10-Q 1 v202443_10q.htm Unassociated Document
    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
£
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).  Yes  ¨     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 INFORMATION
 
     
Item 1.
Financial Statements.
 
     
 
Consolidated Balance Sheets as of December 31, 2009 and September 30, 2010
3
     
 
Consolidated Statements of Operations for the Nine and Three Months Ended September 30, 2009 and 2010
4
     
 
Consolidated Statement of Owners’ Equity for the Nine Months Ended September 30, 2010
5
     
 
Consolidated Statements of Cash Flows for Nine Months Ended September 30, 2009 and 2010
6
     
 
Notes to Consolidated Financial Statements
7
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
47
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
98
     
Item 4T.
Controls and Procedures.
102
     
 
PART II – OTHER INFORMATION
 
     
Item 1.
Legal Proceedings.
103
     
Item 1A.
Risk Factors.
105
     
Item 5.
Other Information
131
     
Item 6. Unregistered Sales of Equity Securities and Use of Proceeds.
130
     
Item 7.
Exhibits.
132
     
 
Signatures
133
     
 
Index 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)
 
ASSETS
           
Cash and Cash Equivalents
  $ 963     $ 4,580  
Mortgage 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       156,001  
Mortgage Loans, Net
    214,020       156,001  
Accrued Interest and Other Receivables
    15,751       7,218  
Real Estate Acquired through Foreclosure Held for Sale, Net
    12,082       38,048  
Real Estate Held for Development, Net:
               
Acquired through Foreclosure
    84,804       67,455  
Purchased for Investment
    7,345       3,803  
Real Estate Held for Development, Net
    92,149       71,258  
Deposits and Other Assets
    1,464       2,348  
Advances to Fund Manager
    1,367       -  
Property and Equipment, Net
    -       1,592  
                 
Total Assets
  $ 337,796     $ 281,045  
                 
LIABILITIES
               
Accounts Payable and Accrued Expenses
  $ 6,582     $ 10,913  
Payables to Fund Manager
    3,342       -  
Notes Payable
    4,182       16,963  
Borrowings from Fund Manager
    1,608       -  
Unearned Income and Other Funds Held
    214       214  
Total Liabilities
    15,928       28,090  
Commitments and Contingent Liabilities (Note 12)
               
                 
OWNERS' EQUITY
               
Common stock, $.01 par value; 200,000,000 shares authorized;
               
16,809,766 shares outstanding at September 30, 2010
    -       168  
Preferred stock, $.01 par value; 100,000,000 shares authorized;
               
none outstanding
    -       -  
Additional Paid in Capital
    -       726,866  
Accumulated 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 at
               
December 31, 2009. No units outstanding at September 30, 2010
    730,383       -  
Total Owners' Equity
    321,868       252,955  
                 
Total 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 September 30,
   
Three Months Ended September 30,
 
   
2009
   
2010
   
2009
   
2010
 
                         
REVENUE:
                       
Mortgage Loan Income
  $ 20,256     $ 1,112     $ 2,697       156  
Rental Income
    379       1,243       378       410  
Investment and Other Income
    115       427       80       274  
                                 
Total Revenue
    20,750       2,782       3,155       840  
                                 
COSTS AND EXPENSES:
                               
Operating Expenses for Real Estate Owned
    2,534       4,072       1,194       1,523  
Professional Fees
    1,830       4,587       641       1,832  
Management Fees
    481       109       62       -  
Default and Related Expenses
    579       533       251       174  
General and Administrative Expenses
    -       1,767       -       1,559  
Loss on Disposal of Real Estate
    -       1,112       -       112  
Write-off of Offering Costs
    -       6,150       -       6,150  
Interest Expense:
                               
Borrowings from Fund Manager
    217       39       115       -  
Borrowings on Notes Payable
    -       1,364       -       562  
Depreciation and Amortization Expense
    283       1,012       283       380  
Total Operating Expenses
    5,924       20,745       2,546       12,292  
                                 
Provision for Credit Losses
    82,000       34,380       82,000       6,830  
Impairment of Real Estate Owned
    8,000       13,221       8,000       2,236  
Total Provisions and Charges
    90,000       47,601       90,000       9,066  
Total Costs and Expenses
    95,924       68,346       92,546       21,358  
Loss 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
         
Total
 
   
Common Stock
   
Members' Capital
   
Accumulated
   
Owners'
 
   
Shares
   
Amount
   
Paid-in Capital
   
Units
   
Capital
   
Deficit
   
Equity
 
                                           
Balances at December 31, 2009
    -     $ -     $ -       73,038     $ 730,383     $ (408,515 )   $ 321,868  
                                                         
Conversion 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
   
2010
 
             
CASH FLOWS - OPERATING ACTIVITIES
           
Net Loss
  $ (75,174 )   $ (65,564 )
Adjustments to reconcile net loss to net
               
cash provided by (used in) operating activities:
               
Provision for Credit Losses
    82,000       34,380  
Impairment of Assets
    8,000       13,221  
Loss on Disposal of Real Estate
    -       1,112  
Depreciation and Amortization Expense
    283       1,012  
Imputed interest on Notes Payable
    -       392  
Increase (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 )     1,093  
Deposits and Other Assets
    (499 )     (1,227 )
Other Payables and Accrued Liabilities
    5,417       3,326  
Unearned Income and Other Funds Helds
    90       -  
Net cash provided by (used in) operating activities
    13,546       (13,263 )
                 
CASH FLOWS - INVESTING ACTIVITIES
               
Proceeds from Sale of Real Estate Owned
    770       5,346  
Acquisition 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       9,825  
Investment in Real Estate Held for Development
    (2,356 )     (694 )
Net cash provided by (used in) investing activities
    (20,749 )     6,629  
                 
CASH FLOWS - FINANCING ACTIVITIES
               
Proceeds 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
    -       14,827  
Repayments of Notes Payable
    -       (2,841 )
Members' Distributions
    (16,669 )     -  
Net cash provided by (used in) financing activities
    (14,149 )     10,251  
                 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    (21,352 )     3,617  
                 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    23,815       963  
                 
CASH AND CASH EQUIVALENTS, END OF PERIOD
  $ 2,463     $ 4,580  
                 
SUPPLEMENTAL CASH FLOW INFORMATION
               
Interest paid
  $ 217     $ 658  
Acquistion of Real Estate Held for Resale through
               
Foreclosure 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
   
Total
 
   
Shares
   
Shares
   
Shares
 
Shares to be issued for purchase of Manager and Holdings
    114,107       781,643       895,750  
Less: 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 Nine
 
   
Months Ended
   
Months Ended
 
   
September 30, 2009
   
September 30, 2010
 
             
Revenue
  $ 30,394     $ 3,096  
                 
Net 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 of
 
   
June 18, 2010
 
Cash and Cash Equivalents
  $ 422  
Accrued Interest and Other Receivables
    50  
Real Estate Held for Sale
    39  
Deposits and Other Assets
    291  
Property and Equipment
    1,727  
Accounts Payable and Accrued Expenses
    (1,138 )
Notes Payable
    (443 )
Payable to Fund
    (810 )
Total Identifiable Net Assets at June 18, 2010
    138  
Less:  Distribution to Owners of Manager and Holdings
    (3,721 )
Add:  Settlement of Obligation with SARs Participants
    234  
Conversion 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, 2010
 
   
Fixed
   
Variable
   
Total
   
Fixed
   
Variable
   
Total
 
   
Rate
   
Rate
   
Loan
   
Rate
   
Rate
   
Loan
 
   
Loans
   
Loans
   
Portfolio
   
Loans
   
Loans
   
Portfolio
 
                                     
Total Principal Outstanding
  $ 274,263     $ 270,185     $ 544,448     $ 272,372     $ 218,510     $ 490,882  
Less 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       43  
                                                 
Average 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, 2010
 
Quarter
 
Amount
   
Percent
   
#
 
Matured
  $ 347,233       70.8 %    
31
 
Q4 2010
    4,206       0.9 %    
1
 
Q1 2011
    1,617       0.3 %    
1
 
Q2 2011
    1,173       0.2 %    
2
 
Q3 2011
    1,100       0.2 %    
1
 
Q4 2011
    33,916       6.9 %    
3
 
Q1 2012
    2,000       0.4 %    
1
 
Q3 2012
    99,423       20.3 %    
2
 
Q3 2013
    214       0.0 %    
1
 
Total
    490,882       100.0 %    
43
 
Less: 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, 2009
 
   
Percent of
                                 
Non-Accrued
       
   
Outstanding
         
Outstanding
   
Allowance for
   
Net Carrying
   
Accrued
   
Note
       
   
Principal
   
#
   
Principal
   
Credit Loss
   
Amount
   
Interest
   
Interest
   
Total
 
Arizona
    52.3 %    
23
    $ 278,306     $ (162,282 )   $ 116,024     $ 5,362     $ 13,723     $ 135,109  
Idaho
    9.3 %    
2
      49,594       (38,981 )     10,613       1,948       5,993       18,554  
California
    33.8 %    
19
      179,773       (120,829 )     58,944       3,959       18,349       81,252  
Texas
    2.1 %    
3
      11,102       (4,272 )     6,830       427       1,170       8,427  
Nevada
    1.5 %    
1
      7,984       (2,613 )     5,371       319       957       6,647  
New Mexico
    1.0 %    
2
      5,240       (1,094 )     4,146       -       586       4,732  
      100.0 %    
50
    $ 531,999     $ (330,071 )   $ 201,928     $ 12,015     $ 40,778     $ 254,721  
 
   
September 30, 2010
 
   
Percent of
                                 
Non-Accrued
       
   
Outstanding
         
Outstanding
   
Valuation
   
Net Carrying
   
Accrued
   
Note
       
   
Principal
   
#
   
Principal
   
Allowance
   
Amount
   
Interest
   
Interest
   
Total
 
Arizona
    51.4 %    
14
    $ 246,801     $ (153,257 )   $ 93,544     $ (2,609 )   $ 16,761     $ 107,696  
Idaho
    10.3 %    
2
      49,637       (43,178 )     6,459       1,948       4,493       12,900  
California
    35.6 %    
17
      171,230       (136,431 )     34,799       3,770       17,915       56,484  
New Mexico
    1.1 %    
2
      5,260       (1,985 )     3,275       (16 )     445       3,704  
Utah
    1.6 %    
1
      7,645       -       7,645       153       460       8,258  
      100.0 %    
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
                                 
Accrued
       
   
Outstanding
         
Outstanding
   
Valuation
   
Net Carrying
   
Accrued
   
Note
       
   
Principal
   
#
   
Principal
   
Allowance
   
Amount
   
Interest
   
Interest
   
Total
 
Pre-entitled Land
    41.4 %    
10
    $ 198,728     $ (167,604 )   $ 31,124     $ 6,380     $ 18,947     $ 56,451  
Entitled Land
    34.5 %    
15
      165,613       (139,926 )     25,687       1,590       15,905       43,182  
Construction
    24.2 %    
11
      116,232       (27,321 )     88,911       (4,724 )     5,222       89,409  
      100.0 %    
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
   
2010
 
             
Loans in Default - Impairment Status:
           
Impaired loans in default
  $ 458,464     $ 414,245  
Non-impaired loans in default
    73,535       66,328  
Total loans in default
  $ 531,999     $ 480,573  
                 
Allowance for Credit Loss / Valuation Allowance on Impaired Loans
               
Impaired loans in default
  $ 458,464     $ 414,245  
Less: Allowance for credit loss / valuation allowance
    (330,071 )     (334,857 )
Net carrying value of impaired loans
  $ 128,393     $ 79,388  
                 
Average investment for impaired loans during period held
  $ 456,993     $ 412,025  
                 
Interest income recognized during the period that loans were impaired
  1,898      -  
                 
Interest income recognized using a cash-basis method of accounting
               
during 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)
 
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.
 
 
·
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,
 
   
2010
 
Balance at beginning of period
  $ 330,428  
Provision for credit losses
    34,380  
Net 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)
 
   
December 31, 2009
   
September 30, 2010
 
   
Significant
               
Significant
             
   
Other
   
Significant
         
Other
   
Significant
       
   
Observable