UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One);

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

		For the quarterly period ended June 30, 2010

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

Commission File Number 1-13610

PMC COMMERCIAL TRUST

 

(Exact name of registrant as specified in its charter)

TEXAS		75-6446078
(State or other jurisdiction		(I.R.S. Employer Identification No.)
of incorporation or organization)
17950 Preston Road, Suite 600, Dallas, TX 75252		(972) 349-3200
(Address of principal executive offices)		(Registrant’s telephone number)

Indicate by check mark whether the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. YES o NO þ

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

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). YES o NO o

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

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

As of August 3, 2010, the Registrant had outstanding 10,558,054 Common Shares of Beneficial Interest, par value $.01 per share.

 

 

PMC COMMERCIAL TRUST AND SUBSIDIARIES

INDEX

		PAGE NO.
PART I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets (Unaudited) — June 30, 2010 and December 31, 2009			2
Consolidated Statements of Income (Unaudited) — Three and Six Months Ended June 30, 2010 and 2009			3
Consolidated Statements of Comprehensive Income (Unaudited) — Three and Six Months Ended June 30, 2010 and 2009			4
Consolidated Statements of Equity (Unaudited) — Three and Six Months Ended June 30, 2010 and 2009			5
Consolidated Statements of Cash Flows (Unaudited) — Six Months Ended June 30, 2010 and 2009			6
Notes to Consolidated Financial Statements (Unaudited)			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 3. Quantitative and Qualitative Disclosures About Market Risk			40
Item 4. Controls and Procedures			44
PART II. Other Information
Item 1. Legal Proceedings			45
Item 1A. Risk Factors			45
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			45
Item 3. Defaults upon Senior Securities			45
Item 4. Reserved			45
Item 5. Other Information			45
Item 6. Exhibits			46
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I

Financial Information

ITEM 1.

Financial Statements

PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)

		June 30,				December 31,
		2010				2009
		(Unaudited)
ASSETS
Loans receivable, net		$	237,882			$	196,642
Cash and cash equivalents			6,409				7,838
Restricted cash and cash equivalents			5,166				1,365
Real estate owned			2,223				5,479
Retained interests in transferred assets			901				12,527
Other assets			4,791				4,392
Total assets		$	257,372			$	228,243
LIABILITIES AND EQUITY
Liabilities:
Junior subordinated notes		$	27,070			$	27,070
Structured notes payable			25,272				8,291
Revolving credit facility			18,900				23,000
Secured borrowings — government guaranteed loans			17,628				—
Debentures payable			8,175				8,173
Borrower advances			3,394				2,368
Accounts payable and accrued expenses			2,527				2,364
Dividends payable			1,712				1,731
Deferred income			685				686
Redeemable preferred stock of subsidiary			—				1,975
Other liabilities			112				127
Total liabilities			105,475				75,785
Commitments and contingencies
Beneficiaries’ equity:
Common shares of beneficial interest; authorized 100,000,000 shares of $0.01 par value; 11,094,383 and 11,084,683 shares issued at June 30, 2010 and December 31, 2009, respectively, 10,558,054 and 10,548,354 shares outstanding at June 30, 2010 and December 31, 2009, respectively			111				111
Additional paid-in capital			152,710				152,611
Net unrealized appreciation of retained interests in transferred assets			76				325
Cumulative net income			170,653				167,686
Cumulative dividends			(167,652	)			(164,274	)
			155,898				156,459
Less: Treasury stock; at cost, 536,329 shares at June 30, 2010 and December 31, 2009			(4,901	)			(4,901	)
Total beneficiaries’ equity			150,997				151,558
Noncontrolling interests — cumulative preferred stock of subsidiary			900				900
Total equity			151,897				152,458
Total liabilities and equity		$	257,372			$	228,243

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

PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)

		Six Months Ended								Three Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
						(Unaudited)
Revenues:
Interest income		$	6,715			$	5,636			$	3,498			$	2,785
Income from retained interests in transferred assets			75				1,697				34				781
Other income			600				530				403				306
Total revenues			7,390				7,863				3,935				3,872
Expenses:
Interest			2,000				1,596				1,011				790
Salaries and related benefits			1,911				1,920				970				999
General and administrative			1,212				977				644				534
Permanent impairments on retained interests in transferred assets			—				77				—				17
Provision for (reduction of) loan losses, net			(98	)			203				104				56
Total expenses			5,025				4,773				2,729				2,396
Income before income tax benefit and discontinued operations			2,365				3,090				1,206				1,476
Income tax benefit			128				50				20				68
Income from continuing operations			2,493				3,140				1,226				1,544
Discontinued operations			8				50				(3	)			20
Net income		$	2,501			$	3,190			$	1,223			$	1,564
Weighted average shares outstanding:
Basic			10,549				10,599				10,550				10,548
Diluted			10,565				10,599				10,566				10,548
Basic and diluted earnings per share:
Income from continuing operations		$	0.24			$	0.30			$	0.12			$	0.15
Discontinued operations			—				—				—				—
Net income		$	0.24			$	0.30			$	0.12			$	0.15

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

PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)

		Six Months Ended								Three Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
		(Unaudited)
Net income		$	2,501			$	3,190			$	1,223			$	1,564
Change in unrealized appreciation of retained interests in transferred assets:
Net unrealized appreciation arising during period			20				182				49				80
Net realized gains included in net income			(4	)			(43	)			(1	)			(28	)
			16				139				48				52
Comprehensive income		$	2,517			$	3,329			$	1,271			$	1,616

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

PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EQUITY
(In thousands, except share and per share data)

		Six Months Ended June 30, 2009
		(Unaudited)
														Net
														Unrealized
		Common												Appreciation
		Shares of												of Retained																Cumulative
		Beneficial								Additional				Interests in				Cumulative												Preferred
		Interest				Par				Paid-in				Transferred				Net				Cumulative				Treasury				Stock of				Total
		Outstanding				Value				Capital				Assets				Income				Dividends				Stock				Subsidiary				Equity
Balances, January 1, 2009			10,694,788			$	111			$	152,460			$	620			$	160,925			$	(156,829	)		$	(3,825	)		$	900			$	154,362
Net unrealized appreciation			—				—				—				139				—				—				—				—				139
Treasury shares, net			(164,834	)			—				—				—				—				—				(1,076	)			—				(1,076	)
Share-based compensation expense			18,400				—				103				—				—				—				—				—				103
Dividends ($0.385 per share)			—				—				—				—				—				(4,069	)			—				—				(4,069	)
Net income			—				—				—				—				3,190				—				—				—				3,190
Balances, June 30, 2009			10,548,354			$	111			$	152,563			$	759			$	164,115			$	(160,898	)		$	(4,901	)		$	900			$	152,649

		Six Months Ended June 30, 2010
		(Unaudited)
														Net
														Unrealized
		Common												Appreciation
		Shares of												of Retained																Cumulative
		Beneficial								Additional				Interests in				Cumulative												Preferred
		Interest				Par				Paid-in				Transferred				Net				Cumulative				Treasury				Stock of				Total
		Outstanding				Value				Capital				Assets				Income				Dividends				Stock				Subsidiary				Equity
Balances, January 1, 2010			10,548,354			$	111			$	152,611			$	325			$	167,686			$	(164,274	)		$	(4,901	)		$	900			$	152,458
Cumulative effect adjustment			—				—				—				(265	)			466				—				—				—				201
Net unrealized appreciation			—				—				—				16				—				—				—				—				16
Share-based compensation expense			9,700				—				99				—				—				—				—				—				99
Dividends ($0.32 per share)			—				—				—				—				—				(3,377	)			—				—				(3,377	)
Net income			—				—				—				—				2,501				—				—				—				2,501
Balances, June 30, 2010			10,558,054			$	111			$	152,710			$	76			$	170,653			$	(167,652	)		$	(4,901	)		$	900			$	151,897

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

PMC COMMERCIAL TRUST AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

		Six Months Ended
		June 30,
		2010				2009
		(Unaudited)
Cash flows from operating activities:
Net income		$	2,501			$	3,190
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation			9				13
Permanent impairments on retained interests in transferred assets			—				77
Gains on sales of real estate			(78	)			(50	)
Deferred income taxes			(502	)			(109	)
Provision for (reduction of) loan losses, net			(98	)			203
Unrealized premium adjustment			1,082				156
Amortization and accretion, net			30				(223	)
Share-based compensation			99				103
Capitalized loan origination costs			(183	)			(85	)
Loans funded, held for sale			(19,826	)			(6,454	)
Proceeds from sale of guaranteed loans			—				7,677
Principal collected on loans			64				—
Loan fees remitted, net			(37	)			(17	)
Change in operating assets and liabilities:
Other assets			(81	)			199
Borrower advances			1,026				(1,262	)
Accounts payable and accrued expenses			249				(1,236	)
Other liabilities			(28	)			(19	)
Net cash provided by (used in) operating activities			(15,773	)			2,163
Cash flows from investing activities:
Loans funded			(3,118	)			(1,348	)
Principal collected on loans			8,677				7,541
Principal collected on retained interests in transferred assets			109				143
Principal collected on mortgage-backed security of affiliate			—				22
Investment in retained interests in transferred assets			—				(338	)
Proceeds from sales of real estate owned			2,291				—
Investment in restricted cash and cash equivalents, net			(404	)			(1,313	)
Net cash provided by investing activities			7,555				4,707
Cash flows from financing activities:
Purchase of treasury shares			—				(1,076	)
Proceeds from (repayment of) revolving credit facility, net			(4,100	)			1,100
Payment of principal on structured notes payable			(2,289	)			(260	)
Proceeds from secured borrowings — government guaranteed loans			18,639				—
Payment of principal on secured borrowings — government guaranteed loans			(64	)			—
Redemption of redeemable preferred stock of subsidiary			(2,000	)			(2,000	)
Payment of dividends			(3,397	)			(6,295	)
Net cash provided by (used in) financing activities			6,789				(8,531	)
Net decrease in cash and cash equivalents			(1,429	)			(1,661	)
Cash and cash equivalents, beginning of year			7,838				10,606
Cash and cash equivalents, end of period		$	6,409			$	8,945

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

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1. Basis of Presentation:

The accompanying interim financial statements of PMC Commercial Trust (“PMC Commercial” or together with its wholly-owned subsidiaries, “we,” “us” or “our”) have not been audited by independent accountants. These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statement presentation. In the opinion of management, the financial statements reflect all adjustments necessary to present a fair statement of our financial position at June 30, 2010 and results of operations for the three and six months ended June 30, 2010 and 2009. These adjustments are of a normal recurring nature. All material intercompany balances and transactions have been eliminated. The results for the three and six months ended June 30, 2010 are not necessarily indicative of future financial results. Therefore, these financial statements should be read in conjunction with the financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009.

Certain prior period amounts have been reclassified to conform to the current year presentation. These reclassifications had no effect on previously reported consolidated net income or cash flows.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect (1) the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and (2) the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. Our most sensitive estimates involve the valuation of our real estate owned and determination of loan loss reserves.

At December 31, 2009, we had two off-balance sheet securitizations: PMC Joint Venture, L.P. 2000 (the “2000 Joint Venture”) and PMC Capital L.P. 1998-1 (the “1998 Partnership”). Due to a change in accounting rules, these qualified special purpose entities were consolidated beginning January 1, 2010. We used the unpaid principal balance method to recognize the assets and liabilities of these securitizations. The following table summarizes the assets and liabilities of the 2000 Joint Venture and the 1998 Partnership (which represents a non-cash transaction) which were previously included as retained interests in transferred assets (“Retained Interests”):

		January 1,
		2010
		(In thousands)
Loans receivable, net		$	27,752
Restricted cash and cash equivalents			3,396
Other assets			168
Total assets		$	31,316
Structured notes payable (1)		$	19,524
Other liabilities			58
Total liabilities		$	19,582

Note 2. Summary of Significant Accounting Policies:

Our significant accounting policies are included in our Annual Report on Form 10-K for the year ended December 31, 2009. The following additional policies relate to changes in accounting principles effective January 1, 2010:

Restricted Cash and Cash Equivalents

Represents the collection and cash reserve accounts required to be held on behalf of the structured noteholders as collateral pursuant to the transaction documents. Cash reserve accounts may be required to be used to repay the structured noteholders pursuant to the transaction documents.

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Secured Borrowings — Government Guaranteed Loans

Secured borrowings — government guaranteed loans represents legally sold SBA 7(a) loans which are treated as secured borrowings either temporarily (if the loans were sold for cash premiums until any potential contingency period for having to refund the premium has expired) or permanently (if the loans were sold for excess spread or if the loans were sold for excess spread and a premium). Excess spread represents the difference between the interest rate paid to us from our borrowers and the rate we paid to the purchaser of the guaranteed portion of the loan and servicing costs. To the extent secured borrowings include cash premiums, these premiums will be recognized as income after a period of at least 90 days for the loans sold solely for a cash premium or amortized as a reduction to interest expense over the life of the loan using the interest method for loans sold for a premium and excess spread.

Note 3. Recently Issued Accounting Pronouncements:

ASC topic 860 (formerly Financial Accounting Standards Board (“FASB”) No. 166, “Accounting for Transfers of Financial Assets — amendment of FASB Statement No. 140”) was issued in June 2009. ASC 860 amended the accounting guidance for transfers of financial assets including (1) eliminating the concept of qualified special purpose entities for prospective securitizations, (2) a new unit of account definition that must be met for transfers of portions of financial assets to be eligible for sale accounting, (3) clarifications and changes to the derecognition criteria for a transfer to be accounted for as a sale, (4) a change to the amount of recognized gain or loss on a transfer of financial assets accounted for as a sale when beneficial interests are received by the transferor, and (5) extensive new disclosures. ASC 860 was effective for interim and annual reporting periods beginning after November 15, 2009. This standard affected our accounting for secondary market loan sale transactions beginning on January 1, 2010, the date we adopted the standard. At a minimum, any premium income to be recognized is deferred for a period of at least 90 days since the proceeds received from legally sold portions of loans are treated as secured borrowings until any potential contingency period for having to refund the premiums is satisfied. Upon satisfaction of the contractual contingency period, both the unpaid principal balance of the guaranteed portion of the loan and the unamortized balance of the net secured borrowing will be derecognized, with the resulting gain on sale recorded in the income statement in the period when the contingencies are satisfied. Furthermore, to the extent certain criteria are not met, we are required to permanently treat certain of the proceeds received from legally sold portions of loans (those sold for excess spread or those sold for a cash premium and excess spread) as secured borrowings for the life of the loan. For statement of cash flows purposes, proceeds received from the sale of the guaranteed portion of SBA 7(a) loans are now reflected as a financing activity; whereas previously these proceeds were reflected as operating activities.

ASC topic 810 (formerly FASB No. 167, “Amendments to FASB Interpretation No. 46(R)”) was issued in June 2009. ASC 810 required an entity to perform an analysis to determine whether the entity’s variable interest or interests give it a controlling financial interest in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity that has both of the following characteristics: (1) the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (2) the obligation to absorb the losses of the entity that could potentially be significant to the variable interest entity. ASC 810 was effective for interim and annual reporting periods beginning after November 15, 2009. Our off-balance sheet securitizations were consolidated beginning January 1, 2010, the date we adopted the standard. Determining the carrying amounts of the assets and liabilities of the securitizations was not practicable and the assets of the securitizations can only be used to settle obligations of the securitizations; thus, the unpaid principal balance method was used to recognize assets and liabilities of the securitizations. The difference of $466,000 between the net amounts added to our consolidated balance sheet as assets and liabilities and our Retained Interests was recognized as a cumulative effect adjustment in our beneficiaries’ equity. Unrealized appreciation of Retained Interests of $265,000 was reversed in conjunction with the consolidation; therefore, the net effect to our beneficiaries’ equity was an increase of $201,000.

ASC topic 310 was issued in July 2010. ASC 310 requires additional disclosures about the credit quality of financing receivables and the allowance for credit losses. ASC 310 is effective for interim and annual reporting periods ending on or after December 15, 2010. We are currently evaluating the effect of ASC 310 on our consolidated financial statements.

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 4. Share-Based Compensation Plans:

We granted 26,500 option awards on June 12, 2010 at an exercise price of $8.35 (the closing price on June 11, 2010). The fair value of this option award was estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions:

Assumption
Expected Term (years)			3.0
Risk-Free Interest Rate			1.23	%
Expected Dividend Yield			7.66	%
Expected Volatility			40.29	%
Expected Forfeiture Rate			10.0	%

The expected term of the options granted represents the period of time that the options are expected to be outstanding and was based on historical data. The risk-free rate was based on the three-year U.S. Treasury rate corresponding to the expected term of the options. We used historical information to determine our expected volatility and forfeiture rates. We recorded compensation expense of approximately $33,000 during the three and six months ended June 30, 2010 related to this option grant. We granted 15,000 option awards on June 13, 2009 at an exercise price of $8.35 (the closing price on June 12, 2009) and recorded compensation expense of approximately $11,000 during the three and six months ended June 30, 2009.

In addition, we issued an aggregate of 13,100 restricted shares to executive officers and our Board of Trust Managers on June 12, 2010 at the then current market price of the shares of $8.35. We issued an aggregate of 18,400 and 16,500 restricted shares to executive officers and our Board of Trust Managers on June 13, 2009 and June 14, 2008, respectively, at the then current market price of the shares. There were forfeitures of 3,400 restricted shares during June 2010. The restricted shares vest based on two years of continuous service with one-third of the shares vesting immediately upon issuance of the shares and one-third vesting at the end of each of the next two years. Restricted share awards provide for accelerated vesting if there is a change in control (as defined in the plan).

Compensation expense related to the restricted shares is being recognized over the vesting periods. We recorded compensation expense of $42,000 and $72,000 during the three months ended June 30, 2010 and 2009, respectively, and $66,000 and $92,000 during the six months ended June 30, 2010 and 2009, respectively, related to restricted shares. As of June 30, 2010, there was approximately $81,000 of total unrecognized compensation expense related to restricted shares which will be recognized over the next two years.

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 5. Loans Receivable, net:

Loans receivable, net, consisted of the following:

		June 30,				December 31,
		2010				2009
		(In thousands)
Commercial mortgage loans (1)		$	176,389			$	155,137
SBA 7(a) program loans (2)			35,346				15,256
SBIC commercial mortgage loans (3)			27,438				27,854
Total loans receivable			239,173				198,247
Less:
Deferred commitment fees, net			(91	)			(348	)
Loan loss reserves			(1,200	)			(1,257	)
Loans receivable, net		$	237,882			$	196,642

The activity in our loan loss reserves was as follows:

		Six Months Ended
		June 30,
		2010				2009
		(In thousands)
Balance, beginning of year		$	1,257			$	480
Provision for loan losses			306				267
Reduction of loan losses			(404	)			(64	)
Consolidation of the 2000 Joint Venture and the 1998 Partnership reserves			184				—
Principal balances written-off			(143	)			(11	)
Balance, end of period		$	1,200			$	672

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Information on those loans considered to be impaired loans (loans for which it is probable that the lender will be unable to collect all amounts due according to the original contractual terms of the loan) was as follows:

		June 30,				December 31,
		2010				2009
		(In thousands)
Impaired loans requiring reserves		$	1,104			$	3,132
Impaired loans expected to be fully recoverable			1,216				228
Total impaired loans		$	2,320			$	3,360

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
		(In thousands)
Average impaired loans		$	3,915			$	7,582			$	4,190			$	6,456
Interest income on impaired loans		$	57			$	9			$	71			$	17

Note 6. Retained Interests:

Our Retained Interests consisted of the following:

		June 30, 2010								December 31, 2009
		Estimated								Estimated
		Fair Market								Fair Market
		Value				Cost				Value				Cost
		(In thousands)
First Western		$	901			$	825			$	994			$	934
1998 Partnership (1)			—				—				1,393				1,355
2000 Joint Venture (1)			—				—				10,140				9,913
		$	901			$	825			$	12,527			$	12,202

The SBA guaranteed portions of the loans receivable are sold to either dealers in government guaranteed loans receivable or institutional investors (“Secondary Market Loan Sales”) when each individual loan becomes fully funded. Our SBA 7(a) subsidiary has Retained Interests related to the sale of loans originated pursuant to the SBA 7(a) Program prior to January 1, 2010. Effective January 1, 2010, based on a change in accounting rules, we no longer record additions to Retained Interests.

On Secondary Market Loan Sales prior to January 1, 2010, to the extent we retained an excess spread between the interest rate paid to us from our borrowers and the rate we paid to the purchaser of the guaranteed portion of the note and the required minimum servicing spread, we established Retained Interests. In determining the estimated fair value of our Retained Interests related to Secondary Market Loan Sales completed prior to January 1, 2010, our assumptions at June 30, 2010 included a prepayment speed of 20% per annum and a discount rate of 14%.

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following sensitivity analysis of our Retained Interests at June 30, 2010 highlights the volatility that results when prepayments and discount rates are different than our assumptions:

		Estimated
		Fair
Changed Assumption		Value				Asset Change (1)
		(In thousands)
Prepayments increase by 500 basis points per annum		$	797				($104	)
Prepayments increase by 1000 basis points per annum		$	716				($185	)
Discount rates increase by 300 basis points		$	846				($55	)
Discount rates increase by 500 basis points		$	813				($88	)

No credit losses are assumed for our Retained Interests since the SBA has guaranteed the payment of the principal on these loans.

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 estimated fair value is not 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.

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 7. Debt:

Information on our debt was as follows:

																		Weighted
																		Average
																		Interest Rate
										Weighted Average								on Underlying
		Carrying Value (1)								Coupon Rate at								Loans at
		June 30,				December 31,				June 30,				December 31,				June 30,
		2010				2009				2010				2009				2010
		(Dollars in thousands, except footnotes)
Structured notes payable (2):
2003 Joint Venture		$	7,701			$	8,291				2.79	%			2.79	%			4.29	%(3)
2000 Joint Venture			14,031				—				7.28	%			NA				9.49	%
1998 Partnership			3,540				—				2.25	%			NA				4.97	%
			25,272				8,291
Junior subordinated notes			27,070				27,070				3.54	%			3.53	%			NA
Revolving credit facility			18,900				23,000				3.25	%			3.25	%			NA
Debentures payable			8,175				8,173				5.90	%			5.90	%			NA
Secured borrowings — government guaranteed loans (4):
Loans sold for premiums			5,816				—				4.52	%			NA				5.97	%
Loans sold for a premium and excess spread			5,846				—				4.03	%			NA				6.00	%
Loans sold for excess spread			5,966				—				1.59	%			NA				5.96	%
			17,628				—
Redeemable preferred stock of subsidiary (5)			—				1,975				NA				4.00	%			NA
Debt		$	97,045			$	68,509

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Principal payments on our debt at June 30, 2010 were as follows:

						Structured
						Notes and
Years Ending						Secured				All Other
June 30,		Total				Borrowings (1)				Debt (2)
						(In thousands)
2011		$	28,668			$	9,768			$	18,900
2012			4,230				4,230				—
2013			4,546				4,546				—
2014			8,675				4,485				4,190
2015			8,579				4,579				4,000
Thereafter			42,362				15,292				27,070
		$	97,060			$	42,900			$	54,160

Note 8. Earnings Per Share:

The computations of basic earnings per common share are based on our weighted average shares outstanding. For purposes of calculating diluted earnings per share, the weighted average shares outstanding were increased by 16,000 shares during both the three and six months ended June 30, 2010. During the three and six months ended June 30, 2009, no shares were added to the weighted average shares outstanding for purposes of calculating diluted earnings per share as options were anti-dilutive.

Not included in the computation of diluted earnings per share were outstanding options to purchase approximately 77,000 and 90,000 common shares during the three and six months ended June 30, 2010 and 2009, respectively, because the options’ exercise prices were greater than the average market price of the shares.

Note 9. Dividends Declared:

Dividends declared during 2010 were as follows:

						Amount
Date Paid		Record Date				Per Share
April 12, 2010		March 31, 2010				$	0.16
July 12, 2010		June 30, 2010					0.16
						$	0.32

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

We have certain covenants within our revolving credit facility which 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.

Note 10. Income Taxes:

PMC Commercial has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). To qualify as a REIT, PMC Commercial must meet a number of organizational and operational requirements, including a requirement that we distribute at least 90% of our REIT taxable income to our shareholders. As a REIT, PMC Commercial generally will not be subject to corporate level Federal income tax on net income that is currently distributed to shareholders. In order to meet our 2009 taxable income distribution requirements, we will make an election under the Code to treat a portion of the distributions declared in 2010 as distributions of 2009’s REIT taxable income.

PMC Commercial has wholly-owned taxable REIT subsidiaries (“TRS’s”) which are subject to Federal income taxes. The income generated from the TRS’s is taxed at normal corporate rates.

Note 11. Fair Value Measurements:

At June 30, 2010, Retained Interests was our only asset that was required to be measured at fair value on a recurring basis. No liabilities were required to be measured at fair value on a recurring basis. A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. In general, quoted market prices from active markets for the identical asset (Level 1 inputs), if available, should be used to value an asset. If quoted prices are not available for the identical asset, then a determination should be made if Level 2 inputs are available. Level 2 inputs include quoted prices for similar assets in active markets or for identical or similar assets in markets that are not active (i.e., markets in which there are few transactions for the asset, the prices are not current, price quotations vary substantially, or in which little information is released publicly). There is little or no market information for our Retained Interests, thus there are no Level 1 or Level 2 determinations available. Level 3 inputs are unobservable inputs for the asset. Unobservable inputs are used to measure fair value when observable inputs are not available. These inputs include our expectations about the assumptions that market participants would use in pricing the asset in a current transaction.

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

We use Level 3 inputs to determine the estimated fair value of our Retained Interests. The following is activity for our Retained Interests:

		Six Months Ended
		June 30,
		2010				2009
		(In thousands)
Value, beginning of period		$	12,527			$	33,248
Principal collections			(109	)			(143	)
Realized gains included in net income (1)			(4	)			(43	)
Investments			—				556
Permanent impairments			—				(77	)
Consolidation (2)			(11,734	)			(8,565	)
Cumulative effect adjustment (3)			201				—
Accretion (4)			—				241
Unrealized appreciation			20				182
Value, end of period		$	901			$	25,399
Cost, end of period		$	825			$	24,640

We may be required, from time to time, to measure certain other assets at fair value on a nonrecurring basis. These adjustments to fair value usually result in the recognition of loan loss reserves on individual loans and valuation reserves on real estate owned based on the estimated fair value.

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

For impaired loans measured at fair value on a nonrecurring basis during the six months ended June 30, 2010 and 2009, the following table provides the carrying value of the related individual assets at quarter end. We used Level 3 inputs to determine the estimated fair value of our impaired loans.

										Provision for
										Loan Losses
		Carrying Value at								Six Months Ended
		June 30,								June 30, (2)
		2010				2009				2010				2009
						(In thousands)
Impaired loans (1)		$	2,053			$	7,961			$	101			$	173

For real estate owned, our carrying value approximates the estimated fair value at the time of foreclosure and the lower of cost or fair value thereafter. We use Level 3 inputs to determine the estimated fair value of our real estate owned. The carrying value of our real estate owned is established at the time of foreclosure based upon management’s assessment of its fair value based on numerous factors including operating statistics to the extent available, the appraised value, tax assessed value and market environment. At June 30, 2010, the carrying value and estimated fair value of our real estate owned was $2,223,000.

The estimated fair values of our financial and nonfinancial instruments were as follows at June 30, 2010:

						Estimated
		Carrying				Fair
		Amount				Value
		(In thousands)
Assets:
Loans receivable, net		$	237,882			$	232,329
Retained Interests			901				901
Restricted cash and cash equivalents			5,166				5,166
Cash and cash equivalents			6,409				6,409
Liabilities:
Structured notes payable			25,272				25,249
Secured borrowings — government guaranteed loans			17,628				16,569
Debentures payable			8,175				8,886
Revolving credit facility			18,900				18,900
Junior subordinated notes			27,070				16,612

In general, estimates of fair value may differ from the carrying amounts of the financial assets and liabilities primarily as a result of the effects of discounting future cash flows. Considerable judgment is required to interpret market data and develop estimates of fair value. Accordingly, the estimates presented may not be indicative of the amounts we could realize in a current market exchange.

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Loans receivable, net: Our loans receivable are recorded at cost and adjusted by net loan origination fees and discounts. In order to determine the estimated fair value of our loans receivable, we use a present value technique for the anticipated future cash flows using certain assumptions including a current discount rate, prepayment tendencies and potential loan losses. Reserves are established based on numerous factors including, but not limited to, the creditor’s payment history, collateral value, guarantor support and other factors. In the absence of a readily ascertainable market value, the estimated value of our loans receivable may differ from the values that would be placed on the portfolio if a ready market for the loans receivable existed.

Retained Interests: In order to determine the estimated fair value of our Retained Interests, we use a present value technique for the anticipated future cash flows using certain assumptions including a current discount rate and prepayment tendencies.

Restricted cash and cash equivalents: Restricted cash and cash equivalents represent our collection and reserve accounts of the securitizations. The carrying amount is considered to be a reasonable estimate of their fair value due to (1) the short maturity of the collection account and (2) the reserve accounts providing collateral value at their current carrying amounts to the structured noteholders.

Cash and cash equivalents: The carrying amount is considered to be reasonable estimates of fair value due to the short maturity of these funds.

Structured notes payable, debentures payable and junior subordinated notes: The estimated fair value is based on a present value calculation based on prices of the same or similar instruments after considering market risks, current interest rates and remaining maturities.

Secured borrowings — government guaranteed loans: The estimated fair value approximates cost, adjusted for cash premiums, as the loans were sold in current third-party transactions.

Revolving credit facility: The carrying amount is a reasonable estimation of fair value as the interest rate on this instrument is variable and the short duration to maturity.

Note 12. Supplemental Disclosure of Cash Flow Information:

Information regarding our non-cash activities was as follows:

		Six Months Ended
		June 30,
		2010				2009
		(In thousands)
Loans receivable reclassified to real estate owned		$	2,380			$	—
Reclassification from secured borrowings — government guaranteed loans to loans receivable, net		$	2,007			$	—
Loans receivable originated to facilitate sales of real estate owned		$	3,325			$	—
Consolidation of loans receivable		$	—			$	12,570

In addition, as described in Note 1, effective January 1, 2010, we are now consolidating the assets and liabilities of the 2000 Joint Venture and the 1998 Partnership, representing non-cash transactions. Previously, the 2000 Joint Venture and the 1998 Partnership were reflected as Retained Interests.

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 13. Commitments and Contingencies:

Loan Commitments

Commitments to extend credit are agreements to lend to a customer provided the terms established in the contract are met. Our outstanding loan commitments and approvals to fund loans were approximately $9.5 million at June 30, 2010, the majority of which were for prime-based loans to be originated by First Western, the government guaranteed portion of which is intended to be sold. Commitments generally have fixed expiration dates. Since some commitments are expected to expire without being drawn upon, total commitment amounts do not necessarily represent future cash requirements.

Operating Lease

We lease office space in Dallas, Texas under a lease which expires in October 2011. Future minimum lease payments under this lease approximate $295,000.

Employment Agreements

We have employment agreements with our executive officers for three-year terms expiring June 30, 2013. Under certain circumstances, as defined within the agreements, the agreements provide for severance compensation to the executive officer in a lump sum payment in an amount equal to 2.99 times the average of the last three years annual compensation paid to the executive officer.

Structured Loan Sale Transactions

The documents of the structured loan sale transactions contain provisions (the “Credit Enhancement Provisions”) that govern the assets and the inflow and outflow of funds of the entities originally formed as part of the structured loan sale transactions. The Credit Enhancement Provisions include specified increased reserve requirements. If, at any measurement date, the loans in structured loan transactions were delinquent in excess of specified limits or were considered “charged-off” loans in accordance with the transaction documents, the Credit Enhancement Provisions would require an increase in the level of credit enhancement (reserve fund). During the period in which the Credit Enhancement Provisions were in effect, excess cash flow from the entity, if any, which would otherwise be distributable to us, would be used to fund the increased credit enhancement levels until the specified reserve requirement was met and would delay or reduce our distribution. In general, there can be no assurance that amounts deferred under Credit Enhancement Provisions would be received in future periods or that future deferrals or losses would not occur. As a result of a delinquent loan in the 2003 Joint Venture, Credit Enhancement Provisions were triggered during the first quarter of 2009. As a consequence, cash flows related to this transaction otherwise distributable to us are being deferred and utilized to fund the increased credit enhancement requirement. Based on current cash flow assumptions, management anticipates that the funds will be received in future periods or used to repay the structured notes to the extent we exercise the “clean-up” call option.

Litigation

We had significant outstanding claims against Arlington Hospitality, Inc.’s and its subsidiary, Arlington Inns, Inc.’s (together “Arlington”) bankruptcy estates. Arlington objected to our claims and initiated a complaint in the bankruptcy seeking, among other things, the return of payments Arlington made pursuant to the property leases and the master lease agreement. While confident that a substantial portion of our claims would have been allowed and the claims against us would have been disallowed, due to the exorbitant cost of defense coupled with the likelihood of reduced available assets in the debtors’ estates to pay claims, we executed an agreement with Arlington to settle our claims against Arlington and Arlington’s claims against us. The settlement provides that Arlington will dismiss its claims seeking the return of certain payments made pursuant to the property leases and master lease agreement and substantially reduces our claims against the Arlington estates. The settlement further provides for mutual releases among the parties. The Bankruptcy Court approved the settlement. Accordingly, there are no remaining assets or liabilities recorded in the accompanying consolidated financial statements related to this matter. However, the settlement will only become final upon the Bankruptcy Court’s approval of Arlington’s liquidation plan which was filed during the third quarter of 2007. Due to the complexity of the bankruptcy, we cannot estimate when, or if, the liquidation plan will be approved.

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.

PMC COMMERCIAL TRUST AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Other

We provide standard representations and warranties to the SBA at the time we sell the guaranteed portion of the loan. If the SBA establishes that a loss on an SBA guaranteed loan is attributable to significant technical deficiencies (a breach of standard representations and warranties) in the manner in which the loan was originated, funded or serviced by First Western, the SBA may seek recovery of funds from us. With respect to the guaranteed portion of SBA loans that have been sold, the SBA will first honor its guarantee and then seek compensation from us in the event that a loss is deemed to be attributable to technical deficiencies.

ITEM 2.
Management’s Discussion and Analysis of Financial Condition
and Results of Operations

This Form 10-Q contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which are intended to be covered by the safe harbors created thereby. Such forward-looking statements can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “believe,” “anticipate,” “estimate,” or “continue,” or the negative thereof or other variations or similar words or phrases. These statements include the plans and objectives of management for future operations, including, but not limited to, plans and objectives relating to future growth of the loan portfolio and availability of funds. The forward-looking statements included herein are based on current expectations and there can be no assurance that these expectations will be attained. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this Form 10-Q will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. Readers are cautioned not to place undue reliance on forward-looking statements. Forward-looking statements speak only as of the date they are made. We do not undertake to update them to reflect changes that occur after the date they are made.

The following discussion of our financial condition at June 30, 2010 and results of operations for the three and six months ended June 30, 2010 and 2009 should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2009. For a more detailed description of the risks affecting our financial condition and results of operations, see “Risk Factors” in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009.

EXECUTIVE SUMMARY

Liquidity

Our revolving credit facility (the “Revolver”), which is collateralized by PMC Commercial’s loans, matures on December 31, 2010. The amount available under the Revolver is currently $30 million and reduces to $25 million on October 1, 2010. Upon maturity the amount available will be $20 million. We are currently addressing the extension of our facility for an additional year with our lender.

During the first half of 2010, we were able to reduce the outstanding balance under our Revolver by $4.1 million while our capital outlay to fund loans was $22.9 million. We received $18.6 million in proceeds from selling the government guaranteed portion of loans, $5.7 million in principal from payments on our loans receivable that collateralize our Revolver and $2.3 million in proceeds from selling real estate owned.

Our net capital outlay for loans during the second half of 2010 (loans to be funded less proceeds from loans to be sold) is anticipated to be approximately $4.0 million. Our anticipated scheduled principal payments on our loan portfolio during the second half of 2010 are $3.0 million which would be available to repay a portion of the existing balance under the Revolver. Based on the above cash activity and other factors, we currently anticipate that the balance outstanding under our Revolver will be approximately $20.0 million, without any proceeds from loan principal prepayments or cash sales of real estate owned or alternatively, any unforeseen uses of funds.

For 2011, we will need funds to originate loans. To the extent the maximum guarantees under the SBA 7(a) Program are capped at 75%, we anticipate that we would need between $7.5 million and $10.0 million in 2011 to fund our SBA 7(a) anticipated gross fundings of between $30.0 million and $40.0 million. Our anticipated scheduled principal payments on our loan portfolio in 2011 are $6.0 million which would be available to repay a portion of any balance under the Revolver. Accordingly, without any loan principal prepayments, we would need additional borrowing capacity of between $1.5 million and $4.0 million. This analysis does not take into account potential additional working capital needs such as (1) timing differences between when we originate a loan and when we receive the proceeds from the sold loan, (2) continuation of a cash dividend that exceeds our cash generated from operations, (3) outlay of funds needed to protect our loans receivable during the foreclosure process or (4) unforeseen cash needs.

We believe that we will be able to get the liquidity to fund our loans in 2011 by extending and increasing our Revolver to between $25.0 million and $30.0 million and through funds provided by principal prepayments on our loans. To the extent we are unable to extend or increase our Revolver, we may have to reduce the level of loan originations in 2011.

General Economic Environment

There has been an increase in mortgage defaults in the broader commercial real estate market and a belief that these defaults may increase. This increase is due in part to credit market turmoil and declining property cash flows and property values. In addition, when there are more foreclosures on commercial real estate properties the property values typically decline even further as supply exceeds demand in the market for the properties underlying these mortgages. We have experienced an increase in foreclosure activity. In conjunction with this increase in foreclosure activity, we have experienced, and will likely continue to experience, an increase in expenses as costs associated with these properties are incurred. In addition, we may experience an increase in loan losses and/or impairment losses. Further, our ability to sell our real estate owned will be affected by many factors, including but not limited to, the number of potential buyers, number of competing properties on the market and other market conditions.

Market Conditions

As a result of the current business environment including depressed real estate markets, liquidity has been severely restricted. Capital providers (including banks and insurance companies) substantially reduced the availability and increased the cost of debt capital for many companies originating commercial mortgages. We are uncertain as to how long the present economic conditions will remain and what shape the economy will take.

In response, legislators and financial regulators implemented a number of mechanisms designed to add stability to the financial markets. These programs and other legislative and regulatory efforts related to the financial markets provided increased liquidity to global financial markets. However, many of the government sponsored programs were temporary or have been completely utilized. The expiration of these or other legislative or regulatory initiatives may cause a further reduction in liquidity to the financial markets and as a result, we may need to modify our strategies, businesses or operations, and incur increased costs in order to satisfy new regulatory requirements or to compete in a changing business environment. Given the volatile nature of the market and uncertainties underlying efforts to mitigate or reverse the disruption, we may not timely anticipate or manage existing, new or additional risks, contingencies or developments. Our failure to do so could materially and adversely affect our business, financial condition, results of operations and prospects.

We rely on the market for Secondary Market Loan Sales. This market may diminish and/or the premiums achieved on selling loans into that market may be reduced which could have a material adverse effect on our ability to originate new loans.

Strategic Alternatives

The current credit and capital market environment remains unstable. While we continue to explore and evaluate strategic opportunities, our primary focus is on maximizing the value of our current investment portfolio and business strategy as well as exploring opportunities for alternative liquidity sources.

SBA 7(a) Program and Regulatory Environment

As a result of reduced liquidity, we continue to focus on the origination of SBA 7(a) Program loans which require less capital due to the ability to sell the government guaranteed portion of such loans. We utilize the SBA 7(a) Program to originate small business loans and then sell the government guaranteed portion to investors.

The American Recovery and Reinvestment Act (the “Stimulus Bill”), passed in February 2009, contained provisions that benefitted the SBA which we believe had a positive impact on our lending operations. The Stimulus Bill provided the SBA with temporary funding to eliminate fees on SBA 7(a) Program loans and provided increased SBA guarantee percentages on SBA 7(a) Program loans of up to 90% for certain loans during periods of time all of which ended before May 31, 2010. There is currently legislation being reviewed by Congress that contains provisions to allow the SBA to support larger loans and provide more financing options to a larger segment of small businesses including (1) increasing the 7(a) loan limit from $2 million to $5 million, (2) allowing the 504 loan program to refinance short-term commercial real estate debt into long-term, fixed-rate loans and (3) extending the authorization to provide 90% guarantees on 7(a) loans and fee elimination for borrowers on 7(a) and 504 loans through December 31, 2010. We believe that we would benefit from the increase in 7(a) loan limits, extension of 90% guarantees on 7(a) loans and fee elimination for borrowers on 7(a) loans. We are not currently utilizing the 504 program due to our limited liquidity.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Act”), passed in July 2010, provides new regulations and oversight of the financial services industry. We do not believe that this Act will have a material impact on us.

Secondary Market Loan Sales

During the first half of 2010, we sold $18.6 million of the guaranteed portion of SBA 7(a) Program loans. Loans were sold for (1) cash premiums and a benefit of 100 basis points (1%) (the minimum spread required to be retained pursuant to SBA regulations) for a servicing spread on the sold portion of the loan, (2) future servicing spreads averaging 437 basis points (including the 100 basis points required to be retained) and no cash premiums, or (3) future servicing spreads averaging 156 basis points (including the 100 basis points required to be retained) and cash premiums of 10% (i.e., “hybrid loan sales”). As a result of the new accounting rules regarding sale treatment for selling the guaranteed portion of our SBA 7(a) Program loans, no gain is recognized at the time of sale for any of these loan sales.

For the loan sales where we received cash premiums and the minimum servicing spread of 1%, sale treatment will occur after any contingencies have been satisfied which should occur 90 to 120 days after the proceeds were received. We recorded $204,000 (before cost allocations) in gains on sale during the second quarter of 2010 relating to these loans sales in the first quarter of 2010 (reflected as premium income included in other income in our consolidated income statements). We expect to record a gain from sale of $570,000 (before cost allocations) during the third quarter of 2010 relating to these loan sales in the second quarter of 2010. Once gains are recorded, there is no significant difference between the old and new accounting rules for these sales. In effect, the change in the accounting rules is to defer gain recognition during the contingency period of at least 90 days.

The more significant accounting rule change relates to those loans where management believes the best economic opportunity was to forego the up-front cash premiums in lieu of significant future servicing spread or to sell the loan for an up-front cash premium and lesser future servicing spread (than if the loan was sold solely for future servicing spread). On these loan sales, we receive a spread between the rate we collect from our borrowers and the rate we pay the buyers of the guaranteed portion of the loan. For loans sold solely for excess spread, this spread includes the average excess spread of 337 basis points to be received in future periods in addition to the SBA mandated 100 basis points.

For tax purposes, since all of these transactions are legal sales, we are required to record gains based on present value cash flow techniques consistent with the book accounting treatment utilized until January 1, 2010.

Consequently, for tax purposes, we had gains of approximately $658,000 during the six months ended June 30, 2010 related to sales of loans solely for excess spread but will not recognize any gains for book purposes. Instead, we will record book income as we receive the average 437 basis point spread as we service the sold portion of the loan. There can be no assurance that the loans will remain outstanding until maturity. However, management believes that the discounted present value of the future servicing income will be greater than the cash premiums we would have received since we expect the life of the loans (and the future incremental cash flows) to exceed the foregone premiums.

In addition, for tax purposes, we had gains of approximately $629,000 during the six months ended June 30, 2010 related to sales of loans for a cash premium and excess spread but will not recognize gain for book purposes. Upon expiration of the contingency period, the cash premium will be amortized as a reduction of interest expense over the life of the loan using the interest method. We will record book income as we receive the average 156 basis point excess spread as we service the sold portion of the loan.

The following highlights the difference between selling a loan for cash premium versus selling a loan for future excess spread versus selling a loan for a cash premium and future excess spread:

		Cash				Excess
		Premium				Spread				Hybrid
Loan amount		$	1,000,000			$	1,000,000			$	1,000,000
Guaranteed portion of total loan			90.00	%			90.00	%			90.00	%
Guaranteed loan amount		$	900,000			$	900,000			$	900,000
Rate paid by borrower			6.00	%			6.00	%			6.00	%
Rate paid to purchaser			5.00	%			1.75	%			4.43	%
Total spread on sold portion of loan			1.00	%			4.25	%			1.57	%
Premium percentage			10.25	%			—				10.00	%
Proceeds from sale		$	992,250			$	900,000			$	990,000
Premium received		$	92,250			$	—			$	90,000
Future servicing spread:
Estimated cash flow — Year 1		$	8,900			$	37,900			$	14,000
Estimated cash flow — Initial 5 years		$	42,800			$	182,200			$	67,300
Total cash from sale at the end of 5 years (1)		$	1,035,050			$	1,081,900			$	1,057,300