UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
DC 20549


____________________


FORM
10-Q




(Mark
One)




x Quarterly Report
pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934





For the
quarter ended September 30, 2010




or




 ̈ 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 000-52611





IMH
FINANCIAL CORPORATION


(Name of
registrant as specified in its charter)





Delaware
            81-0624254(State
      or other jurisdiction of incorporation or
              organization)
            (I.R.S.
      Employer Identification Number)


4900
N. Scottsdale Rd #5000


Scottsdale,
Arizona, 85251


(Address
of principal executive offices)





(480)
840-8400


(Issuer’s
telephone number)




(Former name, former
address and former fiscal year, if changed since last report)




Indicate
by check mark whether the registrant (1) 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    ̈




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




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.




Large
      accelerated filer
                £
                Accelerated
      filer
                £Non-accelerated
      filer
                R
                Smaller
      reporting company
                £








Indicate
by check mark whether the registrant is a shell company (as defined in Exchange
Act Rule 12b-2).  Yes   ̈   
 No  þ





The
registrant had 3,811,342 Shares of Class B-1 Common Stock, 3,811,342 shares of
Class B-2 Common Stock, 7,721,055 shares of Class B-3 Common Stock, 627,579
shares of Class B-4 Common Stock and 838,448 shares of Class C Common Stock,
which were collectively convertible into 16,809,766 outstanding common shares as
of November 15, 2010.  The Class B and Class C common stock of IMH
Financial Corporation was exchanged for the membership interests of IMH Secured
Loan Fund, LLC as a result of the conversion of IMH Secured Loan Fund, LLC into
IMH Financial Corporation and is deemed registered pursuant to Section 12 of the
Securities Exchange Act of 1934 under Rule 12g-3.










IMH
FINANCIAL CORPORATION


QUARTERLY
REPORT ON FORM 10-Q


INDEX




PART
      I - FINANCIAL INFORMATIONItem
      1.
                                                      Financial
      Statements.Consolidated
      Balance Sheets as of December 31, 2009 and September 30,
    2010
                                                      3Consolidated
      Statements of Operations for the Nine and Three Months Ended September 30,
      2009 and 2010
                                                      4Consolidated
      Statement of Owners’ Equity for the Nine Months Ended September 30,
      2010
                                                      5Consolidated
      Statements of Cash Flows for Nine Months Ended September 30, 2009 and
      2010
                                                      6Notes
      to Consolidated Financial Statements
                                                      7Item
      2.
                                                      Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations.
                                                      47Item
      3.
                                                      Quantitative
      and Qualitative Disclosures About Market Risk.
                                                      98Item
      4T.
                                                      Controls
      and Procedures.
                                                      102PART
      II – OTHER INFORMATIONItem
      1.
                                                      Legal
      Proceedings.
                                                      103Item
      1A.
                                                      Risk
      Factors.
                                                      105Item
      5.
                                                      Other
      Information
                                                      131Item
      6.
                                                      Unregistered
      Sales of Equity Securities and Use of Proceeds.
                                                      130Item
      7.
                                                      Exhibits.
                                                      132Signatures
                                                      133Index
      to Exhibits
                                                      134




2


PART
I




FINANCIAL
INFORMATION




Item
      1.
            Financial
      Statements.




IMH
FINANCIAL CORPORATION


(formerly
known as IMH Secured Loan Fund, LLC)


Consolidated
Balance Sheets


(In
thousands, except unit and share data)


December 31,
                                        
                                        
                                        September 30,2009
                                        
                                        
                                        2010(unaudited)ASSETSCash
      and Cash Equivalents
                                        
                                        $
                                        963
                                        
                                        
                                        $
                                        4,580Mortgage
      Loans:Mortgage
      Loan Note Obligations
                                        
                                        
                                        554,848
                                        
                                        
                                        
                                        -Less
      Undisbursed Portion of Loans-in-Process and Interest
    Reserves
                                        
                                        
                                        (15,975
                                        )
                                        
                                        
                                        -Principal
      Outstanding Held for Investment
                                        
                                        
                                        538,873
                                        
                                        
                                        
                                        -Less
      Allowance for Credit Loss
                                        
                                        
                                        (328,060
                                        )
                                        
                                        
                                        -Mortgage
      Loans Held for Investment, Net
                                        
                                        
                                        210,813
                                        
                                        
                                        
                                        -Mortgage
      Loans Held for Sale, Net
                                        
                                        
                                        3,207
                                        
                                        
                                        
                                        156,001Mortgage
      Loans, Net
                                        
                                        
                                        214,020
                                        
                                        
                                        
                                        156,001Accrued
      Interest and Other Receivables
                                        
                                        
                                        15,751
                                        
                                        
                                        
                                        7,218Real
      Estate Acquired through Foreclosure Held for Sale, Net
                                        
                                        
                                        12,082
                                        
                                        
                                        
                                        38,048Real
      Estate Held for Development, Net:Acquired
      through Foreclosure
                                        
                                        
                                        84,804
                                        
                                        
                                        
                                        67,455Purchased
      for Investment
                                        
                                        
                                        7,345
                                        
                                        
                                        
                                        3,803Real
      Estate Held for Development, Net
                                        
                                        
                                        92,149
                                        
                                        
                                        
                                        71,258Deposits
      and Other Assets
                                        
                                        
                                        1,464
                                        
                                        
                                        
                                        2,348Advances
      to Fund Manager
                                        
                                        
                                        1,367
                                        
                                        
                                        
                                        -Property
      and Equipment, Net
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,592Total
      Assets
                                        
                                        $
                                        337,796
                                        
                                        
                                        $
                                        281,045LIABILITIESAccounts
      Payable and Accrued Expenses
                                        
                                        $
                                        6,582
                                        
                                        
                                        $
                                        10,913Payables
      to Fund Manager
                                        
                                        
                                        3,342
                                        
                                        
                                        
                                        -Notes
      Payable
                                        
                                        
                                        4,182
                                        
                                        
                                        
                                        16,963Borrowings
      from Fund Manager
                                        
                                        
                                        1,608
                                        
                                        
                                        
                                        -Unearned
      Income and Other Funds Held
                                        
                                        
                                        214
                                        
                                        
                                        
                                        214Total
      Liabilities
                                        
                                        
                                        15,928
                                        
                                        
                                        
                                        28,090Commitments
      and Contingent Liabilities (Note 12)OWNERS'
      EQUITYCommon
      stock, $.01 par value; 200,000,000 shares authorized;16,809,766
      shares outstanding at September 30, 2010
                                        
                                        
                                        -
                                        
                                        
                                        
                                        168Preferred
      stock, $.01 par value; 100,000,000 shares authorized;none
      outstanding
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Additional
      Paid in Capital
                                        
                                        
                                        -
                                        
                                        
                                        
                                        726,866Accumulated
      Deficit
                                        
                                        
                                        (408,515
                                        )
                                        
                                        
                                        (474,079
                                        )Members'
      Equity - $10,000 per unit stated value,authorized
      units set at discretion of the Manager -73,038
      units issued and outstanding atDecember
      31, 2009. No units outstanding at September 30, 2010
                                        
                                        
                                        730,383
                                        
                                        
                                        
                                        -Total
      Owners' Equity
                                        
                                        
                                        321,868
                                        
                                        
                                        
                                        252,955Total
      Liabilities and Owners' Equity
                                        
                                        $
                                        337,796
                                        
                                        
                                        $
                                        281,045






The
accompanying notes are an integral part of these statements





3





IMH
FINANCIAL CORPORATION


(formerly
known as IMH Secured Loan Fund, LLC)


Consolidated
Statements of Operations


(Unaudited)


(In
thousands, except share and per share data)




Nine Months Ended September30,
                                                    
                                                    
                                                    Three Months Ended September30,2009
                                                    
                                                    
                                                    2010
                                                    
                                                    
                                                    2009
                                                    
                                                    
                                                    2010REVENUE:Mortgage
      Loan Income
                                                    
                                                    $
                                                    20,256
                                                    
                                                    
                                                    $
                                                    1,112
                                                    
                                                    
                                                    $
                                                    2,697
                                                    
                                                    
                                                    
                                                    156Rental
      Income
                                                    
                                                    
                                                    379
                                                    
                                                    
                                                    
                                                    1,243
                                                    
                                                    
                                                    
                                                    378
                                                    
                                                    
                                                    
                                                    410Investment
      and Other Income
                                                    
                                                    
                                                    115
                                                    
                                                    
                                                    
                                                    427
                                                    
                                                    
                                                    
                                                    80
                                                    
                                                    
                                                    
                                                    274Total
      Revenue
                                                    
                                                    
                                                    20,750
                                                    
                                                    
                                                    
                                                    2,782
                                                    
                                                    
                                                    
                                                    3,155
                                                    
                                                    
                                                    
                                                    840COSTS
      AND EXPENSES:Operating
      Expenses for Real Estate Owned
                                                    
                                                    
                                                    2,534
                                                    
                                                    
                                                    
                                                    4,072
                                                    
                                                    
                                                    
                                                    1,194
                                                    
                                                    
                                                    
                                                    1,523Professional
      Fees
                                                    
                                                    
                                                    1,830
                                                    
                                                    
                                                    
                                                    4,587
                                                    
                                                    
                                                    
                                                    641
                                                    
                                                    
                                                    
                                                    1,832Management
      Fees
                                                    
                                                    
                                                    481
                                                    
                                                    
                                                    
                                                    109
                                                    
                                                    
                                                    
                                                    62
                                                    
                                                    
                                                    
                                                    -Default
      and Related Expenses
                                                    
                                                    
                                                    579
                                                    
                                                    
                                                    
                                                    533
                                                    
                                                    
                                                    
                                                    251
                                                    
                                                    
                                                    
                                                    174General
      and Administrative Expenses
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    1,767
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    1,559Loss
      on Disposal of Real Estate
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    1,112
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    112Write-off
      of Offering Costs
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    6,150
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    6,150Interest
      Expense:Borrowings
      from Fund Manager
                                                    
                                                    
                                                    217
                                                    
                                                    
                                                    
                                                    39
                                                    
                                                    
                                                    
                                                    115
                                                    
                                                    
                                                    
                                                    -Borrowings
      on Notes Payable
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    1,364
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    562Depreciation
      and Amortization Expense
                                                    
                                                    
                                                    283
                                                    
                                                    
                                                    
                                                    1,012
                                                    
                                                    
                                                    
                                                    283
                                                    
                                                    
                                                    
                                                    380Total
      Operating Expenses
                                                    
                                                    
                                                    5,924
                                                    
                                                    
                                                    
                                                    20,745
                                                    
                                                    
                                                    
                                                    2,546
                                                    
                                                    
                                                    
                                                    12,292Provision
      for Credit Losses
                                                    
                                                    
                                                    82,000
                                                    
                                                    
                                                    
                                                    34,380
                                                    
                                                    
                                                    
                                                    82,000
                                                    
                                                    
                                                    
                                                    6,830Impairment
      of Real Estate Owned
                                                    
                                                    
                                                    8,000
                                                    
                                                    
                                                    
                                                    13,221
                                                    
                                                    
                                                    
                                                    8,000
                                                    
                                                    
                                                    
                                                    2,236Total
      Provisions and Charges
                                                    
                                                    
                                                    90,000
                                                    
                                                    
                                                    
                                                    47,601
                                                    
                                                    
                                                    
                                                    90,000
                                                    
                                                    
                                                    
                                                    9,066Total
      Costs and Expenses
                                                    
                                                    
                                                    95,924
                                                    
                                                    
                                                    
                                                    68,346
                                                    
                                                    
                                                    
                                                    92,546
                                                    
                                                    
                                                    
                                                    21,358Loss
      Before Income Taxes
                                                    
                                                    
                                                    (75,174
                                                    )
                                                    
                                                    
                                                    (65,564
                                                    )
                                                    
                                                    
                                                    (89,391
                                                    )
                                                    
                                                    
                                                    (20,518
                                                    )Provision
      for Income Taxes
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -NET
      LOSS
                                                    
                                                    $
                                                    (75,174
                                                    )
                                                    
                                                    $
                                                    (65,564
                                                    )
                                                    
                                                    $
                                                    (89,391
                                                    )
                                                    
                                                    $
                                                    (20,518
                                                    )Pro
      Forma Net Loss per Share
                                                    
                                                    $
                                                    (4.67
                                                    )
                                                    
                                                    $
                                                    (4.01
                                                    )
                                                    
                                                    $
                                                    (5.55
                                                    )
                                                    
                                                    $
                                                    (1.22
                                                    )Pro
      Forma Weighted Average Common Shares Outstanding
                                                    
                                                    
                                                    16,093,487
                                                    
                                                    
                                                    
                                                    16,366,355
                                                    
                                                    
                                                    
                                                    16,093,487
                                                    
                                                    
                                                    
                                                    16,809,766





The
accompanying notes are an integral part of these statements




4


IMH
FINANCIAL CORPORATION


(formerly
known as IMH Secured Loan Fund, LLC)


Consolidated
Statements of Owners’ Equity


Nine
Months Ended September 30, 2010


(Unaudited)


(In
thousands, except unit and share data)





IMH Financial Corp
                                      
                                      
                                      IMH Secured Loan Fund
                                      
                                      
                                      
                                      
                                      
                                      TotalCommon Stock
                                      
                                      
                                      Members' Capital
                                      
                                      
                                      Accumulated
                                      
                                      
                                      Owners'Shares
                                      
                                      
                                      Amount
                                      
                                      
                                      Paid-in Capital
                                      
                                      
                                      Units
                                      
                                      
                                      Capital
                                      
                                      
                                      Deficit
                                      
                                      
                                      EquityBalances
      at December 31, 2009
                                      
                                      
                                      -
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      
                                      73,038
                                      
                                      
                                      $
                                      730,383
                                      
                                      
                                      $
                                      (408,515
                                      )
                                      
                                      $
                                      321,868Conversion
      of Member units to Common Shares
                                      
                                      
                                      16,093,487
                                      
                                      
                                      
                                      161
                                      
                                      
                                      
                                      730,222
                                      
                                      
                                      
                                      (73,038
                                      )
                                      
                                      
                                      (730,383
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -Common
      Shares issued for Acquistion of Manager
                                      
                                      
                                      716,279
                                      
                                      
                                      
                                      7
                                      
                                      
                                      
                                      (3,356
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (3,349
                                      )Net
      Loss - Nine Months Ended September 30, 2010
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (65,564
                                      )
                                      
                                      
                                      (65,564
                                      )Balances
      at September 30, 2010
                                      
                                      
                                      16,809,766
                                      
                                      
                                      $
                                      168
                                      
                                      
                                      $
                                      726,866
                                      
                                      
                                      
                                      -
                                      
                                      
                                      $
                                      -
                                      
                                      
                                      $
                                      (474,079
                                      )
                                      
                                      $
                                      252,955




The
accompanying notes are an integral part of these statements





5




IMH
FINANCIAL CORPORATION


(formerly
known as IMH Secured Loan Fund, LLC)


Consolidated
Statements of Cash Flows


Nine
Months Ended September 30, 2010


(Unaudited)


(In
thousands)


Nine Months Ended September 30,2009
                      
                      
                      2010CASH
      FLOWS - OPERATING ACTIVITIESNet
      Loss
                      
                      $
                      (75,174
                      )
                      
                      $
                      (65,564
                      )Adjustments
      to reconcile net loss to netcash
      provided by (used in) operating activities:Provision
      for Credit Losses
                      
                      
                      82,000
                      
                      
                      
                      34,380Impairment
      of Assets
                      
                      
                      8,000
                      
                      
                      
                      13,221Loss
      on Disposal of Real Estate
                      
                      
                      -
                      
                      
                      
                      1,112Depreciation
      and Amortization Expense
                      
                      
                      283
                      
                      
                      
                      1,012Imputed
      interest on Notes Payable
                      
                      
                      -
                      
                      
                      
                      392Increase
      (decrease) in cash resulting from changes in:Due
      from/to Fund Manager
                      
                      
                      (38
                      )
                      
                      
                      (1,000
                      )Due
      from/to Strategic Wealth & Income Fund, LLC
                      
                      
                      -
                      
                      
                      
                      (8
                      )Accrued
      Interest Receivable
                      
                      
                      (6,533
                      )
                      
                      
                      1,093Deposits
      and Other Assets
                      
                      
                      (499
                      )
                      
                      
                      (1,227
                      )Other
      Payables and Accrued Liabilities
                      
                      
                      5,417
                      
                      
                      
                      3,326Unearned
      Income and Other Funds Helds
                      
                      
                      90
                      
                      
                      
                      -Net
      cash provided by (used in) operating activities
                      
                      
                      13,546
                      
                      
                      
                      (13,263
                      )CASH
      FLOWS - INVESTING ACTIVITIESProceeds
      from Sale of Real Estate Owned
                      
                      
                      770
                      
                      
                      
                      5,346Acquisition
      of Manager, Net of Cash Acquired
                      
                      
                      -
                      
                      
                      
                      (3,299
                      )Purchases
      of Property and Equipment
                      
                      
                      -
                      
                      
                      
                      (14
                      )Mortgage
      Loans Fundings
                      
                      
                      (25,827
                      )
                      
                      
                      (4,535
                      )Mortgage
      Loan Repayments
                      
                      
                      6,664
                      
                      
                      
                      9,825Investment
      in Real Estate Held for Development
                      
                      
                      (2,356
                      )
                      
                      
                      (694
                      )Net
      cash provided by (used in) investing activities
                      
                      
                      (20,749
                      )
                      
                      
                      6,629CASH
      FLOWS - FINANCING ACTIVITIESProceeds
      from Borrowings from Manager
                      
                      
                      6,000
                      
                      
                      
                      -Repayments
      of Borrowings from Manager
                      
                      
                      (3,480
                      )
                      
                      
                      (1,608
                      )Payments
      on Notes payable to Stockholders
                      
                      
                      -
                      
                      
                      
                      (101
                      )Payments
      on Note Payable to Lessor
                      
                      
                      -
                      
                      
                      
                      (26
                      )Proceeds
      from Notes Payable
                      
                      
                      -
                      
                      
                      
                      14,827Repayments
      of Notes Payable
                      
                      
                      -
                      
                      
                      
                      (2,841
                      )Members'
      Distributions
                      
                      
                      (16,669
                      )
                      
                      
                      -Net
      cash provided by (used in) financing activities
                      
                      
                      (14,149
                      )
                      
                      
                      10,251NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                      
                      
                      (21,352
                      )
                      
                      
                      3,617CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
                      
                      
                      23,815
                      
                      
                      
                      963CASH
      AND CASH EQUIVALENTS, END OF PERIOD
                      
                      $
                      2,463
                      
                      
                      $
                      4,580SUPPLEMENTAL
      CASH FLOW INFORMATIONInterest
      paid
                      
                      $
                      217
                      
                      
                      $
                      658Acquistion
      of Real Estate Held for Resale throughForeclosure
      of Note Receivable
                      
                      $
                      41,169
                      
                      
                      $
                      21,854





The
accompanying notes are an integral part of these statements




6




IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
1- BUSINESS, BASIS OF PRESENTATION AND LIQUIDITY




IMH
Financial Corporation, IFC or the Company, a corporation incorporated under the
laws of the State of Delaware, was formed from the conversion of IMH Secured
Loan Fund, LLC, or the Fund, a Delaware limited liability company, on June 18,
2010.  The conversion was effected following a consent solicitation process
pursuant to which approval was obtained from a majority of the members of the
Fund to effect the Conversion Transactions and involved (i) the conversion of
the Fund from a Delaware limited liability company into a Delaware corporation
named IMH Financial Corporation, and (ii) the acquisition by the Company of all
of the outstanding shares of the manager of the Fund, Investors Mortgage
Holdings Inc., or the Manager, as well as all of the outstanding membership
interests of a related entity, IMH Holdings LLC, or Holdings, on June 18,
2010.  See Note 3 for further discussion of the Conversion
Transactions.  References to “we” or “our” refer to the
Company.




We are a
real estate finance company based in the southwest United States with over 13
years of experience in various and diverse facets of the real estate lending and
investment process, including origination, acquisition, underwriting,
documentation, servicing, construction, enforcement, development, marketing, and
disposition. Our primary focus is on the acquisition and origination of high
yield, short-term, senior secured commercial real estate mortgage loans
principally to developers of residential and commercial real estate, a niche
segment of the real estate market we believe is underserved by community,
regional and national banks.




Basis of
Presentation




The
accompanying unaudited, condensed consolidated financial statements of IMH
Financial Corporation have been prepared in accordance with accounting
principles generally accepted in the United States of America for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted in the United
States of America for a complete set of financial statements. In the opinion of
management, all adjustments considered necessary for a fair presentation of the
results for the periods presented have been made. Operating results for the nine
and three months ended September 30, 2010 are not necessarily indicative of the
results that may be expected for the fiscal year ending December 31, 2010. These
condensed consolidated financial statements should be read in conjunction with
our consolidated financial statements and notes thereto included in our annual
report on Form 10-K/A for the fiscal year ended December 31, 2009.




The
accompanying condensed consolidated financial statements include the accounts of
IMH Financial Corporation and the following wholly-owned operating subsidiaries:
Investor’s Mortgage Holdings, Inc., an Arizona corporation licensed as a
mortgage banker by the state of Arizona, IMH Holdings, LLC, a Delaware limited
liability corporation, and various other wholly owned subsidiaries established
in connection with the acquisition of real estate either through foreclosure or
purchase.  All significant intercompany accounts and transactions have been
eliminated in consolidation.




Reclassifications




Certain
2009 amounts have been reclassified to conform to the 2010 financial statement
presentation.




Liquidity




As of
September 30, 2010, our accumulated deficit aggregated $474,079 as a direct
result of provisions for credit losses and impairment charges relating to the
change in the fair value of the collateral securing our loan portfolio and the
fair value of real estate owned assets primarily acquired through foreclosure in
prior years. During the nine months ended September 30, 2010, total cash
increased by $3,617 as a result of proceeds received from financing obtained, as
well as, from the sale of certain loan and real estate assets. At September 30,
2010, we had cash and cash
equivalents of $4,580 and undisbursed loans-in-process and interest reserves
funding estimates totaling $15,026. As a result of the erosion of the U.S. and
global credit markets, we continue to experience loan defaults and foreclosures
on our mortgage loans.   In addition, we have found it necessary to
modify certain loans, which modifications have resulted in extended maturities
of two years or longer, and believe we may need to modify additional loans in an
effort to, among other things, protect our collateral.




7




IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE 1- BUSINESS,
BASIS OF PRESENTATION AND LIQUIDITY - (continued)




Our
liquidity plan includes obtaining additional financing, selling whole loans or
participating interests in loans and selling certain of our real estate owned
assets. As of September 30, 2010, our entire loan portfolio with carrying values
of $156,001, net of valuation allowance of $334,881, is held for sale. In
addition, as of September 30, 2010, real estate owned (“REO”) projects with a
carrying value totaling $38,048 are being actively marketed for sale.
Accordingly, these REO assets are reflected as held for sale in the accompanying
consolidated balance sheets. During the nine months ended September 30, 2010, we
sold certain REO and loan assets for approximately $8,660 resulting in a net
loss on disposal of $1,112.




Also,
during the nine months ended September 30, 2010, we secured third-party
financing from lenders with a total borrowing capacity of $16,100 for the
purpose of funding anticipated development costs for REO assets, remaining loan
obligations, settlement of conversion transaction liabilities and working
capital needs, of which $12,073 was outstanding as of September 30, 2010. In
addition, we are currently in negotiations with a third-party lender to secure
additional debt to fund operations and to satisfy short-term obligations that
are due within the next twelve months. Management also continues to evaluate the
existing outstanding loan obligations to ascertain the necessary funding amounts
and timing for each loan, and to determine potential reductions in, or cessation
of, funding commitments for loans in default or to find alternative sources for
such fundings. This analysis is on-going, although the results are not expected
to materially affect our current estimate of outstanding loan commitments
presented in the accompanying financial statements.





Given the
current state of the real estate and credit markets, we believe the realization
of full recovery of the cost basis in our assets is unlikely to occur in a
reasonable time frame and may not occur at all, and we may be required to
liquidate portions of our assets for liquidity purposes at a price significantly
below the initial cost basis or potentially below current carrying values. If we
are not able to liquidate a sufficient portion of our assets or access credit
under the credit facility currently under negotiation, there may be substantial
doubt about our ability to continue as a going concern. Nevertheless, we believe
that our cash and cash equivalents, coupled with liquidity derived from the
credit facility currently under negotiation and the disposition of certain of
the loans and real estate held for sale, will allow us to fund current
operations over the next 12 months.





NOTE
2 — SIGNIFICANT ACCOUNTING POLICIES





Our
significant accounting policies are disclosed in our previously filed Annual
Report on Form 10-K/A for the fiscal year ended December 31, 2009. 
During the nine months ended September 30, 2010, there have been no material
changes in our significant accounting policies, except for those shown below,
resulting from the acquisition of the Manager effective June 18,
2010.




8
 
  IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)
  NOTE 2 — SIGNIFICANT
ACCOUNTING POLICIES - continued


Revenue
Recognition




Interest
on mortgage loans is recognized as revenue when earned using the interest method
based on a 365-day year. We do not recognize interest income on loans once they
are deemed to be impaired and placed in non-accrual status. Generally, a loan is
placed in non-accrual status when it is past its scheduled maturity by more than
90 days, when it becomes
delinquent as to interest due by more than 90 days or when the related fair
value of the collateral is less than the total principal, accrued interest and
related costs. We may determine that a loan, while delinquent in payment status,
should not be placed in non-accrual status in instances where the fair value of
the loan collateral significantly exceeds the principal and the accrued
interest, as we expect that income recognized in such cases is probable of
collection. Unless and until we have determined that the value of underlying
collateral is insufficient to recover the total contractual amounts due under
the loan term, generally our policy is to continue to accrue interest until the
loan is more than 90 days delinquent with respect to accrued, uncollected
interest or more than 90 days past scheduled maturity, whichever comes
first.





A loan is
typically not removed from non-accrual status until the borrower has brought the
respective loan current as to the payment of past due interest, and unless we
are reasonably assured as to the collection of all contractual amounts due under
the loan based on the value of the underlying collateral of the loan, the
receipt of additional collateral required and the financial ability of the
borrower to service our loan.





We do not
generally reverse accrued interest on loans once they are deemed to be impaired
and placed in non-accrual status. In conducting our periodic valuation analysis,
we consider the total recorded investment for a particular loan, including
outstanding principal, accrued interest and estimated foreclosure costs when
computing the amount of valuation allowance required.





Cash
receipts are first allocated to interest, except when such payments are
specifically designated by the terms of the loan as a principal reduction. Loans
with a principal or interest payment one or more days delinquent are in
technical default and are subject to various fees and charges including default
interest rates, penalty fees and reinstatement fees. Often these fees are
negotiated in the normal course of business and, therefore, not subject to
estimation. Accordingly, income pertaining to these types of fees is recorded as
revenue when received.





Historically,
in accordance with the Fund’s operating agreement, all fees relating to loan
origination, documentation, processing, administration, loan extensions and
modifications were earned by the Manager prior to its termination as a result of
the Conversion Transactions.  After consummation of the Conversion
Transactions effective June 18, 2010, these fees inure to our
benefit.





Fees for
loan origination, processing and modifications, net of direct origination costs,
are deferred at origination and amortized as an adjustment to interest income
over the contractual term of the related loan.  Non-refundable commitment
fees are recognized as revenue when received.





Loans
Held for Sale





Loans
that we intend to sell, subsequent to origination or acquisition, are classified
as loans held for sale, net of any applicable valuation allowance. Loans
classified as held for sale are generally subject to a specific marketing
strategy or a plan of sale.





Loans
held for sale are accounted for at the lower of cost or fair value on an
individual basis and are reported as a component of mortgage loans. Direct costs
related to selling such loans are deferred until the related loans are sold and
are included in the determination of the gains or losses upon sale. Valuation
adjustments related to loans held for sale are not included in the valuation
allowance in the consolidated balance sheets, but rather are reported net of
related principal of loans held for sale on the consolidated balance sheets and
the provision for credit losses in the statements of operations.




9





IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)




NOTE
2 — SIGNIFICANT ACCOUNTING POLICIES - continued






Management
Fees




We,
through a wholly owned subsidiary, earn revenues for services rendered in
connection with our management of the Strategic Wealth & Income Fund, or SWI
Fund. Such revenues include asset management fees, organization fees,
acquisition fees and origination fees. These fees are recorded when earned in
accordance with the management agreement. We are also entitled to allocated
earnings from SWI Fund when SWI Fund exceeds certain performance objectives, as
defined in the operating agreement.




Property
and Equipment





Property
and equipment are recorded at historical cost and are depreciated using the
straight-line method over the shorter of the expected lease term or the
estimated useful life of the asset.  Expenditures for repairs and
maintenance are charged to expense as incurred.  For items that are
disposed, the cost and related accumulated depreciation are removed from the
accounts and any resulting gain or loss is recognized in the statements of
operations.  See Note 5 for a discussion of our real estate owned
assets.





Internally
Developed Software





We own
certain proprietary software for use in our business.  We capitalize the
costs incurred during the application development stage, which include costs to
design the software configuration and interfaces, coding, installation and
testing. Costs incurred during the preliminary project along with
post-implementation stages of internal use computer software are expensed as
incurred.  Capitalized development costs are amortized over various periods
up to five years.  Costs incurred to maintain existing software
applications are expensed as incurred.





Stock-Based
Compensation





Our 2010
Stock Incentive Plan provides for awards of stock options, stock appreciation
rights, restricted stock units and other performance based awards to our
officers, employees, directors and certain consultants. The maximum number of
shares of common stock that may be issued under such awards shall not exceed
1,200,000 common shares. We measure the cost of employee services received in
exchange for an award of equity instruments based on the grant date fair value
of the award. No awards have been granted under this plan as of September 30,
2010.





401(k)
Plan.





We have a
defined contribution plan for the benefit of all eligible employees under the
provisions of Section 401(k) of the U.S. Internal Revenue Code.  The 401(k)
plan allows us to make discretionary contributions based upon the participants’
wages in accordance with the approved plan document.  No contributions have
been made under this plan as of September 30, 2010.





Income
Taxes.





We
recognize deferred tax assets and liabilities and record a deferred income tax
(benefit) provision when there are differences between assets and liabilities
measured for financial reporting and for income tax purposes. We regularly
review our deferred tax assets to assess our potential realization and establish
a valuation allowance for such assets when we believe it is more likely than not
that we will not recognize some portion of the deferred tax asset. Generally, we
record any change in the valuation allowance in income tax expense. Income tax
expense includes (i) deferred tax expense, which generally represents the
net change in the deferred tax asset or liability balance during the year plus
any change in the valuation allowance and (ii) current tax expense, which
represents the amount of taxes
currently payable to or receivable from a taxing authority plus amounts accrued
for income tax contingencies (including both penalty and interest). Income tax
expense excludes the tax effects related to adjustments
recorded to accumulate other comprehensive income (loss) as well as the tax
effects of cumulative effects of changes in accounting principles. In evaluating
the ability to recover our deferred tax assets, we consider all available
positive and negative evidence regarding the ultimate realizability of our
deferred tax assets including past operating results and our forecast of future
taxable income. In addition, general uncertainty surrounding the future economic
and business conditions have increased the likelihood of volatility in our
future earnings. We have recorded a valuation allowance against our net deferred
tax assets.




10




IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)
  NOTE 2 —
SIGNIFICANT ACCOUNTING POLICIES – continued


Prior to
consummation of the Conversion Transactions, because we were a partnership for
tax purposes, no income taxes were paid by us. Instead, the members separately
paid taxes based on their pro rata shares of the Fund’s income, deductions,
losses and credits and members could elect to either reinvest or receive cash
distributions from the Fund. Whether received in cash or reinvested, members are
individually responsible to pay their respective income taxes on income
allocated to them in respect of the period prior to the conversion.




Use
of Estimates





In
accordance with GAAP, we have made a number of estimates and assumptions with
respect to the reporting of assets and liabilities and the disclosure of
contingencies at the date of the condensed consolidated financial statements and
the reported amounts of income and expenses during the reporting period.
Accordingly, actual results could differ from those estimates. These estimates
primarily include the allowance for credit loss, valuation allowance, valuation
of real estate owned assets and the accretable amount and timing for loans
purchased at a discount.





Recent
Accounting Pronouncements





In April
2009, the Financial Accounting Standards Board, or FASB, issued new accounting
guidance that provides additional guidance for determining whether market
activity for a financial asset or liability has significantly decreased, as well
as for identifying circumstances that indicate that transactions are not
orderly. The new guidance reiterates that if a market is determined to be
inactive and the related market price is deemed to be reflective of a
“distressed sale” price, then management judgment may be required to estimate
fair value. The new guidance identifies factors to be considered when
determining whether or not a market is inactive. The adoption of this
pronouncement did not have a material effect on our financial position or
results of operations.





In June
2009, the FASB issued new accounting guidance that will require the FASB
Accounting Standards Codification, or ASC, to become the source of authoritative
U.S. accounting and reporting standards for nongovernmental entities in addition
to the guidance issued by the SEC. FASB ASU significantly changes the way
financial statement preparers, auditors, and academics perform accounting
research. The statement is effective for financial
statements issued for interim and annual periods ending after September 15,
2009. The adoption of this guidance did not have a material impact on our
financial statements.





In
October 2009, the FASB issued ASU 2009-16, Transfers and Servicing (Topic
860) — Accounting
for Transfers of Financial Assets. This update amends the codification
for the issuance of FASB Statement No. 166, Accounting for Transfers of
Financial Assets-an amendment of FASB Statement No. 140. The amendments
in this update improve financial reporting by eliminating the exceptions for
qualifying special- purpose entities from the consolidation guidance and the
exception that permitted sale accounting for certain mortgage securitizations
when a transferor has not surrendered control over the transferred financial
assets. In addition, the amendments require enhanced disclosures about the risks
that a transferor continues to be exposed to because of its continuing
involvement in transferred financial assets. Comparability and consistency in
accounting for transferred financial assets
will also be improved through clarifications of the requirements for isolation
and limitations on portions of financial assets that are eligible for sale
accounting. This update was effective at the start of a reporting entity’s first
fiscal year beginning after November 15, 2009. Early application was not
permitted. The adoption of this standard did not have a material impact on our
financial position or results of operation.




11




IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)
  NOTE 2 —
SIGNIFICANT ACCOUNTING POLICIES - continued




In
October 2009, the FASB issued ASU 2009-17, Consolidations (Topic
810) — Improvements
to Financial Reporting by Enterprises Involved with Variable Interest
Entities. This update amends the codification for the issuance of FASB
Statement No. 167, Amendments to FASB Interpretation No. 46(R). The amendments
in this update replace the quantitative-based risks and rewards calculation for
determining which reporting entity, if any, has a controlling financial interest
in a variable interest entity with an approach focused on identifying which
reporting entity has the power to direct the activities of a variable interest
entity that most significantly impact the entity’s economic performance and (1)
the obligation to absorb losses of the entity or (2) the right to receive
benefits from the entity. An approach that is expected to be primarily
qualitative will be more effective for identifying which reporting entity has a
controlling financial interest in a variable interest entity. The amendments in
this update also require additional disclosures about a reporting entity’s
involvement in variable interest entities, which will enhance the information
provided to users of financial statements. This update was effective at the
start of a reporting entity’s first fiscal year beginning after November 15,
2009. Early application is not permitted. We do not expect the adoption of this
standard to have a material impact on our financial position or results of
operation.





In
January 2010, the FASB issued ASU 2010-01, Equity (Topic 505) — Accounting for Distributions to
Shareholders with Components of Stock and Cash. The amendments in this
update clarify that the stock portion of a distribution to stockholders that
allows them to elect to receive cash or stock with a potential limitation on the
total amount of cash that all stockholders can elect to receive in the aggregate
is considered a share issuance that is reflected in earnings per share
prospectively and is not a stock dividend. This update is effective for interim
and annual periods ending on or after December 15, 2009, and should be applied
on a retrospective basis. The implementation of this standard did not have a
material impact on our consolidated financial statements.





In January 2010, the FASB issued Accounting Standards Update
(“ASU”) 2010-06, “Fair Value
Measurements and Disclosures,” which amends the disclosure requirements
related to recurring and nonrecurring fair value measurements. This guidance
requires disclosure of transfers of assets and liabilities between Level 1 and
Level 2 of the fair value measurement hierarchy, including the reasons and the
timing of the transfers and information on purchases, sales, issuance, and
settlements on a gross basis in the reconciliation of the assets and liabilities
measured under Level 3 of the fair value measurement hierarchy. The guidance is
effective for annual and interim reporting periods beginning after
December 15, 2009, except for Level 3 reconciliation disclosures which are
effective for annual and interim periods beginning after December 15,
2010.  The adoption of this standard did not have a material impact on our
financial position or results of operation.





In
February 2010, the FASB issued new accounting guidance to address concerns about
conflicts with SEC guidance and other practice issues regarding disclosures of
subsequent events. This accounting guidance was effective upon issuance in
February 2010, except for the use of the issued date for conduit debt obligors.
That amendment is effective for interim or annual periods ending after June 15,
2010. The implementation of this standard did not have a material impact on our
consolidated financial statements.





In
February 2010, the FASB issued new accounting guidance which defers the
effective date of the amendments to the consolidation requirements for a
reporting entity’s interest in entities (1) that have all of the attributes of
an investment company, as specified in Topic 946, Financial Services—Investment
Companies, or (2) for which it is industry practice to apply measurement
principles for financial reporting that are consistent with those in Topic 946.
The deferral does not apply to:





12
 
  IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
2 — SIGNIFICANT ACCOUNTING POLICIES - continued




·
            A reporting entity’s interest in
      an entity if the reporting entity and its related parties have an explicit
      or implicit obligation to losses of the entity that could potentially be
      significant to the entity. This condition should be evaluated considering
      the legal structure of the reporting entity’s interest, the purpose and
      design of the entity, and any guarantees provided by the reporting
      entity’s related parties.


·
            Interests
      in securitization entities, asset-backed financing entities, or entities
      formerly considered the “qualified special-purpose
      entities”(QSPEs).





This
accounting guidance is expected to most significantly affect reporting entities
in the investment management industry, but may also affect reporting entities
with interests in entities that are required to comply with or operate in
accordance with requirements that are similar to those in Rule 2a-7 of the
Investment Company Act of 1940 for registered money market funds.





In July
2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality
of Financing Receivables and the Allowance for Credit Losses,” (ASU
2010-20) which amends ASC 310, “Receivables,” to require
further disaggregated disclosures that improve financial statement users’
understanding of (1) the nature of an entity’s credit risk associated with
its financing receivables and (2) the entity’s assessment of that risk in
estimating its allowance for credit losses as well as changes in the allowance
and the reasons for those changes. The new and amended disclosures as of the end
of a reporting period are effective for interim and annual reporting periods
ending on or after December 15, 2010. The adoption of ASU 2010-20 will only
impact disclosures and is not expected to have a material impact on our
consolidated financial statements.





Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force), the American Institute of Certified Public Accountants and
the SEC did not, or are not expected to, have a material effect on our 
results of operations or financial position.





NOTE
3 – THE CONVERSION TRANSACTIONS




We were
formed from the conversion of our predecessor entity, IMH Secured Loan Fund,
LLC, or (“the Fund”), into a Delaware corporation. The Fund, which was organized
in May 2003, commenced operations in August 2003, focusing on investments in
short-term commercial real estate mortgage loans collateralized by first
mortgages on real property. The Fund was externally managed by Investors
Mortgage Holdings, Inc., or (“the Manager”), which was incorporated in Arizona
in June 1997 and is licensed as a mortgage banker by the State of Arizona. Due
to the cumulative number of investors in the Fund, the Fund registered under the
Securities Exchange Act of 1934, as amended, on April 30, 2007 and began filing
periodic reports with the Securities and Exchange Commission, or (“the
SEC”).  In the Conversion Transactions, we also acquired IMH Holdings, LLC,
or (“Holdings”), a related entity through common ownership of the Manager, which
is a Delaware limited liability company and serves as a holding company for two
wholly-owned subsidiaries, IMH Management Services, LLC, an Arizona limited
liability company and SWI Management, LLC, an Arizona limited liability company.
IMH Management Services, LLC provides us and our affiliates with human resources
and administrative services, including the supply of employees, and SWI
Management, LLC, or SWIM, acts as the manager for the Strategic Wealth &
Income Fund, LLC, or the SWI Fund. At September 30, 2010, the SWI Fund had
$11,400 under management. The SWI Fund is a Delaware limited liability company
whose investment strategies and objectives are substantially similar to our
historic strategy. We have a $25 equity interest in and receive fee income for
managing the SWI Fund.




13
 
  IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)
  NOTE 3 – THE CONVERSION
TRANSACTIONS - continued


On June
18, 2010, the Fund became internally-managed through a series of transactions we
refer to as the Conversion Transactions, which included (i) the conversion of
the Fund from a Delaware limited liability company
into a newly-formed Delaware corporation named IMH Financial Corporation, and
(ii) the acquisition by the Company of all of the outstanding shares of the
Manager, and all of the outstanding membership interests of Holdings.The Fund
intended the Conversion Transactions to position the Fund to become a publicly
traded corporation listed on the NYSE, create the opportunity for liquidity for
Fund members and create the opportunity to raise additional capital in the
public markets, thereby enabling the Fund to better acquire and originate
commercial mortgage
loans and other real estate-related investments with a view to achieving long
term value creation through dividends and capital appreciation.





We
acquired the Manager, through the issuance of 716,279 shares of Class B common
stock to the equity holders of the Manager and its affiliates, on June 18,
2010.   In exchange for their ownership interest, the previous owners
of the Manager and Holdings, as well as certain participants in the Manager’s
stock appreciation rights plan, agreed to receive an aggregate of 895,750 shares
of Class B-3 and B-4 common stock in the Company. Under the terms of the
Conversion Transaction, the aggregate number of shares issuable to the owners of
Manager and Holdings was reduced by one share for each $20 of the net loss
incurred by the Manager and Holdings from January 1, 2010 through the
acquisition date of June 18, 2010. Based on a net loss through the date of
acquisition of $3,531, the shares issued to the owners of Manager and Holdings
was reduced pro rata by 176,554 shares. We also withheld 2,917 shares for SARS
withholding taxes. Additionally, the previous owners received a distribution in
June 2010 totaling $4,000 based on the December 31, 2009 equity of the
Manager.





Final
shares issued for the purchase of the Manager and Holdings were computed as
follows:





Class
      B-3
                            
                            
                            Class
      B-4
                            
                            
                            TotalShares
                            
                            
                            Shares
                            
                            
                            SharesShares
      to be issued for purchase of Manager and Holdings
                            
                            
                            114,107
                            
                            
                            
                            781,643
                            
                            
                            
                            895,750Less:
      reduction in shares for Manager and Holdings net loss
                            
                            
                            (22,490
                            )
                            
                            
                            (154,064
                            )
                            
                            
                            (176,554
                            )Less:
      shares withheld for SARS tax withholdings
                            
                            
                            (2,917
                            )
                            
                            
                            -
                            
                            
                            
                            (2,917
                            )Final
      shares issued for purchase of Manager and Holdings
                            
                            
                            88,700
                            
                            
                            
                            627,579
                            
                            
                            
                            716,279




For
accounting purposes, the Conversion Transactions were simultaneously treated as
a recapitalization of the Fund into IMH Financial Corporation and IMH Financial
Corporation’s acquisition of all of the ownership interests in the Manager and
Holdings. Recapitalization of membership units of the Fund into common stock of
IMH Financial Corporation had no accounting effect except for the requirement to
record deferred taxes on the date of change in tax status from a pass through
entity to a taxable entity (see Note 10). The Conversion Transactions also
terminated the Manager’s pass through tax status and it became a taxable entity
resulting in the requirement to record deferred taxes on the date of change in
tax status. Upon the exchange of common stock of IMH Financial Corporation for
all of the ownership interest in the Manager and Holdings, IMH Financial
Corporation included the assets and liabilities of Manager and Holdings in its
financial statements at their carryover basis. The acquisition of the Manager
and Holdings was effected in order to, among other things; align the interests
of management and stockholders of the Company.




14
 
  IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)
  In
connection with the Manager’s adoption of applicable accounting guidance, the
Manager was required to consolidate the Fund effective January 1, 2010. With the
adoption of the applicable accounting guidance, the Fund and the Manager were
one reporting entity subsequent to January 1, 2010, and the Company and the
Manager remain one reporting entity after the completion of the Conversion
Transactions. As a result, the exchange of our common stock for all of the
ownership interests in the Manager and Holdings is not considered a business
combination resulting in a new basis of the assets obtained and liabilities
assumed. Instead such assets and liabilities were recorded at the Manager’s and
Holding’s carryover basis.




The
Manager contributed approximately $269 to revenue and ($1,658) to pre-tax net
loss for the period from June 18, 2010 (the effective date of acquisition)
through September 30, 2010.




The
following table presents unaudited pro forma revenue and net loss for the nine
months ended September 30, 2010 (assuming the acquisition of the Manager
occurred January 1, 2010) and September 30, 2009 (assuming the acquisition of
the Manager occurred January 1, 2009). The pro forma financial information
presented in the following table is for informational purposes only and is not
indicative of the results of operations that would have been achieved if the
acquisition had taken place at the beginning of the earliest period presented,
nor does it intend to be a projection of future results.




Pro Forma Nine
                                
                                
                                Pro Forma NineMonths Ended
                                
                                
                                Months EndedSeptember 30, 2009
                                
                                
                                September 30, 2010Revenue
                                
                                $
                                30,394
                                
                                
                                $
                                3,096Net
      loss
                                
                                $
                                (71,878
                                )
                                
                                $
                                (69,096
                                )Provision
      for income taxes
                                
                                $
                                -
                                
                                
                                $
                                -




After the
consummation of the Conversion Transactions, the Manager was internalized, the
executive officers and employees of the Manager became our executive officers
and employees and assumed the duties previously performed by the Manager, and we
no longer pay management fees to the Manager. We are now entitled to retain all
management, origination fees, gains and basis points previously allocated to the
Manager.





15
 
  IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)
 NOTE 3 – THE CONVERSION
TRANSACTIONS – continued


The
following table summarizes the assets acquired and liabilities assumed recorded
at the Manager’s carrying value at the acquisition date:




As
      ofJune
      18, 2010Cash
      and Cash Equivalents
                            
                            $
                            422Accrued
      Interest and Other Receivables
                            
                            
                            50Real
      Estate Held for Sale
                            
                            
                            39Deposits
      and Other Assets
                            
                            
                            291Property
      and Equipment
                            
                            
                            1,727Accounts
      Payable and Accrued Expenses
                            
                            
                            (1,138
                            )Notes
      Payable
                            
                            
                            (443
                            )Payable
      to Fund
                            
                            
                            (810
                            )Total
      Identifiable Net Assets at June 18, 2010
                            
                            
                            138Less: 
      Distribution to Owners of Manager and Holdings
                            
                            
                            (3,721
                            )Add: 
      Settlement of Obligation with SARs Participants
                            
                            
                            234Conversion
      Transaction impact to Stockholders' Equity
                            
                            $
                            (3,349
                            )




Prior to
June 18, 2010, the Manager distributed $279 to the owners of Manager and
Holdings. This distribution plus the $3,721 distribution reflected in the
preceding table is equal to the $4,000 distribution due to the owners of the
Manager and Holdings based on the December 31, 2009 consolidated equity balance
of the Manager and Holding.




Offering
Costs




The
Conversion Transactions were undertaken primarily to position us for an initial
public offering through the filing of Form S-11 with the SEC.  We received
notice on June 8, 2010 that we were the subject of an SEC investigation. 
After consultation with our potential underwriters, legal counsel and others, we
believe that it is not probable at this time that we will be in a position to
complete an IPO until matters concerning the SEC’s investigation are clarified
or resolved and market conditions are more favorable.  We cannot determine
at this time when matters before the SEC will be clarified or
resolved.





As a
result of this change in circumstances, due to the postponement of the IPO by
more than 90 days and the fact that we cannot assert that it is probable that it
will occur in near term, we wrote-off all previously capitalized incremental
costs totaling $6,150 relating to the IPO to our current operations as of
September 30, 2010.




16
 
  IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
4 – MORTGAGE LOANS, LOAN PARTICIPATIONS AND LOAN SALES




Lien
Priority




Historically,
all mortgage loans have been collateralized by first deeds of trust (mortgages)
on real property and generally include a personal guarantee by the principals of
the borrower. Often the loans are secured by additional collateral. However, as
of September 30, 2010, we had agreed to subordinate portions of two of our first
lien mortgages to third-party lenders in the amount of $20,000 (representing
approximately 25% and 2% of the outstanding principal for each loan,
respectively). One subordination was originally for $14,000 and was granted in
order to provide liquidity to the borrower to complete the construction of the
project, an obligation for which we had been responsible under the original loan
terms. During the quarter ended September 30, 2010, we agreed to subordinate an
additional $2,500 to this lender commensurate with an equal paydown on this
loan. Under the terms of the
subordination agreement, we may purchase or pay off the loan to the third-party
lender at par. The second subordination for $1,500 was granted in order to
satisfy a financial obligation to a utility company in relation to the
development of the collateral, and to bring the interest payments current on
other liens totaling approximately $2,000 for which the lien holders were
seeking foreclosure. The other liens totaling $2,000 are also superior to our
deed of trust and are held by two lenders. However, we entered into
intercreditor agreements with these lenders which stipulate that they must
notify us of any loan default or foreclosure proceedings, and we have the right,
but not the obligation, to cure any event of default or to purchase the liens.
The aggregate of these superior liens total $3,500 (representing approximately
5% of the outstanding principal for the related loan), and are collateralized by
11 of the 55 parcels that comprise the collateral for this loan. While
subordinations of our first lien positions are not expected to be a common
occurrence in the future, we may find it necessary to do so in an effort to
maximize the opportunity for recovery of our investment.




As we
have done historically, we will acquire almost exclusively first mortgages and
trust deeds unless a second mortgage on a different property is offered as
additional credit support. Even in those cases, we will not advance funds solely
in respect of a second mortgage. However, we may accept any reasonable financing
terms or make additional acquisitions we deem to be in the best interests of our
stockholders.





Loan
Classification





In
connection with the consummation of the Conversion Transactions, we revised our
business strategy.  Although we have historically focused on the
origination of senior short-term commercial bridge loans with maturities of 12
to 18 months with the intent of holding such loans to maturity with the
availability of permanent take-out financing, our primary near-term future focus
is on the acquisition and origination of interim loans, or other short-term
financings, that are used to pay off construction,  commercial or
residential property loans and are not reliant on the availability of take-out
financing. In addition, we will target the acquisition or financing of whole
commercial real estate mortgage loans, which may be performing, distressed or
non-performing, and participating interests in performing commercial real estate
mortgage loans.  Accordingly, as of September 30, 2010, the entire loan
portfolio is reflected as held for sale in the accompanying consolidated balance
sheets.





Loan
Interest Rates





We invest
in both fixed and variable interest rate loans. As of September 30, 2010, we
held 43 loans, 21 of which were variable rate loans and 22 of which were fixed
rate loans. Thirty-six of these loans are non-performing loans for financial
reporting purposes (although not all such loans are necessarily in technical
default under the loan terms), for which we are actively pursuing enforcement on
the loans as well as judgments against personal guarantors of such loans, when
applicable.





·
            Variable Interest Rate
      Loans.  All variable interest rate loans are indexed to the
      Wall Street Journal Prime Interest Rate, or Prime, all of which are
      subject to interest rate floors and none of which are subject to interest
      rate ceilings. At September 30, 2010, the weighted average interest rate
      on our variable interest rate loans, which accounted for 44.5% of the
      outstanding principal amount in our portfolio of commercial mortgage
      loans, net of the valuation allowance, was 13.05% per annum.  As of
      December 31, 2009 and September 30, 2010, the weighted average contractual
      interest rates on our variable rate loans (including loans in non-accrual
      status) was Prime plus 9.63% and Prime plus 9.80%, respectively. The Prime
      rate was 3.25% per annum at December 31, 2009 and September 30,
      2010.




17
 
  IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
4 – MORTGAGE LOANS, LOAN PARTICIPATIONS AND LOAN SALES –
(continued)





·
            Fixed Interest Rate
      Loans.  At September 30, 2010, fixed interest rate loans
      accounted for 55.5% of the outstanding principal amount in our portfolio
      of commercial mortgage loans, net of the allowance for credit loss, and
      the average weighted interest rate on these loans was 9.85% per
      annum.





While a
substantial portion of our portfolio loans are in default or non-accrual status,
a summary of our outstanding principal balances on our portfolio loans
(including non-accrual loans), net of the allowance for credit loss and
valuation allowance, as of December 31, 2009 and September 30, 2010,
respectively, is provided by the contractual loan terms for fixed and variable
interest rate loans as follows:




December 31, 2009
                            
                            
                            September 30, 2010Fixed
                            
                            
                            Variable
                            
                            
                            Total
                            
                            
                            Fixed
                            
                            
                            Variable
                            
                            
                            TotalRate
                            
                            
                            Rate
                            
                            
                            Loan
                            
                            
                            Rate
                            
                            
                            Rate
                            
                            
                            LoanLoans
                            
                            
                            Loans
                            
                            
                            Portfolio
                            
                            
                            Loans
                            
                            
                            Loans
                            
                            
                            PortfolioTotal
      Principal Outstanding
                            
                            $
                            274,263
                            
                            
                            $
                            270,185
                            
                            
                            $
                            544,448
                            
                            
                            $
                            272,372
                            
                            
                            $
                            218,510
                            
                            
                            $
                            490,882Less
      Allowance for Credit Loss /Valuation
      Allowance
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (330,428
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (334,881
                            )Net
      Principal Outstanding
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            $
                            214,020
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            $
                            156,001%
      of Portfolio
                            
                            
                            50.4
                            %
                            
                            
                            49.6
                            %
                            
                            
                            100.0
                            %
                            
                            
                            55.5
                            %
                            
                            
                            44.5
                            %
                            
                            
                            100.0
                            %Weighted
      Average Rate
                            
                            
                            9.84
                            %
                            
                            
                            12.88
                            %
                            
                            
                            11.34
                            %
                            
                            
                            9.85
                            %
                            
                            
                            13.05
                            %
                            
                            
                            11.27
                            %Number
      of Loans
                            
                            
                            23
                            
                            
                            
                            32
                            
                            
                            
                            55
                            
                            
                            
                            22
                            
                            
                            
                            21
                            
                            
                            
                            43Average
      Principal Balance
                            
                            $
                            11,924
                            
                            
                            $
                            8,443
                            
                            
                            $
                            9,899
                            
                            
                            $
                            12,381
                            
                            
                            $
                            10,405
                            
                            
                            $
                            11,416




As of
September 30, 2010, the valuation allowance totaled $334,881 (all of which
relates to mortgage loans held for sale), representing 68.2% of the total loan
portfolio principal balances. As of December 31, 2009, the allowance for credit
loss totaled $330,428 (of which $328,060 relates to mortgage loans held to
maturity and $2,368 relates to mortgage loans held for sale), representing 60.7%
of the total loan portfolio principal balances.




18
 
  IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)
  NOTE
4 – MORTGAGE LOANS, LOAN PARTICIPATIONS AND LOAN SALES –
(continued)


Loan
Maturities and Loans in Default




The
outstanding principal balances of our mortgage loans, net of the allowance for
credit loss, as of September 30, 2010, have scheduled maturity dates within the
next several quarters, as follows:




September 30, 2010Quarter
                      
                      Amount
                      
                      
                      Percent
                      
                      
                      #Matured
                      
                      $
                      347,233
                      
                      
                      
                      70.8
                      %
                      
                      
                      31Q4
      2010
                      
                      
                      4,206
                      
                      
                      
                      0.9
                      %
                      
                      
                      1Q1
      2011
                      
                      
                      1,617
                      
                      
                      
                      0.3
                      %
                      
                      
                      1Q2
      2011
                      
                      
                      1,173
                      
                      
                      
                      0.2
                      %
                      
                      
                      2Q3
      2011
                      
                      
                      1,100
                      
                      
                      
                      0.2
                      %
                      
                      
                      1Q4
      2011
                      
                      
                      33,916
                      
                      
                      
                      6.9
                      %
                      
                      
                      3Q1
      2012
                      
                      
                      2,000
                      
                      
                      
                      0.4
                      %
                      
                      
                      1Q3
      2012
                      
                      
                      99,423
                      
                      
                      
                      20.3
                      %
                      
                      
                      2Q3
      2013
                      
                      
                      214
                      
                      
                      
                      0.0
                      %
                      
                      
                      1Total
                      
                      
                      490,882
                      
                      
                      
                      100.0
                      %
                      
                      
                      43Less:
      Valuation Allowance
                      
                      
                      (334,881
                      )Net
      Carrying Value
                      
                      $
                      156,001




Loans
in Default




Loans in
default balances encompass both non-accrual loans and loans for which we are
still accruing income, but are delinquent as to the payment of accrued interest
or are past scheduled maturity. At December 31, 2009, 50 of our 55 loans with
outstanding principal balances totaling $531,999 were in default, of which 34
with outstanding principal balances totaling $347,100 were past their respective
scheduled maturity dates, and the remaining 16 loans were in default as a result
of delinquency on outstanding interest payments or have been deemed
non-performing based on value of the underlying collateral in relation to the
respective carrying value of the loan. At September 30, 2010, 36 of our 43 loans
with outstanding principal balances totaling $480,573 were in default, of which
31 with outstanding principal balances totaling $347,233 were past their
respective scheduled maturity dates, and the remaining 5 loans were in default
as a result of delinquency on outstanding interest payments or have been deemed
non-performing based on value of the underlying collateral in relation to the
respective carrying value of the loan. In light of current economic conditions
and in the absence of a recovery of the credit markets, it is anticipated that
many, if not most, loans with scheduled maturities within one year will not be
paid off at the scheduled maturity.




During
the nine months ended September 30, 2010, we foreclosed on ten loans with net
carrying values of $25,379. We are currently exercising enforcement action which
could lead to foreclosure upon 27 of the 36 loans in default at September 30,
2010. With respect to the loans upon which we are exercising enforcement action,
we expect to complete the foreclosure process on the majority of such loans over
the next six months.





Two
loans, which were previously in non-accrual status during the year ended
December 31, 2009 with principal balances totaling $28,500, related to a
bankruptcy of the borrower and were consolidated into one loan in connection
with the approved plan of reorganization and the loan terms were restructured in
the fourth quarter of 2009. The loan restructure did not result in any
forgiveness of principal or accrued interest. However, due to the value of the
underlying collateral in relation to loan principal for this collateral-based
loan, we have deemed it appropriate to keep this restructured loan in
non-accrual status as of December 31, 2009 and September 30, 2010.





As of
September 30, 2010, five loans that are in non-accrual status relate to two
borrowing groups that are not in technical default under the loan terms.
However, due to the value of the underlying collateral for these collateral
dependent loans, we have deemed it appropriate to maintain these loans in
non-accrual status.




19




IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
4 – MORTGAGE LOANS, LOAN PARTICIPATIONS AND LOAN SALES –
(continued)




We are
continuing to work with the borrowers with respect to the remaining four loans
in default in order to seek to maintain the entitlements on such projects and,
thus, the value of our existing collateral. However, such negotiations may
result in a payoff of an amount that is below our loan principal and accrued
interest, and that discounted payoff may be materially less than the contractual
principal and interest due. Generally, the allowance for credit loss
contemplates the potential loss that may occur as a result of a payoff of the
loan at less than its contractual balance due. We are considering our preferred
course of action with respect to all remaining loans. However, we have not
commenced enforcement action on these other loans thus far.




Of the
principal balances in default as of September 30, 2010: approximately 32% of the
total has been in default status since December 31, 2008; approximately 34% of
the total has been in default status since March 31, 2009; approximately 16% of
the total has been in default status since June 30, 2009; 2% of the total has
been in default status
since September 30, 2009; 13% of the total has been in default status since
December 31, 2009; 2% have been in default since March 31, 2010; 0.3% have been
in default status since June 30, 2010 and 0.7% entered default status during the
quarter ended September 30, 2010.




At
September 30, 2010, all 36 loans in default were in non-accrual status. Total
contractual interest due under the loans classified in non-accrual status was
$43,320, of which $3,246 is included in accrued interest receivable on the
balance sheet, and of which $40,074 has not been recognized as income by us.
Excluding loans whose maturity has not been reached as of September 30, 2010,
loans in default were past their scheduled maturities between one and 1,057 days
as of September 30, 2010.





20
 
  IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE 4 – MORTGAGE LOANS, LOAN
PARTICIPATIONS AND LOAN SALES – (continued)





The
geographic concentration of loans in default, net of the allowance for credit
loss or valuation allowance, at December 31, 2009 and September 30, 2010 is as
follows:




December 31, 2009Percent of
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      Non-AccruedOutstanding
                      
                      
                      
                      
                      
                      Outstanding
                      
                      
                      Allowance for
                      
                      
                      Net Carrying
                      
                      
                      Accrued
                      
                      
                      NotePrincipal
                      
                      
                      #
                      
                      
                      Principal
                      
                      
                      Credit Loss
                      
                      
                      Amount
                      
                      
                      Interest
                      
                      
                      Interest
                      
                      
                      TotalArizona
                      
                      
                      52.3
                      %
                      
                      
                      23
                      
                      
                      $
                      278,306
                      
                      
                      $
                      (162,282
                      )
                      
                      $
                      116,024
                      
                      
                      $
                      5,362
                      
                      
                      $
                      13,723
                      
                      
                      $
                      135,109Idaho
                      
                      
                      9.3
                      %
                      
                      
                      2
                      
                      
                      
                      49,594
                      
                      
                      
                      (38,981
                      )
                      
                      
                      10,613
                      
                      
                      
                      1,948
                      
                      
                      
                      5,993
                      
                      
                      
                      18,554California
                      
                      
                      33.8
                      %
                      
                      
                      19
                      
                      
                      
                      179,773
                      
                      
                      
                      (120,829
                      )
                      
                      
                      58,944
                      
                      
                      
                      3,959
                      
                      
                      
                      18,349
                      
                      
                      
                      81,252Texas
                      
                      
                      2.1
                      %
                      
                      
                      3
                      
                      
                      
                      11,102
                      
                      
                      
                      (4,272
                      )
                      
                      
                      6,830
                      
                      
                      
                      427
                      
                      
                      
                      1,170
                      
                      
                      
                      8,427Nevada
                      
                      
                      1.5
                      %
                      
                      
                      1
                      
                      
                      
                      7,984
                      
                      
                      
                      (2,613
                      )
                      
                      
                      5,371
                      
                      
                      
                      319
                      
                      
                      
                      957
                      
                      
                      
                      6,647New
      Mexico
                      
                      
                      1.0
                      %
                      
                      
                      2
                      
                      
                      
                      5,240
                      
                      
                      
                      (1,094
                      )
                      
                      
                      4,146
                      
                      
                      
                      -
                      
                      
                      
                      586
                      
                      
                      
                      4,732100.0
                      %
                      
                      
                      50
                      
                      
                      $
                      531,999
                      
                      
                      $
                      (330,071
                      )
                      
                      $
                      201,928
                      
                      
                      $
                      12,015
                      
                      
                      $
                      40,778
                      
                      
                      $
                      254,721




September 30, 2010Percent
      of
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              Non-AccruedOutstanding
                              
                              
                              
                              
                              
                              Outstanding
                              
                              
                              Valuation
                              
                              
                              Net
      Carrying
                              
                              
                              Accrued
                              
                              
                              NotePrincipal
                              
                              
                              #
                              
                              
                              Principal
                              
                              
                              Allowance
                              
                              
                              Amount
                              
                              
                              Interest
                              
                              
                              Interest
                              
                              
                              TotalArizona
                              
                              
                              51.4
                              %
                              
                              
                              14
                              
                              
                              $
                              246,801
                              
                              
                              $
                              (153,257
                              )
                              
                              $
                              93,544
                              
                              
                              $
                              (2,609
                              )
                              
                              $
                              16,761
                              
                              
                              $
                              107,696Idaho
                              
                              
                              10.3
                              %
                              
                              
                              2
                              
                              
                              
                              49,637
                              
                              
                              
                              (43,178
                              )
                              
                              
                              6,459
                              
                              
                              
                              1,948
                              
                              
                              
                              4,493
                              
                              
                              
                              12,900California
                              
                              
                              35.6
                              %
                              
                              
                              17
                              
                              
                              
                              171,230
                              
                              
                              
                              (136,431
                              )
                              
                              
                              34,799
                              
                              
                              
                              3,770
                              
                              
                              
                              17,915
                              
                              
                              
                              56,484New
      Mexico
                              
                              
                              1.1
                              %
                              
                              
                              2
                              
                              
                              
                              5,260
                              
                              
                              
                              (1,985
                              )
                              
                              
                              3,275
                              
                              
                              
                              (16
                              )
                              
                              
                              445
                              
                              
                              
                              3,704Utah
                              
                              
                              1.6
                              %
                              
                              
                              1
                              
                              
                              
                              7,645
                              
                              
                              
                              -
                              
                              
                              
                              7,645
                              
                              
                              
                              153
                              
                              
                              
                              460
                              
                              
                              
                              8,258100.0
                              %
                              
                              
                              36
                              
                              
                              $
                              480,573
                              
                              
                              $
                              (334,851
                              )
                              
                              $
                              145,722
                              
                              
                              $
                              3,246
                              
                              
                              $
                              40,074
                              
                              
                              $
                              189,042




The
concentration of loans in default by loan classification as of September 30,
2010 is as follows:


Non-Percent
      of
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          AccruedOutstanding
                          
                          
                          
                          
                          
                          Outstanding
                          
                          
                          Valuation
                          
                          
                          Net
      Carrying
                          
                          
                          Accrued
                          
                          
                          NotePrincipal
                          
                          
                          #
                          
                          
                          Principal
                          
                          
                          Allowance
                          
                          
                          Amount
                          
                          
                          Interest
                          
                          
                          Interest
                          
                          
                          TotalPre-entitled
      Land
                          
                          
                          41.4
                          %
                          
                          
                          10
                          
                          
                          $
                          198,728
                          
                          
                          $
                          (167,604
                          )
                          
                          $
                          31,124
                          
                          
                          $
                          6,380
                          
                          
                          $
                          18,947
                          
                          
                          $
                          56,451Entitled
      Land
                          
                          
                          34.5
                          %
                          
                          
                          15
                          
                          
                          
                          165,613
                          
                          
                          
                          (139,926
                          )
                          
                          
                          25,687
                          
                          
                          
                          1,590
                          
                          
                          
                          15,905
                          
                          
                          
                          43,182Construction
                          
                          
                          24.2
                          %
                          
                          
                          11
                          
                          
                          
                          116,232
                          
                          
                          
                          (27,321
                          )
                          
                          
                          88,911
                          
                          
                          
                          (4,724
                          )
                          
                          
                          5,222
                          
                          
                          
                          89,409100.0
                          %
                          
                          
                          36
                          
                          
                          $
                          480,573
                          
                          
                          $
                          (334,851
                          )
                          
                          $
                          145,722
                          
                          
                          $
                          3,246
                          
                          
                          $
                          40,074
                          
                          
                          $
                          189,042






Of our
loans in default at December 31, 2009, 50% of the loan principal balances
related to residential end-use projects, 33% related to mixed-use projects, and
17% related to commercial and industrial projects. Of our portfolio loans in
default at September 30, 2010, 53% of such loan principal balances related to
residential end-use projects, 32% related to mixed-use projects, and 15% related
to commercial and industrial projects. Other than as discussed in the foregoing
paragraphs, the seven remaining performing loans in our portfolio, with
principal balances totaling $10,310 were current as of September 30, 2010 to
principal and interest payments.




21





IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)




NOTE
4 – MORTGAGE LOANS, LOAN PARTICIPATIONS AND LOAN SALES –
(continued)




Loans
in Default and Impaired Loans




Under
GAAP, an entity is required to recognize a loss when both (a) available
information indicates that it is probable that an asset has been impaired at the
date of the financial statements, and (b) the amount of loss can be reasonably
estimated.





Under
this definition, certain of the loans that are classified as “in default” status
would qualify as impaired under this GAAP definition while others would not so
qualify. Since the majority of our loan portfolio is considered collateral
dependent, the extent to which our loans are considered collectible, with
consideration given to personal guarantees provided in connection with such
loans, is largely dependent on the fair value of the underlying
collateral.





Our loans
in default balances include loans in non-accrual and accrual status for which we
continue to accrue income, but are delinquent as to accrued interest or are past
scheduled maturity, in accordance with our accounting policy. Unless and until
we have determined that the value of the underlying collateral is insufficient
to recover the total contract amounts due under the loans, we expect to continue
to accrue interest until the loan is greater than 90 days delinquent with
respect to accrued, uncollected interest, or greater than 90 days past scheduled
maturity, whichever comes first. This result in the classification of loans in
default that may not be deemed impaired under GAAP.





The
following table presents required disclosures under GAAP for loans that meet the
definition for impaired loans:




As
      of and Year
                                      
                                      
                                      As
      of and 9 Mos.Ended
      December 31,
                                      
                                      
                                      Ended
      September 30,2009
                                      
                                      
                                      2010Loans
      in Default - Impairment Status:Impaired
      loans in default
                                      
                                      $
                                      458,464
                                      
                                      
                                      $
                                      414,245Non-impaired
      loans in default
                                      
                                      
                                      73,535
                                      
                                      
                                      
                                      66,328Total
      loans in default
                                      
                                      $
                                      531,999
                                      
                                      
                                      $
                                      480,573Allowance
      for Credit Loss / Valuation Allowance on Impaired LoansImpaired
      loans in default
                                      
                                      $
                                      458,464
                                      
                                      
                                      $
                                      414,245Less:
      Allowance for credit loss / valuation allowance
                                      
                                      
                                      (330,071
                                      )
                                      
                                      
                                      (334,857
                                      )Net
      carrying value of impaired loans
                                      
                                      $
                                      128,393
                                      
                                      
                                      $
                                      79,388Average
      investment for impaired loans during period held
                                      
                                      $
                                      456,993
                                      
                                      
                                      $
                                      412,025Interest
      income recognized during the period that loans were
    impaired
                                      
                                      $
                                      1,898
                                      
                                      
                                      $
                                      -Interest
      income recognized using a cash-basis method of accountingduring
      the period that the loans were impaired
                                      
                                      $
                                      404
                                      
                                      
                                      $
                                      -




22




IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
4 – MORTGAGE LOANS, LOAN PARTICIPATIONS AND LOAN SALES –
(continued)




Allowance
for Credit Loss / Valuation Allowance and Fair Value Measurement




We
perform a valuation analysis of our loans on a quarterly basis. Evaluating the
collectability of a real estate loan is a matter of judgment. We evaluate our
real estate loans for impairment on an individual loan basis, except for loans
that are cross-collateralized within the same borrowing groups. For those loans,
we perform both an individual evaluation as well as a consolidated evaluation to
assess our overall exposure to those loans. In addition to this analysis, we
also complete an analysis of our loans as a whole to assess our exposure for
loans made in various reporting periods and in terms of geographic diversity.
The fact that a loan may be temporarily past due does not result in a
presumption that the loan is impaired. Rather, we consider all relevant
circumstances to determine if, and to the extent to which, an allowance for
credit losses or valuation allowance is required. During the loan evaluation, we
consider the following matters, among others:





·
            an
      estimate of the net realizable value of any underlying collateral in
      relation to the outstanding mortgage balance, including accrued interest
      and related costs;


·
            the
      present value of cash flows we expect to
  receive;


·
            the
      date and reliability of any
valuations;


·
            the
      financial condition of the borrower and any adverse factors that may
      affect its ability to pay its obligations in a timely
    manner;


·
            prevailing
      economic conditions;


·
            historical
      experience by market and in general;
and


·
            evaluation
      of industry trends.




Next, we
assess the extent, reliability and quality of market participant inputs such as
sales pricing, cost data, absorption, discount rates, and other assumptions, as
well as the significance of such assumptions in deriving the
valuation.




We
generally employ one of five valuation approaches, or a combination of such
approaches, in determining the fair value of the underlying collateral of each
loan: the development approach, the income capitalization approach, the sales
comparison approach, the cost approach, or the receipt of recent offers on
specific properties. The valuation approach taken depends on several factors
including:




·
            the
      type of property;


·
            the
      current status of entitlement and level of development (horizontal or
      vertical improvements) of the respective
  project;


·
            the
      likelihood of a bulk sale as opposed to individual unit
    sales;


·
            whether
      the property is currently or near ready to produce
  income;


·
            the
      current sales price of property in relation to cost of
      development;


·
            the
      availability and reliability of market participant data;
    and


·
            the
      date of an offer received in relation to the reporting
    period.




As more
fully described in our 10-K/A, prior to the significant disruptions in the real
estate and credit markets in the latter part of 2008, for purposes of
determining whether an allowance for credit loss was required, we primarily
utilized a modeling technique known as residual analysis commonly used in our
industry which is based on the assumption that development of our collateral was
the highest and best use of the property. During the first two quarters of 2008,
our process was consistently applied as there was no indication of significant
impairment in the value of our loan portfolio. The underlying collateral of our
loans vary by stage of completion, which consists of either raw land (also
referred to as pre-entitled land), entitled land, partially developed, or mostly
developed/completed lots or projects.




23
 
  IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
4 – MORTGAGE LOANS, LOAN PARTICIPATIONS AND LOAN SALES –
(continued)




In the
latter part of 2008 and part of 2009, the global and U.S. economies experienced
a rapid decline resulting in unprecedented disruptions in the real estate,
capital, credit and other markets. As a result of these factors, we recorded a
provision for credit losses developed in the third quarter of 2008 using a
development/residual analysis approach, reflecting lower pricing assumptions,
slower absorption and a significant increase in discount factors to reflect
current market participant risk levels.




In the
third quarter of 2009, given recent sales activity and the on-going volatility
in the real estate markets, we engaged an independent third-party valuation firm
and other consultants to assist with the analysis of fair value of the
collateral supporting our loans as of September 30, 2009, which was then updated
for financial reporting as of December 31, 2009.  During the quarter ended
June 30, 2010, we re-engaged independent third-party valuation firms to provide
complete updated valuation reports for the majority of our loans.   
For the quarter ended September 30, 2010, we obtained a letter from our
third-party valuation firm concluding there was no material diminution in the
fair value indications reported for the properties valued at June 30,
2010.  Additionally, for the quarter ended September 30, 2010, we engaged a
separate third-party valuation firm to perform valuations on the remaining
portfolio.




The
following is a summary of the procedures performed in connection with our fair
value analysis as of and for the year ended December 31, 2009 and for the nine
months ended September 30, 2010:




1.
            We
      reviewed the status of each of our loans to ascertain the likelihood that
      we will collect all amounts due under the terms of the loans at maturity
      based on current real estate and credit market
  conditions.




2.
            With
      respect to our loans whose collection was deemed to be unlikely, we
      determined when the latest valuation of the underlying collateral was
      performed.




3.
            We
      subjected all of our loans to independent third-party valuation as of
      September 30, 2009, (with a review and update of such valuations provided
      through December 31, 2009), to determine whether any material changes in
      industry or economic conditions warranted a change in the valuation
      conclusions formed since the date of our last valuation. As of June 30,
      2010, we subjected 74% of our outstanding loan portfolio to independent
      third-party valuation. The remaining 26% was subject to independent
      third-party valuation during the quarter ended September 30,
      2010.




4.
            For
      the year ended December 31, 2009 and for the quarter ended June 30, 2010,
      we utilized the services of Cushman & Wakefield, a nationally
      recognized valuation firm, and other valuation firms to perform a
      valuation analysis for the selected projects. Cushman & Wakefield
      valued approximately 89% of the outstanding principal balance of our loan
      portfolio at December 31, 2009, while other valuation firms valued the
      remaining 11%. At June 30, 2010, Cushman & Wakefield valued 73% of the
      portfolio and 1% of the portfolio was valued by another third-party
      valuation firm.  For the 26% of the valuations performed by valuation
      firms other than Cushman & Wakefield, we engaged Cushman &
      Wakefield to perform a review of the valuations and
    reports.




5.
            For
      projects in which we have received a bona fide written third-party offer
      to buy our loan, or the borrower has received a bona fide written
      third-party offer to buy the related project, we utilized the offer amount
      in cases in which the offer exceeded the valuation conclusion reached by
      the independent valuation firms. Such offers are only considered if we
      deem the offer to be valid, reasonable and negotiable, and we believe the
      offeror has the financial wherewithal to execute the transaction. When
      deemed appropriate, the offers received were discounted by up to 20% to
      allow for potential changes in our on-going
  negotiations.




24




IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)




NOTE 4 – MORTGAGE
LOANS, LOAN PARTICIPATIONS AND LOAN SALES – (continued)





A summary
of the results and key assumptions that we utilized, as supported by the
independent valuation firms to derive fair value, is as follows:




·
            Very few of the precedent
      transactions that were analyzed satisfied the market value and fair value
      requirement that the price reflect that of an orderly transaction, rather
      than that of a sale under duress or in markets in turmoil. Inputs for use
      in the development valuation models were reported by the valuation firms
      to be inconsistent and reflective of a distressed market that had not yet
      stabilized for inputs into discounted cash flow or other financial models,
      such as absorption rates and timing, unit pricing and trends, discount
      rate, risk adjustment processes, or the
  like.




·
            A distinction was made between
      owners under duress and properties under duress. Market values are
      determined based on the highest and best use of the real property being
      valued. When owners are under duress, as defined by applicable accounting
      guidance, prices of transactions in which they are involved must be viewed
      as at least potentially subject to duress as well. The valuation firms
      took this distinction into account in arriving at highest and best use
      conclusions and selecting appropriate valuation
      methodologies.




·
            As
      of December 31, 2009 and September 30, 2010, the highest and best use for
      the majority of real estate collateral subject to third-party valuation
      was deemed to be held for investment and/or future development, rather
      than being subject to immediate development and/or sale. In determining
      fair value as of December 31, 2009, we utilized the “as is” sales
      comparable valuation methodology for 31 assets, the development approach
      for six assets, the income capitalization approach for four assets, and
      the cost approach for two assets, and we utilized offers received from
      third parties to estimate fair value for the remaining 14 assets. In
      determining fair value as of September 30, 2010, we utilized the “as is”
      sales comparable valuation methodology for 32 assets, the development
      approach for 6 assets, the income capitalization approach for 3 assets,
      and we utilized offers received from third parties to estimate fair value
      for the remaining 2 assets. We selected a fair value within a
      determinable range as provided by the valuation
  firm.




·
            For
      the projects which included either un-entitled or entitled land lacking
      any vertical or horizontal improvements, given the current distressed
      state of the real estate and credit markets, the development approach was
      deemed to be unsupportable because market participant data was
      insufficient or other assumptions were not readily available from the
      valuation firm’s market research; the “highest and best use” standard in
      these instances required such property to be classified as “held for
      investment” purposes until market conditions provide observable
      development activity to support a valuation model for the development of
      the planned site. As a result, the valuation firms used a sales comparison
      approach using available data to determine fair
  value.




·
            For
      the projects containing partially or fully developed lots, the development
      approach was generally utilized, with assumptions made for pricing trends,
      absorption projections, holding costs, and the relative risk given these
      assumptions. The assumptions were based on currently observable available market
      data.




·
            For
      operating properties, the income approach, using the direct capitalization
      and discounted cash flow methods was used by the valuation firms. The
      anticipated future cash flows and a reversionary value were discounted to
      the net present value at a chosen yield rate. The assumptions were based
      on currently observable available market
data.




For
certain assets as of December 31, 2009, we supplemented our analysis by
utilizing a risk-adjusted cash flow model commonly used in our industry based on
certain assumptions and market participant inputs to determine fair value, which
presumed a development approach as highest and best use for such projects. To
evaluate the collateral relating to these projects, we performed different
procedures depending on the stage of the collateral, which are described below
along with a summary of key assumptions utilized in our evaluations of fair
value were as follows:




·
            For
      collateral to be developed, the initial unit sales price utilized was
      based on local market, comparable prices from non-distressed pricing from
      prior periods utilizing observable and unobservable data
      points,




25
 
  IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)
  NOTE
4 – MORTGAGE LOANS, LOAN PARTICIPATIONS AND LOAN SALES –
(continued)


·
            For
      collateral to be developed prior to being sold, the additional development
      costs, operating and selling cost assumptions were based on observable and
      unobservable cost estimates obtained from a cross section of industry
      experts and market participants.




·
            For
      collateral consisting of partially complete or finished lots, development
      costs, operating and selling cost assumptions we made were based on
      observable and unobservable cost estimates obtained from a cross-section
      of industry experts and market
participants.




·
            For
      collateral whose development is complete or nearly complete and which is
      expected to be leased initially to allow for stabilization of market
      prices before being sold, we utilized operating revenue and costs for
      comparable projects using current operating data obtained by us. Based
      upon an assumed stabilization of applicable real estate markets, we
      utilized unit sales prices comparable to historical
    pricing.




·
            Based
      on the resulting net cash flows derived from the utilization of the above
      assumptions, we applied risk-adjusted annual discount rates, ranging from
      10.5% to 30% for December 31, 2009 and September 30, 2010, to the net cash
      flows, depending on the projected build-out term, the project type, the
      location and assumed project risk.




All of
our loans were subject to valuation by independent third-party valuation firms
and all of the valuation reports were delivered to us within 45 days of the
reporting period. For the quarters ended December 31, 2009 and September 30,
2010, in the event of a change in circumstances from the prior period valuation,
we updated our assessment of certain loans and obtained certain updated
valuations as a result of the change in circumstances. Additionally, we obtained
updated third-party offers and considered other changes to the status of
underlying collateral.




Selection
of Single Best Estimate of Value for Loans




As
previously described, we obtained valuation reports from third-party valuation
specialists for the underlying collateral of each of our loans in 2009 and all
such loans during the quarters ended June 30, 2010 and September 30, 2010.
Because all of our loans are collateral dependent, each loan’s impairment amount
is based on the fair value of its underlying collateral less cost to sell. The
valuation reports provided a range of values for the collateral valued rather
than a single point estimate because of variances in the potential value
indicated from the available sources of market participant information. The
selection of a value from within a range of values depends upon specific market
conditions for each property valued and its stage of entitlement or development.
In addition to third-party valuation reports, we utilized recently received bona
fide purchase offers from independent third-party market participants that were
higher than the high-end of the third-party specialist’s range of values. In
selecting the single best estimate of value, we considered the information in
the valuation reports, credible purchase offers received, as well as multiple
observable and unobservable inputs as described below.




26
 
  IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)
  NOTE 4 – MORTGAGE LOANS,
LOAN PARTICIPATIONS AND LOAN SALES – (continued)


December
31, 2009 Selection of Single Best Estimate





Our
December 31, 2009 valuation assessments were based on updated market participant
information and other data points, which in our judgment provided less
uncertainty than the market participant data that was available at December 31,
2008. The updated information and our analysis of the collateral indicated a
slight improvement in market conditions and corresponding increase in real
estate values. As a result, for the valuation ranges on 41 of the 55 loans
obtained as of December 31, 2009 supporting loan collateral values, we used the
high end of the third-party valuation range for each asset in determining
impairment losses. For the remaining 14 loans, our estimate of fair values were
based on independent third-party market participant purchase offers on those
specific assets, some of which
were well in excess of the fair values indicated in the third-party valuation
reports, including some offers which were two to three times higher than the
valuation report ranges. While consideration of the range of values was
evaluated on a loan-by-loan basis, as a general matter, we used the high end of
the value range, as described above, because, in our judgment, when considering
the multiple applicable observable and unobservable inputs and other current
market factors, the high end of the value range is the best estimate of fair
value, less costs to sell, for purposes of determining impairment losses, based
on the following factors:





·
            In
      conducting the December 31, 2009 valuations, the third-party valuation
      specialist’s data and the research performed in connection with valuations
      were influenced by market duress, economic uncertainty and a relative
      shortage of tangible market data. A number of the relevant transactions
      consummated around the time of preparation of the valuation reports were
      believed to be based on either a property or a seller in distress and,
      thus, the applicable transaction was executed under a condition of duress.
      We noted that the pricing of many actual transactions in what was observed
      to be a less than normal volume of purchases and sales frequently appeared
      to be lower than the expectations of many, if not most, owners of
      competitive properties. As a result, in our judgment, for each of our
      loans not supported by recent bona fide independent third-party purchase
      offers, we concluded that the values at the high end of the range were
      more representative of fair values than any other point in the
      range;





·
            We
      concluded that the third-party valuation specialist’s reported value
      ranges, and the underlying concepts of the ranges themselves, did not
      reflect the improving market conditions as of December 31, 2009, but
      because of the lag in the time frame for gathering and processing
      information, were more representative of early fourth-quarter 2009, if not
      before. We obtained observable and unobservable evidence (such as
      published residential pricing indices and other real estate market
      publications, discussions with real estate brokers with applicable market
      expertise in local markets, discussions with third-party consultants and
      direct market participants with relevant real estate experience) as of
      December 31, 2009 that indicated that fair values had “bottomed out”, and
      there was an indication that the home pricing trends were moving upward.
      Based on our experience, buyers will select parcels that offer the most
      competitive advantage and the highest and best use of their capital in
      order to complete their project and maximize their
  returns.





·
            Individual
      valuation reports were prepared assuming non-leveraged sales transactions
      of the underlying collateral in accordance with professional appraisal
      standards. Because our core business is that of a first lien real estate
      mortgage lender and dealer, we believe that our capacity to provide
      financing, particularly in the absence of available financing in existing
      credit markets, provides us a market advantage that would significantly
      increase the likelihood that qualified buyers would be willing to pay a
      price at the top of the applicable valuation range. We believe that this
      market advantage further supports our selection of the high end of the
      range when determining the single best estimate of value from within the
      range of values provided.




27




IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)




NOTE
4 – MORTGAGE LOANS, LOAN PARTICIPATIONS AND LOAN SALES –
(continued)




September
30, 2010 Selection of Single Best Estimate




In
determining the single best estimate of value for the September 30, 2010
valuation analysis, in our judgment, the updated market participant information
and other economic data points provided less certainty than the market
participant data that was available at December 31, 2009.




In
conducting the June 30, 2010 valuations, and re-confirmed through their updates
as of September 30, 2010, the third-party valuation specialist’s data and the
research performed were influenced by transactions which appeared to reflect
on-going pricing executed under conditions of duress and economic
uncertainty.  Nevertheless, the pricing in such transactions does not
appear to be improving in the short-term and therefore such pricing is
reflective of current market values by market participants.  The updated
information and our analysis of the collateral, indicated an on-going
deterioration in market conditions and corresponding decrease in real estate
values, contrary to such indications provided at December 31, 2009. Such
indicators were reflected in the third-party valuation reports obtained, several
of which resulted in significantly decreased values from the December 31, 2009
range of values provided. For the 43 loans subject to current valuation, the
primary collateral supporting 16 notes increased in value since the December 31,
2009 valuation, while 18 decreased in value and 9 remained unchanged. 
However, based on the midpoint of the valuation ranges, the average valuation
increase for the 16 loans was $819 while the average decrease in valuation on
the 18 loans was $1,264.




A summary
of selected real estate and general economy-related published market participant
observations which influenced management’s current assessment of market status
and trends follows:




·
            According
      to a Bloomberg news article in September 2010, US home builders’
      confidence fell to 13 in August 2010 and remained there in September 2010,
      the lowest level since March 2009. An index level of 50 indicates that
      home builders view sales conditions as equally good as
    poor.


·
            According
      to a Press TV news article in September 2010, the decline in builders’
      confidence is due to consumer reluctance, as unemployment hovers near the
      10-percent mark and the housing market remains glutted with the large
      number of foreclosed properties for
sale.


·
            According
      to an October 2010 Reuters news article, the International Monetary Fund
      (IMF) states that the US economy will have sluggish growth this year and
      in 2011 due to weak consumer spending rates and soaring debt. The IMF
      World Economic Outlook report stated that the growth rate in the American
      economy has slowed from 3.7% in the first quarter of the year to 1.7%,
      adding that the US economy will face a weak recovery in the coming
      months.


·
            The
      Reuters article also stated that the slower-than-predicted US economic
      growth dims any hopes for bringing down the very high unemployment rate
      anytime soon as well as causing a reduction in household wealth due to
      falling home prices.




According
to the press release regarding the Federal Reserve’s September 2010 meeting, the
pace of recovery in output and employment has slowed in recent months. 
Household spending remains constrained by high employment, modest income growth,
lower housing wealth and tight credit.  Additionally, investment in
nonresidential structures continues to be weak and housing starts are on a
depressed level as well as bank lending has continued to contract. The above
observable inputs combined with others and management’s specific knowledge
related to marketing activity surrounding the loan’s collateral have resulted in
the movement of collateral valuation expectations to the lower end of the
determinable range. As a result, in our judgment, for each of our loans not
supported by recent bona fide independent third-party purchase offers or those
assets which were supported by specific circumstances in using either the high
or low end value, management concluded that the values slightly above the low
end of the range (i.e., 25% of the valuation spread over the low end value) were
more representative of fair
values than any other point in the range. In management’s judgment, this point
in the value range was deemed to be the best estimate of fair value, less costs
to sell, for purposes of determining impairment losses as of September 30,
2010.




28
 
  IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)
  NOTE 4 – MORTGAGE LOANS,
LOAN PARTICIPATIONS AND LOAN SALES – (continued)


As such,
for the valuation ranges on the 43 loans obtained as of September 30, 2010
supporting loan collateral values, we used the high end of the third-party
valuation range for one asset and the mid-point value for another asset in
determining impairment losses based on the quality of the collateral and
financial strength of the related borrowers. We utilized the low end value for
15 assets whose geographic location, entitlement status, and long-term
development plan made such assets, in management’s opinion, less desirable and
marketable to market participants. Due to the uncertainty in market conditions
noted above, we selected a point midway between the low end value and mid-range
value for 24 of the loans. For the remaining 2 loans, our estimate of fair
values were based on independent third-party market participant purchase offers
on those specific assets, some of which were in the range of fair value
indicated in the third-party valuation reports and others which were in excess
of such amounts, including some offers which were two to three times higher than
the valuation report ranges. In the aggregate, management’s estimate of fair
value based on these bona fide offers exceeded the high end of the valuation
range by approximately $1,575.




Based on
the results of our evaluation and analysis, we recorded a provision for credit
losses of $34,380 for the nine months ended September 30, 2010, of which $27,550
were recorded during the quarter ended June 30, 2010 and $6,830 was recorded
during the quarter ended September 30, 2010. We recorded a provision for credit
losses of $82,000 for the nine months ended September 30, 2009, which was
adjusted downward by $2,701 in the fourth quarter of 2009.  During the nine
months ended September 30, 2010, we also recorded impairment charges of $13,221,
relating to the further write-down of certain real estate acquired through
foreclosure during the period. The impairment charge for assets acquired through
foreclosure relates to the impairment of REO assets deemed to be other than
temporary. The provision for credit losses and impairment charges are reflective
of the continued deterioration of the real estate markets and the sustained
decline in pricing of residential real estate in recent months combined with the
continuing downturn in the commercial real estate markets.





As of
September 30, 2010, the valuation allowance totaled $334,881 (all of which
related to mortgage loans held for sale), representing 68.2% of the total loan
principal balances. With the existing valuation allowance recorded as of June
30, 2010, we believe that as of that date, the fair value of the underlying
collateral of our loans is adequate in relation to the net carrying value of
loan principal and accrued interest and that no additional valuation allowance
is considered necessary.





While the
above results reflect management’s assessment of fair value as of December 31,
2009 and September 30,  2010 based on currently available data, we will
continue to evaluate our loans in the remaining quarter of 2010 and beyond to
determine the adequacy and appropriateness of the valuation allowance and to
update our loan-to-value ratios. Depending on market conditions, such updates
may yield materially different values and potentially increase or decrease the
valuation allowance.





29




IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)




NOTE 4 – MORTGAGE
LOANS, LOAN PARTICIPATIONS AND LOAN SALES – (continued)





A
roll-forward of the valuation allowance as of September 30, 2010 is as
follows:




September
      30,2010Balance
      at beginning of period
                        
                        $
                        330,428Provision
      for credit losses
                        
                        
                        34,380Net
      charge offs
                        
                        
                        (29,927
                        )Balance
      at end of period
                        
                        $
                        334,881




The
balance reflected in net charge offs pertains to the portion of the carrying
value charged off to the allowance for credit loss or valuation allowance when
transferred to real estate acquired through foreclosure on our consolidated
balance sheets.





Loan
charge offs generally occur under one of two scenarios, including (i) the
foreclosure of a loan and transfer of the related collateral to REO status, or
(ii) we elect to accept a loan payoff at less than the contractual amount due.
Under either scenario, the loan charge off is generally recorded through the
allowance for credit loss or valuation allowance.





A loan
charged off is recorded as a charge to the valuation allowance at the time of
foreclosure in connection with the recording of the transfer of the underlying
collateral to REO status. The amount of the loan charge off is equal to the
difference between the contractual amounts due under the loan and the fair value
of the collateral acquired through foreclosure, net of selling costs. Generally,
the loan charge off amount is equal to the loan’s allowance for credit loss or
valuation allowance. At the time of foreclosure, the contractual value less the
related allowance for credit loss or valuation allowance is compared with the
estimated fair value, less costs to sell, on the foreclosure date and the
difference, if any, is included in the provision for credit losses (recovery) in
the statement of operations. The allowance for credit loss or valuation
allowance is netted against the gross carrying value of the loan, and the net
balance is recorded as the new basis in the REO assets. Once in a REO status,
the asset is evaluated for impairment based on accounting criteria for
long-lived assets.





Valuation
Categories





Except
for mortgage loans which are measured at fair value on a non-recurring basis for
purposes of determining valuation with respect to our valuation allowance, none
of our other assets or liabilities is measured at fair value on a recurring or
non-recurring basis. The following table presents the categories for which net
mortgage loans are measured at fair value based upon the lowest level of
significant input to the valuations as of December 31, 2009 and September 30,
2010, respectively:




30




IMH
FINANCIAL CORPORATION


(formerly
known as IMH Secured Loan Fund, LLC)


NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS


September
30, 2010


(Unaudited)


(In
thousands except unit and share data)





NOTE
4 – MORTGAGE LOANS, LOAN PARTICIPATIONS AND LOAN SALES –
(continued)




December31,2009
                                            
                                            
                                            September30,2010Significant
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            SignificantOther
                                            
                                            
                                            Significant
                                            
                                            
                                            
                                            
                                            
                                            Other
                                            
                                            
                                            SignificantObservable
                                            
                                            
                                            Unobservable
                                            
                                            
                                            
                                            
                                            
                                            Observable
                                            
                                            
                                            UnobservableInputs
                                            
                                            
                                            Inputs
                                            
                                            
                                            
                                            
                                            
                                            Inputs
                                            
                                            
                                            InputsDescription:
                                            
                                            (Level2)
                                            
                                            
                                            (Level3)
                                            
                                            
                                            Total
                                            
                                            
                                            (Level2)
                                            
                                            
                                            (Level3)
                                            
                                            
                                            TotalNet
      Mortgage Loans:Pre-entitled
      Land:Held
      for Investment
                                            
                                            $
                                            -
                                            
                                            
                                            $
                                            4,211
                                            
                                            
                                            $
                                            4,211
                                            
                                            
                                            $
                                            -
                                            
                                            
                                            $
                                            1,931
                                            
                                            
                                            $
                                            1,931Processing
      Entitlements
                                            
                                            
                                            1,028
                                            
                                            
                                            
                                            49,838
                                            
                                            
                                            
                                            50,866
                                            
                                            
                                            $
                                            986
                                            
                                            
                                            
                                            28,053
                                            
                                            
                                            
                                            29,0391,028
                                            
                                            
                                            
                                            54,049
                                            
                                            
                                            
                                            55,077
                                            
                                            
                                            
                                            986
                                            
                                            
                                            
                                            29,984
                                            
                                            
                                            
                                            30,970Entitled
      Land:Held
      for Investment
                                            
                                            
                                            7,693
                                            
                                            
                                            
                                            13,499
                                            
                                            
                                            
                                            21,192
                                            
                                            
                                            
                                            155
                                            
                                            
                                            
                                            3,725
                                            
                                            
                                            
                                            3,880Infrastructure
      under Construction
                                            
                                            
                                            459
                                            
                                            
                                            
                                            29,939
                                            
                                            
                                            
                                            30,398
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            29,706
                                            
                                            
                                            
                                            29,706Improved
      and Held for Vertical Construction
                                            
                                            
                                            2,519
                                            
                                            
                                            
                                            16,012
                                            
                                            
                                            
                                            18,531
                                            
                                            
                                            
                                            476
                                            
                                            
                                            
                                            17,060
                                            
                                            
                                            
                                            17,53610,671
                                            
                                            
                                            
                                            59,450
                                            
                                            
                                            
                                            70,121
                                            
                                            
                                            
                                            631
                                            
                                            
                                            
                                            50,491
                                            
                                            
                                            
                                            51,122Construction
      & Existing Structures:New
      Structure - Construction in-process
                                            
                                            
                                            3,860
                                            
                                            
                                            
                                            12,359
                                            
                                            
                                            
                                            16,219
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            10,528
                                            
                                            
                                            
                                            10,528Existing
      Structure Held for Investment
                                            
                                            
                                            -
                                            
                                            
                                            
                                            16,570
                                            
                                            
                                            
                                            16,570
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            5,878
                                            
                                            
                                            
                                            5,878Existing
      Structure - Improvements
                                            
                                            
                                            -
                                            
                                            
                                            
                                            56,033
                                            
                                            
                                            
                                            56,033
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            57,503
                                            
                                            
                                            
                                            57,5033,860
                                            
                                            
                                            
                                            84,963
                                            
                                            
                                            
                                            88,822
                                            
                                            
                                            
                                            -
                                            
                                            
                                            
                                            73,909
                                            
                                            
                                            
                                            73,909Total
                                            
                                            $
                                            15,559
                                            
                                            
                                            $
                                            198,461
                                            
                                            
                                            $
                                            214,020
                                            
                                            
                                            $
                                            1,617
                                            
                                            
                                            $
                                            154,384
                                            
                                            
                                            $
                                            156,001




Note:
There are no mortgage loans that were measured at fair value using Level 1
inputs. Additionally, except for the offers received on specific properties from
third parties which we use to determine fair value, which are considered a Level
2 valuation, all other valuations are deemed to be Level 3.




The table
presented below summarizes the change in balance sheet carrying values
associated with the mortgage loans measured using significant unobservable
inputs (Level 3) during the nine months ended September 30, 2010:





MortgageLoans, netBalances,
      December 31, 2009
                  
                  $
                  198,461Mortgage
      Loan Fundings
                  
                  
                  12,148Mortgage
      Loan Repayments
                  
                  
                  (7,553
                  )Transfers
      to REO
                  
                  
                  (51,001
                  )Mortgage
      Repayment on whole loan soldTransfers
      into (out of) level 3
                  
                  
                  4,856Included
      in earnings:Provision
      for credit losses
                  
                  
                  (2,527
                  )Balances,
      September 30, 2010
                  
                  $
                  154,384





Loan
Classifications




We
classify loans into categories for purposes of identifying and managing loan
concentrations. As of December 31, 2009 and September 30, 2010, respectively,
loan principal balances by concentration category follows:




31


IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
4 – MORTGAGE LOANS, LOAN PARTICIPATIONS AND LOAN SALES –
(continued)




December
      31, 2009
                      
                      
                      September
      30, 2010Amount
                      
                      
                      %
                      
                      
                      #
                      
                      
                      Amount
                      
                      
                      %
                      
                      
                      #Pre-entitled
      Land:Held
      for Investment
                      
                      $
                      13,834
                      
                      
                      
                      2.5
                      %
                      
                      
                      3
                      
                      
                      $
                      18,303
                      
                      
                      
                      3.7
                      %
                      
                      
                      3Processing
      Entitlements
                      
                      
                      185,608
                      
                      
                      
                      34.1
                      %
                      
                      
                      8
                      
                      
                      
                      180,423
                      
                      
                      
                      36.7
                      %
                      
                      
                      7199,442
                      
                      
                      
                      36.6
                      %
                      
                      
                      11
                      
                      
                      
                      198,726
                      
                      
                      
                      40.4
                      %
                      
                      
                      10Entitled
      Land:Held
      for Investment
                      
                      
                      101,942
                      
                      
                      
                      18.8
                      %
                      
                      
                      14
                      
                      
                      
                      73,082
                      
                      
                      
                      14.9
                      %
                      
                      
                      11Infrastructure
      under Construction
                      
                      
                      69,839
                      
                      
                      
                      12.8
                      %
                      
                      
                      5
                      
                      
                      
                      57,062
                      
                      
                      
                      11.6
                      %
                      
                      
                      3Improved
      and Held for Vertical Construction
                      
                      
                      47,227
                      
                      
                      
                      8.7
                      %
                      
                      
                      4
                      
                      
                      
                      35,918
                      
                      
                      
                      7.3
                      %
                      
                      
                      2219,008
                      
                      
                      
                      40.3
                      %
                      
                      
                      23
                      
                      
                      
                      166,062
                      
                      
                      
                      33.8
                      %
                      
                      
                      16Construction
      & Existing Structures:New
      Structure - Construction in-process
                      
                      
                      46,325
                      
                      
                      
                      8.5
                      %
                      
                      
                      16
                      
                      
                      
                      51,801
                      
                      
                      
                      10.6
                      %
                      
                      
                      11Existing
      Structure Held for Investment
                      
                      
                      23,640
                      
                      
                      
                      4.3
                      %
                      
                      
                      4
                      
                      
                      
                      12,584
                      
                      
                      
                      2.6
                      %
                      
                      
                      4Existing
      Structure - Improvements
                      
                      
                      56,033
                      
                      
                      
                      10.3
                      %
                      
                      
                      1
                      
                      
                      
                      61,709
                      
                      
                      
                      12.6
                      %
                      
                      
                      2125,998
                      
                      
                      
                      23.1
                      %
                      
                      
                      21
                      
                      
                      
                      126,094
                      
                      
                      
                      25.8
                      %
                      
                      
                      17Total
                      
                      
                      544,448
                      
                      
                      
                      100.0
                      %
                      
                      
                      55
                      
                      
                      
                      490,882
                      
                      
                      
                      100.0
                      %
                      
                      
                      43Less:
      Allowance for Credit Loss / Valuation Allowance
                      
                      
                      (330,428
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (334,881
                      )Net
      Carrying Value
                      
                      $
                      214,020
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      156,001




We
classify loans into categories based on the underlying collateral’s projected
end-use for purposes of identifying and managing loan concentrations and
associated risks. As of December 31, 2009 and September 30, 2010, respectively,
outstanding principal loan balances by expected end-use of the underlying
collateral, were as follows:





December 31, 2009
                      
                      
                      September 30, 2010Amount
                      
                      
                      %
                      
                      
                      
                      #
                      
                      
                      Amount
                      
                      
                      %
                      
                      
                      
                      #Residential
                      
                      $
                      273,666
                      
                      
                      
                      50.2
                      %
                      
                      
                      35
                      
                      
                      $
                      264,632
                      
                      
                      
                      53.9
                      %
                      
                      
                      32Mixed
      Use
                      
                      
                      177,308
                      
                      
                      
                      32.6
                      %
                      
                      
                      7
                      
                      
                      
                      155,012
                      
                      
                      
                      31.6
                      %
                      
                      
                      4Commercial
                      
                      
                      92,404
                      
                      
                      
                      17.0
                      %
                      
                      
                      12
                      
                      
                      
                      70,168
                      
                      
                      
                      14.3
                      %
                      
                      
                      6Industrial
                      
                      
                      1,070
                      
                      
                      
                      0.2
                      %
                      
                      
                      1
                      
                      
                      
                      1,070
                      
                      
                      
                      0.2
                      %
                      
                      
                      1Total
                      
                      
                      544,448
                      
                      
                      
                      100.0
                      %
                      
                      
                      55
                      
                      
                      
                      490,882
                      
                      
                      
                      100.0
                      %
                      
                      
                      43Less:
      Allowance for Credit Loss / Valuation Allowance
                      
                      
                      (330,428
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (334,881
                      )Net
      Carrying Value
                      
                      $
                      214,020
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      156,001





We
estimate that, as of September 30, 2010, approximately 60% of the allowance for
credit loss is attributable to residential-related projects, 39% to mixed use
projects and the balance to commercial and industrial projects.At December
31, 2009, approximately 58% of the allowance for credit loss was attributable to
residential-related projects, 40% to mixed use projects and the balance to
commercial and industrial projects.





Geographic
Diversification





Our
mortgage loans consist of loans where the primary collateral is located in
various states. As of December 31, 2009 and September 30, 2010, respectively,
the geographical concentration of our principal loan balances by state, were as
follows:




32


IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
4 – MORTGAGE LOANS, LOAN PARTICIPATIONS AND LOAN SALES –
(continued)




December 31, 2009
                                  
                                  
                                  September 30, 2010Oustanding
                                  
                                  
                                  Allowance for
                                  
                                  
                                  Net Carrying
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  Oustanding
                                  
                                  
                                  Valuation
                                  
                                  
                                  Net CarryingPrincipal
                                  
                                  
                                  Credit Loss
                                  
                                  
                                  Amount
                                  
                                  
                                  Percent
                                  
                                  
                                  
                                  #
                                  
                                  
                                  Principal
                                  
                                  
                                  Allowance
                                  
                                  
                                  Amount
                                  
                                  
                                  Percent
                                  
                                  
                                  
                                  #Arizona
                                  
                                  $
                                  281,492
                                  
                                  
                                  $
                                  (162,639
                                  )
                                  
                                  $
                                  118,853
                                  
                                  
                                  
                                  55.5
                                  %
                                  
                                  
                                  26
                                  
                                  
                                  $
                                  251,287
                                  
                                  
                                  $
                                  (153,288
                                  )
                                  
                                  $
                                  97,999
                                  
                                  
                                  
                                  62.8
                                  %
                                  
                                  
                                  19California
                                  
                                  
                                  181,390
                                  
                                  
                                  
                                  (120,829
                                  )
                                  
                                  
                                  60,561
                                  
                                  
                                  
                                  28.3
                                  %
                                  
                                  
                                  20
                                  
                                  
                                  
                                  177,053
                                  
                                  
                                  
                                  (136,431
                                  )
                                  
                                  
                                  40,622
                                  
                                  
                                  
                                  26.0
                                  %
                                  
                                  
                                  19New
      Mexico
                                  
                                  
                                  5,241
                                  
                                  
                                  
                                  (1,094
                                  )
                                  
                                  
                                  4,147
                                  
                                  
                                  
                                  1.9
                                  %
                                  
                                  
                                  2
                                  
                                  
                                  
                                  5,260
                                  
                                  
                                  
                                  (1,985
                                  )
                                  
                                  
                                  3,275
                                  
                                  
                                  
                                  2.1
                                  %
                                  
                                  
                                  2Texas
                                  
                                  
                                  11,102
                                  
                                  
                                  
                                  (4,272
                                  )
                                  
                                  
                                  6,830
                                  
                                  
                                  
                                  3.2
                                  %
                                  
                                  
                                  3
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  0.0
                                  %
                                  
                                  
                                  0Idaho
                                  
                                  
                                  49,594
                                  
                                  
                                  
                                  (38,981
                                  )
                                  
                                  
                                  10,613
                                  
                                  
                                  
                                  5.0
                                  %
                                  
                                  
                                  2
                                  
                                  
                                  
                                  49,637
                                  
                                  
                                  
                                  (43,177
                                  )
                                  
                                  
                                  6,460
                                  
                                  
                                  
                                  4.2
                                  %
                                  
                                  
                                  2Nevada
                                  
                                  
                                  7,984
                                  
                                  
                                  
                                  (2,613
                                  )
                                  
                                  
                                  5,371
                                  
                                  
                                  
                                  2.5
                                  %
                                  
                                  
                                  1
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  0.0
                                  %
                                  
                                  
                                  0Utah
                                  
                                  
                                  7,645
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  7,645
                                  
                                  
                                  
                                  3.6
                                  %
                                  
                                  
                                  1
                                  
                                  
                                  
                                  7,645
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  7,645
                                  
                                  
                                  
                                  4.9
                                  %
                                  
                                  
                                  1Total
                                  
                                  $
                                  544,448
                                  
                                  
                                  $
                                  (330,428
                                  )
                                  
                                  $
                                  214,020
                                  
                                  
                                  
                                  100.0
                                  %
                                  
                                  
                                  55
                                  
                                  
                                  $
                                  490,882
                                  
                                  
                                  $
                                  (334,881
                                  )
                                  
                                  $
                                  156,001
                                  
                                  
                                  
                                  100.0
                                  %
                                  
                                  
                                  43




Borrower
and Borrower Group Concentrations




Our
investment policy provides that no single loan should exceed 10% of the total of
all outstanding loans and that aggregate loans outstanding to one borrower or
borrower group should not exceed 20% of the total of all outstanding loans.
Following the origination of a loan, however, a single loan or the aggregate
loans outstanding to a borrower or borrower group may exceed those thresholds as
a result of changes in the size and composition of our overall
portfolio.





As of
December 31, 2009 and September 30, 2010, there was one borrower whose
outstanding principal totaled $69,126 which was approximately 12.7% and 14.1%,
respectively, of our total mortgage loan principal balance outstanding and is
classified as pre-entitled land – processing entitlements. In addition, there
was one borrowing group whose aggregate outstanding principal aggregated
$99,423, representing approximately 18.0% and 20.3%, respectively, of our total
mortgage loan principal balance outstanding, which consisted of a $57,503 loan
classified as construction and existing structures – improvements and a $41,920
loan classified as entitled land – infrastructure under construction. Finally,
there was an additional borrowing group whose outstanding principal aggregated
$54,956, representing 10.1% and 11.2%, respectively, of our total mortgage loan
principal balance outstanding, which consisted of nine loans classified as
pre-entitled or entitled land. Each of these loans was in non-accrual status as
of December 31, 2009 and September 30, 2010 due to the shortfall in the combined
current fair value of the underlying collateral for such loans, and we
recognized no mortgage interest income for these loans during the nine months
ended September 30, 2010. However, three other loans from one borrower group,
one of which has been paid off and the other two have principal balances
totaling $1,173 at September 30, 2010, accounted for approximately 30.0% of
total mortgage loan income during the nine months ended September 30, 2010.
Additionally, three other loans with outstanding principal balances of $13,468
at September 30, 2010, accounted for approximately 49.2% of the total mortgage
income during the nine months ended September 30, 2010.  During the
year ended December 31, 2009, one loan accounted for 12.0% of total mortgage
loan income. This loan was foreclosed upon in July 2009.





Mortgage
Loans Held for Sale




At
December 31, 2009, we reflected three loans with carrying values totaling
$3,207, net of allowance for credit loss of $2,368, as held for sale. The sale
of the loans occurred during the nine months ended September 30, 2010 at their
approximate carrying values.  As of September 30, 2010, the entire
loan portfolio is reflected as held for sale in the accompanying consolidated
balance sheets.




33


IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
5 – REAL ESTATE HELD FOR DEVELOPMENT OR SALE




Real
estate owned assets consists of the following at December 31, 2009 and September
30, 2010, respectively,





December31, 2009
                                                    
                                                    
                                                    September30, 2010Held For Development
                                                    
                                                    
                                                    Held for Sale
                                                    
                                                    
                                                    Held For Development
                                                    
                                                    
                                                    Held for Sale# of
                                                    
                                                    
                                                    AggregateNet
                                                    
                                                    
                                                    # of
                                                    
                                                    
                                                    AggregateNet
                                                    
                                                    
                                                    # of
                                                    
                                                    
                                                    AggregateNet
                                                    
                                                    
                                                    # of
                                                    
                                                    
                                                    AggregateNetState
                                                    
                                                    Projects
                                                    
                                                    
                                                    Carrying Value
                                                    
                                                    
                                                    Projects
                                                    
                                                    
                                                    Carrying Value
                                                    
                                                    
                                                    Projects
                                                    
                                                    
                                                    Carrying Value
                                                    
                                                    
                                                    Projects
                                                    
                                                    
                                                    Carrying ValueCalifornia
                                                    
                                                    
                                                    3
                                                    
                                                    
                                                    $
                                                    9,644
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    $
                                                    -
                                                    
                                                    
                                                    
                                                    1
                                                    
                                                    
                                                    $
                                                    4,810
                                                    
                                                    
                                                    
                                                    2
                                                    
                                                    
                                                    $
                                                    1,661Texas
                                                    
                                                    
                                                    3
                                                    
                                                    
                                                    
                                                    39,326
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    2
                                                    
                                                    
                                                    
                                                    28,557
                                                    
                                                    
                                                    
                                                    4
                                                    
                                                    
                                                    
                                                    11,832Arizona
                                                    
                                                    
                                                    6
                                                    
                                                    
                                                    
                                                    31,485
                                                    
                                                    
                                                    
                                                    4
                                                    
                                                    
                                                    
                                                    12,082
                                                    
                                                    
                                                    
                                                    7
                                                    
                                                    
                                                    
                                                    26,178
                                                    
                                                    
                                                    
                                                    15
                                                    
                                                    
                                                    
                                                    18,136Minnesota
                                                    
                                                    
                                                    1
                                                    
                                                    
                                                    
                                                    11,694
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    2
                                                    
                                                    
                                                    
                                                    11,713
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -Nevada
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    -
                                                    
                                                    
                                                    
                                                    1
                                                    
                                                    
                                                    
                                                    6,419Total
                                                    
                                                    
                                                    13
                                                    
                                                    
                                                    $
                                                    92,149
                                                    
                                                    
                                                    
                                                    4
                                                    
                                                    
                                                    $
                                                    12,082
                                                    
                                                    
                                                    
                                                    12
                                                    
                                                    
                                                    $
                                                    71,258
                                                    
                                                    
                                                    
                                                    22
                                                    
                                                    
                                                    $
                                                    38,048





REO
assets are reported as either held for development or held for sale, depending
on whether we plan to develop such assets prior to selling them or instead sell
them immediately. At December 31, 2009, we held total REO assets of $104,231, of
which $92,149 was held for development and $12,082 was held for sale. During
2009, we sold various individual residential units held in our real estate
portfolio for approximately $1,083 which approximated the carrying value of such
assets. At September 30, 2010, we held total REO assets of $109,306 of which
$71,258 was held for development and $38,048 was held for sale. During the nine
months ended September 30, 2010, we foreclosed on ten loans and took title to
the underlying collateral with net carrying values totaling $25,379 as of
September 30, 2010. We also acquired an additional lot held for sale in
connection with the acquisition of the Manager with a fair value of
$39.





Costs
related to the development or improvements of the REO assets are generally
capitalized and costs relating to holding the assets are generally charged to
expense. Cash outlays for capitalized development costs totaled $2,356 and $694
during the nine months ended September 30, 2009 and 2010, respectively. In
addition, costs and expenses related to operating, holding and maintaining such
properties, which were expensed and included in operating expenses for real
estate owned assets in the accompanying consolidated statement of operations,
totaled approximately $2,534 and $4,072 for the nine months ended September 30,
2009 and 2010, respectively, and $1,194 and $1,523 for the three months ended
September 30, 2009 and 2010, respectively. During the nine months ended
September 30, 2010, we sold certain REO assets for $6,810 resulting in a net
loss on disposal of real estate of $1,204 (offset by a gain of $92 on the sale
of a whole loan). The nature and extent of future costs for such properties
depends on the level of development undertaken, the number of additional
foreclosures and other factors. While our assets are generally available for
sale, we continue to evaluate various alternatives for the ultimate disposition
of these investments, including partial or complete development of the
properties prior to sale or disposal of the properties on an as-is basis. As of
September 30, 2010, approximately 41% of our REO assets were originally
projected for development of residential real estate, 21% was scheduled for
mixed used real estate development and 38% was planned for commercial use. We
are currently evaluating our use and disposition options with respect to these
projects. The real estate held for sale consists of improved residential lots,
completed residential units and medical facilities located in Arizona and
Texas.




34




IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
5 – REAL ESTATE HELD FOR DEVELOPMENT OR SALE – (continued)




Real
Estate Owned Asset Valuation
  Valuation
of REO assets is based on our intent and ability to execute our disposition plan
for each asset and the proceeds to be derived from such disposition, net of
selling costs, in relation to the carrying value of such assets. REO assets that
are classified as held for sale are measured at the lower of carrying amount or
fair value, less cost tosell. REO assets that are classified as held for
development are considered “held and used” and are evaluated for impairment
when, based on various criteria set forth in applicable accounting guidance,
circumstances indicate that the carrying amount exceeds the sum of the
undiscounted net cash flows expected to result from the development and eventual
disposition of the asset.  If an asset is considered impaired, an
impairment loss is recognized for the difference between the asset’s carrying
amount and its fair value, less cost to sell.  See Note 5 of our
audited financial statements in our previously filed Annual Report on Form
10-K/A for the year ended December 31, 2009 for a detailed description of the
summary of the procedures performed and assumptions utilized in connection with
our impairment analysis of real estate owned assets as of and for the year ended
December 31, 2009.  If we elect to change the disposition strategy for
our real estate held for development, and such assets were deemed to be held for
sale, we would likely record additional impairment charges, and the amounts
could be significant. During the year ended December 31, 2009, we recorded
impairment charges of $8,000 relating to the impairment in value of REO assets,
deemed to be other than temporary impairment. The results of our December 31,
2009 valuation procedures were re-assessed in the first three quarters of 2010
to determine whether any additional impairment was warranted for the nine months
ended September 30, 2010. As a result of our analysis, we recorded additional
impairment charges totaling $13,221 during the nine months ended September 30,
2010. The impairment charge was primarily a result of a change in management’s
disposition strategy for selected REO assets from a development approach to a
disposal based on recent values. As of December 31, 2009, 48% of real estate
owned assets were valued on an “as is” basis while 52% were valued on an “as
developed” basis. As of September 30, 2010, 64% of real estate owned assets
were valued on an “as is” basis while 36% were valued on an “as developed”
basis.





NOTE
6 – MANAGEMENT FEES AND RELATED PARTY ACTIVITY




Management
Fees and Other Amounts Due to the Manager




Prior to
the consummation of the Conversion Transactions on June 18, 2010, the Manager
was entitled to a 25 basis point annualized fee, payable monthly, for managing
the Fund, based on our total mortgage loan principal balance at each month-end,
excluding loans in non-accrual status and other non-performing assets. 
With the acquisition of the Manager, this arrangement has been terminated as of
June 18, 2010.  For the nine months ended September 30, 2009 and 2010,
management fees totaled approximately $481 and $109, respectively. Management
fees incurred for the three months ended September 30, 2009 and 2010 totaled
approximately $62 and $0, respectively. As of December 31, 2009, the
Manager was owed $114 for unpaid management fees. There was no management fees
payable as of September 30, 2010. In addition, the Manager was entitled to 25%
of any amounts recognized in excess of the our principal and note rate interest
due in connection with loans held in whole or in part by us.  The Manager
earned no such fees in connection with this provision during the nine or three
months ended September 30, 2009 or 2010.




In
connection with various loan modifications, the Manager agreed to defer the
collection of the related loan fees and collect such fees as needed. 
Processing and administrative fees included in Payables to Fund Manager on the
accompanying consolidated balance sheet totaled $3,191 at December 31, 2009.
There was no such amount payable at September 30, 2010.




Advances
to Manager




At
December 31, 2009, the outstanding balance of advances to the Manager of the
Fund totaled $1,367.  Advances to the Manager of the Fund bear
interest at 10% per annum and all unpaid accrued interest and principal was due
September 30, 2011.  Interest earned on advances to the Manager of the Fund
totaled $117 and $39 for the nine months ended September 30, 2009 and 2010,
respectively.  Upon acquisition of the Manager, these amounts were
eliminated in consolidation.




35


IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
6 – MANAGEMENT FEES AND RELATED PARTY ACTIVITY - continued




Loan
Origination, Processing and Modification Revenues Earned




Prior to
the consummation of the Conversion Transactions, the Manager received all the
revenue from loan origination and processing fees (points) and other related
fees for loans originated on behalf of the Fund, which were paid by the borrower
and are not reflected in the accompanying financial statements. See Note 1 for
further discussion. During the nine months ended September 30, 2009 and the
period ended June 18, 2010, the Manager earned origination, processing and other
related fees of approximately $9,356 and $23, respectively. These amounts
include fees earned from the expiration of refundable loan fees previously
collected, which were refundable to the borrower in the event of loan payoff by
a specified date.  With the acquisition of the Manager, we are now
entitled to all such fees. We earned no fees for the period from acquisition to
September 30, 2010.




Related
Party Investments and Borrowings




At
December 31, 2009, the Manager maintained a line of credit with a bank with a
total borrowing capacity of $1,608 which expired on May 31, 2010 and was repaid
in the second quarter of 2010.  Accordingly, we no longer have access to
additional liquidity under this line of credit.  The line of credit bore
annual interest at the Prime Rate plus 1.5% (4.75% at September 30, 2010). 
The line of credit was collateralized by specific loans held by us and
underlying deeds of trust and a guarantee of the Manager’s Chief Executive
Officer.  There is no outstanding balance under this arrangement at
September 30, 2010.




NOTE
7 – NOTES PAYABLE




We
entered into a settlement agreement with respect to certain litigation involving
the responsibility and ownership of certain golf club memberships attributable
to certain property acquired through foreclosure. Under the terms of the
settlement agreement, we agreed to execute two promissory notes for the golf
club memberships totaling $5,310. The notes are secured by the security interest
on the related lots, are non-interest bearing and mature on December 31, 2012.
Due to the non-interest bearing nature of the loans, in accordance with
applicable accounting guidance, we imputed interest on the notes at our
incremental borrowing rate of 12% per annum and recorded the notes net of the
discount of $1,128, or $4,182, as of December 31, 2009. The discount is being
amortized to interest expense over the term of the notes and totaled $392 and
$135, respectively, for the nine and three months ended September 30, 2010,
resulting in an unamortized discount of $736 as of September 30, 2010.  The
net principal balance of the notes payable at September 30, 2010 was
$4,574.




During
the nine months ended September 30, 2010, we secured financing from a bank in
the amount of $9,500 for the purpose of funding anticipated development costs
for REO assets and working capital needs. The note payable, which has an
outstanding balance of $7,500 at September 30, 2010, bears interest at 12% per
annum and requires monthly payments of interest only. During the nine months
ended September 30, 2010, we incurred interest expense of $802 under this
loan. The loan has an initial maturity of March 2011 but may be extended
for two additional six-month periods. The loan is secured by one of our REO
assets with a carrying value at September 30, 2010 of $22,231 and an assignment
of rents and tenant notes receivable of $2,000 derived from the property. We
have also provided a guarantee for such debt.




During
the nine months ended September 30, 2010, we secured financing from a bank in
the amount of $3,600 for the purpose of funding a remaining loan obligation and
anticipated development costs for real REO assets. The note payable, which has
an outstanding balance of $2,073 as of September 30, 2010, bears interest at 12%
per annum, requires monthly payments of interest only, and matures in February
2012. During the nine months ended September 30, 2010, we incurred interest
expense of $83 regarding this loan.  The loan is secured by one of our REO
assets with a carrying value at September 30, 2010 of $3,380 and a Company loan
with a current carrying value of $4,206.




36


IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)
  NOTE
7 – NOTES PAYABLE - continued
  Also
during the quarter ended September 30, 2010, we secured a line of credit from a
bank in the amount of $3,000 for the primary purpose of funding certain
obligations resulting from the Conversion Transactions. The line of credit,
which has an outstanding balance of $2,500 as of September 30, 2010, has an
interest rate of 4.25% per annum, requires monthly interest payments and had a
maturity date of October 5, 2010.  The maturity date under the line of
credit was extended to January 5, 2011. During the nine months ended September
30, 2010, we incurred interest expense of $27 regarding this line of
credit.
  In
connection with the acquisition of the Manager, we assumed a note payable with
an original balance of $450 that is being paid on a monthly basis over 48
months, commencing June 1, 2009, with interest at 8%.  This note was
made in connection with a settlement on a previous lease obligation and has been
personally guaranteed by the CEO.  As of September 30, 2010, the
remaining obligation on the commitment is $316.
  In
connection with the acquisition of Holdings, we assumed two notes payable with a
total balance of $100.  The notes bear interest at 15% per annum
payable monthly and were set to mature December 31, 2013.  The notes
were paid in full on July 1, 2010.


NOTE
8 – PROPERTY AND EQUIPMENT




In
connection with the acquisition of the Manager, we acquired certain property and
equipment, which consisted of the following at September 30, 2010:




September
      30,2010Furniture
      and equipment
                  
                  $
                  1,233Computer
      and communications equipment
                  
                  
                  1,144Leasehold
      improvements
                  
                  
                  644Automobile
      and other
                  
                  
                  60Total
                  
                  
                  3,081Less
      accumulated depreciation and amortization
                  
                  
                  (1,489
                  )Property
      and equipment, net of accumulated depreciation and
      amoritzation
                  
                  $
                  1,592





Depreciation
and amortization expense on property and equipment was $149 for the period from
acquisition, June 18, 2010 through September 30, 2010.  Additionally,
included in real estate held for development are certain assets previously held
for sale with carrying values totaling $22,231. Depreciation expense taken for
this property totaled $863 for the nine months ended September 30,
2010.  We have elected to retain these assets in our ongoing business
operation and re-commenced depreciating these assets during the quarter ended
September 30, 2010.




NOTE
9 – LEASE COMMITMENTS




We lease
28,238 square feet of office space in Scottsdale, Arizona.  The lease
expires on June 19, 2017. The lease payments include the use of all of the
tenant improvements and various computer related equipment. Rent expense was
$217 for the period from acquisition, June 18, 2010 through September 30, 2010,
and is included in operating expenses in the accompanying consolidated statement
of earnings.  We are currently paying 50% of the monthly rental. Rents
currently due and payable to the lessor totaled $260 as of September 30, 2010
and are included in accounts payable and accrued expenses in the accompanying
consolidated balance sheets.




37




IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
9 – LEASE COMMITMENTS - continued




As of
September 30, 2010, future minimum lease payments under the lease agreement are
as follows:




Years ended
                        
                        Amount2010
                        
                        $
                        4442011
                        
                        
                        7342012
                        
                        
                        7342013
                        
                        
                        7412014
                        
                        
                        762Therefter
                        
                        
                        1,874Total
                        
                        $
                        5,289





NOTE
10 — INCOME TAXES




The
consolidated statements of operations for the nine months ended September 30,
2010 reflect income taxes for the period from the recapitalization of the Fund
and acquisition of the Manager on June 18, 2010 through September 30, 2010.
During the nine months ended September 30, 2010, the current and deferred tax
provision for federal and state taxes was zero.




The
difference between the provision for income taxes in the consolidated statements
of operations and the amounts computed by applying the current federal statutory
income tax rate of 35% to income before income taxes is reconciled as
follows:




Amount
                                              
                                              
                                              %Computed
      Tax Benefit at Federal Statutory Rate of 35%
                                              
                                              
                                              (22,947
                                              )
                                              
                                              
                                              -35.0
                                              %Permanent
      Differences:State
      Taxes, Net of Federal Benefit
                                              
                                              
                                              (2,333
                                              )
                                              
                                              
                                              -3.6
                                              %Pre
      C-Corp Loss
                                              
                                              
                                              17,413
                                              
                                              
                                              
                                              26.6
                                              %Change
      of Entity Tax Status
                                              
                                              
                                              (106,779
                                              )
                                              
                                              
                                              (162.9
                                              )%Change
      in Valuation Allowance
                                              
                                              
                                              112,476
                                              
                                              
                                              
                                              171.6
                                              %Non-deductible
      Offering Costs
                                              
                                              
                                              2,170
                                              
                                              
                                              
                                              3.3
                                              %Provision
      (Benefit) for Income Taxes
                                              
                                              
                                              -
                                              
                                              
                                              
                                              0.0
                                              %







38


IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
10 — INCOME TAXES - continued




The
significant components of deferred tax assets and liabilities in the
consolidated balance sheet as of September 30, 2010, are as follows (in
thousands):




Current Deferred Tax AssetsAllowance
      for Credit Loss
                                
                                $
                                94,035Accrued
      Interest
                                
                                
                                3,086Total
      Current Deferred Tax Assets Before Valuation Allowance
                                
                                
                                97,121Valuation
      Allowance
                                
                                
                                (97,121
                                )Net
      Current Deferred Tax Assets
                                
                                
                                -Non-Current Deferred Tax
    AssetsReal
      Estate Owned
                                
                                
                                7,164Loss
      Carryforwards
                                
                                
                                8,191Total
      Non-Current Deferred Tax Assets Before Valuation Allowance
                                
                                
                                15,355Valuation
      Allowance
                                
                                
                                (15,355
                                )Net
      Non-Current Deferred Tax Assets
                                
                                
                                -Total
      Deferred Tax Assets Net of Valuation Allowance
                                
                                $
                                -




Upon the
execution of the Conversion Transactions (recapitalization of the Fund), we are
a corporation and subject to Federal and state income tax. Under GAAP, a change
in tax status from a non-taxable entity to a taxable entity requires recording
deferred taxes as of the date of change in tax status. For tax purposes, the
Conversion Transactions were a contribution of assets at historical tax basis
for holders of the Fund that are subject to federal income tax and at fair
market value for holders that are not subject to federal income
tax.




The
temporary differences that give rise to deferred tax assets and liabilities upon
recapitalization of the Company are primarily related to the allowance for
credit losses, valuation allowance for loans held for sale and impairment of REO
assets which are recorded on our books but deferred for tax
purposes.




We
evaluated the deferred tax asset to determine if it was more likely than not
that it would be realized and concluded that a valuation allowance was required
for the net deferred tax assets.  In making the determination of the
amount of valuation allowance, we evaluated both positive and negative evidence
including recent historical financial performance, forecasts of future income,
tax planning strategies and assessments of the current and future economic and
business conditions.




In the
event of a change in control, under Internal Revenue Code Section 382, the
utilization of our existing net operating loss carryforwards and built in losses
may be subject to limitation.





39


IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)




NOTE
11 — STOCKHOLDERS’ EQUITY AND EARNINGS PER SHARE
  Our
capital structure consisted of the following at September 30, 2010:


Conversion TransactionsConversion of
                  
                  
                  Acquisition of
                  
                  
                  Total Issued andAuthorized
                  
                  
                  Fund
                  
                  
                  Manager
                  
                  
                  OutstandingCommon
      StockCommon
      Stock
                  
                  
                  150,208,500Class
      B Common Stock:Class
      B-1
                  
                  
                  4,023,400
                  
                  
                  
                  3,811,342
                  
                  
                  
                  -
                  
                  
                  
                  3,811,342Class
      B-2
                  
                  
                  4,023,400
                  
                  
                  
                  3,811,342
                  
                  
                  
                  -
                  
                  
                  
                  3,811,342Class
      B-3
                  
                  
                  8,165,700
                  
                  
                  
                  7,632,355
                  
                  
                  
                  88,700
                  
                  
                  
                  7,721,055Class
      B-4
                  
                  
                  781,644
                  
                  
                  
                  -
                  
                  
                  
                  627,579
                  
                  
                  
                  627,579Total
      Class B Common Stock
                  
                  
                  16,994,144
                  
                  
                  
                  15,255,039
                  
                  
                  
                  716,279
                  
                  
                  
                  15,971,318Class
      C Common Stock
                  
                  
                  15,803,212
                  
                  
                  
                  838,448
                  
                  
                  
                  -
                  
                  
                  
                  838,448Class
      D Common Stock
                  
                  
                  16,994,144
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Total
      Common Stock
                  
                  
                  200,000,000
                  
                  
                  
                  16,093,487
                  
                  
                  
                  716,279
                  
                  
                  
                  16,809,766Preferred
      Stock
                  
                  
                  100,000,000
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Total
                  
                  
                  300,000,000
                  
                  
                  
                  16,093,487
                  
                  
                  
                  716,279
                  
                  
                  
                  16,809,766




Common
Stock - Common Stock represents unrestricted, fully tradable, voting common
stock. Upon liquidation, our assets are distributed on a pro rata basis, after
payment in full of any liabilities and amounts due to preferred
stockholders.




Holders
of Class B, C, and D Common Stock generally have the same relative powers and
preferences as the common stockholder’s, except for certain transfer
restrictions, as follows:




Class B Common Stock - The
Class B common stock, which was issued in exchange for membership units of the
Fund, the stock of the Manager or membership units of Holdings, is held by a
custodian and divided into four separate series of Class B common stock. The
Class B-1, B-2 and B-3 common stock are not eligible for conversion into common
stock until, and subject to transfer restrictions that lapse upon, predetermined
intervals of six, nine or 12 months following the earlier of (1) consummation of
an initial public offering or (2) the 90th day following notice given by the
Board of Directors not to pursue an initial public offering, in the case of each
of the Class B-1, Class B-2 and Class B-3 common stock, respectively. If, at any
time after the five-month anniversary of the consummation of an initial public
offering, the closing price of IMH Financial Corporation’s common stock price is
greater than or equal to 125% of the offering price in an initial public
offering for 20 consecutive trading days, all shares of Class B-1, Class B-2 and
Class B-3 common stock will be convertible into shares of IMH Financial
Corporation common stock that will not be subject to restrictions on transfer
under the certificate of incorporation of IMH Financial Corporation. Each share
of Class B-4 common stock shall be convertible to one share of Common Stock upon
the four-year anniversary of the consummation of the Conversion Transactions.
The transfer restrictions will terminate earlier if (1) any time after five
months from the first day of trading on a national securities exchange, either
the market capitalization (based on the closing price of IMH Financial
Corporation common stock) or the book value of IMH Financial Corporation will
have exceeded $730,383 (subject to upward adjustment by the amount of any net
proceeds from new capital raised in an initial public offering or otherwise, and
to downward adjustment by the amount of any dividends or distributions paid on
membership units of the Fund or IMH Financial Corporation securities before or
after the Conversion Transactions), or (2) after entering into an employment
agreement approved by the compensation committee of IMH Financial Corporation,
the holder of Class B common stock is terminated without cause, as this term
will be defined in their employment agreements as approved by the compensation
committee of IMH Financial Corporation. In addition, unless IMH Financial
Corporation has both (i) raised an aggregate of at least $50,000 in one or more
transactions through the issuance of new equity securities, new indebtedness
with a maturity of no less than one year, or any combination thereof, and (ii)
completed a listing on a national securities exchange, then, in the event of a
liquidation of IMH Financial Corporation, no portion of the proceeds
from the liquidation will be payable to the shares of Class B-4 common stock
until such proceeds exceed $730,383. All shares of Class B common stock
automatically convert into Common Stock upon consummation of a change of control
as defined in the certificate of
incorporation.




40


IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
11 — STOCKHOLDERS’ EQUITY AND EARNINGS PER SHARE – (continued)




Class C
Common Stock – There is one series of Class C common stock which is also held by
the custodian and will either be redeemed for cash or converted into shares of
Class B common stock. Following the consummation of an initial public offering,
we intend, in our sole discretion, to use up to 30% of the net proceeds from the
offering (up to an aggregate of $50,000) to effect a pro rata redemption of
Class C common stock (based upon the number of shares of Class C common stock
held by each stockholder) at the initial public offering price, less selling
commissions and discounts paid or allowed to the underwriters in the initial
public offering. It is expected that the amount the electing stockholders of
Class C common stock will receive per share will be less than the amount of
their original investment in the Fund per unit and less than the current net
asset value of the Fund per unit held by such stockholders. Any shares of Class
C common stock that are not so redeemed will automatically convert into shares
of Class B common stock as follows: 25% of the outstanding shares of Class C
common stock will convert into shares of Class B-1 common stock, 25% will
convert into shares of Class B-2 common stock and 50% will convert into shares
of Class B-3 common stock.




Class D
Common Stock – If any holder of Class B common stock submits a notice of
conversion to the custodian, but represents to the custodian that the holder has
not complied with the applicable transfer restrictions, all shares of Class B
common stock held by the holder will be automatically converted into Class D
common stock and will not be entitled to the Special Dividend and will not be
convertible into common stock until the 12-month anniversary of an IPO and,
then, only if the holder submits a representation to the custodian that the
applicable holder has complied with the applicable transfer restrictions in the
90 days prior to such representation and is not currently in
violation.  If any shares of Class B common stock owned by a
particular holder are automatically converted into shares of Class D common
stock, as discussed above, then each share of Class C common stock owned by the
holder will convert into one share of Class D common stock.




Preferred
Stock –  To the fullest extent permitted under Delaware law, our board
of directors is authorized by resolution to divide and issue shares of preferred
stock in series and to fix the voting powers and any designations, preferences,
and relative, participating, optional or other special rights of any series of
preferred stock and any qualifications, limitations or restrictions of the
series as are stated and expressed in the resolution or resolutions providing
for the issue of the stock adopted by the board of directors.




Subject
to prevailing market conditions and regulatory approvals, we intend to conduct
an IPO of our Common Stock and we contemplate that the shares of the Common
Stock of IMH Financial Corporation will become publicly traded on the NYSE. We
do not plan to list the shares of the Class B, Class C or Class D common stock
on any securities exchange or include the shares of Class B, Class C or Class D
common stock in any automated quotation system, and no trading market for the
shares of such classes of common stock is expected to develop.




In
connection with the Conversion Transactions, each membership unit held in the
Fund was exchanged, at the member’s election, for 220.3419 shares of Class B
common stock or 220.3419 shares of Class C common stock of IMH Financial
Corporation, or some combination thereof. The number of shares issued was
computed as follows:




Units
      outstanding as of June 18, 2010 (rounded)
                    
                    
                    73,038Conversion
      Factor
                    
                    
                    220.3419Shares
      issued to Members in Conversion Transactions
                    
                    
                    16,093,487





41


IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
11 — STOCKHOLDERS’ EQUITY AND EARNINGS PER SHARE – (continued)




In
addition, the Conversion Transactions included the acquisition by IMH Financial
Corporation of all of the outstanding equity interests in the Manager and
Holdings (including shares issuable to participant’s in the Manager’s stock
appreciation rights plan), in exchange for an aggregate of 895,750 shares of
Class B-3 and B-4 common stock in IMH Financial Corporation, thereby making the
Manager and Holdings wholly-owned subsidiaries of IMH Financial Corporation.
This includes 781,643 shares issuable to Shane Albers and William Meris in
exchange for their equity interests in the Manager and Holdings of a separate
series of Class B shares called Class B-4 common stock which is subject to
transfer restrictions for a four-year period following the consummation of the
Conversion Transactions, subject to release in certain circumstances. Moreover,
holders of stock appreciation right units in the Manager had their stock
appreciation right units cancelled in exchange for a portion of the 895,750
Class B shares being issued to or on behalf of the stockholders of the Manager
and the members of Holdings in the Conversion Transactions. The number of Class
B shares otherwise issuable to stock appreciation right recipients was reduced
in lieu of payment by each stock appreciation right recipient of applicable cash
withholding tax. The aggregate number of shares issuable to the owners of the
Manager and Holdings was reduced by one share for each $20 of the net loss
incurred by the Manager and Holdings through the closing date of June 18,
2010.  Based on a net loss of $3,531, the shares issued to the owners
of the Manager and Holdings were reduced, on a pro rata basis by 176,554 shares.
After the reduction for net loss, shares of Class B-4 common stock issued to the
owners of the Manager and Holdings were 627,579.




Earnings
per share




Earnings
per share (EPS) is computed in accordance with applicable accounting
guidance.  Shares of Common Stock, Class B Common Stock, Class C
Common Stock and Class D Common Stock share proportionately in our earnings and
losses. Earnings (loss) per share are calculated utilizing net earnings (loss)
divided by the weighted average number of shares of Common Stock, Class B Common
Stock, Class C Common Stock and Class D Common Stock outstanding. Pro forma
weighted average common shares for the three and nine months ended September 30,
2010 were computed by multiplying the actual weighted average member units
outstanding for the respective period by the conversion factor.




Nine
      months ended September 30,
                      
                      
                      Three
      months ended September 30,2009
                      
                      
                      2010
                      
                      
                      2009
                      
                      
                      2010Net
      Loss
                      
                      $
                      (75,174
                      )
                      
                      $
                      (65,564
                      )
                      
                      $
                      (89,391
                      )
                      
                      $
                      (20,518
                      )Weighted
      Average Units Outstanding (rounded)
                      
                      
                      73,038
                      
                      
                      
                      73,038
                      
                      
                      
                      73,038
                      
                      
                      
                      73,038Conversion
      Factor
                      
                      
                      220.3419
                      
                      
                      
                      220.3419
                      
                      
                      
                      220.3419
                      
                      
                      
                      220.3419Proforma
      Weighted Average Common Shares Outstanding
                      
                      
                      16,093,487
                      
                      
                      
                      16,093,487
                      
                      
                      
                      16,093,487
                      
                      
                      
                      16,093,487Add:
      Weighted Average Common Shares for purchase of Manager
                      
                      
                      -
                      
                      
                      
                      272,868
                      
                      
                      
                      -
                      
                      
                      
                      716,279Proforma
      Weighted Average Common Shares Outstanding
                      
                      
                      16,093,487
                      
                      
                      
                      16,366,355
                      
                      
                      
                      16,093,487
                      
                      
                      
                      16,809,766Proforma
      Net Loss per Share
                      
                      $
                      (4.67
                      )
                      
                      $
                      (4.01
                      )
                      
                      $
                      (5.55
                      )
                      
                      $
                      (1.22
                      )








42


IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)





NOTE
12 – COMMITMENTS AND CONTINGENCIES




In
connection with the acquisition of the Manager, we are subject to a contingent
liability which exists with respect to potential payment of previously earned
commissions to certain broker-dealers.  Member units of the Fund were
offered through certain employees of the Manager and through a network of
licensed broker-dealers and their respective registered representatives. Any
sales commissions or other forms of remuneration paid to broker-dealers or their
respective registered representatives in connection with the sale of units were
paid by the Manager. Generally, broker-dealer selling agreements provide for a
2% selling commission and a 25 to 50 basis point trailingcommission,
which is an annual commission paid on the balance of units sold by a
broker-dealer or its registered representatives that are outstanding at each
anniversary of the initial issuance of the units. Such costs were expensed as
period costs in the Manager’s statement of operations.  While new member
investments in the Fund were suspended in October 2008, the trail commission
payable to brokers for Fund member capital that remained in the Fund was to
continue until the Fund was terminated.  Effective August 1, 2009, the
agreement with most broker-dealers was amended such that the broker-dealers
agreed to forgo the “trail” commission and would receive in its place 50% of the
amount paid to the Manager for the Manager’s 25% share of any Fund late fees,
penalties and any net proceeds from the sale of a foreclosed asset, after
payment to the Fund of its original principal and accrued interest due in
connection with the loan associated with the foreclosed asset. It is uncertain
what, if any, obligations we have under these agreements.  Due to the
significant devaluation of such assets, the likelihood of any liability is
generally considered remote.  Nevertheless, during the quarter ended
September 30, 2010, we realized a gain in the amount of $183 from the payoff of
a certain loan during the period, of which 25%, or $46, would have been
allocable to the Manager.  Based on this, we accrued a liability to
the broker-dealers under this arrangement of $23 during the nine months ended
September 30, 2010.  While we believe that the likelihood of further
liability is generally considered remote, such amounts may be due in the
future.




Undisbursed
loans-in-process and interest reserves reflected on the accompanying
consolidated balance sheets generally represent the unaccompanied portion of
construction loans pending completion of additional construction, and interest
reserves for all or part of the loans’ terms. As of December 31, 2009 and
September 30, 2010, undisbursed loans-in-process and interest reserves balances
were as follows:




December 31, 2009
                                          
                                          
                                          September 30, 2010Loans Held
                                          
                                          
                                          Loans Held
                                          
                                          
                                          
                                          
                                          
                                          Loans Held
                                          
                                          
                                          Loans Heldto Maturity
                                          
                                          
                                          for Sale
                                          
                                          
                                          Total
                                          
                                          
                                          to Maturity
                                          
                                          
                                          for Sale
                                          
                                          
                                          TotalUndispersed
      Loans-in-process perNote
      Agreement
                                          
                                          $
                                          63,001
                                          
                                          
                                          $
                                          -
                                          
                                          
                                          $
                                          63,001
                                          
                                          
                                          $
                                          -
                                          
                                          
                                          $
                                          59,570
                                          
                                          
                                          $
                                          59,570Less:
      amounts not to be funded
                                          
                                          
                                          (47,026
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (47,026
                                          )
                                          
                                          
                                          -
                                          
                                          
                                          
                                          (44,544
                                          )
                                          
                                          
                                          (44,544
                                          )Undispersed
      Loans-in-process perFinancial
      Statements
                                          
                                          $
                                          15,975
                                          
                                          
                                          $
                                          -
                                          
                                          
                                          $
                                          15,975
                                          
                                          
                                          $
                                          -
                                          
                                          
                                          $
                                          15,026
                                          
                                          
                                          $
                                          15,026





A
breakdown of loans-in-process expected to be funded is presented
below:




December 31,
                                      
                                      
                                      September 30,Loans-in-Process
      Allocation:
                                      
                                      2009
                                      
                                      
                                      2010Construction/Operations
      Commitments
                                      
                                      $
                                      3,731
                                      
                                      
                                      $
                                      2,921Unfunded
      Interest Reserves
                                      
                                      
                                      7,524
                                      
                                      
                                      
                                      6,157Deferred
      Loan Fees due to Manager
                                      
                                      
                                      2,360
                                      
                                      
                                      
                                      -Reserve
      for Protective Advances
                                      
                                      
                                      654
                                      
                                      
                                      
                                      4,244Taxes
      and Other
                                      
                                      
                                      1,706
                                      
                                      
                                      
                                      1,704Total
      Loan-in-Process
                                      
                                      $
                                      15,975
                                      
                                      
                                      $
                                      15,026




43


IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


NOTE
12 – COMMITMENTS AND CONTINGENCIES – (continued)




While the
contractual amount of unfunded loans-in-process and interest reserves totaled
$63,001 and $59,570 at December 31, 2009 and September 30, 2010, respectively,
we estimate that we will fund approximately $15,026 subsequent to September 30,
2010. Of the $15,026 expected to be funded, $6,157 relates to unfunded interestreserves on a loan restructured in December 2009 (which is a
non-cash commitment), $2,921 relates to anticipated borrower construction or
operating costs, $1,704 relates to tax related reserves and $4,244 relates to
reserves for protective advances not required under the terms of the loan
agreement but that we expect to fund to protect our interest in the asset. The
difference of $44,544, which is not expected to be funded, relates to loans that
are in default, loans that have been modified to lower the funding amount and
loans whose funding is contingent on various project milestones, many of which
have not been met to date and are not expected to be met given current economic
conditions. Accordingly, these amounts are not reflected as funding obligations
in the accompanying consolidated balance sheets. With available cash and cash
equivalents of $4,580 at September 30, 2010, scheduled loan payoffs, the
suspension of member redemptions, the suspension of new loan request funding,
debt financing secured for the Company, and other available sources of
liquidity, including potential loan participations, loan sales or sales of REO
assets, we expect to meet our obligation to fund these undisbursed amounts in
the normal course of business. See Note 1 for discussion of our
liquidity.




At
December 31, 2009, of our 55 borrowers, one of our borrowers had established
unfunded interest reserves, no borrowers had funded interest reserves, and one
borrower prepaid interest on the related note through the conveyance of certain
real estate and the remaining 53 of our borrowers were obligated to pay interest
from their own alternative sources. At September 30, 2010, of our 43 borrowers,
two of our borrowers had established unfunded interest reserves, two borrowers
had funded interest reserves available, and 39 of our borrowers were obligated
to pay interest from their own alternative sources. As noted in the table above,
we had $6,157 of remaining interest reserves on two loans totaling $32,227 at
September 30, 2010.




During
the nine months ended September 30, 2009 and 2010, mortgage loan interest
satisfied by the use of unfunded interest reserves were $5,167 (25.5%) and $11
(1.0%) of total mortgage loan interest income for the periods,
respectively.   During the three months ended September 30, 2009
and 2010, mortgage loan interest satisfied by the use of unfunded interest
reserves were $693 (25.7%) and $0 (0.0%) of total mortgage loan interest income
for the periods, respectively.




During
the nine months ended September 30, 2009 and 2010, mortgage loan interest
satisfied by the use of funded interest reserves were $7,922 (39.1%) and $0
(0.0%) of total mortgage loan interest income for the periods,
respectively.   During the three months ended September 30, 2009
and 2010, mortgage loan interest satisfied by the use of funded interest
reserves were $776 (28.8%) and $0 (0.0%) of total mortgage loan interest income
for the periods, respectively.




We may be
a party to litigation as the plaintiff or defendant in the ordinary course of
business in connection with loans that go into default, or for other reasons,
including, without limitation, potential claims or judicial actions relating to
the Conversion Transactions. While various asserted and unasserted claims exist,
resolution of these matters cannot be predicted with certainty and, we believe,
based upon currently available information, that the final outcome of such
matters will not have a material adverse effect, if any, on our results of
operations or financial condition.





Following
the suspension of certain Fund activities, including the suspension of member
redemptions, certain of the members of the Fund requested that their redemption
requests be honored due to financial hardships or other reasons. In each
instance, we have responded that we will not grant those requests and we are
treating all members uniformly. While we have not been served with any lawsuits
from members, certain members have filed grievances with the SEC and other
regulatory agencies related to our administration of the Fund (including our
suspension of redemptions), and these members’ disapproval of the Conversion
Transactions.





44


IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)




NOTE
12 – COMMITMENTS AND CONTINGENCIES – (continued)




After we
filed the initial Registration Statement on Form S-4 with the SEC on December
30, 2009, or the Form S-4, various disputes have arisen relating to the consent
solicitation/prospectus and the proposed transactions contained therein.
Three proposed class action lawsuits were filed in the Delaware Court of
Chancery (May 26, 2010, June 14, 2010 and June 17, 2010) against us and our
affiliated named individuals and entities. The May 26 and June 14, 2010 lawsuits
contain similar allegations, claiming that fiduciary duties owed to Fund members
and to the Fund were breached because the Conversion Transactions were unfair to
Fund members, constitute self-dealing and because the Form S-4 and/or
information provided about the Form S-4 or Conversion Transactions are false and
misleading. The June 17, 2010 lawsuit asserts that the Conversion Transactions
constitute a “roll up” transaction under the Fund’s operating agreement, and
seeks damages for breach of the operating agreement. We and our affiliated named
individuals and entities dispute these claims and will defend vigorously against
these actions.





An action
was filed on June 14, 2010 by Fund members Ronald Tucek and Cliff Ratliff, as
well as LGM Capital Partners, LLC (also known as The Committee to Protect IMH
Secured Loan Fund, LLC) in the Delaware Court of Chancery against us and
affiliated named individuals and entities. The June 14, 2010 lawsuit claims that
fiduciary duties and the duty of disclosure owed to Fund members and to the Fund
were breached because the Conversion Transactions were unfair to Fund members,
constitute self-dealing and because the Form S-4 and/or information provided
about the Form S-4 or Conversion Transactions are false and misleading.
Plaintiffs sought to enjoin the Conversion Transactions, have an independent
advisor appointed on behalf of Fund members, remove the Manager and obtain
access to contact information for Fund members and certain broker-dealers. We
and our affiliated named individuals and entities dispute these claims and will
defend vigorously against this action.





In July
2010, the parties in the four actions mentioned above filed various motions
and/or briefs seeking competing forms of consolidation and/or coordination of
the four actions.  During a hearing on these motions on October 14,
2010, the parties in the respective actions agreed to consolidate the four
actions for all purposes, subject to certain provisions with “respect to the
unique individual count brought” by the Tucek plaintiffs.  On October
25, 2010, the Delaware Court of Chancery granted the respective parties’
proposed “Order of Consolidation and Appointment of Co-lead Plaintiffs: Counsel
and Co-Liaison Counsel,” which, among other things, consolidated the four
actions, ordered that a consolidated Amended complaint shall be filed within 45
days of October 25, 2010, followed by consolidated discovery, and designated the
plaintiffs’ counsel from the May 25, 2010 and June 17, 2010 lawsuits as
co-lead counsel.  The consolidated action is in its early stage and it
is not possible to estimate at this time the range of exposure, if any, the
consolidated action presents.





A lawsuit was filed in the Superior
Court of California, County of Santa Barbara and served on June 1, 2010 by a
purported Fund member, Barney Weinman, against the Manager and individuals and
entities associated with a broker-dealer that placed Weinman with the Fund. This
action alleges that the broker-dealer who placed Weinman in the Fund did so in
breach of his fiduciary duties to Weinman, and also alleges that the Manager
knew that the Fund’s business was declining and that redemptions would be
frozen, but failed to disclose that to Weinman. The action seeks returns of his
investment and damages. We dispute these claims and will defend vigorously
against this action.A trial date has been set for June 22,
2011.





On June
8, 2010, we received notice the SEC that we were the subject of a SEC
investigation and received from the SEC requests for documents.  Our
present intention is to work cooperatively with the SEC in its investigation.
The resolution of the SEC investigation is not determinable at this
time.  We have completed our production of documents to the
SEC.





45


IMH
FINANCIAL CORPORATION
 (formerly
known as IMH Secured Loan Fund, LLC)
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 (In
thousands except unit and share data)


We
believe that we have always been, and currently are, in compliance with all
regulations that materially affect us and our operations, and that we have acted
in accordance with our operating agreement prior to its termination as a result
of the Conversion Transactions. However, there can be no guarantee that this is
the case or that the above-described or other matters will be resolved
favorably, or that we or our affiliates may not incur significant legal and
other defense costs, damage or settlement payments, regulatory fines, or
limitations or prohibitions relating to our or our affiliates’ business
activities, any of which could harm our operations.





We are
subject to oversight by various state and federal regulatory authorities,
including, but not limited to, the Arizona Corporation Commission, or ACC, the
Arizona Department of Revenue, the Arizona Department of Financial Institutions
(Banking), the SEC and the Internal Revenue Service, or IRS. Our income tax
returns have not been examined by taxing authorities and all statutorily open
years remain subject to examination.





46


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


The
following discussion should be read in conjunction with our Management’s
Discussion and Analysis of Financial Condition and Results of Operations and the
audited financial statements and accompanying notes as of and for the year ended
December 31, 2009 included in our previously filed Annual Report on Form 10-K/A
(“Form 10-K/A”), and with the unaudited interim consolidated financial
statements and accompanying notes included in this Quarterly Report on Form 10-Q
(“Form 10-Q”). Undue reliance should not be placed upon historical financial
statements since they are not indicative of expected results of operations or
financial condition for any future periods.




Forward-Looking
Statements




This Form
10-Q contains forward-looking statementswhich relate to
expectations, beliefs, projections, future plans and strategies, anticipated
events or trends and similar expressions concerning matters that are not
historical facts. In some cases, you can identify forward looking statements by
terms such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,”
“likely,” “may,” “plan,” “potential,” “should” and “would” or the negative of
these terms or other comparable terminology. The forward-looking statements are
based on our beliefs, assumptions and expectations of our future performance.
These beliefs, assumptions and expectations can change,and actual resultsand events may differ
materially,as a
result of many possible events or factors, not all of which are known to us or
are within our control.A detailed discussion of risks and uncertainties that could cause actual
results and events to differ materiallyfromsuchforward-looking
statements is included in the section titled “Risk Factors” (refer to Part
II, Item 1A of this Form 10-Q).




Overview
of the Business




We are a
real estate finance company based in the southwest United States with over 13
years of experience in various and diverse facets of the real estate lending and
investment process, including origination, acquisition, underwriting,
documentation, servicing, construction, enforcement, development, marketing, and
disposition. Although we have historically focused on the origination of senior
short-term commercial bridge loans with maturities of 12 to 18 months oriented
toward the ability of permanent take-out financing, our primary near-term future
focus is on the acquisition and origination of interim loans, or other
short-term financings, that are used to pay off construction, commercial or
residential property loans and are not reliant on the availability of take-out
financing. In addition, we will target the acquisition or financing of whole
commercial real estate mortgage loans, which may be performing, distressed or
non-performing, and participating interests in performing commercial real estate
mortgage loans. Our target transaction size is typically above the upper
investment boundary of community banks, but below the lower investment threshold
of larger financial institutions, which we believe positions us favorably in an
underserved segment of the real estate finance industry.





We
combine traditional credit analysis typically performed by banks, with advanced
property valuation techniques used by developers, in order to produce a more
comprehensive investment decision process. In addition to the property appraisal
and underwriting process performed by traditional bank lenders, we build and
stress test a property-specific valuation model for each real estate investment
we make, based upon, among other factors, acquisition price, carrying cost,
development time, potential cost and time overruns, absorption rate, existing
and potential rental rates, existing and known planned competing properties,
market trends and exit strategy. We test these assumptions with a combination of
field inspections and local market analysis, as well as financial, physical,
legal and environmental due diligence. Through this process, we have acquired or
originated real estate assets as of September 30, 2010 with an original
investment basis of $717.1 million and a current carrying value of $265.6
million consisting of commercial real estate mortgage loans with a carrying
value of $156.0 million and owned property with a carrying value of $109.6
million. The decline in the carrying value of our real estate assets is
reflective of the deterioration of the commercial real estate lending market and
the sustained decline in pricing of residential and commercial real estate in
recent months together with the continuing downturn in the commercial real
estate markets and general economy.





47




Our
portfolio consists primarily of loans that we originated, but are now
focusingour
future investments primarily on the following asset classes, which we consider
to be our target assets:





·
            interim
      loans, which are loans with terms of 18 to 30 months that are not reliant
      upon the immediate availability of traditional or permanent
      financing;


·
            whole
      commercial real estate mortgage loans, which may be performing, distressed
      or non-performing loans;


·
            participating
      interests in performing commercial real estate mortgage loans;
      and


·
            other
      types of real estate assets and real estate-related debt instruments we
      can acquire from time to time as attractive opportunities continue to
      emerge in the existing economic
environment.





We intend
to continue the process of disposing of a significant portion of our existing
loans and real estate assets, or REO assets, individually or in bulk, and to
reinvest the proceeds from such dispositions in our target assets. We intend to
diversify our assets further across asset classes, with current target
allocations for new investments of approximately 45% of total assets in interim
loans or other short-term loans originated by us, 25% in performing whole, or
participating interests in, commercial real estate mortgage loans we acquire,
15% in whole non-performing commercial real estate loans we acquire and 15% in
other types of real estate-related assets and real estate-related debt
instruments (which may include the acquisition of, or financing the acquisition
of, residential mortgage-backed securities, commercial mortgage-backed
securities and REO assets), although the exact allocations will depend on the
investment opportunities we decide to pursue. We expect the diversification of
our portfolio to continue to evolve to address market circumstances, including
consideration of factors such as asset class, borrower group, geography,
transaction size and investment terms. Once real estate conditions improve, and
the availability of permanent financing returns, we believe our experience,
industry knowledge and comprehensive underwriting process will allow us to
refocus on our historical model of originating short-term senior secured whole
commercial real estate mortgage loans.





In
addition, we believe opportunities will arise to use our stock or cash to
acquire, on attractive terms, real estate-related assets or companies, including
real estate investment trusts, or REITs, real estate vehicles, limited
partnerships and similar vehicles. Many of these entities are seeking to
reposition their portfolios or dispose of assets, and may also have investors
who are seeking liquidity or exit options.





On June
18, 2010, we became an internally managed real estate finance company formed
through the conversion of IMH Secured Loan Fund, LLC, or the Fund, into a
Delaware corporation named IMH Financial Corporation and the acquisition by IMH
Financial Corporation of Investors Mortgage Holdings Inc., or the Manager, and
IMH Holdings, LLC, or Holdings.




Recent
Events and Response




We have
experienced significant financial strain since the decline in the credit and
real estate markets that began in the latter part of 2008.  To address
our financial condition, we entered into an agreement with the Manager and its
stockholders, and Holdings, and its members, pursuant to which the Fund
converted into a Delaware corporation named IMH Financial Corporation, and IMH
Financial Corporation acquired all of the equity interests in the Manager, and
Holdings. We refer to these transactions as the Conversion Transactions, see
Note 3 to our unaudited consolidated financial statements included in this Form
10-Qfor further
discussion. On May 10, 2010, the agreement was amended to provide that for the
period January 1, 2010 through the date of consummation of the Conversion
Transactions, any consolidated net losses of the Manager and Holdings were to be
allocated to the stockholders of the Manager and members of Holdings. To address
the allocation of such net loss to the Manager and Holdings, the number of
shares to be issued to the stockholders of the Manager and members of Holdings
in connection with the Conversion Transactions were reduced, on a pro rata
basis, by one share for each $20 of the allocated net loss. The Fund received
member approval to consummate the Conversion Transactions which were effected on
June 18, 2010. We believe the Conversion Transactions:




·
            have
      positioned us to become a publicly traded corporation listed on the New
      York Stock Exchange;




48




·
            will
      create the opportunity for liquidity for
  members;




·
            have
      caused us to be internally managed, which will eliminate conflicts and
      more fully align our interests with those of the Manager and
      Holdings;




·
            will
      create the opportunity for us to raise additional capital in the public
      markets, thereby enabling us to better acquire and originate commercial
      mortgage loans and other real estate-related investment
      opportunities;




·
            have
      created the opportunity to achieve long term value for our stockholders
      through dividends and capital appreciation;
and




We will
also create a board of directors comprised of a majority of independent
directors, which will enhance our corporate governance.




The
Conversion Transactions were undertaken primarily to position us to file with
the SEC a registration statement on Form S-11 for an initial public
offering.  We received notice on June 8, 2010 that we were the subject
of a SEC investigation.  After consultation with our potential
underwriters, legal counsel and others, we believe that it is not probable at
this time that we will be in a position to complete an IPO until matters
concerning the SEC’s investigation are clarified or resolved and market
conditions are more favorable.  We cannot determine at this time when
matters before the SEC will be clarified or resolved.




Although
we did not know the final determination of the SEC investigation, we proceeded
with filing the  S-11 on October 27, 2010 because we believe it will
better position us to complete an IPO as soon as practicable once the SEC
investigation is clarified and/or resolved and if market conditions are
favorable at that time.




Since the
Conversion Transactions have been consummated, the Manager is now internalized,
the former executive officers and employees of the Manager are now our executive
officers and employees and have assumed the duties previously performed by the
Manager, and we will no longer pay management fees to the Manager and are
entitled to retain all management, origination fees, gains and basis points
previously allocated to the Manager. Holdings is a holding company for two
wholly-owned subsidiaries, IMH Management Services, LLC, an Arizona limited
liability company, and SWI Management, LLC, an Arizona limited liability
company. IMH Management Services, LLC provides us and our affiliates with human
resources and administrative services, including the supply of employees, and
SWI Management, LLC, or SWIM acts as the manager for the Strategic Wealth &
Income Company, LLC, or the SWI Fund.


49


Selected
Financial Data




The
following table presents select financial and operating data for the periods
indicated. The summary financial data was derived from our audited and unaudited
financial statements and other financial records. All dollar amounts are
expressed in thousands, except share and per unit data.


As of and for
                        
                        
                        
                        
                        
                        (Unaudited)the Year Ended
                        
                        
                        As of and for the Nine
                        
                        
                        As of and for the ThreeDecember 31,
                        
                        
                        Months Ended September 30,
                        
                        
                        Months Ended September 30,2009
                        
                        
                        2009
                        
                        
                        2010
                        
                        
                        2009
                        
                        
                        2010Summary
      balance sheet itemsCash
      and cash equivalents
                        
                        $
                        963
                        
                        
                        $
                        2,463
                        
                        
                        $
                        4,580
                        
                        
                        $
                        2,463
                        
                        
                        $
                        4,580Mortgage
      loan principal outstanding
                        
                        $
                        544,448
                        
                        
                        $
                        553,356
                        
                        
                        $
                        490,882
                        
                        
                        $
                        553,356
                        
                        
                        $
                        490,882Allowance
      for credit loss / valuation allowance
                        
                        $
                        (330,428
                        )
                        
                        $
                        (337,000
                        )
                        
                        $
                        (334,881
                        )
                        
                        $
                        (337,000
                        )
                        
                        $
                        (334,881
                        )Mortgage
      loans, net
                        
                        $
                        214,020
                        
                        
                        $
                        216,356
                        
                        
                        $
                        156,001
                        
                        
                        $
                        216,356
                        
                        
                        $
                        156,001Real
      estate owned
                        
                        $
                        104,231
                        
                        
                        $
                        97,305
                        
                        
                        $
                        109,306
                        
                        
                        $
                        97,305
                        
                        
                        $
                        109,306Total
      assets
                        
                        $
                        337,796
                        
                        
                        $
                        334,577
                        
                        
                        $
                        281,099
                        
                        
                        $
                        334,577
                        
                        
                        $
                        281,099Total
      liabilities
                        
                        $
                        15,928
                        
                        
                        $
                        13,406
                        
                        
                        $
                        28,090
                        
                        
                        $
                        13,406
                        
                        
                        $
                        28,090Retained
      earnings (accumulated deficit)
                        
                        $
                        (408,515
                        )
                        
                        $
                        (409,212
                        )
                        
                        $
                        (474,025
                        )
                        
                        $
                        (409,212
                        )
                        
                        $
                        (474,025
                        )Common
      stock
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        168
                        
                        
                        $
                        -
                        
                        
                        $
                        168Additional
      Paid in Capital
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        726,866
                        
                        
                        $
                        -
                        
                        
                        $
                        726,866Members'
      capital, net of redemptions
                        
                        $
                        730,383
                        
                        
                        $
                        730,383
                        
                        
                        $
                        -
                        
                        
                        $
                        730,383
                        
                        
                        $
                        -Total
      owners' equity
                        
                        $
                        321,868
                        
                        
                        $
                        321,171
                        
                        
                        $
                        253,009
                        
                        
                        $
                        321,171
                        
                        
                        $
                        253,009Summary
      income statementMortgage
      loan interest
                        
                        $
                        21,339
                        
                        
                        $
                        20,256
                        
                        
                        $
                        1,112
                        
                        
                        $
                        2,697
                        
                        
                        $
                        156Total
      revenue
                        
                        $
                        22,522
                        
                        
                        $
                        20,750
                        
                        
                        $
                        2,782
                        
                        
                        $
                        3,155
                        
                        
                        $
                        840Operating
      expenses
                        
                        $
                        9,433
                        
                        
                        $
                        5,924
                        
                        
                        $
                        20,691
                        
                        
                        $
                        2,546
                        
                        
                        $
                        12,238Provision
      for credit losses
                        
                        $
                        79,299
                        
                        
                        $
                        82,000
                        
                        
                        $
                        34,380
                        
                        
                        $
                        82,000
                        
                        
                        $
                        6,830Impairment
      of assets
                        
                        $
                        8,000
                        
                        
                        $
                        8,000
                        
                        
                        $
                        13,221
                        
                        
                        $
                        8,000
                        
                        
                        $
                        2,236Total
      costs and expenses
                        
                        $
                        96,999
                        
                        
                        $
                        95,924
                        
                        
                        $
                        68,292
                        
                        
                        $
                        92,546
                        
                        
                        $
                        21,304Net
      earnings (loss)
                        
                        $
                        (74,477
                        )
                        
                        $
                        (75,174
                        )
                        
                        $
                        (65,510
                        )
                        
                        $
                        (89,391
                        )
                        
                        $
                        (20,464
                        )Owners
      Related itemsNumber
      of member accounts
                        
                        
                        4,772
                        
                        
                        
                        4,735
                        
                        
                        
                        -
                        
                        
                        
                        4,735
                        
                        
                        
                        -Average
      Member account balance
                        
                        $
                        67
                        
                        
                        $
                        68
                        
                        
                        $
                        -
                        
                        
                        $
                        68
                        
                        
                        $
                        -Distributions
      to members (including distributions reinvested)
                        
                        $
                        11,706
                        
                        
                        $
                        11,706
                        
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        -Book
      value per member unit/share
                        
                        $
                        4,406.86
                        
                        
                        $
                        4,397.32
                        
                        
                        $
                        -
                        
                        
                        $
                        4,397.32
                        
                        
                        $
                        -Net
      distributions to Members per weighted average membershipunits/share
                        
                        $
                        160.27
                        
                        
                        $
                        160.27
                        
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        -Net
      earnings (loss) per weighted average member unit/share
                        
                        $
                        (1,019.70
                        )
                        
                        $
                        (1,029.24
                        )
                        
                        
                        N/A
                        
                        
                        $
                        (1,223.88
                        )
                        
                        
                        N/AEarnings
      (loss) from continuing operations per weighted averagemember
      unit/share
                        
                        $
                        175.55
                        
                        
                        $
                        202.99
                        
                        
                        $
                        -
                        
                        
                        $
                        8.35
                        
                        
                        $
                        -Pro
      Forma Net earnings (loss) per share
                        
                        
                        N/A
                        
                        
                        $
                        (4.67
                        )
                        
                        $
                        (4.00
                        )
                        
                        $
                        (5.55
                        )
                        
                        $
                        (1.22
                        )Loan
      related itemsNote
      balances originated
                        
                        $
                        47,557
                        
                        
                        $
                        392
                        
                        
                        $
                        3,314
                        
                        
                        $
                        -
                        
                        
                        $
                        3,314Number
      of notes originated
                        
                        
                        3
                        
                        
                        
                        1
                        
                        
                        
                        3
                        
                        
                        
                        -
                        
                        
                        
                        3Average
      note balance originated
                        
                        $
                        15,852
                        
                        
                        $
                        392
                        
                        
                        $
                        1,105
                        
                        
                        
                        N/A
                        
                        
                        $
                        1,105Number
      of loans outstanding
                        
                        
                        55
                        
                        
                        
                        58
                        
                        
                        
                        43
                        
                        
                        
                        58
                        
                        
                        
                        43Average
      loan carrying value
                        
                        $
                        3,891
                        
                        
                        $
                        3,730
                        
                        
                        $
                        3,628
                        
                        
                        $
                        3,730
                        
                        
                        $
                        3,628% of
      portfolio principal – fixed interest rate
                        
                        
                        50.4
                        %
                        
                        
                        50.1
                        %
                        
                        
                        55.5
                        %
                        
                        
                        50.1
                        %
                        
                        
                        55.5
                        %Weighted
      average interest rate – fixed
                        
                        
                        9.8
                        %
                        
                        
                        10.3
                        %
                        
                        
                        9.9
                        %
                        
                        
                        10.3
                        %
                        
                        
                        9.9
                        %% of
      portfolio principal – variable interest rate
                        
                        
                        49.6
                        %
                        
                        
                        49.9
                        %
                        
                        
                        44.5
                        %
                        
                        
                        49.9
                        %
                        
                        
                        44.5
                        %Weighted
      average interest rate – variable
                        
                        
                        12.9
                        %
                        
                        
                        12.9
                        %
                        
                        
                        13.1
                        %
                        
                        
                        12.9
                        %
                        
                        
                        13.1
                        %Principal
      balance % by state:Arizona
                        
                        
                        55.5
                        %
                        
                        
                        53.0
                        %
                        
                        
                        62.8
                        %
                        
                        
                        53.0
                        %
                        
                        
                        62.8
                        %California
                        
                        
                        28.3
                        %
                        
                        
                        31.1
                        %
                        
                        
                        26.0
                        %
                        
                        
                        31.1
                        %
                        
                        
                        26.0
                        %Texas
                        
                        
                        3.2
                        %
                        
                        
                        3.1
                        %
                        
                        
                        0.0
                        %
                        
                        
                        3.1
                        %
                        
                        
                        0.0
                        %Idaho
                        
                        
                        5.0
                        %
                        
                        
                        4.9
                        %
                        
                        
                        4.2
                        %
                        
                        
                        4.9
                        %
                        
                        
                        4.2
                        %Other
                        
                        
                        8.0
                        %
                        
                        
                        7.9
                        %
                        
                        
                        7.0
                        %
                        
                        
                        7.9
                        %
                        
                        
                        7.0
                        %Total
                        
                        
                        100.0
                        %
                        
                        
                        100.0
                        %
                        
                        
                        100.0
                        %
                        
                        
                        100.0
                        %
                        
                        
                        100.0
                        %Credit
      QualityExtension
      fees included in mortgage loan principal
                        
                        $
                        18,765
                        
                        
                        $
                        10,895
                        
                        
                        $
                        17,096
                        
                        
                        $
                        10,895
                        
                        
                        $
                        17,096Interest
      payments over 30 days delinquent
                        
                        $
                        7,530
                        
                        
                        $
                        7,687
                        
                        
                        $
                        6,767
                        
                        
                        $
                        7,687
                        
                        
                        $
                        6,767Loans
      past scheduled maturity
                        
                        
                        34
                        
                        
                        
                        36
                        
                        
                        
                        31
                        
                        
                        
                        36
                        
                        
                        
                        31Principal
      balance of loans past scheduled maturity
                        
                        $
                        347,135
                        
                        
                        $
                        370,255
                        
                        
                        $
                        347,233
                        
                        
                        $
                        370,255
                        
                        
                        $
                        347,233Number
      of loans in non accrual status
                        
                        
                        46
                        
                        
                        
                        43
                        
                        
                        
                        36
                        
                        
                        
                        43
                        
                        
                        
                        36Carrying
      Value of loans in non accrual status
                        
                        $
                        192,334
                        
                        
                        $
                        450,568
                        
                        
                        $
                        145,721
                        
                        
                        $
                        450,568
                        
                        
                        $
                        145,721Allowance
      for credit losses
                        
                        $
                        (330,428
                        )
                        
                        $
                        (337,000
                        )
                        
                        $
                        (334,881
                        )
                        
                        $
                        (337,000
                        )
                        
                        $
                        (334,881
                        )Allowance
      for credit losses as % of loan principal outstanding
                        
                        
                        60.7
                        %
                        
                        
                        60.9
                        %
                        
                        
                        68.2
                        %
                        
                        
                        60.9
                        %
                        
                        
                        68.2
                        %
  50
  December 31,
                        
                        
                        September 30,2008
                        
                        
                        2009
                        
                        
                        2010Average
      Balance Sheets*
                        
                        
                        
                        
                        (in thousands)Cash
      and cash equivalents
                        
                        $
                        78,379
                        
                        
                        $
                        7,719
                        
                        
                        $
                        3,233Mortgage
      loan principal outstanding
                        
                        
                        551,174
                        
                        
                        
                        584,551
                        
                        
                        
                        518,002Allowance
      for credit loss/ Valuation allowance
                        
                        
                        (70,290
                        )
                        
                        
                        (306,712
                        )
                        
                        
                        (334,199
                        )Mortgage
      loans, net
                        
                        
                        480,884
                        
                        
                        
                        277,840
                        
                        
                        
                        183,803Real
      estate owned, net
                        
                        
                        45,055
                        
                        
                        
                        79,292
                        
                        
                        
                        109,825Other
      assets
                        
                        
                        10,808
                        
                        
                        
                        18,884
                        
                        
                        
                        17,665Total
      assets
                        
                        $
                        615,126
                        
                        
                        $
                        383,735
                        
                        
                        $
                        314,526Total
      liabilities
                        
                        
                        21,184
                        
                        
                        
                        9,517
                        
                        
                        
                        22,684Total
      owners'equity
                        
                        
                        593,942
                        
                        
                        
                        374,218
                        
                        
                        
                        291,842Total
      liabilities and owners' equity
                        
                        $
                        615,126
                        
                        
                        $
                        383,735
                        
                        
                        $
                        314,526
 
 *
The average balance sheets were computed using the quarterly average balances
during each fiscal period presented.
 
 Nine MonthsYears Ended December 31,
                  
                  
                  Ended September 30,2008
                  
                  
                  2009
                  
                  
                  2010Analysis
      of Mortgage Loan Income by Loan ClassificationPre-entitled
      Land:Held
      for Investment
                  
                  $
                  780
                  
                  
                  $
                  60
                  
                  
                  $
                  -Processing
      Entitlements
                  
                  
                  20,145
                  
                  
                  
                  6,977
                  
                  
                  
                  70Entitled
      Land:Held
      for Investment
                  
                  
                  14,262
                  
                  
                  
                  2,385
                  
                  
                  
                  27Infrastructure
      under Construction
                  
                  
                  5,586
                  
                  
                  
                  2,163
                  
                  
                  
                  315Improved
      and Held for vertical Construction
                  
                  
                  5,656
                  
                  
                  
                  1,384
                  
                  
                  
                  -Construction
      and Existing Structures:New
      Structure - Construction in process
                  
                  
                  10,976
                  
                  
                  
                  1,058
                  
                  
                  
                  512Existing
      Structure Held for Investment
                  
                  
                  2,825
                  
                  
                  
                  1,201
                  
                  
                  
                  -Existing
      Structure- Improvements
                  
                  
                  5,267
                  
                  
                  
                  6,111
                  
                  
                  
                  188Total
      Mortgage Loan Income
                  
                  $
                  65,497
                  
                  
                  $
                  21,339
                  
                  
                  $
                  1,112
 
 51
 
 December
      31,
                            
                            
                            September
      30,2008
                            
                            
                            2009
                            
                            
                            2010Mortgage
      Loan Balances by Loan Classification**Pre-entitled
      Land:Held
      for Investment
                            
                            $
                            7,178
                            
                            
                            $
                            13,834
                            
                            
                            $
                            18,303Processing
      Entitlements
                            
                            
                            200,902
                            
                            
                            
                            185,608
                            
                            
                            
                            180,424Entitled
      Land:Held
      for Investment
                            
                            
                            114,306
                            
                            
                            
                            101,942
                            
                            
                            
                            73,082Infrastructure
      under Construction
                            
                            
                            57,908
                            
                            
                            
                            69,839
                            
                            
                            
                            57,062Improved
      and Held for vertical Construction
                            
                            
                            54,486
                            
                            
                            
                            47,227
                            
                            
                            
                            35,918Construction
      and Existing Structures:New
      Structure - Construction in process
                            
                            
                            43,814
                            
                            
                            
                            46,325
                            
                            
                            
                            51,801Existing
      Structure Held for Investment
                            
                            
                            37,482
                            
                            
                            
                            23,641
                            
                            
                            
                            12,584Existing
      Structure- Improvements
                            
                            
                            97,777
                            
                            
                            
                            56,033
                            
                            
                            
                            61,708Total
      Mortgage Loan Balances
                            
                            $
                            613,853
                            
                            
                            $
                            544,449
                            
                            
                            $
                            490,882
 ** These amounts are not averaged
  December
      31,
                          
                          
                          September
      30,2008
                          
                          
                          2009
                          
                          
                          2010Average
      Mortgage Loan Balances by Loan Classification***Pre-entitled
      Land:Held
      for Investment
                          
                          $
                          5,673
                          
                          
                          $
                          12,478
                          
                          
                          $
                          14,442Processing
      Entitlements
                          
                          
                          198,886
                          
                          
                          
                          193,261
                          
                          
                          
                          184,342Entitled
      Land:Held
      for Investment
                          
                          
                          117,468
                          
                          
                          
                          116,521
                          
                          
                          
                          89,716Infrastructure
      under Construction
                          
                          
                          59,192
                          
                          
                          
                          66,399
                          
                          
                          
                          66,663Improved
      and Held for vertical Construction
                          
                          
                          43,208
                          
                          
                          
                          47,909
                          
                          
                          
                          43,897Construction
      and Existing Structures:New
      Structure - Construction in process
                          
                          
                          52,480
                          
                          
                          
                          40,329
                          
                          
                          
                          46,418Existing
      Structure Held for Investment
                          
                          
                          26,839
                          
                          
                          
                          26,394
                          
                          
                          
                          15,073Existing
      Structure- Improvements
                          
                          
                          47,428
                          
                          
                          
                          81,260
                          
                          
                          
                          57,453Total
      Average Mortgage Loan Balances
                          
                          $
                          551,174
                          
                          
                          $
                          584,551
                          
                          
                          $
                          518,002
 
 ***
Amounts were computed using the quarterly average balances during each of the
fiscal period presented
 
 December
      31,
                                
                                
                                September
      30,2008
                                
                                
                                2009
                                
                                
                                2010Average
      Interest Rate by Loan Classification****Pre-entitled
      Land:Held
      for Investment
                                
                                
                                12.0
                                %
                                
                                
                                10.8
                                %
                                
                                
                                9.9
                                %Processing
      Entitlements
                                
                                
                                11.5
                                %
                                
                                
                                9.6
                                %
                                
                                
                                9.2
                                %Entitled
      Land:Held
      for Investment
                                
                                
                                12.2
                                %
                                
                                
                                12.4
                                %
                                
                                
                                13.6
                                %Infrastructure
      under Construction
                                
                                
                                12.2
                                %
                                
                                
                                11.0
                                %
                                
                                
                                13.1
                                %Improved
      and Held for vertical Construction
                                
                                
                                11.8
                                %
                                
                                
                                12.1
                                %
                                
                                
                                13.3
                                %Construction
      and Existing Structures:New
      Structure - Construction in process
                                
                                
                                12.3
                                %
                                
                                
                                11.5
                                %
                                
                                
                                12.0
                                %Existing
      Structure Held for Investment
                                
                                
                                13.8
                                %
                                
                                
                                12.0
                                %
                                
                                
                                19.7
                                %Existing
      Structure- Improvements
                                
                                
                                12.5
                                %
                                
                                
                                12.4
                                %
                                
                                
                                13.8
                                %Total
      Overall Average Interest Rate
                                
                                
                                12.3
                                %
                                
                                
                                11.5
                                %
                                
                                
                                13.1
                                %
 
 ****Average
Interest Rate by Loan Classification were computed by taking an average balance
over the trailing 5 quarters
  52
 
 December
      31,
                                
                                
                                September
      30,Average
      Yield*****
                                
                                2008
                                
                                
                                2009
                                
                                
                                2010Pre-entitled
      Land:Held
      for Investment
                                
                                
                                13.7
                                %
                                
                                
                                0.5
                                %
                                
                                
                                0.0
                                %Processing
      Entitlements
                                
                                
                                10.1
                                %
                                
                                
                                3.6
                                %
                                
                                
                                0.0
                                %Entitled
      Land:Held
      for Investment
                                
                                
                                12.1
                                %
                                
                                
                                1.9
                                %
                                
                                
                                0.0
                                %Infrastructure
      under Construction
                                
                                
                                9.4
                                %
                                
                                
                                3.6
                                %
                                
                                
                                0.5
                                %Improved
      and Held for vertical Construction
                                
                                
                                13.1
                                %
                                
                                
                                2.9
                                %
                                
                                
                                0.0
                                %Construction
      and Existing Structures:New
      Structure - Construction in process
                                
                                
                                20.9
                                %
                                
                                
                                2.7
                                %
                                
                                
                                1.1
                                %Existing
      Structure Held for Investment
                                
                                
                                10.5
                                %
                                
                                
                                4.6
                                %
                                
                                
                                0.0
                                %Existing
      Structure- Improvements
                                
                                
                                11.1
                                %
                                
                                
                                8.9
                                %
                                
                                
                                0.3
                                %Overall
      Average Yield
                                
                                
                                12.1
                                %
                                
                                
                                3.7
                                %
                                
                                
                                0.1
                                %
 *****
              Average
      Yield is computed using Mortgage Loan Income by Loan Classification as a
      percent of Average Mortgage Loan Balances by Loan
      Classification
 Note:
Overall Average Yields have decreased due to loans being placed in non-accrual
status
 
 Return
      on Equity and Assets RatioReturn
      on assets
                  
                  
                  (42.0
                  )%
                  
                  
                  (19.4
                  )%
                  
                  
                  (20.8
                  )%Return
      on equity
                  
                  
                  (43.5
                  )%
                  
                  
                  (19.9
                  )%
                  
                  
                  (22.5
                  )%Dividend
      payout ratio
                  
                  
                  (24.8
                  )%
                  
                  
                  (15.7
                  )%
                  
                  
                  0.0
                  %Equity
      to assets ratio
                  
                  
                  96.6
                  %
                  
                  
                  97.5
                  %
                  
                  
                  92.8
                  %
  53
  (in
      Thousands)
                                                  
                                                  As
      of and for the Year ended December 31,
                                                  
                                                  
                                                  September 30,2006
                                                  
                                                  
                                                  2007
                                                  
                                                  
                                                  2008
                                                  
                                                  
                                                  2009
                                                  
                                                  
                                                  2010Principal
      Balanaces Outstanding by LoanClassificationsPre-entitled
      Land:Held
      for Investment
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  7,178
                                                  
                                                  
                                                  $
                                                  13,834
                                                  
                                                  
                                                  $
                                                  18,303Processing
      Entitlements
                                                  
                                                  
                                                  145,219
                                                  
                                                  
                                                  
                                                  203,166
                                                  
                                                  
                                                  
                                                  200,902
                                                  
                                                  
                                                  
                                                  185,608
                                                  
                                                  
                                                  
                                                  180,424Entitled
      Land:Held
      for Investment
                                                  
                                                  
                                                  41,894
                                                  
                                                  
                                                  
                                                  135,060
                                                  
                                                  
                                                  
                                                  114,307
                                                  
                                                  
                                                  
                                                  101,942
                                                  
                                                  
                                                  
                                                  73,082Infrastructure
      under Construction
                                                  
                                                  
                                                  17,621
                                                  
                                                  
                                                  
                                                  60,037
                                                  
                                                  
                                                  
                                                  57,908
                                                  
                                                  
                                                  
                                                  69,839
                                                  
                                                  
                                                  
                                                  57,062Improved
      and Held for vertical Construction
                                                  
                                                  
                                                  29,388
                                                  
                                                  
                                                  
                                                  14,800
                                                  
                                                  
                                                  
                                                  54,486
                                                  
                                                  
                                                  
                                                  47,227
                                                  
                                                  
                                                  
                                                  35,918Construction
      and Existing Structures:New
      Structure - Construction in process
                                                  
                                                  
                                                  16,316
                                                  
                                                  
                                                  
                                                  70,864
                                                  
                                                  
                                                  
                                                  43,814
                                                  
                                                  
                                                  
                                                  46,325
                                                  
                                                  
                                                  
                                                  51,801Existing
      Structure Held for Investment
                                                  
                                                  
                                                  8,177
                                                  
                                                  
                                                  
                                                  26,870
                                                  
                                                  
                                                  
                                                  37,482
                                                  
                                                  
                                                  
                                                  23,640
                                                  
                                                  
                                                  
                                                  12,584Existing
      Structure- Improvements
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  97,777
                                                  
                                                  
                                                  
                                                  56,033
                                                  
                                                  
                                                  
                                                  61,708Total
      Principal Balanaces Outstanding by Loan Classifications
                                                  
                                                  $
                                                  258,615
                                                  
                                                  
                                                  $
                                                  510,797
                                                  
                                                  
                                                  $
                                                  613,854
                                                  
                                                  
                                                  $
                                                  544,448
                                                  
                                                  
                                                  $
                                                  490,882Allocation
      of Allowance for Credit Loss / Valuation Allowance byLoan
      ClassificationPre-entitled
      Land:Held
      for Investment
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  (3,242
                                                  )
                                                  
                                                  $
                                                  (9,623
                                                  )
                                                  
                                                  $
                                                  (15,843
                                                  )Processing
      Entitlements
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (1,900
                                                  )
                                                  
                                                  
                                                  (122,266
                                                  )
                                                  
                                                  
                                                  (134,742
                                                  )
                                                  
                                                  
                                                  (151,761
                                                  )Entitled
      Land:Held
      for Investment
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (79,279
                                                  )
                                                  
                                                  
                                                  (80,750
                                                  )
                                                  
                                                  
                                                  (69,047
                                                  )Infrastructure
      under Construction
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (24,863
                                                  )
                                                  
                                                  
                                                  (39,441
                                                  )
                                                  
                                                  
                                                  (43,433
                                                  )Improved
      and Held for Vertical Construction
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (38,522
                                                  )
                                                  
                                                  
                                                  (28,696
                                                  )
                                                  
                                                  
                                                  (27,476
                                                  )Construction
      & Existing Structures:New
      Structure - Construction in-process
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (28,547
                                                  )
                                                  
                                                  
                                                  (30,106
                                                  )
                                                  
                                                  
                                                  (25,029
                                                  )Existing
      Structure Held for Investment
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (2,954
                                                  )
                                                  
                                                  
                                                  (7,070
                                                  )
                                                  
                                                  
                                                  (2,292
                                                  )Existing
      Structure - Improvements
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (637
                                                  )
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -Allowance
      for Loan Loss/ Valuation Allowance
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  (1,900
                                                  )
                                                  
                                                  $
                                                  (300,310
                                                  )
                                                  
                                                  $
                                                  (330,428
                                                  )
                                                  
                                                  $
                                                  (334,881
                                                  )Rollforward
      of Allowance for Credit Loss / Valuation Allowance byLoan
      ClassificationsBalance
      at the beginning of period
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  (1,900
                                                  )
                                                  
                                                  $
                                                  (300,310
                                                  )
                                                  
                                                  $
                                                  (330,428
                                                  )Additions
      to Allowance for Credit Loss / Valuation AllowancePre-entitled
      Land:Held
      for Investment
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  (3,242
                                                  )
                                                  
                                                  $
                                                  (6,381
                                                  )
                                                  
                                                  $
                                                  (7,442
                                                  )Processing
      Entitlements
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (1,900
                                                  )
                                                  
                                                  
                                                  (120,366
                                                  )
                                                  
                                                  
                                                  (24,851
                                                  )
                                                  
                                                  
                                                  (18,584
                                                  )Entitled
      Land:Held
      for Investment
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (79,279
                                                  )
                                                  
                                                  
                                                  (9,851
                                                  )
                                                  
                                                  
                                                  (4,917
                                                  )Infrastructure
      under Construction
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (24,863
                                                  )
                                                  
                                                  
                                                  (11,990
                                                  )
                                                  
                                                  
                                                  (5,180
                                                  )Improved
      and Held for Vertical Construction
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (38,522
                                                  )
                                                  
                                                  
                                                  801
                                                  
                                                  
                                                  
                                                  1,220Construction
      & Existing Structures:New
      Structure - Construction in-process
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (26,137
                                                  )
                                                  
                                                  
                                                  (3,218
                                                  )
                                                  
                                                  
                                                  4,206Existing
      Structure Held for Investment
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (2,954
                                                  )
                                                  
                                                  
                                                  (4,116
                                                  )
                                                  
                                                  
                                                  4,778Existing
      Structure - Improvements
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (637
                                                  )
                                                  
                                                  
                                                  (19,693
                                                  )
                                                  
                                                  
                                                  -Total
      provision for credit losses
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  (1,900
                                                  )
                                                  
                                                  $
                                                  (296,000
                                                  )
                                                  
                                                  $
                                                  (79,299
                                                  )
                                                  
                                                  $
                                                  (25,919
                                                  )Charge-Offs:Pre-entitled
      Land:Held
      for Investment
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  1,223Processing
      Entitlements
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  12,375
                                                  
                                                  
                                                  
                                                  1,566Entitled
      Land:
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -Held
      for Investment
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  8,380
                                                  
                                                  
                                                  
                                                  16,619Infrastructure
      under Construction
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (2,588
                                                  )
                                                  
                                                  
                                                  1,188Improved
      and Held for Vertical Construction
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  9,025
                                                  
                                                  
                                                  
                                                  -Construction
      & Existing Structures:
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -New
      Structure - Construction in-process
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  1,659
                                                  
                                                  
                                                  
                                                  870Existing
      Structure Held for Investment
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -Existing
      Structure - Improvements
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  20,330
                                                  
                                                  
                                                  
                                                  -Total
      charge-offs
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  49,181
                                                  
                                                  
                                                  $
                                                  21,466Recoveries -
      NoneTotal
      Recoveries
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -Net
      Charge-offs
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  49,181
                                                  
                                                  
                                                  $
                                                  21,466Net
      Change in Allowance for Credit Loss / Valuation Allowance
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  (1,900
                                                  )
                                                  
                                                  $
                                                  (296,000
                                                  )
                                                  
                                                  $
                                                  (30,118
                                                  )
                                                  
                                                  $
                                                  (4,453
                                                  )Other
      changes to Allowance for Credit Loss / Valuation Allowance
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  (2,410
                                                  )
                                                  
                                                  
                                                  -
                                                  
                                                  
                                                  
                                                  -Balance
      at end of period
                                                  
                                                  $
                                                  -
                                                  
                                                  
                                                  $
                                                  (1,900
                                                  )
                                                  
                                                  $
                                                  (300,310
                                                  )
                                                  
                                                  $
                                                  (330,428
                                                  )
                                                  
                                                  $
                                                  (334,881
                                                  )Ratio
      of net charge-offs during the period to average loans outstanding during
      the period
                                                  
                                                  0.0
                                                  %
                                                  
                                                  
                                                  0.0
                                                  %
                                                  
                                                  
                                                  0.0
                                                  %
                                                  
                                                  
                                                  -60.5
                                                  %
                                                  
                                                  
                                                  -37.4
                                                  %
  54
  As
      of and for the Year ended December 31,
                            
                            
                            September 30,2006
                            
                            
                            2007
                            
                            
                            2008
                            
                            
                            2009
                            
                            
                            2010Principal
      Balances Outstanding by LoanClassificationPre-entitled
      Land:Held
      for Investment
                            
                            $
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            7,178
                            
                            
                            $
                            13,834
                            
                            
                            $
                            18,303Processing
      Entitlements
                            
                            
                            145,219
                            
                            
                            
                            203,166
                            
                            
                            
                            200,902
                            
                            
                            
                            185,608
                            
                            
                            
                            180,424Entitled
      Land:Held
      for Investment
                            
                            
                            41,894
                            
                            
                            
                            135,060
                            
                            
                            
                            114,307
                            
                            
                            
                            101,942
                            
                            
                            
                            73,082Infrastructure
      under Construction
                            
                            
                            17,621
                            
                            
                            
                            60,037
                            
                            
                            
                            57,908
                            
                            
                            
                            69,839
                            
                            
                            
                            57,062Improved
      and Held for vertical Construction
                            
                            
                            29,388
                            
                            
                            
                            14,800
                            
                            
                            
                            54,486
                            
                            
                            
                            47,227
                            
                            
                            
                            35,918Construction
      and Existing Structures:New
      Structure - Construction in process
                            
                            
                            16,316
                            
                            
                            
                            70,864
                            
                            
                            
                            43,814
                            
                            
                            
                            46,325
                            
                            
                            
                            51,801Existing
      Structure Held for Investment
                            
                            
                            8,177
                            
                            
                            
                            26,870
                            
                            
                            
                            37,482
                            
                            
                            
                            23,640
                            
                            
                            
                            12,584Existing
      Structure- Improvements
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            97,777
                            
                            
                            
                            56,033
                            
                            
                            
                            61,708Total
      Loan Principal
                            
                            $
                            258,615
                            
                            
                            $
                            510,797
                            
                            
                            $
                            613,854
                            
                            
                            $
                            544,448
                            
                            
                            $
                            490,882
 Scheduled
      MaturitiesScheduled
      Maturities - One year or lessPre-entitled
      Land:Held
      for Investment
                              
                              $
                              -
                              
                              
                              $
                              -
                              
                              
                              $
                              7,178
                              
                              
                              $
                              13,834
                              
                              
                              $
                              18,303Processing
      Entitlements
                              
                              
                              145,219
                              
                              
                              
                              203,166
                              
                              
                              
                              195,168
                              
                              
                              
                              185,608
                              
                              
                              
                              180,424Entitled
      Land:Held
      for Investment
                              
                              
                              41,894
                              
                              
                              
                              135,060
                              
                              
                              
                              89,786
                              
                              
                              
                              101,942
                              
                              
                              
                              73,082Infrastructure
      under Construction
                              
                              
                              17,621
                              
                              
                              
                              60,037
                              
                              
                              
                              57,908
                              
                              
                              
                              27,953
                              
                              
                              
                              24,945Improved
      and Held for vertical Construction
                              
                              
                              29,388
                              
                              
                              
                              14,800
                              
                              
                              
                              13,904
                              
                              
                              
                              47,227
                              
                              
                              
                              35,918Construction
      and Existing Structures:New
      Structure - Construction in process
                              
                              
                              16,316
                              
                              
                              
                              70,864
                              
                              
                              
                              43,814
                              
                              
                              
                              12,653
                              
                              
                              
                              8,082Existing
      Structure Held for Investment
                              
                              
                              8,177
                              
                              
                              
                              26,870
                              
                              
                              
                              37,482
                              
                              
                              
                              23,641
                              
                              
                              
                              10,584Existing
      Structure- Improvements
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              97,777
                              
                              
                              
                              -
                              
                              
                              
                              4,205Total
      Scheduled Maturities - One year or less
                              
                              $
                              258,615
                              
                              
                              $
                              510,797
                              
                              
                              $
                              543,017
                              
                              
                              $
                              412,858
                              
                              
                              $
                              355,543Scheduled
      Maturities - One to five yearsPre-entitled
      Land:Held
      for Investment
                              
                              $
                              -
                              
                              
                              $
                              -
                              
                              
                              $
                              -
                              
                              
                              $
                              -
                              
                              
                              $
                              -Processing
      Entitlements
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              5,735
                              
                              
                              
                              -
                              
                              
                              
                              -Entitled
      Land:Held
      for Investment
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              24,520
                              
                              
                              
                              -
                              
                              
                              
                              -Infrastructure
      under Construction
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              41,886
                              
                              
                              
                              32,117Improved
      and Held for vertical Construction
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              40,582
                              
                              
                              
                              -
                              
                              
                              
                              -Construction
      and Existing Structures:New
      Structure - Construction in process
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              33,671
                              
                              
                              
                              43,719Existing
      Structure Held for Investment
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              2,000Existing
      Structure- Improvements
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              56,033
                              
                              
                              
                              57,503Total
      Scheduled Maturities - One to five years
                              
                              $
                              -
                              
                              
                              $
                              -
                              
                              
                              $
                              70,837
                              
                              
                              $
                              131,590
                              
                              
                              $
                              135,339Total
      Loan Principal
                              
                              $
                              258,615
                              
                              
                              $
                              510,797
                              
                              
                              $
                              613,854
                              
                              
                              $
                              544,448
                              
                              
                              $
                              490,882
 
 Scheduled
      Maturities - One to Five Years by Interest Type
                    
                    As
      of and for the Year ended December 31,
                    
                    
                    September 30,Fixed
      Interest Rates
                    
                    2006
                    
                    
                    2007
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2010Pre-entitled
      Land:Held
      for Investment
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -Processing
      Entitlements
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,929
                    
                    
                    
                    -
                    
                    
                    
                    -Entitled
      Land:Held
      for Investment
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    3,500
                    
                    
                    
                    -
                    
                    
                    
                    -Infrastructure
      under Construction
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    41,886
                    
                    
                    
                    32,117Improved
      and Held for vertical Construction
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    10,461
                    
                    
                    
                    -
                    
                    
                    
                    -Construction
      and Existing Structures:New
      Structure - Construction in process
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    32,053
                    
                    
                    
                    43,719Existing
      Structure Held for Investment
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    2,000Existing
      Structure- Improvements
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    56,033
                    
                    
                    
                    57,503Total
      Scheduled Maturities - Fixed interest rate
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    15,890
                    
                    
                    $
                    129,972
                    
                    
                    $
                    135,339Variable
      Interest RatesPre-entitled
      Land:Held
      for Investment
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    -Processing
      Entitlements
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    3,807
                    
                    
                    
                    -
                    
                    
                    
                    -Entitled
      Land:
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    -Held
      for Investment
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    21,020
                    
                    
                    
                    -
                    
                    
                    
                    -Infrastructure
      under Construction
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Improved
      and Held for vertical Construction
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    30,120
                    
                    
                    
                    -
                    
                    
                    
                    -Construction
      and Existing Structures:
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    -New
      Structure - Construction in process
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,618
                    
                    
                    
                    -Existing
      Structure Held for Investment
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Existing
      Structure- Improvements
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Total
      Scheduled Maturities - Variable interest rate
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    54,947
                    
                    
                    $
                    1,618
                    
                    
                    $
                    -Total
      Loan Principal due One to Five Years
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    70,837
                    
                    
                    $
                    131,590
                    
                    
                    $
                    135,339
  55
  December
      31,
                                                            
                                                            
                                                            September 30,2006
                                                            
                                                            
                                                            2007
                                                            
                                                            
                                                            2008
                                                            
                                                            
                                                            2009
                                                            
                                                            
                                                            2010Performing
      LoansPre-entitled
      Land:Held
      for Investment
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -Processing
      Entitlements
                                                            
                                                            
                                                            131,318
                                                            
                                                            
                                                            
                                                            119,175
                                                            
                                                            
                                                            
                                                            146,460
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -Entitled
      Land:Held
      for Investment
                                                            
                                                            
                                                            41,893
                                                            
                                                            
                                                            
                                                            135,060
                                                            
                                                            
                                                            
                                                            37,146
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            449Infrastructure
      under Construction
                                                            
                                                            
                                                            17,621
                                                            
                                                            
                                                            
                                                            44,557
                                                            
                                                            
                                                            
                                                            40,653
                                                            
                                                            
                                                            
                                                            7,645
                                                            
                                                            
                                                            
                                                            -Improved
      and Held for vertical Construction
                                                            
                                                            
                                                            29,388
                                                            
                                                            
                                                            
                                                            14,800
                                                            
                                                            
                                                            
                                                            35,102
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -Construction
      and Existing Structures:New
      Structure - Construction in process
                                                            
                                                            
                                                            16,317
                                                            
                                                            
                                                            
                                                            45,087
                                                            
                                                            
                                                            
                                                            6,694
                                                            
                                                            
                                                            
                                                            4,805
                                                            
                                                            
                                                            
                                                            3,441Existing
      Structure Held for Investment
                                                            
                                                            
                                                            8,177
                                                            
                                                            
                                                            
                                                            18,620
                                                            
                                                            
                                                            
                                                            23,393
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            2,214Existing
      Structure- Improvements
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            97,777
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            4,206Total
      Performing Loans
                                                            
                                                            $
                                                            244,714
                                                            
                                                            
                                                            $
                                                            377,299
                                                            
                                                            
                                                            $
                                                            387,225
                                                            
                                                            
                                                            $
                                                            12,450
                                                            
                                                            
                                                            $
                                                            10,310Loans
      in Default - Non-AccrualPre-entitled
      Land:Held
      for Investment
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            13,834
                                                            
                                                            
                                                            $
                                                            18,303Processing
      Entitlements
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            64,743
                                                            
                                                            
                                                            
                                                            46,636
                                                            
                                                            
                                                            
                                                            185,608
                                                            
                                                            
                                                            
                                                            180,424Entitled
      Land:Held
      for Investment
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            3,300
                                                            
                                                            
                                                            
                                                            101,942
                                                            
                                                            
                                                            
                                                            72,633Infrastructure
      under Construction
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            17,255
                                                            
                                                            
                                                            
                                                            62,194
                                                            
                                                            
                                                            
                                                            57,062Improved
      and Held for vertical Construction
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            14,632
                                                            
                                                            
                                                            
                                                            40,051
                                                            
                                                            
                                                            
                                                            35,918Construction
      and Existing Structures:New
      Structure - Construction in process
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            2,253
                                                            
                                                            
                                                            
                                                            13,800
                                                            
                                                            
                                                            
                                                            39,102
                                                            
                                                            
                                                            
                                                            48,359Existing
      Structure Held for Investment
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            8,250
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            23,640
                                                            
                                                            
                                                            
                                                            10,370Existing
      Structure- Improvements
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            56,033
                                                            
                                                            
                                                            
                                                            57,503Total
      Loans in Default - Non-Accrual
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            75,246
                                                            
                                                            
                                                            $
                                                            95,623
                                                            
                                                            
                                                            $
                                                            522,404
                                                            
                                                            
                                                            $
                                                            480,572Loans
      in Default - OtherPre-entitled
      Land:Held
      for Investment
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            7,178
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -Processing
      Entitlements
                                                            
                                                            
                                                            13,901
                                                            
                                                            
                                                            
                                                            19,247
                                                            
                                                            
                                                            
                                                            7,806
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -Entitled
      Land:Held
      for Investment
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            73,861
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -Infrastructure
      under Construction
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            15,480
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -Improved
      and Held for vertical Construction
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            4,752
                                                            
                                                            
                                                            
                                                            7,176
                                                            
                                                            
                                                            
                                                            -Construction
      and Existing Structures:New
      Structure - Construction in process
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            23,525
                                                            
                                                            
                                                            
                                                            23,320
                                                            
                                                            
                                                            
                                                            2,418
                                                            
                                                            
                                                            
                                                            -Existing
      Structure Held for Investment
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            14,089
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -Existing
      Structure- Improvements
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -Total
      Loans in Default – Other
                                                            
                                                            $
                                                            13,901
                                                            
                                                            
                                                            $
                                                            58,252
                                                            
                                                            
                                                            $
                                                            131,006
                                                            
                                                            
                                                            $
                                                            9,594
                                                            
                                                            
                                                            $
                                                            -Total
      Loans in Default
                                                            
                                                            $
                                                            13,901
                                                            
                                                            
                                                            $
                                                            133,498
                                                            
                                                            
                                                            $
                                                            226,629
                                                            
                                                            
                                                            $
                                                            531,998
                                                            
                                                            
                                                            $
                                                            480,572Total
      Loan Principal
                                                            
                                                            $
                                                            258,615
                                                            
                                                            
                                                            $
                                                            510,797
                                                            
                                                            
                                                            $
                                                            613,854
                                                            
                                                            
                                                            $
                                                            544,448
                                                            
                                                            
                                                            $
                                                            490,882Loans
      in Default by Basis for DefaultLoans
      past maturity date, or otherPre-entitled
      Land:Held
      for Investment
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            7,178
                                                            
                                                            
                                                            $
                                                            13,834
                                                            
                                                            
                                                            $
                                                            18,303Processing
      Entitlements
                                                            
                                                            
                                                            13,901
                                                            
                                                            
                                                            
                                                            83,990
                                                            
                                                            
                                                            
                                                            52,791
                                                            
                                                            
                                                            
                                                            181,801
                                                            
                                                            
                                                            
                                                            180,424Entitled
      Land:Held
      for Investment
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            73,714
                                                            
                                                            
                                                            
                                                            80,922
                                                            
                                                            
                                                            
                                                            72,633Infrastructure
      under Construction
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            15,480
                                                            
                                                            
                                                            
                                                            17,255
                                                            
                                                            
                                                            
                                                            20,308
                                                            
                                                            
                                                            
                                                            24,945Improved
      and Held for vertical Construction
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            8,923
                                                            
                                                            
                                                            
                                                            17,106
                                                            
                                                            
                                                            
                                                            35,918Construction
      and Existing Structures:New
      Structure - Construction in process
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            25,778
                                                            
                                                            
                                                            
                                                            36,246
                                                            
                                                            
                                                            
                                                            9,522
                                                            
                                                            
                                                            
                                                            4,640Existing
      Structure Held for Investment
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            8,250
                                                            
                                                            
                                                            
                                                            14,089
                                                            
                                                            
                                                            
                                                            23,641
                                                            
                                                            
                                                            
                                                            10,370Existing
      Structure- Improvements
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -Total
      past maturity date
                                                            
                                                            $
                                                            13,901
                                                            
                                                            
                                                            $
                                                            133,498
                                                            
                                                            
                                                            $
                                                            210,196
                                                            
                                                            
                                                            $
                                                            347,134
                                                            
                                                            
                                                            $
                                                            347,233Loans
      past due on interestPre-entitled
      Land:Held
      for Investment
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -Processing
      Entitlements
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            1,650
                                                            
                                                            
                                                            
                                                            3,807
                                                            
                                                            
                                                            
                                                            -Entitled
      Land:Held
      for Investment
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            3,447
                                                            
                                                            
                                                            
                                                            21,020
                                                            
                                                            
                                                            
                                                            -Infrastructure
      under Construction
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            41,886
                                                            
                                                            
                                                            
                                                            32,117Improved
      and Held for vertical Construction
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            10,461
                                                            
                                                            
                                                            
                                                            30,120
                                                            
                                                            
                                                            
                                                            -Construction
      and Existing Structures:New
      Structure - Construction in process
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            875
                                                            
                                                            
                                                            
                                                            31,998
                                                            
                                                            
                                                            
                                                            43,719Existing
      Structure Held for Investment
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -Existing
      Structure- Improvements
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            56,033
                                                            
                                                            
                                                            
                                                            57,503Total
      past due on interest
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            -
                                                            
                                                            
                                                            $
                                                            16,433
                                                            
                                                            
                                                            $
                                                            184,864
                                                            
                                                            
                                                            $
                                                            133,339Total
      loans in default by basis of default
                                                            
                                                            $
                                                            13,901
                                                            
                                                            
                                                            $
                                                            133,498
                                                            
                                                            
                                                            $
                                                            226,629
                                                            
                                                            
                                                            $
                                                            531,998
                                                            
                                                            
                                                            $
                                                            480,572
 
 56
  Analysis
of Changes in Mortgage Loan Income
 
 September
      30,
                        
                        
                        September
      30,2009
      Compared to 2008
                        
                        
                        2010
      Compared to 2009Increase
      (Decrease) due to
                        
                        
                        Increase
      (Decrease) due toVolume
                        
                        
                        Rate
                        
                        
                        Net
                        
                        
                        Volume
                        
                        
                        Rate
                        
                        
                        NetPre-entitled
      Land:Held
      for Investment
                        
                        $
                        (440
                        )
                        
                        $
                        (66
                        )
                        
                        $
                        (506
                        )
                        
                        $
                        (1,052
                        )
                        
                        $
                        992
                        
                        
                        $
                        (60
                        )Processing
      Entitlements
                        
                        
                        -
                        
                        
                        
                        (8,224
                        )
                        
                        
                        (8,224
                        )
                        
                        
                        -
                        
                        
                        
                        (6,876
                        )
                        
                        $
                        (6,876
                        )Entitled
      Land:Held
      for Investment
                        
                        
                        799
                        
                        
                        
                        (9,299
                        )
                        
                        
                        (8,500
                        )
                        
                        
                        452
                        
                        
                        
                        (2,785
                        )
                        
                        $
                        (2,333
                        )Infrastructure
      under Construction
                        
                        
                        1,976
                        
                        
                        
                        (4,453
                        )
                        
                        
                        (2,477
                        )
                        
                        
                        (497
                        )
                        
                        
                        (1,096
                        )
                        
                        $
                        (1,593
                        )Improved
      and Held for vertical Construction
                        
                        
                        -
                        
                        
                        
                        (3,029
                        )
                        
                        
                        (3,029
                        )
                        
                        
                        -
                        
                        
                        
                        (1,174
                        )
                        
                        $
                        (1,174
                        )Construction
      and Existing Structures:New
      Structure - Construction in process
                        
                        
                        834
                        
                        
                        
                        (10,155
                        )
                        
                        
                        (9,321
                        )
                        
                        
                        (1,580
                        )
                        
                        
                        1,361
                        
                        
                        $
                        (219
                        )Existing
      Structure Held for Investment
                        
                        
                        8,429
                        
                        
                        
                        (9,108
                        )
                        
                        
                        (679
                        )
                        
                        
                        (4,179
                        )
                        
                        
                        3,160
                        
                        
                        $
                        (1,019
                        )Existing
      Structure- Improvements
                        
                        
                        10,462
                        
                        
                        
                        (6,911
                        )
                        
                        
                        3,551
                        
                        
                        
                        (9,790
                        )
                        
                        
                        3,920
                        
                        
                        $
                        (5,870
                        )Total
      change in mortgage loan income
                        
                        $
                        22,060
                        
                        
                        $
                        (51,245
                        )
                        
                        $
                        (29,185
                        )
                        
                        $
                        (16,646
                        )
                        
                        $
                        (2,498
                        )
                        
                        $
                        (19,144
                        )
 
 Changes
      in mortgage loan interest income are attributed to either a change in
      average balance (volume change) or changes in average rate (rate change)
      for mortgage loans on which interest is earned. Volume change is
      calculated as change in volume times the previous rate, while rate change
      is change in average rates times the previous volume. The rate/volume
      change, change in rate times change in volume, is allocated between volume
      and rate change at the ratio each bears to the absolute value of their
      total.
  57




Results
of Operations for the Nine Months and Three Months Ended September 30, 2009 and
2010




Factors
Affecting our Financial Results




General
Economic Conditions Affecting the Real Estate Industry




The
global and U.S. economies experienced a rapid decline in recent periods from
which they have not yet recovered. The real estate, credit and other markets
suffered unprecedented disruptions, causing many major institutions to fail or
require government intervention to avoid failure, which has placed severe
pressure on liquidity and asset values. These conditions were brought about
largely by the erosion of U.S. and global credit markets, including a
significant and rapid deterioration of the mortgage lending and related real
estate markets. In this regard, we continue to operate under very difficult
conditions.





Originating,
acquiring and investing in short-term commercial real estate bridge loans to
facilitate real estate entitlement and development, and other interim financing,
have historically constituted the heart of our business model. This model relies
on mortgage capital availability. However, we believe current market conditions
have materially diminished the traditional sources of take-out financing on
which our business model depends. We believe it will take 12 to 24 months or
longer for markets and capital sources to begin to “normalize,” although there
can be no assurance that the markets will stabilize in this timeframe or at all.
Economic conditions have continued to have a material and adverse impact on us.
As of September 30, 2010, 36 of our 43 portfolio loans were in default and are
in non-accrual status. In addition, as of September 30, 2010, the valuation
allowance on our loans totaled $334.9 million, representing 68.2% of the
principal balance of such loans. During the nine months ended September 30,
2010, we foreclosed on ten loans and took title to the underlying real estate
with carrying values totaling $25.4 million at September 30, 2010. Moreover, we
have taken enforcement action on 27 additional loans to date that we anticipate
will result in foreclosure.





Given the
current state of the real estate and credit markets, we believe the realization
of full recovery of the cost basis in our assets is unlikely to occur in a
reasonable time frame and may not occur at all, and we may be required to
liquidate portions of our assets for liquidity purposes at a price significantly
below the initial cost basis or potentially below current carrying values. If we
are not able to liquidate a sufficient portion of our assets or access credit
under the credit facility currently under negotiation, there may be substantial
doubt about our ability to continue as a going concern. Nevertheless, we believe
that our cash and cash equivalents, coupled with liquidity derived from the
credit facility currently under negotiation and the disposition of certain of
the loans and real estate held for sale, will allow us to fund current
operations over the next 12 months.





Revenues.





We have
historically generated income primarily from interest and fees on our mortgage
loans, including default interest, penalties and fees, as well as interest
income from money market, short-term investments or similar accounts in which we
temporarily invest excess cash. As a result of the June 18, 2010 consummation of
the Conversion Transactions, we expect to generate additional revenues from loan
originations, modification and processing fees historically retained by the
Manager. In addition to our historical sources of revenue, we expect to generate
revenues from disposition of existing and newly acquired assets and from the
application of those proceeds in new assets. We expect in the short-term that we
will derive a greater proportion of our capital from dispositions of our REO
properties and from the disposition of loans and other assets we own or acquire
than from the interest and fee income from commercial mortgage loans originated
by us. As economic conditions improve, we expect interest and fee income from
commercial real estate mortgage loans to again become a greater focus for us and
a greater portion of our revenues. We also expect to benefit from management
fees for management services provided by SWIM to SWI Fund.





58




Mortgage Loan Income.
Revenues generated from mortgage loan investments include contractual note rate
interest, default interest and penalty fees collected and accretion on loans
acquired at a discount. Changes to the amount of our loan assets directly affect
the amount of interest and fee income we are able to achieve. Due to the
suspension of the funding of new loans effective October 1, 2008 (excluding
financing of new loans in connection with the sale of collateral under existing
loans or the sale of REO assets), coupled with the increase in defaults and
foreclosures, mortgage loan investment revenues have decreased in recent
periods. As a result of the acquisition of the Manager effective June 18, 2010,
we expect to also generate revenues from loan originations, processing and
modifications. Such amounts, net of direct costs, shall be amortized over the
lives of the respective loans as an adjustment to yield using the effective
interest method. See the heading entitled “Trends in Interest Income and
Effective Portfolio Yield.”





We also
modified certain loans in our portfolio, which has resulted in an extended term
of maturity on such loans of two years or longer and, in some cases, has
required us to accept an interest rate reflective of current market rates, which
are lower than in prior periods. We may decide to modify loans in the future
primarily in an effort to seek to protect our collateral. Additionally, on a
limited basis, we have financed the sale of loan collateral by existing
borrowers to unrelated parties, and it is anticipated that we will engage in
similar lending activities in the future. This effort effectively replaces a
non-performing loan to a defaulting seller with a new performing loan to the
buyer. Although we have in the past modified certain loans by extending the
maturity dates or changing the interest rates thereof on a case by case basis,
we do not have in place at this time a specific loan modification program or
initiative. Rather, as in the past, we may modify any loan, in our sole
discretion, based on the then applicable facts and circumstances, including: (i)
our expectation that the borrower may be capable of meeting its obligations
under the loan, as modified; (ii) the borrower’s perceived motivation to meet
its obligations under the loan, as modified; (iii) whether we perceive that the
risks are greater to us if the loan is modified, on the one hand, or not
modified, on the other hand, and foreclosed upon; (iv) whether the loan is
expected to become fully performing within some period of time after any
proposed modification; (v) the extent of existing equity in the collateral, net
of the loan, as modified; (vi) the creditworthiness of the guarantor of the
loan; (vii) the particular borrower’s track record and financial condition; and
(viii) market based factors regarding supply/demand variables bearing on the
likely future performance of the collateral. In the future, we expect to modify
loans on the same basis as above without any reliance on any specific loan
modification program or initiative.





Rental Income.Rental and
other income is attributable to the foreclosure of certain loans that were
secured by operating properties. We anticipate an increase in rental income as
the occupancy levels of the properties improve. However, as we plan to dispose
of a substantial portion of our existing REO assets, we do not currently
anticipate substantial future rental and related income in future periods unless
we acquire additional operating properties through foreclosure or other
means.





Asset Disposition Income.
Revenues from asset dispositions have not historically been a significant
component of revenues, but as we dispose of existing REO assets and new REO
assets we acquire through the foreclosure of loans, we expect to realize gains
on the disposition of these assets to the extent they are sold above their
carrying value (or losses if sold below carrying values), particularly over the
next 12 to 24 months as we seek to market and sell substantially all of our
existing loans and REO assets. The recognition of revenues from such
dispositions will depend on our ability to successfully market existing loans
and REOs and the timing of such sales.





Investment and Other Income.
Investment and other income is directly attributable to the average amount of
cash available for short-term investment, as well as interest earned on certain
notes receivable from a tenant of one of our operating properties acquired
through foreclosure in the third quarter of the year ended December 31, 2009.
The decrease in cash in recent periods is attributable to the suspension of
acceptance of new member investments, the use of cash to fund remaining loan
commitments and the decrease in loan payoffs. Given the general lack of
available take-out financing accessible to our borrowers, we anticipate cash and
cash equivalents available for short-term investment to remain at minimal levels
for the foreseeable future unless we
raise additional funds through an initial public offering or
otherwise.





Defaults and Foreclosures.
Due to the decline of the economy and real estate and credit markets and our
intent to proactively pursue foreclosure of loans in default so we can dispose
of REO assets, we anticipate defaults and foreclosures to continue, which will
likely result in continuing high levels of non-accrual loans and REO assets,
which are generally non-interest earning assets. As such, we anticipate our
mortgage loan interest income to remain at significantly reduced levels until we
invest the proceeds from the disposition of our existing assets or other debt or
equity financing we may undertake in the future in new investments and begin
generating income from those investments.





59




Expenses.





As a
result of the consummation of the Conversion Transactions, we became responsible
for expenses previously borne by the Manager that are not reflected in our
historical financial statements prior to June 18, 2010. These expenses are only
partially offset by the elimination of management fees, as discussed further
below. Moreover, as a result of our active efforts to pursue enforcement on
defaulted loans, subsequent foreclosure and our resulting ownership of the
underlying collateral, we have incurred significant costs and expenses for
consulting, valuation, legal, property tax and other expenses related to these
activities.





As a
result of our continued active enforcement together with our assumption of
additional expenses in connection with the acquisition of the Manager, we expect
expenses to continue to remain at high levels for the next 12 months. However,
we expect expenses associated with the foreclosure on loans and disposition of
REO assets to decrease through the planned disposition of a substantial part of
our portfolio over the next 12 to 24 months.





Operating Expenses for Real Estate
Owned. Operating expenses for REO assets include direct operating costs
for such property, including property taxes, home owner association dues,
property management fees, utilities, repairs and maintenance, licenses, and
other costs and expenses associated with the ownership of real estate. These
expenses currently average approximately $0.5 million per month. If we were to
foreclose on all of our existing loans, we would incur additional carrying costs
of at least $0.3 million per month related to property taxes attributable to the
underlying collateral, in additional to other carrying costs. While we expect
such operating expenses for REO assets to remain at high levels and potentially
increase as we continue enforcement action on loans in default over the next few
months, we anticipate such costs to decrease proportionately as we dispose of
existing and newly acquired REO assets and redeploy the proceeds in our target
asset classes.





Professional Fees.
Professional fees consist of outside consulting expenses, audit fees for public
reporting related expenses, legal expenses, and valuation services. Currently,
these expenses average approximately $0.5 million per month. We expect such
expenses, to initially increase in expenses as we seek to dispose of REO assets,
but expect these expenses to stabilize at approximately $0.3 million per month
after the disposition of REO assets assuming we conduct our operations
substantially consistent with current levels. We expect these expenses will
stabilize at approximately $0.3 million per month after the disposition of REO
assets.





Management Fees. We no longer
pay the management fee historically paid to the Manager as a result of the June
18, 2010 consummation of the Conversion Transactions. The management fee
recorded in our historical financial statements was an annual fee equal to 0.25%
of our “Earning Asset Base,” which is defined in the Fund’s operating agreement
as mortgage loan investments held by us and income-earning property acquired
through foreclosure and upon which income is being accrued under GAAP.
Accordingly, when defaulted loans or foreclosed property entered into
non-accrual status, or related income was not otherwise recorded, the loan was
removed from the Earning Asset Base for purposes of computing management
fees.





Default and Related Expenses.
Default and related expenses include direct expenses related to defaulted loans,
foreclosure activities or property acquired through foreclosure. These expenses
include certain legal and other direct costs, as well as personnel and
consulting costs directly related to defaulted loans and foreclosure activities.
These expenses currently average less than $0.1 million per month. Because 36 of
our 43 loans are currently in default and our intent is to actively pursue
foreclosures on loans in default, we anticipate our default and related expenses
in future periods will remain at approximately $0.1 million per month in the
year ending December 31, 2011.





General and Administrative
Expenses. General and administrative expenses consist of various costs
such as compensation and benefits for employees, rent, insurance, utilities and
related costs. Prior to the June 18, 2010 consummation of the Conversion
Transactions, the Manager paid most of these expenses, although we paid the
Manager a management fee for management services provided by the Manager. Such
costs currently approximate $0.6 million per month and are expected to remain
generally at that level assuming modest expansion but otherwise maintaining the
general scale and scope of current operations. However, variable cost components
of such expenses are expected to increase as our activities expand.




60





Interest Expense. Interest
expense includes interest incurred in connection with loan participations issued
to third parties, borrowings from the Manager and borrowings from various banks.
We expect interest expense to increase if we procure additional debt financing
to fund our operations or if we are successful in participating our loans with
other lenders.





Depreciation and Amortization
Expense. We record depreciation and amortization on property and
equipment used in our operations. This expense is expected to increase as we
expand our business operations following the internalization of the
Manager.





Provision for Credit Losses.The provision for credit losses on the loan portfolio is based on our
estimate of fair value, using data primarily from reports prepared by
third-party valuation firms, of the underlying collateral of the loan portfolio.
Current asset values have dropped significantly in many of the areas where we
have a security interest in collateral securing our loans, which has resulted in
significant non-cash provisions for credit losses for the year ended December
31, 2009 and the nine months ended September 30, 2010. While we believe our
current valuation allowance is sufficient to minimize future losses, we may be
required to recognize additional provisions for credit losses in the future. In
the absence of a change in valuation of the collateral securing our loans, our
provision for credit losses is expected to increase by $1.0 million on a
quarterly basis for additional unpaid property taxes applicable to the related
loan collateral. Currently all of our portfolio loans are held for sale.
However, we intend to actively market and sell a significant portion of or our
currently-owned loans, individually or in bulk, over the 12 to 24 months as a
means of raising additional capital to pursue our acquisition and origination
objectives.





Impairment Charges on Real Estate
Owned.  Our estimate of impairment charges on REO assets
largely depends on whether the particular REO asset is held for development or
held for sale. Impairment charges on REO assets consist of charges to REO assets
in cases where the reduction in asset value is deemed to be other than
temporary.This
classification depends on various factors, including our intent to sell the
property immediately or further develop and sell the property over time, and
whether a formal plan of disposition has been adopted, among other factors. Real
estate held for sale is carried at the lower of carrying amount or fair value,
less estimated selling costs, which is primarily based on valuation reports
prepared by third-party valuation firms. Reductions in the fair value of assets
held for sale are recorded as impairment charges. Real estate held for
development is carried at the transferred fair value upon foreclosure, less
cumulative impairment charges. Impairment charges on real estate ownedassets
consist of charges to REO assets in cases where the estimated future
undiscounted cash flows of the property is below current carrying value and the
reduction in asset value is deemed to be other than temporary. Asset values have
continued to drop following foreclosure of the related items in many of the
areas where we hold real estate, which has resulted in impairment losses on our
REO assets. We may also be required to recognize additional impairment losses on
our REO assets if our disposition plan for such assets change from held for
development to held for sale, or if such assets are disposed of below their
current carrying values. If management undertakes a specific plan to dispose of
REO assets within twelve months and the real estate is transferred to held for
sale status, the fair value of the real estate may be less than the estimated
future undiscounted cash flows of the property when the real estate was held for
development, and that difference may be material. Currently, only a limited
amount of our REO assets are being held for sale in our financial statements.
However, we intend to actively market and sell these REO assets, individually or
in bulk, over the next 12 to 24 months as a means of raising additional capital
to pursue our acquisition and origination objectives.





Going Concern, Liquidity and Capital
Resources.The amount we
are able to invest in our target assets depends on our liquidity and access to
capital. We expect the proceeds from the disposition of REO assets, recent
liquidity events, including the sale of certain loans and real estate held for
sale, will provide the liquidity necessary to operate our business. Based on our
operating plans, we believe that our cash and cash equivalents, coupled with our
liquidity derived from debt we have secured and intend to secure and the
marketing and sale of existing assets, will allow us to fund operations over the
next 12 months. Our ability to grow revenues will depend in part on our success
in accessing additional debt and equity capital for investment.


61




Revenues (amounts in thousands)Nine Months Ended September 30,
            
            
            Three Months Ended September 30,Revenues
            
            2009
            
            
            2010
            
            
            $ Change
            
            
            % Change
            
            
            2009
            
            
            2010
            
            
            $ Change
            
            
            % ChangeMortgage
      Loan Income
            
            $
            20,256
            
            
            $
            1,112
            
            
            $
            (19,144
            )
            
            
            (94.5
            )%
            
            $
            2,697
            
            
            $
            156
            
            
            $
            (2,541
            )
            
            
            (94.2
            )%Rental
      Income
            
            
            379
            
            
            
            1,243
            
            
            
            864
            
            
            
            228.0
            %
            
            
            378
            
            
            
            410
            
            
            
            32
            
            
            
            8.5
            %Investment
      and Other Income
            
            
            115
            
            
            
            427
            
            
            
            312
            
            
            
            271.3
            %
            
            
            80
            
            
            
            274
            
            
            
            194
            
            
            
            242.5
            %Total
      Revenue
            
            $
            20,750
            
            
            $
            2,782
            
            
            $
            (17,968
            )
            
            
            (86.6
            )%
            
            $
            3,155
            
            
            $
            840
            
            
            $
            (2,315
            )
            
            
            (73.4
            )%




Mortgage
Loan Income




During
the nine months ended September 30, 2010, income from mortgage loans was $1.1
million, a decrease of $19.1 million, or 94.5%, from $20.3 million for the nine
months ended September 30, 2009.  During the three months ended
September 30, 2010, income from mortgage loans was $0.2 million, a decrease of
$2.5 million, or 94.2%, from $2.7 million for the three months ended September
30, 2009.




The
year-over-year decrease in mortgage loan income is attributable to the decrease
in the income-earning portion of our loan portfolio. While the total loan
portfolio was $607.5 million at September 30, 2009, as compared to $490.9
million at September 30, 2010, the income-earning asset balance decreased
significantly from $102.8 million to $10.3 million for the same periods,
respectively. Additionally, the average portfolio interest rate (including
performing and non-performing loans) was 11.56% per annum at September 30, 2009,
as compared to 11.27% per annum at September 30, 2010.  As of September 30,
2010, 36 of our 43 portfolio loans were in non-accrual status, as compared to 43
out of 58 loans at September 30, 2009.  As such, in the absence of
acquiring or originating new loans, we anticipate a further decrease in mortgage
income in future periods. During the three months ended September 30, 2010, in
connection with the sale of certain loans and REO assets, we financed three new
loans with an aggregate principal balance of $3.3 million and a weighted-average
interest rate of 7.26%.




Rental
Income




During
the nine months ended September 30, 2010, we recognized rental income of $1.2
million and $0.4 million in the corresponding period in 2009, an increase of
$0.9 million or 228.0%. During the three months ended September 30, 2010 and
2009, rental income was relatively flat at $0.4 million. Rents and other income
resulted from the foreclosure of a loan in third quarter of 2009 that was
secured by an operating medical office building. We anticipate an increase in
rental income as the occupancy level of the property improves.




Investment
and Other Income




During
the nine months ended September 30, 2010, investment and other income was $0.4
million, an increase of $0.3 million or 271.3%, from $0.1 million for the nine
months ended September 30, 2009.  During the three months ended
September 30, 2010, investment and other income was $0.3 million, as compared to
$0.1 million for the three months ended September 30, 2009, an increase of $0.2
million or 242.5%. The net increase in investments and other income is directly
attributable to an increase in the average amount of cash available for
short-term investment coupled with interest earned on a note receivable from a
tenant for tenant improvements made on one of our operating
properties.




62




Expenses (amounts in thousands)Nine Months Ended September 30,
            
            
            Three Months Ended September 30,Expenses:
            
            2009
            
            
            2010
            
            
            $ Change
            
            
            % Change
            
            
            2009
            
            
            2010
            
            
            $ Change
            
            
            % ChangeOperating
      Expenses for Real Estate Owned
            
            $
            2,534
            
            
            $
            4,072
            
            
            $
            1,538
            
            
            
            60.7
            %
            
            $
            1,194
            
            
            $
            1,523
            
            
            $
            329
            
            
            
            27.6
            %Professional
      Fees
            
            
            1,830
            
            
            
            4,587
            
            
            
            2,757
            
            
            
            150.7
            %
            
            
            641
            
            
            
            1,832
            
            
            
            1,191
            
            
            
            185.8
            %Management
      Fees
            
            
            481
            
            
            
            109
            
            
            
            (372
            )
            
            
            (77.3
            )%
            
            
            62
            
            
            
            -
            
            
            
            (62
            )
            
            
            (100.0
            )%Default
      and Related Expenses
            
            
            579
            
            
            
            533
            
            
            
            (46
            )
            
            
            (7.9
            )%
            
            
            251
            
            
            
            174
            
            
            
            (77
            )
            
            
            (30.7
            )%General
      and Administrative Expenses
            
            
            -
            
            
            
            1,767
            
            
            
            1,767
            
            
            
            N/A
            
            
            
            -
            
            
            
            1,559
            
            
            
            1,559
            
            
            
            N/ALoss
      on Disposal of Real Estate
            
            
            -
            
            
            
            1,058
            
            
            
            1,058
            
            
            
            N/A
            
            
            
            -
            
            
            
            58
            
            
            
            58
            
            
            
            N/AWrite-off
      of Offering Costs
            
            
            -
            
            
            
            6,150
            
            
            
            6,150
            
            
            
            N/A
            
            
            
            -
            
            
            
            6,150
            
            
            
            6,150
            
            
            
            N/AInterest
      Expense:Borrowings
      from Fund Manager
            
            
            217
            
            
            
            39
            
            
            
            (178
            )
            
            
            (82.0
            )%
            
            
            115
            
            
            
            -
            
            
            
            (115
            )
            
            
            (100.0
            )%Borrowings
      on Note Payable
            
            
            -
            
            
            
            1,364
            
            
            
            1,364
            
            
            
            N/A
            
            
            
            -
            
            
            
            562
            
            
            
            562
            
            
            
            N/ATotal
      Interest Expense
            
            
            217
            
            
            
            1,403
            
            
            
            1,186
            
            
            
            546.5
            %
            
            
            115
            
            
            
            562
            
            
            
            447
            
            
            
            388.7
            %Depreciation
      and Amortization Expense
            
            
            283
            
            
            
            1,012
            
            
            
            729
            
            
            
            257.6
            %
            
            
            283
            
            
            
            380
            
            
            
            97
            
            
            
            34.3
            %Provision
      for Credit Losses
            
            
            82,000
            
            
            
            34,380
            
            
            
            (47,620
            )
            
            
            (58.1
            )%
            
            
            82,000
            
            
            
            6,830
            
            
            
            (75,170
            )
            
            
            (91.7
            )%Impairment
      charges
            
            
            8,000
            
            
            
            13,221
            
            
            
            5,221
            
            
            
            65.3
            %
            
            
            8,000
            
            
            
            2,236
            
            
            
            (5,764
            )
            
            
            (72.1
            )%Total
      Provisions and Charges
            
            
            90,000
            
            
            
            47,601
            
            
            
            (42,399
            )
            
            
            (47.1
            )%
            
            
            90,000
            
            
            
            9,066
            
            
            
            (80,934
            )
            
            
            (89.9
            )%Total
      Costs and Expenses
            
            $
            95,924
            
            
            $
            68,292
            
            
            $
            (33,782
            )
            
            
            (35.2
            )%
            
            $
            92,546
            
            
            $
            21,304
            
            
            $
            (77,392
            )
            
            
            (83.6
            )%




Operating Expenses for Real Estate
Owned.




During
the nine months ended September 30, 2010 and 2009, operating expenses for REO
assets were $4.1 million and $2.5 million, respectively, an increase of $1.5
million or 60.7%.  During the three months ended September 30, 2010 and
2009, operating expenses for REO assets were $1.5 million and $1.2 million,
respectively, an increase of $0.3 million or 27.6%. The increase in operating
expenses for REO assets is attributable to the increasing number of properties
acquired through foreclosures, including property taxes, home owner association
dues, utilities, repairs and maintenance, and other expenses attributable to
such properties during the period ended September 30, 2010.




Professional
Fees.




During
the nine months ended September 30, 2010 and 2009, professional fees were $4.6
million and $1.8 million respectively, an increase of $2.8 million, or
150.7%.  During the three months ended September 30, 2010 and 2009,
professional fees were $1.8 million and $0.6 million, respectively, an increase
of $1.2 million or 185.8%. The increase in these costs is attributed to the
increasing defaults and foreclosures in our loan portfolio, the cost of
valuation services provided in connection with our on-going evaluation of the
portfolio, increased litigation related fees and the costs of public reporting,
including requirements under the Sarbanes-Oxley Act and related
requirements.  Also, certain costs that the Manager elected to pay in
previous periods (but was not contractually required to pay), such as public
reporting costs, are now borne by us.  Additionally, we engaged the
services of an outside consulting firm to assist in the determination of the
specific asset disposition strategies.  The consulting firm historically
received $112,000 per month for its services, which was reduced to $85,000 per
month beginning September 1, 2010. The agreement was further modified in
November 2010 whereby, beginning in December 2010, the monthly fixed fee will be
$45,000 plus a finder’s fee equal to 1.75% of any financing proceeds secured by
the consulting firm on our behalf.  Additionally, the consulting firm
will be entitled to a finder’s fee equal to 1⁄2% to 1% of the value received of a
merger or acquisition candidate, if any, identified by the consulting
firm.  As of September 30, 2010, we accrued $0.1 million to the
consulting firm for financing proceeds secured by the consulting firm in the
third quarter of 2010.




Management Fees.




During
the nine months ended September 30, 2010, management fee expense was $0.1
million, a decrease of $0.4 million or 77.3%, from $0.5 million for the nine
months ended September 30, 2009. During the three months ended September 30,
2010, there was no management fee expense, as compared to $0.1 million for the
three months end September 30, 2009.  Management fee expense as a
percentage of total revenue was 3.9% and 2.3% for the nine months ended
September 30, 2010 and 2009, respectively.  During the three months ended
September 30, 2009 and 2010, respectively, management fee expense as a
percentage of total revenue was 0.0% and 0.2%.The decrease in
management fee expense for the nine months ended September 30, 2010 is directly
related to the significant decline in the “Earning Asset Base” of our loan
portfolio as previously described.  The increase in management fees as a
percentage of total revenue is attributed to the increase in “non-earning” or
non-accrual assets and the timing in which such assets entered non-accrual
status, which as described above, and were removed from the asset base on which
management fees were computed. With the acquisition of the Manager effective
June 18, 2010, management fees will no longer be incurred.




63




Default and Related
Expenses.




During
the nine months ended September 30, 2010 and 2009, default and related expenses
was relatively flat at $0.5 million for both periods.  During the
three months ended September 30, 2010 and 2009, default and related expenses
were $0.2 million and $0.3 million respectively, a decrease of $0.1 million or
30.7%.  Default and related expenses remained relatively flat due to
the steady number of defaults and foreclosures experienced by us in 2010 as
compared to 2009.




General and Administrative
Expenses.




In
connection with the acquisition of the Manager effective June 18, 2010, we are
now responsible for various general and administrative expenses previously
incurred by the Manager, including, but not limited to rents, salaries, and
other operational costs.  The amount of $1.8 million reflects the
actual expenses incurred for the period June 18, 2010 (date of acquisition)
through September 30, 2010.  During the three months ended September 30,
2010, general and administrative expenses totaled $1.6 million, or approximately
$0.5 million per month.




Loss
on Disposal of Real Estate.





During
the nine and three months ended September 30, 2010, we sold certain loans and
REO assets for $8.7 million and $2.4 million, respectively
and  recognized a net loss of $1.1 million and $0.1 million,
respectively.  No such transactions occurred during the nine or three
months ended September 30, 2009.





Write-off
of Offering Costs.





During
the nine and three months ended September 30, 2010, we wrote-off all previously
capitalized incremental costs totaling $6.1 million relating to
the  initial public offering and our current operations due to the
postponement of the initial public offering by more than 90 days and the fact
that we cannot assert that the consummation of the initial public offering is
probable or that it will occur in near term,  No such transactions
occurred during the nine or three months ended September 30, 2009.





Interest
Expense.




Interest
expense includes interest incurred in connection with loan participations issued
to third parties, borrowings from the Manager and borrowings from banks. During
the nine months ended September 30, 2010, interest expense was $1.4 million as
compared to $0.2 million for the nine months ended September 30, 2009, an
increase of $1.2 million, or 546.5%. During the three months ended September 30,
2010, interest expense was $0.6 million as compared to $0.1 million for the
three months ended September 30, 2009,   an increase of $0.5
million, or 388.7%. Interest expense for the nine and three months ended
September 30, 2010 was incurred in connection with the previous borrowings from
the Manager and $16.9 million in notes payable, the majority of which were
secured in the first two quarters of 2010.




Depreciation
and Amortization Expense:




During
the nine months ended September 30, 2010 and 2009, depreciation and amortization
expenses were $1.1 million and $0.3 million, respectively, an increase of $0.7
million or 257.6%. This increase is due to the acquisition of an operating
property we acquired through foreclosure in mid-2009.  During the
three months ended September 30, 2010 and 2009, depreciation and amortization
expenses were $0.4 million and $0.3 million respectively, a increase of $0.1
million or 34.3%. The increase in depreciation and amortization expenses is
attributable to the aforementioned acquired property.




64




Provisions
for Credit Losses.




Asset
values have continued to drop significantly in many areas where we have a
security interest in collateral securing our loans which has resulted in
significant non-cash provision for credit losses during the nine months ended
September 30, 2010. Based on the valuation analysis performed on our loan
portfolio during the nine months ended September 30, 2010 and 2009 respectively,
we recorded provision for credit losses of $34.4 million and $82.0
million.




Impairment
Charges.




Asset
values continued to drop significantly in many areas where we hold real estate
during the nine months ended September 30, 2010. For real estate owned assets,
we performed an analysis to determine the extent of impairment in valuation for
such assets deemed to be other than temporary. Based on our analysis, during the
nine months ended September 30, 2010 and 2009, we recorded impairment charges in
the amount of $13.2 million and $8.0 million, respectively.




Unaudited Manager Fund-Related
Income and Expensefor the Interim Period Ended June
18, 2010




Prior to
the acquisition of the Manager effective June 18, 2010, in accordance with
Article 14 of the Fund’s operating agreement, the Manager received from
borrowers, either directly or from loan proceeds, all revenue and fees from loan
origination, processing, servicing and extension. For the nine months ended
September 30, 2009 and 2010, the Manager earned origination, processing and
other related fees of approximately $9.4 million and $23,000, respectively,
substantially all of which were earned on loans funded by the Fund.




Effective
October 1, 2008, we, among other things, suspended funding of new loans
(although we may finance new loans in connection with the sale of collateral
under existing loans or the sale of REO assets). As substantially all of our
loans were originated by the Manager, the Manager’s primary revenue source was
also suspended. Due to the state of the United States economy and the real
estate and credit markets, we cannot predict when loan originations and funding
will re-commence, or whether, once commenced, our loan activity will return to
historical levels, if ever.




In
addition, prior to our acquisition of the Manager, our overhead and certain
operating expenses were paid by the Manager, pursuant to the operating
agreement. Such costs include payroll and direct costs associated with loan
origination or related activities, as well as Member development and operations
and other general overhead costs. Based on our estimates, during the nine and
three months ended September 30, 2010 and 2009, respectively, the Manager
incurred Fund-related expenses as follows (in thousands):




January 1 through
            
            
            9 months ended
            
            
            Three months endedJune 18
            
            
            September 30
            
            
            September 30
            
            
            September 30Fund-related Expenses Paid by Manager:
            
            2010
            
            
            2009
            
            
            2010
            
            
            2009Operations-related
      expenses
            
            $
            1,698
            
            
            $
            3,441
            
            
            $
            -
            
            
            $
            423Origination-related
      expenses
            
            
            963
            
            
            
            1,952
            
            
            
            -
            
            
            
            240Total
            
            $
            2,661
            
            
            $
            5,393
            
            
            $
            -
            
            
            $
            663




The
reduction in expenses from the three months ended September 30, 2010 as compared
to the same period in 2009 is attributable to the reduction in lending
activities and cost cutting measures employed by the Manager.




Changes
in the Loan Portfolio Profile




As
previously discussed, effective October 1, 2008, we elected to suspend certain
of our activities, including the origination and funding of any new loans.
Accordingly, our ability to make adjustments to our loan portfolio was
significantly reduced. In addition, in an effort to seek to preserve our
collateral, certain existing loans have been modified, often times by extending
maturity dates, and, in the absence of available credit financing to repay our
loans, we will likely modify additional loans in the future or foreclose on
those loans.




65




Average
Loan Size




During
the year ended December 31, 2009, we funded one new loan during the first
quarter of 2009, totaling $0.4 million, in connection with the financing of a
sale of certain collateral by an existing borrower to an unrelated party and in
the fourth quarter of 2009, we restructured certain loans for a borrower exiting
bankruptcy.  During the nine months ended September 30, 2010, we
originated three new loans totaling $3.1 million in connection with the
financing of certain loan and REO asset sales.   Aside from these
transactions, no new loans were originated during the remainder of 2009 or
during the nine months ended September 30, 2010.  At December 31,
2009, the average principal balance for performing loans was $2.4 million, as
compared to $1.5 million at September 30, 2010. The decrease in average note
balance is a result of the majority of the loan portfolio that is in non-accrual
status as of December 31, 2009 and September 30, 2010.




Geographic
Diversification




While a
large percentage of mortgage loans are supported by collateral that is located
in Arizona and California, we also currently have loans in New Mexico, Idaho,
and Utah, and previously in Texas and Nevada. As of December 31, 2009 and
September 30, 2010, respectively, the geographic concentration of loan
outstanding principal balances by state is as follows (in thousands except
percentages and unit data):




December 31, 2009
                
                
                September 30, 2010Oustanding
                
                
                Allowance for
                
                
                Net Carrying
                
                
                
                
                
                
                
                
                Oustanding
                
                
                Valuation
                
                
                Net CarryingPrincipal
                
                
                Credit Loss
                
                
                Amount
                
                
                Percent
                
                
                #
                
                
                Principal
                
                
                Allowance
                
                
                Amount
                
                
                Percent
                
                
                #Arizona
                
                $
                281,492
                
                
                $
                (162,639
                )
                
                $
                118,853
                
                
                
                55.5
                %
                
                
                26
                
                
                $
                251,287
                
                
                $
                (153,288
                )
                
                $
                97,999
                
                
                
                62.8
                %
                
                
                19California
                
                
                181,390
                
                
                
                (120,829
                )
                
                
                60,561
                
                
                
                28.3
                %
                
                
                20
                
                
                
                177,053
                
                
                
                (136,431
                )
                
                
                40,622
                
                
                
                26.0
                %
                
                
                19New
      Mexico
                
                
                5,241
                
                
                
                (1,094
                )
                
                
                4,147
                
                
                
                1.9
                %
                
                
                2
                
                
                
                5,260
                
                
                
                (1,985
                )
                
                
                3,275
                
                
                
                2.1
                %
                
                
                2Texas
                
                
                11,102
                
                
                
                (4,272
                )
                
                
                6,830
                
                
                
                3.2
                %
                
                
                3
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                0.0
                %
                
                
                0Idaho
                
                
                49,594
                
                
                
                (38,981
                )
                
                
                10,613
                
                
                
                5.0
                %
                
                
                2
                
                
                
                49,637
                
                
                
                (43,177
                )
                
                
                6,460
                
                
                
                4.2
                %
                
                
                2Nevada
                
                
                7,984
                
                
                
                (2,613
                )
                
                
                5,371
                
                
                
                2.5
                %
                
                
                1
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                0.0
                %
                
                
                0Utah
                
                
                7,645
                
                
                
                -
                
                
                
                7,645
                
                
                
                3.6
                %
                
                
                1
                
                
                
                7,645
                
                
                
                -
                
                
                
                7,645
                
                
                
                4.9
                %
                
                
                1Total
                
                $
                544,448
                
                
                $
                (330,428
                )
                
                $
                214,020
                
                
                
                100.0
                %
                
                
                55
                
                
                $
                490,882
                
                
                $
                (334,881
                )
                
                $
                156,001
                
                
                
                100.0
                %
                
                
                43




The
concentration of our loans in California and Arizona, areas in which values have
been severely impacted by the decline in the real estate market, totals 83.8% at
December 31, 2009 and 90.0% at September 30, 2010. We have stopped funding new
loans and, as a result of this and other factors, our ability to geographically
diversify our loans is significantly impaired.  The change in the
geographic diversification of our loans is primarily attributed to the
foreclosure and transfer of loans to REO assets.




Interest
Rate Information




Our loan
portfolio includes loans that carry variable or fixed interest
rates.   We invest in both fixed and variable interest rate
loans. As of September 30, 2010, we held 43 loans, 21 of which were variable
rate loans and 22 of which were fixed rate loans. Thirty-six of these loans are
non-performing loans for financial reporting purposes (although not all such
loans are necessarily in technical default under the loan terms), for which we
are actively pursuing enforcement on the loans as well as judgments against
personal guarantors of such loans, when applicable.





·
            Variable Interest
      Rate:  All variable interest rate loans are indexed to
      the Prime rate with interest rate floors. At December 31, 2009 and
      September 30, 2010, the Prime rate was 3.25% per annum,
      respectively.  As of December 31, 2009 and September 30, 2010,
      the weighted average contractual interest rates on our variable rate loans
      (including loans in non-accrual status) was Prime plus 9.63% and Prime
      plus 9.74%, respectively. At September 30, 2010, 44.5% of our portfolio
      consisted of variable rate loans, as compared to 49.6% at December 31,
      2009. The decrease in the percentage of variable rate loans in the
      portfolio is primarily attributed to the foreclosure of such loans during
      the year ended December 31, 2010. The weighted average interest rate on
      variable rate loans was 13.05% per annum and 12.88% per annum at September
      30, 2010 and December 31, 2009, respectively. The slight increase in the
      average variable rate at September 30, 2010 as compared to December 31,
      2009 is attributed to the foreclosure of lower variable rate
      loans.


66





At
September 30, 2010 and December 31, 2009, all variable rate loans outstanding
had an interest rate floor and no ceiling interest rates. Accordingly, if the
Prime interest rate increases during the life of the loans and such loans were
performing, interest rates on substantially all these loans would adjust
upward.  Conversely, as the Prime interest rate decreases, the interest
rates on such loans do not decline below the floor rates, which is typically the
original interest rate at the time of origination. For the impact of pro forma
increases or decreases in the Prime rate, see the discussion of “Quantitative and Qualitative
Disclosures about Market Risk” located elsewhere in this Form
10-Q.





·
            Fixed Interest
      Rate:At September 30, 2010, 55.5% of our portfolio
      consisted of fixed rate loans, as compared with 50.4% at December 31,
      2009. The increase in the percentage of fixed rate loans in the portfolio
      is attributed to the modification of certain loans as fixed rate loans
      that were previously variable rate. The average interest rate on fixed
      rate loans as of September 30, 2010 and December 31, 2009was 9.85% and
      9.84%, respectively. The weighted average interest in rates between these
      periods remained consistent.





A substantial portion of
our loans are in default or in non-accrual status as of September 30, 2010 and
December 31, 2009. The following table summarizes our outstanding principal
balances (including non-accrual loans), net of the allowance for credit loss, as
of December 31, 2009 and September 30,2010, respectively, provided by the
contractual loan terms for fixed and variable interest rates (in thousands
except percentages and unit data):





December 31, 2009
                
                
                September 30, 2010Fixed
                
                
                Variable
                
                
                Total
                
                
                Fixed
                
                
                Variable
                
                
                TotalRate
                
                
                Rate
                
                
                Loan
                
                
                Rate
                
                
                Rate
                
                
                LoanLoans
                
                
                Loans
                
                
                Portfolio
                
                
                Loans
                
                
                Loans
                
                
                PortfolioTotal
      Principal Outstanding
                
                $
                274,263
                
                
                $
                270,185
                
                
                $
                544,448
                
                
                $
                272,372
                
                
                $
                218,510
                
                
                $
                490,882Less
      Allowance for Credit Loss /Valuation
      Allowance
                
                
                
                
                
                
                
                
                
                
                (330,428
                )
                
                
                
                
                
                
                
                
                
                
                (334,881
                )Net
      Principal Outstanding
                
                
                
                
                
                
                
                
                
                $
                214,020
                
                
                
                
                
                
                
                
                
                
                $
                156,001%
      of Portfolio
                
                
                50.4
                %
                
                
                49.6
                %
                
                
                100.0
                %
                
                
                55.5
                %
                
                
                44.5
                %
                
                
                100.0
                %Weighted
      Average Rate
                
                
                9.84
                %
                
                
                12.88
                %
                
                
                11.34
                %
                
                
                9.85
                %
                
                
                13.05
                %
                
                
                11.27
                %Number
      of Loans
                
                
                23
                
                
                
                32
                
                
                
                55
                
                
                
                22
                
                
                
                21
                
                
                
                43Average
      Principal Balance
                
                $
                11,924
                
                
                $
                8,443
                
                
                $
                9,899
                
                
                $
                12,381
                
                
                $
                10,405
                
                
                $
                11,416





As of
September 30, 2010, the valuation allowance totaled $333.1 million (all of which
relates to mortgage loans held for sale), representing 67.8% of the total loan
principal balances. As of December 31, 2009, the allowance for credit loss
totaled $330.4 million (of which $328.0 million relates to mortgage loans held
to maturity and $2.4 million relates to mortgage loans held for sale),
representing 60.7% of the total loan portfolio principal balances. See the
heading entitled “Borrower and
Borrower Group Concentrations” for additional information




Concentration
by Category based on Collateral’s Development Status




A summary
of outstanding principal balances on our portfolio loans by development status
of the underlying collateral as well as by expected end-use of the underlying
collateral, as of December 31, 2009 and September 30, 2010, respectively, is
presented in Note 4 of the accompanying financial statements under the heading
entitled “Loan
Classifications”.




67


Unless
loans are modified and additional loan amounts advanced to allow a borrower’s
project to progress to the next phase of the project’s development, the
classifications of our loans generally do not change during the loan term. Thus,
in the absence of funding new loans, we generally do not expect material changes
between loan categories with the exception of changes resulting from
foreclosures. Nevertheless, in several cases, our borrowers have slowed or
halted the level of development from what was originally anticipated as a result
of the material macroeconomic events in the real estate and credit markets.
Risks relative to this lack of development include the possibility of losing
entitlements previously secured, the inability to secure take-out financing,
increased carrying costs, as well as the uncertainty of the recovery of the real
estate markets generally, all of which have led to loan defaults by most of our
borrowers. We expect these loan defaults to continue and they may ultimately
lead to the foreclosure of such loans.




We
estimate that as of September 30, 2010, approximately 60% of the valuation
allowance is attributable to residential-related projects, 39% to mixed use
projects and 1% to commercial and industrial projects.




Borrower
and Borrower Group Concentrations




Our
investment policy provides that no single loan should exceed 10% of the total of
all outstanding loans and that aggregate loans outstanding to one borrower or
borrower group should not exceed 20% of the total of all outstanding loans.
Following the origination of a loan, however, a single loan or the aggregate
loans outstanding to a borrower or borrower group may exceed those thresholds as
a result of changes in the size and composition of our overall portfolio. As of
December 31, 2009, there was one borrower whose outstanding principal totaled
$69.1 million which was approximately 12.7% of our total mortgage loan principal
balance outstanding (although at the time of origination, the aggregate
principal balance on these loans were less than 10% of the total mortgage
principal balance outstanding), and accounted for 15.0% of mortgage interest
income during the year ended December 31, 2009. In addition, as of December 31,
2009, there was one borrowing group, whose aggregate outstanding principal
totaled $97.9 million which was approximately 18.0% of our total mortgage loan
principal balance outstanding (although at the time of origination, the
principal balances on these loans were less than 10% of the total mortgage
principal balance outstanding) and collectively accounted for 21.7% of mortgage
interest income during the year ended December 31, 2009. In addition, during the
year ended December 31, 2009, one loan accounted for 12% of total mortgage
interest income. This loan was foreclosed upon in July 2009.




As of
September 30, 2010, there was one borrower whose outstanding principal totaled
$69.1 million which was approximately 14.1% of our total mortgage loan principal
balance outstanding and is classified as pre-entitled
land – processing entitlements. In addition, there was one borrowing
group whose aggregate outstanding principal aggregated $99.4 million,
representing approximately 20.3% of our total mortgage loan principal balance
outstanding, which consisted of a $57.5 million loan classified as construction
and existing structures – improvements and a $41.9 million loan
classified as entitled land – infrastructure under construction. 
Finally, there was an additional borrowing group whose outstanding principal
aggregated $55.0 million, representing 11.2% of our total mortgage loan
principal balance outstanding, which consisted of nine loans classified as
pre-entitled or entitled land.  Each of these loans was in non-accrual
status as of December 31, 2009 and September 30, 2010 due to the shortfall in
the combined current fair value of the underlying collateral for such loans, and
we recognized no mortgage interest income for these loans during the nine months
ended September 30, 2010. However, three other loans from one borrower group,
one of which has been paid off and the other two have principal balances
totaling $1.2 million at September 30, 2010, accounted for approximately 30.0%
of total mortgage interest income during the nine months ended September 30,
2010.  Additionally, three other loans with outstanding principal
balances of $13.5 million at September 30, 2010, accounted for approximately
49.2% of total mortgage income during the nine months ended September 30,
2010.




Changes
in the Portfolio Profile – Loans in Default Scheduled Maturities




The
following table summarizes the near term scheduled maturities of our mortgage
loans as of September 30, 2010, net of the valuation allowance (in thousands
except percentages and unit data):




68




September 30, 2010Quarter
                
                Amount
                
                
                Percent
                
                
                #Matured
                
                $
                347,233
                
                
                
                70.8
                %
                
                
                31Q4
      2010
                
                
                4,206
                
                
                
                0.9
                %
                
                
                1Q1
      2011
                
                
                1,617
                
                
                
                0.3
                %
                
                
                1Q2
      2011
                
                
                1,173
                
                
                
                0.2
                %
                
                
                2Q3
      2011
                
                
                1,100
                
                
                
                0.2
                %
                
                
                1Q4
      2011
                
                
                33,916
                
                
                
                6.9
                %
                
                
                3Q1
      2012
                
                
                2,000
                
                
                
                0.4
                %
                
                
                1Q3
      2012
                
                
                99,423
                
                
                
                20.3
                %
                
                
                2Q3
      2013
                
                
                214
                
                
                
                0.0
                %
                
                
                1Total
                
                
                490,882
                
                
                
                100.0
                %
                
                
                43Less:
      Valuation Allowance
                
                
                (334,881
                )Net
      Carrying Value
                
                $
                156,001




From time
to time, we may extend a mortgage loan’s maturity date in the normal course of
business.  In this regard, we have modified certain loans, extending
maturity dates in some cases to two or more years, and we expect that we will
modify additional loans in the future in an effort to seek to preserve our
collateral. Accordingly, repayment dates of the loans may vary from their
currently scheduled maturity date. If the maturity date of a loan is not
extended, we classify and report the loan as matured.




Loan
Modifications




The following tables
present various summaries of our loan modifications made on a quarterly basis
for the periods indicated below:




Outstanding Funding
            
            
            
            
            
            Average Loan TermOutstanding Principal
            
            
            Commitment
            
            
            Average Interest Rate
            
            
            (Months)
            
            
            Weighted Avg IntPeriod of
            
            # of
            
            
            Pre-
            
            
            Post-
            
            
            Pre-
            
            
            Post-
            
            
            Pre-
            
            
            Post-
            
            
            Pre-
            
            
            Post-
            
            
            Pre-
            
            
            Post-Modification
            
            Loans
            
            
            Modification
            
            
            Modification
            
            
            Modification
            
            
            Modification
            
            
            Modification
            
            
            Modification
            
            
            Modification
            
            
            Modification
            
            
            Modification
            
            
            Modification(dollar amounts in thousands)Q4
      2008
            
            
            4
            
            
            $
            81,802
            
            
            $
            89,045
            
            
            $
            5,296
            
            
            $
            5,296
            
            
            
            12.88
            %
            
            
            12.06
            %
            
            
            11.25
            
            
            
            17.00
            
            
            
            13.78
            %
            
            
            13.71
            %Q1
      2009
            
            
            5
            
            
            
            59,228
            
            
            
            64,785
            
            
            
            14,328
            
            
            
            14,328
            
            
            
            12.15
            %
            
            
            10.35
            %
            
            
            9.20
            
            
            
            19.00
            
            
            
            11.52
            %
            
            
            8.57
            %Q2
      2009
            
            
            3
            
            
            
            51,103
            
            
            
            52,412
            
            
            
            2,093
            
            
            
            1,241
            
            
            
            12.08
            %
            
            
            12.25
            %
            
            
            10.00
            
            
            
            19.00
            
            
            
            11.72
            %
            
            
            12.10
            %Q3
      2009
            
            
            7
            
            
            
            114,421
            
            
            
            117,244
            
            
            
            7,134
            
            
            
            4,908
            
            
            
            11.39
            %
            
            
            10.11
            %
            
            
            13.29
            
            
            
            29.29
            
            
            
            10.23
            %
            
            
            8.63
            %Q4
      2009
            
            
            4
            
            
            
            44,211
            
            
            
            44,437
            
            
            
            916
            
            
            
            14,025
            
            
            
            12.30
            %
            
            
            10.00
            %
            
            
            15.80
            
            
            
            18.50
            
            
            
            12.64
            %
            
            
            5.51
            %Q1
      2010
            
            
            2
            
            
            
            8,282
            
            
            
            8,359
            
            
            
            74
            
            
            
            662
            
            
            
            10.00
            %
            
            
            10.00
            %
            
            
            4.50
            
            
            
            13.50
            
            
            
            11.47
            %
            
            
            11.47
            %Q2
      2010
            
            
            2
            
            
            
            956
            
            
            
            956
            
            
            
            -
            
            
            
            -
            
            
            
            10.00
            %
            
            
            11.50
            %
            
            
            12.00
            
            
            
            27.50
            
            
            
            10.00
            %
            
            
            11.50
            %Q3
      2010
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Totals
            
            
            27
            
            
            $
            360,003
            
            
            $
            377,238
            
            
            $
            29,841
            
            
            $
            40,460




Loan Status
              
              
              Loan CategoryConstruction &Principal
              
              
              # of
              
              
              #
              
              
              # Non-
              
              
              Pre-entitled
              
              
              Entitled
              
              
              ExistingPeriod
              
              Outstanding
              
              
              Loans
              
              
              Performing
              
              
              Performing
              
              
              Land
              
              
              Land
              
              
              Stuctures(millions)Q4
      2008
              
              $
              89.1
              
              
              
              4
              
              
              
              4
              
              
              
              —
              
              
              
              1
              
              
              
              3
              
              
              
              —Q1
      2009
              
              
              64.8
              
              
              
              5
              
              
              
              5
              
              
              
              —
              
              
              
              —
              
              
              
              3
              
              
              
              2Q2
      2009
              
              
              52.4
              
              
              
              3
              
              
              
              1
              
              
              
              2
              
              
              
              —
              
              
              
              3
              
              
              
              —Q3
      2009
              
              
              117.2
              
              
              
              7
              
              
              
              4
              
              
              
              3
              
              
              
              —
              
              
              
              6
              
              
              
              1Q4
      2009
              
              
              44.4
              
              
              
              4
              
              
              
              3
              
              
              
              1
              
              
              
              —
              
              
              
              4
              
              
              
              —Q1
      2010
              
              
              8.4
              
              
              
              2
              
              
              
              1
              
              
              
              1
              
              
              
              —
              
              
              
              2
              
              
              
              —Q2
      2010
              
              
              1.0
              
              
              
              2
              
              
              
              2
              
              
              
              0
              
              
              
              —
              
              
              
              —
              
              
              
              2Q3
      2010
              
              
              -
              
              
              
              0
              
              
              
              0
              
              
              
              0
              
              
              
              —
              
              
              
              —
              
              
              
              -Total
      loans
              
              $
              377.3
              
              
              
              27
              
              
              
              20
              
              
              
              7
              
              
              
              1
              
              
              
              21
              
              
              
              5




69




Interest
              
              
              Interest
              
              
              Additional
              
              
              BorrowerPrincipal
              
              
              Number
              
              
              Rate
              
              
              Reserves
              
              
              Collateral
              
              
              PrefundedPeriod
              
              Outstanding
              
              
              of Loans
              
              
              Changes
              
              
              Added
              
              
              Taken
              
              
              Interest(millions)Q4
      2008
              
              $
              89.1
              
              
              
              4
              
              
              
              1
              
              
              
              2
              
              
              
              1
              
              
              
              0Q1
      2009
              
              
              64.8
              
              
              
              5
              
              
              
              2
              
              
              
              0
              
              
              
              0
              
              
              
              1Q2
      2009
              
              
              52.4
              
              
              
              3
              
              
              
              1
              
              
              
              0
              
              
              
              0
              
              
              
              0Q3
      2009
              
              
              117.2
              
              
              
              7
              
              
              
              3
              
              
              
              0
              
              
              
              1
              
              
              
              2Q4
      2009
              
              
              44.4
              
              
              
              4
              
              
              
              1
              
              
              
              1
              
              
              
              0
              
              
              
              2Q1
      2010
              
              
              8.4
              
              
              
              2
              
              
              
              0
              
              
              
              0
              
              
              
              0
              
              
              
              0Q2
      2010
              
              
              1.0
              
              
              
              2
              
              
              
              2
              
              
              
              0
              
              
              
              0
              
              
              
              2Q3
      2010
              
              
              -
              
              
              
              0
              
              
              
              0
              
              
              
              0
              
              
              
              0
              
              
              
              0Total
      loans
              
              $
              377.3
              
              
              
              27
              
              
              
              10
              
              
              
              3
              
              
              
              2
              
              
              
              7




September 30, 2010Amount(in thousands)
              
              
              %
              
              
              #Loans
      Not Modified and Currently Matured
              
              $
              347,233
              
              
              
              71
              %
              
              
              31Loans
      Modified to Extend Maturity
              
              
              101,943
              
              
              
              21
              %
              
              
              5Original
      Maturity Date Not Reached
              
              
              41,706
              
              
              
              8
              %
              
              
              7Total
      Loan Principal
              
              $
              490,882
              
              
              
              100
              %
              
              
              43




Real
Estate Held for Development or Sale




REO
assets are reported as either held for development or held for sale, depending
on whether we plan to develop such assets prior to selling them or instead sell
them immediately. The estimation process involved in the determination of fair
value of REO assets is inherently uncertain since it requires estimates as to
the consideration of future events and market conditions. Our estimate of fair
value is based on our intent regarding the proposed development of the related
asset, if deemed appropriate, as opposed to a sale of such property on an as-is
basis. In such cases, we evaluate whether we will have the intent, resources and
ability to carry out the execution of our disposition strategy under normal
operating circumstances, rather than a forced disposition under duress.
Economic, market, environmental and political conditions, such as exit prices
and absorption rates, may affect management’s plans for development and
marketing of such properties. In addition, the implementation of such plans
could be affected by the availability of financing for development and
construction activities, if such financing is required. Accordingly, the
ultimate realization of our carrying values of our real estate properties is
dependent upon future economic and market conditions, the availability of
financing, and the resolution of political, environmental and other related
issues, many of which are beyond our control.




We
utilize an asset management function to manage the activities of any projects
acquired through foreclosure or by other means. Additionally, during the year
ended December 31, 2009, we engaged the services of an outside asset management
consulting firm to assist us in the determination of our specific asset
disposition strategy. The consulting firm received $112,000 per month for its
service, through August 2010.  Effective September 1, 2010, this fee
was reduced to $85,000 per month.  Services rendered under this
agreement include the preparation of analyses to evaluate various alternatives
to determine the highest and best use for the development and ultimate
liquidation of the projects. The agreement was further modified in November 2010
whereby, beginning in December 2010, the monthly fixed fee will be $45,000 plus
a finder’s fee equal to 1.75% of any financing proceeds secured by the
consulting firm on our behalf.  Additionally, the consulting firm will
be entitled to a finder’s fee equal to 1⁄2% to 1% of the value received of a
merger or acquisition candidate, if any, identified by the consulting
firm.  As of September 30, 2010, we accrued $0.1 million to the
consulting firm for financing proceeds secured by the consulting firm in the
third quarter of 2010.




70




We
continue to evaluate various alternatives for the ultimate disposition of these
investments, including partial or complete development of the properties prior
to sale or disposal of the properties on an as-is basis. Project development
alternatives may include, either through joint venture or on a project
management basis, the development of the project through entitlement prior to
sale, completion of various improvements or complete vertical construction prior
to sale. For additional information regarding these properties, see the section
titled “Our
Business — Properties” of our previously filed annual report on
Form 10-K/A.




At
December 31, 2009, we held total REO assets of $104.2 million, of which $92.1
million was held for development and $12.1 million was held for sale. During
2009, we sold various individual residential units held in our real estate
portfolio for approximately $1.1 million which approximated the carrying value
of such assets. At September 30, 2010, we held total REO assets of $109.3
million, of which $71.3 million was held for development and $38.0 million was
held for sale. During the nine months ended September 30, 2010, we foreclosed on
ten loans and took title to the underlying collateral with net carrying values
totaling $25.4 million as of September 30, 2010. Additionally, we acquired an
additional lot held for sale in connection with the acquisition of the Manager
with a fair value of $39,000. All REO assets held by us are located in
California, Arizona, Texas, Minnesota and Nevada.




Costs
related to the development or improvements of the real estate assets are
generally capitalized and costs relating to holding the assets are generally
charged to expense. Cash outlays for capitalized development costs totaled $2.4
million and $0.7 million during the nine months ended September 30, 2009 and
2010, respectively. In addition, costs and expenses related to operating,
holding and maintaining such properties, which were expensed and included in
operating expenses for REO assets in the accompanying consolidated statement of
operations, totaled approximately $2.5 million and $4.1 million for the nine
months ended September 30, 2009 and 2010, respectively, and $1.2 million and
$1.5 million for the three months ended September 30, 2009 and 2010,
respectively. During the nine months ended September 30, 2010, we sold certain
REO assets for $6.8 million resulting in a net loss on disposal of real estate
of $1.2 million.  The nature and extent of future costs for such
properties depends on the level of development undertaken, the number of
additional foreclosures and other factors. While our assets are generally
available for sale, we continue to evaluate various alternatives for the
ultimate disposition of these investments, including partial or complete
development of the properties prior to sale or disposal of the properties on an
as-is basis. As of September 30, 2010, approximately 42% of our REO assets were
originally projected for development of residential real estate, 19% was
scheduled for mixed used real estate development and 39% was planned for
commercial use. We are currently evaluating our use and disposition options with
respect to these projects. The real estate held for sale consists of improved
residential lots, completed residential units and medical facilities located in
Arizona and Texas.




The
following table presents a summary of REO assets held by us as of December 31,
2009 and September 30, 2010, respectively, by state (in thousands except unit
data):




December 31, 2009
            
            
            September 30, 2010Held For Development
            
            
            Held for Sale
            
            
            Held For Development
            
            
            Held for Sale# of
            
            
            Aggregate Net
            
            
            # of
            
            
            Aggregate Net
            
            
            # of
            
            
            Aggregate Net
            
            
            # of
            
            
            Aggregate NetState
            
            Projects
            
            
            Carrying Value
            
            
            Projects
            
            
            Carrying Value
            
            
            Projects
            
            
            Carrying Value
            
            
            Projects
            
            
            Carrying ValueCalifornia
            
            
            3
            
            
            $
            9,644
            
            
            
            -
            
            
            $
            -
            
            
            
            1
            
            
            $
            4,810
            
            
            
            2
            
            
            $
            1,661Texas
            
            
            3
            
            
            
            39,326
            
            
            
            -
            
            
            
            -
            
            
            
            2
            
            
            
            28,557
            
            
            
            4
            
            
            
            11,832Arizona
            
            
            6
            
            
            
            31,485
            
            
            
            4
            
            
            
            12,082
            
            
            
            7
            
            
            
            26,178
            
            
            
            15
            
            
            
            18,136Minnesota
            
            
            1
            
            
            
            11,694
            
            
            
            -
            
            
            
            -
            
            
            
            2
            
            
            
            11,713
            
            
            
            -
            
            
            
            -Nevada
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            1
            
            
            
            6,419Total
            
            
            13
            
            
            $
            92,149
            
            
            
            4
            
            
            $
            12,082
            
            
            
            12
            
            
            $
            71,258
            
            
            
            22
            
            
            $
            38,048


71


Important
Relationships Between Capital Resources and Results of Operations




Mortgage
Loans, Participations and Loan Sales




With the
consummation of the Conversion Transactions, we believe that certain loans are
likely to be sold or participated in the future. While we expect that any future
loan participations or loan sales will also occur at or near par, due in part to
current market conditions, there can be no assurance that this will be the case.
In light of current economic conditions, it may be necessary for us to employ
alternative structures for loan participations and loan sales and they may be
relatively less attractive to us.




Annualized
Rate of Return to Members on Distributions




We
suspended distribution to members in the second quarter of 2009.  As
such, there were no distributions or dividends paid during the nine months ended
September 30, 2010. The annualized yield based on distributions made to members
was 2.1% and 0.0% for the nine and three months ended September 30, 2009,
respectively. The annualized yield was computed by dividing the sum of the
weighted average monthly yield, based on gross distributions made to members of
the Fund, by the number of days in the respective period, and multiplying the
result by 365 days.




Summary
of Existing Loans in Default




Loans in
default balances encompass both non-accrual loans and loans for which we are
still accruing income, but are delinquent as to the payment of accrued interest
or are past scheduled maturity.  At December 31, 2009, 50 of our 55
loans with outstanding principal balances totaling $532.0 million were in
default, of which 34 with outstanding principal balances totaling $347.1 million
were past their respective scheduled maturity dates, and the remaining 16 loans
were in default as a result of delinquency on outstanding interest payments or
have been deemed non-performing based on value of the underlying collateral in
relation to the respective carrying value of the loan. At September 30, 2010, 36
of our 43 loans with outstanding principal balances totaling $480.6 million were
in default, of which 31 with outstanding principal balances totaling $347.2
million were past their respective scheduled maturity dates and the remaining 5
loans were in default as a result of delinquency on outstanding interest
payments or have been deemed non-performing based on value of the underlying
collateral in relation to the respective carrying value of the loan. In light of
current economic conditions and in the absence of a recovery of the credit
markets, it is anticipated that many, if not most, loans with scheduled
maturities within one year will not be paid off at the scheduled maturity. One
of the loans previously in non-accrual status during the year ended December 31,
2009, in which we were a participating lender with a principal balance totaling
$6.3 million, was foreclosed upon by us in the fourth quarter of the year ended
December 31, 2009.





During
the nine months ended September 30, 2010, we foreclosed on ten loans with net
carrying values of $25.4 million. We are currently exercising enforcement action
which could lead to foreclosure by us upon 27 of the 36 loans in default as of
September 30, 2010. With respect to the loans upon which we are exercising
enforcement action, we expect to complete the foreclosure process on the
majority of such loans over the next six months.





Two loans
that were previously in non-accrual status in the year ended December 31, 2009,
with principal balances totaling $28.5 million, related to a bankruptcy of the
borrower and were consolidated into one loan in connection with the approved
plan of reorganization and the loan terms were restructured in the fourth
quarter of 2009. The loan restructure did not result in any forgiveness of
principal or accrued interest. However, due to the value of the underlying
collateral in relation to loan principal for this collateral-based loan, we have
deemed it appropriate to keep this restructured loan in non-accrual status as of
December 31, 2009 and September 30, 2010.





As of
September 30, 2010, five loans that are in non-accrual status relate to two
borrowing groups that are not in technical default under the loan terms.
However, due to the value of the underlying collateral for these collateral
dependent loans, we have deemed it appropriate to maintain these loans in
non-accrual status.





We are
continuing to work with the borrowers with respect to the remaining four loans
in default in order to seek to maintain the entitlements on such projects and,
thus, the value of our existing collateral. However, such negotiations may
result in a payoff of an amount that is below our loan principal and accrued
interest, and that discounted payoff may be materially less than the contractual
principal and interest due. Generally, the allowance for credit loss
contemplates the potential loss that may occur as a result of a payoff of the
loan at less than its contractual balance due. We are considering our preferred
course of action with respect to all remaining loans. However, we have not
commenced enforcement action on these other loans thus far.


72





Of the
principal balances in default as of September 30, 2010, as a percent of the
total: approximately 32% has been in default status since December 31, 2008;
approximately 13% has been in default status since March 31, 2009; approximately
39% has been in default status since June 30, 2009; 2% has been in default
status since September 30, 2009; 12% has been in default status since December
31, 2009; 1% has been in default since March 31, 2010; 0.3% has been in default
status since June 30, 2010 and 0.7% entered default status during the quarter
ended September 30, 2010.





At
September 30, 2010, all 36 loans in default were in non-accrual status. Total
contractual interest due under the loans classified in non-accrual status was
$43.3 million, of which $3.2 million is included in accrued interest receivable
on the balance sheet, and $40.1 million has not been recognized as income by us.
Excluding loans whose maturity has not been reached as of September 30, 2010,
loans in default were past their scheduled maturities between one and 1,057 days
as of September 30, 2010.





The
geographic concentration of loans in default, net of the allowance for credit
loss or valuation allowance, at December 31, 2009 and September 30, 2010 is as
follows:




December 31, 2009Percent of
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            Non-AccruedOutstanding
            
            
            
            
            
            Outstanding
            
            
            Allowance for
            
            
            Net Carrying
            
            
            Accrued
            
            
            NotePrincipal
            
            
            #
            
            
            Principal
            
            
            Credit Loss
            
            
            Amount
            
            
            Interest
            
            
            Interest
            
            
            TotalArizona
            
            
            52.3
            %
            
            
            23
            
            
            $
            278,306
            
            
            $
            (162,282
            )
            
            $
            116,024
            
            
            $
            5,362
            
            
            $
            13,723
            
            
            $
            135,109Idaho
            
            
            9.3
            %
            
            
            2
            
            
            
            49,594
            
            
            
            (38,981
            )
            
            
            10,613
            
            
            
            1,948
            
            
            
            5,993
            
            
            
            18,554California
            
            
            33.8
            %
            
            
            19
            
            
            
            179,773
            
            
            
            (120,829
            )
            
            
            58,944
            
            
            
            3,959
            
            
            
            18,349
            
            
            
            81,252Texas
            
            
            2.1
            %
            
            
            3
            
            
            
            11,102
            
            
            
            (4,272
            )
            
            
            6,830
            
            
            
            427
            
            
            
            1,170
            
            
            
            8,427Nevada
            
            
            1.5
            %
            
            
            1
            
            
            
            7,984
            
            
            
            (2,613
            )
            
            
            5,371
            
            
            
            319
            
            
            
            957
            
            
            
            6,647New
      Mexico
            
            
            1.0
            %
            
            
            2
            
            
            
            5,240
            
            
            
            (1,094
            )
            
            
            4,146
            
            
            
            -
            
            
            
            586
            
            
            
            4,732100.0
            %
            
            
            50
            
            
            $
            531,999
            
            
            $
            (330,071
            )
            
            $
            201,928
            
            
            $
            12,015
            
            
            $
            40,778
            
            
            $
            254,721




September 30, 2010Percent of
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            Non-AccruedOutstanding
            
            
            
            
            
            Outstanding
            
            
            Valuation
            
            
            Net Carrying
            
            
            Accrued
            
            
            NotePrincipal
            
            
            #
            
            
            Principal
            
            
            Allowance
            
            
            Amount
            
            
            Interest
            
            
            Interest
            
            
            TotalArizona
            
            
            51.4
            %
            
            
            14
            
            
            $
            246,801
            
            
            $
            (153,257
            )
            
            $
            93,544
            
            
            $
            (2,609
            )
            
            $
            16,761
            
            
            $
            107,696Idaho
            
            
            10.3
            %
            
            
            2
            
            
            
            49,637
            
            
            
            (43,178
            )
            
            
            6,459
            
            
            
            1,948
            
            
            
            4,493
            
            
            
            12,900California
            
            
            35.6
            %
            
            
            17
            
            
            
            171,230
            
            
            
            (136,431
            )
            
            
            34,799
            
            
            
            3,770
            
            
            
            17,915
            
            
            
            56,484New
      Mexico
            
            
            1.1
            %
            
            
            2
            
            
            
            5,260
            
            
            
            (1,985
            )
            
            
            3,275
            
            
            
            (16
            )
            
            
            445
            
            
            
            3,704Utah
            
            
            1.6
            %
            
            
            1
            
            
            
            7,645
            
            
            
            -
            
            
            
            7,645
            
            
            
            153
            
            
            
            460
            
            
            
            8,258100.0
            %
            
            
            36
            
            
            $
            480,573
            
            
            $
            (334,851
            )
            
            $
            145,722
            
            
            $
            3,246
            
            
            $
            40,074
            
            
            $
            189,042




73







Non-Percent of
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            AccruedOutstanding
            
            
            
            
            
            Outstanding
            
            
            Valuation
            
            
            Net Carrying
            
            
            Accrued
            
            
            NotePrincipal
            
            
            #
            
            
            Principal
            
            
            Allowance
            
            
            Amount
            
            
            Interest
            
            
            Interest
            
            
            TotalPre-entitled
      Land
            
            
            41.4
            %
            
            
            10
            
            
            $
            198,728
            
            
            $
            (167,604
            )
            
            $
            31,124
            
            
            $
            6,380
            
            
            $
            18,947
            
            
            $
            56,451Entitled
      Land
            
            
            34.5
            %
            
            
            15
            
            
            
            165,613
            
            
            
            (139,926
            )
            
            
            25,687
            
            
            
            1,590
            
            
            
            15,905
            
            
            
            43,182Construction
            
            
            24.2
            %
            
            
            11
            
            
            
            116,232
            
            
            
            (27,321
            )
            
            
            88,911
            
            
            
            (4,724
            )
            
            
            5,222
            
            
            
            89,409100.0
            %
            
            
            36
            
            
            $
            480,573
            
            
            $
            (334,851
            )
            
            $
            145,722
            
            
            $
            3,246
            
            
            $
            40,074
            
            
            $
            189,042




Of our
loans in default at December 31, 2009, 50% of the loan principal balances
related to residential end-use projects, 33% related to mixed-use projects, and
17% related to commercial and industrial projects. Of our portfolio loans in
default at September 30, 2010, 53% of such loan principal balances related to
residential end-use projects, 32% related to mixed-use projects, and 15% related
to commercial and industrial projects. Other than as discussed in the foregoing
paragraphs, the seven remaining performing loans in our portfolio, with
principal balances totaling $10.3 million were current as of September 30, 2010
to principal and interest payments.





A summary
of loans that meet the definition for impaired loans is presented in Note 4 of
the accompanying financial statements under the heading entitled “Loans in Default and Impaired
Loans”. There were no material changes in such balances from December 31,
2009 to September 30, 2010.




Allowance
for Credit Loss / Valuation Allowance and Fair Value Measurement




As
discussed in our Significant Accounting Policies of our previously filed Annual
Report on Form 10-K/A, we perform a valuation analysis of our loans not less
frequently than quarterly.




In
considering the highest and best use for individual mortgage loans, we first
consider whether the asset is considered “in use” as opposed to “in exchange”.
Due to the nature of the underlying collateral of our loans and the development
status of such projects, substantially all of our assets are deemed to be “in
exchange” assets for purposes of determining highest and best use.




Next, we
assess the extent, reliability and quality of market participant inputs such as
sales pricing, cost data, absorption, discount rates, and other assumptions, as
well as the significance of such assumptions in deriving the
valuation.




We
generally employ one of five valuation approaches, or a combination of such
approaches, in determining the fair value of the underlying collateral of each
loan: the development approach, the income capitalization approach, the sales
comparison approach, the cost approach, or the receipt of recent offers on
specific properties. The valuation approach taken depends on several factors
including:




·
            the
      type of property;




·
            the
      current status of entitlement and level of development (horizontal or
      vertical improvements) of the respective
  project;




·
            the
      likelihood of a bulk sale as opposed to individual unit
    sales;




·
            whether
      the property is currently or near ready to produce
  income;




·
            the
      current sales price of property in relation to cost of
      development;




·
            the
      availability and reliability of market participant data;
    and




·
            the
      date of an offer received in relation to the reporting
    period.




In the
latter part of 2008 and part of 2009, the global and U.S. economies experienced
a rapid decline resulting in unprecedented disruptions in the real estate,
capital, credit and other markets. As a result of these factors, we recorded a
provision for credit losses developed in the third quarter of 2008 using a
development/residual analysis approach, reflecting lower pricing assumptions,
slower absorption and a significant increase in discount factors to reflect
current market participant risk levels.




74




In the
third quarter of 2009, given recent sales activity and the on-going volatility
in the real estate markets, we engaged an independent third-party valuation
firms and other consultants to assist with the analysis of fair value of the
collateral supporting our loans as of September 30, 2009, which was then updated
for financial reporting as of December 31, 2009.  During the quarter
ended June 30, 2010, we re-engaged independent third-party valuation firms to
provide complete updated valuation reports for the majority of our
loans.    For the quarter ended September 30, 2010, we
obtained a letter from our third-party valuation firm concluding there was no
material diminution in the fair value indications reported for the properties
valued at June 30, 2010.  Additionally, for the quarter ended
September 30, 2010, we engaged a separate third-party valuation firm to perform
valuations on the remaining portfolio.




The
following is a summary of the procedures performed in connection with our fair
value analysis as of and for the year ended December 31, 2009 and for the nine
months ended September 30, 2010:




1.
            We
      reviewed the status of each of our loans to ascertain the likelihood that
      we will collect all amounts due under the terms of the loans at maturity
      based on current real estate and credit market
  conditions.




2.
            With
      respect to our loans whose collection was deemed to be unlikely, we
      reviewed the portfolio to ascertain when the latest valuation of the
      underlying collateral was
performed.




3.
            We subjected all of our loans to
      independent third-party valuation as of September 30, 2009, (with a review
      and update of such valuations provided through December 31, 2009), to
      determine whether any material changes in industry or economic conditions
      warranted a change in the valuation conclusions formed since the date of
      our last valuation.  As of June 30, 2010, we subjected 74% of
      our outstanding loans to independent third-party valuation.  The
      remaining 26% was subject to independent third-party valuation during the
      quarter ended September 30,
2010.




4.
            For
      the year ended December 31, 2009 and for the quarter ended September 30,
      2010, we utilized the services of Cushman & Wakefield, a nationally
      recognized valuation firm, and other valuation firms to perform a
      valuation analysis for the selected projects. Cushman & Wakefield
      valued approximately 89% of the outstanding principal balance of our loan
      portfolio at December 31, 2009 while other valuation firms valued the
      remaining 11%. At June 30, 2010, Cushman & Wakefield valued 73% of the
      portfolio and 1% of the portfolio was valued by another third-party
      valuation firm. For those 26% of valuations performed by valuation firms
      other than Cushman & Wakefield, we engaged Cushman & Wakefield to
      perform a review of the valuations and
reports.




5.
            For
      projects in which we have received a bona fide written third-party offer
      to buy our loan, or the borrower has received a bona fide written
      third-party offer to buy the related project, we utilized the offer amount
      in cases in which the offer exceeded the valuation conclusion reached by
      the independent valuation firms. Such offers are only considered if we
      deem the offer to be valid, reasonable and negotiable, and we believe the
      offeror has the financial wherewithal to execute the transaction. When
      deemed appropriate, the offers received were discounted by up to 20% to
      allow for potential changes in our on-going
  negotiations.




A summary
of the results and key assumptions that we utilized, as supported by the
independent valuation firms to derive fair value, is as follows:




·
            Very few of the precedent
      transactions that were analyzed satisfied the market value and fair value
      requirement that the price reflect that of an orderly transaction, rather
      than that of a sale under duress or in markets in
      turmoil.




·
            Inputs
      for use in the development valuation models were reported by the valuation
      firms to be inconsistent and reflective of a distressed market that had
      not yet stabilized for inputs into discounted cash flow or other financial
      models, such as absorption rates and timing, unit pricing and trends,
      discount rate, risk adjustment processes, or the
  like.




75




·
            A distinction was made between
      owners under duress and properties under duress. Market values are
      determined based on the highest and best use of the real property being
      valued. When owners are under duress, as defined by applicable accounting
      guidance, prices of transactions in which they are involved must be viewed
      as at least potentially subject to duress as well. The valuation firms
      took this distinction into account in arriving at highest and best use
      conclusions and selecting appropriate valuation
      methodologies.




·
            For
      the projects which included either un-entitled or entitled land lacking
      any vertical or horizontal improvements, given the current distressed
      state of the real estate and credit markets, the development approach was
      deemed to be unsupportable because market participant data was
      insufficient or other assumptions were not readily available from the
      valuation firm’s market research; the “highest and best use” standard in
      these instances required such property to be classified as “held for
      investment” purposes until market conditions provide observable
      development activity to support a valuation model for the development of
      the planned site. As a result, the valuation firms used a sales comparison
      approach using available data to determine fair
  value.




·
            For the projects containing
      partially or fully developed lots, the development approach was generally
      utilized, with assumptions made for pricing trends, absorption
      projections, holding costs, and the relative risk given these assumptions.
      The assumptions were based on currently observable available market
      data.




·
            For
      operating properties, the income approach, using the direct capitalization
      and discounted cash flow methods was used by the valuation firms. The
      anticipated future cash flows and a reversionary value were discounted to
      the net present value at a chosen yield rate. The assumptions were based
      on currently observable available market
data.




As of
December 31, 2009 and September 30, 2010, the highest and best use for the
majority of real estate collateral subject to third-party valuation was deemed
to be held for investment and/or future development, rather than being subject
to immediate development and/or sale. In determining fair value as of December
31, 2009, we utilized the “as is” sales comparable valuation methodology for 31
assets, the development approach for six assets, the income capitalization
approach for four assets, and the cost approach for two assets, and we utilized
offers received from third parties to estimate fair value for the remaining 14
assets. In determining fair value as of September 30, 2010, we utilized the “as
is” sales comparable valuation methodology for 32 assets, the development
approach for 6 assets, the income capitalization approach for 3 assets, and we
utilized offers received from third parties to estimate fair value for the
remaining 2 assets. We selected a fair value within a determinable range as
provided by the valuation firm.




For
certain assets, as of December 31, 2009, we supplemented our analysis by
utilizing a risk-adjusted cash flow model commonly used in our industry based on
certain assumptions and market participant inputs to determine fair value, which
presumed a development approach as highest and best use for such projects. To
evaluate the collateral relating to these projects, we performed different
procedures depending on the stage of the collateral, which are described below
along with a summary of key assumptions utilized in our evaluations of fair
value were as follows:




·
            For
      collateral to be developed, the initial unit sales price utilized was
      based on local market, comparable prices from non-distressed pricing from
      prior periods utilizing observable and unobservable data points, generally
      discounted by 20% or more. In general, we assumed a price escalation
      utilizing the low end of a historical 3-year average look back for the
      last 10 years. We considered this a fair exchange price in an orderly
      transaction between market participants to sell the asset, assuming its
      highest and best use as determined by management, in the principal or most
      advantageous market for the asset.




·
            For
      collateral to be developed prior to being sold, the additional development
      costs, operating and selling cost assumptions were based on observable and
      unobservable cost estimates obtained from a cross section of industry
      experts and market participants.




76




·
            For
      collateral consisting of partially complete or finished lots, development
      costs, operating and selling cost assumptions we made were based on
      observable and unobservable cost estimates obtained from a cross-section
      of industry experts and market
participants.




·
            For
      collateral whose development is complete or nearly complete and which is
      expected to be leased initially to allow for stabilization of market
      prices before being sold, we utilized operating revenue and costs for
      comparable projects using current operating data obtained by us. Based
      upon an assumed stabilization of applicable real estate markets, we
      utilized unit sales prices comparable to historical
    pricing.




·
            Based
      on the resulting net cash flows derived from the utilization of the above
      assumptions, we applied risk-adjusted annual discount rates ranging from
      10.5% to 30% for December 31, 2009 and September 30, 2010, respectively to
      the net cash flows, depending on the projected build-out term, the project
      type, the location and assumed project
risk.




All of
our loans were subject to valuation by independent third-party valuation firms
and all of the valuation reports were delivered to us within 45 days of the
reporting period. During the quarters ended December 31, 2009 and September 30,
2010, in the event of a change in circumstances from the prior period valuation,
we updated our assessment of certain loans and obtained certain updated
valuations as a result of the change in circumstances. Additionally, we obtained
updated third-party offers and considered other changes to the status of
underlying collateral.




Selection
of Single Best Estimate of Value for Loans




As
previously described, we obtained valuation reports from third-party valuation
specialists for the underlying collateral of each of our loans in 2009 and all
such loans during the quarters ended June 30, 2010 and September 30, 2010.
Because all of our loans are collateral dependent, each loan’s impairment amount
is based on the fair value of its underlying collateral less cost to sell. The
valuation reports provided a range of values for the collateral valued rather
than a single point estimate because of variances in the potential value
indicated from the available sources of market participant information. The
selection of a value from within a range of values depends upon specific market
conditions for each property valued and its stage of entitlement or development.
In addition to third-party valuation reports, we utilized recently received bona
fide purchase offers from independent third-party market participants that were
higher than the high-end of the third-party specialist’s range of values. In
selecting the single best estimate of value, we considered the information in
the valuation reports, credible purchase offers received, as well as multiple
observable and unobservable inputs as described below.




December
31, 2009 Selection of Single Best Estimate




Our
December 31, 2009 valuation assessments were based on updated market participant
information and other data points, which in our judgment provided less
uncertainty than the market participant data that was available at December 31,
2008. The updated information and our analysis of the collateral indicated a
slight improvement in market conditions and corresponding increase in real
estate values. As a result, for the valuation ranges on 41 of the 55 loans
obtained as of December 31, 2009 supporting loan collateral values, we used the
high end of the third-party valuation range for each asset in determining
impairment losses. For the remaining 14 loans, our estimate of fair values were
based on independent third-party market participant purchase offers on those
specific assets, some of which were well in excess of the fair values indicated
in the third-party valuation reports, including some offers which were two to
three times higher than the valuation report ranges. While consideration of the
range of values was evaluated on a loan-by-loan basis, as a general matter, we
used the high end of the value range, as described above, because, in our
judgment, when considering the multiple applicable observable and unobservable
inputs and other current market factors, the high end of the value range is the
best estimate of fair value, less costs to sell, for purposes of determining
impairment losses, based on the following factors:




77


·
            In
      conducting the December 31, 2009 valuations, the third-party valuation
      specialist’s data and the research performed in connection with valuations
      were influenced by market duress, economic uncertainty, and a relative
      shortage of tangible market data. A number of the relevant transactions
      consummated around the time of preparation of the valuation reports were
      believed to be based on either a property or a seller in distress and,
      thus, the applicable transaction was executed under a condition of duress.
      We noted that the pricing of many actual transactions in what was observed
      to be a less than normal volume of purchases and sales frequently appeared
      to be lower than the expectations of many, if not most, owners of
      competitive properties. As a result, in our judgment, for each of our
      loans not supported by recent bona fide independent third-party purchase
      offers, we concluded that the values at the high end of the range were
      more representative of fair values than any other point in the
      range;





·
            We
      concluded that the third-party valuation specialist’s reported value
      ranges, and the underlying concepts of the ranges themselves, did not
      reflect the improving market conditions as of December 31, 2009, but
      because of the lag in the time frame for gathering and processing
      information, were more representative of early fourth-quarter 2009, if not
      before. We obtained observable and unobservable evidence (such as
      published residential pricing indices and other real estate market
      publications, discussions with real estate brokers with applicable market
      expertise in local markets, discussions with third-party consultants and
      direct market participants with relevant real estate experience) as of
      December 31, 2009 that indicated that fair values had “bottomed out”, and
      there was an indication that the home pricing trends were moving upward.
      Based on our experience, buyers will select parcels that offer the most
      competitive advantage and the highest and best use of their capital in
      order to complete their project and maximize their
  returns.





·
            Individual
      valuation reports were prepared assuming non-leveraged sales transactions
      of the underlying collateral in accordance with professional appraisal
      standards. Because our core business is that of a first lien real estate
      mortgage lender and dealer, we believe that our capacity to provide
      financing, particularly in the absence of available financing in existing
      credit markets, provides us a market advantage that would significantly
      increase the likelihood that qualified buyers would be willing to pay a
      price at the top of the applicable valuation range. We believe that this
      market advantage further supports our selection of the high end of the
      range when determining the single best estimate of value from within the
      range of values provided.




September
30, 2010 Selection of Single Best Estimate




In
determining the single best estimate of value for the September 30, 2010
valuation analysis, in our judgment, the updated market participant information
and other economic data points provided less certainty than the market
participant data that was available at December 31, 2009.




In
conducting the June 30, 2010 valuations and re-confirmed through their updates
as of September 30, 2010, the third-party valuation specialist’s data and the
research performed were influenced by transactions which appeared to reflect
on-going pricing executed under conditions of duress and economic
uncertainty.  Nevertheless, the pricing in such transactions does not
appear to be improving in the short-term and therefore such pricing is
reflective of current market values by market participants.  The
updated information and our analysis of the collateral, indicated an on-going
deterioration in market conditions and corresponding decrease in real estate
values, contrary to such indications provided at December 31, 2009. Such
indicators were reflected in the third-party valuation reports obtained, several
of which resulted in significantly decreased values from the December 31, 2009
range of values provided. For the 43 loans subject to current valuation, the
primary collateral supporting 16 notes increased in value since the December 31,
2009 valuation, while 18 decreased in value and 9 remained unchanged. 
However, based on the midpoint of the valuation ranges, the average valuation
increase for the 16 loans was $819 while the average decrease in valuation on
the 18 loans was $1,264.




A summary
of selected real estate and general economy-related published market participant
observations which influenced management’s current assessment of market status
and trends follows:




·
            According
      to a Bloomberg news article in September 2010, US home builders’
      confidence fell to 13 in August 2010 and remained there in September 2010,
      the lowest level since March 2009. An index level of 50 indicates that
      home builders view sales conditions as equally good as
    poor.




78




·
            According
      to a Press TV news article in September 2010, the decline in builders’
      confidence is due to consumer reluctance, as unemployment hovers near the
      10-percent mark and the housing market remains glutted with the large
      number of foreclosed properties for
sale.




·
            According
      to an October 2010 Reuters news article, the International Monetary Fund
      (IMF) states that the US economy will have sluggish growth this year and
      in 2011 due to weak consumer spending rates and soaring debt. The IMF
      World Economic Outlook report stated that the growth rate in the American
      economy has slowed from 3.7% in the first quarter of the year to 1.7%,
      adding that the US economy will face a weak recovery in the coming
      months.




·
            The
      Reuters article also stated that the slower-than-predicted US economic
      growth dims any hopes for bringing down the very high unemployment rate
      anytime soon as well as causing a reduction in household wealth due to
      falling home prices.




According
to the press release regarding the Federal Reserve’s September 2010 meeting, the
pace of recovery in output and employment has slowed in recent
months.  Household spending remains constrained by high employment,
modest income growth, lower housing wealth and tight credit. Additionally,
investment in nonresidential structures continues to be weak and housing starts
are on a depressed level as well as bank lending has continued to
contract.




The above
observable inputs combined with others and management’s specific knowledge
related to marketing activity surrounding the loan’s collateral have resulted in
the movement of collateral valuation expectations to the lower end of the
determinable range. As a result, in our judgment, for each of our loans not
supported by recent bona fide independent third-party purchase offers or those
assets which were supported by specific circumstances in using either the high
or low end value, management concluded that the values slightly above the low
end of the range (i.e., 25% of the valuation spread over the low end value) were
more representative of fair values than any other point in the range. In
management’s judgment, this point in the value range was deemed to be the best
estimate of fair value, less costs to sell for purposes of determining
impairment losses as of September 30, 2010.




As such,
for the valuation ranges on the 43 loans obtained as of September 30, 2010
supporting loan collateral values, we used the high end of the third-party
valuation range for one asset and the mid-point value for another asset in
determining impairment losses based on the quality of the collateral and
financial strength of the related borrower. We utilized the low end value for
five assets whose geographic location, entitlement status, and long-term
development plan made such assets, in management’s opinion, less desirable and
marketable to market participants. Due to the uncertainty in market conditions
noted above, we selected a point midway between the low end value and mid-range
value for 24 of the loans. For the remaining two loans, our estimate of fair
values were based on independent third-party market participant purchase offers
on those specific assets, some of which were in the range of fair value
indicated in the third-party valuation reports and others which were in excess
of such amounts, including some offers which were two to three times higher than
the valuation report ranges. In the aggregate, management’s estimate of fair
value based on these bona fide offers exceeded the high end of the valuation
range by approximately $1.6 million.




Based on
the results of our evaluation and analysis, we recorded a provision for credit
losses of $79.3 million for the year ended December 31, 2009 and $34.4 million
for the nine months ended September 30, 2010, of which $27.6 million was
recorded during the quarter ended June 30, 2010 and $6.8 million was recorded
during the quarter ended September 30, 2010. We recorded a provision for credit
losses of $82.0 million for the nine months ended September 30, 2009, which was
adjusted downward by $2.7 million in the fourth quarter of
2009.  During the year ended December 31, 2009 and the nine months
ended September 30, 2010, we also recorded impairment charges of $8.0 million
and $13.2 million, respectively, relating to the further write-down of certain
real estate acquired through foreclosure during the respectively periods. The
impairment charge for assets acquired through foreclosure relates to the
impairment of REO assets deemed to be other than temporary. The provision for
credit losses and impairment charges are reflective of the continued
deterioration of the real estate markets and the sustained decline in pricing of
residential real estate in recent months combined with the continuing downturn
in the commercial real estate markets.


79




As of
December 31, 2009, the allowance for credit loss totaled $330.4 million (of
which $328.0 million related to  mortgage loans held to maturity and
$2.4 million related to mortgage loans held for sale), representing 53.2% of the
total loan principal balance.As of September 30,
2010, the valuation allowance totaled $334.9 million (all of which related to
mortgage loans held for sale), representing 68.2% of the total loan principal
balances. With the existing valuation allowance recorded as of June 30, 2010, we
believe that as of that date, the fair value of the underlying collateral of our
loans is adequate in relation to the net carrying value of loan principal and
accrued interest, and that no additional valuation allowance is considered
necessary.




While the
above results reflect management’s assessment of fair value as of December 31,
2009 and September 30, 2010 based on currently available data, we will continue
to evaluate our loans in the remaining quarters of 2010 and beyond to determine
the adequacy and appropriateness of the valuation allowance and to update our
loan-to-value ratios. Depending on market conditions, such updates may yield
materially different values and potentially increase or decrease the valuation
allowance.




A
roll-forward of the valuation allowance as of September 30, 2010 is as
follows:




September 30,2010Balance
      at beginning of period
                
                $
                330,428Provision
      for credit losses
                
                
                34,380Net
      charge offs
                
                
                (29,927
                )Balance
      at end of period
                
                $
                334,881




The
balance reflected in net charge offs pertains to the portion of the carrying
value charged off to the allowance for credit loss or valuation allowance when
transferred to real estate acquired through foreclosure on our consolidated
balance sheets.





Valuation
Categories




Except
for mortgage loans which are measured at fair value on a non-recurring basis for
purposes of determining valuation with respect to our valuation allowance, no
other of our assets or liabilities is measured at fair value on a recurring or
non-recurring basis. The following table presents the categories for which net
mortgage loans are measured at fair value based upon the lowest level of
significant input to the valuations as of December 31, 2009 and September 30,
2010, respectively (in thousands):


80





December 31, 2009
              
              
              September 30, 2010Significant
              
              
              
              
              
              
              
              
              SignificantOther
              
              
              Significant
              
              
              
              
              
              Other
              
              
              SignificantObservable
              
              
              Unobservable
              
              
              
              
              
              Observable
              
              
              UnobservableInputs
              
              
              Inputs
              
              
              
              
              
              Inputs
              
              
              InputsDescription:
              
              (Level 2)
              
              
              (Level 3)
              
              
              Total
              
              
              (Level 2)
              
              
              (Level 3)
              
              
              TotalNet
      Mortgage Loans:Pre-entitled
      Land:Held
      for Investment
              
              $
              -
              
              
              $
              4,211
              
              
              $
              4,211
              
              
              $
              -
              
              
              $
              1,931
              
              
              $
              1,931Processing
      Entitlements
              
              
              1,028
              
              
              
              49,838
              
              
              
              50,866
              
              
              $
              986
              
              
              
              28,053
              
              
              
              29,0391,028
              
              
              
              54,049
              
              
              
              55,077
              
              
              
              986
              
              
              
              29,984
              
              
              
              30,970Entitled
      Land:Held
      for Investment
              
              
              7,693
              
              
              
              13,499
              
              
              
              21,192
              
              
              
              155
              
              
              
              3,725
              
              
              
              3,880Infrastructure
      under Construction
              
              
              459
              
              
              
              29,939
              
              
              
              30,398
              
              
              
              -
              
              
              
              29,706
              
              
              
              29,706Improved
      and Held for Vertical Construction
              
              
              2,519
              
              
              
              16,012
              
              
              
              18,531
              
              
              
              476
              
              
              
              17,060
              
              
              
              17,53610,671
              
              
              
              59,450
              
              
              
              70,121
              
              
              
              631
              
              
              
              50,491
              
              
              
              51,122Construction
      & Existing Structures:New
      Structure - Construction in-process
              
              
              3,860
              
              
              
              12,359
              
              
              
              16,219
              
              
              
              -
              
              
              
              10,528
              
              
              
              10,528Existing
      Structure Held for Investment
              
              
              -
              
              
              
              16,570
              
              
              
              16,570
              
              
              
              -
              
              
              
              5,878
              
              
              
              5,878Existing
      Structure - Improvements
              
              
              -
              
              
              
              56,033
              
              
              
              56,033
              
              
              
              -
              
              
              
              57,503
              
              
              
              57,5033,860
              
              
              
              84,963
              
              
              
              88,822
              
              
              
              -
              
              
              
              73,909
              
              
              
              73,909Total
              
              $
              15,559
              
              
              $
              198,461
              
              
              $
              214,020
              
              
              $
              1,617
              
              
              $
              154,384
              
              
              $
              156,001




There are
no mortgage loans that were measured at fair value using Level 1 inputs.
Additionally, except for the offers received on specific properties from third
parties which we use to determine fair value, which are considered a Level 2
valuation, all other valuations are deemed to be Level 3.




The table
presented below summarizes the change in balance sheet carrying values
associated with the mortgage loans measured using significant unobservable
inputs (Level 3) during the nine months ended September 30, 2010:




MortgageLoans, netBalances,
      December 31, 2009
              
              $
              198,461Mortgage
      Loan Fundings
              
              
              12,148Mortgage
      Loan Repayments
              
              
              (7,553
              )Transfers
      to REO
              
              
              (51,001
              )Mortgage
      Repayment on whole loan soldTransfers
      into (out of) level 3
              
              
              4,856Included
      in earnings:Provision
      for credit losses
              
              
              (2,527
              )Balances,
      September 30, 2010
              
              $
              154,384




Loan
Classification




In
connection with consummation of the Conversion Transactions, we revised our
business strategy.  Although we have historically focused on the
origination of senior short-term commercial bridge loans with maturities of 12
to 18 months oriented toward the ability of permanent take-out financing, our
primary near-term future focus is on the acquisition and origination of interim
loans, or other short-term financings, that are used to pay off construction or
commercial or residential property loans and are not reliant on the availability
of take-out financing. In addition, we will target the acquisition or financing
of whole commercial real estate mortgage loans, which may be performing,
distressed or non-performing, and participating interests in performing
commercial real estate mortgage loans.   Accordingly, as of
September 30, 2010, the entire loan portfolio is reflected as held for sale in
the accompanying consolidated balance sheets.




81


Real
Estate Owned Asset Valuation


Valuation
of REO assets is based on our intent and ability to execute our disposition plan
for each asset and the proceeds to be derived from such disposition, net of
selling costs, in relation to the carrying value of such assets. REO assets for
which management determines it is likely to dispose of such assets without
further development are valued on an “as is” basis based on current valuations
using comparable sales. If management determines that it has the intent and
ability to develop the asset over future periods in order to realize a greater
value, management will perform a valuation on an “as developed” basis, net of
selling costs but without discounting of cash flows, to determine whether any
impairment exists. Management does not write up the carrying value of real
estate assets held for development if the proceeds from disposition are expected
to exceed the carrying value of such asset. Rather, any gain from the
disposition of such assets is recorded at the time of sale.REO
assets that are classified as held for sale are measured at the lower of
carrying amount or fair value, less cost to sell.





REO
assets that are classified as held for development are considered “held and
used” and are evaluated for impairment when, based on various criteria set forth
in applicable accounting guidance, circumstances indicate that the carrying
amount exceeds the sum of the undiscounted net cash flows expected to result
from the development and eventual disposition of the asset.  If an asset is
considered impaired, an impairment loss is recognized for the difference between
the asset’s carrying amount and its fair value, less cost to sell. See Note 5 of
our audited financial statements in our previously filed Annual Report on Form
10-K/A for the year ended December 31, 2009 for a detailed description of the
summary of the procedures performed and assumptions utilized in connection with
our impairment analysis of REO assets as of and for the year ended December 31,
2009.





If we
elect to change the disposition strategy for our real estate held for
development, and such assets were deemed to be held for sale, we would likely
record additional impairment charges, and the amounts could be significant.
During the year ended December 31, 2009, we recorded impairment charges of $8.0
million relating to the impairment in value of REO assets, deemed to be other
than temporary impairment. The results of our December 31, 2009 valuation
procedures were re-assessed in the first three quarters of 2010 to determine
whether any additional impairment was warranted for the nine months ended
September 30, 2010. As a result of our analysis, we recorded additional
impairment charges totaling $13.2 million during the nine months ended September
30, 2010. The impairment charge was primarily a result of a change in
management’s disposition strategy for selected REO assets from a development
approach to a disposal based on recent values. As of December 31, 2009, 62.7% of
REO assets were valued on an “as is” basis while 37.3% were valued on an “as
developed” basis. As of September 30, 2010, 64% of REO assets were valued
on an “as is” basis while 36% were valued on an “as developed”
basis.





Loan
Classifications





We
classify loans into categories for purposes of identifying and managing loan
concentrations. As of December 31, 2009 and September 30, 2010, respectively,
loan principal balances by concentration category follows (in thousands except
percentages and unit data):




82




December 31, 2009
              
              
              September 30, 2010Amount
              
              
              %
              
              
              #
              
              
              Amount
              
              
              %
              
              
              #Pre-entitled
      Land:Held
      for Investment
              
              $
              13,834
              
              
              
              2.5
              %
              
              
              3
              
              
              $
              18,303
              
              
              
              3.7
              %
              
              
              3Processing
      Entitlements
              
              
              185,608
              
              
              
              34.1
              %
              
              
              8
              
              
              
              180,423
              
              
              
              36.7
              %
              
              
              7199,442
              
              
              
              36.6
              %
              
              
              11
              
              
              
              198,726
              
              
              
              40.4
              %
              
              
              10Entitled
      Land:Held
      for Investment
              
              
              101,942
              
              
              
              18.8
              %
              
              
              14
              
              
              
              73,082
              
              
              
              14.9
              %
              
              
              11Infrastructure
      under Construction
              
              
              69,839
              
              
              
              12.8
              %
              
              
              5
              
              
              
              57,062
              
              
              
              11.6
              %
              
              
              3Improved
      and Held for Vertical Construction
              
              
              47,227
              
              
              
              8.7
              %
              
              
              4
              
              
              
              35,918
              
              
              
              7.3
              %
              
              
              2219,008
              
              
              
              40.3
              %
              
              
              23
              
              
              
              166,062
              
              
              
              33.8
              %
              
              
              16Construction
      & Existing Structures:New
      Structure - Construction in-process
              
              
              46,325
              
              
              
              8.5
              %
              
              
              16
              
              
              
              51,801
              
              
              
              10.6
              %
              
              
              11Existing
      Structure Held for Investment
              
              
              23,640
              
              
              
              4.3
              %
              
              
              4
              
              
              
              12,584
              
              
              
              2.6
              %
              
              
              4Existing
      Structure - Improvements
              
              
              56,033
              
              
              
              10.3
              %
              
              
              1
              
              
              
              61,709
              
              
              
              12.6
              %
              
              
              2125,998
              
              
              
              23.1
              %
              
              
              21
              
              
              
              126,094
              
              
              
              25.8
              %
              
              
              17Total
              
              
              544,448
              
              
              
              100.0
              %
              
              
              55
              
              
              
              490,882
              
              
              
              100.0
              %
              
              
              43Less:
      Allowance for Credit Loss / Valuation Allowance
              
              
              (330,428
              )
              
              
              
              
              
              
              
              
              
              
              (334,881
              )Net
      Carrying Value
              
              $
              214,020
              
              
              
              
              
              
              
              
              
              
              $
              156,001




We
classify loans into categories based on the underlying collateral’s projected
end-use for purposes of identifying and managing loan concentrations and
associated risks. As of December 31, 2009 and September 30, 2010, respectively,
outstanding principal loan balances by expected end-use, were as follows (in
thousands except percentages and unit data):




December 31, 2009
              
              
              September 30, 2010Amount
              
              
              %
              
              
              #
              
              
              Amount
              
              
              %
              
              
              #Residential
              
              $
              273,666
              
              
              
              50.2
              %
              
              
              35
              
              
              $
              264,632
              
              
              
              53.9
              %
              
              
              32Mixed
      Use
              
              
              177,308
              
              
              
              32.6
              %
              
              
              7
              
              
              
              155,012
              
              
              
              31.6
              %
              
              
              4Commercial
              
              
              92,404
              
              
              
              17.0
              %
              
              
              12
              
              
              
              70,168
              
              
              
              14.3
              %
              
              
              6Industrial
              
              
              1,070
              
              
              
              0.2
              %
              
              
              1
              
              
              
              1,070
              
              
              
              0.2
              %
              
              
              1Total
              
              
              544,448
              
              
              
              100.0
              %
              
              
              55
              
              
              
              490,882
              
              
              
              100.0
              %
              
              
              43Less:
      Allowance for Credit Loss / Valuation Allowance
              
              
              (330,428
              )
              
              
              
              
              
              
              
              
              
              
              (334,881
              )Net
      Carrying Value
              
              $
              214,020
              
              
              
              
              
              
              
              
              
              
              $
              156,001





We
estimate that, as of September 30, 2010, approximately 60% of the allowance for
credit loss is attributable to residential-related projects, 39% to mixed use
projects and the balance to commercial and industrial projects.At December
31, 2009, approximately 58% of the allowance for credit loss was attributable to
residential-related projects, 40% to mixed use projects and the balance to
commercial and industrial projects.





Mortgage
Loans Held for Sale




At
December 31, 2009, we reflected three loans with carrying values totaling $3.2
million, net of allowance for credit loss of $2.4 million, as held for sale. The
sale of these three loans occurred during the nine months ended September 30,
2010 at their approximate carrying values.  As of September 30, 2010,
the entire loan portfolio is reflected as held for sale in the accompanying
consolidated balance sheets.




83




Trends
in Interest Income and Effective Yield




At
December 31, 2009 and September 30, 2010, our loans had a weighted average note
rate of 11.34% per annum and 11.27% per annum, respectively.  For the
income on these yields to be fully realized, all loans must be “performing” and
accrued interest income must be deemed to be collectible.  At December 31,
2009 and September 30, 2010, accrued interest income totaled $12.0 million and
$3.7 million, respectively, and note rate interest earned but not accrued
totaled approximately $49.7 million and $84.9 million, respectively.  At
December 31, 2009, 46 of the 50 loans in default were in non-accrual status and
had outstanding principal balances totaling $532.0 million. At September 30,
2010, all 36 of the loans in default were in non-accrual status and had
outstanding principal balances totaling $480.6 million. At September 30, 2010,
we have, or expect to, commence enforcement action on 27 loans which will likely
result in foreclosure.  Alternatively, we may continue to modify our loans,
which may result in an extended term of maturity on such loans of two years or
longer and, in some cases, accept an interest rate reflective of current market
rates, which are lower than in prior periods.  Accordingly, we believe
that net interest income, as a percent of the total loans (the combined total of
both accrual and non-accrual loans), will decline, thereby further reducing
monthly earnings. While we believe some of the deferred amounts may be
ultimately realized, we cannot provide any assurance that any deferred amounts
(including non-accrual interest, default interest or fees) will be realized or
that future yields will approximate current or historical yields.




Leverage
to Enhance Yields




We have
not historically employed a significant amount of leverage to enhance our
portfolio’s current yield.  However, during the nine months ended September
30, 2010, we secured financing from a bank in the amount of $9.5 million for the
purpose of funding anticipated development costs for REO assets and working
capital needs. The note payable, which had an outstanding balance of $7.5
million at September 30, 2010, bears interest at 12% per annum and requires
monthly payments of interest only. The loan has an initial maturity of March
2011 but may be extended for two additional six month periods. The loan is
secured by one of our REO assets with a carrying value at September 30, 2010 of
$22.2 million and an assignment of rents and tenant notes receivable derived
from the property. We have also provided a guarantee for such debt.




In
addition, during the nine months ended September 30, 2010, we secured financing
from a bank in the amount of $3.6 million for the purpose of funding a remaining
loan obligation and for anticipated development costs for REO assets. The note
payable, which had an outstanding balance of $2.1 million at September 30, 2010,
bears interest at 12% per annum, requires monthly payments of interest only, and
matures in February 2012. The loan is secured by one of our REO assets with a
carrying value at September 30, 2010 of $3.4 million and one of our loans
with a current carrying value of $4.2 million.




Also
during the three months ended September 30, 2010, we secured a line of credit
from a bank in the amount of $3.0 million which was utilized for the primary
purpose of funding certain obligations resulting from the Conversion
Transactions. The line of credit has an outstanding balance of $2.5 million at
September 30, 2010, an interest rate of 4.25% per annum, requires monthly
interest payments and has a maturity date of October 5, 2010.




In
connection with the acquisition of the Manager, we assumed a note payable with
an original balance of $0.5 million that is being paid on a monthly basis over
48 months, which commenced June 1, 2009, with annual interest at
8%.  This note was made in connection with a settlement on a previous
lease obligation and has been personally guaranteed by our CEO.  As of
September 30, 2010, the remaining obligation on the commitment is $0.3
million.  Additionally, in connection with the acquisition of
Holdings, we assumed two notes payable with a total balance of $0.1
million.  The notes bear interest at 15% per annum payable monthly and
were set to mature December 31, 2013.  We paid the notes in full on
July 1, 2010.




We may
deem it beneficial, if not necessary, to employ additional leverage in the
future.




Off-Balance
Sheet Arrangements




For
certain loans, upon their initial funding, a reserve for future interest
payments is deposited into a controlled disbursement account in the name of the
borrower for our benefit. These accounts, which are held in the name of the
borrowers, are not included in the accompanying balance sheets. As of September
30, 2010, there was $0.2 million of such amount outstanding. We did not have any
other off-balance sheet arrangements.




84




Contractual
Obligations




The
financial obligations to the Manager under the Fund’s operating agreement
(through June 18, 2010, the effective date of the Conversion Transactions), the
lease obligations on the office space, the contingent liability to
broker-dealers and funding commitments to borrowers as of September 30, 2010, as
described elsewhere in this Form 10-Q, reflect our contractual obligations as of
such date. Additionally, we previously engaged the services of an outside
consulting firm to assist with general portfolio oversight and to assist in the
determination of the specific asset disposition strategy for a monthly fee of
$112,000.  Effective September 1, 2010, the monthly fee was reduced to
$85,000.  The agreement was further modified in November 2010 whereby,
beginning in December 2010, the monthly fixed fee will be $45,000 plus a
finder’s fee equal to 1.75% of any financing proceeds secured by the consulting
firm on our behalf.  Additionally, the consulting firm will be
entitled to a finder’s fee equal to 1⁄2% to 1% of the value received of a merger
or acquisition candidate, if any, identified by the consulting
firm.  As of September 30, 2010, we accrued $0.1 million to the
consulting firm for financing proceeds secured by the consulting firm in the
third quarter of 2010.




The
Manager also engaged a consulting firm  to assist in the
identification of financing and capital raising alternatives for a monthly fee
of $32,500.  Additionally, the Company expects to modify this agreement
whereby the consulting firm will be entitled to a one-time fee of $1.5 million
if during the consulting term we either (i) raise $50 million or more in the
aggregate of debt or equity capital or (ii) list our securities on a national
securities exchange. Further, if we raise equity securities capital raises
exceeding $100 million (in one or a series of transactions) during the
consulting term, we expect to pay the consulting firm a one-time fee
of $0.8 million, and if we raise debt securities capital exceeding $100 million
(in one or a series of transactions) during the consulting term, we expect
to pay the consulting firm a one-time fee of $0.5 million. The
contracts are expected to be cancelable by either party with 30 day written
notice.




Our
remaining lending commitments as of September 30, 2010 are expected to be funded
within one to two years.  Aside from these commitments, we had no other
contractual obligations as of September 30, 2010.




Liquidity
and Capital Resources




We
require liquidity and capital resources to acquire and originate our target
assets, as well as for costs, expenses and general working capital needs,
including maintenance and development costs for REO assets, general and
administrative operating costs, loan enforcement costs, interest expense on
participations and loans, repayment of principal on borrowings and other
expenses. We expect our primary sources of liquidity over the next twelve months
to consist of the disposition of a substantial portion of our loans and existing
REO assets. However, given the lack of significant sales activity experienced
and the actual prices that may be realized from the sale of REO assets, the
disposition of these assets may not have a significant effect on our liquidity.
We anticipate redeploying these proceeds to acquire our target assets, which
will generate periodic liquidity from cash flows from dispositions of these
loans through sales and loan participations as well as interest income. We
expect to address our liquidity needs by periodically accessing the capital
markets, lines of credit and credit facilities available to us from time to
time. We discuss our capital requirements and sources of liquidity in further
detail below.





Our
financial statements have been prepared on a going concern basis, which
contemplates the realization of assets and the discharge of liabilities in the
normal course of business for the foreseeable future. Due to unprecedented
dislocations in the real estate and capital markets, we have incurred a
significant reduction in loan payoffs from borrowers and an increase in
delinquencies, non-performing loans and REO assets, resulting in a substantial
reduction in our cash flows. We took a number of measures to provide liquidity,
including, among other things, engaging in efforts to sell whole loans and
participate interests in our loans and to dispose of certain real estate. We
have also consummated the Conversion Transactions in an effort to position us
for an initial public offering, the net proceeds of which will help address our
liquidity needs. In addition, we expect to continue to pursue the sale of assets
and loans in order to assist us in addressing our liquidity needs.




85


In
October 2008, we suspended all of the Fund’s lending activities, member
investment capital raising and all other non-essential operations. We took this
action because we believed that the market for take-out financing for our
borrowers had materially diminished due to the macroeconomic problems in the
real estate, credit and capital markets, concerns about the continued existence
of many major national and international financial institutions, and the
ability, willingness and timeliness of the federal government to intervene.
Further, member redemption requests accelerated during 2008, particularly in
August and September 2008. Further, to adequately protect our available cash
reserves for purposes of honoring our contractual commitments for remaining
unfunded loan obligations, as well as retaining a liquidity reserve for funding
ongoing operations, all new lending activity was ceased.  Lastly, in
the context of our expectations of materially lower borrower payoffs and pay
downs resulting from the absence of available take-out financing from
third-party lenders, we concluded that the viability of our historical business
model was at risk, and deemed it ill-advised to raise capital from new investors
at that time in light of the deterioration of the real estate, credit and other
relevant markets.





In recent
months, we have seen an increased level of market activity and unsolicited
offers received by interested third parties to purchase our assets. Further, in
recent months, we have had ongoing discussions with potential interim lenders,
and have received preliminary indications of borrowing opportunities for us in
amounts that would provide us with sufficient capital to fund the next 12 months
of operations. While none of these borrowing opportunities has advanced to the
point where we believe they are probable, we do believe that we can continue to
sell assets to fund current operations and facilitate our strategic
plan.





We
previously engaged a consulting firm to provide asset management services, which
includes administration of all REO assets, loans currently in default and other
loans for which default is probable. The asset management responsibilities
include (i) addressing our liquidity needs by negotiating for loan pay downs or
payoffs with existing borrowers, (ii) exercising enforcement rights against loan
guarantors, and (iii) considering offers from potential third-party buyers of
loans or REO assets. As part of these duties, we have explored various options,
including the pledging of loans in exchange for borrowings from commercial banks
or private investment funds, and the possibility of private or public equity or
debt offerings. To date, we have closed a limited number of these liquidity
transactions due to the continued disruptions in the real estate-related credit
markets. However, we have sold a sufficient number of assets to continue
operating the business and administrating the loans and real estate. However,
the sales of such assets thus far have been based on distressed valuation
pricing because of the substantial supply of assets in the market. We continue
to seek to secure interim debt financing to allow us the time and resources
necessary to meet liquidity requirements and dispose of assets in a reasonable
manner and on terms favorable to us. However, the dislocations and uncertainty
in the economy, and in the real estate, credit, and other markets, have created
an extremely challenging environment that will likely continue for the
foreseeable future, and we cannot assure you that we will have sufficient
liquidity.





Prior to
its acquisition of the Manager, the Fund had no employees, management group or
independent board of directors, and was dependent on the Manager for those
functions. Accordingly, lenders and other organizations in the past preferred
that the Manager function as an intermediary in business transactions rather
than contracting directly with the Fund. With the acquisition of the Manager
effective June 18, 2010, we will act in such matters on our own
behalf.  Moreover, in order to create liquidity and financial
flexibility for us and our stockholders, we intend to pursue an initial public
offering.





For
additional information regarding the requirements for and sources of liquidity,
please refer to the discussion above and our Form 10-K/A. Except as discussed
below, there have been no material changes in these requirements or sources
since December 31, 2009.





Requirements
for Liquidity





We
require liquidity and capital resources for various financial needs, including
to acquire our target assets of interim loans, commercial real estate mortgage
loans and participating interests in performing commercial real estate mortgage
loans and for loan fundings, maintenance and development costs for REO assets,
loan enforcement costs, interest expense on participations and loans, repayment
of principal on borrowings, cash dividends and general working capital. If we
raise additional capital in an initial public offering or otherwise, we expect
our liquidity and capital requirements to include funds to acquire in our target
assets as well as dividends to stockholders.  We discuss our primary
expected future and historical sources of liquidity in more detail
below.




86




Loan
Fundings




We
require adequate liquidity to acquire our target assets and fund initial loan
advances to the borrowers. We expect our loan funding requirements to decrease
over the shorter term and our requirements for funds to acquire commercial
mortgage loans to increase as we focus more on this asset class.  Our
loan fundings are typically less than the face amount of the mortgage loan
notes, and for disbursements to fund construction costs, development and other
costs and interest. As is customary in the commercial lending business, our loan
terms may require the establishment of funded or unfunded interest reserves
which are included as part of the note commitment and considered in the loan to
value ratios at the time of underwriting. In some cases, the borrower may elect
to pay interest from its own sources. On certain loans, upon their initial
funding, the reserve for future interest payments is deposited into a controlled
disbursement account in the name of the borrower for our benefit. These
accounts, which are held in the name of the borrowers, are not included in the
consolidated balance sheets. At December 31, 2009, one of our borrowers had
remaining unfunded interest reserves, no borrowers had remaining funded interest
reserves, one borrower prepaid interest on the related note through the
conveyance of certain real estate, and the remaining 53 of our borrowers were
obligated to pay interest from other sources or had depleted any available
interest reserves. At September 30, 2010, two of our borrowers had established
unfunded interest reserves, two borrowers had funded interest reserves, and the
remaining 39 borrowers were obligated to pay interest from their own sources or
had depleted their interest reserves.





Estimated
future commitments for construction or development costs, and for interest, are
recorded on the consolidated balance sheets as an Undisbursed Portion of
Loans-in-process and Interest Reserves, which are deducted from Mortgage Loan
Note Obligations to arrive at net principal outstanding, or are shown net of
loans held for sale. As of December 31, 2009 and September 30, 2010, undisbursed
loans-in-process and interest reserves balances were as follows:




December 31, 2009
            
            
            September 30, 2010Loans Held
            
            
            Loans Held
            
            
            
            
            
            Loans Held
            
            
            Loans Heldto Maturity
            
            
            for Sale
            
            
            Total
            
            
            to Maturity
            
            
            for Sale
            
            
            TotalUndispersed
      Loans-in-process per Note Agreement
            
            $
            63,001
            
            
            $
            -
            
            
            $
            63,001
            
            
            $
            -
            
            
            $
            59,570
            
            
            $
            59,570Less:
      amounts not to be funded
            
            
            (47,026
            )
            
            
            -
            
            
            
            (47,026
            )
            
            
            -
            
            
            
            (44,544
            )
            
            
            (44,544
            )Undispersed
      Loans-in-process per Financial Statements
            
            $
            15,975
            
            
            $
            -
            
            
            $
            15,975
            
            
            $
            -
            
            
            $
            15,026
            
            
            $
            15,026




A
breakdown of loans-in-process expected to be funded is presented below (in
thousands):




December 31,
              
              
              September 30,Loans-in-Process Allocation:
              
              2009
              
              
              2010Construction/Operations
      Commitments
              
              $
              3,731
              
              
              $
              2,921Unfunded
      Interest Reserves
              
              
              7,524
              
              
              
              6,157Deferred
      Loan Fees due to Manager
              
              
              2,360
              
              
              
              -Reserve
      for Protective Advances
              
              
              654
              
              
              
              4,244Taxes
      and Other
              
              
              1,706
              
              
              
              1,704Total
      Loan-in-Process
              
              $
              15,975
              
              
              $
              15,026





While the
contractual amount of unfunded loans-in-process and interest reserves totaled
$63.0 million and $59.6 million at December 31, 2009 and September 30, 2010,
respectively, we estimate that we will only be required to fund approximately
$15.0 million subsequent to September 30, 2010. Of the $15.0 million expected to
be funded, $6.2 million relates to unfunded interest reserves on loans totaling
$32.2 million at September 30, 2010 (which is a non-cash commitment), $2.9
million relates to anticipated borrower construction or operating costs, $1.7
million relates to tax related reserves and $4.2 million relates to reserves for
protective advances not required under the terms of the loan agreement, but that
we expect to fund to protect our interest in the asset. The difference of $44.5
million at September 30, 2010, which is not expected to be funded, relates to
loans that are in default, loans that have been modified to lower the funding
amount, and loans whose funding is contingent on various project milestones,
many of which have not been met to date and are not expected to be met given
current economic conditions. Accordingly, these amounts are not reflected as
funding obligations in the consolidated balance sheets. With available cash and
cash equivalents of $4.6 million at September 30, 2010, scheduled loan payoffs,
the suspension of new loan request funding, debt financing secured for us, and
other available sources of liquidity, including potential loan participations,
loan sales or sales of REO assets, we expect to meet our obligation to fund
these undisbursed amounts in the normal course of business. See Note 1 to our
unaudited consolidated financial statements included with this Form 10-Q for
discussion of our liquidity.




87




We
deployed 99.7% and 94.1% of our cash in mortgage loans and REO assets as of
December 31, 2009 and September 30, 2010, respectively. Until appropriate
investments can be identified, our management may invest any future excess cash
in interest-bearing, short-term investments, including money market accounts
and/or U.S. treasury securities or cash.





Maintenance
and Development Costs for Real Estate Owned




We
require liquidity to pay costs and fees to preserve and protect the real estate
we own. Real estate held for development or sale consists primarily of
properties acquired as a result of foreclosure or purchase. At September 30,
2010 and December 31, 2009, our REO assets comprised of 34 and 17 properties,
respectively, acquired through foreclosure or purchase, with carrying values of
$109.3 million and $104.2 million, respectively. Costs related to the
development or improvements of the assets are capitalized and costs relating to
holding the assets are charged to expense. Cash outlays for capitalized
development costs totaled $2.5 million during the year ended December 31, 2009
and $0.7 million during the nine months ended September 30, 2010. Operating
expenses for REO assets totaled approximately $5.0 million (of which $2.4
million relates to property taxes) for the year ended December 31,
2009.  In addition, costs related to holding and maintaining such
properties, which were expensed and included in operating expenses for REO
assets in the accompanying consolidated statement of operations, totaled
approximately $2.5 million and $4.1 million (including $2.1 million in property
tax expense relating to foreclosed properties) during the nine months ended
September 30, 2010 and 2009, respectively. The nature and extent of future costs
for such properties depends on the level of development undertaken, the number
of additional foreclosures and other factors.





Interest
Expense & Borrowing





We also
require liquidity to pay interest expense on loan participations and for notes
payable. During the nine months ended September 30, 2010, we secured financing
from a bank in the amount of $9.5 million for the purpose of funding remaining
loan obligations, anticipated development costs for REO assets, and working
capital needs. The loan has an outstanding balance of $7.5 million at September
30, 2010, bears interest at 12% per annum and requires monthly payments of
interest only. During the nine months ended September 30, 2010, we incurred
interest expense of $0.8 million under this loan. The loan has an initial
maturity of March 2011 but may be extended for two additional six month periods.
The loan is secured by one of our REO assets and an assignment of rents and
tenant notes receivable derived from the property. We have also provided a
guarantee for such debt.




During
the nine months ended September 30, 2010, we secured financing from a bank in
the amount of $3.6 million for the purpose of funding a remaining loan
obligation and for anticipated development costs for REO assets. The note
payable, which has an outstanding balance of $2.1 million as of the period
ending September 30, 2010, bears interest at 12% per annum, requires monthly
payments of interest only and matures in February 2012. During the nine months
ended September 30, 2010, we incurred interest expense of $83,000 under this
loan.  The loan is secured by one of our real estate owned assets with a
carrying value at September 30, 2010 of $3.4 million and a Company loan with a
current carrying value of $4.2 million.




Also
during the quarter ended September 30, 2010, we secured a line of credit from a
bank in the amount of $3.0 million for the primary purpose of funding certain
obligations resulting from the Conversion Transactions. The line of credit has
an outstanding balance of $2.5 million at September 30, 2010, an interest rate
of 4.25% per annum, requires monthly interest payments and has a maturity date
of October 5, 2010.   The maturity date under this line of credit
was extended to January 5, 2011.  During the nine months ended
September 30, 2010, we incurred interest expense of $27,000 under this line of
credit.




88




In
connection with the acquisition of the Manager, we assumed a note payable with
an original balance of $0.5 million that is being paid on a monthly basis over
48 months, commencing June 1, 2009, with interest at 8%.  This note
was made in connection with a settlement on a previous lease obligation and has
been personally guaranteed by the CEO.  As of September 30, 2010, the
remaining obligation on the commitment is $0.3 million.  Interest
expense under this arrangement of $11,000 for the period ended September 30,
2010 is included in interest expense on the accompanying consolidated statement
of operations.




In
connection with the acquisition of Holdings, we assumed two notes payable with a
total balance of $0.1 million.  The notes bear interest at 15% per
annum payable monthly and were set to mature December 31, 2013.  The
notes were paid in full on July 1, 2010.




Until we
generate additional liquidity from dispositions of assets, we may seek
additional short-term borrowings. We do not currently contemplate seeking
additional debt financing, but may consider doing so in the future depending on
the amount of proceeds generated from dispositions of assets, the relative
attractiveness and availability of debt financing and other
factors.





Our
policies with respect to, and the reasoning behind the need for, liquidity, have
not changed in any material respect since our previously filed Form
10-K/A.  For updated information regarding our requirements for these
purposes, please see the discussion above.





General
and Administrative Operating Costs





In
addition to the expenses historically borne by the Fund, we also now require
liquidity to pay various general and administrative costs previously absorbed by
the Manager. As a result, our expenses include compensation and benefits, rent,
insurance, utilities and other related costs of operations. Such costs currently
approximate $0.6 million per month, but the variable components of such expenses
are expected to increase as our activities expand.





Sources
of Liquidity





We expect
our primary sources of liquidity over the next twelve months to consist the
disposition of our existing assets. We anticipate redeploying these proceeds to
acquire various performing real estate-related assets, which will generate
periodic liquidity from cash flows from dispositions of these loans through
sales and loan participations as well as interest income. In addition, we expect
to address our liquidity needs by periodically accessing the capital markets,
lines of credit and credit facilities available to us from time to time.
Historically, our sources of liquidity consisted primarily of investments by
members of the Fund, sales of participations in loans, interest income and loan
payoffs from borrowers, and disposition of REO assets. We have at times in the
past accessed bank lines of credit, though we have not historically relied on
significant leverage or bank financing to fund our operations or investments. We
discuss our primary expected future and historical sources of liquidity in more
detail below.




Disposition of Real Estate Owned and
Loans Held for Sale





The sale
of REO assets creates liquidity for us. During the year ended December 31, 2009,
we received proceeds totaling $1.1 million from the sale of certain REO assets
at its appropriate carrying value. During the nine months ended September 30,
2010, we sold certain loans and REO assets for $8.7 million and recognized a
loss on disposition of real estate of $1.1 million. Additionally, we are holding
REO assets for sale with carrying values of $12.1 million and $43.8 million as
of December 31, 2009 and September 30, 2010, respectively. As development of
certain real estate projects is completed, we anticipate that proceeds from the
disposition of real estate will increase in the future. In connection with our
new business strategy, we anticipate disposing of a significant portion of our
existing REO assets, individually or in bulk, over the next 12 to 24 months.
However, there can be no assurance that such real estate will be sold at a price
in excess of the current carrying value of such real estate.




89





Loan
Payments.





The
repayment of a loan at maturity creates liquidity. In the case of an extension,
we typically charge the borrower a fee for re-evaluating the loan and processing
the modification. Borrowers do not customarily pay this fee out of their own
funds, but instead usually pay the fee out of available loan proceeds, or by
negotiating an increase in the loan amount sufficient to pay the fee. However,
to the extent that we extended a loan in the past, we did not generate liquidity
because the Manager, and not the Fund, received the modification fee, if any.
After consummation of the Conversion Transactions, we will receive any
origination or modification fees. During the year ended December 31, 2009, we
received loan principal payments totaling $10.6 million. During the nine months
ended September 30, 2010, we received loan principal payments totaling $9.9
million. Excluding loan balances past scheduled maturity, our loans have
scheduled maturities through 2010 totaling $4.2 million. However, due to the
state of the economy and the compressed nature of the real estate, credit and
other markets, loan defaults have continued to rise and are expected to rise
further and there can be no assurance that any part of these loans will be
repaid, or when they will be repaid. As we acquire new loans in connection with
our new business strategy, we anticipate that the collateral securing such loans
and the related terms will allow for timely payoff or that liquidity will be
generated from the sale or participation of such loans.





Investment
Income.





We expect
to realize investment income from such investments which may come in the form of
origination and modification fees, interest income, accretion of discounts on
such investments, rental income, and profit participations. The amounts and
proportion of such income is dependent on the amount and timing of the
deployment of our capital into our various target assets. Interest payments and
repayments of loans by our borrowers are governed by the loan documents and by
our practices with respect to granting extensions. A majority of our portfolio
loans had provisions for interest reserves for the initial term of the loan,
which required that a specified portion of the mortgage loan note total is
reserved for the payment of interest. When that portion is exhausted, the
borrower is required to pay interest from other sources. If the interest is
funded in cash when the loan closes, then interest payments are made monthly
from a segregated controlled disbursement cash account which is controlled by us
and held in the name of the borrower. If the interest reserve is not funded at
the closing of the loan, then the interest payment is accrued by adding the
amount of the interest payment to the loan balance. The receipt of interest
income paid in cash by our borrowers creates liquidity; however, our practice of
utilizing unfunded interest reserves uses liquidity.





During
the year ended December 31, 2009, we recognized $3.8 million in mortgage loan
interest which was satisfied by the use of unfunded interest reserves, which
represented approximately 18% of total mortgage loan income. Additionally,
during the year ended December 31, 2009, we recognized $8.2 million in mortgage
loan interest which was satisfied by the use of funded interest reserves, which
represented approximately 38% of total mortgage loan income.





During
the nine months ended September 30, 2009 and 2010, we recognized $5.2 million
and $11,000 respectively, in mortgage loan interest which was satisfied by the
use of unfunded interest reserves, which represented approximately 25.5% and
1.0% of total mortgage loan interest income for the periods,
respectively.  During the three months ended September 30, 2009 and
2010, we recognized $0.7 million and $0 respectively, in mortgage loan interest
which was satisfied by the use of unfunded interest reserves, which represented
approximately 25.7% and 0.0% of total mortgage loan interest income for the
periods, respectively. Additionally, during the nine months ended September 30,
2009 and 2010, we recognized $7.9 million and $0, respectively, in mortgage loan
interest which was satisfied by the use of funded interest reserves, which
represented approximately 39.1% and 0.0% of total mortgage loan interest income
for the periods, respectively.  During the three months ended
September 30, 2009 and 2010, we recognized $0.8 million and $0, respectively, in
mortgage loan interest which was satisfied by the use of funded interest
reserves, which represented approximately 28.8% and 0.0% of total mortgage loan
interest income for the periods, respectively.




90





In
addition to originating commercial mortgage loans, our on-going investment
strategy will include the acquisition of various attractively priced real
estate-related assets, including portfolios of performing, distressed and/or
non-performing commercial whole mortgage loans and bridge loans from the FDIC,
community banks, commercial banks, insurance companies, real estate funds, and
other governmental agencies and financial institutions, as well as potential
investment in residential and commercial mortgage backed securities, REO assets
or other distressed or non-performing real estate properties in order to seek to
reposition them for profitable disposition. We expect to realize investment
income from such investments which may come in the form of origination and
modification fees, interest income, accretion of discounts on such investments,
rental income, and profit participations. The amounts and proportion of such
income is dependent on the amount and timing of the deployment of our capital
into our various target assets.





Anticipated Tax
Benefits.





Because
of the significant declines in the real estate markets in recent years, we
believe we will have approximately $267.8 million of built-in unrealized tax
losses in our portfolio of loans and REO assets. Subject to certain limitations,
these built-in losses may be available to reduce or offset future taxable income
and gains related to the disposition of our existing assets and may allow us to
reduce taxable income from future transactions. Our abilityto use our built-in losses is subject
to various limitations.  For example, there will be limitations on our
ability to use our built-in losses or other net operating losses if we undergo a
“change in
ownership”for U.S. federal
income tax purposes.To the extent we are able to reduce taxes
payable through the use of our built-in losses, the amount of reduction will be
available to be deployed in new fund investment in additional assets, pay
distributions to our stockholders in the form of dividends or address other
liquidity requirements.





Borrowing.





See the
discussion under the heading“Interest Expense”for a discussion of items relating to borrowing as a
source of liquidity.





Participations and Whole Loans
Sold.





Historically,
at times when substantially all available capital had been deployed, or we
wished to mitigate our portfolio risk, for purposes of creating liquidity, we
sometimes elected to either sell to third parties, or purchase on its own
account, all or a portion of the loans in which we had invested. The sales of
whole loans or participations were generally at the par value of the loan. In
the case of sales and participations to the Manager, the Manager typically
pledged the purchased loan to a commercial bank as collateral on its line of
credit. The Manager generally used the proceeds from the line of credit,
together with other funds of the Manager, to purchase the loan from us. We
typically repurchased loans from the Manager, although we were not obligated to
do so. The sales of loans to the Manager were also accounted for as secured
borrowings, and were separately identified in our financial statements as
borrowings from the Manager. In connection with our new business strategy, we
anticipate disposing of a significant portion of our existing loans,
individually or in bulk, over the next 12 to 24 months. However, there can be no
assurance that such assets will be sold at a price in excess of the current
carrying value of such assets, net of valuation allowances. As of September 30,
2010, all loans were classified as held for sale. We expect future investments
in mortgages to be held for sale or participation. See the discussion under the
heading “Mortgage Loans,
Participations and Loan Sales,” above.





Cash
Flows





Cash Provided By/(Used In) Operating
Activities.





Cash
provided by operating activities was $13.5 million for the nine months ended
September 30, 2009 as compared to net cash used in operating activities of $13.3
million for the nine months ended September 30, 2010.  Cash provided
by (used in) operating activities includes the cash generated from interest and
other mortgage income from the Company’s loan portfolio, offset by amounts paid
for management fees to the Manager and interest paid on participated loans to
the Manager for short-term borrowings and to banks for notes payable. The
decrease in cash provided by operating activities from 2009 to 2010 is
attributed to the decrease in the income-earning loans in our loan portfolio and
resulting mortgage income.


91





Cash (Used In)/Provided By Investing
Activities.





Net cash
used in investing activities was $20.7 million for the nine months ended
September 30, 2009 as compared to net cash provided by investing activities of
$6.6 million for the nine months ended September 30, 2010. The increase in net
cash provided by investing activities was attributable to a decrease in the
number and amount of mortgage loan fundings ($25.8 million and $4.5 million
during the nine months ended September 30, 2009 and 2010, respectively), coupled
with a increase in loan paydowns during the same periods ($6.7 million and $9.8
million during the nine months ended September 30, 2009 and 2010, respectively).
Moreover, we decreased the amount expended on real estate held for development
($2.4 million as compared to $0.7 million during the nine months ended September
30, 2009 and 2010, respectively). We also generated $5.3 million from the sale
of certain REO and utilized $3.3 million in connection with acquisition of the
Manager during the nine months ended September 30, 2010.  For the nine
months ended September 30, 2009, sales of REO assets were $0.8
million.




Cash Provided by (Used In) Financing
Activities.




Net cash
used by financing activities was $14.1 million for the nine months ended
September 30, 2009 as compared to net cash provided by financing activities of
$10.3 million for the nine months ended September 30, 2010. The primary reason
for the change in cash flows from financing activities is the suspension of
member distributions during the reporting period $16.7 million and $0 during the
nine months ended September 30, 2009 and 2010, respectively).  Also, we
generated proceeds from notes payable of $14.8 million for the nine months ended
September 30, 2010 as compared to none in 2009.  We also repaid notes
payable totaling $2.8 million during the nine months ended September 30, 2010
versus none in 2009.




Critical
Accounting Policies




Our
critical accounting policies are disclosed in our previously filed Annual Report
on Form 10-K/A for the fiscal year ended December 31, 2009.  During
the nine months ended September 30, 2010, there have been no significant changes
in our critical accounting policies, except for those shown below, resulting
from the acquisition of the Manager effective June 18, 2010.




Revenue
Recognition





Interest
on mortgage loans is recognized as revenue when earned using the interest method
based on a 365-day year. We do not recognize interest income on loans once they
are deemed to be impaired and placed in non-accrual status. Generally, a loan is
placed in non-accrual status when it is past its scheduled maturity by more than
90 days, when it becomes delinquent as to interest due by more than 90 days or
when the related fair value of the collateral is less than the total principal,
accrued interest and related costs. We may determine that a loan, while
delinquent in payment status, should not be placed in non-accrual status in
instances where the fair value of the loan collateral significantly exceeds the
principal and the accrued interest, as we expect that income recognized in such
cases is probable of collection. Unless and until we have determined that the
value of underlying collateral is insufficient to recover the total contractual
amounts due under the loan term, generally our policy is to continue to accrue
interest until the loan is more than 90 days delinquent with respect to accrued,
uncollected interest or more than 90 days past scheduled maturity, whichever
comes first.





A loan is
typically not removed from non-accrual status until the borrower has brought the
respective loan current as to the payment of past due interest, and unless we
are reasonably assured as to the collection of all contractual amounts due under
the loan based on the value of the underlying collateral of the loan, the
receipt of additional collateral required and the financial ability of the
borrower to service our loan.





We do not
generally reverse accrued interest on loans once they are deemed to be impaired
and placed in non-accrual status. In conducting our periodic valuation analysis,
we consider the total recorded investment for a particular loan, including
outstanding principal, accrued interest and estimated foreclosure costs when
computing the amount of valuation allowance required.


92


Cash
receipts are first allocated to interest, except when such payments are
specifically designated by the terms of the loan as a principal reduction. Loans
with a principal or interest payment one or more days delinquent are in
technical default and are subject to various fees and charges including default
interest rates, penalty fees and reinstatement fees. Often these fees are
negotiated in the normal course of business and, therefore, not subject to
estimation. Accordingly, income pertaining to these types of fees is recorded as
revenue when received.





Historically,
in accordance with the Fund’s operating agreement, all fees relating to loan
origination, documentation, processing, administration, loan extensions and
modifications were earned prior to its termination as a result of the Conversion
Transactions by the Manager.  After consummation of the Conversion
Transactions effective June 18, 2010, these fees inure to our
benefit.





Fees for
loan originations, processing and modifications, net of direct origination
costs, are deferred at origination and amortized as an adjustment to interest
income over the contractual term of the related loan.  Non-refundable
commitment fees are recognized as revenue when received.





Allowance
for Credit Losses/Valuation Allowance





A loan is
deemed to be impaired when, based on current information and events, it is
probable that we will be unable to ultimately collect all amounts due according
to the contractual terms of the loan agreement and the amount of loss can be
reasonably estimated.





Our
mortgage loans, which are deemed to be collateral dependent, are subject to an
allowance for credit loss or valuation allowance based on our determination of
the fair value of the subject collateral in relation to the outstanding mortgage
balance, including accrued interest and related accrued or expected costs to
foreclose and sell. We evaluate our mortgage loans for impairment losses on an
individual loan basis, except for loans that are cross collateralized within the
same borrowing group. For such loans, we perform both an individual evaluation
as well as a consolidated evaluation to assess our overall exposure for such
loans. As such, we consider all relevant circumstances to determine impairment
and the need for specific valuation allowances. In the event a loan is
determined not to be collateral dependent, we measure the fair value of the loan
based on the estimated future cash flows of the note discounted at the note’s
contractual rate of interest.





Under
GAAP definitions, certain of the loans that are classified as “in default”
status would qualify as impaired under GAAP while others would not. Since our
loan portfolio is considered collateral dependent, the extent to which our loans
are considered collectible, with consideration given to personal guarantees
provided under such loans, is largely dependent on the fair value of the
underlying collateral.




Fair
Value




Fair
value estimates are based upon certain market assumptions and pertinent
information available to management. As of the dates of the balance sheets, the
respective carrying value of all balance sheet financial instruments
approximated their fair values. These financial instruments include cash and
cash equivalents, mortgage investments, accrued interest, and notes payable.
Fair values of cash equivalents and notes payable are assumed to approximate
carrying values because these instruments are short-term in duration or are
deemed to be at current market rates.





We
perform an evaluation for impairment for all loans in default as of the
applicable measurement date based on the fair value of the collateral if we
determine that foreclosure is probable. We generally measure impairment based on
the fair value of the underlying collateral of the loans because our loan
portfolio is considered collateral dependent. Impairment is measured at the
balance sheet date based on the then fair value of the collateral, less costs to
sell, in relation to contractual amounts due under the terms of the loan. In the
case of loans that are not deemed to be collateral dependent, we measure
impairment based on the present value of expected future cash flows. All of our
loans are deemed to be collateral dependent.


93





In
determining fair value, we have adopted applicable accounting guidance, which
establishes a framework for measuring fair value in accordance with generally
accepted accounting principles, clarifies the definition of fair value within
that framework, and expands disclosures about the use of fair value
measurements. This guidance applies whenever other accounting standards require
or permit fair value measurement. Under this standard, fair value is defined as
the price that would be received to sell an asset or paid to transfer a
liability (the “exit price”) in an orderly transaction between market
participants at the measurement date. Market participants are buyers and sellers
in the principal (or most advantageous) market for the asset or liability that
are (a) independent of the reporting entity; that is, they are not related
parties; (b) knowledgeable, having a reasonable understanding about the asset or
liability and the transaction based on all available information, including
information that might be obtained through due diligence efforts that are usual
and customary; (c) able to transact for the asset or liability; and (d) willing
to transact for the asset or liability; that is, they are motivated but not
forced or otherwise compelled to do so.





Under
applicable accounting guidance, a fair value measurement assumes the highest and
best use of the asset by market participants, considering the use of the asset
that is physically possible, legally permissible, and financially feasible at
the measurement date. Highest and best use is determined based on the use of the
asset by market participants, even if the intended use of the asset by the
reporting entity is different. Determination of the highest and best use of the
asset establishes the valuation premise used to measure the fair value of the
asset. Two asset categories are established under applicable accounting
guidance: in-use assets, and in-exchange assets. When using an in-exchange
valuation premise, the fair value of the asset is determined based on the price
that would be received in a current transaction to sell the asset on a
standalone basis. All of our loans are deemed to be in-exchange
assets.





The
accounting guidance establishes a fair value hierarchy that prioritizes the
inputs into valuation techniques used to measure fair value. The three levels of
the fair value hierarchy under this accounting guidance are as
follows:





Level
      1 —
              Valuations
      based on unadjusted quoted prices in active markets for identical assets
      or liabilities that we have the ability to access at the measurement
      date;




Level
      2 —
            Valuations
      based on quoted market prices for similar instruments in active markets,
      quoted prices for identical or similar instruments in markets that are not
      active or models for which all significant inputs are observable in the
      market either directly or indirectly;
and




Level
      3 —
            Valuations
      based on models that use inputs that are unobservable in the market and
      significant to the fair value
measurement.





The
accounting guidance gives the highest priority to Level 1 inputs, and gives the
lowest priority to Level 3 inputs. The value of a financial instrument within
the fair value hierarchy is based on the lowest level of any input that is
significant to the fair value instrument.





Fair
value is a market-based measure considered from the perspective of a market
participant who holds the asset or owes the liability, rather than an
entity-specific measurement. Therefore, even when market assumptions are not
readily available, our own assumptions attempt to reflect those that market
participants would use in pricing the asset or liability at the measurement
date. Further, fair value measurements are market-based measurements with an
exit price notion, not entity-specific measurements. Therefore, an entity cannot
disregard the information obtained from the current market simply because the
entity is a “willing” seller at that price. If the best information available in
the circumstances indicates that market participants would transact at a price,
it does not matter whether the reporting entity is actually willing to transact
at that particular price.





In the
case of collateral dependent loans, the amount of any improvement in fair value
attributable to the passage of time is recorded as a credit to the provision for
credit losses with a corresponding reduction in the allowance for credit loss or
valuation allowance. In the case of loans not deemed to be collateral dependent,
the amount of any improvement attributable to the passage of time is recorded as
interest income at the loans’ contract rate with the remainder, if any, recorded
as a reduction in the aggregate allowance for credit loss or valuation allowance
and offset recorded as a net component for the period provision for credit
losses.


94





In
connection with our assessment of fair value, we generally utilize the services
of one or more independent third-party valuation firms to provide a range of
values for selected properties. With respect to valuations received from
third-party valuation firms, one of four valuation approaches, or a combination
of such approaches, is used in determining the fair value of the underlying
collateral of each loan: the development approach, the income capitalization
approach, the sales comparison approach and the cost approach. The valuation
approach taken depends on several factors including the type of property, the
current status of entitlements and level of development (horizontal or vertical
improvements) of the respective project, the likelihood of a bulk sale as
opposed to individual unit sales, whether the property is currently or nearly
ready to produce income, the current sales price of property in relation to cost
of development, and the availability and reliability of market participant data.
In a declining market, except in limited circumstances, the valuation approach
taken has shifted from primarily a development approach to a comparable sales
approach.





We
generally select a fair value within a determinable range as provided by the
valuation firm, unless we or the borrower have received a bona fide written
third-party offer on a specific loan or underlying collateral. In determining a
single best estimate of value from the range provided, we consider the macro and
micro economic data provided by the third-party valuation specialists,
supplemented by management’s knowledge of the specific property condition and
development status, borrower status, level of interest by market participants,
local economic conditions, and related factors. Based on our analysis of the
factors described above as of December 31, 2009, we selected the high end of the
range for purposes of assessing fair value for loans other than those for which
a bona fide third-party offer was received. Had we selected the low end of the
range for such properties, the fair value would have been reduced by
approximately $46.1 million. Based on our analysis as of September 30, 2010, for
each of those assets which were supported by specific circumstances in using
either the high or low end value, management concluded that the values slightly
above the low end of the range (i.e., 25% of the valuation spread over the low
end value) were more representative of fair values than any other point in the
range. Had we selected the low end of the range for all such properties
(ignoring loans supported by recent bona fide offers), the fair value would be
been reduced by approximately $9.1 million.





As an
alternative to the third-party valuations obtained, we generally utilize bona
fide written third-party offer amounts received in cases in which the offer
exceeds the valuation conclusion reached by the independent valuation firms
because, in the opinion of management, such offers are more reflective of the
current market and indicative of fair value from direct market participants.
When deemed appropriate, the offer amounts utilized are discounted to allow for
potential changes in our on-going negotiations. Had we utilized the third-party
valuations rather than the offer amounts, our provision for credit loss would
have increased (in relation to the high end of the valuation range) by
approximately $10.1 million for the year ended December 31, 2009 and $1.7
million for the period ended September 30, 2010.





In the
aggregate, our estimate of the fair value of our loans exceeded the low end
range of third-party valuation amounts by $58.1 million and $10.8 million at
December 31, 2009 and September 30, 2010, respectively.





See
additional discussion under the heading “Allowance for Credit Loss/Valuation
Allowance and Fair Value Measurement” in this prospectus for further
discussion regarding valuation assumptions utilized and conclusions
reached.





Loan
Charge Offs





Our loans
are all collateralized by real estate and are deemed to be collateral dependent.
Accordingly, the collateral for each of our loans is subject to a periodic fair
value analysis. Valuation estimates are analyzed and updated, and appropriate
adjustments are recorded on not less than a quarterly basis. When a loan is
foreclosed and transferred to a REO status, an assessment of the most current
valuation is made and updated as necessary, and the asset is transferred to a
REO status at its then current fair value, less estimated costs to sell. Our REO
assets are classified as either held for development or investment (i.e., a long-lived asset) or
held for sale. However, if our real estate held for development is sold, any
difference between the net carrying value and net sales proceeds is charged or
credited to operating results in the period of sale.


95





Loan
charge offs generally occur under one of two scenarios, including (i) the
foreclosure of a loan and transfer of the related collateral to REO status, or
(ii) we elect to accept a loan payoff at less than the contractual amount due.
Under either scenario, the loan charge off is generally recorded through the
allowance for credit loss or valuation allowance.





A loan
charged off is recorded as a charge to the allowance for credit loss or
valuation allowance at the time of foreclosure in connection with the transfer
of the underlying collateral to REO status. The amount of the loan charge off is
equal to the difference between the contractual amounts due under the loan and
the fair value of the collateral acquired through foreclosure, net of selling
costs. Generally, the loan charge off amount is equal to the loan’s allowance
for credit loss or valuation allowance. At the time of foreclosure, the
contractual value less the related allowance for credit loss or valuation
allowance is compared with the estimated fair value, less costs to sell, on the
foreclosure date and the difference, if any, is included in the provision for
credit losses (recovery) in the statement of operations. The allowance for
credit loss or valuation allowance is netted against the gross carrying value of
the loan, and the net balance is recorded as the new basis in the REO assets.
Once in a REO status, the asset is evaluated for impairment based on accounting
criteria for long-lived assets.





Classification
of Loans





Historically,
we generally expected that upon origination, mortgage investments would be held
until maturity or payoff. While we had the ability to do so, we did not
originate or acquire loans with the intent of reselling them as whole loans. In
addition, we did not have any mandatory delivery contracts or forward
commitments to sell loans in the secondary whole loan market. Because we had the
ability and the intent to hold these loans until maturity, they were generally
classified as held for investment pursuant to applicable accounting guidance. In
connection with the Conversion Transactions, we modified our business strategy
such that all mortgage investments are acquired with the intent to sell or
participate such investments. See the discussion under the heading “Participations Issued and Whole
Loans Sold” for additional information.





Loans
Held for Sale





Loans
that we intend to sell, subsequent to origination or acquisition, are classified
as loans held for sale, net of any applicable valuation allowance. Loans
classified as held for sale are generally subject to a specific marketing
strategy or a plan of sale. Loans held for sale are accounted for at the lower
of cost or fair value on an individual basis and are reported as a component of
mortgage loans. Direct costs related to selling such loans are deferred until
the related loans are sold and are included in the determination of the gains or
losses upon sale. Valuation adjustments related to loans held for sale are not
included in the valuation allowance in the consolidated balance sheets, but
rather are reported net of related principal of loans held for sale on the
consolidated balance sheets and the provision for credit losses in the
statements of operations. Because our existing loans are collateral dependent,
the method for determining fair value of our loans held for sale and loans held
for investment is generally the same.





Discounts
on Acquired Loans





We
account for mortgages acquired at a discount in accordance with applicable
accounting guidance. The accounting guidance requires that the amount
representing the excess of cash flows estimated by us at acquisition of the note
over the purchase price is to be accreted into interest income over the expected
life of the loan (accretable discount) using the interest method. Subsequent to
acquisition, if cash flow projections improve, and it is determined that the
amount and timing of the cash flows related to the nonaccretable discount are
reasonably estimable and collection is probable, the corresponding decrease in
the nonaccretable discount is transferred to the accretable discount and is
accreted into interest income over the remaining life of the loan using the
interest method. If cash flow projections deteriorate subsequent to acquisition,
or if the probability of the timing or amount to be collected is indeterminable,
the decline is accounted for through the provision for credit loss. Until such
time that the timing and amount to be collected under such loans is determinable
and probable as to collection, no accretion is recorded.


96




Real
Estate Held for Development or Sale





Real
estate held for development or held for sale consists primarily of assets that
have been acquired in satisfaction of a receivable, such as in the case of
foreclosure. When a loan is foreclosed upon and transferred to a REO status, an
assessment of the fair value is made, and the asset is transferred to real
estate held for development or held for sale at this amount less costs to sell.
We typically obtain a valuation on a REO asset within 90 days of the date of
foreclosure of the related loan. Valuation adjustments required at the date of
transfer are charged off to the allowance for loan loss or valuation
allowance.





Our
determination of whether to classify a particular REO asset as held for
development or held for sale depends on various factors, including our intent to
sell or develop the property and whether a formal plan of disposition has been
adopted, among other circumstances.





Subsequent
to transfer, real estate held for sale is carried at the lower of carrying
amount (transferred value) or fair value, less estimated selling costs. Our real
estate held for development is carried at the transferred value, less cumulative
impairment charges. Real estate held for development requires periodic
evaluation for impairment which is conducted at each reporting period. When
circumstances indicate that there is a possibility of impairment, we will assess
the future undiscounted cash flows of the property and determine whether they
are sufficient to exceed the carrying amount of the asset. In the event these
cash flows are insufficient, we determine the fair value of the asset and record
an impairment charge equal to the difference between the fair value and the
then-current carrying value. The impairment charge is recognized in the
consolidated statement of operations.





Upon sale
of real estate, any difference between the net carrying value and net sales
proceeds are charged or credited to operating results in the period of
sale.





If
management undertakes a specific plan to dispose of real estate own within
twelve months and the real estate is transferred to held for sale status, the
fair value of the real estate may be less than the estimated future undiscounted
cash flows of the property when the real estate was held for development, and
that difference may be material. Based on the valuations obtained from
independent third-party valuation specialists, the low end of the range of the
estimated fair value of real estate held for development exceeded the carrying
value of such assets by approximately $31.4 million as of December 31, 2009 and
by approximately $22.4 million as of September 30, 2010. See additional
discussion under the heading “Real Estate Owned Asset
Valuation” in this report for further discussion regarding valuation
assumptions utilized and conclusions reached.





Statement
of Cash Flows





Certain
loans in our portfolio contain provisions which provide for the establishment of
interest reserves which are drawn from the existing note obligation for the
satisfaction of monthly interest due in accordance with the terms of the related
notes. For purposes of reporting, draws are reflected as cash transactions in
accrued interest and mortgage loan fundings in the accompanying consolidated
statements of cash flows.





Use
of Estimates





In
accordance with U.S. GAAP, we have made a number of estimates and assumptions
with respect to the reporting of assets and liabilities and the disclosure of
contingencies at the date of the consolidated financial statements and the
reported amounts of income and expenses during the reporting period.
Accordingly, actual results could differ from those estimates. These estimates
primarily include the allowance for credit loss, valuation
allowance,  valuation of REO assets and the accretable amount and
timing for loans purchased at a discount.





Stock-Based
Compensation.





Our 2010
Stock Incentive Plan provides for awards of stock options, stock appreciation
rights, restricted stock units and other performance based awards to our
officers, employees, directors and certain consultants. The maximum number of
shares of common stock that may be issued under such awards shall not exceed
1,200,000 common shares, subject
to increase to 1,800,000 shares if we complete an initial public
offering. We measure the cost of employee services received in exchange
for an award of equity instruments based on the grant date fair value of the
award. No awards have been granted under this plan as of September 30,
2010.


97





Income
Taxes.





We
recognize deferred tax assets and liabilities and record a deferred income tax
(benefit) provision when there are differences between assets and liabilities
measured for financial reporting and for income tax purposes. We regularly
review our deferred tax assets to assess our potential realization and establish
a valuation allowance for such assets when we believe it is more likely than not
that we will not recognize some portion of the deferred tax asset. Generally, we
record any change in the valuation allowance in income tax expense. Income tax
expense includes (i) deferred tax expense, which generally represents the net
change in the deferred tax asset or liability balance during the year plus any
change in the valuation allowance and (ii) current tax expense, which represents
the amount of taxes currently payable to or receivable from a taxing authority
plus amounts accrued for income tax contingencies (including both penalty and
interest). Income tax expense excludes the tax effects related to adjustments
recorded to accumulate other comprehensive income (loss) as well as the tax
effects of cumulative effects of changes in accounting principles.





In
evaluating the ability to recover our deferred tax assets, we consider all
available positive and negative evidence regarding the ultimate realizability of
our deferred tax assets including past operating results and our forecast of
future taxable income. In addition, general uncertainty surrounding the future
economic and business conditions have increased the likelihood of volatility in
our future earnings. We have recorded a valuation allowance against our net
deferred tax assets.





Prior to
consummation of the Conversion Transactions, because we were a partnership for
tax purposes, no income taxes were paid by us. Instead, the members separately
paid taxes based on their pro rata shares of the Fund’s income, deductions,
losses and credits and members could elect to either reinvest or receive cash
distributions from the Fund. Whether received in cash or reinvested, members are
individually responsible to pay their respective income taxes on income
allocated to them for all periods prior to the conversion.





Recent
Accounting Pronouncements




For
information regarding recent accounting pronouncements that are applicable to
us, see Note 2 to our unaudited consolidated financial statements included with
this Form 10-Q.




Item 3.  Quantitative and
Qualitative Disclosures about Market Risk.




Our
financial position and results of operations are routinely subject to a variety
of risks. These risks include market risk associated primarily with changes in
interest rates. We do not deal in any foreign currencies and do not enter into,
or intend to enter into, derivative financial instruments for trading or
speculative purposes. Moreover, due to the historically short-term maturities of
our loans and the interest rate floors in place on all variable rate loans,
market fluctuations in interest rates generally do not affect the fair value of
our investment in loans.





Our
analysis of risks is based on our management’s and independent third parties’
experience, estimates, models and assumptions. These analyses rely on models
which utilize estimates of, among other things, fair value and interest rate
sensitivity. Actual economic conditions or implementation of decisions by our
management may produce results that differ significantly from the estimates and
assumptions used in our models and the projected results discussed in this Form
10-Q.





As a
result of the economic decline and market disruptions, we believe there are
severe restrictions on the availability of financing in general and concerns
about the potential impact on credit availability, liquidity, interest rates and
changes in the yield curve. While we have been able to meet all of our liquidity
needs to date, there are still concerns about the availability of financing
generally, and specifically about the availability of take-out financing for our
borrowers. Due to the decline of the economy and real estate and credit markets
and our intent to proactively pursue foreclosure of loans in default so we can
dispose of REO assets, we anticipate defaults and foreclosures to continue,
which will likely result in continuing high levels of non-accrual loans and REO
assets, which are generally non-interest earning assets. Further, the timing and
amount received from the ultimate disposition of those assets cannot be
determined given the current state of the U.S. and worldwide financial and real
estate markets.


98





Our
assets consist primarily of short-term commercial mortgages, real estate held
for development or sale, interest and other receivables and cash and cash
equivalents. The principal balance on our aggregate investment in mortgage loans
was $544.4 million and $490.9 million at December 31, 2009 and September 30,
2010, respectively (before the $330.4 million allowance for credit loss and
$333.1 million valuation allowance, respectively). Our loans historically have
had original maturities between nine and 18 months. However, with the general
lack of take-out financing available to our borrowers, we have modified nine of
our loans to extend the maturity dates to two years or longer. At September 30,
2010, the weighted average remaining scheduled term of our outstanding loans was
20.8 months (excluding loans past their scheduled maturity at September 30,
2010), with 55.5% of the loans at fixed interest rates and 44.5% of the loans at
variable interest rates. However, it is management’s intention to actively
market and sell such loans. At September 30, 2010, the weighted average rate on
our fixed rate portfolio was 9.85% per annum and 13.05% per annum on our
variable rate loans tied to the Prime interest rate. The weighted average
interest rate on all of our loans was 11.27% per annum at September 30,
2010.





We seek
to manage our risks related to the credit quality of our assets, interest rates,
liquidity, prepayment speeds and market value while, at the same time, seeking
to provide an opportunity to our stockholders to realize attractive
risk-adjusted returns through ownership of our capital stock.





Credit
Risk





We expect
to be subject to varying degrees of credit risk in connection with our assets.
We will seek to manage credit risk by, among other things, performing deep
credit fundamental analysis of potential assets.





Prior to
investing in any particular asset, our underwriting team, in conjunction with
third-party providers, will undertake a rigorous asset-level due diligence
process, involving intensive data collection and analysis, to ensure that we
understand fully the state of the market and the risk-reward profile of the
asset. Credit risk will also be addressed through our management’s execution of
an asset-specific business plan focused on actively managing the attendant
risks, evaluating the underlying collateral and updating valuation assumptions,
and determining disposition strategies. Additionally, investments will be
monitored for variance from expected prepayments, defaults, severities, losses
and cash flow on a monthly basis.





Interest
Rate Risk





Interest
rates are highly sensitive to many factors, including fiscal and monetary
policies and domestic and international economic and political considerations,
as well as other factors beyond our control. We will be subject to various
interest rate risks in connection with our assets and our related financing
obligations. Although we currently do not intend to use leverage to finance our
investments, we may in the future use various forms of financing to acquire our
target assets, including, but not limited to, repurchase agreements,
resecuritizations, securitizations, warehouse facilities, bank and private
credit facilities (including term loans and revolving facilities) and borrowings
under government sponsored debt programs. We may mitigate interest rate risk
through utilization of hedging instruments, including, but not limited to,
interest rate swap agreements. Interest rate swap agreements are intended to
serve as a hedge against future interest rate increases on our
borrowings.





At
September 30, 2010, 44.5% of our portfolio consisted of variable rate loans with
a weighted average interest rate of 13.05% per annum, all of which are indexed
to the Prime rate. Each outstanding variable rate loan had an interest rate
floor and no interest rate ceiling. Accordingly, if the Prime rate were to
increase during the life of these loans, and the loans were performing, interest
rates on all of these loans would adjust upward. Conversely, if the Prime rate
were to decrease, the interest rate on any particular loan would not decline
below the applicable floor rate, which is typically the original interest rate
at the time of origination.


99





Interest
Rate Effect on Net Interest Income





Our
operating results will depend, in part, on differences between the income earned
on our assets and the cost of our borrowing and hedging activities. The cost of
our borrowings will generally be based on prevailing market interest rates.
During a period of rising interest rates, our borrowing costs generally will
increase (1) while the yields earned on our fixed-rate mortgage assets will
remain static, and (2) at a faster pace than the yields earned on our floating
and adjustable rate mortgage assets, which could result in a decline in our net
interest spread and net interest margin. The severity of any such decline would
depend on our asset/liability composition at the time as well as the magnitude
and duration of the interest rate increase. Further, an increase in short-term
interest rates could also have a negative impact on the market value of our
target assets. If any of these events happen, we could experience a decrease in
net income or incur a net loss during these periods, which could harm our
liquidity and results of operations. We expect that our short-term lending will
be less sensitive to short-term interest rate movement. This is due to the
traditionally short-term maturities of those loans.





Interest
Rate Cap Risk





We may
acquire floating and adjustable rate mortgage assets, which generally will not
be subject to restrictions on the amount by which the interest yield may change
during any given period. Therefore, in a period of increasing interest rates,
interest rate costs on our borrowings could increase without limitation by caps,
while the interest-rate yields on our adjustable-rate and hybrid mortgage assets
would effectively be limited. In addition, adjustable-rate and hybrid mortgage
assets may be subject to periodic payment caps that result in some portion of
the interest being deferred and added to the principal outstanding. This could
result in our receipt of less cash income on such assets than we would need to
pay the interest cost on our related borrowings. These factors could lower our
net interest income or cause a net loss during periods of rising interest rates,
which would harm our financial condition, cash flows and results of
operations.





Interest
Rate Mismatch Risk





We may
fund a portion of our acquisition of mortgage loans and mortgage backed
securities assets with borrowings that are based on the Wall Street Journal
Prime Interest Rate, or Prime, while the interest rates on these assets may be
indexed to the London Interbank Offer Rate, or LIBOR, or another index rate,
such as the one-year Constant Maturity Treasury, or CMT, index, the Monthly
Treasury Average, or MTA, index or the 11th District Cost of Funds Index, or
COFI. Accordingly, any increase in LIBOR relative to one-year CMT rates, MTA or
COFI will generally result in an increase in our borrowing costs that is not
matched by a corresponding increase in the interest earnings on these assets.
Any interest rate index mismatch could adversely affect our financial condition,
cash flows and results of operations, which may negatively impact distributions
to our stockholders. To mitigate interest rate mismatches, we may utilize the
hedging strategies discussed above.





Prepayment
Risk





Prepayment
risk is the risk that principal will be repaid at a different rate than
anticipated, causing the return on an asset to be less or more than expected. As
we receive prepayments of principal on our assets, premiums paid on such assets
will be amortized against interest income. In general, an increase in prepayment
rates will accelerate the amortization of purchase premiums, thereby reducing
the interest income earned on the assets. Conversely, discounts on these assets
are accreted into interest income. In general, an increase in prepayment rates
will accelerate the accretion of purchase discounts, thereby increasing the
interest income earned on the assets.





Extension
Risk





Our
management will compute the projected weighted-average life of our assets based
on assumptions regarding the rate at which borrowers will prepay the mortgages.
In general, when we acquire a fixed-rate, adjustable-rate or hybrid mortgage
backed securities, we may, but are not required to, enter into an interest rate
swap agreement or other hedging instrument that effectively fixes our borrowing
costs for a period close to the anticipated average life of the fixed-rate
portion of the related assets. This strategy is designed to protect us from
rising interest rates because the borrowing costs are fixed for the duration of
the fixed-rate portion of the related assets.


100





However,
if prepayment rates decrease in a rising interest rate environment, the life of
the fixed-rate portion of the related assets could extend beyond the term of the
interest swap agreement or other hedging instrument. This could have a negative
impact on our results of operations, as borrowing costs would no longer be fixed
after the expiration of the hedging instrument while the income earned on the
hybrid fixed-rate assets would remain fixed. In certain situations, we could be
forced to sell assets to maintain adequate liquidity, which could cause us to
incur losses.





Market
Risk





Market Value
Risk.  Our available-for-sale securities will be reflected at
their estimated fair value, with the difference between amortized cost and
estimated fair value reflected in accumulated other comprehensive income
pursuant to applicable accounting guidance. The estimated fair value of these
securities fluctuates primarily due to changes in interest rates, among other
factors. Generally, in a rising interest rate environment, the estimated fair
value of these securities would be expected to decrease; conversely, in a
decreasing interest rate environment, the estimated fair value of these
securities would be expected to increase. As market volatility increases or
liquidity decreases, the fair value of our assets may be adversely impacted. If
we are unable to readily obtain independent pricing to validate our estimated
fair value of the securities in our portfolio, the fair value gains or losses
recorded in other comprehensive income may be adversely affected. See the
discussion under the heading “Allowance for Credit Loss/Valuation
and Fair Value Measurement.”





Real Estate
Risk.  Commercial and residential mortgage assets are subject
to volatility and may be affected adversely by a number of factors, including,
but not limited to, national, regional and local economic conditions (which may
be adversely affected by industry slowdowns and other factors); local real
estate conditions (including, but not limited to, an oversupply of housing,
retail, industrial, office or other commercial space); changes or continued
weakness in specific industry segments; construction quality, age and design;
demographic factors; and retroactive changes to building or similar codes. In
addition, decreases in property values reduce the value of the collateral and
the potential proceeds available to a borrower to repay the underlying loan or
loans, as the case may be, which could also cause us to suffer
losses.





Historically,
due to the short-term maturities of our loans and the existence of interest rate
floors on our variable rate loans, market fluctuations in interest rates
generally had not affected the fair value of our loans. However, given the
significant decline in the fair value of the underlying real estate collateral
securing our loans and the lack of available take-out financing, we have
experienced a significant increase in loans in default and loans placed in
non-accrual status that has adversely affected our operating results and is
expected to continue to do so in the future. At December 31, 2009 and September
30, 2010, the percentage of our loan principal in default status was 97.1% and
97.9%, respectively, and the percentage of our loan principal in non-accrual
status was 96.0% and 97.9%, respectively.





Significant
and sustained changes in interest rates could also affect our operating results.
If interest rates decline significantly, some of the borrowers could prepay
their loans with the proceeds of a refinancing at lower interest rates. Assuming
we could not replace these loans with loans at interest rates similar to those
that were prepaid (which, given our current status of not funding loans, is
likely the case), prepayments would reduce our earnings and funds available for
dividends to stockholders. On the other hand, a significant increase in market
interest rates could result in a slowdown in real estate development activity,
which could reduce the demand for our real estate loans and the collateral
securing the loans. Due to the complex relationship between interest rates, real
estate investment and refinancing possibilities, we are not able to quantify the
potential impact on our operating results of a material change in our operating
environment other than interest rates. However, assuming our September 30, 2010
portfolio remained unchanged for one year, a 100 basis point increase or
decrease in the Prime rate would cause our portfolio yield to remain unchanged
at 11.27% per annum. The result is due to the interest rate floor contained in
our variable rate loans and current Prime rate. The following table presents the
impact on annual interest income, assuming all loans were performing (however,
substantially all of ours loans are in non-accrual status), based on changes in
the Prime rate:


101





(in thousands)September 30, 2010 Portfolio InformationFixed Rate
                                                                                                              
                                                                                                              
                                                                                                              Variable Rate
                                                                                                              
                                                                                                              
                                                                                                              TotalOutstanding
      Balance
                                                                                                              
                                                                                                              $
                                                                                                              272,372
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              218,510
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              490,882Current
      Weighted Average Yield
                                                                                                              
                                                                                                              
                                                                                                              9.85
                                                                                                              %
                                                                                                              
                                                                                                              
                                                                                                              13.05
                                                                                                              %
                                                                                                              
                                                                                                              
                                                                                                              11.27
                                                                                                              %Annualized
      Interest Income
                                                                                                              
                                                                                                              $
                                                                                                              26,829
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              28,517
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              55,346Change
      in Annual Interest Income
                                                                                                              
                                                                                                              
                                                                                                              Pro-forma
                                                                                                              
                                                                                                              
                                                                                                              ChangeFixed
      Rate
                                                                                                              
                                                                                                              
                                                                                                              Variable
      Rate
                                                                                                              
                                                                                                              
                                                                                                              Total
                                                                                                              
                                                                                                              
                                                                                                              Yield
                                                                                                              
                                                                                                              
                                                                                                              In
      YieldIncrease
      in Prime Rate:0.5%
      or 50 basis points
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              11.27
                                                                                                              %
                                                                                                              
                                                                                                              
                                                                                                              0.00
                                                                                                              %1.0%
      or 100 basis points
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              11.27
                                                                                                              %
                                                                                                              
                                                                                                              
                                                                                                              0.00
                                                                                                              %2.0%
      or 200 basis points
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              5
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              5
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              11.28
                                                                                                              %
                                                                                                              
                                                                                                              
                                                                                                              0.00
                                                                                                              %Decrease
      in Prime Rate:0.5%
      or 50 basis points
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              11.27
                                                                                                              %
                                                                                                              
                                                                                                              
                                                                                                              0.00
                                                                                                              %1.0%
      or 100 basis points
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              11.27
                                                                                                              %
                                                                                                              
                                                                                                              
                                                                                                              0.00
                                                                                                              %2.0%
      or 200 basis points
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              $
                                                                                                              -
                                                                                                              
                                                                                                              
                                                                                                              
                                                                                                              11.27
                                                                                                              %
                                                                                                              
                                                                                                              
                                                                                                              0.00
                                                                                                              %





As of
September 30, 2010, over 97.9% of the principal balance of our loans is in
non-accrual status. As such, the change in interest income reflected in the
foregoing table, although negligible, would be unlikely to be realized upon a
change in interest rates.





The
following table contains information about our mortgage loan principal balances
as of September 30, 2010, presented separately for fixed and variable rates and
the calendar quarters in which such mortgage investments mature.





Loan
      Rates:
                                                                                                                
                                                                                                                Matured
                                                                                                                
                                                                                                                
                                                                                                                Q4
      2010
                                                                                                                
                                                                                                                
                                                                                                                Q1
      2011
                                                                                                                
                                                                                                                
                                                                                                                Q1
      2011
                                                                                                                
                                                                                                                
                                                                                                                Q3
      2011
                                                                                                                
                                                                                                                
                                                                                                                Q4
      2011
                                                                                                                
                                                                                                                
                                                                                                                Q3
      2012
                                                                                                                
                                                                                                                
                                                                                                                Q3
      2013
                                                                                                                
                                                                                                                
                                                                                                                Total(in
      thousands)Variable
                                                                                                                
                                                                                                                $
                                                                                                                212,688
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                4,206
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                1,618
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                -
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                -
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                -
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                -
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                -
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                218,512Fixed
                                                                                                                
                                                                                                                
                                                                                                                134,545
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                -
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                -
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                1,172
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                1,100
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                33,916
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                99,423
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                214
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                272,370$
                                                                                                                347,233
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                4,206
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                1,618
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                1,172
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                1,100
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                33,916
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                99,423
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                214
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                490,882Less:
      Valuation Allowance
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                (334,881
                                                                                                                )Net
      Carrying Value
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                
                                                                                                                $
                                                                                                                156,001





As of
September 30, 2010, we had cash and cash equivalents totaling $4.6 million (or
1.6% of total assets), all of which were held in bank accounts or highly liquid
money market accounts or short-term certificates of deposit. We have
historically targeted 3% - 5% of the principal balance of our outstanding loans
to be held in such accounts as a working capital reserve. However, our actual
deployment may vary depending on the timing and amount of investor capital
raised and the timing and amount of loans identified and funded. We believe that
these financial assets do not give rise to significant interest rate risk due to
their short-term nature.




Item 4T.   Controls and
Procedures




Controls
and Procedures




Our
management has evaluated, with the participation of the Chief Executive Officer
and Chief Financial Officer, of the effectiveness of our disclosure controls and
procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the
Exchange Act), as of the end of the period covered by this Form
10-Q.




Based on
this evaluation, the Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures were effective as of
the period ended September 30, 2010 to ensure that information required to be
disclosed by us in reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in SEC rules and forms and is accumulated and communicated to management,
including our principal executive officer and principal financial officer, as
appropriate to allow timely decisions regarding required
disclosure.




102




Changes
to Internal Control over Financial Reporting




There
were no changes in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our fiscal quarter
ended September 30, 2010 that have materially affected, or are reasonably likely
to materially affect, our evaluation of the effectiveness of our internal
control over financial reporting.




In
designing and evaluating our disclosure controls and procedures and internal
control over financial reporting, management recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
necessarily is required to apply its judgment in designing and evaluating the
controls and procedures.  We regularly review and document our disclosure
controls and procedures, and is in the process of refining our internal control
over financial reporting, and may from time to time make appropriate changes
aimed at enhancing their effectiveness and ensure that our systems evolve with
our business.




PART
II




OTHER
INFORMATION




Item
1.    Legal Proceedings




We may be
a party to litigation as the plaintiff or defendant in the ordinary course of
business in connection with loans that go into default, or for other reasons,
including, without limitation, potential claims or judicial actions relating to
the Conversion Transactions. While various asserted and unasserted claims exist,
resolution of these matters cannot be predicted with certainty and, we believe,
based upon currently available information, that the final outcome of such
matters will not have a material adverse effect, if any, on our results of
operations or financial condition. See the section entitled “Management’s Discussion and
Analysis — Results of Operations — Changes in the Portfolio
Profile — Scheduled Maturities” for further information on our
current foreclosure proceedings.





Following
the suspension of certain Fund activities, including the suspension of member
redemptions, certain of the members of the Fund requested that their redemption
requests be honored due to financial hardships or other reasons. In each
instance, we have responded that we will not grant those requests and we are
treating all members uniformly. While we have not been served with any lawsuits
from members, certain members have filed grievances with the SEC and other
regulatory agencies related to our administration of the Fund (including
regarding our suspension of redemptions), and these members’ disapproval of the
Conversion Transactions.





After we
filed the initial Registration Statement on Form S-4 with the SEC on December
30, 2009, or the Form S-4, various disputes have arisen relating to the consent
solicitation/prospectus and the proposed transactions contained therein. Three
proposed class action lawsuits were filed in the Delaware Court of Chancery (May
26, 2010, June 14, 2010 and June 17, 2010) against us and our affiliated named
individuals and entities. The May 26 and June 14, 2010 lawsuits contain similar
allegations, claiming that fiduciary duties owed to Fund members and to the Fund
were breached because the Conversion Transactions were unfair to Fund members,
constitute self-dealing and because the Form S-4 and/or information provided
about the Form S-4 or Conversion Transactions are false and misleading. The June
17, 2010 lawsuit focuses on whether the Conversion Transactions constitute a
“roll up” transaction under the Fund’s operating agreement, and seeks damages
for breach of the operating agreement. We and our affiliated named individuals
and entities dispute these claims and will defend vigorously against these
actions.





An action
was filed on June 14, 2010 by Fund members Ronald Tucek and Cliff Ratliff, as
well as LGM Capital Partners, LLC (also known as The Committee to Protect IMH
Secured Loan Fund, LLC) in the Delaware Court of Chancery against us and
affiliated named individuals and entities. The June 14, 2010 lawsuit claims that
that fiduciary duties and the duty of disclosure owed to Fund members and to the
Fund were breached because the Conversion Transactions were unfair to Fund
members, constitute self-dealing and because the Form S-4 and/or information
provided about the Form S-4 or Conversion Transactions are false and misleading.
Plaintiffs sought to enjoin the Conversion Transactions, have an independent
advisor appointed on behalf of Fund members, remove the Manager and obtain
access to contact information for Fund members and certain broker-dealers. We
and our affiliated named individuals and entities dispute these claims and will
defend vigorously against this action.


103





In July 2010, the parties in the four
actions mentioned above filed various motions and/or briefs seeking competing forms of
consolidation and/or coordination of the four actions.  During a
hearing on these motions on October 14, 2010, the parties in the respective
actions agreed to consolidate the four actions for all purposes, subject tocertain provisions with “respect to the unique individual count
brought”by the Tucek
plaintiffs.  On October 25, 2010, the Delaware Court of Chancery
granted the respective parties’proposed “Order of Consolidation and Appointment
of Co-lead Plaintiffs: Counsel and Co-Liaison
Counsel,”which, among
other things, consolidated the four actions, ordered that a consolidated Amended
complaint shall be filed within 45 days of October 25, 2010, followed by
consolidated discovery, and designated the plaintiffs’counsel from the May 25, 2010 and June 17,
2010 lawsuits as co-lead counsel.  The consolidated action is in its
early stage and it is not possible to estimate at this time the range of
exposure, if any, the consolidated action presents.





A lawsuit
was filed in the Superior Court of California, County of Santa Barbara and
served on June 1, 2010 by a purported Fund member, Barney Weinman, against the
Manager and individuals and entities associated with a broker-dealer that placed
Weinman with the Fund. This action alleges that the broker-dealer who placed
Weinman in the Fund did so in breach of his fiduciary duties to Weinman, and
also alleges that the Manager knew that the Fund’s business was declining and
that redemptions would be frozen, but failed to disclose that to Weinman. The
action seeks returns of his investment and damages. We dispute these claims and
will defend vigorously against this action.  A trial date has been set for June 22,
2011.





On June 8, 2010,we received
notice from the SEC that we
were the subject of a SEC investigationand received requests for
documents.  Our present intention is to work cooperatively with the
SEC in its investigation. The resolution of the SEC investigation is not determinable at this
time.





We
believe that we have always been, and currently are, in compliance with all
regulations that materially affect us and our operations, and that we have acted
in accordance with our operating agreement prior to its termination as a result
of the Conversion Transactions. However, there can be no guarantee that this is
the case or that the above-described or other matters will be resolved
favorably, or that we or our affiliates may not incur significant legal and
other defense costs, damage or settlement payments, regulatory fines, or
limitations or prohibitions relating to our or our affiliates’ business
activities, any of which could harm our operations.


104


Item
1A.        Risk Factors




In
addition to the other information set forth in this Form 10-Q, you should
carefully consider the factors discussed in Item 1A, “Risk Factors,” in our
previously filed Form 10-K/A, as supplemented by subsequent Quarterly Reports on
Form 10-Q, which could materially affect our business, financial condition or
results of operations.   The risks described below are not the only
risks we face.  Additional risks and uncertainties not currently known to
us or that we currently deem to be immaterial also may materially adversely
affect our business, financial condition or operating results.




Forward-LookingStatements




This Form 10-Q contains forward-looking
statements which relate to expectations, beliefs, projections, future plans and
strategies, anticipated events or trends and similar expressions concerning
matters that are not historical facts. In some cases, you can identify forward looking
statements by terms such as “anticipate,”“believe,”“could,”“estimate,”“expect,”“intend,”“likely,”“may,”“plan,”“potential,”“should”and “would”or the negative of these terms or other
comparable terminology.




The forward-looking statements are based
on our beliefs, assumptions and expectations of our future performance. These
beliefs, assumptions and expectations can change, and actual results and events
may differ materially, as a result of many possible events or factors, not all of which are known
to us or are within our control. A detailed discussion of risks and
uncertainties that could cause actual results and events to differ materially
from such forward-looking statements is included in the section titled "Risk
Factors" (refer to Part II,
Item 1A of this Form 10-Q).




·
            Various disputes have arisen
      regarding the Conversion Transactions and we are a named defendant in
      three class-action proceedings and a separate suit initiated by two
      members of the Fund.Additionally, the SEC has notified
      us that it is conducting an investigation related to us.  We
      cannot predict when or how these matters will be resolved and we could be
      subject to significant money damages, which could harm our business and
      results of operations;




·
            The decline in economic conditions
      and disruptions to markets may not improve for the foreseeable future,
      which could cause us to suffer continuing operating losses, adversely
      affect our liquidity and create other business problems for
      us;




·
            We are subject to the risk that, despite
      recent actions and proposals by the U.S. government and governments around
      the world, the economy and real estate and other markets will not improve,
      which could continue to harm our ability to sell or dispose of the assets
      weown and the ability of our
      borrowers to pay obligations under, or repay our commercial mortgage loans
      on maturity or obtain take-out financing in a timely manner, on reasonable
      terms, or at all, which would harm our liquidity and operating
      results;




·
            We believe that our ability to
      continue as a “going
      concern”for the next
      12 months is predicated on our cash and cash equivalents, coupled with
      liquidity derived from the credit facility currently under negotiation and
      the disposition of certain of theloans and real estate assets held
      for sale.




·
            The suspension of certain of our
      activities resulting from current market conditions and our liquidity
      status may persist for an extended period of time and we may not resume
      historical levels of activities, orat
  all;




·
            If our liquidity continues to
      dissipate and we are unable to meet our obligations, we may be forced to
      sell certain of our assets for a price at or below the current book value
      of the assets, which could result in a loss to
  us;




·
            We are subjectto risks generally associated with
      the lending to, and ownership of, real estate-related assets, including
      changing economic conditions, environmental risks, unforeseen statutory
      and regulatory changes, the cost of and ability to obtain insurance and
      risksrelated to developing and leasing
      of properties;




105




·
            Real estate assets we may acquire
      in foreclosure or through other means are generally non-earning assets
      that would correspondingly reduce the distributable yield to our
      investors, if any. In the event of foreclosure, we would also be
      responsible for thepayment of past due property taxes, a liability not currently recorded,
      but is reflected in our asset valuation, which approximates $7.6 million
      as of September 30, 2010.  Moreover, the ultimate disposition of
      such assets may not occur for an extended period of time or at prices we seek,
      which would harm our
liquidity;




·
            As a commercial real estate
      mortgage lender, we are subject to a variety of external forces that could
      harm our operations and results, including, without limitation,
      fluctuations in interest rates, fluctuations in economic conditions (which
      are exacerbated by
      our limited geographic diversity), and the effect that regulators or
      bankruptcy courts could have on our operations and rights as a secured
      commercial real estate mortgage
lender;




·
            Our commercial real estate
      mortgage loans, which are not guaranteedby any government agency, are
      risky and are not sold on any well established secondary market, and the
      underwriting standards that we previously utilized may not be sufficient
      to protect stockholders from our borrowers’loan defaults or to ensure that
      sufficient collateral, including
      collateral pledged by guarantors, will exist to protect our stockholders
      from any such defaults in the context of the continued market stress
      currently applicable in the real estate sector;
  and




·
            Our directors and executive
      officers may have conflicts of interest, including, without limitation,
      competing demands upon their time and their involvement with other
      activities, all of which could result in less time spent developing and
      managing our business.




Except to the extent required by law, we
undertake no obligation to update or revise publicly any forward-looking
statements, whether as a result of new information, future events or otherwise.
In light of these risks, uncertainties and assumptions, the events described by our
forward-looking statements might not occur. We qualify any and all of our
forward-looking statements by these cautionary factors. Please keep this
cautionary note in mind as you read this Form 10-Q and the documents
incorporated by reference into this Form
10-Q.




Risks
Related to Our Business Strategy and Our Operations:





We
have recorded losses for the years ended December 31, 2008 and 2009 and for the
nine months ended September 30, 2010 and may continue to do so.





Due
primarily to the recording of a provision for credit losses relating to our
commercial mortgage loans, we reported a net loss of $258.3 million, $74.5
million and $65.6 million for the years ended December 31, 2008, 2009 and the
nine months ended September 30, 2010, respectively. As of September 30, 2010,
our accumulated deficit aggregated $474.1 million. Our historical business model
relied on the availability of third-party capital to our borrowers to re-finance
short-term commercial real estate bridge loans that we provided to the borrowers
to facilitate real estate entitlement and development. However, the erosion of
the U.S. and global credit markets in 2008 and 2009, including a significant and
rapid deterioration of the commercial mortgage lending and related real estate
markets, has substantially curtailed the availability of traditional sources of
take-out financing. As a result, we have experienced increased default and
foreclosure rates on our commercial real estate mortgage loans. In addition, as
a result of these changes, we modified certain commercial real estate mortgage
loans, including modifications to the applicable periodic repayment rates and
extended maturity dates by two years or longer. We may continue to record net
losses in the future as a result of additional provisions for record losses or
otherwise.


106





Our
operating expenses will continue to increase as a result of the recent
completion of the Conversion Transactions and our active efforts to pursue
enforcement on defaulted loans, subsequent foreclosure and our resulting
ownership of the underlying collateral.





We bear
overhead or operating expenses, including costs associated with commercial real
estate mortgage loan originations, member development and operations, and other
general overhead costs which the Manager previously was required to bear or
voluntarily paid on behalf of the Fund prior to the consummation of the
Conversion Transactions. As a result, we expect our overhead and operating
expenses to increase, and the increase in these expenses may not necessarily be
offset in whole or in part by increased revenues as a result of the acquisition
of the Manager and Holdings. For the years ended December 31, 2007, 2008, and
2009 and the period from January 1, 2010 through June 18, 2010 (the date of the
acquisition), the Manager paid $19.9 million, $18.2 million, $5.9 million and
$2.7 million, respectively, of those expenses. Additionally, we are required to
pay direct expenses or costs, which include salaries paid to our employees,
expenses or costs related to our defaulted commercial real estate mortgage
loans, foreclosure activities, property acquired through foreclosure, and
interest expense paid on mortgage loans that we have sold or participated. As a
result of our active efforts to pursue enforcement on defaulted loans,
subsequent foreclosure and our resulting ownership of the underlying collateral,
the costs related to these activities have also significantly increased and are
expected to continue to increase. These costs are material and may harm our
results of operations, cash flow and liquidity.





We
anticipate that a significant portion of our portfolio will continue to be in
the form of non-performing and distressed commercial real estate mortgage loans,
or loans that may become non-performing and distressed, which are subject to
increased risks relative to performing mortgage loans.





As is the
case with our current assets, we anticipate that a significant portion of our
future assets will continue to be in the form of commercial real estate mortgage
loans that we originate or acquire, including non-performing and distressed
commercial mortgage loans, which are subject to increased risks of loss. These
loans may already be, or may become, non-performing or distressed for a variety
of reasons, including, without limitation, because the underlying property is
too highly leveraged or the borrower becomes financially distressed, in either
case, resulting in the borrower being unable to meet its debt service or
repayment obligations to us. These non-performing or distressed commercial real
estate mortgage loans may require a substantial amount of workout negotiations
or restructuring, which may divert the attention of our management from other
activities and entail, among other things, a substantial reduction in the
interest rate, capitalization of interest payments, and a substantial write-down
of the principal of our loans. However, even if we successfully accomplish these
restructurings, our borrowers may not be able or willing to maintain the
restructured payments or refinance the restructured commercial real estate
mortgage loans upon maturity.





In
addition, certain non-performing or distressed commercial real estate mortgage
loans that we acquire may have been originated by financial institutions that
are or may become insolvent or suffer from serious financial stress or are no
longer in existence. As a result, the recourse to the selling institution or the
standards by which these loans are being serviced or operated may be adversely
affected. Further, loans on properties operating under the close supervision of
a mortgage lender are, in certain circumstances, subject to certain additional
potential liabilities that may exceed the value of our investment.





As with
our current commercial real estate mortgage loans, we may find it necessary or
desirable to foreclose on many of the mortgage loans we originate or acquire,
and the foreclosure process may be lengthy and expensive. Borrowers may resist
mortgage foreclosure actions by asserting numerous claims, counterclaims and
defenses against us, including, without limitation, lender liability claims and
defenses, even when the assertions may have no basis in fact, in an effort to
prolong the foreclosure action and seek to force the lender into a modification
of the loan or a favorable buy-out of the borrower’s position in the loan. In
some states, foreclosure actions can take several years or more to litigate. At
any time prior to or during the foreclosure proceedings, the borrower may file
for bankruptcy, which would have the effect of staying the foreclosure actions
and further delaying the foreclosure process. Foreclosure may create a negative
public perception of the related mortgaged property, resulting in a diminution
of its value. Even if we are successful in foreclosing on a loan, the
liquidation proceeds upon sale of the underlying real estate may not be
sufficient to recover our cost basis in the loan, resulting in a loss to us.
Furthermore, any costs or delays involved in the foreclosure of the loan or a
liquidation of the underlying property will further reduce the net proceeds and,
thus, increase the loss.





Whether
or not we have participated in the negotiation of the terms of any such
commercial real estate mortgage loans, we cannot assure you as to the adequacy
of the protection of the terms of the applicable loan, including the validity or
enforceability of the loan and the maintenance of the anticipated priority and
perfection of the applicable security interests. Furthermore, claims may be
asserted by lenders or borrowers that might interfere with enforcement of our
rights.


107





Commercial
real estate mortgage loans are also subject to “special hazard” risk (property
damage caused by hazards, harm such as earthquakes or environmental hazards, not
covered by standard property insurance policies), and to bankruptcy risk
(reduction or discharge of a borrower’s mortgage debt by a bankruptcy court). In
addition, claims may be assessed against us on account of our position as
mortgage holder or property owner, including responsibility for tax payments,
environmental hazards and other liabilities, which could harm our results of
operations, financial condition and our ability to make distributions to our
stockholders.





Recent
market conditions may make it more difficult for us to analyze potential
investment opportunities for our assets.





Our
success depends, in part, on our ability to analyze effectively potential
investment opportunities in order to assess the level of risk-adjusted returns
that we should expect from any particular asset. To estimate the value of a
particular asset, we may use historical assumptions that may or may not be
appropriate during the current unprecedented downturn in the real estate market
and general economy. To the extent that we use historical assumptions that are
inappropriate under current market conditions, we may lend on a real estate
asset that we might not otherwise lend against, overpay for an asset or acquire
an asset that we otherwise might not acquire or be required to later write-down
the value of assets acquired on the basis of such assumptions as we have been
required to do with our current portfolio, which may harm our results of
operations and our ability to pay dividends to our stockholders.





In
addition, as part of our overall risk management, we analyze interest rate
changes and prepayment trends separately and collectively to assess their
effects on our assets. In conducting our analysis, we may depend on certain
assumptions based upon historical trends with respect to the relationship
between interest rates and prepayments under normal market conditions. Recent
dislocations in the real estate mortgage market or other developments may change
the way that prepayment trends have historically responded to interest rate
changes, which may harm our ability to (i) assess the market value of our
assets, (ii) implement any hedging strategies we may decide to pursue, and (iii)
implement techniques to reduce our prepayment rate volatility. If our estimates
prove to be incorrect or our hedges do not adequately mitigate the impact of
changes in interest rates or prepayments, we may incur losses that could harm
our financial condition, results of operations and our ability to pay dividends
to our stockholders.





The
supply of commercial mortgage loans available at significant discounts will
likely decrease as the economy improves, which may cause us to adjust our
business strategies.





Our
business strategy focuses on the acquisition and origination of commercial
mortgage loans and other distressed real estate-related assets and the
disposition of a significant portion of our existing assets, individually or in
bulk,. However, when the current conditions in the commercial mortgage market,
the financial markets and the economy stabilize or improve, the availability of
borrowers and projects that meet our underwriting criteria, or commercial
mortgage loans that meet our business objectives and strategies will likely
decrease, which could prevent us from implementing our business strategies. At
that time, we intend to reevaluate our business strategies; however, any of our
current or future strategies may not be successful. Additionally, the manner in
which we compete and the types of assets we seek to acquire will be affected by
sudden changes in our industry, the regulatory environment, the role of
government-sponsored entities, the role of credit rating agencies or their
rating criteria or process, or the U.S. and global economies generally. If we do
not effectively respond to these changes, or if our strategies to respond to
these changes are not successful, our financial condition and results of
operations may be harmed. In addition, we may not be successful in executing our
business strategies and even if we successfully implement our business
strategies, we may not ever generate revenues or profits.


108





We
are subject to litigation or claims, including in connection with the recently
consummated Conversion Transactions.





We are
subject to a number of claims relating to the recently consummated Conversion
Transactions and our historical operations. As discussed more fully under the
heading “Item 1- Legal
Proceedings,” three proposed class action lawsuits have been filed in the
Delaware Court of Chancery against us and affiliated named individuals and
entities, containing similar allegations. An action was also filed on June 14,
2010 by certain Fund members, alleging that fiduciary duties and the duty of
disclosure owed to Fund members and to the Fund were breached. On October 25, 2010, the Delaware Court
of Chancery consolidated the four actions, ordered that a consolidated amended
complaint be filed within 45 days, followed by consolidated discovery, and
designated co-lead counsel for plaintiffs.  The consolidated action is in its early stage and
it is not possible to estimate, at this time, the range of exposure, if any, the
consolidated action presents.We
and the named individuals and entities affiliated with us dispute these claims
and will defend vigorously against this action.





In
addition, on June 8, 2010, we received notice from the SEC that it is conducting
an investigation related to us, and received document requests. Our present
intention is to work cooperatively with the SEC in its investigation, but we do
not believe that we have violated any federal securities laws. A member has also
filed a lawsuit against us and individuals and entities associated with a
broker-dealer who placed the member in the Fund, alleging breach of fiduciary
duty by the broker-dealer and failure to disclose by us. A trial date for this lawsuit has been
set for June 22, 2011.In
addition, certain of the members have filed grievances with the SEC and possibly
other regulatory agencies related to the Manager’s administration of the Fund,
and we are unable to predict the outcome of any such grievances.





We have
been required to devote substantial time and resources to defend against such
actions. Regardless of the merits of these claims, we have incurred significant
additional expenses and devoted significant attention to the outcome of these
matters. Other parties may also assert claims or legal actions against us, our
directors or executive officers or other parties indemnified by us. Although we
believe these existing claims are insured (subject to applicable deductions),
there can be no guarantee these existing or future claims will be covered by our
carrier. Regardless of the merits of any such claim or legal action, we may
incur significant additional expenses, liabilities and indemnification
obligations, and any uncertainty as to the outcome of litigation and could
distract management attention from focusing on managing our business and make it more difficult to raise
capital on attractive terms or at all. As a result, we could be required
to make cash payments at a time when we lack sufficient liquidity to do so,
which would force us to sell assets at a significant discount to values that may
otherwise be realizable.





If
we are required to fund the entire amount of unfunded loans-in-process, our
liquidity may be adversely affected.





We have
contractual commitments on unfunded commercial mortgage loans to our borrowers
in process and interest reserves totaling $18.7 million at September 30, 2010,
of which we estimate we will be required to fund no more than $15.0 million and
no more than $8.9 million in cash. The latter amount excludes amounts of
previous commitments that we are no longer obligated to fund because the
borrowers are in default, the loans have been modified to lower the funding
amount, or the loan funding was contingent on various project milestones which
were not met. If we are required to fund any of the unfunded contractual
commitments to our borrowers for unfunded commercial mortgage loans-in-process,
this could adversely affect our liquidity. For more information about our loan
fundings, see the discussion under the heading “Management’s Discussion and Analysis
of Financial Condition and Results of Operations of IMH Financial
Corporation —  Requirements for Liquidity — Loan
Fundings.”


109





We
depend in part on outside consultants for loan workouts.





Substantially
all of our commercial mortgage loans are in default, and currently performing
loans may default in the future. We have historically engaged a team of
consultants who are physically located at our premises to assist us in
negotiating and managing non-performing and distressed loans. We recently
internalized most of these consultants, but continue to engage consultants
physically resident on our premises to assist our team. We rely on these
consultants to supplement our loan workout department. Some of these consultants
are also employed by other unrelated clients to whom the consultant is obligated
to provide time and attention and, thus, these consultants may be unavailable to
us from time to time. If employees or consultants are not available to assist us
in negotiating and managing non-performing or distressed loans, our rights as a
lender or creditor could be compromised and we may not be able to realize the
full potential value of these loans.





A
secondary market for our loans or other assets we acquire may not develop, in
which case we may not be able to diversify our assets in response to changes in
economic and other conditions, and we may be forced to bear the risk of
deteriorating real estate markets, which could increase the borrower’s defaults
on our loans and cause us to experience losses.





Many of
our target assets, including commercial mortgage loan related assets, generally
experience periods of illiquidity, such as the current period of delinquencies
and defaults with respect to commercial mortgage loans. In addition, a secondary
market for our portfolio loans or other assets we acquire may not develop. We
will generally bear all the risk of our assets until the loans mature, are
repaid or are sold. A lack of liquidity may result from the absence of a willing
buyer or an established market for these assets, as well as legal or contractual
restrictions on resale or the unavailability of financing for these assets. In
addition, certain of our target assets, such as bridge loans and other
commercial real estate mortgage loans may also be particularly illiquid assets
due to their short life, their potential unsuitability for securitization and
the greater difficulty of recovery in the event of a borrower’s default. The
potential illiquidity of our assets may make it difficult for us to sell such
assets at advantageous times or at favorable prices, including, if necessary, to
maintain our exemption from the Investment Company Act. Moreover, turbulent
market conditions, such as those currently in effect, could harm the liquidity
of our assets. As a result, our ability to sell our assets and purchase new
assets may be relatively limited, which may cause us to incur losses. If we are
required to sell all or a portion of our assets quickly, we may realize
significantly less than the value at which we have previously recorded our
assets. This will limit our ability to mitigate our risk in changing real estate
markets and may result in reduced returns to our stockholders.





Our
access to public capital markets and private sources of financing may be limited
and, thus, our ability to make additional investments may be
limited.





Our
access to public capital markets and private sources of financing will depend
upon a number of factors over which we have little or no control, including,
among others, the following:





·
            general
      market conditions;


·
            the
      market’s view of the quality of our
assets;


·
            the
      market’s view of our management;


·
            the
      market’s perception of our growth
potential;


·
            our
      eligibility to participate in, and access capital from, programs
      established by the U.S. government;


·
            our
      current and potential future earnings and cash distributions;
      and


·
            the
      market price of our common stock.





The
current dislocations and weaknesses in the capital and credit markets could
adversely affect one or more private lenders and could cause one or more lenders
to be unwilling or unable to provide us with financing or to increase the costs
of such financing to us. In addition, several banks and other institutions that
historically have been reliable sources of financing have gone out of business,
which has reduced significantly the number of lending institutions and the
availability of credit. Moreover, the return on our assets and cash available
for distribution to our stockholders may be reduced to the extent that market
conditions prevent us from leveraging our assets or cause the cost of our
financing to increase relative to the income that can be derived from the assets
acquired. If we are unable to obtain financing on favorable terms or at all, we
may have to curtail our investment activities, which could limit our growth
prospects, and we may be forced to dispose of assets at inopportune times in
order to maintain our Investment Company Act exemption.


110





Under
current market conditions, structured financing arrangements are generally
unavailable, the shortage of which has also limited borrowings under warehouse
and repurchase agreements that are intended to be refinanced by such financings.
Consequently, depending on market conditions at the relevant time, we may have
to rely more heavily on additional equity issuances, which may be dilutive to
our stockholders, or on more expensive forms of debt financing that require a
larger portion of our cash flow from operations, thereby reducing funds
available for our operations, future business opportunities, cash dividends to
our stockholders and other purposes. We may not have access to such equity or
debt capital on favorable terms at the desired times, or at all, which may cause
us to curtail our investment activities or to dispose of assets at inopportune
times, and could harm our results of operations and growth
prospects.





We
may lack control over certain of our commercial mortgage loans and other
investments that we participate in with other lenders, which could limit our
ability to manage such mortgage loans in a manner we deem
advisable.





Our
ability to manage our portfolio of loans and other investments may be limited by
the form in which they are made. Certain of our assets are participations in
existing mortgage loans with other lenders, and we may purchase commercial
mortgage loans jointly with other lenders, acquire investments subject to rights
of senior classes and servicers under inter-creditor or servicing agreements;
acquire only a participation interest in an underlying investment; or rely on
independent third-party management or strategic partners with respect to the
management of an asset. Therefore, we may not be able to exercise control over
the loan or investment. Such financial assets may involve risks not present in
investments where senior creditors, servicers or third-party controlling
investors are not involved. Our rights to enforcement following a borrower
default may be subject to the rights of senior creditors or servicers or
third-party partners with economic, business or other interests or goals which
may be inconsistent with ours. In addition, we may, in certain circumstances, be
liable for the actions of our third-party partners. These decisions and
judgments may be different than those we would make and may be adverse to
us.





Short-term
loans that we may originate or acquire may involve a greater risk of loss than
traditional investment-grade mortgage loans with fully insured
borrowers.





We have
historically, and intend to continue to, originate or acquire commercial real
estate-bridge loans secured by first lien mortgages on properties of borrowers
who are typically seeking short-term capital to be used in the acquisition,
construction or rehabilitation of properties. The typical borrower under a
short-term loan has usually identified what they believe is an undervalued asset
that may have been under-managed or located in a recovering market. If the
market in which the asset is located fails to recover according to the
borrower’s projections, or if the borrower fails to improve the quality of the
asset’s management or the value of the asset, the borrower may not receive a
sufficient return on the asset to satisfy the short-term loan, and we bear the
risk that we may not recover some or all of our loan amount.





In
addition, borrowers under a bridge loan usually use the proceeds of a
conventional mortgage loan to repay a short-term loan. The risk of a borrower’s
inability to obtain permanent financing is increased under current market
conditions. Therefore, bridge loans are subject to the risk of a borrower’s
inability to obtain permanent financing to repay the short-term loan. Short-term
loans are also subject to the risk associated with all commercial mortgage
loans — borrower defaults, bankruptcies, fraud, losses and “special
hazard” losses that are not covered by standard hazard insurance. In the event
of any default under short-term loans held by us as lenders, we bear the risk of
loss of principal and non-payment of interest and fees to the extent of any
deficiency between the value of the mortgage collateral and the principal amount
and unpaid interest accrued under the short-term loan. To the extent we suffer
such losses with respect to our short-term loans, the value of our company and
the price of our shares of common stock may be harmed.


111





The
subordinated loan assets that we may acquire will involve greater risks of loss
than senior loans secured by income-producing properties.





We may
acquire subordinated loans secured by junior mortgages on the underlying
property or loans secured by a pledge of the ownership interests of either the
entity owning the property or a pledge of the ownership interests of the entity
that owns the interest in the entity owning the property. These types of assets
involve a higher degree of risk than long-term senior mortgage lending secured
by income-producing real property, because the loan may become unsecured as a
result of foreclosure by the senior lender. In addition, these loans may have
higher loan-to-value ratios than conventional mortgage loans, resulting in less
equity in the property and increasing the risk of loss of principal. If a
borrower defaults on our subordinated loan or debt senior to our loan, or in the
event of a borrower bankruptcy, our subordinated loan will be satisfied only
after the senior debt is paid in full. Where debt senior to our portfolio loan
exists, the presence of intercreditor arrangements between the holder of the
mortgage loan and us, as the subordinated lender, may limit our ability to amend
our loan documents, assign our loans, accept prepayments, exercise our remedies
and control decisions made in bankruptcy proceedings relating to borrowers. As a
result, we may not recover some or all of our investment, which could result in
losses to us. In addition, even if we are able to foreclose on the underlying
collateral following a borrower’s default on a subordinated loan, we may assume
the rights and obligations of the defaulting borrower under the loan and, to the
extent income generated on the underlying property is insufficient to meet
outstanding debt obligations on the property, we may need to commit substantial
additional capital to stabilize the property and prevent additional defaults to
lenders with existing liens on the property. Significant losses related to our
subordinated loans could harm our results of operations and our ability to make
distributions to our stockholders.





Our
due diligence may not reveal all of a borrower’s assets or liabilities and may
not reveal other investment risks or weaknesses in a business.





Before
acquiring an asset or making a loan to a borrower, we assess the strength and
skills of the asset or potential borrower and other factors that we believe are
material to the performance of the asset. In making this assessment and
otherwise conducting customary due diligence, we rely on numerous resources
reasonably available to us and, in some cases, an investigation by third
parties. This process is particularly subjective, and of lesser value than would
otherwise be the case, with respect to newly organized entities because there
may be little or no information publicly available about those entities. There
can be no assurance that our due diligence processes will uncover all relevant
facts or problems, or that any particular asset will be successful.





We
may enter into hedging transactions that could expose us to contingent
liabilities in the future.





We may
enter into hedging transactions that could require us to fund cash payments in
certain circumstances such as the early termination of the hedging instrument
caused by an event of default or other early termination event, or the decision
by a counterparty to request margin securities it is contractually owed under
the terms of the hedging instrument. The amount due upon early termination or as
the result of a request for margin securities would be equal to the unrealized
loss of the open swap positions with the respective counterparty and could also
include other fees and charges. These economic losses would be reflected in our
results of operations. Our ability to fund these obligations will depend on the
liquidity of our assets and access to capital at the time. The need to fund
these obligations could harm our financial condition. We also may pursue various
hedging strategies to seek to reduce our exposure to adverse changes in interest
rates. Our hedging activity will vary in scope based on the level and volatility
of interest rates, the type of assets held and other changing market conditions.
Interest rate hedging could harm or fail to protect us because, among other
things:





·
            interest
      rate hedging can be expensive, particularly during periods of rising and
      volatile interest rates;


·
            available
      interest rate hedges may not
      correspond directly with the interest rate risk for which protection is
      sought;


·
            the
      duration of the hedge may not match the duration of the related
      liability;


·
            the
      credit quality of the hedging counterparty owing money on the hedge may be
      downgraded to such an extent that it impairs our ability to sell or assign
      our side of the hedging transaction;
and


·
            the
      hedging counterparty owing money in the hedging transaction may default on
      its obligation to pay.


112





In
addition, hedging instruments involve risk since they often are not traded on
regulated exchanges, guaranteed by an exchange or its clearing house, or
regulated by any U.S. or foreign governmental authorities. Consequently, there
are no requirements with respect to record keeping, financial responsibility or
segregation of customer funds and positions. Furthermore, the enforceability of
agreements underlying hedging transactions may depend on compliance with
applicable statutory and commodity and other regulatory requirements and,
depending on the identity of the counterparty, applicable international
requirements. The business failure of a hedging counterparty with whom we enter
into a hedging transaction will most likely result in its default. Default by a
party with whom we enter into a hedging transaction may result in unrealized
losses or the loss of unrealized profits and force us to cover our commitments,
if any, at the then current market price. It may not always be possible to
dispose of, close out or terminate a hedging position without the consent of the
hedging counterparty, and we may not be able to enter into an offsetting
contract in order to cover our risk. A liquid secondary market may not exist for
any hedging instruments purchased or sold, and we may be required to maintain a
position until exercise or expiration, which could result in losses to us.
Moreover, there can be no assurance that the hedging agreement would qualify for
hedge accounting or that our hedging activities would have the desired
beneficial impact on our financial performance and liquidity. Should we choose
to terminate a hedging agreement, there could be significant costs and cash
requirements involved to fulfill our initial obligation under the hedging
agreement. The risks above relating to any of our hedging transactions may harm
our results of operations and limit our ability to make distributions to our
stockholders.





Any
repurchase agreements and bank credit facilities that we may use in the future
to finance our assets may require us to provide additional collateral or pay
down debt.





We have
and may continue to utilize repurchase agreements and bank credit facilities
(including term loans and revolving facilities) to finance our assets if such
financing becomes available to us on acceptable terms. In the event we utilize
such financing arrangements, they would involve the risk that the market value
of the loans pledged or sold by us to the repurchase agreement counterparty or
provider of the bank credit facility may decline in value, in which case the
lender may require us to provide additional collateral or to repay all or a
portion of the funds advanced. We may not have the funds available to repay our
debt at that time, which would likely result in defaults unless we are able to
raise the funds from alternative sources, which we may not be able to achieve on
favorable terms or at all. A lender’s requirement that we post additional
collateral would reduce our liquidity and limit our ability to leverage our
assets. If we cannot meet these requirements, the lender could accelerate our
indebtedness, increase the interest rate on advanced funds and terminate our
ability to borrow funds from them, which could harm our financial condition and
ability to implement our business plan. In addition, in the event that a lender
to us files for bankruptcy or becomes insolvent, the loans to us may become
subject to bankruptcy or insolvency proceedings, thus depriving us, at least
temporarily, of the benefit of these assets. Such an event could restrict our
access to bank credit facilities and increase our cost of capital. The providers
of repurchase agreement financing and bank credit facilities may also require us
to maintain a certain amount of cash or set aside assets sufficient to maintain
a specified liquidity position that would allow us to satisfy our collateral
obligations. As a result, we may not be able to leverage our assets as fully as
we would choose which could reduce our return on assets. In the event that we
are unable to meet these collateral obligations, our financial condition and
prospects could deteriorate rapidly.





As of
September 30, 2010, through wholly-owned subsidiaries, we had secured financing
from lenders with a total borrowing capacity of $16.1 million, of which $12.1
million was outstanding at September 30, 2010, for the purpose of funding
remaining loan obligations, anticipated development costs for REO assets and
working capital needs.





We
may use leverage to execute our business strategy, which may reduce the return
on our assets, reduce cash available for distribution to our stockholders and
increase losses when economic conditions are unfavorable.





Subject
to market conditions and availability, we may use leverage to finance our assets
through borrowings from a number of sources, including repurchase agreements,
resecuritizations, securitizations, warehouse facilities and bank credit
facilities (including term loans and revolving facilities). Given current market
conditions, we may also seek to take advantage of available borrowings, if any,
under government sponsored debt programs, to acquire all types of commercial
real estate mortgage loans and other real estate-related assets, to the extent
such assets are eligible for funding under such programs. Although we are not
currently required to maintain any particular assets-to-equity leverage ratio,
the amount of leverage we may deploy for particular assets will depend on our
available capital, our ability to access financing arrangements, our estimated
stability of cash flows generated from the assets in our portfolio and our
assessment of the risk-adjusted returns associated with those assets. The
percentage of leverage will vary over time depending on our ability to enter
into repurchase agreements, resecuritizations, securitizations, warehouse
facilities and bank credit facilities (including term loans and revolving
facilities), our ability to participate in and obtain funding under programs
established by the U.S. government, available credit limits and financing rates,
type or amount of collateral required to be pledged and our assessment of the
appropriate amount of leverage for the particular assets we are
funding.


113





To the
extent that we use leverage to finance our assets, our financing costs will
reduce cash available for distribution to our stockholders. We may not be able
to meet our financing obligations and, to the extent that we cannot, we risk the
loss of some or all of our assets to liquidation or sale to satisfy our
obligations. We may leverage certain of our assets through repurchase
agreements. A decrease in the value of these assets may lead to margin calls
which we will have to satisfy. We may not have the funds available to satisfy
any such margin calls and may be forced to sell assets at significantly
depressed prices due to market conditions or otherwise, which may result in
losses to us. The satisfaction of such margin calls may reduce cash flow
available for distribution to our stockholders. Our inability to pay dividends
to our stockholders may cause the value of our common stock to
decline.





Any
borrowing by us will increase our risk and may harm our operations and reduce
the amount we have available to distribute to our stockholders.





We
anticipate that from time to time we may continue to borrow funds to generate
additional liquidity for the payment of operating expenses, costs relative to
the ownership of REO assets, and obligations under our loans to borrowers or for
purposes of making investments. As of September 30, 2010, through wholly-owned
subsidiaries, we had secured financing from lenders with a total borrowing
capacity of $16.1 million, of which $12.1 million was outstanding at September
30, 2010, for the purpose of funding remaining loan obligations, anticipated
development costs for REO assets, and working capital needs. We expect that
additional borrowings may be necessary or advisable from time to time. Any
borrowings will require us to carefully manage our cost of funds and we may not
be successful in this effort. If we are unable to repay any indebtedness we
incur or make interest payments on any loans we incur, our lenders would likely
declare us in default and could require that we repay all amounts owing under
our loan facilities or take possession of the collateral. Even if we are
repaying the indebtedness in a timely manner, interest payments owing on the
borrowed funds may reduce our income and any distributions to our stockholders.
We may borrow funds from several sources, and the terms of any indebtedness we
incur may vary.





Borrowing
subjects us to a number of other risks, including, among others, the
following:





·
            if
      we are unable to repay any indebtedness or make interest payments on any
      loans we incur, our lenders would likely declare us in default and could
      require that we repay all amounts outstanding under our loan
      facilities;


·
            acceleration
      of debt (and any other debt containing a cross-default or
      cross-acceleration provision) that we may be unable to repay from internal
      funds or to refinance on favorable terms, or at
  all;


·
            our
      inability to borrow unused amounts under our financing arrangements, even
      if we are current in payments on our borrowings under those
      arrangements;


·
            the
      loss of some or all of our assets securing the loans to foreclosure or
      sale;


·
            even
      if we are repaying the indebtedness in a timely manner, interest payments
      owing by us on the borrowed funds may reduce our income and any
      distributions to our stockholders;


·
            our
      debt may increase our vulnerability to adverse economic and industry
      conditions with no assurance that investment yields will increase with
      higher financing costs;


·
            we
      may be required to dedicate a substantial portion of our cash flow from
      operations to payments on our debt, thereby reducing funds available for
      operations, future business opportunities, stockholder distributions or
      other purposes;


·
            we
      may not be able to refinance debt that matures prior to the investment it
      was used to finance on favorable terms, or at all;
  and


·
            some
      lenders may require as a condition of making a loan to us that the lender
      receive a priority on mortgage repayments received by us on our mortgage
      portfolio, thereby requiring the first dollars we collect to go to our
      lenders.


114





Any of
these risks could harm our business and financial condition.





We
cannot predict the effect of recent legislative and regulatory
initiatives.





The U.S.,
state and foreign governments have taken or are considering extraordinary
actions in an attempt to address the worldwide financial crisis and the severe
decline in the global economy, and to seek to address the perceived underlying
causes of the financial crisis to prevent or mitigate the recurrence. These
actions or other actions under consideration may not ultimately be successful or
beneficial to us and could result in unintended consequences or new regulatory
requirements which may be difficult or costly to comply with. On July 21, 2010,
the Dodd-Frank Wall Street Reform and Consumer Protection Act or the Dodd-Frank
Act, was signed into law in the U.S. Among other things, the Dodd-Frank Act
creates of a Financial Services Oversight Council to identify emerging systemic
risks and improve interagency communication, creates a Consumer Financial
Protection Agency authorized to promulgate and enforce consumer protection
regulations relating to financial products, which would affect both banks and
non-bank finance companies, imposes a comprehensive new regulatory regime of
financial markets, including derivatives and securitization markets and creates
an Office of National Insurance within Treasury. While the bill has been signed
into law, a number of provisions of the law remain to be implemented through the
rulemaking process at various regulatory agencies. We are unable to predict what
the final form of these rules will be when implemented by the respective
agencies, but we believe that certain aspects of the new legislation, including,
without limitation, the additional cost of higher deposit insurance and the
costs of compliance with disclosure and reporting requirements and examinations
by the new Consumer Financial Protection Agency, could have a significant impact
on our business, financial condition and results of operations. Additionally, we
cannot predict whether there will be additional proposed laws or reforms that
would affect the U.S. financial system or financial institutions, whether or
when such changes may be adopted, how such changes may be interpreted and
enforced or how such changes may affect us. For example, bankruptcy legislation
could be enacted that would hinder the ability to foreclose promptly on
defaulted mortgage loans or permit limited assignee liability for certain
violations in the mortgage origination process, any or all of which could
adversely affect our business or result in us being held responsible for
violations in the mortgage loan origination process even were we were not the
originator of the loan.





Other
laws, regulations, and programs at the federal, state and local levels are under
consideration that seek to address the economic climate and real estate and
other markets and to impose new regulations on various participants in the
financial system. We cannot predict the effect that these or other actions will
have on our business, results of operations and financial condition. Further,
the failure of these or other actions and the financial stability plan to
stabilize the economy could harm our business, results of operations and
financial condition.


115





Maintenance
of our exemption from registration under the Investment Company Act will impose
significant limitations on our operations, which may have a material adverse
effect on our ability to execute our business strategy.





We
currently conduct our business in a manner that will allow us to avoid being
regulated as an investment company under the Investment Company Act and intend
to continue to do so. If we become subject to the Investment Company Act, we
would be required to comply with numerous additional regulatory requirements and
restrictions, any or all of which could harm the sustainability of our
operations and our ability to pay dividends, and force us to discontinue the
business. We believe that we have qualified for the exemption from registration
under the Investment Company Act. Pursuant to Section 3(c)(5)(C) of the
Investment Company Act, entities that are primarily engaged in the business of
purchasing or otherwise acquiring “mortgages and other liens on and interests in
real estate” are exempted from regulation thereunder. The staff of the SEC has
provided guidance on the availability of this exemption, expressing the position
that the SEC would regard an issuer as being engaged primarily in the business
of purchasing or otherwise acquiring mortgages and other liens on and interests
in real estate if (i) at least 55% of the value of the issuer’s assets consists
of mortgages and other liens on, and interests in, real estate, or Qualifying
Assets, and (ii) at least an additional 25% of the value of the issuer’s assets
consists of Qualifying Assets or other real estate type interests (including
loans in respect of which 55% of the fair market value of each such loan is
secured by real estate at the time the issuer acquires the loan) or Real
Estate-Related Assets. Not more than 20% of the issuer’s assets may consist of
miscellaneous investments, including all other loans held by an issuer, cash,
government securities, and investments in partnerships or other businesses not
qualifying as either Qualifying Assets or Real Estate-Related Assets.
Mortgage-related securities that do not represent all of the certificates issued
with respect to the underlying pool of mortgages may also not qualify under this
55% test. Therefore, our ownership of these types of loans and equity interests
may be limited by the provisions of the Investment Company Act. To the extent we
do not comply with the SEC staff’s 55% test, another exemption or exclusion from
registration as an investment company under the Investment Company Act or other
interpretations of the Investment Company Act, we may be deemed an investment
company. If we fail to maintain an exemption or other exclusion from
registration as an investment company we could, among other things, be required
either to substantially change the manner in which we conduct our operations to
avoid being required to register as an investment company, effect sales of our
assets in a manner that, or at a time when, we would not otherwise choose to do
so, or to register as an investment company, either of which could have an
adverse effect on us and the market price of our common stock. If we were
required to register as an investment company under the Investment Company Act,
we would become subject to substantial regulation with respect to our capital
structure (including our ability to use leverage), management, operations,
transactions with affiliated persons (as defined in the Investment Company Act),
portfolio composition, including restrictions with respect to diversification
and industry concentration and other matters. As of September 30, 2010, more
than approximately 92% of our total assets were invested in assets we consider
to be Qualifying Assets, approximately less than an additional 1% of our total
assets were invested in assets we believe to be Real Estate-Related Assets, and
less than 7% of our assets constituted other assets.





If the
market value or income potential of our real estate-related investments declines
as a result of increased interest rates, prepayment rates or other factors, we
may need to increase our real estate investments and income or liquidate our
non-qualifying assets in order to maintain our exemption from the Investment
Company Act. In view of the illiquid nature of certain of our real estate and
real estate-related investments, we may not be able to liquidate our
non-qualifying assets at opportune times or prices, if at all, in order to
maintain our Investment Company Act exemption. Similarly, we may not have
sufficient capital or access to capital at favorable prices, if at all, if we
were required to increase our qualifying real estate assets in order to maintain
our Investment Company Act exemption. If the value of our assets fluctuates
dramatically, our ability to maintain compliance may be particularly difficult,
which may cause us to make investment decisions that we otherwise would not make
absent Investment Company Act considerations. Moreover, as the real estate
market evolves, we may determine that the commercial real estate market does not
offer the potential for attractive risk-adjusted returns pursuant to an
investment strategy that is consistent with our intention to operate in a manner
to maintain our exemption from registration under the Investment Company Act.
For example, if we believe the maintenance of our exemption under the Investment
Company Act imposes undue limitations on our ability to generate attractive
risk-adjusted returns to our investors, our board of directors may approve the
wind down of our assets and liquidation of our business.





If we
were required to register as an investment company under the Investment Company
Act but failed to do so, the SEC could bring an action to enjoin us from further
violating the Investment Company Act. Also, there can be no assurance that the
laws and regulations governing the Investment Company Act status of our company,
including the Division of Investment Management of the SEC providing more
specific or different guidance regarding the treatment of assets as qualifying
real estate assets or real estate-related assets, will not change in a manner
that adversely affects our operations. As a result, the Investment Company Act
may limit our ability to generate returns for our stockholders.





To
the extent that we obtain debt financing as a borrower, we expect that certain
of our financing facilities may contain restrictive covenants relating to our
operations, which could harm our business, results of operations, ability to pay
dividends to our stockholders and the market value of our common
stock.





If or
when we obtain debt financing as a borrower, lenders (especially in the case of
bank credit facilities) may impose restrictions on us that would affect our
ability to incur additional debt, make certain acquisitions, reduce liquidity
below certain levels, pay dividends to our stockholders, redeem debt or equity
securities and impact our flexibility to determine our operating policies and
business strategies. For example, such loan documents could contain negative
covenants that limit, among other things, our ability to repurchase shares of
our common stock, distribute more than a certain amount of our net income or
funds from operations to our stockholders, hold portfolio mortgage loans for
longer than established time periods, employ leverage beyond certain amounts,
sell assets, engage in mergers or consolidations, grant liens, and enter into
transactions with affiliates. If we fail to meet or satisfy any of these
covenants, we would be in default under these agreements, and our lenders could
elect to declare loans outstanding to us due and payable, terminate their
commitments, require the posting of additional collateral and enforce their
respective interests against existing collateral from us. We also may be subject
to cross-default and acceleration rights and, with respect to collateralized
debt, requirements for us to post additional collateral, and foreclosure rights
upon default. A default also could limit significantly our financing
alternatives, which could cause us to curtail our investment activities or
prematurely dispose of assets.


116





We
may seek to utilize non-recourse long-term securitizations in the future, and
such structures may expose us to risks, which could result in losses to
us.





In the
future, we may seek to utilize non-recourse long-term securitizations of our
mortgage loans, especially loan originations, if and when they become available
and to the extent consistent with the maintenance of our exemption from the
Investment Company Act, in order to generate cash for funding new assets. This
would involve conveying a pool of assets to a special purpose vehicle (or the
issuing entity) which would issue one or more classes of non-recourse promissory
notes pursuant to the terms of an indenture. The notes would be secured by the
pool of assets. In exchange for the transfer of assets to the issuing entity, we
would receive the cash proceeds on the sale of the non-recourse notes and a 100%
interest in the equity of the issuing entity. The securitization of our assets
might magnify our exposure to losses on those assets because any equity interest
we retain in the issuing entity would be subordinate to the notes issued to
investors and we would, therefore, absorb all of the losses sustained with
respect to a securitized pool of assets before the owners of the notes
experience any losses. Moreover, we may not be able to access the securitization
market, or be able to do so at favorable rates. The inability to consummate
securitizations of our assets to finance our assets on a long-term basis could
require us to seek other forms of potentially less attractive financing or to
dispose of assets at an inopportune time or price, which could harm our
performance and our ability to grow our business.





Any
warehouse facilities that we may obtain may limit our ability to acquire or
originate assets and we may incur losses if the collateral is
liquidated.





We may
utilize, if available, warehouse facilities pursuant to which we would
accumulate mortgage loans, which assets would be pledged as collateral for such
facilities. In order to borrow funds to originate or acquire assets under any
future warehouse facilities, we expect that our lenders thereunder would have
the right to review the potential assets for which we are seeking financing. We
may be unable to obtain the consent of a lender to acquire assets that we
believe would be beneficial to us and we may be unable to obtain alternate
financing for such assets. The lender could liquidate the warehoused collateral
and we would then have to pay any amount by which the original purchase price of
the collateral assets exceeds its sale price, subject to negotiated caps, if
any, on our exposure. Currently, we have no warehouse facilities in place, and
may not be able to obtain one or more warehouse facilities on favorable terms,
or at all.





If
we are unable to sell our existing assets, or are only able to do so at a
substantial loss, we may be unable to continue as a “going concern” or implement
our investment strategy.





We are
marketing a significant portion of our existing assets, individually or in bulk,
to generate liquidity and capital to redeploy in our target assets and implement
our investment strategy. In addition, we are pursuing enforcement (in most cases
foreclosure) on almost all our loans that are currently in default, and expect
to take ownership of the underlying collateral and position the asset for future
monetization. As a result of the rapid decline in the economy and substantial
disruptions in the real estate, capital, credit and other markets, we may be
unable to sell our existing assets or be required to do so at a price below our
adjusted carrying value, which could harm our business and our ability to
implement our investment strategy. In addition, our ability to continue as a
“going concern” for the next 12 months is predicated on our ability to sell a
substantial portion of our existing assets.


117





If
we do not resume our mortgage lending activities, we will not be able to grow
our business and our financial results and financial condition will be
harmed.





Effective
October 1, 2008, we elected to suspend certain of our activities, including,
among other things, the funding and origination of any new commercial mortgage
loans. This election was made in order to preserve our capital and to seek to
stabilize our operations and liquid assets in order to assist us in our efforts
to meet our future obligations, including those pursuant to current loan
commitments we have made to borrowers. The inability to fund new loans prevents
us from capitalizing on interest or other fee paying assets, and managing
interest rate and other risk as our existing assets are sold, restructured or
refinanced. Any one or more of the foregoing could harm our results and
financial condition.





Due
to the decline of the economy and real estate and credit markets, we anticipate
defaults on our commercial mortgage loan assets and foreclosures to continue,
which may harm our business.





We are in
the business of acquiring, originating, marketing and selling commercial
mortgage loans and, as such, we are at risk of default by borrowers. Any failure
of a borrower to repay the mortgage loans or to pay interest on such loans will
reduce our (i) revenue and distributions, if any, to stockholders, and (ii)
potentially, the trading price of our common stock. At September 30, 2010, 36 of
our loans with principal balances totaling $480.6 million were in default, and
we had commenced enforcement action on 27 of these 36 loans. We are negotiating
with the borrowers for possible discounted payoff or assessing the possibility
of modifying the loan terms of the remaining nine loans in default. In addition,
during the nine months ended September 30, 2010, we acquired real estate assets
through foreclosure of the ten related mortgage loans with a carrying value of
$25.4 million. The actual net realizable value of such properties may not exceed
the carrying value of these properties at September 30, 2010. Due to the decline
of the economy and real estate and credit markets and our intent to proactively
pursue foreclosure of loans in default so we can dispose of REO assets, we
anticipate defaults and foreclosures to continue, which will likely result in
continuing high levels of non-accrual loans and REO assets, which are generally
non-interest earning assets. As such, we anticipate our mortgage loan interest
income to remain at significantly reduced levels until we invest the proceeds
from the disposition of REO assets and this offering or other debt or equity
financing in new investments and begin generating income from those
investments.





Our
borrowers are exposed to risks associated with owning real estate and unexpected
expenses or liabilities resulting from such ownership could reduce the
likelihood that our borrowers will be able to develop or sell the real estate
that serves as collateral for our loans, which will increase the likelihood that
our borrowers will default on the loans that we fund or acquire.





Among
other matters, our borrowers are subject to risks, expenses and liabilities
associated with owning real estate, including, among others:





·
            the
      expense of maintaining, operating, developing and protecting the real
      estate that serves as collateral for our
loans;


·
            the
      risk of a decline in value of such real estate due to market or other
      forces;


·
            the
      absence of financing for development and construction activities, if
      financing is required;


·
            the
      risk of default by tenants who occupy such real estate and have rental
      obligations to the owners of such real
estate;


·
            the
      risks of zoning, rezoning, and many other regulatory matters affecting
      such real estate;


·
            acts
      of God, including earthquakes, floods and other natural disasters, which
      may result in uninsured losses;


·
            acts
      of war or terrorism;


·
            adverse
      changes in national and local economic and market
    conditions;


·
            changes
      in, related costs of compliance with, or fines or private damage awards
      for failure to comply with existing or future federal, state and local
      laws and regulations, fiscal policies and zoning
    ordinances;


·
            costs
      of remediation and liabilities associated with environmental
      conditions;


·
            the
      potential for uninsured or under-insured property
  losses;


118





·
            the
      impact of economic, market, environmental and political conditions on the
      ability to market or develop
properties;


·
            financial
      and tort liability risks, including construction defect claims, associated
      with the ownership, development and construction on such real estate;
      and


·
            market
      risk and the possibility that they will not be able to develop, sell or
      operate such real estate to generate the income expected from such real
      estate.





Any or
all of these risks, if not properly managed by the borrower, could impose
substantial costs or other burdens on our borrower or such real estate, or
result in a reduction in the value of such real estate, thereby increasing the
likelihood of default by the borrower on our portfolio loan and reducing or
eliminating our ability to make distributions to our stockholders. In addition,
to the extent we foreclose on any such real estate securing our portfolio loans,
we become directly subject to these same risks.





By
becoming the owner of property, we become subject to the various risks of owning
real property and we could incur unexpected costs and expenses, which could harm
our business.





We have
acquired real property in connection with foreclosures of our commercial
mortgage loans in which we have invested, and we may acquire additional real
property in this manner in the future. As of September 30, 2010, we owned 34
properties with an aggregate net carrying value of $109.3 million and had
commenced enforcement action on 27 additional properties. As an owner of real
property, we will incur some of the same obligations and be exposed to some of
the same risks as our applicable borrower was prior to our foreclosure on the
applicable loan. See the risk factor above starting with “Our borrowers are exposed to risks
associated with owning real estate”.





The
commercial mortgage loans we acquire are subject to the ability of the
commercial property owner to generate net income from operating the property as
well as the risks of delinquency and foreclosure.





The
ability of a commercial mortgage loan borrower to repay a loan secured by an
income-producing property, such as a multi-family or commercial property,
typically is dependent primarily upon the successful operation of the property
rather than upon the existence of independent income or assets of the borrower.
If the net operating income of the property is reduced, the borrower’s ability
to repay the loan may be impaired. Net operating income of an income producing
property can be affected by, among other things, tenant mix, success of tenant
businesses, property management decisions, property location and condition,
competition from comparable types of properties, changes in laws that increase
operating expenses or limit rents that may be charged, any need to address
environmental contamination at the property, the occurrence of any uninsured
casualty at the property, changes in national, regional or local economic
conditions or specific industry segments, declines in regional or local real
estate values, declines in regional or local rental or occupancy rates,
increases in interest rates, real estate tax rates and other operating expenses,
changes in governmental rules, regulations and fiscal policies, including
environmental legislation, acts of God, terrorism, social unrest and civil
disturbances.





Although
we have recourse to the borrower or in some cases, guarantors of the borrower,
most of our commercial mortgage loans against an insolvent or financially
distressed borrower means in practice there is generally no recourse against the
borrower’s assets other than the underlying collateral. In the event of any
default under a recourse or non-recourse commercial mortgage loan held directly
by us, we generally bear a risk of loss of principal to the extent of any
deficiency between the value of the collateral (or our ability to realize such
value through foreclosure) and the principal and accrued interest on the
mortgage loan, which could harm our results of operations and cash flow from
operations and limit amounts available for distribution to our stockholders. In
the event of the bankruptcy of a commercial mortgage loan borrower, the mortgage
loan to such borrower will be deemed to be secured only to the extent of the
value of the underlying collateral at the time of bankruptcy (as determined by
the bankruptcy court), and the lien securing the commercial mortgage loan will
be subject to the avoidance powers of the bankruptcy trustee or
debtor-in-possession to the extent the lien is unenforceable under state law.
Foreclosure of a commercial mortgage loan can be an expensive and lengthy
process, which could have a substantial negative effect on our anticipated
return on the foreclosed commercial mortgage loan.


119





We
rely on the value of our real estate collateral to protect our commercial
mortgage loans, and that real estate collateral is subject to appraisal errors
and the collateral’s realizable value is subject to decrease based on events
beyond our control.





We depend
upon the value of our real estate collateral to protect the commercial mortgage
loans that we make or acquire. We depend upon the skill of independent
appraisers and other techniques to value the collateral of the commercial
mortgage loans we hold. However, notwithstanding the experience of the
appraisers we select or approve, they may make mistakes or may err in their
judgment. Also, the realizable value of the real estate securing our loans may
decrease due to subsequent events, such as the precipitous decline in value
experienced as a result of the real estate market downturn. As a result, the
value of the collateral may be less than anticipated at the time the applicable
commercial mortgage loan was originated or acquired. In this regard, in recent
periods, the real estate markets across the United States have declined. If the
value of the collateral supporting our commercial mortgage loans declines and a
foreclosure sale occurs, we may not recover the full amount of our commercial
mortgage loan, thus reducing the amount of our cash available, if any, and may
harm our business.





Our
underwriting standards and procedures may not have protected us from loan
defaults, which could harm our business.





Due to
the nature of our business model, we believe the underwriting standards and
procedures we use are different from conventional lenders. While several
procedures in our underwriting process are similar to those of traditional
lenders, there are also some differences that provide us with more flexibility
in underwriting and closing loans. Due to the nature of our loan approval
process, there is a risk that the underwriting we performed did not, and the
underwriting we perform in the future will not, reveal all material facts
pertaining to the borrower and the collateral, and there may be a greater risk
of default by our borrowers which, as described above, could harm our business.
In addition, the underwriting standards we applied to our existing assets did
not anticipate the current unprecedented downturn in the real estate market and
general economy, and as a result we may recognize additional losses from loan
defaults.





Guarantors
of our loans may not have sufficient assets to support their guarantees, which
could make enforcing such guarantees difficult and costly and could harm our
operations.





Our
commercial mortgage loans are not insured or guaranteed by any federal, state or
local government agency. Our loans may be guaranteed by individuals or entities
which are typically affiliated with the borrower. These guarantors may not have
sufficient assets to back up their guarantees in whole or in part, and
collections pursuant to any such guarantees may be difficult and costly.
Consequently, if there is a default on a particular commercial mortgage loan and
the guarantee, our only recourse may be to foreclose upon the mortgaged real
property. The value of the foreclosed property may have decreased and may not be
equal to the amount outstanding under the corresponding loan, resulting upon
sale in a decrease of the amount of our cash available, if any, and may harm our
business.





We
have limited experience in managing and developing real estate and, following a
foreclosure, we may not be able to manage the real estate we foreclose upon or
develop the underlying projects in a timely or cost-effective manner, or at all,
which could harm our results of operations.





We have
limited experience in managing and developing real estate. When we acquire real
estate through foreclosure on one of our loans or otherwise, we may seek to
complete the underlying projects, either alone or through joint ventures. We may
not be able to manage the development process in a timely or cost-effective
manner or at all.





We
require third-party assistance in managing or developing projects, and may
obtain such assistance in the future either through joint ventures or selling
the rights to manage or develop projects in whole, and we may be unable to find
such assistance at an attractive cost or at all. Even if we are able to locate
such assistance, we may be exposed to the risks associated with the failure of
the other party to complete the development of the project as expected or
desired. These risks include the risk that the other party would default on its
obligations, necessitating that we complete the other components ourselves
(including providing any necessary financing).


120





If we
enter into joint ventures to manage or develop projects, such joint ventures
involve certain risks, including, without limitation, that:





·
            we
      may not have voting control over the joint
  venture;


·
            we
      may not be able to maintain good relationships with the joint venture
      partners;


·
            the
      joint venture partner may have economic or business interests that are
      inconsistent with our interests;


·
            the
      joint venture partner may fail to fund its share of operations and
      development activities, or to fulfill its other commitments, including
      providing accurate and timely accounting and financial information to us;
      and


·
            the
      joint venture or venture partner could lose key
  personnel.





Any one
or more of these risks could harm our results of operations.





We
may experience a decline in the fair value of our assets, which could harm our
results of operations, financial condition and our ability to make distributions
to our stockholders.





A decline
in the fair value of our assets may require us to recognize a provision for
credit losses or impairment charge against such assets under accounting
principles generally accepted in the United States, or GAAP, if we were to
determine that, with respect to any assets in unrealized loss positions, we do
not have the ability and intent to hold such assets to maturity or for a period
of time sufficient to allow for recovery to the amortized cost of such assets.
If such a determination were to be made, we would recognize unrealized losses
through earnings and write down the amortized cost of such assets to a new cost
basis, based on the fair value of such assets on the date they are considered to
be impaired. For example, we recorded a provision for credit losses totaling
$296.0 million and $79.3 million, respectively, for the years ended December 31,
2008 and 2009, and $34.4 million for the nine months ended September 30, 2010,
as well as impairment charges on REO assets of $27.2 million, $8.0 million and
$13.2 million, respectively. For further information, see the section entitled
“Management’s Discussion and
Analysis of Financial Condition and Results of Operations of IMH Financial
Corporation — Results of Operations for the Nine and Three Months
Ended September 30, 2009 and 2010 — Expenses — Provision for
Credit Losses.” We could be required to record additional valuation
adjustments in the future. Even in the absence of decreases in the value of real
estate, we may be required to recognize provisions for credit losses as a result
of the accrual of unpaid taxes on collateral underlying a loan. We also may be
required to recognize impairment charges if we reclassify particular REO assets
from being held for development to being held for sale. Such a provision for
credit losses or impairment charges reflect non-cash losses at the time of
recognition; subsequent disposition or sale of such assets could further affect
our future losses or gains, as they are based on the difference between the sale
price received and carrying value of such assets at the time of sale. If we
experience a decline in the fair value of our assets, our results of operations,
financial condition and our ability to make distributions to stockholders could
be harmed.





Some
of our assets are and will be recorded at fair value and, as a result, there
will be uncertainty as to the value of these assets.





The fair
value of our assets may not be readily determinable, requiring us to make
certain estimates and adjustments. We will value certain of these investments
quarterly at fair value, as determined in accordance with applicable accounting
guidance, which may include unobservable inputs. Because such valuations are
subjective, the fair value of certain of our assets may fluctuate over short
periods of time and our determinations of fair value may differ materially from
the values that would have been used if a ready market for these assets existed.
The value of our common stock could be harmed if our determinations regarding
the fair value of these assets were materially higher than the values that we
ultimately realize upon their disposal.


121





Valuations
of certain assets may be difficult to obtain or unreliable. In general,
third-party dealers and pricing services heavily disclaim their valuations.
Dealers may claim to furnish valuations only as an accommodation and without
special compensation, and so they may disclaim any and all liability for any
direct, incidental or consequential damages arising out of any inaccuracy or
incompleteness in valuations, including any act of negligence or breach of any
warranty. Depending on the complexity and illiquidity of an asset, valuations of
the same asset can vary substantially from one dealer or pricing service to
another. Therefore, conflicts of interest exist to the extent that we are
involved in the determination of the fair value of our investments.
Additionally, our results of operations for a given period could be harmed if
our determinations regarding the fair value of these investments were materially
higher than the values that we ultimately realize upon their disposal. The
valuation process has been particularly challenging recently as market events
have made valuations of certain assets more difficult, unpredictable and
volatile.





We
may refinance existing loans at rates lower than those currently available to
us.





Substantially
all of the variable rate loans we own contain provisions for interest rate
floors, which have allowed us to benefit from interest rate terms in excess of
the current Prime rate. However, given current market conditions and the likely
necessity to extend loans to 24-month terms, or longer, we have negotiated in
the past, and expect to continue to renegotiate in the future, certain of the
commercial mortgage loans in our portfolio at terms that are more reflective of
current market rates, which may be lower than current contractual rates. The
corresponding reduction in interest income and decline in the value of such
loans may harm our results of operations.





Increases
in interest rates could adversely affect the value of our assets and cause our
interest expense to increase, which could result in reduced earnings or losses
and negatively affect our profitability as well as the cash available for
distribution to our stockholders.





Certain
of our assets will generally decline in value if long-term interest rates
increase. Declines in market value may ultimately reduce earnings or result in
losses to us, which may negatively affect cash available for distribution to our
stockholders. A significant risk associated with our target assets is the risk
that both long-term and short-term interest rates will increase significantly.
If long-term rates increased significantly, the market value of these
investments would decline, and the duration and weighted average life of the
investments would increase.





In
addition, in a period of rising interest rates, our operating results will
depend in large part on the difference between the income from our assets and
financing costs. We anticipate that, in most cases, the income from such assets
will respond more slowly to interest rate fluctuations than the cost of our
borrowings. Consequently, changes in interest rates, particularly short-term
interest rates, may significantly influence our net interest income, which is
the difference between the interest income we earn on our interest-earning
investments and the interest expense we incur in financing these assets.
Increases in these rates will tend to decrease our net income and market value
of our assets.





Rising
interest rates may also cause our target assets that were originated or acquired
prior to an interest rate increase to provide yields that are below prevailing
market interest rates. If rising interest rates cause us to be unable to acquire
a sufficient volume of our target assets with a yield that is above our
borrowing cost, our ability to satisfy our investment objectives and to generate
income and pay dividends may be harmed. An increase in interest rates may cause
a decrease in the volume of certain of our target assets, which could harm our
ability to acquire target assets that satisfy our investment objectives and to
generate income and make distributions to our stockholders.





The
relationship between short-term and longer-term interest rates is often referred
to as the “yield curve.” Ordinarily, short-term interest rates are lower than
longer-term interest rates. If short-term interest rates rise disproportionately
relative to longer-term interest rates (a flattening of the yield curve), our
borrowing costs may increase more rapidly than the interest income earned on our
assets. Because we expect our investments, on average, generally will bear
interest based on longer-term rates than our borrowings, a flattening of the
yield curve would tend to decrease our net income and the market value of our
net assets. Additionally, to the extent cash flows from assets that return
scheduled and unscheduled principal are reinvested, the spread between the
yields on the assets and available borrowing rates may decline, which would
likely decrease our net income. It is also possible that short-term interest
rates may exceed longer-term interest rates (a yield curve inversion), in which
event our borrowing costs may exceed our interest income and we could incur
operating losses. As a result of the foregoing, significant fluctuations in
interest rates could harm affect our results of operations, financial conditions
and our ability to make distributions to our stockholders.


122





Prepayment
on our loans may harm the value of our assets.





The value
of our assets may be harmed by prepayment rates on mortgage loans. If we
purchase assets at a premium to par value, when borrowers prepay their mortgage
loans faster than expected, these prepayments may reduce the expected yield on
such loans because we will have to amortize the related premium on an
accelerated basis. Our loans do not currently provide for any prepayment
penalties or fees. Conversely, if we purchase assets at a discount to par value,
when borrowers prepay their mortgage loans slower than expected, the decrease in
corresponding prepayments on the mortgage assets may reduce the expected yield
on such loans because we will not be able to accrete the related discount as
quickly as originally anticipated. Prepayment rates on loans may be affected by
a number of factors, including, without limitation, the availability of mortgage
credit, the relative economic vitality of the geographic area in which the
related properties are located, the servicing of the mortgage loans, possible
changes in tax laws, other opportunities for investment, and other economic,
social, geographic, demographic, legal and other factors beyond our control.
Consequently, such prepayment rates cannot be predicted with certainty and no
strategy can completely insulate us from prepayment or similar risks. In periods
of declining interest rates, prepayment rates on mortgage loans generally
increase. If general interest rates decline at the same time, we are likely to
reinvest the proceeds of such prepayments received during such periods in assets
yielding less than the yields on the assets that were prepaid. In addition, as a
result of the risk of prepayment, the market value of the prepaid assets may
benefit less than other fixed income assets from declining interest
rates.





Our
loans generally contain provisions for balloon payments upon maturity, which are
riskier than loans with fully amortized payments and which increases the
likelihood that a borrower may default on the loan.





Substantially
all of our existing loans provide for monthly payment of interest only with a
“balloon” payment of principal payable in full upon maturity of the loan. To the
extent that a borrower has an obligation to pay us mortgage loan principal in a
large lump sum payment, its ability to repay the loan may depend upon its
ability to sell the property, obtain suitable refinancing or otherwise raise a
substantial amount of cash. A borrower may not have sufficient resources
available to make a balloon payment when it becomes due. As a result, these
loans may involve a higher risk of default than amortizing loans.





Competition
for buyers of real estate that we own, or for take-out financing for our
borrowers, places severe pressure on asset values, and we may not be able to
realize the full value of any of our assets as a result.





The
industry in which we operate is serviced primarily by conventional mortgage
lenders and loan investors, which include commercial banks, insurance companies,
mortgage brokers, pension funds, and private and other institutional lenders.
There are also a relatively smaller number of non-conventional lenders that are
similar to us. If we resume lending operations, we expect to compete with these
same lenders as well as new entrants to the competitive landscape who are also
focused on originating and acquiring commercial mortgage loans. We continue to
compete with many market participants. Additionally, as we seek to locate
purchasers for real estate we have acquired, or for takeout financing for our
borrowers, we are competing with a large number of persons and entities that
have acquired real estate, whether through foreclosure or otherwise, and that
have originated commercial mortgage loans, in the past few years. Many of these
persons and entities utilized leverage to purchase the real estate or fund the
loans, and many are selling collateral or accepting takeout financing worth less
than the original principal investment in order to generate liquidity and
satisfy margin calls or other regulatory requirements. If we are not able to
compete successfully, our ability to realize value from our existing loans may
be harmed or delayed, and we may not be able to grow our asset
portfolio.


123





Our
business is subject to regulation by several government agencies and a
disciplinary or civil action that occurs as a result of an actual or alleged
violation of any rules or regulations to which we are subject could harm our
business.





We are
subject to extensive regulation and oversight by various state and federal
regulatory authorities, including, without limitation, the Arizona Corporation
Commission, or the ACC, the Arizona Department of Revenue, the Arizona
Department of Financial Institutions (Banking) and the SEC. Many of these
authorities have generally increased their scrutiny of the entities they
regulate following recent events in the homebuilding, finance and capital
markets sectors. We are also subject to various federal and state securities
laws regulating the issuance and sale of securities. We also in the future may
be required to obtain various approvals and/or licenses from federal or state
governmental authorities, government sponsored entities in connection with our
mortgage-related activities. There is no assurance that we will be able to
obtain or maintain any or all of the approvals that we need in a timely manner.
In the event that we do not adhere to these license and approval requirements
and other laws and regulations which apply to us, we could face potential fines
or disciplinary or other civil action that could restrict or otherwise harm our
business.





We
received notice from the SEC on June 8, 2010 that it is conducting an
investigation related to us, as well as requests for documents. Our present
intention is to work cooperatively with the SEC in its investigation, but we do
not believe that we have violated any federal securities laws. Regardless of the ultimate outcome, the
existence of a pending investigation could harm our business or make it more difficult or
impossible to raise additional financing on attractive terms or at
all.




In
addition, following the suspension of certain of our activities, including the
suspension of our willingness to execute redemption requests from holders of
membership units in the Fund, certain of the members have requested that their
redemption requests be honored due to financial hardships or other reasons. In
each instance, we have responded that we will not grant such requests and are
treating all of the members uniformly. While we have not been served with any
lawsuits from any of the members relating to our decision to not grant such
requests, certain of the members have filed grievances with the SEC and possibly
other regulatory agencies related to the Manager’s administration of the Fund,
and we are unable to predict the outcome of any such grievances.





We
have historically originated and acquired construction loans, which are subject
to risks associated with the uncertainty of completion of the underlying
project.





We have
historically originated and acquired, and may continue to originate and acquire,
construction loans, which are inherently risky because the collateral securing
the loan typically has not been built or is only partially built. As a result,
if we do not fund our entire commitment on a construction loan, or if a borrower
otherwise fails to complete the construction of a project, there could be
adverse consequences to us associated with the loan, including: a loss of the
potential value of the property securing the loan, especially if the borrower is
unable to raise funds to complete it from other sources; claims against us for
failure to perform our obligations as a lender under the loan documents;
increased costs for the borrower that the borrower is unable to pay, that could
lead to default on the loan; a bankruptcy filing by the borrower that could make
it difficult to collect on the loan on a timely basis, if at all; and
abandonment by the borrower of the collateral for our loan, which could
significantly decrease the value of the collateral.





Risks
of cost overruns and non-completion of renovation of the properties underlying
rehabilitation loans may result in significant losses.





We have
historically originated and acquired, and may continue to originate and acquire,
rehabilitation loans. The renovation, refurbishment or expansion by a borrower
of a mortgaged property involves risks of cost overruns and non-completion.
Estimates of the costs of improvements to bring an acquired property up to
standards established for the market position intended for that property may
prove inaccurate. Other risks may include: rehabilitation costs exceeding
original estimates, possibly making a project uneconomical; environmental risks;
and rehabilitation and subsequent leasing of the property not being completed on
schedule. If such renovation is not completed in a timely manner, or if
renovation costs are more than expected, the borrower may experience a prolonged
impairment of net operating income and may not be able to make payments to us on
our loan on a timely basis or at all, which could result in significant losses
to us.


124





We
may acquire non-Agency residential mortgage-backed securities, or RMBS,
collateralized by subprime and Alt A mortgage loans, which are subject to
increased risks.





We may
acquire non-Agency RMBS, which are backed by residential real estate property
but, in contrast to Agency RMBS, their principal and interest are not guaranteed
by federally chartered entities such as the Federal National Mortgage
Association, or Fannie Mae, or the Federal Home Loan Mortgage Corporation, or
Freddie Mac and, in the case of the Government National Mortgage Association, or
Ginnie Mae, the U.S. Government. We may acquire non-Agency RMBS backed by
collateral pools of mortgage loans that have been originated using underwriting
standards that are less restrictive than those used in underwriting “prime
mortgage loans” and “Alt A mortgage loans.” These lower standards include
mortgage loans made to borrowers having imperfect or impaired credit histories,
mortgage loans where the amount of the loan at origination is 80% or more of the
value of the mortgage property, mortgage loans made to borrowers with low credit
scores, mortgage loans made to borrowers who have other debt that represents a
large portion of their income and mortgage loans made to borrowers whose income
is not required to be disclosed or verified. Due to current economic conditions,
including fluctuations in interest rates and lower home prices, as well as
aggressive lending practices, subprime mortgage loans have in recent periods
experienced increased rates of delinquency, foreclosure, bankruptcy and loss,
and they are likely to continue to experience delinquency, foreclosure,
bankruptcy and loss rates that are higher, and that may be substantially higher,
than those experienced by mortgage loans underwritten in a more traditional
manner. Thus, because of the higher delinquency rates and losses associated with
subprime mortgage loans, the performance of non-Agency RMBS backed by subprime
mortgage loans that we may acquire could be adversely affected, which could
materially and adversely impact our results of operations, financial condition
and business.





Past
or future actions to manage us through the recession may not be successful, in
part or at all, and a failure of any one or more of these actions could harm
us.





We have
taken various actions to seek to manage us through the recession, including,
among other things, marketing certain of our whole loans and participation
interests for sale, and disposing of REO properties that were acquired by us
through foreclosure. We also continue to evaluate other options. Many of the
challenges being faced by us are beyond our control, including a lack of
adequate lender credit availability in the marketplace, the general illiquidity
in financial markets in the United States, and the decline in real estate prices
and the prices of real estate-related assets. These or other actions we may take
may not be successful, in part or at all, and a failure of any one or more of
these actions could harm us.





Our
loans and real estate assets are concentrated geographically and a further
downturn in the economies or markets in which we operate could harm our asset
values.





We have
commercial and residential mortgage loans and real property in Arizona,
California, Texas, New Mexico, Idaho, Minnesota, Utah and Nevada. Because we are
generally not diversified geographically and are not required to observe any
specific geographic diversification criteria, a further downturn in the
economies of the states in which we own real estate or have commercial mortgage
loans, or a further deterioration of the real estate market in these states,
could harm our loan and real estate portfolio.





We
may have difficulty protecting our rights as a secured lender, which could
reduce the value or amount of collateral available to us upon foreclosure and
harm our business.





We
believe that our loan documents enable us to enforce our rights thereunder with
our borrowers. However, the rights of borrowers and the rights of other secured
lenders may limit our practical realization of those benefits. For
example:


125





·
            Foreclosure
      is subject to the delays in the legal processes involved. Judicial
      foreclosure could involve protracted litigation. Although we expect to
      generally use non-judicial foreclosure, which is generally quicker, our
      collateral may deteriorate and decrease in value during any delay in the
      foreclosure process.


·
            The
      borrower’s right of redemption following foreclosure proceedings can delay
      or deter the sale of our collateral and can, for practical purposes,
      require us to own and manage any property acquired through foreclosure for
      an extended period of time.


·
            Unforeseen
      environmental hazards may subject us to unexpected liability and
      procedural delays in exercising our
rights.


·
            The rights of junior secured
      creditors in the same property can create procedural hurdles for us when we
      foreclose on collateral.


·
            We
      may not be able to obtain a deficiency judgment after we foreclose on
      collateral. Even if a deficiency judgment is obtained, it may be difficult
      or impossible to collect on such a
judgment.


·
            State
      and federal bankruptcy laws can temporarily prevent us from pursuing any
      actions against a borrower or guarantor, regardless of the progress in any
      suits or proceedings and can, at times, permit our borrowers to incur
      liens with greater priority than the liens held by
  us.


·
            Lawsuits
      alleging lender liabilities, regardless of the merit of such claims, may
      delay or preclude foreclosure.





We
may be subject to lender liability claims.





A number
of judicial decisions have upheld the right of borrowers to sue lending
institutions on the basis of various evolving legal theories, collectively
termed “lender liability.” Generally, lender liability is founded on the premise
that a lender has either violated a duty, whether implied or contractual, of
good faith and fair dealing owed to the borrower or has assumed a degree of
control over the borrower resulting in the creation of a fiduciary duty by the
lender to the borrower or its other creditors or stockholders. Such claims may
arise and we may be subject to significant liability if a claim of this type did
arise.





Potential
losses may not be covered by insurance.





We carry
comprehensive liability, fire, extended coverage, earthquake, business
interruption and rental loss insurance covering all of our properties under
various insurance policies. Furthermore, we maintain title insurance to protect
us against defects affecting the security for our loans. We select policy
specifications and insured limits which we believe to be appropriate given the
perceived relative risk of loss, the cost of the coverage and our understanding
of industry practice. We do not carry insurance for generally uninsured losses
such as loss from riots, war or nuclear reactions. Our policies are insured
subject to certain limitations, including, among others, large deductibles or
co-payments and policy limits which may not be sufficient to cover losses. In
addition, we may discontinue certain policies on some or all of our properties
in the future if the cost of premiums for any of these policies exceeds, in our
judgment, the value of the coverage relative to the perceived risk of loss. If
we, or one or more of our borrowers, experiences a loss which is uninsured or
which exceeds policy limits or which our carriers will not or cannot cover, we
could lose the capital invested in the damaged properties as well as the
anticipated future cash flows from those properties.





We
may be exposed to liabilities for risks associated with the use of hazardous
substances on any of our properties.





Under
various U.S. federal, state and local laws, an owner or operator of real
property may become liable for the costs of removal of certain hazardous
substances released on its property. These laws often impose liability without
regard to whether the owner or operator knew of, or was responsible for, the
release of such hazardous substances. The presence of hazardous substances may
harm an owner’s ability to sell real estate or borrow using real estate as
collateral. To the extent that an owner of a property underlying one of our
loans becomes liable for removal costs, the ability of the owner to make
payments to us may be reduced, which in turn may diminish the value of the
relevant mortgage asset held by us and our ability to make distributions to our
stockholders. If we acquire a property through foreclosure or otherwise, the
presence of hazardous substances on such property may harm our ability to sell
the property and we may incur substantial remediation costs, which could harm
our results of operations, financial condition and our ability to make
distributions to our stockholders.


126





Other
Risk Factors





We
may not be able to utilize our built-in losses as anticipated.





Due to
the significant decline in the real estate markets in recent years, we believe
that the tax basis of our existing assets exceeds the fair market value of such
assets by approximately $267.8 million. Subject to certain limitations, such
“built-in losses” may be available to offset future taxable income and gain from
our existing assets as well as potentially income and gain from new assets we
acquire. Our ability to use our built-in losses is dependent upon our ability to
generate taxable income in future periods. In addition, the use of our built-in
losses is subject to various limitations. For example, there will be limitations
on our ability to use our built in losses or other net operating losses if we
undergo a “change in ownership” for U.S. federal income tax purposes. In
addition, it is possible that our built-in losses may not be fully available or
usable in the manner anticipated. To the extent these limitations occurred or
governmental challenges were asserted and sustained with respect to such
built-in losses, we may not be permitted to use our built-in losses to offset
our taxable income, in which case our tax liabilities could be greater than
anticipated.





The
decline in economic conditions and disruptions to markets may not improve for
the foreseeable future, which could cause us to suffer continuing operating
losses, adversely affect our liquidity, and create other business problems for
us.





The
global and U.S. economies experienced a rapid decline in 2008 and 2009 from
which they have not recovered. The real estate and other markets suffered
unprecedented disruptions, causing many major institutions to fail or require
government intervention to avoid failure, which has placed severe pressure on
liquidity and asset values. These conditions were brought about largely by the
erosion of U.S. and global credit markets, including a significant and rapid
deterioration of the mortgage lending and related real estate
markets.





These
events have caused, among other things, numerous foreclosures and an excess of
residential housing inventory and finished residential lots, and a glut of
stalled commercial real estate projects. Excess inventory could result in a
decline in the values of real estate that we own or that secures the loans we
hold in our portfolio. This, in turn, could reduce the proceeds we realize upon
sale and that are available to our borrowers to repay our portfolio mortgage
loans.





The
foregoing could result in defaults on our portfolio mortgage loans and might
require us to record reserves with respect to non-accrual loans, write-down our
REO assets, and realize credit losses with respect to our portfolio mortgage
loans. These factors could harm our business, financial condition, results of
operations and cash flows.





As a
consequence of the difficult economic environment, we have recorded significant
losses, resulting primarily from significant provisions for credit losses and
impairment charges resulting in substantial decreases in the net carrying value
of our assets. Economic conditions or the real estate and other markets
generally may not improve in the near term, in which case we could continue to
experience additional losses and write-downs of assets, and could face capital
and liquidity constraints and other business challenges.





We
depend on key personnel and an error in judgment or the loss of their services
could harm our business.





Our
success depends upon the experience, skill, resources, relationships, contacts
and continued efforts of certain key personnel, including, among others, Shane
Albers, our chief executive officer, William Meris, our president, and Steven
Darak, our chief financial officer. If any of these individuals were to make an
error in judgment in conducting our operations, our business could be harmed. If
either of these individuals were to cease employment with us, our operating
results could suffer. Our future success also depends in large part upon our
ability to hire and retain highly skilled managerial, operational and marketing
personnel. Competition for such personnel is intense. Should we be unable to
attract and retain such key personnel, our ability to make prudent investment
decisions may be impaired, which could harm our results of operations and
prospects.


127





We
will face conflicts of interest that may arise with respect to our business
activities and also may limit the allocation of investments to us.





We may
face conflicts of interest with other funds managed by us. For example, one of
our wholly-owned subsidiaries, SWI Management, LLC, or SWIM, is the manager of
the SWI Fund and has obligations to the SWI Fund and its members pursuant to the
operating agreement between SWIM and the SWI Fund. The SWI Fund, which had $11.4
million under management as of September 30, 2010, is a real estate investment
fund with target asset classes that are substantially similar to ours. The
management fees we receive from SWIM for managing the SWI Fund may be less than
the income we would receive from investment opportunities allocated to SWI Fund
that we may have otherwise been able to invest in.





Any
policy or procedural protections we adopt to address potential conflicts of
interest may not adequately address all of the conflicts that may arise or will
address such conflicts in a manner that results in the allocation of a
particular investment opportunity to us or is otherwise favorable to us. Since
our executive officers are also executive officers of SWIM, subject to oversight
from our independent directors (or a committee thereof), the same personnel may
determine the price and terms of the investments for both us and other entities
managed by us or affiliated with our executive officers, and there can be no
assurance that any procedural protections, such as obtaining market prices or
other reliable indicators of value, will prevent the consideration we pay for
these investments from exceeding the fair market value or ensure that we receive
terms for a particular investment that are as favorable as those available to a
third-party.





We
may compensate broker-dealers to eliminate contingent claims under existing
selling agreements, which could result in additional expense for us or dilation
of our stockholders.





The
Manager is also party to selling agreements with certain broker-dealers who
assisted the Manager in raising equity capital for us, which provide for a 2%
selling commission and either a 25 or 50 basis point trailing commission. Such
commissions totaled $6.1 million, $5.4 million and $0 for the years ended
December 31, 2007, 2008 and 2009, respectively. Pursuant to amendments to such
selling agreements, certain broker-dealers representing approximately 97% of the
Fund’s committed capital agreed to forego these amounts and accept, in lieu of
such obligation, a pro rata portion (representing either the 25 or 50 basis
points described above) of 50% of any amount “earned and received” by the
Manager under the terms of the Fund’s operating agreement, which provided that
the Manager receives 25% of any net proceeds (including late fees and penalties
and excluding repayment of principal and contractual note interest rates) from
the sale of a foreclosed asset. Because the operating agreement has been
terminated pursuant to the Conversion Transactions, no fees will be payable to
the Manager pursuant to the operating agreement, but the broker-dealers may
argue that they should nonetheless receive from us 50% of any amounts “earned
and received” that would have been otherwise payable to the Manager under the
Fund’s operating agreement had the operating agreement still been in effect or,
alternatively, that they are entitled to the trailing commission under the
original selling agreement. Although we may terminate the selling agreements at
any time (but not the commissions and additional compensation payable for
certain investments or in connection with certain investors), we have not
entered into any agreements, arrangements or understandings to terminate the
selling agreement or any trail obligations because we believe the relationships
with the broker-dealers established through these selling agreements remain
useful to our business. If we terminate the selling agreements, we may decide to
compensate the broker-dealers to eliminate any residual contingent commission
claims on gains or trail commissions under the selling agreements or for future
services provided by the broker-dealers through the issuance of warrants or
equity, payment of fees or otherwise, which could result in additional expense
for us or dilution of our stockholders.


128





Accounting
rules for certain of our assets are highly complex and involve significant
judgment and assumptions, and changes in such rules, accounting interpretations
or our assumptions could harm our ability to timely and accurately prepare our
financial statements.





Accounting
rules for commercial mortgage loan sales and securitizations, valuations of
financial instruments, asset consolidations and other aspects of our anticipated
operations are highly complex and involve significant judgment and assumptions.
These complexities could lead to a delay in the preparation of financial
information and the delivery of this information to our stockholders. Changes in
accounting rules, interpretations or our assumptions could undermine our ability
to prepare timely and accurate financial statements, which could result in a
lack of investor confidence in our publicly filed information and could harm the
market price of our common stock.





If
we fail to maintain proper and effective internal controls, our ability to
produce accurate financial statements could be impaired, which could cause us to
fail to meet our reporting obligations or cause investors to lose confidence in
our reported financial information, which could lead to a decline in the value
of our common stock.





Substantial
work has been required, and may continue to be required, to implement, document,
assess, test and remediate our system of internal controls. This process has
been and will continue to be both costly and challenging. Implementing any
appropriate changes to our internal controls may entail substantial costs to
modify our existing financial and accounting systems, take a significant period
of time to complete, and distract us from the operation of our business. These
changes may not, however, be effective in maintaining the adequacy of our
internal controls, and any failure to maintain that adequacy, or a consequent
inability to produce accurate financial statements on a timely basis, could
increase our operating costs and could impair our ability to operate our
business. In addition, the existence of any material weakness in our internal
control over financial reporting could also result in errors in our financial
statements that could require us to restate our financial statements, cause us
to fail to meet our reporting obligations and cause investors to lose confidence
in our reported financial information, all of which could lead to a decline in
the value of our common stock. Although not currently applicable, in the future
we will be required, pursuant to Section 404 of the Sarbanes-Oxley Act, to
furnish a report by management on, among other things, the effectiveness of our
internal control over financial reporting for the first fiscal year beginning
after the effective date of this offering. This assessment will need to include
disclosure of any material weaknesses identified by our management in our
internal control over financial reporting, as well as a statement that our
auditors have issued an attestation report on effectiveness of our internal
controls. If in the future we are unable to assert that our internal control
over financial reporting is effective, or if our auditors are unable to express
an opinion on the effectiveness of our internal controls, investors could lose
confidence in the accuracy and completeness of our financial reports, which
would have a material adverse effect on the price of our common
stock.





We
may change our business, leverage and financing strategies without stockholder
consent.





We may
change our business and financing strategies without a vote of, or notice to,
our stockholders, which could result in our making investments and engaging in
business activities that are different from, and possibly riskier than, other
businesses. In particular, a change in our business strategy, including the
manner in which we allocate our resources across our commercial mortgage loans
or the types of assets we seek to acquire, may increase our exposure to interest
rate risk, default risk and real estate market fluctuations. In addition, we may
in the future use leverage at times and in amounts deemed prudent by our
management in its discretion, and such decisions would not be subject to
stockholder approval. Changes to our strategies regarding the foregoing could
harm our financial condition, results of operations and our ability to pay
dividends to our stockholders.





Risks
Related to our Common Stock





We
have not established a minimum dividend and distribution level and we may not
have the ability to pay dividends and other distributions to you in the
future.





There
have been no cash dividends declared on our common stock since our company was
formed from our predecessor entity, but our predecessor made periodic
distributions to its members prior to suspending distributions in the third
quarter of the year ended December 31, 2008. We have not established a minimum
distribution level and we may not be able to make any distributions at all. In
addition, some of our distributions may include a return of capital. All
distributions will be made at the discretion of our board of directors and will
depend on our earnings, our financial condition and other factors as our board
of directors may deem relevant from time to time. Subject to the availability of
legally available funds,


129





Offerings
of debt or equity securities, which would be senior to our common stock in
liquidation, or equity securities, which would dilute our existing stockholders’
interests, may be senior to our common stock for the purposes of distributions,
and may harm the market price of our common stock.





In the
future, we may attempt to increase our capital resources by making offerings of
debt or equity securities, including commercial paper, medium-term notes, senior
or subordinated notes, preferred stock or common stock. The terms of our charter
documents will not preclude us from issuing additional indebtedness.
Accordingly, we could become more highly leveraged, resulting in (i) an increase
in debt service that could harm our ability to make expected distributions to
our stockholders, and (ii) an increased risk of default on our obligations. If
we were to liquidate, holders of our debt and shares of preferred stock and
lenders with respect to other borrowings will receive a distribution of our
available assets before the holders of our common stock. Additional equity
offerings by us may dilute your interest in us or reduce the market price of our
common stock, or both. Any preferred stock could have a preference on
distribution payments that could limit our ability to make a distribution to our
stockholders. Because our decision to issue securities in any future offering
will depend on market conditions and other factors beyond our control, we cannot
predict or estimate the amount, timing or nature of our future offerings.
Further, market conditions could require us to accept less favorable terms for
the issuance of our securities in the future. Thus, you will bear the risk that
any future offerings by us could reduce the market price of our common stock and
dilute your interest in us.





Certain
provisions of our certificate of incorporation, bylaws, debt instruments and the
Delaware General Corporation Law could make it more difficult for a third-party
to acquire us, even if doing so would benefit our stockholders.





Certain
provisions of the Delaware General Corporation Law, or DGCL, may have the effect
of deterring hostile takeovers or otherwise delaying or preventing changes in
our management or in the control of our company, including transactions in which
our stockholders might otherwise receive a premium over the fair market value of
their securities. In particular, Section 203 of the DGCL may, under certain
circumstances, make it more difficult for a person who would be an “interested
stockholder” (defined generally as a person with 15% or more of a corporation’s
outstanding voting stock) to effect a “business combination” (defined generally
as mergers, consolidations and certain other transactions, including sales,
leases or other dispositions of assets with an aggregate market value equal to
10% or more of the aggregate market value of the corporation) with the
corporation for a three-year period. Under Section 203, a corporation may under
certain circumstances avoid the restrictions imposed by Section 203. Moreover, a
corporation’s certificate of incorporation or bylaws may exclude a corporation
from the restrictions imposed by Section 203. We have not made this election,
and accordingly we are subject to the restrictions of Section 203 of the DGCL.
Furthermore, as discussed under the heading entitled “Description of IMH Financial
Corporation’s Capital Stock,” upon any “change of control” transaction,
the restrictions on transfer applicable to the shares of our Class B and Class C
common stock will terminate, which could act to discourage certain change of
control transactions.




Item
2.           Unregistered Sales of Equity
Securities and Use of Proceeds.




There
were no sales of common shares during the quarter ended September 30, 2010.
Pursuant to the terms of a
consulting services agreement with ITH Partners, LLC, or ITH, and
in consideration of services provided to us by ITH, we agreed to issue
50,000 shares of common stockto ITH in the
event we raise $50 million or more of debt or equity capital or list our shares
of common stock on a national securities exchange during the term of the
consulting agreement and warrants exercisable for ten years to
purchase 150,000 shares of common stock at the offering price in the
event we (i) consummate an initial public offering during the term of the
consulting agreement and (ii) list our shares of common stock on a national
securities exchange during the term of the consulting agreement, all pursuant to
the terms and conditions of the consulting agreement.  Such
issuance would be made in a private placement pursuant to section 4(2)
of the Securities Act.




130




Item 5.Other Information.




On
November 19, 2010, we entered into an indemnification agreement with each of (i)
Shane Albers, our chief executive officer and the chairman of our board of
directors, (ii) William Meris, our president and a member of our board of
directors, and (iii) Steven Darak, our chief financial officer, in the forms
attached hereto as Exhibits 10.1, 10.2 and 10.3. Pursuant to these agreements,
we have agreed to indemnify each of Messrs. Albers, Meris and Darak against
certain expenses, judgments, fines and amounts paid in connection with certain
actions, suits, investigations and hearings related to the fact of their service
as one of our directors and or officers, or related to actions taken by each in
such capacity.




Each
indemnification agreement supplements existing indemnification provisions of our
certificate of incorporation and bylaws, and, in general, provides for
indemnification to the maximum extent permitted by Delaware law, subject to the
exceptions, terms and conditions provided in each indemnification
agreement.  We have agreed to provide indemnity for fees and expenses,
damages, losses, liabilities, judgments and amounts paid in settlement, each to
the extent actually and reasonably incurred by or on behalf of the indemnitee in
any action, demand, suit or proceeding, including any investigation, inquiry,
hearing or alternative dispute resolution process, in which an indemnitee is or
is threatened to be involved as a party, witness or otherwise by reason of the
fact that he or she is or was one of our directors or officers or is or was
serving as a director or officer of another entity at our request. Each
indemnification agreement also provides that, if requested by an indemnified
person, we will advance to the indemnified person expenses incurred in
connection with any proceeding arising out of such indemnified person's service
to us, subject to reimbursement by the indemnified person should a final
judicial determination be made that indemnification is not available under
applicable law, and that we may purchase and maintain insurance against any
liability asserted against, and incurred by, the indemnified person arising out
of their service to us, if such insurance is available on commercially
reasonable terms.




On
November 19, 2010, we also entered into a consulting services agreement in the
form attached hereto as Exhibit 10.4, or consulting agreement, with ITH Partners
LLC, or ITH, a consulting firm we have retained since 2009. The consulting
agreement addresses the responsibilities of ITH thereunder, the fee, other
compensatory and indemnification arrangements to ITH and other obligations. The
services to be provided to us by ITH under the consulting agreement include:
diligence on, and analytical work with respect to, our loan portfolio and
prospective loan purchases and sales; advising us with respect to unrealized
gains and losses in our loan portfolio; advising us with respect to the work of
our valuation consultants and related issues; advising us with respect to
certain accounting oriented issues, and interface with various parties,
including, without limitation, us and our auditor; advising us with respect to
the implementation and management of certain matters in the final Form S-4,
including, without limitation, all issues with our transfer agent, including the
lock-up of the shares; advising us with respect to liquidity strategies
including, without limitation, an initial public offering, potential debt
offerings and assistance in the arrangement of commercial banking facilities;
advising us regarding the selection of an independent board of directors and
committees thereof, including, without limitation, candidates and proposed
compensation terms, among other issues; and other advice to us from time to time
as requested by us.





In
consideration of ITH’s services to us under the consulting agreement, the
consulting agreement provides for the payment to ITH of a monthly fee of
$32,500, a one-time fee of $1.5 million in the event we raise $50 million or
more in the aggregate of debt or equity capital or list our shares of common
stock, par value $0.01, on a national securities exchange, a one-time fee of
$750,000 in the event we raise equity securities exceeding $100 million and a
one-time fee of $500,000 in the event we raise debt securities $100 million, all
pursuant to the terms and conditions of the consulting agreement. The consulting
agreement also provides for a one-time issuance to ITH of 50,000 shares of our
common stock in the event we raise $50 million or more of debt or equity capital
or list our shares of common stock on a national securities exchange during the
term of the consulting agreement and a one-time issuance to ITH of warrants to
purchase 150,000 shares of our common stock in the event that we (i) consummate
an initial public offering during the term of the consulting agreement and (ii)
list our shares of common stock on a national securities exchange during the
term of the consulting agreement, all pursuant to the terms and conditions of
the consulting agreement.


131


Item
6.   Exhibits




Exhibit





No.
            
            Description10.1*
            
            Form
      of Indemnification Agreement, by and between Shane Albers and IMH
      Financial Corporation.10.2*
            
            Form
      of Indemnification Agreement, by and between William Meris and IMH
      Financial Corporation.10.3*
            
            Form
      of Indemnification Agreement, by and between Steven Darak and IMH
      Financial Corporation.10.4*
            
            Form
      of Consulting Services Agreement, by and between ITH Partners, LLC and IMH
      Financial Corporation.31.1*
            
            Certification
      of Chief Executive Officer of IMH Financial Corporation pursuant to
      Section 302 of the Sarbanes-Oxley Act of 200231.2*
            
            Certification
      of Chief Financial Officer of IMH Financial Corporation pursuant to
      Section 302 of the Sarbanes-Oxley Act of 200232.1*†
            
            Certification
      of Chief Executive Officer and the Chief Financial Officer of IMH
      Financial Corporation pursuant to Section  906 of the Sarbanes-Oxley
      Act of 2002*
            
            Filed
      herewith.†
            
            This
      certification is being furnished solely to accompany this report pursuant
      to 18 U.S.C. Section 1350, and is not being filed for purposes of Section
      18 of the Exchange Act, and is not to be incorporated by reference into
      any filings of the Company, whether made before or after the date hereof,
      regardless of any general incorporation language in such
      filing.




132





SIGNATURES





In
accordance with the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.




Date:
      November 19, 2010
            IMH
      FINANCIAL CORPORATIONBy:
            /s/ Steven DarakSteven
      DarakChief
      Financial Officer(Principal
      Financial and Accounting Officer and
              Duly
      Authorized Officer)





133





INDEX
TO EXHIBITS




No.
            
            Description10.1*
            
            Form
      of Indemnification Agreement, by and between Shane Albers and IMH
      Financial Corporation.10.2*
            
            Form
      of Indemnification Agreement, by and between William Meris and IMH
      Financial Corporation.10.3*
            
            Form
      of Indemnification Agreement, by and between Steven Darak and IMH
      Financial Corporation.10.4*
            
            Form
      of Consulting Services Agreement, by and between ITH Partners, LLC and IMH
      Financial Corporation.31.1*
            
            Certification
      of Chief Executive Officer of IMH Financial Corporation pursuant to
      Section 302 of the Sarbanes-Oxley Act of 200231.2*
            
            Certification
      of Chief Financial Officer of IMH Financial Corporation pursuant to
      Section 302 of the Sarbanes-Oxley Act of 200232.1*†
            
            Certification
      of Chief Executive Officer and the Chief Financial Officer of IMH
      Financial Corporation pursuant to Section  906 of the Sarbanes-Oxley
      Act of 2002*
            
            Filed
      herewith.†
            
            This
      certification is being furnished solely to accompany this report pursuant
      to 18 U.S.C. Section 1350, and is not being filed for purposes of Section
      18 of the Exchange Act, and is not to be incorporated by reference into
      any filings of the Company, whether made before or after the date hereof,
      regardless of any general incorporation language in such
      filing.





134