0001104659-13-046596.txt : 20130604 0001104659-13-046596.hdr.sgml : 20130604 20130604081025 ACCESSION NUMBER: 0001104659-13-046596 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20130604 ITEM INFORMATION: Other Events ITEM INFORMATION: Financial Statements and Exhibits FILED AS OF DATE: 20130604 DATE AS OF CHANGE: 20130604 FILER: COMPANY DATA: COMPANY CONFORMED NAME: Ares Commercial Real Estate Corp CENTRAL INDEX KEY: 0001529377 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 453148087 STATE OF INCORPORATION: MD FILING VALUES: FORM TYPE: 8-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-35517 FILM NUMBER: 13889749 BUSINESS ADDRESS: STREET 1: TWO NORTH LASALLE STREET, STE 925 CITY: CHICAGO STATE: IL ZIP: 60602 BUSINESS PHONE: 312.324.5900 MAIL ADDRESS: STREET 1: TWO NORTH LASALLE STREET, STE 925 CITY: CHICAGO STATE: IL ZIP: 60602 8-K 1 a13-13231_18k.htm 8-K

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 8-K

CURRENT REPORT

Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934

Date of report (Date of earliest event reported): June 4, 2013

ARES COMMERCIAL REAL ESTATE CORPORATION

(Exact Name of Registrant as Specified in Charter)

Maryland		001-35517		45-3148087
(State or Other Jurisdiction of Incorporation)		(Commission File Number)		(IRS Employer Identification No.)

Two North LaSalle Street, Suite 925, Chicago, IL		60602
(Address of Principal Executive Offices)		(Zip Code)

Registrant’s telephone number, including area code (312) 324-5900

N/A

(Former Name or Former Address, if Changed Since Last Report)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2. below):

o Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)

o Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)

o Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))

o Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

Item 8.01. Other Events.

Purchase and Sale Agreement

On May 14, 2013, Ares Commercial Real Estate Corporation, a Maryland corporation (the “Company”), entered into a Purchase and Sale Agreement (the “Agreement”) with Alliant, Inc., a Florida corporation, and The Alliant Company, LLC, a Florida limited liability company (each a “Seller” and, collectively, the “Sellers”). The Agreement provides that, upon the terms and conditions set forth therein, at the closing of the transaction, the Company will purchase from Sellers all of the outstanding common units of EF&A Funding, L.L.C., d/b/a Alliant Capital LLC, a Michigan limited liability company (“Alliant Capital”). The Agreement provides that the Company will pay $52.9 million in cash, subject to certain adjustments, and issue 588,235 shares of its common stock in a private placement exempt from registration under Section 4(2) of the Securities Act of 1933, as consideration for the acquisition.

Alliant Capital is a nationwide originator and servicer of multifamily residential mortgage loans, utilizing the platform of certain U.S. Government-sponsored entities, including the Federal National Mortgage Association (“Fannie Mae”), the Federal Housing Administration (“FHA”), the Government National Mortgage Association (“Ginnie Mae”) and the United States Department of Housing and Urban Development (“HUD”). Alliant Capital has developed a significant origination, asset management and servicing platform, primarily through Fannie Mae’s Delegated Underwriting and Servicing (“DUS”) program. As of March 31, 2013, Alliant Capital had a servicing portfolio of approximately $3.9 billion in multifamily loans. As of March 31, 2013, Alliant Capital’s mortgage servicing rights (“MSRs”) had a fair value of approximately $61.9 million. Recently, Alliant Capital was approved to originate loans insured by FHA and to securitize those loans through Ginnie Mae, subject to putting in place certain operational requirements.

Summary of Strategic Benefits

The Company expects the acquisition of Alliant Capital’s business segments to benefit it in the following ways:

· Accelerated Scaling of the Company and Increased Market Presence: The Company believes Alliant Capital’s national direct origination platform focused on Fannie Mae and FHA/Ginnie Mae multifamily loans (“Agency Loans”) will provide further scale to the Company’s platform and enhance its direct origination capabilities. The Company believes its market capabilities will expand considerably with the addition of the mortgage professionals it will acquire in the transaction.

· Broadened Product Offerings to Unlock Revenue Opportunities: Currently, the Company provides transitional “bridge loans” to multifamily owners and operators that ultimately seek permanent financing through Agency Loans. The Company believes that Alliant Capital’s focus on long-term multifamily Agency Loans will expand the Company’s product offerings and extend relationships with borrowers. The Company expects to be able to provide a complete turnkey financial solution for multifamily owners and operators seeking short- and long-term financing options. The Company also

believes that Alliant Capital’s recent approvals to provide FHA and Ginnie Mae loans will provide opportunities for incremental revenue growth.

· Diversified Revenues and Predictable Servicing Cash Flows: The Company believes that the addition of Alliant Capital’s approximately $3.9 billion multifamily loan servicing portfolio, as of March 31, 2013, consisting of approximately 1,000 multifamily loans will diversify the Company’s revenue stream by adding servicing income and extending the duration of the Company’s revenue-generating investment portfolio. The Company expects the combination of its direct lending model with the fee-based origination and servicing revenues of Alliant Capital to result in improved balance sheet and cost efficiencies. The Company also believes that the self-funding nature of Alliant Capital’s business provides a more stable growth platform that minimizes capital markets volatility risk.

· Favorable Competitive Landscape: There are a limited number of approved Fannie Mae DUS lenders and the strict multifamily approval standards for other U.S. Government-sponsored entities has limited the number of direct competitors. The Company therefore believes that the long-term competitive landscape remains favorable, particularly for GSE-approved providers, which collectively account for approximately 60% of the multifamily market.

Multifamily Finance

Alliant Capital operates a mortgage banking business focused on multifamily lending. Alliant Capital primarily originates, sells and services small, middle-market loans, operating as a licensed DUS provider to Fannie Mae. Alliant Capital recently received FHA, Ginnie Mae, HUD Multifamily Accelerated Processing (“MAP”) and HUD Section 232 LEAN (“LEAN”) approvals as well.

DUS Program Finance

Alliant Capital is one of 24 approved lenders that participate in Fannie Mae’s DUS program for multifamily, manufactured housing communities, student housing and certain healthcare properties. Under the Fannie Mae DUS program, Alliant Capital is responsible for ensuring that the loans it originates under the Fannie Mae DUS program satisfy the underwriting and other eligibility requirements established from time to time by Fannie Mae. As an approved Fannie Mae DUS program lender, Alliant Capital shares risk with Fannie Mae for a portion of the losses that may result from a borrower’s default. Most of the Fannie Mae loans that Alliant Capital originates are sold in the form of a Fannie Mae-insured security to third-party investors. Alliant Capital is also contracted by Fannie Mae to service all loans originated by Alliant Capital under the Fannie Mae DUS program.

FHA Finance

As an approved MAP and LEAN lender and Ginnie Mae issuer, Alliant Capital is licensed to provide construction and permanent loans to developers and owners of multifamily housing, senior housing and healthcare facilities. Alliant Capital must submit its completed loan underwriting package to HUD and obtain HUD’s approval to originate the loan.

FHA-insured loans are typically placed in single loan pools that back Ginnie Mae securities. Ginnie Mae securities are backed by the full faith and credit of the United States, and Alliant Capital generally does not bear any risk of loss on Ginnie Mae securities. In the event of a default on an FHA-insured loan, FHA generally will reimburse approximately 99% of any losses of principal and interest on the loan and Ginnie Mae will reimburse the remaining losses of principal and interest. Alliant Capital is obligated to continue to advance principal and interest payments and tax and insurance escrow amounts on Ginnie Mae securities until the FHA mortgage insurance claim has been paid and the Ginnie Mae security is fully paid.

Risks Relating to Alliant Capital’s Business and

the Company’s Pending Acquisition of Alliant Capital

You should carefully consider these risk factors, together with all of the other information included in our periodic filings with the Securities and Exchange Commission (the “SEC”), including our annual report on Form 10-K (including the risks described in the section entitled “Item 1A — Risk Factors,” and our consolidated financial statements and the related notes thereto) before you decide whether to make an investment in our securities. The risks described in our periodic filings are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition and/or operating results. If any of the following events occur, our business, financial condition and results of operations could be materially adversely affected. In such case, the value of our common stock and the trading price of our securities could decline, and you may lose all or part of your investment. Unless otherwise indicated or the context requires otherwise, references in these risk factors to “we,” “us” and “our” mean the Company and its consolidated subsidiaries.

The loss of or changes with Alliant Capital’s relationships with Fannie Mae, HUD and institutional investors would adversely affect its ability to originate commercial real estate loans through Fannie Mae and HUD programs, which would materially adversely affect us.

Currently, Alliant Capital originates and services its loans for sale through Fannie Mae or HUD programs. Alliant Capital is approved as a Fannie Mae DUS lender, Ginnie Mae issuer (subject to putting in place certain operational requirements) and FHA (including MAP and LEAN) lender nationwide. Alliant Capital’s status as an approved lender and issuer under these programs affords Alliant Capital a number of advantages and may be terminated by the applicable agency at any time. The loss of such status would, or changes in Alliant Capital’s relationships could, prevent Alliant Capital from being able to originate and service commercial real estate loans for sale through Fannie Mae or HUD, which would materially adversely affect us. It could also result in Alliant Capital’s loss of similar approvals from other agencies.

We may not realize all of the anticipated benefits of the Alliant Capital acquisition or such benefits may take longer to realize than expected.

The success of the Alliant Capital acquisition will depend, in part, on our ability to realize the anticipated benefits from successfully integrating Alliant Capital’s business with ours. The combination of two independent companies is a complex, costly and time-consuming process. As a result, we will be required to devote significant management attention and resources to integrating the business practices and operations of Alliant Capital. The integration process may disrupt our business and, if implemented ineffectively, could preclude us from realizing all of the potential benefits we expect to realize with respect to the acquisition. Our failure to meet the challenges involved in successfully integrating our operations and Alliant Capital’s operations or to fully realize the anticipated benefits of the transaction could cause an interruption of, or a loss of momentum in, our business and could seriously harm our results of operations. In addition, the overall

integration of the two companies may result in material unanticipated problems, expenses, liabilities, competitive responses, loss of business relationships and diversion of management’s attention, and may cause our stock price to decline. The difficulties of integrating Alliant Capital’s business with our operations include, among others:

· managing a significantly larger company, including an internally managed subsidiary with approximately 90 employees;

· managing a business subject to significant regulations previously inapplicable to us;

· the fact that we and our Manager have limited experience operating a TRS;

· the potential diversion of management focus and resources from other strategic opportunities and from operational matters and potential disruption associated with the acquisition;

· maintaining Alliant Capital employee morale and retaining key Alliant Capital management and other Alliant Capital employees;

· integrating two unique business cultures;

· the possibility of faulty assumptions underlying expectations regarding the integration process;

· consolidating corporate and administrative infrastructures and eliminating duplicative operations;

· coordinating geographically separate organizations;

· unanticipated issues in integrating information technology, communications and other systems;

· unanticipated changes in applicable laws and regulations;

· managing tax costs or inefficiencies associated with integrating our operations and Alliant Capital’s;

· suffering losses if we do not experience the anticipated benefits of the transaction;

· unforeseen expenses or delays associated with the acquisition of Alliant Capital; and

· making any necessary modifications to Alliant Capital’s internal financial control standards to comply with the Sarbanes-Oxley Act of 2002 and the rules and regulations promulgated thereunder.

Many of these factors will be outside of our control and any one of them could result in increased costs, decreases in the amount of expected revenues and diversion of management’s time and energy, which could materially impact our business, financial condition and results of operations. In addition, even if our operations and Alliant Capital’s are successfully integrated, we may not realize the full benefits of the acquisition within the anticipated time frame, or at all.

In addition, pursuant to the terms of the Agreement, the Company is required to remit to Alliant Capital certain origination fees and premiums received or receivable by the Company with respect to certain HUD mortgage loans as of the later of (i) the closing of the transaction or (ii) the date a specified HUD mortgage loan is settled and securities in respect thereof are issued. The aggregate amount of such origination fees and premiums are estimated to be approximately $3.8 million as of May 31, 2013 (based on certain assumptions; actual amount may vary). Until the Company’s remittance obligations with respect to such origination fees and premiums expire pursuant to the terms of the Agreement, the Company’s ability to accelerate its scaling and enhance its direct origination and servicing capabilities with respect to HUD mortgage loans may be limited.

Alliant Capital may not be able to hire and retain qualified loan originators, and if it is unable to do so, its ability to implement its business and growth strategies could be limited.

Alliant Capital depends on its loan originators to generate borrower clients by, among other things, developing relationships with commercial property owners, real estate agents and brokers, developers and others, which Alliant Capital believes leads to repeat and referral business. Accordingly, Alliant Capital must be able to attract, motivate and retain skilled loan originators. As of December 31, 2012, Alliant Capital employed approximately 15 loan originators throughout its 15 offices. The market for loan originators is highly competitive and may lead to increased costs to hire and retain them. Alliant Capital cannot guarantee that it will be able to attract or retain qualified loan originators. If it cannot attract, motivate or retain a sufficient number of skilled loan originators, or even if it can motivate or retain them but at higher costs, we could be materially adversely affected.

If financing for the acquisition of Alliant Capital becomes unavailable, we may be forced to liquidate other assets to pay for the acquisition or may be unable to close the acquisition.

We intend to finance a portion of the purchase price for the Alliant Capital acquisition with equity or debt financing. In the event that suitable equity or debt financing is not available to us, we may be required to obtain alternative financing on terms that are less favorable to us than those we anticipate. If other financing becomes necessary and we are unable to secure such other financing on acceptable terms, we may be forced to liquidate other assets in order to pay the purchase price of the acquisition, which could have an adverse effect on our results of operations and financial condition, or we may be unable to close the acquisition at all.

If we decide to issue common stock to finance the Acquisition, holders of our common stock may experience dilution to the extent we issue stock at a price that is below stockholders’ equity per share.

Failure to complete the acquisition of Alliant Capital could negatively impact our stock price and future business and financial results.

If the acquisition of Alliant Capital is not completed, we may be adversely affected and we will be subject to several risks and consequences, including the following:

· We deposited $1 million in cash in escrow with Citibank, N.A., as escrow agent, on May 15, 2013 in connection with the execution and delivery of the Agreement. We may terminate the Agreement at any time on or prior to June 12, 2013 and obtain a refund of the $1 million escrow deposit. Thereafter, the escrow deposit will be non-refundable except in certain limited circumstances;

· We will be required to pay certain costs relating to the acquisition, whether or not the acquisition is completed, such as legal, accounting and financial advisor fees and costs related to any approval or transfer fee charged by Fannie Mae, FHA and Ginnie Mae and costs related to the preparation and negotiation of certain consent and approval applications; and

· Matters relating to the acquisition may require substantial commitments of time and resources by our management team, which could otherwise have been devoted to other opportunities that may have been beneficial to us.

In addition, if the acquisition is not completed, we may experience negative reactions from the financial markets and from our employees. We could also be subject in some circumstances to stockholder or other litigation relating to the failure to complete the acquisition, as well as proceedings by Sellers to seek specific performance of our obligations under the Agreement or to recover damages for any breach by us of the Agreement.

The unaudited pro forma combined financial statements relating to the Alliant Capital acquisition may not reflect our actual performance or the performance that we anticipate for future periods in the near-term.

We are required to prepare unaudited pro forma combined financial statements relating to the Alliant Capital acquisition. The unaudited pro forma combined financial statements are prepared and presented in accordance with U.S. generally accepted accounting principles and pursuant to specific requirements under federal securities laws. The unaudited pro forma combined balance sheet as of March 31, 2013 and the unaudited pro forma combined statements of income for the year ended December 31, 2012, and the three months ended March 31, 2013, are based on our historical financial statements and the historical financial statements of Alliant Capital (after giving effect to our acquisition of Alliant Capital using the purchase method of accounting and adjustment described in the notes to the unaudited pro forma combined financial statements).

Our financial statement presentation may change materially as a result of our acquisition of Alliant Capital.

After our acquisition of Alliant Capital, we may adopt new accounting policies with respect to certain items of Alliant Capital’s financial statement presentation. In addition, our financial statement presentation will include assets and expenses that we have not previously reported, including MSRs and employee compensation and benefits. After our acquisition of Alliant Capital, our financial statements will reflect the sale of loans (in addition to holding loans) that Alliant Capital originates, which may result in new treatment of fees and expenses associated with loan origination. In addition, as a result of the acquisition of Alliant Capital, our tax-related accounting may include deferred tax liabilities. As a result of the foregoing, our financial statements may be more complex and more difficult to understand than if we did not acquire Alliant Capital.

The market price of the common stock of the combined company may be affected by factors different from those affecting the market price for our common stock.

Our business differs from that of Alliant Capital, and the business of the combined company will differ from our existing business, and accordingly, our results of operations and the market price of our common stock after the acquisition may be affected by factors different from those currently affecting our results of operations and stock price.

Alliant Capital is subject to risk of loss in connection with defaults on loans sold under the Fannie Mae DUS program that could materially adversely affect our results of operations and liquidity.

Under the Fannie Mae DUS program, Alliant Capital originates and services multifamily loans for Fannie Mae without having to obtain Fannie Mae’s prior approval for certain loans, as long as the loans meet the underwriting guidelines set forth by Fannie Mae. In return for the delegated authority to make loans and the commitment to purchase loans by Fannie Mae, Alliant Capital must maintain minimum collateral and is generally required to share the risk of loss on loans sold through Fannie Mae. Under the pari passu risk-sharing formula, Alliant Capital is required to share the loss with Fannie Mae, with its maximum loss capped at one-third of the unpaid principal balance of a loan. Alliant Capital’s risk-sharing obligations have been modified and reduced on some Fannie Mae DUS loans. In addition, Fannie Mae can significantly increase Alliant Capital’s

risk-sharing obligations if the loan does not meet specific underwriting criteria or if the loan defaults within 12 months of its sale to Fannie Mae. As of December 31, 2012, Alliant Capital had pledged securities and cash of $13.7 million as collateral against future losses under $3.9 billion of loans outstanding that are subject to risk-sharing obligations, which we refer to as Alliant Capital’s “at risk balance.” As of December 31, 2012, Alliant Capital had pledged securities and cash of $13.7 million as collateral against future losses under $3.9 billion of loans outstanding that are subject to risk-sharing obligations, which we refer to as Alliant Capital’s “at risk balance.” Alliant Capital’s DUS lender contract with Fannie Mae gives Fannie Mae the ability to increase the amounts required to be held in reserve as operational liquidity or restricted reserves for a number of reasons in order to protect its interests. In this regard, Fannie Mae previously required Alliant Capital to bolster its operational and restricted liquidity positions by increasing its total acceptable operational liquidity by $6.0 million and also increasing its restricted reserve liquidity by $2.5 million. In August of 2012, Fannie Mae agreed to allow Alliant Capital to use the $6.0 million of additional operational liquidity to make advances on defaulted Fannie Mae loans and/or to meet future loss sharing obligations on Fannie Mae loans. However, Fannie Mae still requires that the additional restricted reserve of $2.5 million be maintained. If Fannie Mae deems it necessary and appropriate, it may raise these collateral requirements again in the future, which would limit Alliant Capital’s ability to utilize those funds. As of December 31, 2012, Alliant Capital’s allowance for risk-sharing as a percentage of the at-risk balance was 0.29%, or $11.4 million, and reflects Alliant Capital’s current estimate of its future payouts under its risk-sharing obligations. We cannot assure you that Alliant Capital’s estimate will be sufficient to cover future write offs. While Alliant Capital originates loans that meet the underwriting guidelines defined by Fannie Mae, in addition to its own internal underwriting guidelines, underwriting criteria may not always protect against loan defaults. In addition, commercial real estate values have generally declined in recent years, in some cases to levels below the current outstanding principal balance of the loan. Also, underwriting standards, including loan-to-value ratios, have become stricter. These factors create a risk that some older loans may not be able to be refinanced at maturity and thus may experience maturity defaults. Other factors may also affect a borrower’s decision to default on a loan, such as property, cash flow, occupancy, maintenance needs, and other financing obligations. As of December 31, 2012, the outstanding unpaid principal balance of the assets comprising Alliant Capital’s 60+ days delinquency rate segment represented 0.32% of the at-risk portfolio’s aggregate unpaid principal balance. If loan defaults increase, actual risk-sharing obligation payments under the Fannie Mae DUS program may increase, and such defaults and payments could have a material adverse effect on our results of operations and liquidity. In addition, any failure by Alliant Capital to pay its share of losses under the Fannie Mae DUS program could result in the revocation of its license from Fannie Mae and the exercise of various remedies available to Fannie Mae under the Fannie Mae DUS program.

If Alliant Capital fails to act proactively with delinquent borrowers in an effort to avoid a default, its number of delinquent loans could increase, which could have a material adverse effect on us.

As a loan servicer, Alliant Capital maintains the primary contact with the borrower throughout the life of the loan and is responsible, pursuant to its servicing agreements with Fannie Mae, for asset management. Alliant Capital is also responsible, together with Fannie Mae, for taking actions to mitigate losses. We believe that Alliant Capital has developed an extensive asset management process for tracking each loan that it services. However, Alliant Capital may be unsuccessful in identifying loans that are in danger of underperforming or defaulting or in taking appropriate action once those loans are identified. While Alliant Capital can recommend a loss mitigation strategy for Fannie Mae, decisions regarding loss mitigation are within the control of Fannie Mae. Recent turmoil in the real estate, credit and capital markets have made this process even more difficult and unpredictable. When loans become delinquent, Alliant Capital incurs additional expenses in servicing and asset managing the loan, it is typically required to advance principal and interest payments and tax and insurance escrow amounts, it could be subject to a loss of its contractual servicing fee and it could suffer losses of up to 33.33% (or more for loans that do not meet specific underwriting criteria or default within 12 months of their sale to Fannie Mae) of the unpaid principal balance of a Fannie Mae DUS loan with Level I pari passu risk-sharing, as well as potential losses on Fannie Mae DUS loans with modified risk-sharing. These items could have a negative impact on its cash flows and a negative effect on the net carrying value of the MSR on its balance sheet and could result in a charge to its earnings. As a result of the foregoing, a continuing rise in Alliant Capital’s delinquencies could have a material adverse effect on us.

A reduction in the prices paid for Alliant Capital’s loans and services or an increase in loan or security interest rates by investors could materially adversely affect our results of operations and liquidity.

Our results of operations and liquidity could be materially adversely affected if Fannie Mae lowers the price they are willing to pay to Alliant Capital for Alliant Capital’s loans or services or adversely change the material terms of their loan purchases or service arrangements with Alliant Capital. A number of factors determine the price Alliant Capital receives for its loans. With respect to Fannie Mae related originations, Alliant Capital’s loans are generally sold as Fannie Mae-insured securities to third-party investors. With respect to HUD related originations, Alliant Capital’s loans are generally sold as Ginnie Mae securities to third-party investors. In both cases, the price paid to Alliant Capital reflects, in part, the competitive market bidding process for these securities.

Loan servicing fees are based, in part, on the risk-sharing obligations associated with the loan and the market pricing of credit risk. The credit risk premium offered by Fannie Mae for new loans can change periodically but remains fixed once Alliant Capital enters into a commitment to sell the loan. Over the past several years, Fannie Mae loan servicing fees have been higher due to the market pricing of credit risk. There can be no assurance that such fees will continue to remain at such levels or that such levels will be sufficient if delinquencies occur.

Servicing fees for loans placed with institutional investors are negotiated with each institutional investor pursuant to agreements that Alliant Capital has with them. These fees for new loans vary over time and may be materially adversely affected by a number of factors, including competitors that may be willing to provide similar services at better rates.

Over the past few years, Alliant Capital has originated multifamily real estate loans that are eligible for sale through Fannie Mae programs, and within the past year, Alliant Capital has been approved to originate loans that are eligible to be insured by FHA and securitized through Ginnie Mae. This focus may expose Alliant Capital to greater risk if the CMBS market continues its nascent recovery or alternative sources of liquidity become more readily available to the commercial real estate finance market.

Alliant Capital originates multifamily real estate loans that are eligible for sale through Fannie Mae programs or are eligible to be insured by FHA and securitized through Ginnie Mae. Over the past few years, the number of multifamily loans financed by Fannie Mae programs has represented a significantly greater percentage of overall multifamily loan origination volume than in prior years. Alliant Capital believes that this increase is the result, in part, of market dislocation and illiquidity in the secondary markets for non-Fannie Mae loans. The CMBS market has shown signs of a nascent recovery over the past year. To the extent the CMBS market continues its recovery or liquidity in the commercial real estate finance market significantly increases, there may be less demand for loans that are eligible for sale through Fannie Mae programs or eligible to be insured by FHA and securitized through Ginnie Mae, and Alliant Capital’s loan origination volume may be adversely impacted, which could materially adversely affect us.

A significant portion of Alliant Capital’s revenue is derived from loan servicing fees, and declines in or terminations of servicing engagements or breaches of servicing agreements, including as a result of non-performance by third parties that Alliant Capital engages for back-office loan servicing functions and loan origination, could have a material adverse effect on us.

We expect that loan servicing fees will continue to constitute a significant portion of Alliant Capital’s revenues for the foreseeable future. Nearly all of these fees are derived from loans that Alliant Capital originates and sells through Fannie Mae or HUD programs or places with institutional investors. A decline in the number

or value of loans that Alliant Capital originates for these investors or terminations of its servicing engagements will decrease these fees. HUD has the right to terminate Alliant Capital’s current servicing engagements for cause. In addition to termination for cause, Fannie Mae may terminate Alliant Capital’s servicing engagements without cause by paying a termination fee. Alliant Capital is also subject to losses that may arise as a result of servicing errors, such as a failure to maintain insurance, pay taxes or provide notices. In addition, Alliant Capital has contracted with a third party to perform certain routine back-office aspects of loan servicing and to originate certain loans. If Alliant Capital or this third party fails to perform, or Alliant Capital breaches or the third-party causes Alliant Capital to breach its servicing obligations to Fannie Mae, Alliant Capital’s servicing engagements may be terminated. Declines or terminations of servicing engagements or breaches of such obligations could materially adversely affect us.

If one or more of Alliant Capital’s warehouse facilities, on which Alliant Capital is highly dependent, are terminated, Alliant Capital may be unable to find replacement financing on favorable terms, or at all, which would have a material adverse effect on it.

Alliant Capital requires a significant amount of funding capacity on an interim basis for loans it originates. As of December 31, 2012, Alliant Capital had $100 million of committed loan funding available (which includes a $20 million accordion feature) through Bank of America, N.A., pursuant to a Mortgage Warehousing and Security Agreement (which facility is currently scheduled to mature on June 30, 2013), and uncommitted funding available through Fannie Mae’s As Soon As Pooled (“ASAP”) and ASAP Plus programs. Consistent with industry practice, Alliant Capital’s existing mortgage warehousing facility with Bank of America is short-term, requiring annual renewal. If any of Alliant Capital’s committed facilities are terminated or are not renewed or Alliant Capital’s uncommitted facilities are not honored, Alliant Capital may be unable to find replacement financing on favorable terms, or at all, and it might not be able to originate loans, which would have a material adverse effect on us. Additionally, as Alliant Capital’s business continues to expand, it may need additional warehouse funding capacity for loans it originates. There can be no assurance that, in the future, Alliant Capital will be able to obtain additional warehouse funding capacity on favorable terms, on a timely basis, or at all.

If Alliant Capital fails to meet or satisfy any of the financial or other covenants included in its warehouse facilities, Alliant Capital would be in default under one or more of these facilities and its lenders could elect to declare all amounts outstanding under the facilities to be immediately due and payable, enforce their interests against loans pledged under such facilities and restrict Alliant Capital’s ability to make additional borrowings. These facilities also contain cross-default provisions, such that if a default occurs under any of Alliant Capital’s debt agreements, generally the lenders under its other debt agreements could also declare a default. These restrictions may interfere with Alliant Capital’s ability to obtain financing or to engage in other business activities, which could materially adversely affect Alliant Capital. While Alliant Capital was in compliance with all financial and other covenants included in its warehouse facilities as of December 31, 2012, there can be no assurance that it will not experience a default in the future.

Alliant Capital is subject to the risk of failed loan deliveries, and even after a successful closing and delivery, may be required to repurchase the loan or to indemnify the investor if it breaches a representation or warranty made by it in connection with the sale of the loan through a Fannie Mae program, any of which could have a material adverse effect on Alliant Capital.

Alliant Capital bears the risk that a borrower will choose not to close on a loan that has been pre-sold to an investor or that the investor will choose not purchase the loan (“failed loan delivery”), including because a

catastrophic change in the condition of a property occurs after Alliant Capital funds the loan and prior to the investor purchase date. Alliant Capital also has the risk of serious errors in loan documentation which prevent timely delivery of the loan prior to the investor purchase date. A complete failure to deliver a loan could be a default under the warehouse line used to finance the loan. There can be no assurance that Alliant Capital will not experience failed deliveries or that any losses will not be material or will be mitigated through property insurance or payment protections.

Alliant Capital must make certain representations and warranties concerning each loan originated by it for Fannie Mae programs. The representations and warranties relate to Alliant Capital’s practices in the origination and servicing of the loans and the accuracy of the information being provided by it. For example, Alliant Capital is generally required to provide the following, among other, representations and warranties: it is authorized to do business and to sell or assign the loan; the loan conforms to the requirements of Fannie Mae and certain laws and regulations; the underlying mortgage represents a valid lien on the property and there are no other liens on the property; the loan documents are valid and enforceable; taxes, assessments, insurance premiums, rents and similar other payments have been paid or escrowed; the property is insured, conforms to zoning laws and remains intact; and it does not know of any issues regarding the loan that are reasonably expected to cause the loan to be delinquent or unacceptable for investment or adversely affect its value. Alliant Capital is permitted to satisfy certain of these representations and warranties by furnishing a title insurance policy.

In the event of a breach of any representation or warranty, investors could, among other things, increase the level of risk-sharing on the Fannie Mae DUS loan or require Alliant Capital to repurchase the full amount of the loan and seek indemnification for losses from Alliant Capital. Alliant Capital’s obligation to repurchase the loan is independent of its risk-sharing obligations. Fannie Mae could require Alliant Capital to repurchase the loan if representations and warranties are breached, even if the loan is not in default. Because the accuracy of many such representations and warranties generally is based on Alliant Capital’s actions or on third-party reports, such as title reports and environmental reports, Alliant Capital may not receive similar representations and warranties from other parties that would serve as a claim against them. Even if Alliant Capital receives representations and warranties from third parties and has a claim against them in the event of a breach, its ability to recover on any such claim may be limited. Alliant Capital’s ability to recover against a borrower that breaches its representations and warranties to it may be similarly limited. Alliant Capital’s ability to recover on a claim against any party would also be dependent, in part, upon the financial condition and liquidity of such party. Although we believe that Alliant Capital has capable personnel at all levels, uses qualified third parties and has established controls to ensure that all loans are originated pursuant to requirements established by Fannie Mae, in addition to its own internal requirements, there can be no assurance that Alliant Capital, its employees or third parties will not make mistakes. Any significant repurchase or indemnification obligations imposed on Alliant Capital could have a material adverse effect on us.

Alliant Capital expects to offer additional new loan products to meet evolving borrower demand, including new types of loans that it originates for its balance sheet. Because it is not as experienced with such loan products, it may not be successful or profitable in offering such products

In the future, Alliant Capital expects to offer new loan products to meet evolving borrower demands, including loans that Alliant Capital originates for its balance sheet. Alliant Capital may initiate new loan product and service offerings or acquire them through acquisitions of operating businesses. Because Alliant Capital may not be as experienced with new loan products or services, it may require additional time and

resources for offering and managing such products and services effectively or may be unsuccessful in offering such new products and services at a profit.

Alliant Capital’s business is significantly affected by general business, economic and market conditions and cycles, particularly in the multifamily and commercial real estate industry, including changes in government fiscal and monetary policies, and, accordingly, Alliant Capital could be materially harmed in the event of a continued market downturn or changes in government policies, which could have a material adverse effect on us.

Alliant Capital is sensitive to general business, economic and market conditions and cycles, particularly in the multifamily and commercial real estate industry. These conditions include changes in short-term and long-term interest rates, inflation and deflation, fluctuations in the real estate and debt capital markets and developments in national and local economies, unemployment rates, commercial property vacancy and rental rates. Any sustained period of weakness or weakening business or economic conditions in the markets in which Alliant Capital does business or in related markets could result in a decrease in the demand for Alliant Capital’s loans and services, which could materially harm us. In addition, the number of borrowers who become delinquent, become subject to bankruptcy laws or default on their loans could increase, resulting in a decrease in the value of Alliant Capital’s MSRs and servicer advances and higher levels of loss on Alliant Capital’s Fannie Mae loans for which it shares risk of loss, and could materially adversely affect us.

Alliant Capital also is significantly affected by the fiscal and monetary policies of the U.S. government and its agencies. Alliant Capital is particularly affected by the policies of the Board of Governors of the Federal Reserve System (the “Federal Reserve”), which regulates the supply of money and credit in the United States. The Federal Reserve’s policies affect interest rates, which have a significant impact on the demand for commercial real estate loans. Significant fluctuations in interest rates as well as protracted periods of increases or decreases in interest rates could adversely affect the operation and income of multifamily and other commercial real estate properties, as well as the demand from investors for commercial real estate debt in the secondary market. In particular, higher interest rates tend to decrease the number of loans originated. An increase in interest rates could cause refinancing of existing loans to become less attractive and qualifying for a loan to become more difficult. Changes in fiscal and monetary policies are beyond our control, are difficult to predict and could materially adversely affect us.

In addition, the fair value of Alliant Capital’s MSRs is subject to market risk. For example, a 100 basis point increase or decrease in the weighted average discount rate would decrease or increase, respectively, the fair value of Alliant Capital’s MSRs outstanding as of December 31, 2012 by approximately $2 million.

Alliant Capital is dependent upon the success of the multifamily real estate sector and conditions that negatively impact the multifamily sector may reduce demand for Alliant Capital’s products and services and materially adversely affect us.

Alliant Capital provides commercial real estate financial products and services primarily to developers and owners of multifamily properties. Accordingly, the success of its business is closely tied to the overall success of the multifamily real estate market. Various changes in real estate conditions may impact the multifamily sector. Any negative trends in such real estate conditions may reduce demand for Alliant Capital’s products and services and, as a result, adversely affect our results of operations. These conditions include:

· oversupply of, or a reduction in demand for, multifamily housing;

· a favorable interest rate environment that may result in a significant number of potential residents of multifamily properties deciding to purchase homes instead of renting;

· rent control or stabilization laws, or other laws regulating multifamily housing, which could affect the profitability of multifamily developments;

· the inability of residents and tenants to pay rent;

· increased competition in the multifamily sector based on considerations such as the attractiveness, location, rental rates, amenities and safety record of various properties; and

· increased operating costs, including increased real property taxes, maintenance, insurance and utilities costs.

Moreover, other factors may adversely affect the multifamily sector, including changes in government regulations and other laws, rules and regulations governing real estate, zoning or taxes, changes in interest rate levels, the potential liability under environmental and other laws and other unforeseen events. Any or all of these factors could negatively impact the multifamily sector and, as a result, reduce the demand for Alliant Capital’s products and services. Any such reduction could materially adversely affect us.

For most loans that Alliant Capital services under the Fannie Mae and HUD programs, Alliant Capital is required to advance payments due to investors if the borrower is delinquent in making such payments, which requirement could adversely impact our liquidity and harm our results of operations.

For most loans Alliant Capital services under the Fannie Mae DUS program, Alliant Capital is currently required to advance the principal and interest payments and tax and insurance escrow amounts if the borrower is delinquent in making loan payments. After four continuous months of making advances on behalf of the borrower, Alliant Capital can submit a reimbursement claim to Fannie Mae, which Fannie Mae may approve at its discretion. Alliant Capital is reimbursed by Fannie Mae for these advances in the event the loan is brought current. In the event of a default, any advances made by Alliant Capital are used to reduce the proceeds required to settle any loss. Alliant Capital’s advances may also be reimbursed, to the extent that the default settlement proceeds on the collateral exceed the unpaid principal balance.

Under the HUD program, Alliant Capital is obligated to continue to advance principal and interest payments and tax and insurance escrow amounts on Ginnie Mae securities until the FHA mortgage insurance claim and the Ginnie Mae security have been fully paid. In the event of a default on an FHA insured loan, FHA will generally reimburse approximately 99% of any losses of principal and interest on the loan and Ginnie Mae will reimburse the remaining losses of principal and interest.

Although Alliant Capital has funded all required advances from operating cash flow in the past, there can be no assurance that it will be able to do so in the future. If Alliant Capital does not have sufficient operating cash flows to fund such advances, it would need to finance such amounts. Such financing could be costly and could prevent us from pursuing its business and growth strategies.

Alliant Capital has numerous significant competitors and potential future competitors, some of which may have greater resources and access to capital than Alliant Capital does; consequently, Alliant Capital may not be able to compete effectively in the future.

Alliant Capital faces significant competition across its business, including, but not limited to, commercial banks, commercial real estate service providers and life insurance companies, some of which are also investors in loans it originates. Many of these competitors enjoy competitive advantages over Alliant Capital, including:

· greater name recognition;

· a stronger, more established network of correspondents and loan originators;

· established relationships with institutional investors;

· an established market presence in markets where Alliant Capital does not yet have a presence or where it has a smaller presence;

· ability to diversify and grow by providing a greater variety of commercial real estate loan products on more attractive terms, some of which require greater access to capital and the ability to retain loans on the balance sheet; and

· greater financial resources and access to capital to develop branch offices and compensate key employees.

Commercial banks may have an advantage over Alliant Capital in originating loans if borrowers already have a line of credit with the bank. Commercial real estate service providers may have an advantage over Alliant Capital to the extent they also offer an investment sales platform. Alliant Capital competes on the basis of quality of service, relationships, loan structure, terms, pricing and industry depth. Industry depth includes the knowledge of local and national real estate market conditions, commercial real estate, loan product expertise and the ability to analyze and manage credit risk. Alliant Capital’s competitors seek to compete aggressively on the basis of these factors and Alliant Capital’s success depends on its ability to offer attractive loan products, provide superior service, demonstrate industry depth, maintain and capitalize on relationships with investors, borrowers and key loan correspondents and remain competitive in pricing. In addition, future changes in laws, regulations and Fannie Mae program requirements and consolidation in the commercial real estate finance market could lead to the entry of more competitors. We cannot guarantee that it will be able to compete effectively in the future, and its failure to do so would materially adversely affect it.

Risks Related to Regulatory Matters

A change to the conservatorship of Fannie Mae and related actions, along with any changes in laws and regulations affecting the relationship between Fannie Mae and the U.S. federal government, could materially adversely affect Alliant Capital’s business.

There continues to be substantial uncertainty regarding the future of Fannie Mae, including the length of time for which it may continue to exist and in what form it may operate during that period.

Due to increased market concerns about the ability of Fannie Mae to withstand future credit losses associated with securities on which it provides guarantees and loans held in its investment portfolio without the direct support of the U.S. federal government, in September 2008, the Federal Housing Finance Agency (the “FHFA”) placed Fannie Mae into conservatorship and, together with the U.S. Treasury, established a program designed to boost investor confidence in Fannie Mae by supporting the availability of mortgage financing and protecting taxpayers. The U.S. government program includes contracts between the U.S. Treasury and Fannie Mae that seek to ensure that Fannie Mae maintains a positive net worth by providing for the provision of cash by the U.S. Treasury to Fannie Mae if FHFA determines that its liabilities exceed its assets. Although the U.S. government has described some specific steps that it intends to take as part of the conservatorship process, efforts to stabilize this entity may not be successful and the outcome and impact of these events remain highly uncertain. Under the statute providing the framework for Fannie Mae’s conservatorship, it could also be placed into receivership under certain circumstances.

The problems faced by Fannie Mae resulting in its placement into conservatorship and its delisting from the New York Stock Exchange have stirred debate among some U.S. federal policymakers regarding the continued role of the U.S. government in providing liquidity for mortgage loans. Future legislation could further change the relationship between Fannie Mae and the U.S. government, which could change Fannie Mae’s business charters or structure, or could nationalize or eliminate it entirely. We cannot predict if or when any such legislation may be enacted.

In February 2011, as part of the Obama administration’s financial industry recovery proposal, the U.S. Treasury, in consultation with HUD and other government agencies, released a white paper, “Reforming America’s Housing Finance Market, A Report to Congress”, which put forth options to reform America’s housing finance market. All options involve an eventual phasing out of Fannie Mae. The proposals identified a series of short-term modifications to the current government role that are intended to attract greater private capital to the housing market, as the operations of Fannie Mae are wound down and the government’s role in the housing finance sector is reduced. The modifications to the long-term structure of the U.S. housing finance system included the following three options presented by the U.S. Treasury:

· Option 1: dramatically reduce the government’s role in insuring or guaranteeing mortgages, limiting it to FHA and other programs targeted to creditworthy lower and moderate income borrowers; with the majority of mortgage financing coming from the private sector.

· Option 2: dramatically reduce the government’s role in insuring or guaranteeing mortgages, limiting it to FHA and other programs targeted to creditworthy lower and moderate income borrowers; with a government backstop mechanism to ensure access to credit during a housing crisis.

· Option 3: dramatically reduce the government’s role in insuring or guaranteeing mortgages, limiting it to FHA and other programs targeted to creditworthy lower and moderate income borrowers; private mortgage guarantor companies (subject to stringent oversight and capital requirements) would provide guarantees for mortgage-backed securities, with government reinsurance available for the holders of the securities.

Each of the above options assumes the continuation and possible expansion of programs operated by FHA to assist targeted borrower groups. The report also states the importance of a careful transition plan and continued financial support for Fannie Mae during any transition period.

On February 21, 2012, FHFA released “A Strategic Plan for Enterprise Conservatorships: The Next Chapter in a Story that Needs an Ending”, which details the strategic plan set forth by FHFA to gradually contract Fannie Mae’s presence in the marketplace, and specifies actions that FHFA is either taking, or planning to take, to achieve its strategic goal. The strategic plan recognizes that Fannie Mae’s multifamily business, in contrast to its single-family business, has remained cash flow positive during the recent housing crisis. As a result, the strategic plan states that “generating potential value for taxpayers and contracting Fannie Mae’s multifamily market footprint should be approached differently from single-family, and it may be accomplished using a much different and more direct method.” To evaluate how to accomplish FHFA’s strategic goal, as it relates to the multifamily business, the release states that Fannie Mae will embark on a market analysis to determine the viability of its multifamily business without the benefit of government guarantees, including operating on a stand-alone basis upon attracting private capital.

It is widely anticipated that the U.S. Congress will address the administration’s white paper and FHFA’s release regarding its strategic plan for the operations of Fannie Mae, although it is not known when, or if, that will occur. In Section 1491 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), signed into law on July 21, 2010, Congress stated that the “hybrid public-private status of Fannie Mae and Freddie Mac is untenable and must be resolved” and, further, “[i]t is the sense of the Congress that efforts to enhance by [sic] the protection, limitation, and regulation of the terms of residential mortgage credit and the practices related to such credit would be incomplete without enactment of meaningful structural reforms of Fannie Mae and Freddie Mac.”

On March 4, 2013, FHFA released its 2013 Conservatorship Scorecard for Fannie Mae. As part of the scorecard, FHFA directed that Fannie Mae contract its presence in the marketplace while simplifying and shrinking certain operations (by lines of business). Specifically, FHFA directed Fannie Mae to reduce the unpaid principal balance amount of new multifamily business relative to 2012 by at least ten percent by tightening underwriting, adjusting pricing, and limiting product offerings, while not increasing the proportion of Fannie Mae’s retained risk.

If the FHFA mandates additional reductions to Fannie Mae’s volumes for new multifamily originations or imposes additional restrictions on Fannie Mae’s multifamily business beyond 2013, the volume of loans that Alliant Capital originates with Fannie Mae could be adversely impacted. These additional mandates and restrictions could have a material impact on our financial results in future periods.

Neither the administration’s white paper proposals nor FHFA’s strategic plan addresses the existing contractual seller/servicer relationships Fannie Mae has and the impact of anticipated Fannie Mae reform on the existing selling/servicing and/or risk-sharing agreements.

Currently, Alliant Capital originates a substantial majority of its loans for sale through Fannie Mae programs. Furthermore, a substantial majority of its servicing rights are derived from loans Alliant Capital sells through Fannie Mae programs. Changes in the business charter, structure or existence of Fannie Mae could eliminate or substantially reduce the number of loans Alliant Capital originates, which would have a material adverse effect on us. We cannot predict the extent to which these recommendations may be implemented, or the timing of when any implementation may occur.

If Alliant Capital fails to comply with the numerous government regulations and program requirements of Fannie Mae, it may lose its approved lender status with these entities and fail to gain additional approvals or licenses for its business. Alliant Capital is also subject to changes in laws, regulations and existing Fannie Mae program requirements, including potential increases in reserve and risk retention requirements that could increase its costs and affect the way it conducts its business, which could materially adversely affect Alliant Capital.

Alliant Capital’s operations are subject to regulation by federal, state and local government authorities, various laws and judicial and administrative decisions, and regulations and policies of Fannie Mae. These laws, regulations, rules and policies impose, among other things, minimum net worth, operational liquidity and collateral requirements. Fannie Mae requires Alliant Capital to maintain operational liquidity based on a formula that considers the balance of the loan and the level of credit loss exposure (“level of risk-sharing”). Fannie Mae requires Fannie Mae DUS lenders to maintain collateral, which may include pledged securities, for Alliant Capital’s risk-sharing obligations. The amount of collateral required under the Fannie Mae DUS program is calculated at the loan level and is based on the balance of the loan, the level of risk-sharing, the seasoning of the loans and the rating of the Fannie Mae DUS lender.

Regulatory authorities also require Alliant Capital to submit financial reports and to maintain a quality control plan for the underwriting, origination and servicing of loans. Numerous laws and regulations also impose qualification and licensing obligations on Alliant Capital and impose requirements and restrictions affecting, among other things: Alliant Capital’s loan originations; maximum interest rates, finance charges and other fees that Alliant Capital may charge; disclosures to consumers; the terms of secured transactions; collection, repossession and claims handling procedures; personnel qualifications; and other trade practices. Alliant Capital is also subject to inspection by Fannie Mae and regulatory authorities. Alliant Capital’s failure to comply with these requirements could lead to, among other things, the loss of a license as an approved Fannie Mae lender, the inability to gain additional approvals or licenses, the termination of contractual rights without compensation, demands for indemnification or loan repurchases, class action lawsuits and administrative enforcement actions.

Regulatory and legal requirements are subject to change. For example, in March of 2013, Fannie Mae notified all DUS lenders that collateral requirements on existing mortgage loans that are considered Tier 1 as a result of a defensive refinance or modification were increasing from 90 basis points to 110 basis points, and that the collateral requirements for Tier 2 mortgage loans were increasing from 60 basis points to 75 basis points. The new requirements were implemented retroactive to January 1, 2013, but to lessen the impact on DUS lenders, the Tier 2 requirement is increasing gradually by three basis points per quarter until December 31, 2014. The collateral requirements for Tier 3 and Tier 4 mortgage loans were not changed, but the collateral requirements for new loans with Levels II and III loss sharing (for breach penalties) were raised from 98 basis points to 120 basis points and from 130 basis points to 140 basis points, respectively. Fannie Mae indicated that the next evaluation of DUS Capital Standards will occur on or before June 30, 2014. Alliant Capital currently has three loans with a collective balance of $14.9 million as of March 31, 2013 in its portfolio which were affected by the announced collateral changes and we do not expect it will have a material impact on Alliant Capital’s future operations; however, Fannie Mae has indicated that it would likely increase collateral requirements in the future, which may adversely impact us.

In addition, Congress has been considering proposals requiring lenders to retain a portion of all loans sold to Fannie Mae. The Dodd-Frank Act imposes a requirement that securitizers retain “not less than 5 percent of the credit risk” of certain securitized loans, particularly those that are not “qualified residential mortgages.” It is currently unclear whether and how the Dodd-Frank Act will apply to commercial real estate lenders. The Dodd-Frank Act requires the federal banking agencies and the SEC to issue rules implementing this

requirement no later than 270 days after Dodd-Frank’s enactment. It also requires the federal banking agencies, the SEC and the Federal Trade Commission, HUD, and FHFA to issue in the same timeframe a joint rule implementing this requirement with respect to residential mortgage assets, including defining a “qualified residential mortgage.” While proposed rules were issued for comment on April 29, 2011, final rules are still pending. Therefore, the applicability of this provision to Alliant Capital and its effect upon Alliant Capital’s business will not be fully known until these agencies issue the final joint rule. By statute, compliance is required with respect to securitizers and originators of securitized loans backed by residential mortgages one year after issuance of the final rule. It is also impossible to predict any future legislation that Congress may enact regarding the selling of loans to Fannie Mae or any other matter relating to Fannie Mae or loan securitizations. Fannie Mae and other investors may also change underwriting criteria, which could affect the volume and value of loans that Alliant Capital originates. Changes to regulatory and legal requirements could be difficult and expensive with which to comply and could affect the way Alliant Capital conducts its business, which could materially adversely affect us.

If Alliant Capital fails to comply with laws, regulations and market standards regarding the privacy, use and security of customer information, Alliant Capital may be subject to legal and regulatory actions and its reputation would be harmed, which would materially adversely affect us.

Alliant Capital receives, maintains and stores the non-public personal information of its loan applicants. The technology and other controls and processes designed to secure Alliant Capital’s customer information and to prevent, detect and remedy any unauthorized access to that information were designed to obtain reasonable, not absolute, assurance that such information is secure and that any unauthorized access is identified and addressed appropriately. Accordingly, such controls may not have detected, and may in the future fail to prevent or detect, unauthorized access to Alliant Capital’s borrower information. If this information is inappropriately accessed and used by a third party or an employee for illegal purposes, such as identity theft, Alliant Capital may be responsible to the affected applicant or borrower for any losses he or she may have incurred as a result of misappropriation. In such an instance, Alliant Capital may be liable to a governmental authority for fines or penalties associated with a lapse in the integrity and security of its customers’ information, which could materially adversely affect us.

U.S. Federal Income Tax Risks Related to the Alliant Capital Transaction

Our taxable REIT subsidiaries are subject to a number of requirements that must be closely monitored in order for us to qualify as a real estate investment trust for U.S. Federal Income tax purposes (“REIT”).

A REIT may own up to 100% of the stock of one or more taxable REIT subsidiaries. Both the subsidiary and the REIT must jointly elect to treat the subsidiary as a taxable REIT subsidiary. A corporation of which a taxable REIT subsidiary directly or indirectly owns more than 35% of the voting power or value of the stock will automatically be treated as a taxable REIT subsidiary. Overall, no more than 25% of the gross value of a REIT’s assets may consist of stock or securities of one or more taxable REIT subsidiaries. Accordingly, if one or more of our taxable REIT subsidiaries has significant earnings, such subsidiary may be required to make distributions to us in order to ensure the value of our securities in our taxable REIT subsidiaries remains below 25% of our gross assets. A taxable REIT subsidiary may hold assets and earn income that would not be qualifying assets or income if held or earned directly by a REIT, including gross income from operations such as loan servicing income. Accordingly, we will generally use taxable REIT subsidiaries to hold properties for sale in the ordinary course of a trade or business and to hold assets or conduct activities that we cannot conduct

directly as a REIT, including assets acquired and activities conducted as a result of the Alliant Capital acquisition. However, to the extent that such assets and the income attributable to such assets qualify under the REIT asset and income tests, we may consider holding such assets directly. A taxable REIT subsidiary will be subject to applicable U.S. federal, state, local and foreign income tax on its taxable income. In addition, the rules, which are applicable to us as a REIT, impose a 100% excise tax on certain transactions between a taxable REIT subsidiary and its parent REIT that are not conducted on an arm’s-length basis.

Cautionary Statement Regarding Forward-Looking Statements

We make forward-looking statements in this Current Report on Form 8-K that are subject to risks and uncertainties. These forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. When we use the words “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “may” or similar expressions, we intend to identify forward-looking statements. Statements regarding the following subjects, among others, may be forward-looking:

· factors described in the section captioned “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, and in the Company’s other periodic reports filed with the SEC;

· our business and investment strategy;

· our projected operating results;

· the timing of cash flows, if any, from our investments;

· the state of the U.S. economy generally or in specific geographic regions;

· defaults by borrowers in paying debt service on outstanding items;

· actions and initiatives of the U.S. Government and changes to U.S. Government policies;

· our ability to obtain financing arrangements;

· the amount of commercial mortgage loans requiring refinancing;

· financing and advance rates for our target investments;

· our expected leverage;

· general volatility of the securities markets in which we may invest;

· the impact of a protracted decline in the liquidity of credit markets on our business;

· the uncertainty surrounding the strength of the U.S. economic recovery;

· the return or impact of current and future investments;

· changes in interest rates and the market value of our investments;

· effects of hedging instruments on our target investments;

· rates of default or decreased recovery rates on our target investments;

· the degree to which our hedging strategies may or may not protect us from interest rate volatility;

· changes in governmental regulations, tax law and rates, and similar matters (including interpretation thereof);

· our ability to maintain our qualification as a real estate investment trust;

· our ability to maintain our exemption from registration under the Investment Company Act of 1940, as amended;

· availability of investment opportunities in mortgage related and real estate related investments and securities;

· our ability to complete our pending acquisition of Alliant Capital as described in this Current Report on Form 8-K and the performance of Alliant Capital subsequent to the acquisition;

· our ability to integrate Alliant Capital into our business and achieve the benefits that we anticipate from our acquisition of Alliant Capital;

· availability of qualified personnel;

· estimates relating to our ability to make distributions to our stockholders in the future;

· our understanding of our competition; and

· market trends in our industry, interest rates, real estate values, the debt securities markets or the general economy.

Item 9.01. Financial Statements and Exhibits.

(a) Financial Statements of Business Acquired.

The audited financial statements of EF&A Funding L.L.C. as of and for the years ended December 31, 2012 and 2011, including the notes and the reports of the independent auditors related thereto, are filed as Exhibit 99.1 to

this Current Report on Form 8-K. The consents of the independent auditors related thereto are filed as Exhibits 23.1 and 23.2, respectively, to this Current Report on Form 8-K.

The unaudited financial statements of EF&A Funding L.L.C. as of March 31, 2013 and for the three months ended March 31, 2013 and 2012 and the related notes, are filed as Exhibit 99.2 to this Current Report on Form 8-K.

(b) Pro Forma Financial Information.

Ares Commercial Real Estate Corporation unaudited pro forma consolidated financial information, comprised of a pro forma consolidated balance sheet as of March 31, 2013 and pro forma consolidated statements of income for the year ended December 31, 2012, and the three months ended March 31, 2013, and the related notes, are filed as Exhibit 99.3 to this Current Report on Form 8-K. The risk factors set forth in Item 8.01 are hereby incorporated by reference in this Item 9.01(b).

(d) Exhibits

Exhibit Number		Description

23.1		Consent of CohnReznick LLP, as independent auditors for EF&A Funding L.L.C.’s financial statements as of and for the year ended December 31, 2012.

23.2		Consent of Reznick Group, P.C., as independent auditors for EF&A Funding L.L.C.’s financial statements as of and for the year ended December 31, 2011.

99.1		EF&A Funding L.L.C. financial statements as of and for the years ended December 31, 2012 and 2011, and independent auditors’ reports with respect to the financial statements as of and for the years ended December 31, 2012 and 2011.

99.2		EF&A Funding L.L.C. financial statements (unaudited) as of March 31, 2013 and for the three months ended March 31, 2013 and 2012.

99.3		Ares Commercial Real Estate Corporation pro forma consolidated financial information (unaudited), comprised of a pro forma consolidated balance sheet as of March 31, 2013 and pro forma consolidated statements of income for the year ended December 31, 2012 and for the three months ended March 31, 2013.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

	ARES COMMERCIAL REAL ESTATE CORPORATION

Date: June 4, 2013

	By:	/s/ John B. Bartling, Jr.
	Name:	John B. Bartling, Jr.
	Title:	Chief Executive Officer

Exhibit Index

Exhibit Number		Description

23.1		Consent of CohnReznick LLP, as independent auditors for EF&A Funding L.L.C.’s financial statements as of and for the year ended December 31, 2012.

23.2		Consent of Reznick Group, P.C., as independent auditors for EF&A Funding L.L.C.’s financial statements as of and for the year ended December 31, 2011.

99.1		EF&A Funding L.L.C. financial statements as of and for the years ended December 31, 2012 and 2011, and independent auditors’ reports with respect to the financial statements as of and for the years ended December 31, 2012 and 2011.

99.2		EF&A Funding L.L.C. financial statements (unaudited) as of March 31, 2013 and for the three months ended March 31, 2013 and 2012.

99.3		Ares Commercial Real Estate Corporation pro forma consolidated financial information (unaudited), comprised of a pro forma consolidated balance sheet as of March 31, 2013 and pro forma consolidated statements of income for the year ended December 31, 2012 and for the three months ended March 31, 2013.

EX-23.1 2 a13-13231_1ex23d1.htm EX-23.1

Exhibit 23.1

CONSENT OF INDEPENDENT AUDITOR

We consent to the incorporation by reference in Registration Statement No. 333-188496 of Ares Commercial Real Estate Corporation on Form S-3 and in Registration Statement No. 333-181077 of Ares Commercial Real Estate Corporation on Form S-8 of our report dated March 30, 2013 on the financial statements of EF&A Funding, LLC as of December 31, 2012 and for the year then ended included in the Form 8-K of Ares Commercial Real Estate Corporation dated June 3, 2013.

/s/ CohnReznick LLP

Atlanta, Georgia

May 30, 2013

EX-23.2 3 a13-13231_1ex23d2.htm EX-23.2

Exhibit 23.2

CONSENT OF INDEPENDENT AUDITOR

We consent to the incorporation by reference in Registration Statement No. 333-188496 of Ares Commercial Real Estate Corporation on Form S-3 and in Registration Statement No. 333-181077 of Ares Commercial Real Estate Corporation on Form S-8 of our report dated April 25, 2012 on the financial statements of EF&A Funding, LLC as of December 31, 2011 and for the year then ended included in the Form 8-K of Ares Commercial Real Estate Corporation dated June 3, 2013.

/s/ Reznick Group, P.C.

Atlanta, Georgia

May 30, 2013

EX-99.1 4 a13-13231_1ex99d1.htm EX-99.1

Exhibit 99.1

EF&A Funding, LLC

Financial Statements and

Independent Auditor’s Report

December 31, 2012 and 2011

EF&A Funding, LLC

Index

		Page

Independent Auditor’s Report		3

Financial Statements

Balance Sheets		6

Statements of Operations		7

Statements of Changes in Members’ Equity		8

Statements of Cash Flows		10

Notes to Financial Statements		11

Independent Auditor’s Report

To the Members

EF&A Funding, LLC

We have audited the accompanying financial statements of EF&A Funding, LLC which comprise the balance sheet as of December 31, 2012, and the related statements of operations, changes in members’ equity and cash flows for the year then ended, and the related notes to the financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

Auditor’s Responsibility

Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinion

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of EF&A Funding, LLC as of December 31, 2012, and the results of its operations and its cash flows for the year then ended, in accordance with accounting principles generally accepted in the United States of America.

/s/ Cohn Reznick LLP

Atlanta, Georgia

March 30, 2013

INDEPENDENT AUDITOR’S REPORT

To the Members

EF&A Funding, LLC

We have audited the accompanying balance sheet of EF&A Funding, LLC as of December 31, 2011, and the related statements of operations, changes in members’ equity and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of EF&A Funding, LLC as of December 31, 2011, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ Reznick Group, P.C.

Atlanta, Georgia

April 25, 2012

EF&A Funding, LLC

Balance Sheets

December 31, 2012 and 2011

	2012		2011
Assets

Cash and cash equivalents	$	4,924,016	$	875,492
Restricted cash	14,366,851		12,124,074
Mortgage loans held for sale	54,424,000		44,080,678
Receivables	1,711,520		4,675,499
Property and equipment, net	290,945		275,586
Mortgage servicing rights, at fair value	60,980,749		55,070,413
Intangible assets, net	10,120,000		10,120,000
Retained interest in securitization	367,414		394,127
Goodwill	3,247,000		3,247,000
Prepaid expenses and other assets	1,301,036		1,234,738

Total assets	$	151,733,531	$	132,097,607

Liabilities and Members’ Equity

Liabilities
Warehouse lines of credit	$	47,350,526	$	32,799,111
Note payable - related party	47,833,607		47,833,607
Accrued interest on related party note payable	6,477,042		5,262,792
Accounts payable and other accrued liabilities	3,094,734		3,006,738
Borrowers’ deposits	637,596		400,566
Recourse liability	11,435,059		12,908,790
Deferred income and other liabilities	1,179,671		1,154,212

Total liabilities	118,008,235		103,365,816

Commitments and contingencies	—		—

Members’ Equity	33,725,296		28,731,791

Total liabilities and members’ equity	$	151,733,531	$	132,097,607

See notes to financial statements

EF&A Funding, LLC

Statements of Operations

Years ended December 31, 2012 and 2011

	2012			2011
Revenues
Loan servicing revenue	$	14,766,574		$	13,642,731
Change in fair value of mortgage servicing rights	5,910,336			1,932,541
Loan origination revenue	7,876,697			5,708,861
Gain on loan sales	2,121,172			935,436
Interest	1,806,919			1,836,272
Recourse liability provision	(4,543,556		)	(3,538,644		)

Total revenues	27,938,142			20,517,197

Expenses
Compensation and benefits	14,804,393			11,024,846
Termination benefits	—			3,103,374
Occupancy and office expenses	760,175			784,503
Data processing	231,365			238,967
Professional fees	392,177			359,940
Interest	4,956,617			4,853,526
Depreciation expense	105,935			85,872
Amortization expense	—			1,148,000
Other general and administrative expenses	1,693,975			1,134,113

Total expenses	22,944,637			22,733,141

Net income (loss)	$	4,993,505		$	(2,215,944	)

See notes to financial statements

EF&A Funding, LLC

Statements of Changes In Members’ Equity

Years ended December 31, 2012 and 2011

Members’ equity, December 31, 2010	$	24,047,335

Net loss	(2,215,944		)

Members’ contributions	6,900,400

Members’ equity, December 31, 2011	28,731,791

Net income	4,993,505

Members’ equity, December 31, 2012	$	33,725,296

See notes to financial statements

EF&A Funding, LLC

Statements of Cash Flows

Years ended December 31, 2012 and 2011

	2012			2011
Cash flows from operating activities
Net income (loss)	$	4,993,505		$	(2,215,944	)
Adjustments to reconcile net income (loss) to net cash used in operating activities
Change in fair value of mortgage servicing rights	(5,910,336		)	(1,932,541		)
Change in fair value of interest rate lock commitments	(56,000		)	85,000
Change in fair value of forward sale commitments	85,000			(9,000		)
Change in fair value of retained interest in securitization	26,713			(106,317		)
Change in recourse liability	(1,473,731		)	(3,676,784		)
Loss on disposal of property and equipment	69,670			2,618
Depreciation and amortization	105,935			1,233,871
Mortgage loans originated	(575,864,275		)	(499,096,050		)
Proceeds from sales of mortgage loans	565,520,953			492,345,377
Changes in:
Receivables	2,963,979			1,011,542
Prepaid expenses and other assets	(10,297		)	(29,555		)
Accrued interest on related party note payable	1,214,249			3,059,046
Accounts payable and other accrued liabilities	87,997			1,815,400
Borrowers’ deposits	237,030			(748,143		)
Deferred income and other liabilities	(59,541		)	1,959

Net cash used in operating activities	(8,069,149		)	(8,259,521		)

Cash flows from investing activities
Net increase in restricted cash	(2,242,777		)	(817,444		)
Purchases of property and equipment	(190,965		)	(120,948		)

Net cash used in investing activities	(2,433,742		)	(938,392		)

(continued)

EF&A Funding, LLC

Statements of Cash Flows - Continued

Years ended December 31, 2012 and 2011

	2012		2011
Cash flows from financing activities
Proceeds from warehouse lines of credit	14,551,415		932,330
Net decrease in preferred capital units	—		(300,000		)
Members’ contributions	—		6,900,400

Net cash provided by financing activities	14,551,415		7,532,730

Net increase (decrease) in cash and cash equivalents	4,048,524		(1,665,183		)

Cash and cash equivalents, beginning of year	875,492		2,540,675

Cash and cash equivalents, end of year	$	4,924,016	$	875,492

Supplemental disclosures of cash flow information
Cash paid for interest	$	3,742,367	$	1,797,532

See notes to financial statements

EF&A Funding, LLC

Notes to Financial Statements

December 31, 2012 and 2011

Note 1 - Organization

On January 12, 2007, EF&A Funding, LLC (the “Company”) was acquired under a recapitalization transaction whereby its former members’ ownership interests were redeemed by two new members controlled by The Alliant Company, LLC (“TAC” or “Alliant”). The financial statements of EF&A reflect the allocation of the purchase price of the new owners under the application of push down accounting.

The Company originates, sells, and services multifamily loans under the Delegated Underwriting and Servicing (“DUS”) program of the Federal National Mortgage Association (“Fannie Mae”). As a result, the Company is dependent on the DUS program for all of its servicing and origination revenue. The Company is a HUD-approved Title II Non-supervised Mortgagee, however no Title II Non-supervised Mortgages have been closed in 2012 or 2011. For the years ended December 31, 2012 and 2011, the Company originated loans in 24 states and 19 states, respectively.

Note 2 - Significant Accounting Policies

Basis of Financial Statement Presentation

The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and reporting practices applicable to the mortgage banking industry.

Risks and Uncertainties

In the normal course of its business, the Company encounters two significant types of risk: economic and regulatory. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the extent that in a rising interest rate environment, the Company may experience a decrease in loan production, which may negatively impact the Company’s operations. In a falling interest rate environment, the Company may be exposed to prepayment risk that may negatively impact the Company’s operations, including servicing revenue as well as the valuation of the mortgage servicing rights. Credit risk is the risk of default, primarily in the Company’s servicing portfolio that can result in a larger recourse liability. Market risk reflects changes in the value of securities, the value of collateral underlying loans receivable and the valuation of real estate owned, if any.

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

The Company is subject to the regulations of the Fannie Mae DUS program and the Federal Housing Administration Title II Non-Supervised Mortgagee Program. These regulations may change significantly from period to period. Such regulations can also restrict the growth of the Company as a result of capital, underwriting and servicing requirements.

Use of Estimates

The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to change in the near term relate to the valuation of mortgage servicing rights, retained interest in securitization and liability for recourse obligations. Because of inherent uncertainties in estimating these items, it is at least reasonably possible that the estimates used will change in the near term.

Cash and Cash Equivalents

For the purpose of reporting cash flows, cash and cash equivalents includes cash on hand and money market securities with original maturities of less than 90 days.

Receivables

Receivables are reported net of an allowance for doubtful accounts. Management’s estimate of the allowance is based on historical collection experience and a review of the current status of receivables.

Mortgage Loans Held for Sale

The Company originates low-income multi-family mortgage loans which are recorded at the lower of cost or market. The holding period for these loans is generally one month and the loans are sold to investors at an amount equal to their carrying basis.

Mortgage loans held for sale are sold with mortgage servicing rights retained by the Company. The carrying value of the mortgage loans sold is reduced by the cost allocated to the associated mortgage servicing rights based on relative fair market values at the time of sale. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the adjusted value of the related mortgage loans sold.

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

Property and Equipment

Furniture, equipment, leasehold improvements and software are stated at cost less accumulated depreciation. Depreciation of furniture, equipment and software is computed using the straight-line method over the estimated useful lives of the assets, ranging from 3 to 7 years.

Amortization of leasehold improvements is computed over the shorter of estimated useful lives of the assets or the term of the related lease using the straight-line method. Repairs and maintenance costs are expensed as incurred.

Mortgage Servicing Rights

The Company records an asset representing the right to service loans for others whenever it sells a loan and retains the mortgage servicing rights (“MSRs”). When the Company sells mortgage loans, it allocates the cost of the mortgage loans between the loans sold and the interest it continues to hold, based on relative fair values. In accordance with GAAP, the Company reports all MSRs using the fair value method. Under the fair value method, these MSRs are carried in the balance sheet at fair value and the changes in fair value, primarily due to changes in valuation inputs and assumptions and to the collection/realization of expected cash flows, are reported in income.

Retained Interest in Securitization

The Company classifies its retained interest in securitizations as available-for-sale and carries these securities at their estimated fair value. If the fair value of the retained interest declines below its amortized cost, the change in valuation is recognized as a loss in the statement of operations. Interest income on the retained interest is recognized using the effective yield method. Because market quotes are generally not available for retained interests, the Company estimates fair value based upon the present value of estimated future cash flows using assumptions of loss severity rates and discount rates that the Company believes market participants would use for similar assets and liabilities.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the entity, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the entity does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

Mortgage loan sales to Fannie Mae or other private investors under the DUS program meet the criteria described above. Accordingly, when financial assets are transferred, management removes the sold loans from the balance sheet and recognizes a gain on sale in the statement of operations.

Interest Rate Lock Commitments

The Company enters into interest rate lock commitments with borrowers on loans intended to be held for resale and enters into forward sale commitments under the Fannie Mae DUS program. In accordance with GAAP, those commitments are considered freestanding derivative instruments. The interest rate exposure on the interest rate lock commitments is economically hedged with forward sale commitments entered into with Fannie Mae. Under the Fannie Mae DUS program, both the interest rate lock commitment and forward sale commitment are entered into simultaneously. The Company records all interest rate lock commitments to customers and commitments to sell to Fannie Mae at fair value, and any changes in fair value are recorded in earnings.

Borrowers’ Deposits

The Company holds borrowers’ deposits, which represent undisbursed funds that were collected for the processing of borrowers’ loan applications and rate lock commitments. These deposits are collected from borrowers to be used for loan processing costs that are disbursed by the Company on behalf of the borrowers. These funds are deposited in an account separate from the Company’s operating funds. It is the Company’s policy to refund undisbursed deposits within 60 days after the close of escrow. Borrowers’ deposits from the small loan group are typically refunded at loan closing. The Company holds other deposits, which represent non-refundable application deposits and rate lock deposits.

Recourse Liability

Under the Fannie Mae DUS program, the Company is responsible for absorbing losses on Fannie Mae Level I originated loans in accordance with its loss sharing agreement with Fannie Mae. The Company’s loss sharing obligation is limited to a maximum amount equal to 33.33 percent of the original mortgage loan amount. The recourse liability is based on estimates and is maintained at a level considered adequate to provide for future loss obligations. An estimate of the recourse liability is recorded at the time of transfer. The liability is increased by provisions charged to income and reduced by net charge-offs. In evaluating the adequacy of the liability, the Company performs credit reviews of the servicing portfolio that considers the borrower’s ability to repay, the value of any underlying collateral, the seriousness of the loan’s delinquency status and other factors that affect the collectability of the loan and the estimated amount of the Company’s recourse liability.

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

Loan Origination Fees

Loan origination fees and certain direct loan origination costs for mortgage loans held for sale are deferred until the related loans are sold. Net deferred loan origination fees as of December 31, 2012 and 2011 were $262,671 and $247,534, respectively and are included in deferred income and other liabilities on the balance sheet.

Loan Servicing Revenue

Loan servicing revenue is earned for servicing loans, including all activities related to servicing the loans, for Fannie Mae under the DUS program and other investors and is recognized as services are provided.

Goodwill and Other Intangible Assets

Goodwill consists principally of the excess of cost over the fair value of net assets acquired in business combinations, $3,247,000 at acquisition date, and is not amortized. Other intangible assets include identifiable intangible assets with indefinite lives of approximately $10,120,000 and identifiable intangible assets with finite lives of approximately $9,320,000. Intangible assets with indefinite lives (trade name, trademark and Fannie Mae DUS agreement) are not amortized and intangible assets with finite lives (borrower relationships, technology, and non-compete agreements) are amortized over periods ranging from 4 to 5 years.

For the years ended December 31, 2012 and 2011, amortization expense was $- and $1,148,000, respectively. As of December 31, 2012 and 2011, accumulated amortization for amortizable intangible assets was $9,320,000 and $9,320,000, respectively. All amortizable intangible assets were fully amortized during the year ended December 31, 2012.

In accordance with GAAP, the Company performs an annual assessment of impairment of its intangible assets in the fourth quarter of each year, unless circumstances dictate assessments that are more frequent. Each test of goodwill requires the Company to determine the fair value of each reporting unit, and compare the fair value to the reporting unit’s carrying amount. A reporting unit is defined as an operating segment or one level below an operating segment. The Company determines the fair value of its reporting units using a combination of three valuation methods: market multiple approach; discounted cash flow approach; and comparable transactions approach. To the extent a reporting unit’s carrying amount exceeds its fair value, an indication exists that the reporting unit’s goodwill may be impaired and the Company must perform a second more detailed impairment assessment. The second impairment assessment involves allocating the reporting unit’s fair value to all of its recognized and unrecognized assets and liabilities in order to determine the implied fair value of the reporting unit’s goodwill as of the assessment date. The implied fair value of the reporting unit’s goodwill is then

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

compared to the carrying amount of goodwill to quantify an impairment charge as of the assessment date. The Company’s annual assessment concluded that there was no impairment of goodwill or indefinite-lived intangible assets as of the Company’s testing date.

Income Taxes

The Company has elected to be treated as a pass-through entity for income tax purposes and, as such, is not subject to income taxes. Rather, all items of taxable income, deductions and tax credits are passed through to and are reported by its owners on their respective income tax returns. The Company’s federal tax status as a pass-through entity is based on its legal status as a limited liability company. Accordingly, the Company is not required to take any tax positions in order to qualify as a pass-through entity. The Company is required to file and does file tax returns with the Internal Revenue Service and other taxing authorities. Accordingly, these financial statements do not reflect a provision for income taxes and the Company has no other tax positions that must be considered for disclosure. Income tax returns filed by the Company are subject to examination by the Internal Revenue Service for a period of three years. While no income tax returns are currently being examined by the Internal Revenue Service, tax years since 2009 remain open.

Fair Value of Financial Instruments

The Company’s financial instruments consist of cash, cash equivalents, mortgage loans held for sale, short-term accounts receivable, short-term accounts payable and accrued expenses. The carrying value of these financial instruments approximates fair value due to the short-term nature of these items. Management believes it is not practical to determine the fair value of its related party notes payable and its preferred capital units.

Reclassifications

Certain items from the prior period financial statements have been reclassified to conform to the current year presentation. The reclassifications have no effect on net income or loss for that period.

Recent Accounting Pronouncements

In May 2011, the FASB issued an ASU to the fair value measurement and disclosure accounting guidance which provides a consistent definition and measurement of fair value, as well as similar disclosure requirements between U.S. GAAP and International Financial Reporting Standards. The ASU changes certain fair value measurement principles, clarifies the application of existing fair value measurement and expands the fair value disclosure requirements, particularly for Level 3 fair value measurements which was effective for the Company on January 1, 2012. The

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

adoption of the ASU did not have a material effect on its financial statements, but may require certain additional disclosures.

In September 2011, the FASB issued an ASU related to the accounting for goodwill. Under the goodwill ASU, entities have the option of performing a qualitative assessment before calculating the fair value of the reporting unit when testing goodwill for impairment. If the fair value of the reporting unit is determined, based on qualitative factors, to be more likely than not less than the carrying amount of the reporting unit, then entities are required to perform the two-step goodwill impairment test. The ASU was effective for the Company on January 1, 2012, with early adoption permitted. The adoption of the goodwill ASU did not have a material effect on the Company’s financial statements.

Note 3 - Restricted Cash

As of December 31, 2012 and 2011, restricted cash consisted of the following:

	2012		2011
Borrowers’ deposits	$	657,098	$	400,566
FDIC-insured money market accounts	13,709,753		11,723,508

Total restricted cash	$	14,366,851	$	12,124,074

Note 4 - Receivables

As of December 31, 2012 and 2011, receivables consisted of the following:

	2012		2011
Service fees receivables	$	1,339,435	$	1,198,210
Servicing expense receivables	44,913		248,205
Advances on delinquent loans	221,577		2,728,395
Inspection fee receivable	—		232,800
Note receivable and accrued interest	—		138,954
Miscellaneous receivables	105,595		128,935

Total Receivables	$	1,711,520	$	4,675,499

Advances on delinquent loans of $221,577 and $2,728,395 as of December 31, 2012 and 2011, respectively, are advances paid to Fannie Mae in connection with the loss sharing recourse liability (see Note 9 - Recourse Liability). These advances will be applied against the Company’s obligations under the recourse liability when settlements occur. Accordingly, they are presented in the financial statements at

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

their full amount. The Company expects a majority of the non-performing loan receivable balances to be applied against the final recourse amount.

Property Inspection Fees Receivable

The Company receives fees for property inspections that it performs on behalf of Alliant Asset Management Company (“AAMC”), an entity with common ownership to TAC. For the years ended December 31, 2012 and 2011, $151,200 and $232,800 was earned, included in loan servicing revenue in the accompanying statement of operations. As of December 31, 2012 and 2011, the balance of the related receivable from AAMC was $- and $232,800, respectively, included in receivables on the accompanying balance sheet.

Note 5 - Property and Equipment

As of December 31, 2012 and 2011, property and equipment consisted of the following:

	2012			2011
Furniture and equipment	$	505,392		$	483,056
Leasehold improvements	12,520			10,489
Software	109,399			121,976

	627,311			615,521
Less accumulated depreciation	(336,366		)	(339,935		)

Property and equipment, net	$	290,945		$	275,586

For the years ended December 31, 2012 and 2011, depreciation expense was $105,935 and $85,872, respectively.

Note 6 - Mortgage Servicing Rights

The value of MSRs is derived from the cash flows associated with the servicing contracts on loans sold. The Company receives a servicing fee ranging generally from 5 to 84 basis points annually on the remaining outstanding principal balances of the loans. The servicing fees are collected from the monthly payments made by the mortgagees. The Company generally receives other remuneration including rights to various mortgagor-contracted fees such as late charges, collateral re-conveyance charges and loan prepayments penalties and the Company is generally entitled to retain the interest earned on funds held pending remittance related to its collection of mortgagor principal.

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

The precise market value of MSRs cannot be readily determined because this asset is not actively traded in stand-alone markets. Considerable judgment is required to determine the fair values of this asset and the exercise of such judgment can significantly impact the Company’s earnings. Therefore, management exercises extensive and active oversight of this process.

The Company’s MSR valuation process combines the use of a discounted cash flow model, extensive analysis of current market data and senior financial management oversight to arrive at an estimate of fair value at each balance sheet date. The cash flow assumptions and prepayment assumptions used in the discounted cash flow model are based on management’s own empirical data drawn from the historical performance of the MSRs, which management believes is consistent with assumptions and data used by market participants valuing MSRs. The most critical assumptions used in the valuation of MSRs include the rate mortgages are prepaid and discount rates. These variables can, and generally do, change from quarter to quarter as market conditions and projected interest rates change. Management does contract with an outside service to make the associated calculations and reviews the calculations and assumptions used prior to recording any fair value adjustment.

As of December 31, 2012 and 2011, key assumptions used in estimating the fair value of the Company’s MSRs and the effect on the estimated fair value from adverse changes in those assumptions were as follows (weighted averages are based upon unpaid principal balance):

	2012			2011
Fair value of MSRs	$	60,980,749		$	55,070,413
Weighted average prepayment rate	1.43		%	1.47		%
Weighted average life (in months)	64			64
Cash flow discount rate	12.00		%	12.00		%

As of December 31, 2012 and 2011, mortgage servicing rights consisted of the following:

	2012			2011
Fair value, beginning of year	$	55,070,413		$	53,137,872
Servicing resulting from transfers of financial assets	15,107,538			11,727,876
Change in fair value due to payments and payoffs on loans	(9,197,202		)	(9,795,335		)

Fair value, end of year	$	60,980,749		$	55,070,413

Note 7 - Fair Value Disclosures

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

standard for fair value measurement and disclosures as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. It also establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three levels. The following summarizes the three levels of inputs and hierarchy of fair value the Company uses when measuring fair value:

Level 1

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.

Level 2

Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3

Level 3 inputs are unobservable inputs for the asset or liability that are typically based on an entity’s own assumptions as there is little, if any, related market activity.

In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the fair value measurement will fall within the lowest level input that is significant to the fair value measurement in its entirety.

The following describes valuation methodologies used to measure each assets and liabilities at fair value on a recurring and nonrecurring basis, as well as the classification of the assets or liability within the fair value hierarchy.

Mortgage Servicing Rights

Mortgage servicing rights are valued based on valuation models that utilize assumptions based on the predominant risk characteristics of the underlying loans, including principal balance, interest rate, weighted average life, cost to service and estimated prepayment speeds. See Note 6 for specific assumptions used in valuing mortgage servicing rights. The valuation models estimate the present value of estimated future net servicing income. The Company classifies mortgage servicing rights subjected to recurring fair value adjustments as Level 3.

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

Retained Interest in Securitization

Retained interest in securitization is valued based on the estimated fair value based on the net present value of estimated future cash flows. See Note 8 for the specific assumptions used in valuing retained interest in securitization. The Company classifies retained interest in securitization subjected to recurring fair value adjustments as Level 3.

Loan Commitments

Unlike most other derivative instruments, there is no active market for the forward loan commitments that can be used to determine their fair value. The Company has developed a method for estimating the fair value by calculating the change in market value from a commitment date to a measurement date based upon changes in applicable interest rates during the period. The Company classifies loan commitments subjected to recurring fair value adjustments as Level 3.

Items Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis as of December 31, 2012 and 2011 are reflected in the following tables:

December 31, 2012

(In thousands of dollars)	Level 1		Level 2		Level 3			Fair Value
Mortgage servicing rights	$	—	$	—	$	60,981		$	60,981
Retained interest in securitization	—		—		367			367
Interest rate lock commitments	—		—		809			809
Forward sale commitments	—		—		(917		)	(917		)

December 31, 2011

(In thousands of dollars)	Level 1		Level 2		Level 3			Fair Value
Mortgage servicing rights	$	—	$	—	$	55,070		$	55,070
Retained interest in securitization	—		—		394			394
Interest rate lock commitments	—		—		753			753
Forward sale commitments	—		—		(832		)	(832		)

Note 8 - Retained Interest in Securitization

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

estimated fair value was $367,414 and $394,127 and related to all tranches of this security held by the Company (included in Note 11 as “Loans Serviced - Fannie Mae Non DUS”).

In 2011, management elected to revise the discount rate to better reflect the economic performance of the retained interest securities. The significant assumptions used in estimating the fair value of the retained interest were as follows:

	2012		2011
Cash flow discounted rate	10	%	10	%
Loss severity rate	1	%	1	%

The revision to the discount rate was accounted for prospectively as a change in accounting estimate, and as a result, the estimated fair value of the retained interest in securitization increased by $111,052 over the previous discount rate.

As of December 31, 2012, retained interest in securitization consisted of the following:

Fair value, beginning of year	$	394,127
Loss on interest in securitization	(26,713		)

Fair value, end of year	$	367,414

Note 9 - Recourse Liability

As of December 31, 2012 and 2011, recourse liability consisted of the following:

	2012			2011
Balance, beginning of year	$	12,908,790		$	16,585,574
Provision for recourse liability	4,543,556			3,538,644
Losses incurred/settlements	(6,017,287		)	(7,215,428		)

Balance, end of year	$	11,435,059		$	12,908,790

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

Loans sold under the Fannie Mae DUS program are subject to the Fannie Mae master loss sharing agreement, which was amended and restated during 2012. The amended agreement modified primarily the way in which the Company shares losses with Fannie Mae and the modifications were retroactive to cover primarily all loans under service by the Company. Under the amended agreement, the Company is required to share the losses incurred by Fannie Mae of up to 33.33 percent of the outstanding mortgage balance. As of December 31, 2012 and 2011, the outstanding balance of loans sold under this program was approximately $3.9 billion and $3.7 billion, respectively, and represents off-balance sheet risk in the normal course of business. The recourse liability has been established to address the Company’s potential loss exposure under the Fannie Mae loss sharing agreement.

Note 10 - Notes Payable

Line of Credit

As of December 31, 2012 and 2011, the Company maintained a line of credit with Bank of America, N.A. of $80,000,000 with a stated interest rate of BBA LIBOR Daily Floating Rate plus 1.60 and BBA LIBOR Daily Floating Rate plus 2.50, respectively. As of December 31, 2012 and 2011, the rate was 1.812 percent and 2.796 percent, respectively. The current line of credit agreement expires June 30, 2013, and is expected to be renewed. As of December 31, 2012 and 2011, outstanding borrowings under this line were $47,350,527 and $15,997,354, respectively.

The line is collateralized by a first lien on the Company’s interest in the mortgage loans that it originates and has not yet sold. Advances from the line of credit cannot exceed 95 percent of the principal amounts of the mortgage loans originated by the Company and must be repaid at the earlier of the sale or other disposition of the mortgage loans or at the expiration date of the warehouse line of credit. The terms under the line of credit agreement require the Company to comply with various covenants, including a minimum tangible net worth requirement. Management believes the Company is in compliance with all covenants as of the balance sheet dates.

ASAP Line of Credit

In 2009, the Company entered into a Multifamily As Soon As Pooled (“ASAP”) sale agreement with Fannie Mae. The agreement authorizes the Company to deliver closed and funded multifamily mortgage loans concurrent with entering into a designated forward sale agreement with each of those loans for a specified price. Fannie Mae then advances payment to the Company in two separate installments according to the terms as set forth ASAP sale agreement. The first installment is considered an advance to the Company from Fannie Mae and not a sale until the

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

second advance and settlement. Installments received by the Company from Fannie Mae to fund loans are financed on the Fannie Mae ASAP Line of Credit which charges interest at a floating daily rate of LIBOR+150 with a floor of 1.85 percent and secured by the originated loan. In November 2012, the floating daily rate was adjusted to LIBOR+150 with a floor of 1.75 percent. As of December 31, 2012 and 2011, the rate was at the stated minimum of 1.75 percent and 1.85 percent, respectively. As of December 31, 2012 and 2011, $-0- and $16,801,757 of loans are being held for sale through the ASAP program and are in included in Mortgages loans held for sale on the accompanying balance sheets. Furthermore, a corresponding outstanding borrowing of $-0- and $16,801,757 on the ASAP Line exists at December 31, 2012 and 2011, respectively, and included in the Warehouse Line of Credit line of the accompanying balance sheet.

Note Payable - Related Party

As part of the recapitalization agreement on January 12, 2007, a $64,000,000 subordinated note payable to TAC was created. The note payable to TAC is related to a loan the TAC has with a bank. The note bears interest at a rate of 8 percent per annum and matures in 2014. For the years ended December 31, 2012 and 2011, interest incurred on the note was $3,890,466 and $3,879,838, respectively. As of December 31, 2012 and 2011, accrued and unpaid interest was $6,477,042 and $5,262,792, respectively. As of December 31, 2012 and 2011, the balance of the note payable to TAC was $47,833,607 and $47,833,607, respectively.

The financial covenants were modified for the measurement period ending December 31, 2009, and management believes the Company was in compliance with all covenants as of December 31, 2011. However, in 2011, the Company was not able to meet all of the debt covenant ratio requirement due to the unexpected expense related to payment of a termination benefit paid to the Company’s former CEO who retired due to a terminal illness (see Note 13). Because of the unusual nature of the CEO’s termination expense which resulted in the Company’s inability to meet the required debt service ratio requirement, management requested and received waivers from the lender regarding the debt covenant violation for each of the two quarterly compliance periods ended December 31, 2011 and for the first two quarterly compliance periods during the year ended December 31, 2012. Management believes the Company was in compliance with all debt covenants for the remaining two quarterly compliance periods during the year ended December 31, 2012.

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

March 31, 2012, June 30, 2012, and September 30, 2012. Management believes the Company was in compliance with all covenants, as modified, as of December 31, 2012

As of December 31, 2012, the principal payments required under the loan between TAC and the bank for each of the next three years were as follows:

Ending December 31,	Amount
2013	$	8,250,000
2014	8,000,000
2015	8,750,000

	$	25,000,000

The Company is not required to make periodic principal payments according to the terms of its loan agreement with TAC, and made no principal payments during the years ended December 31, 2012 and 2011.

Note 11 - Loan Servicing and Escrow Funds

As of December 31, 2012 and 2011, the Company’s loans servicing consisted of the following:

	2012			2011
	Loans	Dollar Value		Loans	Dollar Value
Loans serviced - Fannie
Mae Level I	1,011	$	3,880,027,693	931	$	3,689,377,076
Loans serviced - Fannie
Mae Non DUS	8	8,279,859		8	9,245,345

Totals	1,019	$	3,888,307,552	939	$	3,698,622,421

As of December 31, 2012 and 2011, related custodial funds on deposit in custodial bank accounts were $77,700,901 and $71,151,765, respectively, which are not included in the accompanying balance sheets. However, the Company does benefit from these deposits by retaining interest earned.

Note 12 - 401(k) Plan

The Company has adopted a 401(k) savings plan (the “Plan”) that covers all employees having completed at least three months of service and attained age 21. Participants may make voluntary contributions to the Plan of up to 90 percent of their compensation or the maximum allowed by the Internal Revenue Service. The Company does not match employees’ contributions.

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

Note 13 - Commitments and Contingencies

Loan Commitments

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business. To date, these financial instruments include commitments to extend credit and sell loans.

Commitments to extend credit are generally agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Occasionally, the commitments may expire without being drawn upon, therefore, the total commitment amounts does not necessarily represent future cash requirements.

As of December 31, 2012, outstanding commitments were as follows:

Commitments to sell loans	$	54,424,000

Commitments to fund loans	$	5,297,100

As of December 31, 2011, outstanding commitments were as follows:

Commitments to sell loans	$	44,080,678

Commitments to fund loans	$	8,163,275

The Company sells substantially all of its loan originations in the secondary market. The Company uses derivative instruments to manage interest rate risk associated with these activities. Specifically, the Company enters into interest rate lock commitments (“IRLCs”) with borrowers, which are considered to be derivative instruments. The Company manages its exposure to interest rate risk in IRLCs by entering into forward sale commitments to sell loans to Fannie Mae. Commitments to sell loans expose the Company to interest rate risk if market rates of interest decrease during the commitment period. Such forward sale commitments are considered to be derivative instruments. These derivatives are not designated as accounting hedges as specified in GAAP. As such, changes in the fair value of the derivative instruments are recognized currently through earnings.

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

As of December 31, 2012 and 2011, the fair value of interest rate lock commitments was as follows:

	2012		2011
Fair value, beginning of year	$	753,000	$	838,000
Gain (loss) in interest rate lock commitments	56,000		(85,000		)

Fair value, end of year	$	809,000	$	753,000

As of December 31, 2012 and 2011, the fair value of forward sale commitments was as follows:

	2012			2011
Fair value, beginning of year	$	(832,000	)	$	(841,000	)
Gain (loss) in forward sale commitments	(85,000		)	9,000

Fair value, end of year	$	(917,000	)	$	(832,000	)

As of December 31, 2012 and 2011, net unrealized cumulative losses of $29,000 and $79,000, respectively, were recognized in net loss on loan sales activities on the derivative instruments specified in the previous paragraph.

The following table summarizes the Company’s derivative assets and liabilities as of December 31, 2012 and 2011:

	2012			2011
Interest rate lock commitments	$	809,000		$	753,000
Forward sale commitments	(917,000		)	(832,000		)

Net unrealized cumulative loss	$	(108,000	)	$	(79,000	)

Unrealized gains of $809,000 and $753,000 on IRLCs are included in other assets and unrealized losses of $917,000 and $832,000 on forward sale commitments are included in other liabilities at December 31, 2012 and 2011, respectively.

Fannie Mae DUS Reserve

As of December 31, 2012 and 2011, U.S. Government and governmental agency securities and cash equivalents pledged to Fannie Mae were approximately $13,700,000 and $11,700,000, respectively. Fannie Mae requires the Company to maintain in its favor permitted investments or a letter of credit that serves as additional collateral to secure any loan loss obligation of a DUS lender to Fannie

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

Mae. The amount of the permitted investments or letter of credit increases or decreases depending upon the amount of the original principal balance of mortgage loans sold to Fannie Mae by the DUS lender.

Mortgage Impairment Insurance

As of December 31, 2012 and 2011, the Company carried mortgage impairment insurance coverage of $25,000,000 each year. Mortgage impairment insurance provides the Company with hazard insurance coverage for mortgage loan collateral in the event of a catastrophe for which the borrowers insurance does not provide sufficient coverage to protect the Company from loss on loans originated under the Fannie Mae DUS program.

Mortgage Bankers’ Blanket Bond

As of December 31, 2012 and 2011, the Company carried a mortgage bankers’ blanket bond of $5,000,000, and carried errors and omissions insurance coverage in excess of the mortgage bankers’ blanket bond of $8,500,000 for the years ended December 31, 2012 and 2011.

Lease Commitments

The Company is obligated under a non-cancelable lease for office space in various cities through March 31, 2017. As of December 31, 2012, future minimum lease payments under non-cancelable leases were estimated as follows:

Ending December 31,	Amount
2013	$	350,899
2014	316,246
2015	86,697
2016	88,944
2017	37,450

	$	880,236

The Company currently leases office space in Washington D.C.; San Francisco, California; Chicago, Illinois; Seattle, Washington; and Alpharetta, Georgia on a year-to-year basis that is not included in the future lease commitments detailed above. For the years ended December 31, 2012 and 2011, total rent expense was $555,020 and $559,313, respectively.

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

Litigation

In the normal course of business, the Company is at times subject to pending and threatened legal actions and proceedings. After reviewing with counsel, management does not believe that any pending proceedings will result in a material adverse effect on the Company’s financial condition, results of operations, or cash flows.

Fannie Mae Loan Guarantee

In early 2009, the Company originated and sold a $25,998,500 loan (the “Southside Loan”) to Fannie Mae. Subsequently, in November 2009, an affiliate of the Company purchased the Southside Loan with financing provided by Fannie Mae. The Company and TAC provided a guarantee to Fannie Mae for the loan totaling $26,489,662. Separately, TAC has entered into a Guaranty Reimbursement Agreement (see below) with the Company whereby TAC has agreed to fund any payments under the Fannie Mae loan guaranty. The affiliate incurred a loss of $13,427,952 based upon appraised values of its underlying collateral related to the loan. As of November 1, 2012, this loan was paid in full by the affiliate.

Guaranty Reimbursement Agreement

The Company entered into a Guaranty Reimbursement Agreement with TAC on November 1, 2009, whereby TAC has agreed to fund any payments required to be made under the Fannie Mae loan guaranty described above related to the Southside Loan. As a result, the Company did not make any payments pursuant to the Southside Loan and the loan was paid in full by the affiliate in November 1, 2012.

Percentage Compensation Put

During 2011, the Company’s CEO became disabled and the Company exercised its rights to terminate his employment on June 1, 2011. The termination resulted in payment of specified termination benefits totaling $350,000, which is included in compensation and benefits in the accompanying statement of operations.

Additionally, during 2010 the Company entered into a compensation agreement which provided the CEO with certain vested rights in the future income on the Company’s mortgage servicing portfolio upon occurrence of certain events. On October 1, 2011, an option under the agreement was exercised whereby remaining payments could be accelerated on a discounted basis. The accelerated payment provision provides for payment of one third of the entire benefit upon the exercise of the put, and the remaining balance over equal monthly installments over the subsequent 36 months. The total benefit under the agreement is $3,170,916, of

EF&A Funding, LLC

Notes to Financial Statements - Continued

December 31, 2012 and 2011

which $640,708 was reserved for losses on loans. As of December 31 2012 and 2011, $1,098,824 and $1,633,495, respectively, of the percentage compensation remains payable, included in accounts payable and other accrued liabilities in the accompanying balance sheet.

Note 14 - Subsequent Events

Events that occur after the balance sheet date but before the financial statements were available to be issued must be evaluated for recognition or disclosure. The effects of subsequent events that provide evidence about conditions that existed at the balance sheet date are recognized in the accompanying financial statements. Subsequent events which provide evidence about conditions that existed after the balance sheet date require disclosure in the accompanying notes. Management evaluated the activity of the Company through March 30, 2013 and concluded that no subsequent events have occurred that would require recognition in the financial statements.

EX-99.2 5 a13-13231_1ex99d2.htm EX-99.2

Exhibit 99.2

EF&A Funding, LLC

Financial Statements

Three months ended March 31, 2013 (Unaudited)

EF&A Funding, LLC

Index

	Page

Financial Statements

Balance Sheets	3

Statements of Operations	4

Statements of Changes in Members’ Equity	5

Statements of Cash Flows	6

Notes to Financial Statements	8

EF&A Funding, LLC

Balance Sheets (Unaudited)

March 31, 2013 and December 31, 2012

	March 31, 2013		December 31, 2012
Assets

Cash and cash equivalents	$	1,261,580	$	4,924,016
Restricted cash	15,014,909		14,366,851
Mortgage loans held for sale	65,025,001		54,424,000
Receivables	2,039,910		1,711,520
Property and equipment, net	315,368		290,945
Mortgage servicing rights, at fair value	61,897,080		60,980,749
Intangible assets	10,120,000		10,120,000
Retained interest in securitization	353,458		367,414
Goodwill	3,247,000		3,247,000
Prepaid expenses and other assets	1,277,862		1,301,036

Total assets	$	160,552,168	$	151,733,531

Liabilities and Members’ Equity

Liabilities
Warehouse lines of credit	$	54,540,293	$	47,350,526
Note payable - related party	47,833,607		47,833,607
Accrued interest on related party note payable	7,433,714		6,477,042
Accounts payable and other accrued liabilities	2,851,331		3,094,734
Borrowers’ deposits	734,863		637,596
Recourse liability	11,671,115		11,435,059
Deferred income and other liabilities	1,125,420		1,179,671

Total liabilities	126,190,343		118,008,235

Commitments and contingencies	—		—

Members’ Equity	34,361,825		33,725,296

Total liabilities and members’ equity	$	160,552,168	$	151,733,531

See notes to financial statements

EF&A Funding, LLC

Statements of Operations (Unaudited)

Three months ended March 31, 2013 and 2012

	Three months ended March 31,
	2013			2012
Revenues
Loan servicing revenue	$	3,946,442		$	3,525,605
Change in fair value of mortgage servicing rights	916,332			30,806
Loan origination revenue	1,776,013			993,779
Gain on loan sales	698,928			313,113
Interest	339,613			256,537
Recourse liability provision	(236,056		)	(189,323		)

Total revenues	7,441,272			4,930,517

Expenses
Compensation and benefits	4,678,975			3,044,781
Occupancy and office expenses	214,683			181,374
Data processing	228,357			102,948
Professional fees	61,196			86,727
Interest	1,146,119			1,111,733
Depreciation expense	26,340			26,825
Other general and administrative expenses	449,073			377,401

Total expenses	6,804,743			4,931,789

Net income (loss)	$	636,529		$	(1,272	)

See notes to financial statements

EF&A Funding, LLC

Statements of Changes In Members’ Equity (Unaudited)

Three months ended March 31, 2013 and 2012

Members’ equity, December 31, 2011	$	28,731,791

Net loss	(1,272		)

Members’ equity, March 31, 2012	$	28,730,519

Members’ equity, December 31, 2012	$	33,725,296

Net income	636,529

Members’ equity, March 31, 2013	$	34,361,825

See notes to financial statements

EF&A Funding, LLC

Statements of Cash Flows (Unaudited)

Three months ended March 31, 2013 and 2012

	Three months ended March 31,
	2013			2012
Cash flows from operating activities
Net income (loss)	$	636,529		$	(1,272	)
Adjustments to reconcile net income to net cash
Change in fair value of mortgage servicing rights	(916,332		)	(30,806		)
Change in fair value of interest rate lock commitments	(28,000		)	(193,000		)
Change in fair value of forward sale commitments	(90,000		)	201,000
Change in fair value of retained interest in securitization	13,956			18,004
Change in recourse liability	236,056			(1,779,289		)
Loss on disposal of property and equipment	455			689
Depreciation and amortization	26,340			26,825
Mortgage loans originated	(123,179,100		)	(105,179,275		)
Proceeds from sales of mortgage loans	112,578,099			77,091,280
Changes in:
Receivables	(328,390		)	234,853
Prepaid expenses and other assets	51,175			77,227
Accrued interest on related party note payable	956,672			967,302
Accounts payable and other accrued liabilities	(243,403		)	(209,552		)
Borrowers’ deposits	97,267			99,129
Deferred income and other liabilities	35,749			(11,704		)

Net cash used in operating activities	(10,152,927		)	(28,688,589		)

Cash flows from investing activities
Net increase in restricted cash	(648,058		)	(599,418		)
Purchases of property and equipment	(51,218		)	(68,761		)

Net cash used in investing activities	(699,276		)	(668,179		)

(continued)

EF&A Funding, LLC

Statements of Cash Flows — Continued (Unaudited)

Three months ended March 31, 2013 and 2012

	Three months ended March 31,
	2013			2012
Cash flows from financing activities
Proceeds from warehouse lines of credit	7,189,767			29,008,763

Net cash provided by financing activities	7,189,767			29,008,763

Net decrease in cash and cash equivalents	(3,662,436		)	(348,005		)

Cash and cash equivalents, beginning of year	4,924,016			875,492

Cash and cash equivalents, end of year	$	1,261,580		$	527,487

Supplemental disclosures of cash flow information
Cash paid for interest	$	189,447		$	165,051

See notes to financial statements

EF&A Funding, LLC

Notes to Financial Statements (Unaudited)

March 31, 2013

Note 1 - Organization

The Company originates, sells, and services multifamily loans under the Delegated Underwriting and Servicing (“DUS”) program of the Federal National Mortgage Association (“Fannie Mae”). As a result, the Company is dependent on the DUS program for all of its servicing and origination revenue. The Company is a HUD-approved Title II Non-supervised Mortgagee, and has had zero and zero Title II Non-supervised Mortgages closed in 2013 or 2012, respectively. During the three months ended March 31, 2013, the Company was approved as a Government National Mortgage Association (“Ginnie Mae”) lender, however no Ginnie Mae loans had been funded as of March 31, 2013. For the three months ended March 31, 2013 and 2012, the Company originated loans in 18 states and 12 states, respectively.

Note 2 - Significant Accounting Policies

Basis of Financial Statement Presentation

Risks and Uncertainties

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

Use of Estimates

Cash and Cash Equivalents

For the purpose of reporting cash flows, cash and cash equivalents includes cash on hand and money market securities with original maturities of less than 90 days.

Concentration of Credit Risk

At various times throughout the year, the Company maintains cash and cash equivalents in accounts with various financial institutions in excess of the amount insured by the Federal Deposit Insurance Corporation. The Company’s management regularly monitors the financial stability of these financial institutions and does not believe there is a significant credit risk associated with deposits in excess of federally insured amounts.

Receivables

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

Mortgage Loans Held for Sale

The Company originates multi-family mortgage loans which are recorded at the lower of cost or market. The holding period for these loans is generally one month and the loans are sold to investors at an amount equal to their carrying basis.

Property and Equipment

Mortgage Servicing Rights

Retained Interest in Securitization

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

loss severity rates and discount rates that the Company believes market participants would use for similar assets and liabilities.

Transfers of Financial Assets

Interest Rate Lock Commitments

Borrowers’ Deposits

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

Recourse Liability

Loan Origination Fees

Loan origination fees and certain direct loan origination costs for mortgage loans held for sale are deferred until the related loans are sold. Net deferred loan origination fees as of March 31, 2013 and December 31, 2012 were $298,420 and $262,671, respectively and are included in deferred income and other liabilities on the balance sheet.

Loan Servicing Revenue

Goodwill and Other Intangible Assets

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

comparable transactions approach. To the extent a reporting unit’s carrying amount exceeds its fair value, an indication exists that the reporting unit’s goodwill may be impaired and the Company must perform a second more detailed impairment assessment. The second impairment assessment involves allocating the reporting unit’s fair value to all of its recognized and unrecognized assets and liabilities in order to determine the implied fair value of the reporting unit’s goodwill as of the assessment date. The implied fair value of the reporting unit’s goodwill is then compared to the carrying amount of goodwill to quantify an impairment charge as of the assessment date. The Company’s annual assessment concluded that there was no impairment of goodwill or indefinite-lived intangible assets as of the Company’s most recent testing date.

Income Taxes

Fair Value of Financial Instruments

Recent Accounting Pronouncements

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

measurements which will be effective for the Company on January 1, 2012. The adoption of the ASU is not expected to have a material effect on its financial statements, but may require certain additional disclosures.

In September 2011, the FASB issued an ASU related to the accounting for goodwill. Under the goodwill ASU, entities have the option of performing a qualitative assessment before calculating the fair value of the reporting unit when testing goodwill for impairment. If the fair value of the reporting unit is determined, based on qualitative factors, to be more likely than not less than the carrying amount of the reporting unit, then entities are required to perform the two-step goodwill impairment test. The ASU was effective for the Company on January 1, 2012, with early adoption permitted. The adoption of the goodwill ASU has not had a material effect on the Company’s financial statements.

Note 3 - Restricted Cash

As of March 31, 2013 and December 31, 2012, restricted cash consisted of the following:

	3/31/2013		12/31/2012
Borrowers’ deposits	$	804,818	$	657,098
FDIC-insured money market accounts	14,210,091		13,709,753

Total restricted cash	$	15,014,909	$	14,366,851

Note 4 - Receivables

As of March 31, 2013 and December 31, 2012, receivables consisted of the following:

	3/31/2013		12/31/2012
Service fees receivables	$	1,380,775	$	1,339,435
Servicing expense receivables	52,090		44,913
Advances on delinquent loans	515,611		221,577
Miscellaneous receivables	91,434		105,595

Total Receivables	$	2,039,910	$	1,711,520

Advances on delinquent loans of $515,611 and $221,577 as of March 31, 2013 and December 31, 2012, respectively, are advances paid to Fannie Mae in connection with the loss sharing recourse liability (see Note 9 - Recourse Liability). These advances will be applied against the Company’s obligations under the recourse

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

liability when settlements occur. Accordingly, they are presented in the financial statements at their full amount. The Company expects a majority of the non-performing loan receivable balances to be applied against the final recourse amount.

Property Inspection Fees Receivable

The Company receives fees for property inspections that it performs on behalf of Alliant Asset Management Company (“AAMC”), an entity with common ownership to TAC. For the three months ended March 31, 2013 and 2012, $4,300 and $2,840 was earned, included in loan servicing revenue in the accompanying statement of operations. As of March 31, 2013 and December 31, 2012, there was no balance for the related receivable from AAMC included in receivables on the accompanying balance sheet.

Note 5 - Property and Equipment

As of March 31, 2013 and December 31, 2012, property and equipment consisted of the following:

	3/31/2013			12/31/2012
Furniture and equipment	$	554,189		$	505,392
Leasehold improvements	12,520			12,520
Software	109,561			109,399

	676,270			627,311
Less accumulated depreciation	(360,902		)	(336,366		)

Property and equipment, net	$	315,368		$	290,945

For the three months ended March 31, 2013 and 2012, depreciation expense was $26,340 and $26,825, respectively.

Note 6 - Mortgage Servicing Rights

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

As of March 31, 2013 and December 31, 2012, key assumptions used in estimating the fair value of the Company’s MSRs and the effect on the estimated fair value from adverse changes in those assumptions were as follows (weighted averages are based upon unpaid principal balance):

	3/31/2013			12/31/2012
Fair value of MSRs	$	61,897,080		$	60,980,749
Weighted average prepayment rate	1.43		%	1.43		%
Weighted average life (in months)	64			64
Cash flow discount rate	12.00		%	12.00		%

As of March 31, 2013 and December 31, 2012, mortgage servicing rights consisted of the following (amounts utilized in the following table to reconcile the change in fair value for December 31, 2012 are for the annual period then ended; whereas amounts utilized in the March 31, 2013 reconciliation are for the three months ended):

	3/31/2013			12/31/2012
Fair value, beginning of year	$	60,980,749		$	55,070,413
Servicing resulting from transfers of financial assets	3,487,931			15,107,538
Change in fair value due to payments and payoffs on loans	(2,571,600		)	(9,197,202		)

Fair value, end of year	$	61,897,080		$	60,980,749

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

Note 7 - Fair Value Disclosures

The accounting standard for fair value measurement and disclosures defines fair value, establishes a framework for measuring fair value, and provides for expanded disclosure about fair value measurements. Fair value is defined by the accounting standard for fair value measurement and disclosures as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. It also establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three levels. The following summarizes the three levels of inputs and hierarchy of fair value the Company uses when measuring fair value:

Level 1

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access.

Level 2

Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3

Level 3 inputs are unobservable inputs for the asset or liability that are typically based on an entity’s own assumptions as there is little, if any, related market activity.

Mortgage Servicing Rights

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

mortgage servicing rights. The valuation models estimate the present value of estimated future net servicing income. The Company classifies mortgage servicing rights subjected to recurring fair value adjustments as Level 3.

Retained Interest in Securitization

Loan Commitments

Unlike most other derivative instruments, there is no active market for the loan commitments that can be used to determine their fair value. The Company has developed a method for estimating the fair value by calculating the change in market value from a commitment date to a measurement date based upon changes in applicable interest rates during the period. The Company classifies loan commitments subjected to recurring fair value adjustments as Level 3.

Items Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis as of March 31, 2013 and December 31, 2012 are reflected in the following tables:

March 31, 2013

(In thousands of dollars)	Level 1		Level 2		Level 3			Fair Value
Mortgage servicing rights	$	—	$	—	$	61,897		$	61,897
Retained interest in securitization	—		—		353			353
Interest rate lock commitments	—		—		837			837
Forward sale commitments	—		—		(827		)	(827		)

December 31, 2012

(In thousands of dollars)	Level 1		Level 2		Level 3			Fair Value
Mortgage servicing rights	$	—	$	—	$	60,981		$	60,981
Retained interest in securitization	—		—		367			367
Interest rate lock commitments	—		—		809			809
Forward sale commitments	—		—		(917		)	(917		)

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

Note 8 - Retained Interest in Securitization

As a part of an arrangement where the Company originated $406,375,200 of loans in 1995 for an entity that securitized and sold such loans, the Company received the highest risk unrated traunch of this security that absorbs all future losses on the $406,375,200 of loans up to $8,127,504. As of March 31, 2013 and December 31, 2012, the estimated fair value was $347,831 and $367,414 each period and related to all traunches of this security held by the Company (included in Note 11 as “Loans Serviced - Fannie Mae Non DUS”).

The significant assumptions used in estimating the fair value of the retained interest were as follows:

	3/31/2013		12/31/2012
Cash flow discounted rate	10	%	10	%
Loss severity rate	1	%	1	%

As of March 31, 2013, retained interest in securitization consisted of the following:

Fair value, beginning of year	$	367,414
Loss on interest in securitization	(13,956		)

Fair value, end of year	$	353,458

Note 9 - Recourse Liability

As of March 31, 2013 and December 31, 2012, recourse liability consisted of the following (amounts utilized in the following table to reconcile the change in the liability balance for December 31, 2012 are for the annual period then ended; whereas amounts utilized in the March 31, 2013 reconciliation are for the three months ended):

	3/31/2013		12/31/2012
Balance, beginning of year	$	11,435,059	$	12,908,790
Provision for recourse liability	236,056		4,543,556
Losses incurred/settlements	—		(6,017,287		)

Balance, end of year	$	11,671,115	$	11,435,059

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

losses with Fannie Mae and the modifications were retroactive to cover primarily all loans under service by the Company. Under the amended agreement, the Company is required to share the losses incurred by Fannie Mae of up to 33.33 percent of the original mortgage balance. As of March 31, 2013 and December 31, 2012, the outstanding balance of loans sold under this program was approximately $3.9 billion and $3.9 billion, respectively, and represents off-balance sheet risk in the normal course of business. The recourse liability has been established to address the Company’s potential loss exposure under the Fannie Mae loss sharing agreement. Because of inherent uncertainties in estimating these items, it is at least reasonably possible that the estimates used will change in the near term and that actual results could differ from these estimates.

Note 10 - Notes Payable

Line of Credit

As of March 31, 2013 and December 31, 2012, the Company maintained a line of credit with Bank of America, N.A. of $80,000,000 with a stated interest rate of BBA LIBOR Daily Floating Rate plus 1.60. As of March 31, 2013 and December 31, 2012, the rate was 1.804 percent and 1.812 percent, respectively. The current line of credit agreement expires June 30, 2013, and is expected to be renewed. As of March 31, 2013 and December 31, 2012, outstanding borrowings under this line were $9,613,558 and $47,350,527, respectively.

ASAP Line of Credit

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

Fannie Mae to fund loans are financed on the Fannie Mae ASAP Line of Credit which charges interest at a floating daily rate of LIBOR+150 with a floor of 1.85 percent and secured by the originated loan. In November 2012, the floating daily rate was adjusted to LIBOR+150 with a floor of 1.75 percent. As of March 31, 2013 and December 31, 2012, the rate was at the stated minimum of 1.75 percent. As of March 31, 2013 and December 31, 2012, $44,926,733 and $-0- of loans are being held for sale through the ASAP program and are in included in Mortgages loans held for sale on the accompanying balance sheets. Furthermore, a corresponding outstanding borrowing of $44,926,733 and $-0- on the ASAP Line exists at March 31, 2013 and December 31, 2012, respectively, and included in the Warehouse Line of Credit line of the accompanying balance sheet.

Note Payable - Related Party

As part of the recapitalization agreement on January 12, 2007, a $64,000,000 subordinated note payable to TAC was created. The note payable to TAC is related to a loan the TAC has with a bank. The note bears interest at a rate of 8 percent per annum and matures in 2014. For the three months ended March 31, 2013 and 2012, interest incurred on the note was $956,672 and $967,302, respectively. As of March 31, 2013 and December 31, 2012, accrued and unpaid interest was $7,433,714 and $6,477,042, respectively. As of March 31, 2013 and December 31, 2012, the balance of the note payable to TAC was $47,833,607 and $47,833,607, respectively.

The financial covenants were modified for the measurement period ending December 31, 2009, and management believes the Company was in compliance with all covenants as of March 31, 2013. However, in 2012, the Company was not able to meet all of the debt covenant ratio requirement due to the unexpected expense related to payment of a termination benefit paid to the Company’s former CEO who retired due to a terminal illness (see Note 13). Because of the unusual nature of the CEO’s termination expense which resulted in the Company’s inability to meet the required debt service ratio requirement, management requested and received waivers from the lender regarding the debt covenant violation for the first two quarterly compliance periods during the year ended December 31, 2012. Management believes the Company was in compliance with all debt covenants for the remaining two quarterly compliance periods during the year ended December 31, 2012.

The financial covenants were modified during November of 2012. These modifications primarily included a reduction in the required debt service ratio and in the exclusion of any payments or expenses related to the termination of the former CEO from the calculating the debt service ratio for the compliance quarters ending March 31, 2012, June 30, 2012, and September 30, 2012. Management believes the Company was in compliance with all covenants, as modified, as of March 31, 2013 and December 31, 2012.

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

As of December 31, 2012, the principal payments required under the loan between TAC and the bank for each of the next three years were as follows:

Ending December 31,	Amount
2013	$	8,250,000
2014	8,000,000
2015	8,750,000

	$	25,000,000

The Company is not required to make periodic principal payments according to the terms of its loan agreement with TAC, and made no principal payments during the three months ended March 31, 2013 and 2012.

Note 11 - Loan Servicing and Escrow Funds

As of March 31, 2013 and December 31, 2012, the Company’s loans servicing portfolio consisted of the following:

	3/31/2013			12/31/2012
	Loans	Dollar Value		Loans	Dollar Value
Loans serviced - Fannie
Mae Level I	1,026	$	3,931,953,794	1,011	$	3,880,027,693
Loans serviced - Fannie
Mae Non DUS	8	8,025,320		8	8,279,859

Totals	1,034	$	3,939,979,114	1,019	$	3,888,307,552

As of March 31, 2013 and December 31, 2012, related custodial funds on deposit in custodial bank accounts were $84,019,517 and $77,700,901, respectively, which are not included in the accompanying balance sheets. However, the Company does benefit from these deposits by retaining interest earned.

Note 12 - 401(k) Plan

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

Note 13 - Commitments and Contingencies

Loan Commitments

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business. To date, these financial instruments include commitments to extend credit and sell loans.

As of March 31, 2013, outstanding commitments were as follows:

Commitments to sell loans	$	65,025,000

Commitments to fund loans	$	9,746,000

As of December 31, 2012, outstanding commitments were as follows:

Commitments to sell loans	$	54,424,000

Commitments to fund loans	$	5,297,100

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

As of March 31, 2013 and December 31, 2012, the fair value of interest rate lock commitments was as follows:

	3/31/2013		12/31/2012
Fair value, beginning of year	$	809,000	$	753,000
Gain in interest rate lock commitments	28,000		56,000

Fair value, end of year	$	837,000	$	809,000

As of March 31, 2013 and December 31, 2012, the fair value of forward sale commitments was as follows:

	3/31/2013			12/31/2012
Fair value, beginning of year	$	(917,000	)	$	(832,000	)
Gain (loss) in forward sale commitments	90,000			(85,000		)

Fair value, end of year	$	(827,000	)	$	(917,000	)

As of March 31, 2013 and December 31, 2012, net unrealized cumulative gains (losses) of $10,000 and ($108,000), respectively, were recognized in net gain (loss) on loan sales activities on the derivative instruments specified in the previous paragraph.

The following table summarizes the Company’s derivative assets and liabilities as of March 31, 2013 and December 31, 2012:

	3/31/2013			12/31/2012
Interest rate lock commitments	$	837,000		$	809,000
Forward sale commitments	(827,000		)	(917,000		)

Net unrealized cumulative gain (loss)	$	10,000		$	(108,000	)

Unrealized gains of $837,000 and $809,000 on IRLCs are included in other assets and unrealized losses of $827,000 and $917,000 on forward sale commitments are included in other liabilities at March 31, 2013 and December 31, 2012, respectively.

Fannie Mae DUS Reserve

As of March 31, 2013 and December 31, 2012, U.S. Government and governmental agency securities and cash equivalents pledged to Fannie Mae were approximately $14,200,000 and $13,700,000, respectively. Fannie Mae requires the Company to maintain in its favor permitted investments or a letter of credit that serves as

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

additional collateral to secure any loan loss obligation of a DUS lender to Fannie Mae. The amount of the permitted investments or letter of credit increases or decreases depending upon the amount of the original principal balance of mortgage loans sold to Fannie Mae by the DUS lender.

Mortgage Impairment Insurance

As of March 31, 2013 and December 31, 2012, the Company carried mortgage impairment insurance coverage of $25,000,000 at each date. Mortgage impairment insurance provides the Company with hazard insurance coverage for mortgage loan collateral in the event of a catastrophe for which the borrowers insurance does not provide sufficient to protect the Company from loss on loans originated under the Fannie Mae DUS program.

Mortgage Bankers’ Blanket Bond

As of March 31, 2013 and December 31, 2012, the Company carried a mortgage bankers’ blanket bond of $5,000,000, and carried errors and omissions insurance coverage in excess of the mortgage bankers’ blanket bond of $8,500,000 as of March 31, 2013 and December 31, 2012.

Lease Commitments

Ending December 31,	Amount
2013	$	380,029
2014	355,086
2015	127,317
2016	130,616
2017	47,888

	$	1,040,936

The Company currently leases office space in Washington D.C.; San Francisco, California; Chicago, Illinois; Seattle, Washington; and Alpharetta, Georgia on a year-to-year basis that is not included in the future lease commitments detailed above. For the three months ended March 31, 2013 and 2012, total rent expense was $160,463 and $128,093, respectively.

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

Litigation

Fannie Mae Loan Guarantee

Guaranty Reimbursement Agreement

Percentage Compensation Put

EF&A Funding, LLC

Notes to Financial Statements — Continued (Unaudited)

March 31, 2013

which $640,708 was reserved for losses on loans. As of March 31, 2013 and December 31, 2012, $947,743 and $1,098,824, respectively, of the percentage compensation remains payable, included in accounts payable and other accrued liabilities in the accompanying balance sheet.

Note 14 - Subsequent Events

Events that occur after the balance sheet date but before the financial statements were available to be issued must be evaluated for recognition or disclosure. The effects of subsequent events that provide evidence about conditions that existed at the balance sheet date are recognized in the accompanying financial statements. Subsequent events which provide evidence about conditions that existed after the balance sheet date require disclosure in the accompanying notes. Management evaluated the activity of the Company through May 3, 2013 and concluded that no subsequent events have occurred that would require recognition in the financial statements.

EX-99.3 6 a13-13231_1ex99d3.htm EX-99.3

Exhibit 99. 3

Unaudited Pro Forma Consolidated Financial Statements

of Ares Commercial Real Estate Corporation

The following financial statements present unaudited pro forma condensed consolidated financial information about the financial condition and results of operations of Ares Commercial Real Estate Corporation (“ACRE” or the “Company”), after giving effect to the proposed acquisition (the “Acquisition”) of EF&A Funding, L.L.C., d/b/a Alliant Capital LLC, a Michigan limited liability company (“Alliant Capital”), pursuant to the terms of a Purchase and Sale Agreement (the “PSA”) among ACRE and Alliant, Inc., a Florida corporation, and The Alliant Company, LLC, a Florida limited liability company (collectively, the “Sellers”).

The unaudited pro forma consolidated balance sheet as of March 31, 2013 gives effect to the Acquisition as if the Acquisition had taken place on March 31, 2013 and the unaudited pro forma consolidated statements of operations for the year ended December 31, 2012 and the three months ended March 31, 2013, give effect to the Acquisition as if the Acquisition had taken place on January 1, 2012.

The Acquisition has been accounted for as a business combination in accordance with Accounting Standards Codification 805, Business Combinations (“ASC 805”). In accordance with ASC 805, the preliminary purchase price of $62.8 million is allocated to the net tangible and intangible assets acquired and liabilities assumed in connection with the acquisition, based on their estimated fair values. Management has made a preliminary allocation of the estimated purchase price based on various preliminary estimates. The allocation of the estimated purchase price is preliminary pending finalization of those estimates and analyses. Final purchase accounting adjustments may differ materially from the pro forma adjustments presented herein.

The pro forma financial statements are based upon available information, preliminary estimates and certain assumptions that we believe are reasonable in the circumstances, as set forth in the notes to the pro forma financial statements. The unaudited pro forma consolidated financial statements do not take into account any synergies or cost savings that may or are expected as a result of the acquisition.

The unaudited pro forma statements are presented for informational purposes only and are not necessarily indicative of the future financial position or results of operations of the consolidated company or the consolidated financial position or the results of operations that would have been realized had the Acquisition been consummated during the period or as of the dates for which the pro forma financial statements are presented.

Certain reclassification adjustments have been made to the presentation of Alliant Capital’s historical financial statements to conform them to the presentation followed by ACRE. The unaudited pro forma consolidated financial information is based on, should be read in conjunction with, and are qualified by reference to, our historical consolidated financial statements and notes thereto and those of Alliant Capital (which are being filed concurrently as an exhibit to this Current Report on Form 8-K).

ARES COMMERCIAL REAL ESTATE CORPORATION

UNAUDITED PRO FORMA CONSOLIDATED BALANCE SHEET

AS OF MARCH 31, 2013
(in thousands, except for share, per share data and as otherwise indicated)

	Historical ACRE			Historical Alliant			Eliminated Assets and Liabilities and Other Adjustments			Purchase Accounting Adjustments			Purchase Price			Financing and Other Capital Transactions			ACRE Pro Forma
							(A)			(B)			(C)
ASSETS
Cash and cash equivalents	$	22,550		$	1,262		$	2,766	(D)(E)				$	(52,900	)	$	48,150	(F)(M)	$	21,828
Restricted cash	3,719			15,015			(3,305		)(F)							2,500		(F)	17,929
Loans held for investment	409,943																		409,943
Deferred financing costs, net	4,780																		4,780
Mortgage loans held for sale				65,025															65,025
Mortgage servicing rights, at fair value				61,897		(G)													61,897
Intangible assets				10,120						(4,520		)(H)							5,600
Goodwill				3,247						(3,247		)(I)							—
Other assets	2,961			3,986			(1,190		)	2,772		(J)							8,529

Total assets	$	443,953		$	160,552		$	(1,729	)	$	(4,995	)	$	(52,900	)	$	50,650		$	595,531

LIABILITIES
Secured financing arrangements	200,050																		200,050
Convertible notes	67,411																		67,411
Derivative liability	2,223																		2,223
Dividends payable	2,317																		2,317
Warehouse lines of credit				54,540			10,485		(E)										65,025
Note payable - related party				47,834			(47,834		)(K)										—
Accrued interest - related party note payable				7,434			(7,434		)(K)										—
Recourse liability				11,671						5,999		(J)							17,670
Other liabilities	8,368			4,712			(2,036		)	1,760		(L)							12,804

Total liabilities	280,369			126,191			(46,819		)	7,759			—			—			367,500

STOCKHOLDERS’ AND MEMBERS’ EQUITY
Preferred stock, par value $0.01 per share, 50,000,000 shares authorized at March 31, 2013, no shares issued and outstanding at March 31, 2013																			—
Common stock, par value $0.01 per share, 450,000,000 shares authorized at March 31, 2013, 9,267,162 shares issued and outstanding at March 31, 2013	92												6			40		(D)	138
Additional paid in capital	169,336												9,529			52,860		(D)	231,725
Members’ equity				34,361			45,090			(12,754		)	(66,697		)				—
Accumulated earnings (deficit)	(5,844		)										4,262		(N)	(2,250		)(O)	(3,832		)

Total equity	163,584			34,361			45,090			(12,754		)	(52,900		)	50,650			228,031

Total liabilities and equity	$	443,953		$	160,552		$	(1,729	)	$	(4,995	)	$	(52,900	)	$	50,650		$	595,531

See accompanying notes to unaudited pro forma consolidated financial statements.

ARES COMMERCIAL REAL ESTATE CORPORATION

UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS

FOR THE YEAR ENDED DECEMBER 31, 2012
(in thousands, except for share, per share data and as otherwise indicated)

	Historical ACRE			Historical Alliant			Adjustments			ACRE Pro Forma
REVENUES
Interest income	$	9,278		$	1,807					$	11,085
Interest expense (from secured funding facilities)	(2,342		)							(2,342		)
Net Interest Income	6,936			1,807						8,743
Loan servicing revenue				14,767			(27		)(AA)	14,740
Loan origination revenue and gain on loan sales				9,998						9,998
Change in fair value of mortgage servicing rights				5,910						5,910
Recourse liability provision				(4,544		)				(4,544		)

Total Revenues	6,936			27,938			(27		)	34,847

EXPENSES
Other interest expense	313			4,957			(3,639		)(BB)	1,631
Management fees to affiliate	1,665						937		(CC)	2,602
Professional fees	1,194			392						1,586
Acquisition and investment pursuit costs
General & administrative expenses	1,285			2,686						3,971
General & administrative expenses reimbursed to affiliate	1,619									1,619
Compensation and benefits				14,804						14,804
Depreciation & amortization				106						106

Total Expenses	6,076			22,945			(2,702		)	26,319

Income from Continuing Operations	860			4,993			2,675			8,528

Preferred dividends	674									674
Taxes							2,991		(DD)	2,991
Net income	$	186		$	4,993		$	(316	)	$	4,863

Basic Earnings Per Share	$	0.03								$	0.46
Diluted Earnings Per Share	$	0.03								$	0.46

Pro forma weighted average shares outstanding - Basic	6,532,706						4,023,412		(EE)(FF)	10,556,118
Pro forma weighted average shares outstanding - Diluted	6,567,309						4,023,412		(EE)(FF)	10,590,721

See accompanying notes to unaudited pro forma consolidated financial statements.

ARES COMMERCIAL REAL ESTATE CORPORATION

UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS

FOR THE THREE MONTHS ENDED MARCH 31, 2013
(in thousands, except for share, per share data and as otherwise indicated)

	Historical ACRE			Historical Alliant			Adjustments			ACRE Pro Forma
REVENUES
Interest income	$	6,711		$	340					$	7,051
Interest expense (from secured funding facilities)	(1,385		)							(1,385		)
Net Interest Income	5,326			340						5,666
Loan servicing revenue				3,946			(14		)(AA)	3,932
Loan origination revenue and gain on loan sales				2,475						2,475
Change in fair value of mortgage servicing rights				916						916
Recourse liability provision				(236		)				(236		)

Total Revenues	5,326			7,441			(14		)	12,753

EXPENSES
Other interest expense	1,950			1,146			(910		)(BB)	2,186
Management fees to affiliate	614						234		(CC)	848
Professional fees	566			61						627
Acquisition and investment pursuit costs	640						(640		)(GG)
General & administrative expenses	482			892						1,374
General & administrative expenses reimbursed to affiliate	747									747
Compensation and benefits				4,679						4,679
Depreciation & amortization				26						26

Total Expenses	4,999			6,804			(1,316		)	10,487

Income from Continuing Operations	327			637			1,302			2,266

Preferred dividends
Taxes							512		(DD)	512
Net income	$	327		$	637		$	790		$	1,754

Basic Earnings Per Share	$	0.04								$	0.13
Diluted Earnings Per Share	$	0.04								$	0.13

Pro forma weighted average shares outstanding - Basic	9,212,644						4,023,412		(EE)(FF)	13,236,056
Pro forma weighted average shares outstanding - Diluted	9,267,162						4,023,412		(EE)(FF)	13,290,574

See accompanying notes to unaudited pro forma consolidated financial statements.

ARES COMMERCIAL REAL ESTATE CORPORATION

NOTES TO THE UNAUDITED

PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except for share, per share data and as otherwise indicated)

(1) Unaudited Pro Forma Consolidated Balance Sheet Adjustments and Assumptions

A - Represents certain assets and liabilities of Alliant Capital that are expected to be (i) eliminated or (ii) distributed or assumed by its members prior to or at closing pursuant to the PSA.

B - In accordance with ASC 805, the preliminary purchase price has been allocated based on a preliminary valuation of Alliant Capital’s tangible and intangible assets and liabilities as if the transaction occurred as of March 31, 2013. The allocations are preliminary and are subject to change when the purchase price allocations are finalized and the valuations are complete.

C - Pursuant to the PSA, the purchase price for Alliant Capital will consist of (a) 588,235 shares of ACRE’s common stock (valued at approximately $9.5 million based on the closing price of $16.21 per common share as of May 31, 2013) and (b) $52.9 million in cash.

D - Pursuant to the PSA, Alliant Capital will distribute to its members at closing all of its cash and cash equivalents other than the required net working capital balance at closing.

E - Pursuant to the PSA, Alliant Capital will seek to leverage its mortgage loans held for sale to the extent permitted under the applicable loan agreements (assumed to equal 100% of the mortgage loan amount for purposes of this Unaudited Pro Forma Consolidated Balance Sheet and Statement of Operations) in order to fund the distribution at closing as described in Notes A and D.

F - Pursuant to the PSA, Alliant Capital will distribute to its members at closing $2,500 from restricted cash. Unless such requirement for restricted cash is waived by the Federal National Mortgage Association, ACRE will replace such amounts in restricted cash upon closing.

G - Mortgage servicing rights are presented at fair value. Please see Alliant Capital’s 2012 and three months ended March 31, 2013 financial statements and notes thereto. The allocation is preliminary and is subject to change when the purchase price allocation is finalized and the valuation is complete.

H - Represents preliminary purchase price allocation of certain intangible assets of Alliant Capital, including the Fannie Mae DUS license. Alliant Capital is also in the process of putting in place certain operational requirements in connection with its ability to originate and sell FHA/HUD/Ginnie Mae agency loans; as of March 31, 2013, such operational requirements were not complete. Upon finalizing such operational requirements with FHA/HUD/Ginnie Mae, additional purchase price allocation may be made to such intangible asset.

I - Represents $3,247 in goodwill that Alliant Capital has historically carried and that will be eliminated at closing.

J - Pursuant to the PSA, after closing, certain affiliates of the members of Alliant Capital have agreed to contribute towards losses, if any, incurred by Alliant Capital on fifteen identified loans (subject to meeting certain limitations and conditions as outlined in the PSA, including the timing of such actual share of losses) for which Alliant Capital is required to share the risk of loss on loans previously sold by Alliant Capital through Fannie Mae. $2,772 represents the preliminary estimate of the portion of such contributions towards such losses by affiliates of members of Alliant Capital relating to the recourse liabilities of Alliant Capital. $5,999 represents the gross adjustment to the recourse liability of Alliant Capital (resulting in a total $17,670 recourse liability amount for Alliant Capital) without taking into account the $2,772 potential contribution by affiliates of members of Alliant Capital. Our estimate of the recourse liability is based on our underwriting of the $3.9 billion outstanding balance of loans sold under the Fannie Mae program. Our analysis included analyses of specific loans where we have assessed the guaranty is probable and estimable in addition to an estimate of the fair value of the guarantee on the remaining loans using Alliant Capital’s historical loss experience, the risk profile of the collateral and other market indicators.

K - Pursuant to the PSA, Alliant Capital will fully settle the note payable - related party, which, as of March 31, 2013, had an outstanding principal balance of $47,834 and accrued and unpaid interest of $7,434.

L - Represents preliminary purchase price allocation of potential payments to certain current and former employees of Alliant Capital.

M - The Unaudited Pro Forma Consolidated Balance Sheet and Statement of Operations shown herein assumes the issuance by ACRE of an additional 3,435,176 shares of its common stock in a public offering at an assumed net offering price of approximately $15.40 per common share (a 5.0% discount from the closing price on May 31, 2013 of $16.21 per common share) to raise net proceeds of $52.9 million. This assumption has been made for pro forma financial statement purposes only and ACRE may finance the acquisition of Alliant Capital from other sources, which may include new debt or preferred securities, borrowings under existing credit facilities, asset sales, and cash on hand, dependent on a number of factors, including market conditions at closing, strategic alternatives, and ACRE’s liquidity position and outlook.

N - Represents potential gain that may be recognized at closing of the acquisition of Alliant Capital by ACRE based on the excess of the net preliminary purchase price allocations of the underlying tangible and intangible assets acquired less liabilities assumed over the preliminary purchase price (see Notes B and C). The purchase price allocations are preliminary and are subject to change when the purchase price is finalized and the valuations are complete.

O - Represents estimated contractual transaction expenses that have not been reflected in ACRE’s historical financial statements for the year ended December 31, 2012 and three months ended March 31, 2013. Significant additional transition expenses are expected to be incurred.

(2) Unaudited Pro Forma Consolidated Statement of Operations Adjustments and Assumptions

AA - Adjustment represents historical revenues from certain assets that are expected to be retained by the members of Alliant Capital pursuant to the PSA.

BB - Adjustment represents the elimination of interest expense of $3,890 and $957 for the year ended December 31, 2012 and for three months ended March 31, 2013, respectively, related to the note payable - related party that will be settled at the closing of the transaction (see Note K). In addition, $251 and $47 represent estimates of additional interest expense that would have been incurred for the year ended December 31, 2012 and for three months ended March 31, 2013, respectively, if the incremental leverage of the mortgage loans held for sale occurred as outlined in Note E. The warehouse line of credit has a stated rate of LIBOR plus 1.60% (1.80% as of December 31, 2012 and March 31, 2013) for purposes of the pro-forma adjustment.

CC - Adjustment represents base management fees that would have been incurred as a result of the assumed issuance of additional common shares of ACRE as described in Notes C and M. The base management fee is 1.50% per annum, resulting in additional estimated base management fees of $937 for the year ended December 31, 2012 and $234 for the three months ended March 31, 2013.

DD - ACRE currently expects to elect and qualify to be taxed as a real estate investment trust, or “REIT,” under the Internal Revenue Code of 1986, as amended, or the “Code,” commencing with the Company’s taxable year ended December 31, 2012. ACRE intends to conduct the business activities that will be acquired from Alliant Capital in one or more taxable REIT subsidiaries (“TRSs”), including the origination, sale and servicing of multi-family loans, provided that certain assets and liabilities may be held outside of a TRS. Certain investments may be made and activities conducted in a TRS that (a) may otherwise be subject to prohibited transaction tax and (b) may not comply with the various requirements for REIT qualification. The income, if any, within a TRS is subject to federal and state income taxes as a domestic C corporation. These adjustments represent the estimated income tax that would have been incurred (either current or deferred) had ACRE conducted all activities of Alliant Capital in a TRS during the year ended December 31, 2012 and the three months ended March 31, 2013, based on current statutory rates. These adjustments have been made for Unaudited Pro Forma Consolidated Balance Sheet and Statement of Operations purposes only and do not represent income tax payments or liabilities that will be assumed or paid by ACRE in connection with the transaction.

EE - As discussed in Note M, the Unaudited Pro Forma Consolidated Balance Sheet and Statement of Operations shown herein assume the issuance by ACRE of an additional 3,435,176 shares of its common stock in a public offering at an assumed net offering price of approximately $15.40 per common share (a 5.0% discount from the closing price on May 31, 2013 of $16.21 per common share) to raise net proceeds of $52.9 million. This assumption has been made for pro forma financial statement purposes only and ACRE may finance the acquisition of Alliant Capital from other sources, which may include new debt or preferred securities, borrowings under existing credit facilities, asset sales, and cash on hand, dependent on a number of factors, including market conditions at closing, strategic alternatives, and ACRE’s liquidity position and outlook.

FF - As discussed in Note C, the purchase price for Alliant Capital consists of (a) 588,235 shares of ACRE’s common stock (valued at approximately $9.5 million based on the closing price of $16.21 per common share as of May 31, 2013) and (b) $52.9 million in cash.

GG - Represents $640 in acquisition and investment pursuit costs incurred by ACRE during the three months ended March 31, 2013 related to the acquisition of Alliant Capital.