IMH Financial Corp - FORM 10-Q - November 13, 2014

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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 quarterly period ended September 30, 2014
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
(Exact name of registrant as specified in its charter)
Delaware
27-1537126
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification Number)
7001 N. Scottsdale Rd #2050
Scottsdale, Arizona 85253
(Address of principal executive offices and zip code)

(480) 840-8400
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
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 þ 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
¨
 
Smaller reporting company
þ
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ

The registrant had 50,000 shares of Common Stock, 3,491,758 shares of Class B-1 Common Stock, 3,492,954 shares of Class B-2 Common Stock, 7,159,759 shares of Class B-3 Common Stock, 313,790 shares of Class B-4 Common Stock, 735,801 shares of Class C Common Stock, 5,595,148 shares of Series B-1 Preferred Stock and 2,604,852 shares of Series B-2 Preferred Stock, all of which were collectively convertible into 23,444,062 outstanding common shares as of November 13, 2014.



IMH FINANCIAL CORPORATION
QUARTERLY REPORT ON FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
PART II – OTHER INFORMATION
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.


2


PART I
FINANCIAL INFORMATION

Item 1. Financial Statements.
IMH FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data) 
 
 
September 30, 2014
 
December 31, 2013
ASSETS
 
(Unaudited)

 
 
Cash and Cash Equivalents
 
$
3,000

 
$
7,875

Restricted Cash and Cash Equivalents
 
10,020

 
5,777

Mortgage Loans Held for Sale, Net
 
13,189

 
12,541

Real Estate Acquired through Foreclosure Held for Sale
 
74,950

 
86,562

Real Estate Acquired through Foreclosure Held for Development
 
7,603

 
12,262

Operating Properties Acquired through Foreclosure
 
83,783

 
103,683

Deferred Financing Costs, Net
 
—

 
3,733

Other Receivables
 
2,980

 
983

Other Assets
 
3,251

 
3,159

Property and Equipment, Net
 
695

 
826

Total Assets
 
$
199,471

 
$
237,401

 
 
 
 
 
LIABILITIES
 
 

 
 

Accounts Payable and Accrued Expenses
 
$
6,519

 
$
8,400

Accrued Property Taxes
 
1,088

 
1,084

Dividends Payable
 
399

 
—

Accrued Interest Payable
 
1,773

 
2,974

Tenant Deposits and Funds Held for Others
 
354

 
1,016

Convertible Notes Payable and Deferred Interest, Net of Discount
 
—

 
54,975

Notes Payable, Net of Discount
 
81,186

 
46,043

Capital Lease Obligation
 
1,210

 
1,251

Special Assessment Obligations
 
5,057

 
5,339

Exit Fee Payable
 
—

 
10,448

Total Liabilities
 
97,586

 
131,530

 
 
 
 
 
Commitments and Contingent Liabilities
 
 
 
 
 
 
 
 
 
Redeemable Convertible Preferred Stock, $.01 par value; 100,000,000 shares authorized; 8,200,000 outstanding; liquidation preference of $39,570 and $0 at September 30, 2014 and December 31, 2013, respectively
 
26,780

 
—

Fair Value of Puttable Shares Pursuant to Legal Settlement
 
—

 
4,871

 
 
 
 
 
STOCKHOLDERS' EQUITY
 
 

 
 

Common stock, $.01 par value; 200,000,000 shares authorized; 16,873,880 shares issued at September 30, 2014 and December 31, 2013; 15,244,062 and 16,832,221 shares outstanding at September 30, 2014 and December 31, 2013, respectively
 
169

 
169

Less: Treasury stock, 1,629,818 and 41,659 shares at September 30, 2014 and December 31, 2013, respectively
 
(5,948
)
 
(172
)
Paid-in Capital
 
727,130

 
720,150

Accumulated Deficit
 
(646,246
)
 
(619,147
)
Total Stockholders' Equity
 
75,105

 
101,000

 
 
 
 
 
Total Liabilities and Stockholders' Equity
 
$
199,471

 
$
237,401

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

F-1



IMH FINANCIAL CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
 
REVENUE:
 
 
 
 
 
 
 
 
Operating Property Revenue
 
$
6,351

 
$
5,660

 
$
20,077

 
$
11,065

Investment and Other Income
 
324

 
866

 
1,213

 
2,030

Mortgage Loan Income, Net
 
1,321

 
201

 
2,191

 
585

Total Revenue
 
7,996

 
6,727

 
23,481

 
13,680

 
 
 
 
 
 
 
 
 
OPERATING EXPENSES:
 
 
 
 
 
 
 
 
Operating Property Direct Expenses (exclusive of Interest and Depreciation)
 
5,572

 
4,904

 
16,815

 
9,402

Expenses for Non-Operating Real Estate Owned
 
481

 
410

 
1,627

 
1,336

Professional Fees
 
890

 
1,992

 
6,251

 
5,478

General and Administrative Expenses
 
3,582

 
1,485

 
6,739

 
4,201

Interest Expense
 
3,454

 
5,224

 
13,043

 
13,913

Debt Termination Charge
 
21,658

 
—

 
21,658

 
—

Depreciation and Amortization Expense
 
797

 
987

 
2,798

 
2,062

Settlement and Related Costs
 
—

 
840

 
—

 
1,962

Total Operating Expenses
 
36,434

 
15,842

 
68,931

 
38,354

 
 
 
 
 
 
 
 
 
RECOVERY OF CREDIT LOSSES AND GAIN ON DISPOSAL OF ASSETS:
 
 
 
 
 
 
 
 
Gain on Disposal of Assets
 
(5,630
)
 
(252
)
 
(17,630
)
 
(953
)
Recovery of Credit Losses
 
(172
)
 
(679
)
 
(721
)
 
(8,250
)
Total Recovery of Credit Losses and Gain on Disposal of Assets
 
(5,802
)
 
(931
)
 
(18,351
)
 
(9,203
)
 
 
 
 
 
 
 
 
 
Total Costs and Expenses
 
30,632

 
14,911

 
50,580

 
29,151

 
 
 
 
 
 
 
 
 
Loss before Income Taxes
 
(22,636
)
 
(8,184
)
 
(27,099
)
 
(15,471
)
 
 
 
 
 
 
 
 
 
Provision for Income Taxes
 
—

 
—

 
—

 
—

 
 
 
 
 
 
 
 
 
NET LOSS
 
(22,636
)
 
(8,184
)
 
(27,099
)
 
(15,471
)
 
 
 
 
 
 
 
 
 
Cash Dividend on Redeemable Convertible Preferred Stock
 
(399
)
 
—

 
(399
)
 
—

Deemed Dividend on Redeemable Convertible Preferred Stock
 
(400
)
 
—

 
(400
)
 
—

 
 
 
 
 
 
 
 
 
Net Loss Attributable to Common Shareholders
 
$
(23,435
)
 
$
(8,184
)
 
$
(27,898
)
 
$
(15,471
)
 
 
 
 
 
 
 
 
 
Basic and diluted loss per common share
 
 
 
 
 
 
 
 
Net Loss per Common Share
 
$
(1.53
)
 
$
(0.49
)
 
$
(1.74
)
 
$
(0.92
)
Weighted Average Common Shares Outstanding
 
15,323,933

 
16,873,880

 
16,026,515

 
16,873,880

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

F-2


IMH FINANCIAL CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
Nine Months Ended September 30, 2014
(In thousands, except share data)
 
 
 
Common Stock
 
Treasury Stock
 
 
 
Accumulated Deficit
 
Total Stockholders' Equity
 
 
Shares
 
Amount
 
Shares
 
Amount
 
Paid-in Capital
 
 
Balances at December 31, 2013
 
16,873,880

 
$
169

 
41,659

 
$
(172
)
 
$
720,150

 
$
(619,147
)
 
$
101,000

Net Loss
 
—

 
—

 
—

 
—

 
—

 
(27,099
)
 
(27,099
)
Dividends Declared on Redeemable Convertible Preferred Stock
 
—

 
—

 
—

 
—

 
(399
)
 
—

 
(399
)
Deemed Dividend on Redeemable Convertible Preferred Stock
 
—

 
—

 
—

 
—

 
(400
)
 
—

 
(400
)
Stock-Based Compensation
 
—

 
—

 
—

 
—

 
2,908

 
—

 
2,908

Treasury Stock
 
—

 
—

 
1,588,159

 
(5,776
)
 
—

 
—

 
(5,776
)
Reclassification of Fair Value of Puttable Shares Pursuant to Legal Settlement
 
—

 
—

 
—

 
—

 
4,871

 
—

 
4,871

Balances at September 30, 2014
 
16,873,880

 
$
169

 
1,629,818

 
$
(5,948
)
 
$
727,130

 
$
(646,246
)
 
$
75,105

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


F-3



IMH FINANCIAL CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
 
 
Nine Months Ended September 30,
 
 
2014
 
2013
 
 
 
 
 
 
 
CASH FLOWS - OPERATING ACTIVITIES
 
 
 
 
 
Net Loss
 
$
(27,099
)
 
$
(15,471
)
 
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
 
Debt Termination Charge
 
21,658

 
—

 
Non-cash Provision (Recovery of) Credit Losses
 
—

 
(6,975
)
 
Stock-Based Compensation and Option Amortization
 
578

 
434

 
Gain on Disposal of Assets
 
(17,630
)
 
(953
)
 
Amortization of Deferred Financing Costs
 
881

 
1,607

 
Depreciation and Amortization Expense
 
2,798

 
2,062

 
Investment Discount Amortization
 
—

 
(669
)
 
Accretion of Mortgage Income
 
(1,689
)
 
—

 
Accretion of Discount on Notes Payable
 
1,425

 
1,521

 
Increase (decrease) in cash resulting from changes in:
 
 
 
 
 
Accrued Interest Receivable
 
110

 
275

 
Other Receivables
 
(1,997
)
 
(356
)
 
Other Assets
 
595

 
(111
)
 
Accrued Property Taxes
 
4

 
350

 
Accounts Payable and Accrued Expenses
 
510

 
1,342

 
Accrued Interest Payable
 
2,274

 
3,065

 
Tenant Deposits and Funds Held for Others
 
(662
)
 
11

 
Total adjustments, net
 
8,855

 
1,603

 
Net cash used in operating activities
 
(18,244
)
 
(13,868
)
 
 
 
 
 
 
 
CASH FLOWS - INVESTING ACTIVITIES
 
 
 
 
 
Proceeds from Sale/Recovery of Real Estate Owned
 
51,001

 
6,499

 
Purchases of Property and Equipment
 
(23
)
 
(246
)
 
Issuance of Other Notes Receivables
 
(2,100
)
 
—

 
Mortgage Loan Fundings and Protective Advances
 
(27
)
 
(473
)
 
Mortgage Loan Repayments
 
5,681

 
8,617

 
Collection of Other Notes Receivables
 
2,100

 
—

 
Preferred Equity Investment
 
—

 
(15,000
)
 
Investment in Real Estate Owned
 
(4,678
)
 
(1,643
)
 
Capitalized Foreclosure Acquisition Costs
 
—

 
(2,473
)
 
Net cash provided by (used in) investing activities
 
51,954

 
(4,719
)
 
 
 
 
 
 
 
CASH FLOWS - FINANCING ACTIVITIES
 
 
 
 
 
Proceeds from Issuance of Preferred Equity
 
18,580

 
—

 
Proceeds from Notes Payable
 
—

 
10,150

 
Proceeds from Convertible Notes Payable
 
71

 
—

 
Repayment of Convertible Debt
 
(28,295
)
 
—

 
Debt Termination Costs
 
(1,802
)
 
—

 
Debt Issuance Costs Paid
 
—

 
(1,073
)
 

F-4

 
 
Nine Months Ended September 30,
 
 
2014
 
2013
 
 
 
 
 
 
 
(Increase) Decrease in Restricted Cash
 
(4,243
)
 
10,195

 
Repayments of Notes Payable
 
(19,001
)
 
(1,251
)
 
Purchase of Notes Payable
 
(1,289
)
 
—

 
Repayments of Capital Leases
 
(41
)
 
(45
)
 
Dividends Paid
 
—

 
(800
)
 
Purchase of Treasury Stock
 
(2,565
)
 
—

 
Net cash provided by (used in) financing activities
 
(38,585
)
 
17,176

 
 
 
 
 
 
 
NET DECREASE IN CASH AND CASH EQUIVALENTS
 
(4,875
)
 
(1,411
)
 
 
 
 
 
 
 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
 
7,875

 
3,084

 
 
 
 
 
 
 
CASH AND CASH EQUIVALENTS, END OF PERIOD
 
$
3,000

 
$
1,673

 
 
 
 
 
 
 
SUPPLEMENTAL CASH FLOW INFORMATION:
 
 
 
 
 
Interest paid
 
$
5,543

 
$
12,757

 
Real Estate Acquired Through Foreclosure or Deed in Lieu of Foreclosure
 
$
521

 
$
91,380

 
Reclassification of Convertible Debt to Notes Payable
 
$
45,000

 
$
—

 
Deferred Interest added to Notes Payable Principal
 
$
1,923

 
$
2,205

 
Seller Financing provided for Asset Sales
 
$
8,400

 
$
1,085

 
Accounts Payable and Accrued Liabilities Assumed in Foreclosure
 
$
—

 
$
3,382

 
Capital Lease Obligation Assumed in Foreclosure
 
$
—

 
$
1,279

 
Note Payable Assumed in Foreclosure
 
$
—

 
$
24,712

 
Reclassification of Paid in Capital to Fair Value of Puttable Shares Pursuant to Legal Settlement
 
$
4,871

 
$
—

 
Debt Assumed for Asset Acquisitions
 
$
7,875

 
$
—

 
Non-cash Issuance of Exchange Offering Debt
 
$
6,389

 
$
—

 
Assets Acquired in Satisfaction of Loan Principal
 
$
4,020

 
$
—

 
Assets Surrendered to Satisfy Debt Obligations
 
$
4,838

 
$
—

 
Notes Payable and Other Liabilities Relieved through Asset Surrender
 
$
8,119

 
$
—

 
Conversion of Convertible Debt to Series B Preferred Stock
 
$
7,800

 
$
—

 
Deemed Dividend on Redeemable Convertible Preferred Stock
 
$
400

 
$
—

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



F-5
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014



NOTE 1- BUSINESS, BASIS OF PRESENTATION AND LIQUIDITY
 
Our Company
 
IMH Financial Corporation (the “Company”) is a real estate investor and finance company based in the southwest United States with over a decade 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. The Company’s focus is to invest in, manage and dispose of commercial real estate mortgage investments or other real estate assets, and to perform all functions reasonably related thereto, including developing, managing and either holding for investment or disposing of real property acquired through foreclosure or other means. The Company also seeks to capitalize on opportunities to invest in selected real estate platforms under the direction of seasoned professionals in those areas. The Company was formed as a result of a series of transactions that were executed on June 18, 2010 that are referred to as the Conversion Transactions, which included (i) the conversion of our predecessor entity, IMH Secured Loan Fund (the “Fund”), from a Delaware limited liability company into a newly-formed Delaware corporation named IMH Financial Corporation, and (ii) internalization of the Fund manager, Investor's Mortgage Holdings, Inc. (the “Manager”), through an acquisition by the Company of all of the outstanding shares of the Manager, and all of the outstanding membership interests of IMH Holdings, LLC.

During 2013 and 2012, we acquired certain operating properties through deed-in-lieu of foreclosure which have contributed significantly to our operating revenues and expenses during these periods and thereafter. As described more fully in note 4, at September 30, 2014, our operating properties consist of two operating hotels located in Sedona, Arizona, a golf course operation located in Bullhead City, Arizona and, prior to entering into a sales agreement for the property in the third quarter of 2014, a commercial office building located in Stafford, Texas. Due to our limited lending activities since 2008, these operating properties currently contribute the majority of our revenue.

Basis of Presentation

The accompanying unaudited, condensed consolidated financial statements 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 three and nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2014. 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 for the fiscal year ended December 31, 2013.

The accompanying unaudited condensed consolidated financial statements include the accounts of IMH Financial Corporation and the following wholly-owned operating subsidiaries: Investors Mortgage Holdings, Inc., an Arizona corporation, Investors Mortgage Holdings California, Inc., a California corporation, IMH Holdings, LLC, a Delaware limited liability company (“Holdings”), and various other wholly owned subsidiaries established in connection with the acquisition of real estate either through foreclosure or purchase. IMH Holdings is a holding company for two wholly-owned subsidiaries: IMH Management Services, LLC, an Arizona limited liability company, and SWI Management, LLC, an Arizona limited liability company. IMH Management Services, LLC provides us and our affiliates with human resources and administrative services, including the supply of employees, and SWI Management, LLC, or “SWIM”, acted as the manager for the Strategic Wealth & Income Company, LLC, or the SWI Fund. All significant intercompany accounts and transactions have been eliminated in consolidation.

Liquidity
 
As of September 30, 2014, our accumulated deficit aggregated $646.2 million primarily as a result of previous provisions for credit losses recorded relating to the decrease in the fair value of the collateral securing our loan portfolio and impairment charges relating to the value of real estate owned ("REO") assets acquired primarily through foreclosure, as well as on-going net operating losses in recent periods resulting from the lack of income-producing assets and the high cost of our debt financing. Beginning in 2008, we experienced significant defaults and foreclosures in our mortgage loan portfolio due primarily to the erosion of the U.S. and global real estate and credit markets during those periods. As a result, since that time we have been focused on enforcing our

F-6
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014
 

NOTE 1 – BUSINESS, BASIS OF PRESENTATION AND LIQUIDITY - continued

rights under our loan documents, working to repossess the collateral properties underlying those loans, and pursuing recovery from guarantors under such loans.

Our liquidity plan has included obtaining additional financing, selling whole loans or participating interests in loans, and selling the majority of our legacy real estate assets. As more fully described in note 7, in June 2011, we entered into and closed funding of a $50.0 million senior secured convertible loan with NWRA Ventures I, LLC (“NW Capital”). In addition, during the year ended December 31, 2013, we secured an additional $10.0 million in financing secured by certain REO assets. These financings, along with proceeds from asset sales, have been our primary sources of working capital. During the nine months ended September 30, 2014, we repaid the $10.0 million note payable primarily using proceeds from asset sales. In addition, during the nine months ended September 30, 2014, we entered into a series of transactions to, among other things, restructure and partially refinance the NW Capital senior loan which will also allow for the prepayment of the total loan balance. The restructure and partial refinance of the NW Capital loan are considered to be the first step in a two-step overall refinancing strategy, the primary objective of which is to reduce the Company’s current and future annual interest expense and related costs, in order to improve the Company’s overall liquidity. Management continues to seek to secure replacement financing to refinance the remaining outstanding balance of the NW Capital loan and other Company indebtedness.

As of September 30, 2014, our entire loan portfolio with an aggregate carrying value of $13.2 million is held for sale. In addition, as of September 30, 2014, real estate owned (“REO”) projects with a carrying value totaling $75.0 million were being actively marketed for sale. During the nine months ended September 30, 2014, we sold certain loans and REO assets and collected other recoveries generating approximately $51.0 million in cash, net of the amounts financed by us. We also received $5.7 million in mortgage loan paydowns during the nine months ended September 30, 2014.
 
In connection with the NW Capital loan, we entered into a cash management agreement with the lender under which the amount of discretionary funds available to us is limited to the following 90 days of budgeted operating cash, which is funded on a monthly basis, subject to NW Capital approval and release. The balance of all remaining cash (including the balance of loan proceeds and any and all proceeds received from operations, loan payments, asset sales or other cash generating events) is collected and maintained in a trust account as collateral under the loan for the benefit of NW Capital (the "Collateral Account"). Subsequent to September 30, 2014, we secured a construction loan in the amount of $24.0 million in connection with the development of a multi-family project, which will require a minimum liquidity balance of $7.5 million upon the first draw of the construction loan (expected to occur in the first quarter of 2015). At September 30, 2014, we had cash and cash equivalents of $3.0 million and restricted cash in the Collateral Account of $10.0 million.
 
While we have been successful in securing financing through September 30, 2014 to provide adequate funding for working capital purposes and have generated liquidity through asset sales and mortgage receivable collections, there is no assurance that we will be successful in selling our remaining loan and REO assets in a timely manner or in obtaining additional or replacement financing, if needed, to sufficiently fund future operations, repay existing debt or to implement our investment strategy. Any sale of a loan or REO asset requires prior approval of NW Capital. Our failure to generate sustainable earning assets, and successfully liquidate a sufficient number of our loans and REO assets, including receiving approval, if required, from our lender of such liquidations, may have a material adverse effect on our business, results of operations and financial position.
 

F-7
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014



NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES
 
Reclassifications
Certain 2013 amounts have been reclassified to conform to the 2014 financial statement presentation. During 2013, the Company completed a conversion to a new accounting system which provides more detailed reporting and greater visibility. As a result of this conversion, we identified various changes in the classifications of certain previously reported income statement amounts and segment information. While these changes had no impact on net loss or basic and diluted net loss per share, there were certain significant reclassifications in the consolidated statement of operations which are summarized below:

•
During the year ended December 31, 2013, we combined the revenues of our various operating properties into a single line entitled Operating Property Revenue. Accordingly, we reclassified the related 2013 activity to conform to the 2014 presentation;
•
Similarly, during the year ended December 31, 2013, we created a line item entitled Operating Property Direct Expenses (exclusive of Interest and Depreciation) and reclassified appropriate amounts primarily from Other Operating Expenses for Real Estate Owned to capture those expenses directly attributable to operating properties, thereby segregating incidental costs of ownership of non-operating REO properties with the creation of a line item entitled Expenses for Non-Operating Real Estate Owned.
•
In addition, we reclassified the presentation of certain other 2013 amounts previously reported in property taxes, professional fees, and general and administrative expenses to conform to the 2014 presentation.

The effects of these reclassifications are presented in the table below:

 
Three Months Ended September 30, 2013
Reclassifications - Statement of Operations - 2013
As Previously
Reported
 
Reclassification
Adjustment
 
As
Reclassified
Rental Income
$
394

 
$
(394
)
 
$
—

Hospitality and Entertainment Income
5,266

 
(5,266
)
 
—

Operating Property Revenue
—

 
5,660

 
5,660

Operating Property Direct Expenses (exclusive of Interest and Depreciation)
4,575

 
329

 
4,904

Property Taxes for REO
284

 
(284
)
 
—

Other Operating Expenses for REO
259

 
(259
)
 
—

Expenses for Non-Operating Real Estate Owned
—

 
410

 
410

Professional Fees
2,173

 
(181
)
 
1,992

General and Administrative Expenses
1,500

 
(15
)
 
1,485


 
Nine Months Ended September 30, 2013
Reclassifications - Statement of Operations - 2013
As Previously
Reported
 
Reclassification
Adjustment
 
As
Reclassified
Rental Income
$
1,205

 
$
(1,205
)
 
$
—

Hospitality and Entertainment Income
9,860

 
(9,860
)
 
—

Operating Property Revenue
—

 
11,065

 
11,065

Operating Property Direct Expenses (exclusive of Interest and Depreciation)
8,570

 
832

 
9,402

Property Taxes for REO
998

 
(998
)
 
—

Other Operating Expenses for REO
647

 
(647
)
 
—

Expenses for Non-Operating Real Estate Owned
—

 
1,336

 
1,336

Professional Fees
5,968

 
(490
)
 
5,478

General and Administrative Expenses
4,234

 
(33
)
 
4,201



Restatement of Previously Issued Consolidated Financial Statements

F-8
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES – continued

 
Segment Information
As a result of the accounting system conversion described above, we identified misstatements in the classifications of certain previously reported segment information. For income statement items, the adjustments primarily related to the allocation of certain professional fees, interest and general and administrative costs into the proper segments. We have adjusted our segment disclosures for the three and nine months ended September 30, 2013 to reflect the proper comparative amounts in each segment as shown in the table below.
Assessment of Restatements
 
These corrections had no impact on net loss or basic and diluted loss per share for the period ended September 30, 2013. The Company has assessed these misstatements in financial statement presentation and has determined that, on both a qualitative and quantitative basis, the adjustments are immaterial, both individually and in the aggregate, to the consolidated financial statements, and thus, the Company did not and will not amend any of its prior quarterly and annual reports on Form 10-Q and 10-K, and it has adjusted its presentation on a prospective basis. In order to provide consistency in the Company's financial reporting, the September 30, 2013 segment information presented herein has been restated to appropriately reflect the corrections described above. The following tables summarizes the effects of these corrections and reclassifications on the previously filed consolidated financial statements for the three and nine months ended September 30, 2013, which was restated for comparative purposes only (in thousands):


F-9
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES – continued

 
Three Months Ended September 30, 2013
 
As Previously
Reported
Restatement
Adjustment
Reclassification
Adjustment
As
Restated
Segment Information - Income Statement Items
 
 
 
 
Expenses
 
 
 
 
Expenses Mortgage and REO - Legacy Portfolio and Other Operations
$
—

$
(1
)
$
1

$
—

Mortgage and REO - Legacy Portfolio and Other Operations - Operating Property Direct Expense
1,098

—

(1,098
)
—

Mortgage and REO - Legacy Portfolio and Other Operations - Expenses for Non-Operating REO
—

—

408

408

Mortgage and REO - Legacy Portfolio and Other Operations - Professional Fees
—

—

934

934

Mortgage and REO - Legacy Portfolio and Other Operations - General and Administrative
—

—

6

6

Mortgage and REO - Legacy Portfolio and Other Operations - Interest
423

—

—

423

Mortgage and REO - Legacy Portfolio and Other Operations - Loss on Disposal of Assets
—

—

(252
)
(252
)
Mortgage and REO - Legacy Portfolio and Other Operations - Settlement and Related
—

—

1

1

Mortgage and REO - Legacy Portfolio and Other Operations - Credit Loss Recoveries
(676
)
—

—

(676
)
Total Expenses Mortgage and REO - Legacy Portfolio and Other Operations
845

(1
)
—

844

 
 
 
 
 
Expenses Commercial Real Estate Leasing Operations
—

(1
)
1

—

Commercial Real Estate Leasing Operations - Operating Property Direct Expense
702

—

(337
)
365

Commercial Real Estate Leasing Operations - Interest
527

—

—

527

Commercial Real Estate Leasing Operations - Depreciation and Amortization
—

—

336

336

Commercial Real Estate Leasing Operations - Credit Loss Recoveries
(3
)
—

—

(3
)
Total Expenses Commercial Real Estate Leasing Operations
1,226

(1
)
—

1,225

 
 
 
 
 
Expenses Hospitality and Entertainment Operations
—

2

(2
)
—

Hospitality and Entertainment Operations - Operating Property Direct Expense
5,131

—

(592
)
4,539

Hospitality and Entertainment Operations - Interest
846

—

—

846

Hospitality and Entertainment Operations - Depreciation and Amortization
—

—

594

594

Total Expenses Hospitality and Entertainment Operations
5,977

2

—

5,979

 
 
 
 

Expenses Corporate and Other
—

—

—

—

Corporate and Other - Operating Property Direct Expense
3,435

—

(3,435
)
—

Corporate and Other - Expenses for Non-Operating REO
—

—

2

2

Corporate and Other - Professional Fees
—

—

1,058

1,058

Corporate and Other - General and Administrative
—

—

1,479

1,479

Corporate and Other - Interest
3,428

—

—

3,428

Corporate and Other - Depreciation and Amortization
—

—

57

57

Corporate and Other - Settlement and related
—

—

839

839

Total Expenses Corporate and Other
$
6,863

$
—

$
—

$
6,863



F-10
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES – continued

 
Nine Months Ended September 30, 2013
 
As Previously
Reported
Restatement
Adjustment
Reclassification
Adjustment
As
Restated
Segment Information - Income Statement Items
 
 
 
 
Expenses
 
 
 
 
Expenses Mortgage and REO - Legacy Portfolio and Other Operations
$
—

$
(18
)
$
18

$
—

Mortgage and REO - Legacy Portfolio and Other Operations - Operating Property Direct Expense
2,729

—

(2,729
)
—

Mortgage and REO - Legacy Portfolio and Other Operations - Expenses for Non-Operating REO
—

—

1,328

1,328

Mortgage and REO - Legacy Portfolio and Other Operations - Professional Fees
—

—

2,305

2,305

Mortgage and REO - Legacy Portfolio and Other Operations - General and Administrative
—

—

27

27

Mortgage and REO - Legacy Portfolio and Other Operations - Interest
1,359

—

—

1,359

Mortgage and REO - Legacy Portfolio and Other Operations - Loss on Disposal of Assets
—

—

(957
)
(957
)
Mortgage and REO - Legacy Portfolio and Other Operations - Settlement and Related
—

—

8

8

Mortgage and REO - Legacy Portfolio and Other Operations - Credit Loss Recoveries
(8,242
)
—

—

(8,242
)
Total Expenses Mortgage and REO - Legacy Portfolio and Other Operations
(4,154
)
(18
)
—

(4,172
)
 
 
 
 
 
Expenses Commercial Real Estate Leasing Operations
—

—

—

—

Commercial Real Estate Leasing Operations - Operating Property Direct Expense
2,080

—

(997
)
1,083

Commercial Real Estate Leasing Operations - Interest
1,275

—

—

1,275

Commercial Real Estate Leasing Operations - Depreciation and Amortization
—

—

997

997

Commercial Real Estate Leasing Operations - Credit Loss Recoveries
(8
)
—

—

(8
)
Total Expenses Commercial Real Estate Leasing Operations
3,347

—

—

3,347

 
 
 
 
 
Expenses Hospitality and Entertainment Operations
—

17

(17
)
—

Hospitality and Entertainment Operations - Operating Property Direct Expense
9,212

—

(893
)
8,319

Hospitality and Entertainment Operations - Interest
1,256

—

—

1,256

Hospitality and Entertainment Operations - Depreciation and Amortization
—

—

910

910

Total Expenses Hospitality and Entertainment Operations
10,468

17

—

10,485

 
 
 
 
 
Expenses Corporate and Other
—

1

(1
)
—

Corporate and Other - Operating Property Direct Expense
9,467

—

(9,467
)
—

Corporate and Other - Expenses for Non-Operating REO
—

—

8

8

Corporate and Other - Professional Fees
—

—

3,173

3,173

Corporate and Other - General and Administrative
—

—

4,174

4,174

Corporate and Other - Interest
10,023

—

—

10,023

Corporate and Other - Depreciation and Amortization
—

—

155

155

Corporate and Other - Loss on disposal of Assets
—

—

4

4

Corporate and Other - Settlement and related
—

—

1,954

1,954

Total Expenses Corporate and Other
$
19,490

$
1

$
—

$
19,491


Use of Estimates
 
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Certain accounting policies involve judgments and uncertainties to such an extent that there is reasonable likelihood that materially different amounts could have been reported under different conditions, or if different assumptions had been used. The Company evaluates its estimates and assumptions on a regular basis. The Company uses historical experience and various other assumptions that are believed to be reasonable under the circumstances to form the basis for making judgments about carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may materially differ from these estimates and assumptions used in preparation of the consolidated financial statements.
 

F-11
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES – continued

Restricted Cash
 
At September 30, 2014 and December 31, 2013, restricted cash and cash equivalents totaled $10.0 million and $5.8 million, respectively. Restricted cash includes cash items that are legally or contractually restricted as to usage or withdrawal, which include amounts relating to: a) the Collateral Account established pursuant to the terms of NW Capital loan. While the funds in the Collateral Account are not restricted for a specified purpose and are expected to be used to fund on-going operations, capital purchases and investments, the Company's use of funds in that account is subject to NW Capital approval; b) as described in note 7, under the terms of our loan agreement with Canpartners Realty Holding Company IV LLC ("Canpartners"), we were required to maintain a minimum $5.0 million balance of cash and cash equivalents at all times during the term of the loan, which included balances in the Collateral Account, as well as other reserve accounts required under the Canpartners' loan agreement; and c) amounts maintained in escrow accounts for contractually specified purposes. During the nine months ended September 30, 2014, we repaid the CanPartners loan in full thereby removing the restriction specified in b) above. However, as described in note 11, subsequent to September 30, 2014, we secured a construction loan in the amount of $24.0 million in connection with the development of a multi-family project, which will require a minimum liquidity balance of $7.5 million upon the first draw of the construction loan (expected to occur in the first quarter of 2015).

Recent Accounting Pronouncements
 
Changes to GAAP are established by the Financial Accounting Standards Board (“FASB”) in the form of accounting standards updates (“ASUs”) to the FASB’s Accounting Standards Codification (“ASC”). The Company considers the applicability and impact of all ASUs.
 
In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This update applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The assessment of whether a deferred tax asset is available is based on the unrecognized tax benefit and deferred tax asset that exist at the reporting date and should be made presuming disallowance of the tax position at the reporting date. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The adoption of this ASU did not have a material impact on the Company’s financial statements.

Accounting Standard Update No 2014-04, Receivables - Troubled Debt Restructuring by Creditors Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure, was created to provide conformity from when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage so that the asset would be derecognized in the receivable and recognized as real estate property. This updates specifies that an in substance repossession occurs when either the creditor has obtained the legal title to the property after a foreclosure or the borrower has transferred all interest in the property to the creditor through a deed in lieu of foreclosure or similar legal agreement so that at that time the asset should be reclassified from a loan receivable to real estate property. This update also provides that a disclosure of the amount of foreclosed residential real estate property and the recorded investment in consumer mortgage loans collateralized by residential real estate property that is the process of foreclosure must be included in both interim and annual financial reports. This amendment update is effective for periods for fiscal years beginning after December 15, 2014. The adoption of ASU 2014-04 is not expected to have a material impact on our financial condition, liquidity or results of operations.

In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Components of an Entity, which changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. The guidance applies prospectively to new disposals and new classifications of disposal groups as held for sale after the effective date. The standard is required to be adopted by public business entities in annual periods beginning on

F-12
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 2 — SIGNIFICANT ACCOUNTING POLICIES – continued

or after December 15, 2014, and interim periods within those annual periods. We adopted this standard during the period ended September 30, 2014, which did not have a material impact on the Company’s financial statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers: Topic 606 . This update applies to entities that enter into contracts with customers to transfer goods or services or for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. The guidance in this update supersedes the revenue recognition requirements in Topic 605, Revenue Recognition and most industry-specific guidance. The core principle of the guidance is that an entity should recognize revenue to illustrate the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new guidance also includes a cohesive set of disclosure requirements that will provide users of financial statements with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from a reporting organization’s contracts with customers. This ASU is effective retrospectively for fiscal years, and interim periods within those years, beginning after December 15, 2016 for public companies. Management is evaluating the effect, if any, on the Company’s financial position and results of operations.

In June 2014, the FASB issued ASU No. 2014-12, Compensation - Stock Compensation (Topic 718):  Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. ASU 2014-12 requires an entity to treat performance targets that can be met after the requisite service period of a share-based award has ended, as a performance condition that affects vesting. The ASU is effective for interim and annual reporting periods in fiscal years that begin after December 15, 2015. The Company does not expect the adoption of this update to have a material impact on the Company's operating results or financial position.
In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern,. ASU 2014-15 introduces an explicit requirement for management to assess and provide certain disclosures if there is substantial doubt about an entity’s ability to continue as a going concern. ASU 2014-15 is effective for the annual period ending after December 15, 2016. The Company does not expect the adoption of ASU 2014-15 to have a material impact on the Company's operating results or financial position.
 



F-13
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014



NOTE 3 — MORTGAGE INVESTMENTS, LOAN PARTICIPATIONS AND LOAN SALES
 
Lending Activities
 
Given the non-performing status of the majority of our loan portfolio and the suspension of significant lending activities, there has been limited loan activity during the nine months ended September 30, 2014. Except for the origination of two loans in the aggregate principal amount of $8.4 million in connection with the financing of a portion of the sale of certain REO assets during 2014, no new loans were originated during the nine months ended September 30, 2014. We originated one loan during the nine months ended September 30, 2013 in the principal amount of $1.1 million in connection with the partial financing of the sale of an REO asset. During the nine months ended September 30, 2014, we received mortgage loan principal payoffs totaling $5.7 million for two of our performing loans.

A roll-forward of loan activity for the nine months ended September 30, 2014 is as follows (in thousands):
 
 
Principal
Outstanding
 
Interest
Receivable
 
Valuation
Allowance
 
Carrying
Value
Balances at December 31, 2013
 
$
30,222

 
$
527

 
$
(18,208
)
 
$
12,541

Additions:
 
 

 
 

 
 

 
 

Principal fundings - cash
 
27

 
—

 
—

 
27

Principal fundings - asset sale financing
 
8,400

 
—

 
—

 
8,400

Mortgage loans acquired in modification
 
864

 
 
 
—

 
864

Accrued interest revenue
 
1,689

 
226

 
—

 
1,915

Reductions:
 
 
 
 
 
 
 
 
Principal and interest repayments
 
(5,681
)
 
(336
)
 
—

 
(6,017
)
Assets acquired in satisfaction of loan balance
 
(4,020
)
 
—

 
—

 
(4,020
)
Foreclosures/transfers to Real Estate Owned
 
(4,917
)
 
(53
)
 
4,449

 
(521
)
Balances at September 30, 2014
 
$
26,584

 
$
364

 
$
(13,759
)
 
$
13,189

 
During the nine months ended September 30, 2014, we modified one loan under the terms of a court-approved order in which the Company accepted, in lieu of cash payment, certain assets with an aggregate estimated fair value of $4.0 million, and established the remaining loan balance principal at $4.0 million. As a result of the modification, (a) the aggregate balance of the assets received and the newly established loan balance exceeded the carrying value of the loan at the time of modification, (b) the interest rate on the loan was increased from 12.0% to 16.25%, and (c) the Company received additional collateral to further secure the remaining loan balance. The modification is deemed to be a "troubled debt restructuring" primarily because the total amount to be collected was below the contractual amount otherwise due under the loan when considering default interest due under the original loan terms (none of which was previously recorded by the Company). The failure to collect the full amount of default interest was deemed to be a concession under applicable accounting guidance. As a result, the fair value of the assets received was treated as a reduction to the recorded investment in the loan and the carrying value was recorded at the remaining net balance of $2.9 million (rather than the contractual balance of $4.0 million). The difference between the remaining net balance and the contractual amount due upon maturity was amortized as an adjustment to yield (i.e., interest income) over the remaining term of the loan which matured on September 30, 2014. Subsequent to September 30, 2014, the borrower defaulted on the loan and the Company commenced enforcement action against the borrower.
As of September 30, 2014, we had eight loans outstanding with an average principal and interest balance of $3.3 million, as compared to $4.4 million for our seven loans at December 31, 2013. Of our eight outstanding loans at September 30, 2014, we had two performing loans with an average outstanding principal and interest balance of $4.2 million and a weighted average interest rate of 7.0%. Of our seven outstanding loans at December 31, 2013, we had two performing loans with an average outstanding principal and interest balance of $2.9 million and a weighted average interest rate of 12.5%. As of September 30, 2014 and December 31, 2013, the valuation allowance represented 51.1% and 59.2%, respectively, of the total outstanding loan principal and interest balances.
 Scheduled Loan Maturities

F-14
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 3 — MORTGAGE INVESTMENTS, LOAN PARTICIPATIONS AND LOAN SALES – continued

 
The outstanding principal and interest balance of mortgage investments, net of the valuation allowance, as of September 30, 2014, have scheduled maturity dates within the next several quarters as follows:
September 30, 2014
(in thousands, except percentage and unit data)
Quarter
 
Outstanding Balance
 
Percent
 
#
Matured
 
$
18,585

 
69.0
%
 
6

Q3 2015
 
7,249

 
26.9
%
 
1

Q1 2017
 
600

 
2.2
%
 
—

Q1 2020
 
514

 
1.9
%
 
1

Total Principal and Interest
 
26,948

 
100.0
%
 
8

Less: Valuation Allowance
 
(13,759
)
 
 

 
 

Net Carrying Value
 
$
13,189

 
 

 
 


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

Given the non-performing status of the majority of the loan portfolio, we do not expect the payoffs to materialize for our legacy loans, particularly for loans past their respective maturity date. We may find it necessary to foreclose, modify, extend, make protective advances or sell such loans in order to protect our collateral, maximize our return or generate additional liquidity.

Summary of Loans in Default
 
We continue to experience loan defaults due to, among other reasons, loan balances that exceed the value of the underlying collateral and the absence of takeout financing in the marketplace. A summary and roll-forward of activity of loans in default for the nine months ended September 30, 2014 is as follows (dollars in thousands):
 
 
Principal
Outstanding
 

Interest
Receivable
 
Valuation
Allowance
 

Carrying
Value
 
# of
Loans
Balances at December 31, 2013
 
$
24,636

 
$
401

 
$
(18,208
)
 
$
6,829

 
5

 
 
 
 
 
 
 
 
 
 
 
Additions:
 
 
 
 
 
 
 
 
 
 
Additional loan fundings
 
27

 
—

 
—

 
27

 
—

Mortgage loans acquired in modification
 
864

 
—

 
—

 
864

 
2

Accrued interest revenue
 
1,689

 
—

 
—

 
1,689

 
—

 
 
 
 
 
 
 
 
 
 
 
Reductions :
 
 
 
 
 
 
 
 
 
 
Principal repayments
 
(4
)
 
(37
)
 
—

 
(41
)
 
—

Assets acquired in satisfaction of loan balance
 
(4,020
)
 
—

 
—

 
(4,020
)
 
—

Loans removed from default - foreclosure
 
(4,917
)
 
(53
)
 
4,449

 
(521
)
 
(1
)
 
 
 
 
 
 
 
 
 
 
 
Balances at September 30, 2014
 
$
18,275

 
$
311

 
$
(13,759
)
 
$
4,827

 
6


Of the five loans that were in default at December 31, 2013, four remained in default status as of September 30, 2014, one was removed upon foreclosure and transferred to REO. During the nine months ended September 30, 2014, two loans assigned to us in connection with the modification described above were added to loans in default.


F-15
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 3 — MORTGAGE INVESTMENTS, LOAN PARTICIPATIONS AND LOAN SALES – continued

During the nine months ended September 30, 2014, we completed foreclosure on one loan asset and transferred the underlying collateral to REO held for sale. We are exercising enforcement action which could lead to foreclosure or other disposition with respect to the remaining loans in default. However, the completion and/or timing of foreclosure on the remaining loans is dependent on several factors, including applicable states statutes, potential bankruptcy filings by the borrowers, and our ability to negotiate a deed-in-lieu of foreclosure.
 
At September 30, 2014, all loans in default were also in non-accrual status. In addition, as of September 30, 2014 and December 31, 2013, interest receivable recorded on such loans prior to being placed in non-accrual status totaled $0.3 million and $0.4 million for each period, respectively, and is included in mortgage loans held for sale on the accompanying condensed consolidated balance sheet.
As described above, prior to its default, the Company had one loan modification during the nine months ended September 30, 2014 and amortized the difference between the net loan balance and the contractual amount due upon maturity as an adjustment to yield (i.e., interest income) over the remaining term of the loan which matured on September 30, 2014. No interest income was recognized on any other non-accrual loans on a cash or accrual basis during the periods ended September 30, 2014 or 2013. Borrower concentrations, geographic concentrations of our loan portfolio, related loan classifications and end-user categories have not materially changed since December 31, 2013.

F-16
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014



NOTE 4 — OPERATING PROPERTIES AND REAL ESTATE HELD FOR DEVELOPMENT OR SALE
 
Operating properties and REO assets consist primarily of properties acquired as a result of foreclosure or purchase and were initially recorded at the lower of cost or fair value, less estimated costs to sell the property. Our fair value assessment procedures are more fully described in note 6. At September 30, 2014, we held total operating properties and REO assets of $166.3 million, of which $7.6 million were held for development, $75.0 million were held for sale, and $83.8 million were held as operating properties. At December 31, 2013, we held total operating properties and REO assets of $202.5 million, of which $12.3 million were held for development, $86.6 million were held for sale, and $103.7 million were held as operating properties. A roll-forward of REO activity from December 31, 2013 to September 30, 2014 is as follows (dollars in thousands):
 
 
 
Operating
Properties
 
# of
Projects
 
Held for
Development
 
# of
Projects
 
Held for
Sale
 
# of
Projects
 
Total Net
Carrying Value
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balances at December 31, 2013
 
$
103,683

 
4

 
$
12,262

 
7

 
$
86,562

 
31

 
$
202,507

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Additions:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net principal carrying value of loans foreclosed
 
—

 
—

 
—

 
—

 
521

 
1

 
521

Capital costs/ additions
 
481

 
—

 
672

 
—

 
11,515

 
2

 
12,668

REO acquired in satisfaction of loan
 
—

 
—

 
—

 
—

 
3,290

 
4

 
3,290

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reductions :
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost of properties sold
 
—

 
—

 
(44
)
 


 
(45,124
)
 
(13
)
 
(45,168
)
Assets Surrendered in Trustee Sale
 
—

 
—

 
(4,838
)
 
(1
)
 
—

 
—

 
(4,838
)
Depreciation and amortization
 
(2,644
)
 
—

 
—

 
—

 
—

 
—

 
(2,644
)
Transfers, net
 
(17,737
)
 
(1
)
 
(449
)
 
(3
)
 
18,186

 
4

 
—

Balances at September 30, 2014
 
$
83,783

 
3

 
$
7,603

 
3

 
$
74,950

 
29

 
$
166,336

 
Operating properties includes depreciable building and improvements, furniture, fixtures and equipment, and tenant improvements with balances totaling $41.8 million, net of accumulated depreciation and amortization of $3.5 million. In addition, REO held for sale includes certain balances of previously depreciable building and improvements, furniture, fixtures and equipment, and tenant improvements with balances totaling $15.8 million, net of accumulated depreciation and amortization of $6.8 million, which was recorded prior to such assets being classified as held for sale.

The nature and extent of future capitalized costs for REO held for development depends on the level of development undertaken, the number of additional foreclosures and other factors. While our assets are generally available for sale, we continue to evaluate various alternatives for the ultimate disposition of these investments, including partial or complete development of the properties prior to sale or disposal of the properties on an as-is basis.

During the nine months ended September 30, 2014, we executed a series of transactions to acquire through purchase certain residential land in a master planned community that was located contiguous to other parcels previously acquired by the Company through foreclosure. The combined cost basis of the newly acquired parcels totaled $9.4 million. Shortly after the purchase of these assets, we sold the entire aggregation of the five new and previously owned parcels to a homebuilder for a net sales price of $19.0 million and realized a net gain of $5.6 million. In addition, during the nine months ended September 30, 2014, we sold twelve other REO assets (or portions thereof) for $40.4 million (net of selling costs), of which we financed $8.4 million, resulting in a net gain of $8.7 million. Also, as described in note 7, during nine months ended September 30, 2014, we surrendered certain REO assets with a carrying value of 4.8 million in satisfaction of related liabilities totaling $8.1 million, resulting in a gain on disposal of $3.3 million. In total, during the three months ended September 30, 2014, we sold or otherwise disposed of four REO assets (or portions thereof) for $11.3 million (net of selling costs) and an $8.1 million debt reduction, resulting in a total net gain of $5.6 million. During the nine months ended September 30, 2013, we sold six REO assets (or portions thereof) for $7.6 million (net of selling costs), of which we financed $1.1 million, for a net gain of $1.0 million.


F-17
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 4 — OPERATING PROPERTIES AND REAL ESTATE HELD FOR DEVELOPMENT OR SALE – continued

In addition, during the nine months ended September 30, 2014, we transferred one REO asset that was previously held for sale to REO held for development based on management’s plan to develop the property as a multi-family residential project. We also transferred certain REO assets that were previously held for development to REO held for sale based on a contract with a homebuilder to take down certain residential lots. During the nine months ended September 30, 2014, we also entered into a contract to sell a commercial office building previously accounted for as an operating property, which is now classified as REO held for sale. Aside from these reclassifications, there were no material changes with respect to REO classifications or planned development during the nine months ended September 30, 2014 other than as a result of REO asset sales.
 


F-18
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014



NOTE 5 - GUARANTEE ON SENIOR SECURED INDEBTEDNESS
In connection with the sale of our preferred equity investment in a joint venture to the holder of the other primary interests in the joint venture during the fourth quarter of 2013, the Company agreed to continue to serve as a limited guarantor on the senior indebtedness of the joint venture that is secured by the acquired operating properties and for which we are entitled to receive certain remuneration until we are released from the limited guarantee. We have agreed to remain as a limited guarantor until the earlier of 1) the borrower's identification of a suitable substitute guarantor, the approval thereof by the senior lender, and our release from the guarantee, or 2) repayment of the senior indebtedness which matures on February 28, 2017. As consideration for its limited guarantee, the Company received quarterly payments of $0.3 million on each of December 1, 2013 and March 31, 2014, and $0.5 million on June 30, 2014, and is contractually entitled to receive additional payments of $0.5 million of the last day of each subsequent quarter until the guarantee is released. We received a payment of $0.2 million during the quarter ended September 30, 2014, and an additional $0.4 million subsequent to September 30, 2014. Such payments are considered earned when received. In the event of the borrower's default, the Company’s maximum obligation under the guarantee is limited to the amount of any shortfall between the sales price of the underlying collateral assets and the net payoff of the senior loan, if any. The Company's obligation under this guarantee is further limited to the extent, and only in the event that the borrower commits certain "bad acts" as defined in the guarantee, including, but not limited to, filing for bankruptcy, fraud, misrepresentation or theft. In the event of default by the borrower or occurrence of one or more of these bad acts, the Company has multiple remedies, including foreclosing on the membership interests in the entities that own the operating assets that serve as collateral under the senior indebtedness. During the three months ended September 30, 2014, the borrower performed certain acts which allegedly gave rise to a non-financial default under the senior loan agreement, as well as violations under our agreement with the borrower. While the senior lender has issued a notice of default to the borrower regarding the alleged default, the senior lender has not made a claim against us under our guarantee. We have commenced enforcement action against the borrower which could ultimately result in foreclosing the membership interests in the entities that own the operating assets. While the borrower is taking certain actions to address these violations, we are continuing to monitor this situation in order to protect our position. The principal balance of the senior indebtedness as of September 30, 2014 was approximately $90.1 million. Management believes the estimated fair value of the underlying collateral, which consists of 11 operating multifamily properties with an average occupancy of approximately 77.8% (unaudited), exceeds this principal balance. The net operating cash flows of these properties have, to date, been sufficient to cover debt service payments required under the loan which are collected through a lockbox. As a result, we have not recorded any liability related to our limited guarantee because we believe there is a remote likelihood of any liability to us given these factors; however, in the event of a claim against our limited guarantee, there could be a material adverse impact on the Company.

NOTE 6 — FAIR VALUE
 
Valuation Allowance and Fair Value Measurement of Loans and Real Estate Held for Sale

Our valuation analysis processes and procedures are disclosed in our previously filed Annual Report on Form 10-K for the fiscal year ended December 31, 2013.  We perform a valuation analysis of our loans, REO held for sale and derivative investments not less frequently than on a quarterly basis. We consider all relevant circumstances to determine if, and the extent to which, a valuation allowance is required.

Impairment for our collateral dependent loans is measured at the balance sheet date based on the then fair value of the collateral in relation to contractual amounts due under the terms of the applicable loan if foreclosure is probable. Substantially all of our loans are deemed to be collateral dependent.
  
Similarly, REO assets that are classified as held for sale are measured at the lower of carrying amount or fair value, less estimated cost to sell. REO assets that are classified as operating properties or held for development are considered “held and used” and are evaluated for impairment when circumstances indicate that the carrying amount exceeds the sum of the undiscounted net cash flows expected to result from the development and eventual disposition of the asset. If an asset is considered impaired, an impairment loss is recognized equal to the difference between the asset’s carrying amount and its fair value, less estimated cost to sell. If we elect to change the disposition strategy for our real estate held for development, and such assets were deemed to be held for sale, we may record additional impairment charges, and the amounts could be significant. See our consolidated audited financial statements in our previously filed Annual Report on Form 10-K for the year ended December 31, 2013 for a detailed description of the procedures performed and assumptions utilized in connection with our impairment analysis of real estate owned assets as of and for the year ended December 31, 2013.

F-19
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 6 — FAIR VALUE – continued

 
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 or executed purchase and sales agreements on specific properties.
 
For projects in which we have received a bona fide written third-party offer (or have executed a purchase and sale agreement) to buy our real estate or loan, or we or the borrower has received a bona fide written third-party offer (or has executed a purchase and sale agreement) to buy the related project, we generally utilize the offer or agreement amount in cases in which such amount may fall outside our current valuation range. Such offers or agreements are only considered if we deem it to be valid, reasonable, negotiable, and we believe the counterparty has the financial wherewithal to execute the transaction. When deemed appropriate, the offers received are discounted to allow for potential changes in our on-going negotiations.
 
Factors Affecting Valuation
 
The underlying collateral of our loans and our REO varies 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. Historically, for purposes of determining whether a valuation allowance was required, we primarily utilized a modeling technique utilizing the development approach, known as residual analysis commonly used in the lending industry, which is based on the assumption that development of our collateral was the highest and best use of the property.
 
We engage outside independent third-party valuation firms on a periodic, as-needed basis to provide complete valuation reports for certain of our larger loans and REO assets. In recent periods, we noted indications that a stabilizing trend in real estate market values began to unfold and, in certain circumstances, improved in certain markets. As a result, we have recently reduced the extent to which we utilize outside independent third-party valuation firms to assist with our analysis of fair value of the collateral supporting our loans and REO. As such, we currently rely largely on our internal asset management staff and certain other third party consultants to gather available market participant data from independent sources to update assumptions used to derive fair value of the collateral supporting our loans and REO assets not subject to third party valuation.

Our fair value measurement is based on the highest and best use of each property which is generally consistent with our current use for each property subject to valuation. In addition, our assumptions are established based on assumptions that we believe market participants for those assets would also use. During the period ended September 30, 2014, we performed both a macro analysis of market trends and economic estimates, as well as a detailed analysis on selected significant loan and REO assets.

The following is a summary of the procedures performed in connection with our fair value analysis as of and for the period ended September 30, 2014:

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.
We reviewed the status of each of our REO assets to determine whether such assets continue to be properly classified as held for sale, held for development or as operating properties as of the reporting date.

3.
For the period ended September 30, 2014, given the lack of significant change in overall general market conditions since December 31, 2013, we performed an internal analysis to evaluate fair value of our portfolio. Our internal analysis of fair value included a review and update of current market participant activity, overall market conditions, the current status of the project, our direct knowledge of local market activity affecting the project, as well as other market indicators obtained through our asset management group and various third parties to determine whether there were any indications of a material increase or decrease in the value of the underlying collateral or REO asset since the last complete third party valuation for such asset. Our asset-specific analysis focused on the higher valued assets of our loan collateral and REO portfolio. We considered the results of our analysis and the potential valuation implication to the balance of the portfolio based on similar asset types and geographic location.


F-20
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 6 — FAIR VALUE – continued

4.
In certain instances, we engaged outside independent third party valuation firms to provide updated valuation reports for REO assets, primarily those recently obtained in foreclosure or by deed-in-lieu of foreclosure.

5.
In addition, in those instances where we have received a bona fide written third-party offer to buy our loans or REO assets (or have executed a purchase and sale agreement), or the borrower has received a bona fide written third-party offer to buy the related project (or has executed a purchase and sale agreement), we generally utilized the purchase price in such offer or agreement when that amount was outside our current valuation range. Such offers or agreements are only considered if we deem it to be valid, reasonable and negotiable, and we believe the counterparty has the financial wherewithal to execute the transaction.

Based on our analysis, the valuation approach taken and assumptions utilized with respect to each asset at December 31, 2013 remained generally applicable at September 30, 2014, except for those assets subject to a recent bona fide written third-party offer or executed purchase and sales agreements to buy our loan or REO asset. See our previously filed Annual Report on Form 10-K for the fiscal year ended December 31, 2013 for a summary of the key assumptions and valuation methodologies utilized to derive fair value.

Selection of Single Best Estimate of Value
 
As previously described, we have historically obtained periodic valuation reports from third-party valuation specialists, consultants and/or from our internal asset management department for the underlying collateral of our loans and REO held for sale. The results of our valuation efforts generally provide 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 general overall market conditions as well as specific market conditions for each property valued and its stage of entitlement or development. In addition to third-party valuation reports, we utilize recently received bona fide purchase offers from independent third-party market participants or executed purchase and sale agreements that may be outside of the range of values indicated by the report from the third-party valuation specialist. In selecting the single best estimate of value, we consider the information in the valuation reports, credible purchase offers received and agreements executed, as well as multiple observable and unobservable inputs.

Valuation Conclusions

Based on the results of our evaluation and analysis, during the three and nine months ended September 30, 2014, we recorded no non-cash provision for credit losses on our loan portfolio. We recorded other net recoveries of credit losses of $0.5 million and $0.7 million during the three and nine months ended September 30, 2014, respectively, relating to the collection of cash and other assets from guarantors on certain legacy loans. We recorded no impairment of real estate owned during the three and nine months ended September 30, 2014.

We recorded no provision for credit losses on our loan portfolio during the three months ended September 30, 2013 and we recorded non-cash recoveries of credit losses on our loan portfolio in the amount of $7.0 million during the nine months ended September 30, 2013 arising from our hotel operations and residential lots acquired through foreclosure in the second quarter of 2013. During the three and nine months ended September 30, 2013, we also recorded net cash and asset recoveries of $0.7 million and $1.5 million, respectively, arising from the collection of cash and other assets from guarantors on certain legacy loans. We recorded no impairment of real estate owned during the three or nine months ended September 30, 2013.

As of September 30, 2014 and December 31, 2013, the valuation allowance totaled $13.8 million and $18.2 million, respectively, representing 51.1% and 59.2%, respectively, of the total outstanding loan principal and accrued interest balances. Based on the valuation and impairment allowance recorded as of September 30, 2014, we believe that, as of that date, the fair value of our loans and REO assets held for sale is adequate in relation to the net carrying value of the related assets and that no additional valuation allowance or impairment is considered necessary. While the above results reflect management’s assessment of fair value as of September 30, 2014 based on currently available data, we will continue to evaluate our loan and REO portfolio to determine the adequacy and appropriateness of the valuation allowance and/or impairment balances. Depending on market conditions, such updates may yield materially different values and potentially increase or decrease the valuation allowance for loans or impairment charges for REO assets.
 

F-21
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 6 — FAIR VALUE – continued

Valuation Categories
 
There were no losses recorded during the three or nine months ended September 30, 2014 or 2013 in the categories for which net mortgage loans and REO held for sale were measured at fair value on a non-recurring basis based upon the lowest level of significant input to the valuation as of September 30, 2014 or 2013.

Additionally, there were no other assets that were measured at fair value using Level 1 or Level 2 inputs for which any losses were recorded during the three or nine months ended September 30, 2014 or 2013. Generally, all of our mortgage loans and REO held for sale are valued using significant unobservable inputs (Level 3) obtained through updated analysis prepared by our asset management staff, except for such assets for which third party offers or executed purchase and sale agreements were used, which are considered Level 2 inputs. Changes in the use of Level 3 valuations are based solely on whether we utilized third party offers for valuation purposes.

Fair Value Measurement of Equity Securities
 
As described elsewhere in this Form 10-Q, during the three and nine months ended September 30, 2014, we issued certain redeemable preferred convertible stock, repurchased certain common stock and issued certain common stock warrants in connection with the restructure of the NW Capital convertible debt and other transactions described elsewhere in this Form 10-Q. In order to estimate the fair value of the securities subject to these transactions pursuant to applicable accounting standards, we utilized the transaction price as negotiated with unrelated third-parties, along with other information provided by an independent third-party valuation firm incorporating financial and other information, including prospective financial information, provided by us, as well as information obtained from various public, financial, and industry sources. Based on this analysis, management estimated the fair value of the equity securities issued or granted in connection with transaction completed July 24, 2014 as follows:
Subject Securities
 
Estimated Fair Value per Share
Preferred Stock
 
3.22
Common Stock
 
1.72
ITH Warrants
 
1.19
Juniper Warrants
 
1.14
Options to former CEO
 
1.19

Stock-based compensation expense for stock-based awards granted is based on the grant date fair value. For stock option and warrant awards, the fair value was estimated at the date of grant using the Black-Scholes option-pricing model based on the exercise price of the award and other assumptions relating to expected dividend yield, expected stock price volatility, risk-free interest rate, and expected life of options granted which are as follows:

Expected stock price volatility
 
79%
Risk-free interest rate
 
2%
Expected life of options/warrants
 
5 years
Expected dividend yield
 
—%
Discount for lack of marketability
 
35%



F-22
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014



NOTE 7 — DEBT, NOTES PAYABLE AND SPECIAL ASSESSMENT OBLIGATIONS

A roll-forward of notes payable and related obligations from December 31, 2013 to September 30, 2014 is as follows (in thousands):
 
 
Convertible
 
 
 
 Special
 
 
 
 
Notes Payable
 
Notes
 
Assessment
 
 
 
 
and Exit Fee
 
Payable
 
Obligations
 
Totals
 
 
 
 
 
 
 
 
 
Balances at December 31, 2013
 
$
65,423

 
$
46,043

 
$
5,339

 
$
116,805

 
 
 
 
 
 
 
 
 
Additions:
 
 
 
 
 
 
 
 
Removal/reclassification of convertible debt
 
(45,000
)
 
45,000

 
—

 
—

Rights Offering
 
97

 
—

 
—

 
97

Exchange Offering
 
—

 
6,389

 
—

 
6,389

Note additions
 
—

 
7,875

 
—

 
7,875

Deferred Interest
 
1,735

 
188

 
—

 
1,923

Accretion of discount
 
1,194

 
231

 
—

 
1,425

Other Additions
 
—

 
688

 
—

 
688

Reductions:
 
 
 
 
 
 
 
—

Conversion of Debt to Preferred
 
(7,800
)
 
 
 
 
 
(7,800
)
Repayments
 
(15,552
)
 
(18,719
)
 
(282
)
 
(34,553
)
Rights Offering redemption
 
(97
)
 
—

 
—

 
(97
)
Debt Relieved through Trustee Sale
 
 
 
(5,220
)
 
 
 
(5,220
)
Other Reductions
 
—

 
(1,289
)
 
—

 
(1,289
)
 
 
 
 
 
 
 
 
 
Balances at September 30, 2014
 
$
—


$
81,186


$
5,057


$
86,243


Interest expense for the three months ended September 30, 2014 and 2013 was $3.5 million and $5.2 million, respectively. Interest expense for the nine months ended September 30, 2014 and 2013 was $13.0 million and $13.9 million, respectively.

Convertible Notes Payable/Exit Fee Payable

As more fully described in our Form 10-K for the year ended December 31, 2013, on June 7, 2011, we entered into and closed funding of a $50.0 million senior secured convertible loan with NW Capital. The loan was originally scheduled to mature on June 6, 2016 and bore contractual interest at a rate of 17% per year. As described below, this loan has been restructured.

The lender, at its sole option, may and did make an annual election to defer a portion of interest due representing 5% of the total accrued interest amount, with the balance of 12% payable in cash. Interest was payable quarterly in arrears each April, July, October and January during the term of the loan. The lender made its election to defer the 5% portion for the years ending December 31, 2014 and 2013. Deferred interest was capitalized and added to the outstanding loan balance on a quarterly basis. Prior to the restructuring of the NW Capital debt as described below, total deferred interest added to the principal balance of the convertible note totaled $12.1 million, of which $1.7 million was added during the nine months ended September 30, 2014.

In addition, we were required to pay an exit fee (“Exit Fee”) upon maturity equal to 15% of the then outstanding principal, unpaid accrued and deferred interest and other amounts owed under the loan agreement. The Exit Fee was considered fully earned under the terms of the loan agreement and was recorded as a liability with an offsetting amount reflected as a discount to the convertible note payable. The Exit Fee and corresponding discount of $10.4 million was estimated assuming the lender elected its annual interest deferral option over the term of the loan. This amount was being amortized to interest expense over the term of the loan using the effective interest method. Prior to the restructuring of the NW Capital debt as described below, the remaining unamortized discount totaled $4.2 million. The amortized discount added to the principal balance of the convertible note during the nine months ended September 30, 2014 and 2013 totaled $1.2 million and $1.5 million, respectively.

F-23
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 7 — DEBT, NOTES PAYABLE AND SPECIAL ASSESSMENT OBLIGATIONS – continued


Debt issuance costs incurred in connection with the NW Capital loan financing were being amortized over the term of the loan using the effective interest method. In connection with the restructure of the NW Capital debt described below, $2.9 million of unamortized debt issuance costs were written off and charged as a component of the debt termination charge. With the contractual interest, and the amortization of the Exit Fee and related deferred financing costs, the effective interest rate under the NW Capital loan was approximately 23%. The loan is severally, but not jointly, guaranteed by substantially all of our existing and future subsidiaries, subject to certain exceptions and releases, and is secured by a security interest in substantially all of our assets. Under the terms of the original loan agreement, the loan could not be prepaid prior to December 7, 2014 and was otherwise subject to substantial prepayment fees and premiums. In the event of any prepayment, we were also required to redeem all of the common shares held by an affiliate of NW Capital at a purchase price equal to the greater of (a) the original purchase price of $8.02 per share and (b) the original purchase price plus 50% of the excess book value over the original purchase price, if any.
 
The loan agreement also contains certain restrictive covenants which require NW Capital’s consent as a condition to our taking certain actions. The restrictive covenants relate to our ability to sell or encumber our assets, issue additional indebtedness, restructure or modify our ownership structure, settle litigation over $10.5 million, enter into new material agreements and certain other operational matters.

Conversion Feature
 
As more fully described in our annual report on Form 10-K for the year ended December 31, 2013, the NW Capital loan was convertible into IMH Financial Corporation Series A preferred stock at any time prior to maturity at an initial conversion rate of 104.3 shares of our Series A preferred stock per $1,000 principal amount of the loan, subject to adjustment. Dividends on the Series A preferred stock were to accrue from the issue date at the rate of 17% of the issue price per year, compounded quarterly in arrears, a portion of which may have, at the election of NW Capital, been payable in additional shares of stock.

If the NW Capital loan was converted into shares of Series A preferred stock, we would have been obligated to redeem all such preferred stock on the fifth anniversary of the loan date (i.e., June 6, 2016) in cash, at a price equal to 115% of the original purchase price, plus all accrued and unpaid dividends (whether or not earned or declared), if any, to and including the date fixed for redemption, without interest. In addition, the Series A preferred stock has certain redemption features in the event of default or the occurrence of certain other events.

NW Capital Loan Restructure
As described in the Current Report on Form 8-K filed on July 29, 2014, on July 24, 2014, the Company entered into a series of agreements and transactions in connection with the partial refinancing and restructuring of the NW Capital loan pursuant to a payoff agreement, as amended (“Payoff Agreement”), the principal terms of which have been described in the Current Report on Form 8-K filed on April 9, 2014. The following summarizes the primary terms of the Payoff Agreement and is qualified in its entirety by reference to the above-referenced Current Reports:
Pursuant to the Payoff Agreement, the Company and NW Capital entered into certain amendments to the NW Capital loan (collectively, the "Modified Loan") the principal terms of which are as follows: (1) the new maturity date is July 22, 2015 (the "Maturity Date"); (2) the conversion rights that had been held by NW Capital to convert the debt into our Series A preferred stock were eliminated; (3) the new principal balance is $45.0 million; (4) interest accrues at 17% per annum, payable by the Company on a quarterly basis; and (5) on October 24, 2014, and no later than every 90 days thereafter until the Maturity Date, the Company is required to make payments equal to the sum of: (x) $5.0 million (which payment will be applied toward the then-outstanding principal and interest due on the Modified Loan); and (y) a fee of one percent (1)% of the then-outstanding principal balance of the Modified Loan. As a result of the material change in loan terms, the NW Capital loan was treated as a termination of the existing loan and issuance of a new loan. Under the Payoff Agreement, a total payment of $81.4 million was made to NW Capital consisting of the $45.0 million Modified Loan, $18.6 million from the issuance of preferred shares and approximately $10.0 million in cash. The Company incurred additional debt termination charges from other costs associated with the transaction, including the issuance of various equity instruments as described in note 9 related directly to the Modified Loan. As a result of the NW Capital debt restructuring, the Company recorded a debt termination charge of $21.7 million during the three and nine months ended September 30, 2014.

F-24
IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 7 — DEBT, NOTES PAYABLE AND SPECIAL ASSESSMENT OBLIGATIONS – continued

As described in note 11, subsequent to September 30, 2014, the Company entered into an amendment of the Modified Loan to extend the payment date of the initial $5.0 million principal payment from October 24, 2014 to December 24, 2014.
Rights Offering Convertible Notes

As more fully described in our annual report on Form 10-K for the year ended December 31, 2013, we were required under the terms of a class action settlement to effect an offering to issue up to $10.0 million in senior secured convertible notes to participating accredited shareholders at terms economically equivalent to the NW Capital loan ("Rights Offering"). The Rights Offering was completed on April 28, 2014 and we ultimately issued notes in the aggregate principal amount of $70,000 to participating shareholders. The notes issued under the Rights Offering ("RO Notes") were recorded by the Company at their fair value. Based on the fair value assessment performed, management determined that the estimated fair value of the RO Notes was $97,000 (as compared to the face amount of $70,000) based on the derived fair value and the imputed effective yield of such notes of 7.1% (as compared to the note rate of 17% plus the derived exit fee of $12,000 resulting in an effective rate of approximately 22.3%) as of the offering settlement date. The difference between the fair value of the RO Notes and its actual face amount totaling $26,000 was recorded as a debt premium by the Company. This debt premium and exit fee was being amortized and recorded as a reduction of interest expense using the effective interest method over the term of the RO Notes. During the three months ended September 30, 2014, the Company repurchased and retired all of the outstanding RO Notes.

Exchange Notes

As more fully described in our annual report on Form 10-K for the year ended December 31, 2013, we were required under the terms of the same class action settlement to effect an offering to issue up to $20.0 million in five-year, 4%, unsecured notes to participating shareholders in exchange for common stock held by such shareholders at a price of $8.02 per share ("Exchange Offering"). The Exchange Offering was completed on April 28, 2014 and we ultimately issued Exchange Offering notes ("EO Notes") to participating shareholders with a face value of $10.2 million, which were recorded by the Company at fair value. The estimated fair value of the EO Notes was $6.4 million based on the fair value and the imputed effective yield of such notes of 14.6% (as compared to the note rate of 4%) resulting in a debt discount of the EO Notes of $3.8 million. This amount was recorded as a debt discount on the Company’s financial statements during the nine months ended September 30, 2014, and is being amortized as an adjustment to interest expense using the effective interest method over the term of the EO Notes. The amortized discount added to the principal balance of the EO Notes during the nine months ended September 30, 2014 totaled $0.2. Interest is payable quarterly in arrears each April, July, October, and January during the term of the EO Notes with the initial interest payment due in July 2014. The EO Notes mature on April 28, 2019, and may be prepaid in whole or in part without penalty at the option of the Company. However, subject to certain minimum cash and profitability conditions, the terms of the EO Notes may require a 50% prepayment on April 29, 2018.

Other Notes Payable Activity

As described in note 4, during the nine months ended September 30, 2014, we purchased certain residential land in a master planned community. This property, which was subsequently sold, had an aggregate cost basis of $9.4 million. In connection with the purchase of these properties, we assumed certain notes payable the terms and current disposition of which are as follows:
•
$1.45 million note bearing annual interest at 5%, secured by the underlying collateral property. This note was repaid in full upon sale of the related property.
•
$3.25 million note bearing annual interest at 10%, secured by the underlying collateral property. This note was repaid in full upon sale of the related property.
•
$3.18 million note bearing annual interest at 3%, interest only payable monthly, unsecured, maturing June 5, 2023. This note remained as an outstanding obligation of the Company as of September 30, 2014. As described in note 10, a majority of the note balance is payable to certain entities affiliated with a loan guarantor against whom the Company has obtained a judgment. As a result, the Company has sought court approval to offset this liability against the outstanding judgment, which approval was granted by the court subsequent to September 30, 2014.

During 2013, we assumed a note payable from a bank in connection with a deed-in-lieu of foreclosure that is secured by the related hotel operating properties with a gross asset basis of approximately $81.8 million at September 30, 2014. The note payable had a balance of $24.8 million at September 30, 2014. During the nine months ended September 30, 2014, we negotiated with the lender to extend the original maturity date of the loan from March 28, 2014 to March 28, 2017 and to reduce the loan's annual

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IMH FINANCIAL CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2014


NOTE 7 — DEBT, NOTES PAYABLE AND SPECIAL ASSESSMENT OBLIGATIONS – continued

interest rate of from 12% to 8.0%, with interest only payments due during the first year of the loan, and monthly payments of principal and interest of approximately $0.2 million thereafter until maturity.

During 2013, we secured financing of $10.0 million from CanPartners that was secured by certain REO assets. Prior to its maturity in February 2014, the note payable bore annual interest of 12%, with required monthly payments of interest and the outstanding principal due at maturity. The note matured in February 2014 at which time the balance was repaid in full.

During 2013, we acquired residential property with a fair value of approximately $3.8 million in connection with a judgment we obtained against a former guarantor on certain legacy loans. The residential property was subject to four liens which had sole recourse to the residential property. Such liens aggregated $17.4 million in principal, exclusive of unpaid interest at December 31, 2013. We recorded these liens (one of which was a bank lien for $2.4 million) at their fair value at acquisition, which was determined to approximate the fair value of the related asset which totaled $3.8 million. During the nine months ended September 30, 2014, we purchased two of the liens totaling $15 million from the counterparty for $1.3 million, which approximated the carrying value of such liens. The residential property was sold in June 2014 for a gain of $0.7 million, at which time the bank lien associated with the property was repaid.

In connection with our proposed multifamily housing development in Apple Valley, Minnesota (the "Apple Valley Project"), we entered into, among other agreements, a business subsidy agreement and related loan agreement dated March 29, 2013, as amended on July 10, 2014, with the Apple Valley Economic Development Authority ("EDA"). Under the terms of the business subsidy agreement, the EDA agreed to advance to us up to $1.1 million as a loan, but in no event to exceed the amount received from Dakota County for the statutory penalty and interest on special assessment taxes which were assessed in the tax years 2007 through 2011, and for which we have recorded a liability. The loan bears interest at the rate of 6.0% per annum which accrues until the loan is satisfied or paid in full. If we complete the development project by no later than December 31, 2015, and certain other conditions are satisfied, the EDA is expected to forgive the loan and accrued interest in its entirety. If we do not meet certain specified development goals, the loan and all accrued unpaid interest must be repaid on or before December 31, 2016. In addition, under the EDA loan agreement, we are not allowed to sell, transfer or otherwise convey all or part of the property for a period of five years following completion without the prior written consent of EDA. As of September 30, 2014, the total amount advanced to us under the loan agreement was $0.2 million. Under the terms of the business subsidy agreement, we are required to commence construction by November 2014. As described in note 11, subsequent to September 30, 2014, we secured construction financing in connection with this project and commenced construction activities.

In conjunction with the Apple Valley Project, we also entered into a settlement agreement in June 2012 with the local municipality relating to outstanding past due property taxes, penalties and interest on various parcels totaling $3.7 million and bearing annual interest of 10%. Under the terms of the settlement agreement, we are required to make annual payments over either a five or ten year period, depending on the parcel. The outstanding balance of the settlement obligation totaled $1.2 million and $2.3 million at September 30, 2014 and December 31, 2013, respectively. Subsequent to September 30, 2014, we made an additional principal payment under this settlement agreement of $0.6 million in connection with the construction loan described in note 11.

Under the terms of a settlement agreement in 2010, we executed two promissory notes for certain golf club memberships totaling $5.2 million. The notes were secured by the security interest on the related residential lots, were non-interest bearing and matured on December 31, 2012. Due to the non-interest bearing nature of the loans, in accordance with applicable accounting guidance, we imputed interest on the notes at our then-incremental borrowing rate of 12% per annum and recorded the notes net of the discount. The discount was amortized to interest expense over the term of the notes and was fully amortized as of December 31, 2012. During 2012, we defaulted for strategic reasons on the terms of an agreement related to the loan, which resulted in an acceleration of the maturity date of such debt. During the period ended September 30, 2014, we made no principal payments under the notes and continued to accrue interest at the default rate of 10% per annum. The lender filed a notice of delinquency and a notice of trustee sale was scheduled for June 12, 2012. The subsidiary that owned these assets was placed into bankruptcy which stayed the trustee sale. During 2013, the bankruptcy court rejected our proposed plan of reorganization and lifted the stay on the trustee sale, which we appealed. During the per