees primarily represent one-time increases in our other income when collected and/or earned. Other loan related income decreased from 2005 to 2006 primarily due to a decrease in assumption fees.

Interest Expense

     Interest expense consisted of the following:

		Years Ended
		December 31,								Increase
		2006				2005				(Decrease)
		(In thousands)
Junior subordinated notes		$	2,318			$	1,497			$	821
Conduit facility			1,383				724				659
Debentures payable			813				971				(158	)
Mortgages on hotel properties			304				346				(42	)
Structured notes			201				451				(250	)
Revolving credit facility			125				214				(89	)
Uncollateralized notes payable			—				223				(223	)
Other			291				262				29
		$	5,435			$	4,688			$	747

     Total interest expense increased primarily as a result of an increase in variable interest rates (LIBOR) and outstanding borrowings under our conduit facility. The weighted average LIBOR used in the determination of interest rates charged on our outstanding obligations with variable interest rates increased by approximately 180 basis points from 2005 to 2006. The weighted average cost of our funds at December 31, 2006 was 7.1% compared to 6.5% at December 31, 2005. In addition, during March 2005 we prepaid $20 million of uncollateralized notes with proceeds from our junior subordinated notes. Interest on our junior subordinated notes increased (1) by approximately $400,000 since they were outstanding 12 months during 2006 compared to ten months during 2005 and (2) by approximately $400,000 due to increases in LIBOR. Interest on our conduit facility and revolving credit facility increased primarily as a result of increased utilization of the facilities mainly to fund loans during the fourth quarter of 2006. Our average outstanding balance on our credit facilities increased to $18.4 million during 2006 compared to $13.2 million during 2005.

     On September 1, 2006, we prepaid, without penalty, $7,310,000 of fixed-rate SBA debentures with an interest rate of approximately 8.5%. In addition, the remaining balance outstanding on our structured notes was repaid on December 1, 2006.

Other Expenses

     Our combined expenses for general and administrative and salaries and related benefits remained relatively constant at $7,387,000 during 2006 compared to $7,548,000 during 2005. General and administrative expenses decreased to $2,648,000 during 2006 from $2,995,000 during 2005 primarily related to a decrease in legal fees, mainly those associated with Arlington’s bankruptcies. Salaries and related benefits increased to $4,739,000 during 2006 from $4,553,000 during 2005 due primarily to an increase in bonuses to executive officers and cost of living increases.

     Permanent impairments on Retained Interests were $1,167,000 for 2006 resulting from reductions in expected future cash flows due primarily to increased actual and anticipated prepayments. During 2005, we had $467,000 of permanent impairments on Retained Interests primarily due to reductions in expected future cash flows due to increased anticipated and actual prepayments mainly on our acquired Retained Interests.

     Impairment losses were $436,000 for 2005 while we had no impairment losses during 2006. Our impairment losses recorded during 2005 were a result of Arlington’s defaults under the lease agreements. 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. Future cash flows were 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.

     Provision for losses on rent and related receivables was $925,000 and $1,255,000 during 2006 and 2005, respectively. Provision for losses during 2006 primarily resulted from reductions in available cash due to

unanticipated and unforecasted cash expenditures by Arlington. Provision for losses during 2005 pertained to our initial evaluation of rent and related receivables subsequent to the bankruptcy of AHI. We performed analyses of our anticipated future distribution related to the bankruptcy of Arlington based on best available information provided to us through the bankruptcy proceedings to determine the collectibility of our investment in the rent and related receivables. Due to the uncertainties regarding the bankruptcy proceedings, there can be no assurance that we will be awarded, or ultimately receive, any proceeds from the Arlington bankruptcy proceedings. To the extent there is a reduction of the anticipated future proceeds, we would record an additional allowance against these receivables. The bankruptcy estates/debtors continue to litigate certain claims asserted by other creditors, including claims related to the initial financing provided to the debtors and other outstanding secured claims. These disputes have led to protracted and expensive litigation that has yet to be completed. Our anticipated recovery continues to be diminished and delayed as long as these disputes remain outstanding. The litigation between the debtors and the other creditors has been expensive and will continue to have an adverse effect on our potential recovery. As for our claims in the bankruptcy cases (and the debtors’ claims in response), we anticipate trying to negotiate a settlement of those claims with the debtors; however, there is no certainty that we will be able to settle with the debtors or that any settlement would be approved by the official unsecured creditor’s committee or the Bankruptcy Court, among others. Further, our future prospects for recovery from the bankruptcy estates continues to be impacted by the litigation with third parties.

     Provision for loan losses, net, was $103,000 during 2006 and $298,000 during 2005. We recorded loan loss reserves of $186,500 during 2005 primarily related to a limited service hospitality property on which significant doubt existed as to the ultimate realization of the loan. The primary collateral underlying the loan was acquired through foreclosure during January 2006 and the property was sold in May 2006.

     Income tax provision remained constant at $649,000 during 2006 compared to $658,000 during 2005. Our income tax provision decreased due to an increase in costs reimbursed by one of our taxable lending subsidiaries to PMC Commercial Trust. This decrease was offset by an increase in the profitability of our lending subsidiaries due to increased interest income and prepayment fees.

Hotel Property Activity

     Hotel property activity consists of lease income, hotel property revenues and expenses. During 2005, we recorded lease revenue of $942,000 compared to $58,000 during 2006, a decrease of $884,000. Effective February 1, 2006, upon rejection of the leases by our former tenant, we no longer collected rent on the hotel properties. As a result, during January 2006 we commenced operating the hotel properties through third party management companies. The operations of hotel properties sold prior to December 31, 2006 are included in discontinued operations. Partially offsetting the decrease in lease income is net income of $499,000 generated from the operations of our remaining hotel properties during 2006. Hotel property revenues were $2,113,000 and hotel property expenses were $1,614,000 during 2006.

     One of our remaining hotel properties was leased effective September 29, 2006 with annual base rent of $116,700. The lessee has the option, and is expected to exercise this option, to purchase the property for $1,825,000 at termination of the lease in January 2011 or earlier if certain events occur. Due to the nature of the lease, the subsidiary that owns the hotel property is no longer consolidated in our financial statements and the equity method is used to account for our investment in the subsidiary effective September 29, 2006. We are currently marketing to lease the remaining two properties.

Gain on Early Extinguishment of Debt

     Gain on early extinguishment of debt represents a gain of $563,000 resulting from the repayment of $7,310,000 of SBA debentures owed by our SBICs which were prepaid, without penalty, on September 1, 2006. The debentures had a carrying value of $7,873,000 when repaid. When acquired in the merger, these debentures were recorded at fair value which was greater than face value. Management’s decision to repay the debentures was based upon excess cash at the subsidiary levels which was unavailable, due to SBIC requirements, to be used by the parent company. In addition, there were no significant loan commitments at the SBIC level.

Discontinued Operations

     We had net realized gains on the sales of real estate of $2,064,000 during 2006 resulting primarily from the sale of ten hotel properties for approximately $20.6 million generating gains of approximately $1.9 million and eight assets acquired in liquidation for approximately $4.1 million generating gains of approximately $0.2 million. As the

down payments received were not sufficient to qualify for full accrual gain treatment on certain of the sales, we recorded initial installment gains and deferred the remaining gains. Our deferred gains total approximately $1.6 million at December 31, 2006. We had net realized gains on sale of real estate of $2,256,000 during 2005 resulting primarily from the sale of (1) six hotel properties for net sales proceeds of approximately $12.8 million and cost of sales of approximately $11.5 million and (2) two assets acquired in liquidation (one of which was a limited service hospitality property and the other a retail establishment) for net sales proceeds of approximately $2.8 million and cost of sales of approximately $1.9 million. In addition, during 2005 we sold a limited service hospitality property for $3,098,000. As the down payment received was not sufficient to qualify for full accrual gain treatment, we recorded an installment gain of approximately $86,000 during 2005 and the remaining gain of approximately $344,000 was deferred. Deferred gains are recorded to income as principal is received on the related loans receivable until the required amount of cash proceeds are obtained from the purchaser to qualify for full accrual gain treatment. In addition, upon receipt of updated financial information from the purchaser, if the requirements are met, the transaction would qualify for the full accrual method and the remaining deferred gain would be recognized.

     Impairment losses were $94,000 for 2006. We performed a recoverability test to determine if the expected net sales proceeds for the hotel properties exceeded the carrying value of the hotel properties. Based on this analysis, we recorded impairment losses of $43,000 on our hotel properties during 2006. In addition, we recorded an impairment loss of $51,000 related to an asset acquired in liquidation due to a decline in the estimate of its value. During 2005, we recorded impairment losses of $1,774,000 on our hotel properties.

     Net earnings from discontinued operations were $66,000 during 2006 compared to $1,437,000 during 2005. During 2005, our tenant was obligated for rent. Due to the tenant’s bankruptcy filing, effective January 2006 the leases were rejected and for any properties that had not been sold we commenced operations through third party management companies. Accordingly, the primary reason for the decrease in net earnings from discontinued operations was a reduction in rent income, including base rent and straight-line rent, of approximately $3.7 million when comparing 2006 to 2005. This reduction was partially offset by a decrease in depreciation expense of approximately $0.9 million due to the discontinuation of depreciation on our held for sale properties and a reduction in property tax expense of $0.9 million resulting primarily from the sale of properties. Net earnings from discontinued operations included 12 and 16 hotel properties during 2006 and 2005, respectively, and assets acquired in liquidation (primarily three limited service hospitality properties) during 2006.

Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004

Overview

     Our income from continuing operations decreased to $9,378,000 during 2005 from $9,923,000 during 2004. Income from continuing operations during 2005 includes a provision for loss on our rent and related receivables of $1,255,000, impairment losses of $436,000 on our real estate investments held for use and permanent impairments on our Retained Interests of $467,000. Income from continuing operations during 2004 includes permanent impairments on our Retained Interests of $1,182,000. Excluding these significant non-cash items, our income from continuing operations would have remained relatively constant at $11,536,000 during 2005 compared to $11,105,000 during 2004. The lending division’s income from continuing operations increased to $11,807,000 during 2005 from $9,960,000 during 2004 while our property division had losses from continuing operations of $2,429,000 during 2005 and $37,000 during 2004 due primarily to the losses described above.

     Our total revenues increased by approximately $4.2 million compared to 2004 primarily from an increase in interest income due to an increase in our loans receivable outstanding and an increase in variable interest rates (both prime and LIBOR). Our loans receivable increased as a result of loans acquired in the merger ($55.1 million) and loan originations during 2004 ($53.7 million) and 2005 ($58.9 million). During 2005, our income from Retained Interests increased approximately $0.7 million due to the merger, increased accretion rates and unanticipated prepayment fees.

     Our total expenses increased by approximately $4.2 million primarily as a result of (1) increased overhead (comprised of salaries and related benefits, general and administrative and advisory and servicing fees expense) of approximately $1.9 million due in large part to the increase in our serviced investment portfolio from the merger (upon merger with PMC Capital, we became a self-managed REIT whereas historically we were managed by PMC Capital pursuant to an advisory and servicing agreement) and increased professional fees primarily relating to Arlington’s bankruptcy and increased accounting/auditing fees, (2) a provision for loss on our rent and related receivables of approximately $1.3 million, (3) increased interest expense of approximately $0.8 million due primarily to an increase in outstanding debt mainly due to borrowings necessary to fund our increased loan portfolio and an increase in LIBOR which increased interest on our variable-rate debt and (4) impairment losses of

approximately $0.4 million on our real estate investments included in continuing operations. The merger substantially increased our overhead effective March 1, 2004 as a result of the significant increase in assets under management. Therefore, the impact was less in 2004 (ten months post merger) than 2005 (12 months).

     Our discontinued operations provided income of $3.3 million during 2004 and $1.9 million during 2005. Included in discontinued operations were gains on sales of real estate of $2,256,000 during 2005 resulting primarily from the sale of six hotel properties and two assets acquired in liquidation. In addition, we incurred impairment losses of $1,774,000 during 2005 related to our hotel properties.

     More detailed comparative information on the composition of and changes in our revenues and expenses is provided below.

Revenues

     Interest income consisted of the following:

		Years Ended
		December 31,								Increase
		2005				2004				(Decrease)
		(In thousands)
Interest income — loans		$	11,106			$	7,588			$	3,518
Accretion of loan fees and discounts			297				290				7
Interest income — idle funds			175				284				(109	)
		$	11,578			$	8,162			$	3,416

     The increase in interest income – loans was primarily attributable to an increase in (1) our loan portfolio (our weighted average loans receivable outstanding increased $36.1 million (36%) to $136.9 million during 2005 from $100.8 million during 2004) primarily as a result of loans acquired in the merger and loan originations and (2) the weighted average interest rate on our loans receivable from 7.1% at December 31, 2004 to 8.5% at December 31, 2005. The increase in our weighted average interest rate is primarily due to increases in LIBOR and the prime rate. At December 31, 2005, approximately 88% of our loans receivable had variable interest rates.

     Lease income consisted of the following:

		Years Ended
		December 31,								Increase
		2005				2004				(Decrease)
		(In thousands)
Base rent		$	696			$	821			$	(125	)
Straight-line rent			215				107				108
Percentage rent			24				83				(59	)
Other			7				6				1
		$	942			$	1,017			$	(75	)

     In addition to rent being paid during 2005, rent was paid for January 2006; however, during January 2006, Arlington rejected all remaining property leases.

     Changes in, and descriptions of, lease income are as follows:

	•		Base rent: Base rent consisted of the required monthly rental payment obligation from Arlington. Base rent declined due to the decrease in the pay rate from approximately 10.5% to 8.5% of the stated value established for the hotel properties based on the terms of the lease agreement (effective October 2004);
	•		Straight-line rent: In accordance with the terms of the lease agreement, beginning in October 2004, we recorded lease income on a straight-line basis based on all remaining payments due from Arlington over the remaining fixed non-cancelable term of the lease agreement; however, due to the uncertainty of collection we discontinued recording straight-line rent effective July 1, 2005;

•

Percentage rent: We historically received percentage rent equal to 4% of the gross room revenues of the hotel properties for future capital expenditures. Arlington did not pay the percentage rent due commencing May 2005. Due to the uncertainty of collection, we discontinued recording percentage rent effective May 1, 2005.

     The primary reasons for the increase in income from Retained Interests of approximately $0.7 million were (1) increased accretion income of approximately $588,000 due to a combination of a full year of accretion during 2005 for Retained Interests acquired in the merger compared to ten months during 2004 and an increase in accretion rates and (2) an increase in the collection of unanticipated prepayment fees of approximately $80,000. The weighted average balance of our Retained Interests decreased during 2005 to $65.2 million from $65.9 million during 2004. The income from our Retained Interests consists of the accretion earned on our Retained Interests which is determined based on estimates of future cash flows and includes any fees collected by the QSPEs in excess of anticipated fees. The yield on our Retained Interests, which is comprised of the income earned less permanent impairments, increased to 13.8% during 2005 from 11.5% during 2004. Excluding the impact of permanent impairments, the yield on our Retained Interests increased to 14.5% during 2005 from 13.3% during 2004.

     Other income consisted of the following:

		Years Ended
		December 31,								Increase
		2005				2004				(Decrease)
		(In thousands)
Servicing income		$	1,222			$	1,142			$	80
Other loan related income			646				475				171
Premium income			618				526				92
Prepayment fees			590				656				(66	)
Equity in earnings of unconsolidated subsidiary			45				—				45
Debt release income			—				175				(175	)
		$	3,121			$	2,974			$	147

     As a result of the merger, we earn fees for servicing all loans held by the QSPEs and loans sold into the secondary market by our SBLC. As these fees are based on the principal balances of Sold Loans outstanding, they will naturally decrease over time as scheduled principal payments and prepayments occur. The increase during 2005 compared to 2004 is due primarily to the merger occurring on February 29, 2004.

     Our prepayment activity has remained at relatively high levels. Prepayment fees on our variable-rate loans receivable are generally less than on our fixed-rate loans receivable which are generally based on a yield maintenance premium. At December 31, 2005, approximately 88% of our loans receivable had variable interest rates; therefore, while our prepayment activity has continued at higher levels, the prepayment fees we received have decreased.

     Other loan related income includes late fees, assumption fees, forfeited commitment fees and other fees. These fees represent one-time increases in our other income when collected and/or earned.

     Premium income results from the sale of loans into the secondary market by our SBLC. We sold 14 loans during 2005 and collected cash premiums of approximately $700,000. To the extent we were to increase our volume of loans originated by our SBLC, there should be a corresponding increase in premiums received.

Interest Expense

     Interest expense consisted of the following:

		Years Ended
		December 31,								Increase
		2005				2004				(Decrease)
		(In thousands)
Junior subordinated notes		$	1,497			$	—			$	1,497
Debentures			971				976				(5	)
Conduit facility			724				—				724
Mortgages on hotel properties			346				361				(15	)
Structured notes			451				880				(429	)
Uncollateralized notes payable			223				970				(747	)
Revolving credit facility			214				471				(257	)
Other			262				215				47
		$	4,688			$	3,873			$	815

     Interest expense increased primarily as a result of an increase in our outstanding debt which corresponded to the increase in our loan portfolio including the loans acquired in the merger. Our average debt outstanding increased by 8% to $78.3 million during 2005 from $72.5 million during 2004. In addition, since we have variable-rate debt, the cost of funds on that debt has increased due to increases in LIBOR and the prime rate. The weighted average cost of our funds at December 31, 2005 was 6.5% compared to 5.9% at December 31, 2004.

     During March 2005, we prepaid $20 million of uncollateralized notes with proceeds from our junior subordinated notes. The cost of funds on the junior subordinated notes is LIBOR plus 3.25%. The cost of funds for the uncollateralized notes payable was 7.44% on $10 million and LIBOR plus 1.3% on the other $10 million. In addition, the cost of funds for our conduit facility approximates LIBOR, plus 1% and our current revolving credit facility cost of funds is LIBOR plus 1.625%.

     During March 2005, we “rolled-over” $4.0 million of debentures and repaid $3.0 million of debentures. Our debentures had a weighted average cost of funds of 6.0% at December 31, 2005.

     At December 31, 2005, we had mortgage notes related to our hotel properties included in continuing operations. These mortgages mature from January 2011 to December 2017 and have restrictive provisions which provide for substantial prepayment penalties.

     The average structured notes outstanding decreased to $6.2 million during 2005 from $13.0 million during 2004.

Other Expenses

     During the first two months of 2004, (1) our overhead expense for identifying, originating and servicing our investment portfolio and costs of corporate overhead was covered by an investment advisory agreement with PMC Capital and (2) other general and administrative costs were limited primarily to professional fees, directors and officers insurance, trust manager fees and shareholder expenses. As a result of the merger, on March 1, 2004, we became a self-managed REIT and our assets under management substantially increased from approximately $244.4 million to approximately $563.9 million. Beginning March 1, 2004, our operating expenses consisted of salaries and related benefits, rent and other general and administrative expenses necessary to service our investment portfolio, identify and originate new investments and provide for our corporate administrative needs. Since our assets under management increased, the increase in our general and administrative expenses is greater than our historical advisory fee expense.

     Our combined general and administrative expenses, advisory fee expense and salaries and related benefits during 2005 increased from $5.7 million during 2004 to $7.5 million during 2005 primarily as a result of the increased costs related to our larger investment portfolio and corporate structure. In addition, our professional fees, including accounting, legal and consulting services, increased to $1,755,000 during 2005 from $880,000 during

2004. The increase related primarily to accounting and auditing fees and legal fees, including those associated with Arlington’s bankruptcies. Direct costs associated with the Sarbanes-Oxley Act of 2002 were approximately $390,000 during both 2005 and 2004. Our salaries and related benefits were $3,557,000 for the ten months of 2004 or $4,268,000 on an annualized basis compared to $4,553,000 during 2005. The 6.7% increase was primarily due to cost of living salary increases and increased costs associated with share-based compensation awards.

     Permanent impairments on Retained Interests were $467,000 during 2005 compared to $1,182,000 during 2004. The permanent impairments during 2005 resulted primarily from reductions in expected future cash flows due to increased anticipated and actual prepayments primarily on our acquired Retained Interests while the permanent impairments during 2004 resulted primarily from reductions in expected future cash flows due to increased anticipated and actual prepayments and anticipated losses primarily on our acquired Retained Interests.

     We recorded impairment losses of $436,000 during 2005 on our 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 their carrying value. Future cash flows are based on anticipated proceeds from the sale and anticipated property operations or lease income. No impairment losses were recorded during 2004.

     We performed an analysis of our anticipated future proceeds related to the Arlington bankruptcy based on best available information provided to us through the bankruptcy proceedings to determine the collectibility of our investment in the rent and related receivables. Based on this analysis, we recorded a provision for loss of $1,255,000 during 2005. If anticipated future proceeds decline, we would record an additional allowance against these receivables and losses would result.

     Our provision for (reduction of) loan losses, net, was $298,000 during 2005 and ($253,000) during 2004. We recorded loan loss reserves of $186,500 during 2005 primarily related to a limited service hospitality property on which significant doubt existed as to the ultimate realization of the loan. The primary collateral underlying the loan was acquired through foreclosure during January 2006. The property was sold in May 2006. During 2004, we reversed $675,000 of previously recorded loan loss reserves due to the reduction in the expected loss on a loan collateralized by a limited service hospitality property due to repayment in full of all principal on the loan. We recorded loan loss reserves of $422,000 during 2004 primarily related to two limited service hospitality properties on which significant doubt existed as to the ultimate realization of the loans.

     Our income tax provision increased to $658,000 during 2005 compared to $116,000 during 2004. PMC Commercial has four wholly-owned taxable REIT subsidiaries which are subject to Federal income taxes. The income generated from these taxable REIT subsidiaries is taxed at normal corporate rates.

Discontinued Operations

     During 2005, 16 hotel properties were included in discontinued operations while during 2004, 18 hotel properties were included in discontinued operations. The primary reasons for the decrease in net earnings from discontinued operations of approximately $2.1 million during 2005 were (1) property tax expense of $895,000 recorded during 2005 for the properties sold or considered held for sale, (2) lease termination fee income of $624,000 recorded during 2004 and (3) a 20% reduction in rent charged from 2004 to 2005. Per the lease agreement, Arlington is obligated to pay all property taxes on the hotel properties. However, to the extent Arlington did not make the required property tax payments, these property taxes were our responsibility, although we are pursuing recovery from Arlington. Pursuant to the sale of a hotel property in August 2004, we received a lease termination fee from Arlington in the form of a note receivable with an estimated fair value of $624,000 which is included in net earnings from discontinued operations.

     We had gains on the sales of real estate of $2,256,000 during 2005 resulting primarily from the sale of (1) six hotel properties for net sales proceeds of approximately $12.8 million and cost of sales of approximately $11.5 million and (2) two assets acquired in liquidation (one of which was a limited service hospitality property and the other a retail establishment) for net sales proceeds of approximately $2.8 million and cost of sales of approximately $1.9 million. In addition, during 2005 we sold a limited service hospitality property for $3,098,000. As the down payment received was not sufficient to qualify for full accrual gain treatment, we recorded an installment gain of approximately $86,000 during 2005 and the remaining gain of approximately $344,000 was deferred.

     During 2004 we had a net loss on sales of real estate of $252,000 primarily comprised of the sale of a limited service hospitality property acquired through liquidation of the collateral underlying a loan and the sale of two hotel properties. The limited service hospitality property was sold for approximately $1.5 million and generated

a gain of approximately $205,000. The two hotel properties were sold during August 2004 and December 2004 for approximately $1.8 million each resulting in losses of approximately $354,000 and $116,000, respectively.

     For our hotel properties to be sold, we performed a recoverability test to determine if the expected net sales proceeds for the hotel properties exceeded their carrying value. As a result, we recorded impairment losses of $1,774,000 during 2005. No impairment losses were recorded during 2004.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow Analysis

     Information on our cash flow was as follows:

		Years Ended
		December 31,
		2006				2005				Change
		(in thousands)
Cash provided by operating activities		$	13,832			$	16,029			$	(2,197	)
Cash provided by (used in) investing activities		$	16,377			$	(12,962	)		$	29,339
Cash used in financing activities		$	(30,437	)		$	(8,165	)		$	(22,272	)

     In general, we experienced significantly greater positive cash flow from investing activities during 2006 due to the heavy prepayments on our loans combined with low amounts of cash used for originating loans. These cash flows were used, in general, to repay outstanding debt which increased our cash used in financing activities. See “Executive Summary.”

Operating Activities

     Our net cash flow from operating activities is primarily used to fund our dividends. The decrease in cash provided by operating activities was primarily related to changes in our operating assets and liabilities. We had a decrease of $2,410,000 in borrower advances due primarily to the repayment of certain loans and release of borrower advances. Our dividends paid during 2006 and 2005, included in financing activities, were $12,903,000 and $14,037,000, respectively.

Investing Activities

     During 2006, the primary sources of funds were (1) net principal collected on Retained Interests of $5,085,000, (2) net proceeds from the sales of hotel properties and assets acquired in liquidation of $4,307,000 and (3) principal collected on loans receivable in excess of loans funded of $3,872,000. During 2005, the primary sources of funds were net proceeds from the sales of hotel properties and assets acquired in liquidation of $10,940,000 and net principal collected on Retained Interests of $4,080,000. Funds used in investing activities during 2005 consisted primarily of loans funded in excess of principal collected on loans receivable of $26,859,000. The change in net loans funded is primarily due to high prepayment activity. This increased prepayment activity is primarily a result of competitors providing refinance opportunities to our borrowers combined with the effect of the reduction or expiration of prepayment fees on certain of our loans due to the structure of the fees (i.e., expiration of lock out or yield maintenance provisions). In addition, prepayment activity for our variable-rate loans receivable has increased since borrowers with variable-rate loans are generally seeking fixed-rate loans due to currently marketed fixed interest rates being lower than the current interest rate on their loan and/or concerns of rising interest rates. We believe that we will continue to see prepayment activity at these higher levels during 2007.

Financing Activities

     We used funds in financing activities during 2006 primarily for payment of principal on mortgages payable and debentures of $19,994,000 and dividends of $12,903,000. Our primary source of funds during 2006 was net borrowings on our conduit facility of $2,763,000. Other financing activities during 2005 were generally a repositioning of our debt. We refinanced or repaid (1) $20,000,000 in uncollateralized notes payable acquired in the merger, (2) $3,000,000 of SBA debentures acquired in the merger and (3) $14,600,000 on our revolving credit facility with proceeds of $27,070,000 of junior subordinated notes and net proceeds of $24,205,000 from our conduit facility.

Sources and Uses of Funds

General

     In general, our liquidity requirements include origination of new loans, debt principal payment requirements, payment of dividends and operating costs. We intend to utilize, as deemed appropriate by prevailing market conditions, a combination of the following sources to generate funds:

	•		Operating revenues;
	•		Principal collections on existing loans receivable and Retained Interests;
	•		Structured loan financings or sales;
	•		Advances under our conduit facility;
	•		Borrowings under our short-term uncollateralized revolving credit facility (the “Revolver”);
	•		Issuance of SBA debentures;
	•		Issuance of junior subordinated notes; and/or
	•		Common equity issuance