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, 2007

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, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
			(Do not check if a smaller reporting company)

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

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, 2007 as reported on the American Stock Exchange, was approximately $126 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 5, 2008, the Registrant had outstanding 10,765,033 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, 2007

TABLE OF CONTENTS

ITEM				PAGE
PART I
1.		Business			2
1A.		Risk Factors			12
1B.		Unresolved Staff Comments			20
2.		Properties			21
3.		Legal Proceedings			21
4.		Submission of Matters to a Vote of Security Holders			21
PART II
5.		Market for Registrant’s Common Equity and Related Shareholder Matters and Issuer Purchases of Equity Securities			22
6.		Selected Consolidated Financial Data			23
7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			24
7A.		Quantitative and Qualitative Disclosures About Market Risk			47
8.		Consolidated Financial Statements and Supplementary Data			49
9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			50
9A.		Controls and Procedures			50
9B.		Other Information			51
PART III
10.		Directors, Executive Officers and Corporate Governance			52
11.		Executive Compensation			52
12.		Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters			53
13.		Certain Relationships and Related Transactions, Director Independence			53
14.		Principal Accountant Fees and Services			53
PART IV
15. Exhibits and Financial Statement Schedules					54
Signatures					55
Consolidated Financial Statements					F-1
Exhibits					E-1
Employment Agreement with Ron Dekelbaum
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 and retail industries. 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. 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. During the years ended December 31, 2007 and 2006, our total revenues were approximately $27.3 million and $29.0 million, respectively, and our net income was approximately $13.1 million and $15.7 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”).

     First Western is 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 may receive cash premiums at the time of sale that approximate up to 10% of the principal amount of the loan sold. Due to the existence of the SBA guarantee which generally provides us with premiums

upon sale, we are able to originate loans that would not typically meet our underwriting criteria. 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. During periods of falling interest rates, due to the significant level of our variable-rate loans, our interest income is subject to interest rate risk. See “Item 7a. Quantitative and Qualitative Disclosures About Market Risk.”

     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.

     We historically operated in two identifiable reportable segments: (1) the lending division, which originates loans to small businesses primarily in the limited service hospitality industry and (2) the property division, which owned and operated our hotel properties. As of December 31, 2007, we had sold or leased all of our hotel properties. All revenues and expenses of the properties sold are included in discontinued operations. See detailed financial information regarding our segments in “Item 8. Consolidated Financial Statements and Supplementary Data.”

LENDING ACTIVITIES

Overview

     We are a national lender that primarily originates loans to small businesses, primarily in the limited service hospitality industry. In addition to first liens on real estate of the related business, our loans are typically personally guaranteed by the principals of the entities obligated on the loans. For the year ended December 31, 2007, total revenues and income from continuing operations of our lending division were approximately $27.3 million (100% of revenues) and $12.4 million (approximately 94% of net income), respectively.

     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 real estate and loan brokers, franchise representatives, existing borrowers, lawyers and accountants. Payments are sometimes 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 for owner-operated facilities operating under national franchises, including Comfort Inn, Hampton Inn & Suites, Holiday Inn Express, Best Western, Clarion and Candlewood Suites, among others. We believe that franchise operations offer attractive lending opportunities because such businesses generally employ proven business concepts, have national reservation systems, national advertising and 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 generally 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, improvement was seen in lodging demand in 2007. For 2008, lodging demand has been predicted by industry analysts to be relatively flat; however, average daily room rates and revenue per available room are expected to increase. These increases are 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 positive results will continue in 2008.

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 industry and competitive environment in which the borrower operates;
	•		The financial strength of the guarantors;
	•		The ease with which the collateral can be liquidated;
	•		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 also utilize 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 80% of either the replacement cost or 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 initially 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). 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.

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

		At December 31,
		2007												2006
										Weighted												Weighted
										Average												Average
		Loans Receivable, net								Interest				Loans Receivable, net								Interest
		Amount				%				Rate				Amount				%				Rate
		(Dollars in thousands)
Variable-rate — LIBOR		$	129,650				78.1	%			9.0	%		$	127,931				75.6	%			9.4	%
Fixed-rate			22,794				13.8	%			8.6	%			23,419				13.9	%			8.8	%
Variable-rate — prime			13,525				8.1	%			9.6	%			17,831				10.5	%			10.2	%
Total		$	165,969				100.0	%			9.0	%		$	169,181				100.0	%			9.4	%

     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,
		2007				2006				2005				2004				2003
		(In thousands)
Loans receivable, net — beginning of year		$	169,181			$	157,574			$	128,234			$	50,534			$	71,992
Loans originated			44,419				71,530				58,852				53,659				31,320
Loans acquired (1)			—				—				—				55,144				—
Principal collections (2)			(32,559	)			(47,240	)			(13,826	)			(23,196	)			(5,655	)
Repayments of SBA 504 program loans (3)			(8,085	)			(2,342	)			(2,180	)			(1,621	)			(1,963	)
Loans sold (4)			(1,971	)			(6,373	)			(7,785	)			(6,222	)			—
Loans transferred to AAL (5)			(4,917	)			(3,730	)			(5,657	)			(2,115	)			—
Structured loan sales (6)			—				—				—				—				(45,456	)
Loan deemed to be repurchased from QSPE (7)			—				—				—				2,126				—
Other adjustments (8)			(99	)			(238	)			(64	)			(75	)			296
Loans receivable, net — end of year		$	165,969			$	169,181			$	157,574			$	128,234			$	50,534

Quarterly Loan Originations

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

		Years Ended December 31,
		2007				2006				2005				2004				2003
		(In thousands)
First Quarter		$	15,401			$	17,630			$	8,251			$	6,609			$	9,009
Second Quarter			18,632				13,536				11,236				17,255				12,103
Third Quarter			2,150				5,710				15,010				14,998				5,557
Fourth Quarter			8,236				34,654				24,355				14,797				4,651
Total		$	44,419			$	71,530			$	58,852			$	53,659			$	31,320

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,
		2007												2006
		Aggregate								Loans				Aggregate								Loans
		Portfolio				Sold Loans				Receivable				Portfolio				Sold Loans				Receivable
		(Dollars in thousands)
Portfolio outstanding (1)		$	326,368			$	159,945			$	166,423			$	397,567			$	227,874			$	169,693
Weighted average interest rate			9.2	%			9.4	%			9.0	%			9.5	%			9.6	%			9.4	%
Annualized average yield (2)			10.5	%			10.9	%			10.1	%			10.5	%			10.1	%			11.0	%
Weighted average contractual maturity (in years)			14.8				12.6				17.0				15.0				13.6				16.7
Impaired loans (3)		$	4,135			$	1,022			$	3,113			$	5,415			$	3,496			$	1,919
Hospitality industry concentration %			90.9	%			88.1	%			93.5	%			91.7	%			90.0	%			93.9	%
Texas concentration % (4)			25.3	%			25.7	%			25.0	%			24.7	%			26.5	%			22.3	%

Industry Concentration

     The distribution of our loan portfolio by industry was as follows at December 31, 2007:

		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			143			$	155,655				93.5	%			252			$	296,593				90.9	%
Convenience stores/service stations			13				7,852				4.7	%			19				14,578				4.5	%
Restaurants			12				1,178				0.7	%			12				2,498				0.8	%
Services			13				517				0.3	%			17				3,603				1.1	%
Retail			7				469				0.3	%			7				1,016				0.3	%
Other			12				752				0.5	%			21				8,080				2.4	%
			200			$	166,423				100.0	%			328			$	326,368				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. 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 its outstanding loans receivable and other investments or (2) $1.0 million, and is subject to 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 (“CDCs”) 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 from a CDC 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 those 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.

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.

     We anticipate that our next securitization would be a structured loan financing. A structured loan financing is similar to a structured loan sale, with the exception that the transaction is not treated as a sale for financial reporting purposes. Therefore, the loans contributed to the SPE and the notes payable issued by the SPE would be included in our consolidated financial statements and as a result, the ownership interest in the SPE would not be accounted for as a retained interest. The terms of the notes payable issued by the SPE would provide that PMC Commercial would not be liable for payment on the notes. Accordingly, even though the loans receivable and notes payable of the SPE would be included in our consolidated financial statements, if the SPE failed to pay the principal or interest on the notes, the sole recourse of the holders of the notes would be against the loans receivable and any other assets of the SPE.

     Our structured loan sale transactions receive opinions from outside counsel that opine to the legal sale of the loans to the legal entity formed in connection with the securitization. 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, 2007, the QSPEs consisted of:

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

     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”) in the merger. We previously owned a portion of the 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.

     At December 31, 2007, the cost of our Retained Interests was approximately $46.7 million with an estimated fair value of $48.6 million. See Note 5 to the Consolidated Financial Statements for detailed information on our Retained Interests.

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 (the “overcollateralized piece”), 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 (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 – Investment Risks 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, 2007 and 2006, our consolidated balance sheets do not include $141.8 million and $207.7 million in assets,

respectively, and $94.4 million and $156.5 million in liabilities, respectively, related to these structured loan sale transactions recorded by the QSPEs. At December 31, 2007, the partners’ capital of the QSPEs was approximately $47.4 million compared to the estimated value of the associated Retained Interests of approximately $48.2 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 46 individuals including marketing professionals, investment professionals, operations professionals and administrative staff as of December 31, 2007. In addition, we have employment agreements with our executive officers. Our operations are conducted from our Dallas, Texas office. We believe the relationship with our employees is good.

COMPETITION

     When 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. In addition, increased competition has caused margin compression.

     Fixed-rate lending: As a result of the prolonged period in which the yield curve was 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 was no longer economically viable for us to compete for fixed-rate loans. In the current market, 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 or anticipated levels.

Investment Risks – Lending Activities

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

     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, interest income on our currently outstanding loans receivable will decline. See “Item 7a. Quantitative and Qualitative Disclosures About Market Risk.”

     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).

     In addition, our net income 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 are primarily originating 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.

Commercial mortgage loans expose us to a high degree of risk associated with investing in real estate.

     The performance and value of our loans depends upon many factors beyond our control. Commercial real estate has experienced significant fluctuations in the past and cyclical performance that impacts the value of our real estate collateralized loans. The ultimate performance and value of our loans are subject to risks associated with the ownership and operation of the properties which collateralize our loans includes the property owner’s ability to operate the property with sufficient cash flow to meet debt service requirements. Property operations may be adversely affected by:

	•		changes in national economic conditions;
	•		changes in local real estate market conditions due to changes in national or local economic conditions or changes in local property market characteristics;
	•		the extent of the impact of the current disruptions in the credit markets;
	•		the lack of demand for commercial real estate collateralized loans used in asset-backed securitizations which may be substantially reduced as a result of the current disruptions in the credit markets;
	•		competition from other properties;
	•		changes in interest rates and the condition of the debt and equity capital markets;
	•		the ongoing need for capital improvements;
	•		changes in real estate tax rates and other operating expenses (including utilities);
	•		adverse changes in governmental rules and fiscal policies; Acts of God, including earthquakes, hurricanes and other natural disasters; Acts of war or terrorism; decrease in the availability of or increase in the cost of insurance;
	•		adverse changes in zoning laws;
	•		the impact of present or future environmental legislation and compliance with environmental laws; and
	•		other factors that are beyond our control or the control of the commercial property owners.

     In the event that any of the properties underlying our loans experience any of the foregoing events or occurrences, the value of, and return on, such loans may be negatively impacted. Moreover, our profitability and the market price of our common shares may be negatively impacted.

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 or anticipated 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 or anticipated 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 local or macro 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.

Our operating results will depend, in part, on the effectiveness of our marketing programs.

     In general, due to the highly competitive nature of our business, we must execute efficient and effective promotional and marketing programs with respect to our businesses. We may, from time to time, change our marketing strategies, including the timing or nature of promotional programs. The effectiveness of our marketing and promotion practices is important to our ability to locate potential borrowers and retain existing borrowers. If our marketing programs are not successful, our business, results of operations and financial condition may be adversely affected.

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 certain 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

We may not be able to successfully integrate new investments, which could decrease our profitability.

     Our future business and financial performance depend, in part, on our ability to grow through successfully integrating new investments. We may incur significant costs in the evaluation of new investment opportunities. Successfully integrating new investments puts pressure on our marketing and management resources and we may fail to invest sufficient funds to make it successful. If we are not successful in the integration of new investments, our results of operations could be materially adversely affected, our revenues could decrease and our profitability could decline.

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, 2007 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)		$	48,072			($	544	)
Losses increase by 100 basis points per annum (2)		$	47,271			($	1,345	)
Rate of prepayment increases by 5% per annum (3)		$	48,586			($	30	)
Rate of prepayment increases by 10% per annum (3)		$	48,537			($	79	)
Discount rates increase by 100 basis points		$	47,829			($	787	)
Discount rates increase by 200 basis points		$	47,059			($	1,557	)

     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, 2007, our loans receivable were approximately 94% concentrated in the hospitality industry and approximately 92% of the loans sold to our QSPEs were concentrated in the hospitality industry. Any economic factors that negatively impact the hospitality industry, including travel restrictions, gasoline prices, bankruptcies or other political or geopolitical events, could have a material adverse effect on our financial condition and results of operations.

     At December 31, 2007, approximately 25% of our loans receivable were collateralized by properties in Texas and approximately 23% 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, 2007. 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 the current low level of 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 generally will have a negative impact on our financial condition and/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 government 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 common shares.

     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 common shares; however, the effect could be adverse.

Liquidity and Capital Resources Risks

     In general, 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. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recent Developments and Trends That May Affect Our Business.”

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 demand for structured loan transactions may decline, which would decrease the availability of, and/or increase the cost of, working capital and negatively affect earnings and 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, 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 the temporary suspension of our 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 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.

Operating Risks

The occurrence of recent adverse developments in the mortgage finance and credit markets has affected our business.

     In recent months, the mortgage industry has come under enormous pressure due to numerous economic and industry related factors. Many companies operating in the mortgage sector have failed and others are facing serious operating and financial challenges. At the same time, many mortgage securities have been downgraded and delinquencies and credit performance of mortgage loans, primarily residential, have deteriorated. We face significant challenges due to these adverse conditions in pricing and financing our mortgage assets. There is no assurance that these conditions have stabilized or that they will not worsen. Recent adverse changes in the mortgage finance and credit markets have also eliminated or reduced the availability, or increased the cost, of significant sources of funding for us.

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. 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.

     We believe the risks associated with our operations are more severe during periods of economic slowdown or recession. Declining real estate values may reduce the level of new mortgage loan originations, since borrowers often use existing property value increases to support investment in additional properties.

     Borrowers may also be less able to meet their debt service requirements if the real estate economy weakens. Furthermore, declining real estate values significantly increase the likelihood that we will incur losses on our loans in the event of default because the value of our collateral may be insufficient to cover our exposure. Increased payment defaults, foreclosures or losses could adversely affect our results of operations, financial condition, liquidity, business prospects and our ability to make dividend distributions.

     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 that 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 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 through June 2010. 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 and subsequent changes 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 our financial condition or results of operations. 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% through 2010. 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.

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 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.

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.

     A hotel property is owned by our unconsolidated subsidiary. The property is located in Indiana, was built in 1992 and has 60 rooms.

Item 3. LEGAL PROCEEDINGS

     We had significant outstanding claims against Arlington Hospitality, Inc.’s and its subsidiary Arlington Inns, Inc.’s (together “Arlington”) bankruptcy estates. Arlington Inns, Inc. was the former lessee of our hotel properties. Arlington objected to our claims and initiated a complaint in the bankruptcy seeking, among other things, return of certain payments Arlington made pursuant to the property leases and the Master Lease Agreement.

     While confident 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 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.

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 2007.

PART II

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

     Our 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, 2007		$	13.50			$	10.75			$	0.30				—
September 30, 2007		$	14.55			$	12.22			$	0.30				—
June 30, 2007		$	14.85			$	12.53			$	0.30				—
March 31, 2007		$	15.90			$	14.22			$	0.30				—
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				—

     On March 5, 2008, there were approximately 900 holders of record of our common shares, excluding stockholders whose shares were held by brokerage firms, depositories and other institutional firms in “street name” for their customers. The last reported sales price of our common shares on March 5, 2008 was $9.95.

     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. In general, the Board also uses cash flow from operating activities adjusted for changes in operating assets and liabilities 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 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, 2007. 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,
		2007				2006				2005				2004 (1)				2003
		(In thousands, except per share information)
Total revenues		$	27,295			$	28,973			$	24,437			$	20,201			$	9,330
Income from continuing operations (2)		$	12,094			$	13,532			$	9,345			$	9,641			$	4,618
Discontinued operations (2)		$	1,041			$	2,152			$	1,952			$	3,547			$	2,845
Gain on sale of loans receivable		$	—			$	—			$	—			$	—			$	711
Extraordinary item: negative goodwill		$	—			$	—			$	—			$	11,593			$	—
Net income		$	13,135			$	15,684			$	11,297			$	24,781			$	8,174
Basic weighted average common shares outstanding			10,760				10,748				10,874				10,134				6,448
Basic and diluted earnings per common share:
Income from continuing operations and gain on sale of loans receivable (2)		$	1.12			$	1.26			$	0.86			$	0.95			$	0.83
Extraordinary item: negative goodwill		$	—			$	—			$	—			$	1.14			$	—
Net income		$	1.22			$	1.46			$	1.04			$	2.44			$	1.27
Dividends declared, common		$	12,915			$	13,975			$	13,569			$	14,140			$	9,932
Dividends per common share		$	1.20			$	1.30			$	1.25			$	1.40			$	1.54

		At December 31,
		2007				2006				2005				2004 (1)				2003
		(In thousands)
Loans receivable, net		$	165,969			$	169,181			$	157,574			$	128,234			$	50,534
Retained Interests		$	48,616			$	55,724			$	62,991			$	70,523			$	30,798
Real estate investments		$	—			$	4,414			$	23,550			$	38,082			$	43,339
Total assets		$	231,420			$	240,404			$	259,192			$	253,840			$	131,736
Debt		$	59,185			$	64,841			$	84,040			$	75,349			$	33,380
Redeemable preferred stock of subsidiary		$	3,768			$	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. Our loans are primarily to borrowers in the limited service hospitality industry. 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 include the following:

	•		Interest earned on our loans receivable;
	•		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 of, amount of and cost of funds for 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); and
	•		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.

RECENT DEVELOPMENTS AND TRENDS THAT MAY AFFECT OUR BUSINESS

     During 2007, we originated $44.4 million of loans. The market segment for limited service hospitality loans continues to be extremely competitive and our ability to offer fixed-rate loans is constrained by our cost of funds. We anticipate that our 2008 aggregate loan originations will be approximately $40 million to $50 million. During January and February 2008 we funded approximately $16.4 million of loans.

     The availability of capital for providers of real estate financing generally deteriorated during 2007 and into 2008. The initial cause of the deterioration was credit concerns in the sub-prime residential mortgage market. We are neither an originator of sub-prime mortgages nor an originator of residential mortgages. As a result of these concerns, there appears to be a spillover effect and banks and securities firms have substantially reduced the availability and increased the cost of debt capital for many companies originating commercial mortgages.

     On January 25, 2008, we amended our conduit facility, which among other things, extended its maturity date from February 2008 to May 2, 2008. Based on current market conditions and communications from our conduit lender, we expect that the lender will not extend the conduit facility beyond May 2, 2008. Accordingly, we increased the amount available under our revolving credit facility, which matures December 31, 2009, from $20 million to $45 million. As of February 29, 2008, we had approximately $31 million in combined borrowings outstanding under our conduit facility and revolving credit facility. We are working with the provider of our revolving credit facility to further increase the availability of funds from $45 million to $65 million. There can be no assurance that we will be able to increase the amount available under our revolving credit facility. We have availability through 2009 under our current revolving credit facility; however, the limited amount of capital available to originate new loans may cause us to curtail some non-SBA 7(a) loan origination activity.

     Our 2007 volume of loan originations decreased due to increased competition. Lenders to the limited

service hospitality market, where we have traditionally concentrated, have become more aggressive in the last three years as this segment has become more mainstream. Banks have expanded their position in this market through the use of deposits to fund fixed-rate mini-perm loans with five-year maturities and 15 to 25-year amortization periods. In addition, conduit lending programs sponsored by large investment banks have been more aggressive in lending to the limited service hospitality market with maturities of ten years or greater and 20 to 30-year amortization periods. This competition has resulted in fewer new loan originations to non-bank lenders with a reduced spread on loans originated. While recently some of our competitors have scaled back their origination activity due to credit market disruptions, the overall competition remains strong.

     The competitive nature of this market has also resulted in a significant increase in the amount of prepayments of our serviced loans. We had greater than $91 million of prepayments of our serviced portfolio in 2006 and over $84 million in 2007. As shown in the table below, the result has been a reduction in our total serviced portfolio outstanding from its peak of approximately $498 million during 2004 to $326 million at December 31, 2007. During January and February 2008, we had prepayments of our retained portfolio and securitized loans of approximately $5.4 million and $16.6 million, respectively. While we believe that we will continue to see high levels of prepayment activity during the remainder of 2008, the credit market disruptions may have a moderating effect. Information on our serviced portfolio is provided since we retain a residual interest in the cash flows from our sold loans. Therefore, the performance of these loans impacts our profitability and our cash available for dividend distributions. Information on our serviced portfolio, including prepayment trends, was as follows:

		December 31,
		2007				2006				2005				2004
		(Dollars in thousands)
Serviced portfolio (1)		$	326,368			$	397,567			$	447,220			$	468,158
Loan originations		$	44,419			$	71,530			$	58,852			$	53,659
Prepayments		$	84,137			$	91,710			$	41,049			$	15,931
% Prepayments (2)			21.2	%			20.5	%			8.8	%			3.2	%

     We continue to explore additional investment and business opportunities. However, as a result of current credit market disruptions, investment in these opportunities may be limited. We are evaluating investment opportunities in the banking industry which may provide alternative and/or lower cost of funds as well as alternative lending products. To the extent we were to invest in certain opportunities in the banking industry, we may no longer be able to operate as a REIT. These changes may require shareholder approval. 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 dividend payments at their current or anticipated levels. In order to finance these investments, we anticipate utilizing alternative sources of funds and/or our revolving credit facility.

     We are in the process of further expanding our marketing initiatives for the SBA 7(a) Program. The typical size of a SBA 7(a) Program loan is smaller than our other lending programs. We anticipate that as a result of First Western’s preferred lender status and these expanded marketing initiatives, our originations under the SBA 7(a) Program will increase; however, to date we have not realized an increase in origination volume. We are beginning to see an increase in commitments. Our SBA 7(a) commitments and approvals at December 31, 2007 were $7.0 million compared to fundings of $2.9 million during 2007.

     The Federal Reserve Bank lowered its federal funds rate by 1% during 2007 and by another 1.25% during January 2008. These reductions have led to corresponding decreases in LIBOR. Most of our retained loans (approximately $143.2 million) and our consolidated debt (approximately $51.0 million) are based on LIBOR or the prime rate. On the net difference of $92.2 million between our variable rate loans and debt, interest rate reductions will have a negative impact on our future earnings. The weighted average LIBOR used in the determination of the base interest rates charged to our borrowers during 2007 was 5.33%. During the first quarter of 2008, the base interest rate (LIBOR) charged to our borrowers was 4.73% and more recently, LIBOR decreased to 3.08% as of

February 29, 2008. A 2% reduction in variable interest rates will cause a reduction in our net interest income of approximately $1.8 million assuming no other portfolio changes.

     On our variable-rate loans, we charge a spread over a base rate, either LIBOR or the prime rate. The base rates were as follows:

		2007				2006				2005
LIBOR
First Quarter			5.36	%			4.53	%			2.56	%
Second Quarter			5.35	%			4.99	%			3.10	%
Third Quarter			5.36	%			5.51	%			3.50	%
Fourth Quarter			5.23	%			5.37	%			4.05	%
Prime Rate
First Quarter			8.25	%			7.25	%			5.25	%
Second Quarter			8.25	%			7.75	%			5.75	%
Third Quarter			8.25	%			8.25	%			6.25	%
Fourth Quarter			7.75	%			8.25	%			6.75	%

     The interest rate yield curve combined with increased competition has caused margin compression (i.e., 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). Whereas historically we originated variable-rate loans at 3.5% to 4.5% over LIBOR, currently we are offering rates between 3.0% and 3.5% 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 rates charged to our borrowers and the cost of funds may be less than the spread of 2.77% on our variable-rate securitization completed during 2003. 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. The margin compression lowers our profitability and may have an impact on our ability to maintain our dividend at the current or anticipated amounts.

     We have sold all our hotel properties and assets acquired in liquidation. In addition, during June 2007, we executed a settlement agreement with Arlington Hospitality, Inc. and its subsidiary Arlington Inns, Inc. (together “Arlington”) that substantially eliminated our involvement with Arlington’s bankruptcy estate. As a result, management is now able to increase their focus on our core business including expansion of SBA 7(a) Program initiatives and potential new investment opportunities.

     Management believes that a useful measure of our operating profitability is our income from continuing operations. Recently, we have experienced a reduction in yield from our Retained Interests and lower prepayment fee income. Primarily as a result of these trends, our income from continuing operations declined from $3,542,000 during the third quarter of 2007 to $2,167,000 during the fourth quarter of 2007. Since interest rates have recently decreased and we do not anticipate reversal of the trend of reducing yield on our Retained Interests or reduced prepayment fee income, management anticipates that our income from continuing operations will be lower in 2008 than 2007. Therefore, our Board of Trust Managers declared a quarterly cash dividend of $0.20 per common share to be paid to shareholders of record on March 31, 2008. This quarterly cash dividend compares to a dividend of $0.30 per common share paid to shareholders of record on December 31, 2007. The Board of Trust Managers established the dividend in an amount it believes can reasonably be paid each of the four quarters of 2008. Our Board of Trust Managers believes that it is prudent to conserve capital to enhance our core lending programs during this period of market volatility.

LOAN PORTFOLIO INFORMATION AND STATISTICS

General

     Loans originated during 2007 and 2006 were $44.4 million (of which approximately $10.7 million were originated in conjunction with sales of our hotel properties and assets acquired in liquidation and approximately $5.0

million were repurchased from our securitizations) and $71.5 million (of which approximately $19.8 million were originated in conjunction with sales of our hotel properties and assets acquired in liquidation) of loans, respectively. We currently anticipate aggregate loan originations to be between $50 million and $60 million during 2008. Our average loan commitment at December 31, 2007, excluding SBA 7(a) Program loans, was approximately $3.1 million per loan. Accordingly, a change in a few loans funding in periods other than expected or a few loan commitments being cancelled or approved would have a material impact on our estimates. At December 31, 2007 and 2006, our outstanding commitments to fund new loans were approximately $32.1 million and $32.6 million, respectively. All of our current commitments are for variable-rate loans which provide an interest rate match with our present sources of funds. 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.

     Our loans receivable were approximately 94% concentrated in the hospitality industry at December 31, 2007. Any economic factors that negatively impact the hospitality industry could have a material adverse effect on our financial condition or results of operations.

     Lodging demand in the United States generally 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 was seen in lodging demand in 2007. For 2008, lodging demand has been predicted by industry analysts to be relatively flat; however, average daily room rates and revenue per available room are expected to increase. These increases are 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 positive results will continue in 2008.

Loan Portfolio Rollforward

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

		Years Ended
		December 31,
		2007				2006				2005
		(In millions)
Loan Originations:
Commercial mortgage loans		$	28.3			$	36.9			$	35.9
SBA 7(a) Program loans			2.9				8.5				10.7
Loans originated in connection with sale of assets acquired in liquidation and hotel properties			10.7				19.8				8.5
SBA 504 program loans (1)			2.5				6.3				3.8
Total loans originated		$	44.4			$	71.5			$	58.9
Principal Repayments:
Prepayments		$	26.5			$	40.7			$	9.4
Proceeds from the sale of SBA 7(a) guaranteed loans			2.0				6.4				7.8
Scheduled principal payments			4.0				5.3				3.8
Balloon maturities of SBA 504 program loans			8.1				3.6				2.8
Total principal repayments		$	40.6			$	56.0			$	23.8

Prepayment Activity

     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 to lock in at the current low level of

fixed interest rates. While we believe that we will continue to see prepayment activity at these higher levels during 2008, the credit market disruptions may have a moderating effect.

     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.

     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.

     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 current market 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. During the last two years we have originated, and may continue to originate, variable-rate loans with no prepayment fees or significantly reduced prepayment fees. For our loans receivable, the proceeds from the prepayments we receive are either used to repay debt or invested initially in temporary investments.

     Our SBLC sells the government 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,
		2007				2006
		(Dollars in thousands)
Problem Loans:
Loans receivable		$	49			$	1,887
Sold loans of QSPEs (1)			—				—
		$	49			$	1,887
Special Mention Loans:
Loans receivable		$	3,064			$	32
Sold loans of QSPEs (1)			1,022				3,496
		$	4,086			$	3,528
Percentage Problem Loans:
Loans receivable			—				1.1	%
Sold loans of QSPEs (1)			—				—
Percentage Special Mention Loans:
Loans receivable			1.8	%			—
Sold loans of QSPEs (1)			0.8	%			1.9	%

     At December 31, 2007 and 2006, we had reserves of $42,000 and $63,000, respectively. Our provision for loan losses (excluding reductions of loan losses) as a percentage of our weighted average outstanding loans receivable was 0.07% and 0.11% during 2007 and 2006, 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.

RETAINED INTERESTS

     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 “overcollateralized piece”), (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.

     We use an income approach in order to value our Retained Interests. 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, including risk premiums, 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.

     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.

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 limited service 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.

     Positive trends have been occurring in the limited service hospitality industry since 2003 and are expected to continue during 2008. These positive trends 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. However, 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, we utilize our own data and assumptions to determine the value of our Retained Interests, in conjunction with our knowledge of similar markets for our type of Retained Interests. Based on these factors, 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 and the effect of these revised assumptions may have a material impact on our consolidated financial statements. 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. The riskiest component of our Retained Interests is the interest-only strip receivable which is subject to prepayment risk and risk of loss as a result of monetary default by an underlying loan. The discount rates for the interest-only strip receivable take into account the uncertainty resulting from the potential for prepayments and/or losses exceeding estimates. The reserve funds are available to repay the noteholders if the excess spread is not sufficient to satisfy the noteholder requirements (i.e., if loan defaults occur). In addition, the reserve fund is restricted until the transaction matures; accordingly, the discount rate utilized takes into account the risk premium for this restriction. Our overcollaterized piece is discounted based on a risk premium assuming that the reserve fund and excess spread are insufficient to pay the balances due to the noteholders. Although we believe these estimates of discount rates are reasonable estimates of market rate, purchasers of these types of investments may utilize different discount rates in determining their value of the estimated future cash flows.

     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”) in the merger. 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 Rates								Aggregate Losses Assumed
		At December 31,								At December 31,
		2007				2006				2007				2006
Originated:
2000 Joint Venture			18.0	%			18.0	%			1.09	%			1.45	%
2001 Joint Venture (1)			—				18.0	%			—				—
2002 Joint Venture			18.0	%			18.0	%			0.93	%			1.42	%
2003 Joint Venture			18.0	%			16.0	%			0.88	%			1.36	%
Acquired:
Secondary Market Sales (2)			22.0	%			20.0	%			—				—
1998 Partnership			16.0	%			16.0	%			1.02	%			1.71	%
1999 Partnership			18.0	%			18.0	%			1.02	%			1.82	%
2000 Joint Venture			18.0	%			18.0	%			1.30	%			1.39	%
2001 Joint Venture			18.0	%			18.0	%			1.06	%			1.20	%
2002 Joint Venture			18.0	%			18.0	%			0.81	%			1.79	%
2003 Joint Venture			18.0	%			16.0	%			0.86	%			1.48	%

     Aggregate losses assumed have generally decreased from December 31, 2006 to December 31, 2007 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.

     Our discount rates are based on a spread over the 5-year treasury rate. At December 31, 2007, the 5-year treasury rate was 3.45% which is a reduction of 124 basis points from the 5-year

treasury rate of 4.69% at December 31, 2006. Based on the limited information available in the markets, the spread over the 5-year treasury rate which we utilize to estimate the discount rates on our Retained Interests has increased from 2006, primarily as a result of the credit market disruptions experienced commencing in the second half of 2007. As a result, the spread on our interest-only strip receivable increased from approximately 7.75% at December 31, 2006 to approximately 11.50% at December 31, 2007, an increase of approximately 375 basis points. Comparable increases on our reserve fund and overcollateralized piece spreads were 230 basis points and 200 basis points, respectively.

     The following is a sensitivity analysis of our Retained Interests as of December 31, 2007 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)		$	48,072				($    544	)
Losses increase by 100 basis points per annum (2)		$	47,271				($1,345	)
Rate of prepayment increases by 5% per annum (3)		$	48,586				($     30	)
Rate of prepayment increases by 10% per annum (3)		$	48,537				($     79	)
Discount rates increase by 100 basis points		$	47,829				($   787	)
Discount rates increase by 200 basis points		$	47,059				($1,557	)

     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.

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.

     Origination fees and direct loan origination costs are deferred and amortized to income 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.

     For loans purchased at a discount and loans recorded with a Retained Loan Discount, 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.

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.

RESULTS OF OPERATIONS

Year Ended December 31, 2007 Compared to the Year Ended December 31, 2006

Overview

     Income from continuing operations during 2007 decreased by $1,438,000 to $12,094,000 ($1.12 per share) from $13,532,000 ($1.26 per share) during 2006, a 10.6% decrease. This was primarily due to reduced revenues partially offset by reduced expenses and the occurrence of a $563,000 one-time gain in 2006.

     Our total revenues decreased $1,678,000 (5.8%) primarily due to reductions in income from Retained Interests and other income partially offset by increased interest income. The decrease in income from Retained Interests was due primarily to a decrease in the outstanding balance of our Retained Interests mainly from prepayments. Our other income decreased primarily due to a reduction in prepayment fees and servicing income mainly due to prepayments.

     Offsetting these decreases was an increase in interest income due primarily to an increase in our weighted average loans outstanding and a slight year over year increase in variable interest rates. However, our outstanding loan portfolio declined to $166,423,000 at December 31, 2007 from $169,693,000 at December 31, 2006. This 1.9% decrease will cause future reductions in interest income until our investment portfolio increases. Approximately 78% of our loans receivable at December 31, 2007 were based on LIBOR. The average base LIBOR charged to our borrowers during 2007 was 5.33% compared to the first quarter 2008 rate charged of 4.73%. During 2008, there have been additional interest rate reductions as the prime rate decreased from 7.25% to 6.00% and the 90-day LIBOR, on which interest is based to be charged to our borrowers, decreased from 4.73% at January 1, 2008 to 3.08% at February 29, 2008. Assuming LIBOR remains the same or continues to decrease as expected, our interest income will decrease until our investment portfolio increases.

     Net income decreased to $13,135,000 ($1.22 per share) during 2007 from $15,684,000 ($1.46 per share) during 2006. In addition to the changes to continuing operations described above, net income decreased due to a $329,000 reduction in net gains on sales of real estate included in discontinued operations.

     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,
		2007				2006
		(In thousands)
Interest income — loans		$	15,483			$	14,781
Interest income — idle funds			548				242
Accretion of loan fees and discounts			434				437
		$	16,465			$	15,460

     The increase in interest income – loans (4.7%) was primarily attributable to an increase in our weighted

average loans receivable outstanding of $9.6 million (6.2%) to $165.2 million during 2007 from $155.6 million during 2006. There was a slight increase in our year over year weighted average LIBOR charged from 5.10% during 2006 to 5.33% during 2007 which was offset by a decrease in the spread we charged over LIBOR on new loans. Our weighted average interest rate decreased from 9.4% at December 31, 2006 to 9.0% at December 31, 2007. The increase in our idle funds interest income is primarily due to the increased balance of cash and cash equivalents of our SBIC’s. These funds can only be used for commitments of the SBICs. As discussed above, as a result of recent lower short-term interest rates it is anticipated that our interest yield will be lower in 2008.

     Income from Retained Interests decreased $947,000 primarily due to a decrease in the weighted average balance of our Retained Interests outstanding of $5.5 million to $52.8 million during 2007 compared to $58.3 million during 2006. Offsetting this decrease was an increase in unanticipated prepayment fees of approximately $350,000. The yield on our Retained Interests, which is comprised of the income earned less permanent impairments, decreased to 13.9% during 2007 from 14.1% during 2006. Excluding the impact of permanent impairments, the yield on our Retained Interests decreased to 16.0% during 2007 from 16.1% during 2006. We believe that our income from Retained Interests will continue to decrease as scheduled principal payments and prepayments of our Sold Loans occur.

     Other income consisted of the following:

		Years Ended December 31,
		2007				2006
		(In thousands)
Servicing income		$	754			$	1,025
Prepayment fees			615				1,653
Other loan related income			572				403
Premium income			220				499
Other			226				93
		$	2,387			$	3,673

     While prepayment activity has remained at relatively high levels, which we believe will continue during 2008, prepayment fees have decreased. Prepayment fees on our variable-rate loans are generally less per loan than fixed-rate loans. As we are primarily originating variable-rate loans, we anticipate, as the outstanding principal balance of our fixed-rate loans declines, that prepayment fees will decline. In addition, during the last two years we have originated, and may continue to originate, variable-rate loans with no prepayment fees or significantly reduced prepayment fees. Prepayment fee income is dependent upon a number of factors and is not generally predictable as the mix of loans prepaying is not known.

     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, they will decrease over time as scheduled principal payments and prepayments occur, unless we complete a securitization or there is an increase in loans sold into the secondary market.

     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. Other loan related income increased from 2006 to 2007 primarily due to proceeds received from settlement of litigation related to a loan.

     Premium income results from the sale of the guaranteed portion of First Western’s loans into the secondary market. Our SBA 7(a) Program loan commitments have recently been increasing. 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.

Interest Expense

     Interest expense consisted of the following:

		Years Ended December 31,
		2007				2006
		(In thousands)
Junior subordinated notes		$	2,381			$	2,318
Conduit facility			2,108				1,383
Debentures payable			497				813
Revolving credit facility			99				125
Mortgage on hotel property			—				86
Structured notes			—				201
Other			318				291
		$	5,403			$	5,217

     The weighted average cost of our funds was relatively constant at 7.0% at December 31, 2007 compared to 7.1% at December 31, 2006.

     Interest expense on our conduit facility increased primarily as a result of increased utilization of the facility and increases in variable interest rates. Our weighted average borrowings outstanding on our conduit facility increased to $27.0 million during 2007 compared to $15.5 million during 2006. The interest rate on the conduit facility approximates LIBOR plus 0.85%. The rate that approximates LIBOR is a “pass-through” rate that the bank facility pays for its commercial paper commonly referred to as the “CP Rate.” During periods of credit market uncertainty, the bank facility may have to pay higher daily interest rates and consequently passes the higher rates to us. During September through December 2007, the pass-through rates were greater than LIBOR by an average of approximately 42 basis points which increased our interest expense by approximately $35,000. While the January 2008 pass-through rate was again higher than LIBOR, it appears that current pass-through rates have stabilized at closer to LIBOR.

     The reduction of interest expense on our debentures payable was a result of the prepayment, without penalty, of $7,310,000 of fixed-rate SBA debentures with an interest rate of approximately 8.5% during the third quarter of 2006. In addition, interest expense was reduced since 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 increased to $7,775,000 during 2007 compared to $7,433,000 during 2006. General and administrative expenses increased slightly to $2,717,000 during 2007 compared to $2,694,000 during 2006. Salaries and related benefits expense increased to $5,058,000 during 2007 compared to $4,739,000 during 2006 primarily due to cost of living increases.

     Permanent impairments on Retained Interests (write downs of the value of our Retained Interests) were $1,111,000 and $1,167,000 for 2007 and 2006, respectively, resulting from reductions in expected future cash flows due primarily to increased actual and anticipated loan prepayments on the underlying portfolio.

     Provision for losses on rent and related receivables was $239,000 and $925,000 during 2007 and 2006, respectively. These losses pertain to our lease agreements with Arlington. We had significant claims in the bankruptcy cases and the debtors had claims against our assets in response. While confident 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 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 the liquidation plan will be approved.

Gain on Early Extinguishment of Debt

     Gain on early extinguishment of debt during 2006 represented a gain of $563,000 that resulted 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, at that time there were no significant loan commitments at the SBIC level.

Discontinued Operations

     We recorded gains of $1,735,000 during 2007 resulting primarily from (1) the sale of two hotel properties for approximately $5.5 million generating gains of $1.1 million and three assets acquired in liquidation for approximately $7.6 million generating gains of approximately $185,000 and (2) the recognition of $420,000 in gain relating to the repayment in full of principal on a loan originated in connection with the sale of a hotel property with a deferred gain. We had net realized gains on the sales of real estate of $2,064,000 during 2006.

     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. At December 31, 2007, our remaining deferred gains were approximately $2.2 million. 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.

     Impairment losses were $233,000 and $94,000 for 2007 and 2006, respectively. During 2007, we recorded an impairment loss related to an estimated decline in fair value of an asset acquired in liquidation. For our real estate assets held for sale during 2006, we performed a recoverability test to determine if the expected net sales proceeds exceeded their carrying value. Based on this analysis, we recorded impairment losses of $94,000 during 2006.

     Net earnings (losses) from discontinued operations were ($461,000) and $182,000 during 2007 and 2006, respectively. The primary cause of the net loss from discontinued operations during 2007 was fees for the prepayment of two mortgage notes of approximately $452,000 incurred in connection with the sale of the related hotel properties.

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

Overview

     Income from continuing operations increased by $4,187,000 to $13,532,000 ($1.26 per share) during 2006 from $9,345,000 ($0.86 per share) 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 on early extinguishment of debt of $563,000 resulting from the repayment of $7,310,000 of SBA debentures with unamortized premiums; and
	•		An increase in other income of $272,000 due primarily to prepayment fees received; partially offset by
	•		An increase in interest expense of $758,000 due primarily to increases in variable interest rates and borrowings under our conduit facility.

     Discontinued operations increased by $200,000 to $2,152,000 ($0.20 per share) during 2006 from $1,952,000 ($0.18 per share) during 2005. As described in more detail below, significant changes between these periods were:

	•		Impairment losses decreased by $1,857,000; partially offset by
	•		Net gains on property sales decreased by $192,000; and
	•		Net earnings from our hotel properties decreased by $1,465,000.

Revenues

     Interest income consisted of the following:

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

     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. 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,
		2006				2005
		(In thousands)
Prepayment fees		$	1,653			$	590
Servicing income			1,025				1,222
Premium income			499				618
Other loan related income			403				646
Other			93				325
		$	3,673			$	3,401

     Prepayment activity remained at high levels during 2006. Prepayment activity for our fixed-rate loans receivable remained at high levels as a result of the continuation during 2006 of the 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 increased during 2006 since borrowers with variable-rate loans were 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, they will decrease over time as scheduled principal payments and prepayments occur, unless we complete a securitization or there is an increase in loans sold into the secondary market.

     Premium income results from the sale of the guaranteed portion 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.

     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,
		2006				2005
		(In thousands)
Junior subordinated notes		$	2,318			$	1,497
Conduit facility			1,383				724
Debentures payable			813				971
Structured notes			201				451
Revolving credit facility			125				214
Mortgage on hotel property			86				117
Uncollateralized notes payable			—				223
Other			291				262
		$	5,217			$	4,459

     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 $7,433,000 during 2006 compared to $7,606,000 during 2005. General and administrative expenses decreased to $2,694,000 during 2006 from $3,053,000 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 (write downs of the value of our 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 of $259,000 were recorded in 2005 for valuation decreases on our owned hotel properties. 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. These losses pertain to our lease agreements with Arlington. 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 Arlington Hospitality, Inc. 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.

     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.

Gain on Early Extinguishment of Debt

     Gain on early extinguishment of debt represented a gain of $563,000 that resulted 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 during this time.

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 totaled 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.

     Impairment losses were $94,000 and $1,951,000 for 2006 and 2005, respectively. 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.

     Net earnings from discontinued operations were $182,000 during 2006 compared to $1,647,000 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 $4.3 million when comparing 2006 to 2005. This reduction was partially offset by a decrease in depreciation expense of approximately $1.0 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 14 and 18 hotel properties during 2006 and 2005, respectively, and assets acquired in liquidation during 2006.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow Analysis

     Information on our cash flow was as follows:

		Years Ended
		December 31,
		2007				2006				Change
		(In thousands)
Cash provided by operating activities		$	11,733			$	13,832			$	(2,099	)
Cash provided by investing activities		$	15,660			$	16,377			$	(717	)
Cash used in financing activities		$	(19,647	)		$	(30,437	)		$	10,790

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. Our dividends paid during 2007 and 2006, included in financing activities, were $13,987,000 and $12,903,000, respectively. In 2006 and 2005 we had cash from operating activities before the change in operating assets and liabilities of $15,958,000 and $15,088,000, respectively, that were in excess of our dividend distributions by $3,055,000 and $1,051,000, respectively. During 2007, the comparable cash flows were reduced to $13,249,000 and accordingly dividend distributions were in excess by $738,000. To the extent cash from operating activities is not covering the current dividend distribution rate, the Board may choose to modify the dividend policy. See “Dividends.”

Investing Activities

     We continue to experience high prepayment activity and expect prepayment activity to remain at these higher levels during 2008. See “Loan Portfolio Information and Statistics – Prepayment Activity.” During 2007, the primary sources of funds were (1) principal collected on loans receivable in excess of loans funded of $8,910,000, (2) net principal collected on Retained Interests of $4,704,000 and (3) net proceeds from the sales of hotel properties and assets acquired in liquidation of $2,176,000. We have sold all of our hotel properties and assets acquired in liquidation; therefore, no additional proceeds are expected. 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. We do not expect the net principal collected on Retained Interests to continue at the historically achieved levels since reserve funds have reached their minimums.

Financing Activities

     We used funds for our financing activities during 2007 to pay dividends of $13,987,000. In addition, during the second quarter of 2007, we repaid the remaining balances on our mortgage notes of approximately $2.6 million primarily using our short-term credit facilities. Due primarily to prepayments, excess cash at the parent and SBA 7(a) subsidiary level which is not restricted was used to repay a portion of the balance outstanding on our conduit facility. 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.

Sources and Uses of Funds

Sources of Funds

     Our financial condition remains strong. We continue to have debt-to-equity ratios well below 1:1 with the ratio being approximately 0.5:1 at December 31, 2007. This ratio is well below that of typical specialty commercial finance companies. In general, our liquidity requirements include origination of new loans, debt principal and interest payment requirements. Our operating revenues are typically utilized to pay our operating expenses and dividends. We have been utilizing principal collections on existing loans receivable and Retained Interests and a combination of advances under our conduit facility and borrowings under our uncollateralized revolving credit

facility (the “Revolver”) as our primary source of funds. In addition, we may utilize, as deemed appropriate by prevailing market conditions, a combination of the following sources to generate funds:

	•		Structured loan financings or sales;
	•		Issuance of SBA debentures;
	•		Issuance of junior subordinated notes; and/or
	•		Common equity issuance.

     On January 25, 2008, we amended our conduit facility, which among other things, extended its maturity date from February 2008 to May 2, 2008. Based on current market conditions and communications from our conduit lender, we expect that the lender will not extend the conduit facility beyond May 2, 2008. Accordingly, we increased the amount available under our revolving credit facility, which matures December 31, 2009, from $20 million to $45 million. As of February 29, 2008, we had approximately $31 million in combined borrowings outstanding under the conduit facility and Revolver. We are working with the provider of our Revolver to further increase the availability of funds from $45 million to $65 million. There can be no assurance that we will be able to increase the amount available under our Revolver. We have availability through 2009 under our current Revolver; however, the limited amount of capital available to originate new loans may cause us to curtail some non-SBA 7(a) loan origination activity.

     We also had approximately $11.5 million of cash and cash equivalents at December 31, 2007, of which approximately $8.3 million was available only for future operating commitments of our SBICs. During 2008, we utilized approximately $5.1 million of the cash and cash equivalents of our SBIC to originate a loan. Pursuant to SBA rules and regulations, our SBICs cannot advance funds to us. As a result, we borrow funds on our credit facilities to make investments even though our SBICs have available cash and cash equivalents. We may utilize the cash and cash equivalents of our SBICs to prepay SBA debentures and/or the preferred stock.

     We expect that these sources of funds and cash on hand will be sufficient to meet our working capital needs. However, there can be no assurance that we will be able to raise funds through these financing sources. A reduction in the availability of the above sources of funds could have a material adverse effect on our financial condition and results of operations. If these sources are not available, we may have to originate loans at reduced levels or sell assets, potentially on unfavorable terms.

     As a REIT we must distribute to our shareholders at least 90% of our REIT taxable income to maintain our tax status under the Code. Accordingly, to the extent the sources above represent taxable income, such amounts have historically been distributed to our shareholders. In general, if we receive less cash from our portfolio of investments, we can lower the dividend so as not to cause any material cash shortfall. During 2008, we anticipate that our cash flows from operating activities will be utilized to fund our expected 2008 dividend distributions and generally will not be available to fund portfolio growth or for the repayment of principal due on our debt.

     Prior to 2004, our primary source of long-term funds was structured loan sale transactions. From 2004 to 2007, our working capital was provided through credit facilities and the issuance of junior subordinated notes. The timing of future securitization transactions is dependent upon our portfolio and loan originations. As a result of higher than anticipated prepayments on our loan portfolio and the current interest rate environment, we do not anticipate completing our next structured loan transaction earlier than the latter half of 2008 if (1) we have a sufficient pool of variable-rate loans to complete a securitization and (2) the credit market will support a reasonable spread. See “Item 1A. Risk Factors.”

     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 sell loans receivable thereby reducing our ability to originate loans. The timing and pricing of a structured loan transaction also has significant impact on our financial condition and results of operations. We currently have a sufficient amount of available capital under our Revolver and conduit facility.

     PMC Conduit’s principal repayment obligations are expected to be refinanced either through a future securitization of the loans collateralizing advances under the conduit facility, borrowings under our Revolver or an alternative facility. PMC Commercial has not guaranteed the repayment of the advances outstanding under the conduit facility. The conduit facility allows for advances based on the amount of eligible collateral sold to the conduit facility and has minimum requirements. At December 31, 2007, approximately $47.0 million of our loans were collateral for the conduit facility and we had outstanding advances of approximately $24.0 million. At

December 31, 2007, PMC Commercial had available approximately $24.4 million of additional loans which are conduit eligible loans and we had availability of approximately $9.4 million under the conduit facility (as amended) at December 31, 2007 without additional sales of loans receivable. The conduit facility has covenants, the most restrictive of which are maximum delinquency ratios for our contributed loans and serviced portfolio, as defined in the transaction documents. In addition, the conduit facility is subject to cross default provisions with the Revolver. At December 31, 2007, we were in compliance with the covenants of the conduit facility.

     Our $45 million Revolver matures December 31, 2009 and requires us to meet certain covenants, the most restrictive of which provides for an asset coverage test based on our cash and cash equivalents, loans receivable and Retained Interests as a ratio to our senior debt and limits our ability to pay out returns of capital as part of our dividends. The ratio must exceed 1.25 times. At December 31, 2007, we were in compliance with the covenants of this facility. As of February 29, 2008, we had $8.0 million outstanding under our Revolver which was used primarily to originate loans.

Use of Funds

     The primary use of our funds is to originate commercial mortgage loans to small businesses in the limited service hospitality industry. Our outstanding commitments to fund new loans were $32.1 million at December 31, 2007, of which $7.0 million were for prime-rate based loans to be originated by First Western, the government guaranteed portion of which (approximately 75% of each individual loan) will be sold into the secondary market and $6.4 million were for loans to be originated by an SBIC. Commitments have fixed expiration dates and generally require payment of a fee to us. Since some commitments expire without the proposed loan closing, total committed amounts do not necessarily represent future cash requirements. During 2008, we anticipate aggregate loan originations will range from $40 million to $50 million which has been negatively impacted by the current market of diminished liquidity available to us. To the extent we are able to increase the amount of capital available under our Revolver or generate other financing sources, loan originations may exceed $50 million.

     We may use funds to repurchase loans from the QSPEs which (1) become “charged-off” as defined in the transaction documents either through delinquency or initiation of foreclosure or (2) reach maturity. We repurchased a loan from a QSPE which had become “charged-off” as defined in the transaction documents with an outstanding principal balance of approximately $3.5 million during 2007.

     During 2007, we repaid the remaining balances on our mortgage notes of approximately $2.6 million primarily using our credit facilities.

SUMMARIZED CONTRACTUAL OBLIGATIONS, COMMITMENTS AND CONTINGENCIES

     The following summarizes our contractual obligations at December 31, 2007:

		Payments Due by Period
						Less than				1 to 3				3 to 5				After 5
Contractual Obligations		Total				1 year				years				years				years
		(In thousands, except footnotes)
Debt:
Debentures payable (1)		$	8,190			$	—			$	—			$	—			$	8,190
Redeemable preferred stock of subsidiary (2)			4,000				—				4,000				—				—
Conduit facility			23,950				23,950				—				—				—
Junior subordinated debt (3)			27,070				—				—				—				27,070
Interest:
Consolidated debt (4)			66,211				3,091				5,746				5,558				51,816
Mortgage note of unconsolidated subsidiary			295				102				186				7				—
Other Contractual Obligations:
Mortgage note of unconsolidated subsidiary (5)			1,236				70				159				1,007				—
Operating lease (6)			794				191				416				187				—
Total contractual cash obligations		$	131,746			$	27,404			$	10,507			$	6,759			$	87,076

     Our commitments at December 31, 2007 are summarized as follows:

		Amount of Commitment Expiration Per Period
		Total Amounts				Less than				1 to 3				3 to 5				After 5
Commitments		Committed				1 year				years				years				years
		(In thousands)
Loan commitments		$	32,076			$	32,076			$	—			$	—			$	—
Total commitments		$	32,076			$	32,076			$	—			$	—			$	—

     See Note 20 to the Consolidated Financial Statements for a detailed discussion of commitments and contingencies.

OFF-BALANCE SHEET ARRANGEMENTS

     Our off-balance sheet arrangements have historically been structured as sales which are our primary method of obtaining funds for new loan originations. In a structured loan sale transaction, we contribute loans receivable to a QSPE that is not subject to consolidation in exchange for cash and beneficial interests in that entity. The QSPE issues notes payable (usually through a private placement) to unaffiliated parties and then distributes a portion of the notes payable proceeds to us. The notes payable are collateralized solely by the assets of the QSPE. The terms of the notes payable issued by the QSPEs provide that the owners of these QSPEs are not liable for any payment on the notes. Accordingly, if the financial assets in the QSPE are insufficient for the trustee 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 QSPE. We have no

obligation to pay the notes, nor do the holders of the notes have any recourse against our assets. We account for structured loan sale transactions as sales of our loans receivable and the SPE meets the definition of a QSPE; 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 “Item 1. Business – Structured Loan Transactions” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies and Estimates – Valuation of Retained Interests.”

     During 2006, we entered into a lease agreement for one of our hotel properties. The property had a mortgage with a principal balance of $1.3 million with a significant prepayment penalty. Therefore, we structured the lease with the potential buyer of the property for a term equal to the term remaining on the mortgage (matures January 1, 2011) and then a purchase with a price of $1,825,000. Based on this lease agreement, including the fixed price purchase option, the subsidiary was determined to be a variable interest entity. Since we do not expect to absorb the majority of the entity’s future expected losses or receive the entity’s expected residual returns, PMC Commercial Trust is not considered to be the primary beneficiary. Thus, the subsidiary was no longer consolidated in PMC Commercial Trust’s financial statements and the equity method was used to account for our investment in the subsidiary effective September 29, 2006.

RISK MANAGEMENT

     In conducting our business, we are exposed to a range of risks including:

	•		Market risk which is the risk to our earnings or capital resulting from adverse changes in the values of assets resulting from movement in market interest rates;
	•		Credit risk which is the risk of loss due to an individual borrower’s unwillingness or inability to pay their obligations;
	•		Operations risk which is the risk of loss resulting from systems failure, inadequate controls, human error, fraud or unforeseen catastrophes;
	•		Liquidity risk which is the potential that we would be unable to meet our obligations as they come due because of an inability to liquidate assets or obtain funding. Liquidity risk also includes the risk of having to sell assets at a loss to generate liquid funds, which is a function of the relative liquidity (market depth) of the asset(s) and general market conditions;
	•		Compliance risk which is the risk of loss, including fines or penalties, from failing to comply with Federal, state or local laws, rules and regulations pertaining to lending and licensed activities;
	•		Legal risk which is the risk of loss, disruption or other negative effect on our operations or condition that arises from unenforceable contracts, lawsuits, adverse judgments, or adverse governmental or regulatory proceedings, or the threat thereof; and
	•		Reputational risk which is the risk that negative publicity regarding our practices whether true or not will cause a decline in our customer base.

     Our risk management policies and procedures are established and evaluated under the supervision of our executive management. The policies and procedures are designed to focus on the following:

	•		identifying, assessing and reporting on corporate risk exposures and trends;
	•		establishing, and revising as necessary, policies and procedures;
	•		monitoring and reporting on adherence with risk policies; and
	•		approving new product developments or business initiatives.

     We cannot provide assurance that our risk management process or our internal controls will prevent or reduce the risks to which we are exposed. See “Risk Factors” in Item 1A of this Form 10-K.

IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

     See Note 1 of the Consolidated Financial Statements for a full description of recent accounting pronouncements including the respective dates adopted or expected dates of adoption and effect, if any, on our results of operations and financial condition.

RELATED PARTY TRANSACTIONS

     Servicing fee income for the years ended December 31, 2007, 2006 and 2005 for loans held by the QSPEs was approximately $495,000, $676,000 and $833,000, respectively.

     We received approximately $13.4 million, $14.6 million and $15.4 million in cash distributions from the QSPEs during 2007, 2006 and 2005, respectively.

     We may use funds to repurchase loans from the QSPEs which (1) become “charged-off” as defined in the transaction documents either through delinquency or initiation of foreclosure or (2) reach maturity. During 2007, 2006 and 2005, we repurchased loans with an aggregate principal balance of approximately $5.0 million, $2.5 million and $5.1 million, respectively, from the QSPEs.

DIVIDENDS

     During 2007, our dividends were declared as follows:

				Amount
Record Date		Date Paid		Per Share
March 30, 2007		April 9, 2007		$	0.30
June 29, 2007		July 9, 2007			0.30
September 28, 2007		October 9, 2007			0.30
December 31, 2007		January 7, 2008			0.30
				$	1.20

     Our shareholders are entitled to receive dividends when and as declared by our Board. Our Board considers many factors 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 in determining dividend policy. In general, the Board also uses cash flow from operating activities adjusted for changes in operating assets and liabilities in determining the amount of dividends declared. In addition, as a REIT, PMC Commercial is 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.

     In March 2008, the Board declared a $0.20 per share quarterly dividend to common shareholders of record on March 31, 2008 which will be paid on April 7, 2008. The Board established the dividend in an amount it believes can reasonably be paid each of the four quarters of this year. In setting the dividend, the Board considered the likely adverse impact on our earnings from declining interest rates affecting our existing portfolio, which is composed primarily of variable-rate loans, and greater uncertainty surrounding our prospects for new loan originations in the current market of diminished liquidity available to us.

     As a result of our REIT taxable income being greater than our distributions during prior periods, dividends paid during 2008 will be used to satisfy our 2007 dividend requirement. These distributions are known as spillover dividends. The Board may utilize the shortfall caused by spillover dividends to allow dividends declared in 2008 to exceed our 2008 REIT taxable income.

     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 dividend payments expected during 2008.

REIT TAXABLE INCOME

     REIT taxable income is a financial measure that is presented quarterly to assist investors in analyzing our performance and is one of the factors utilized by our Board in determining the level of dividends to be paid to our shareholders.

     The following reconciles net income to REIT taxable income:

		Years Ended December 31,
		2007				2006				2005
		(In thousands)
Net income		$	13,135			$	15,684			$	11,297
Book/tax difference on depreciation			(65	)			(277	)			(243	)
Book/tax difference on property sales			236				171				(350	)
Book/tax difference on Retained Interests, net			1,631				1,973				1,880
Impairment losses			233				43				2,210
Book/tax difference on rent and related receivables			(1,152	)			925				(25	)
Book/tax difference on amortization and accretion			(239	)			(641	)			(264	)
Asset valuation			(299	)			(890	)			181
Other book/tax differences, net			189				(59	)			16
Subtotal			13,669				16,929				14,702
Less: taxable REIT subsidiaries net income, net of tax			(852	)			(1,280	)			(1,414	)
REIT taxable income		$	12,817			$	15,649			$	13,288
Distributions declared		$	12,915			$	13,975			$	13,569
Basic weighted average common shares outstanding			10,760				10,748				10,874

     As a REIT, PMC Commercial generally will not be subject to corporate level Federal income tax on net income that is currently distributed to shareholders provided the distribution exceeds 90% of REIT taxable income. We may make an election under the Code to treat distributions declared in the current year as distributions of the prior year’s taxable income. Upon election, the Code provides that, in certain circumstances, a dividend declared subsequent to the close of an entity’s taxable year and prior to the extended due date of the entity’s tax return may be considered as having been made in the prior tax year in satisfaction of income distribution requirements.

     Our taxable REIT subsidiaries net income has not been distributed to PMC Commercial. To the extent the subsidiary distributes their retained earnings through dividends to PMC Commercial, these dividends would be included in REIT taxable income when distributed. From 2005 to 2007, approximately $3.5 million of earnings were accumulated but not distributed. A portion of these earnings may be distributed to PMC Commercial in 2008.

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     We are subject to market risk, liquidity risk, real estate risk and interest rate risk as described below. Although management believes that the quantitative analysis on interest rate risk below is indicative of our sensitivity to interest rate changes, it does not adjust for potential changes in credit quality, size and composition of our consolidated balance sheet and other business developments that could affect our financial position and net income. Accordingly, no assurances can be given that actual results would not differ materially from the potential outcome simulated by these estimates.

MARKET RISK

     Market risk is the exposure to loss resulting from changes in various market metrics. The primary risks that we are exposed to are liquidity risk, real estate risk and interest rate risk.

LIQUIDITY RISK