IMH Financial (IFCN) 10-Q2020 Q1 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

As of May 15, 2020, the registrant had outstanding the following classes and series of stock: (i) 2,003,028 shares of Common Stock, (ii) 3,375,528 shares of Class B-1 Common Stock, (iii) 3,376,660 shares of Class B-2 Common Stock, (iv) 6,909,922 shares of Class B-3 Common Stock, (v) 313,790 shares of Class B-4 Common Stock, (vi) 666,700 shares of Class C Common Stock, (vii) 2,604,852 shares of Series B-1 Cumulative Convertible Preferred Stock, (viii) 5,595,148 shares Series B-2 Cumulative Convertible Preferred Stock, (ix) 2,352,941 shares of Series B-3 Cumulative Convertible Preferred Stock, (x) 1,875,000 shares of Series B-4 Cumulative Convertible Preferred Stock and (xi) 22,000 shares of Series A Preferred Stock. There is no established market for the registrant’s shares of common stock or preferred stock.

IMH Financial Corporation (together with its subsidiaries, the “Company”) is a real estate investment and finance company based in the southwestern United States engaged in various and diverse facets of the real estate lending and investment process, including origination, acquisition, underwriting, servicing, enforcement, development, marketing, and disposition. The Company’s focus is to invest in, manage and dispose of commercial real estate mortgage investments, hospitality assets, and other real estate assets, and to perform all functions reasonably related thereto, including developing, managing and either holding for investment or disposing of real property acquired through acquisition, foreclosure or other means.

We were formed from the conversion of our predecessor entity, IMH Secured Loan Fund, LLC (the “Fund”), into a Delaware corporation. The Fund, which was organized in May 2003, commenced operations in August 2003, focusing on investments in senior short-term whole commercial real estate mortgage loans collateralized by first mortgages on real property. The Fund was externally managed by Investors Mortgage Holdings, Inc. (the “Manager”), which was incorporated in Arizona in June 1997 and is licensed as a mortgage banker by the State of Arizona. Through a series of private placements to accredited investors, the Fund raised $875 million of equity capital from May 2003 through December 2008. Due to the cumulative number of investors in the Fund, the Fund registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), on April 30, 2007 and began filing periodic reports with the Securities and Exchange Commission (“SEC”). On June 18, 2010, the Fund became internally-managed through the acquisition of the Manager, and converted into a Delaware corporation in a series of transactions that we refer to as the “Conversion Transactions”. Effective August 1, 2019, the Company entered into a Non-Discretionary Investment Advisory Agreement (“Advisory Agreement”) with Juniper Investment Advisors, LLC (“JIA”) pursuant to which JIA agreed to manage certain assets of the Company, including the Company’s loan portfolio and certain of its legacy real estate owned properties.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The accompanying unaudited condensed consolidated financial statements include the accounts of IMH Financial Corporation and the following wholly-owned operating subsidiaries: 11333, Inc. (formerly known as Investors Mortgage Holdings, Inc.), an Arizona corporation; Investors Mortgage Holdings California, Inc., a California corporation; IMH Holdings, LLC, a Delaware limited liability company (“Holdings”); and various other wholly owned subsidiaries established in connection with the acquisition of real estate either through foreclosure or purchase and/or for borrowing purposes and majority owned or controlled real estate entities and interests in variable interest entities (“VIEs”) in which the Company is considered the primary beneficiary. IMH Management Services, LLC, an Arizona limited liability company, provides us and our affiliates with human resources and administrative services, including the supply of employees. Other entities in which we have invested and have the ability to exercise significant influence over operating and financial policies of the investee, but upon over which we do not possess control, are accounted for by the equity method of accounting within the financial statements and they are therefore not consolidated.

All significant intercompany accounts and transactions have been eliminated in consolidation.

We require liquidity and capital resources for our general working capital needs, including maintenance, development costs and capital expenditures for our operating properties and non-operating real estate owned (“REO”) assets, professional fees, general and administrative operating costs, loan enforcement costs, financing costs, debt service payments, and dividends to our preferred shareholders, as well as to acquire our target assets.

As of March 31, 2020, our accumulated deficit aggregated $723.0 million primarily as a result of previous provisions for credit losses recorded between 2008 and 2010 (due primarily to the erosion of the U.S. and global real estate and credit markets during those periods) relating to the decrease in the fair value of the collateral securing our legacy loan portfolio, impairment charges

relating to the value of REO assets acquired primarily through foreclosure, as well as on-going net operating losses resulting primarily from the lack of income-producing assets.

On January 30, 2020, the World Health Organization (“WHO”) announced a global health emergency because of a new strain of Coronavirus originating in Wuhan, China (the “COVID-19 outbreak”) and the risks to the international community as the virus spreads globally beyond its point of origin. In March 2020, the WHO classified the COVID-19 outbreak as a pandemic, based on the rapid increase in exposure globally.

On March 17, 2020, in response to the COVID-19 pandemic, the Company temporarily closed its MacArthur Place hotel (“MacArthur Place”) located in Sonoma, California. While we expect restaurants, hotels and other hospitality assets to gradually reopen in the near future, we cannot state with any degree of reasonable certainty when MacArthur Place, our only operating asset, will re-open and when it does open, what occupancy or other operational restrictions will be put in place. If closure of or demand for the Company’s hotel rooms and other services is negatively impacted for an extended period as a result of cancellations, travel restrictions, governmental travel advisories and/or state of emergency declarations, or a prevailing reluctance with respect to traveling and patronizing hotels and restaurants the Company’s hospitality business and financial results could be materially and adversely impacted. As a result of the uncertainty with respect to when the MacArthur Place hotel may reopen, we furloughed certain hotel employees. Further employee furloughs or layoffs may be necessary in the future. The full impact of the COVID-19 outbreak continues to evolve as of the date of this report. The extent to which the Company’s business will be affected by the current outbreak of the Coronavirus will largely depend on both current and future developments, including its duration, spread and treatment, and related travel advisories and restrictions, which could impact overall demand in the hospitality industry, all of which are highly uncertain and cannot be reasonably predicted. Accordingly, we cannot be certain as to the full magnitude the pandemic will have on the Company’s consolidated financial condition, liquidity, and future results of operations. Subsequent to March 31, 2020, the Company applied and received funding totaling $1.8 million under the CARES Act in the form of Payroll Protection Program loan (“PPP Loans”). The PPP Loans may be forgivable if the Company’s use of funds meets the criteria for such forgiveness.

In connection with the Company’s acquisition and renovation of the MacArthur Place hotel, in October 2017, the Company entered into a building loan agreement and related agreements with MidFirst Bank in the amount of $37.0 million (the “MacArthur Loan”).

In connection with the MacArthur Loan, the Company was required to provide a loan repayment guaranty equal to 50% of the original principal amount of the MacArthur Loan along with a guaranty of interest and operating deficits, as well as other customary non-recourse carve-out matters such as bankruptcy and environmental matters. Under the guarantees, the Company is required to maintain a minimum Tangible Net Worth, as defined, of $50.0 million and minimum liquidity of $5.0 million throughout the term of the MacArthur Loan. The Company was in compliance with such financial covenants as of March 31, 2020. In addition, the MacArthur Loan requires MacArthur Place to establish various operating and reserve accounts at MidFirst Bank which are subject to a cash management agreement. In the event of default, MidFirst Bank has the ability to take control of such accounts for the allocation and distribution of proceeds in accordance with the cash management agreement. The MacArthur Loan has an initial maturity of October 1, 2020 with two one-year extension options available if certain criteria is met, including minimum debt service coverage ratios. Given the impact of the COVID-19 outbreak and resulting temporary closure of MacArthur Place, the Company does not expect it will meet the current criteria to exercise its extension options. The Company has commenced negotiations with the lender for potential forbearance of debt service payments and extension of the maturity date.

As of March 31, 2020, we had cash and cash equivalents of $9.9 million, REO assets held for sale with a carrying value of $7.4 million and other REO assets with a carrying value of $33.3 million that we seek to dispose of within the next 12 months. We continue to evaluate potential disposition strategies for our remaining REO assets and to seek additional sources of debt and equity for investment and working capital purposes.

At any time after July 24, 2020, each holder of our Series B-1 and B-2 Preferred Stock may require the Company to redeem, out of legally available funds, the shares held by such holder at a price (the “Redemption Price”) equal to the greater of (i) 150% of the sum of the original price per share plus all accrued and unpaid dividends or (ii) the sum of the tangible book value of the Company per share of voting Common Stock and all accrued and unpaid dividends as of the date of redemption. As of March 31,

2020, the aggregate Redemption Price for the Series B-1 and Series B-2 Preferred Stock would be approximately $39.6 million. In addition, pursuant to an agreement to extend the Redemption Date, a cash payment in the aggregate amount of $2.6 million is due and payable to the holders of the Series B-1 and B-2 Preferred Stock on July 24, 2020 whether or not a redemption is requested. The current holders of our Series B Preferred Stock are collectively referred to herein as the “Series B Investors”. We are presently in discussions with the Series B Investors regarding a restructuring of the of terms of these securities. There is no assurance, however, that all or any of the Series B Investors will agree to restructure these securities, or if so, whether the terms will be beneficial to the Company. See Note 10.

We expect our primary sources of liquidity over the next twelve months to consist of proceeds from the disposition of our existing REO assets, proceeds from borrowings and equity issuances, current cash, revenues from the ownership and management of hotels, and investment income.

Historically, we have used proceeds from the issuance of preferred equity and/or debt, proceeds from the sale of our REO assets, and the liquidation of mortgages and related investments to satisfy our working capital requirements. As described above, we sold our Broadway Tower commercial office building in January 2020, netting $8.0 million in cash to the Company after payment of related debt. We also are in discussions with the holders of our Series B Preferred Stock regarding a restructuring or modification of those securities and our obligations. There can be no assurance that these efforts will be successful or that we will sell our remaining REO assets in a timely manner or that will be successful in obtaining additional or replacement financing, if needed, to sufficiently fund our future operations, redeem our Series B-1 and B-2 Preferred Stock if so required, repay existing debt, or to implement our investment strategy. In the event we are unsuccessful in negotiating a deferral or restructuring of the terms of our Series B-1 and B-2 Preferred Stock, we will be required to fund the redemption of $39.6 million, in an addition to the cash payment in the aggregate amount of $2.6 million, in July 2020. In the absence of proceeds from asset sales, equity issuances or borrowings to fund payment of the Redemption Price, the required redemption would likely render the Company insolvent. Moreover, our failure to generate sustainable earning assets and to successfully liquidate a significant portion of our REO assets will have a material adverse effect on our business, results of operations and financial position. In addition, the Company may continue to be materially adversely impacted by the COVID-19 outbreak. These accompanying unaudited condensed consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

The collective nature of the above uncertainties create substantial doubt about our ability to continue as a going concern for a period beyond one year from the date of issuance of these accompanying unaudited condensed consolidated financial statements. The accompanying unaudited condensed consolidated financial statements have been prepared assuming the Company will continue to operate as a going concern, which contemplates the realization of assets and settlement of liabilities in the normal course of business. They do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from uncertainty related to its ability to continue as a going concern.

The balance sheet item, “Funds held by lender and restricted cash”, includes amounts maintained in escrow or other restricted accounts deposited into reserve accounts held by lenders for contractually specified purposes. The following table provides a reconciliation of cash, cash equivalents, and funds held by lender and restricted cash reported within the accompanying condensed consolidated balance sheets that sum to the total of the amounts shown in the accompanying unaudited condensed consolidated statement of cash flows as of March 31, 2020 and December 31, 2019 (in thousands):

The balance of “Funds held by lender and restricted cash” includes property tax, insurance and construction related reserves for the MacArthur Loan totaling $2.4 million and $2.6 million at March 31, 2020 and December 31, 2019, respectively.

Revenue is measured based on consideration specified in a contract with a customer. The Company recognizes revenue when it satisfies a performance obligation by transferring control over a product or service to a customer. ASC Topic 606 defines a five-step process to achieve this core principle. The significant accounting policies under ASC Topic 606 are set forth below.

The Company derives hotel revenues from our hotel in Sonoma, California, which is reflected as operating property revenue in the accompanying unaudited consolidated statements of operations. Rooms revenue represents revenue from the occupancy of our hotel rooms and is driven by the occupancy and daily rate charged. Rooms revenue also includes revenue for guest no-shows, day use, and early late departure fees. The contracts for room stays with customers are generally short in duration and revenues are recognized as services are provided over the course of the hotel stay. Food & Beverage (“F&B”) revenue consists of revenue from the restaurants and lounges at our hotel, in-room dining and minibar revenue, and banquet/catering revenue from group and social functions. Other F&B revenue may include revenue from audiovisual equipment/services, rental of function rooms, and other F&B related revenue. Revenue is recognized as the services or products are provided. Our hotel property may employ third parties to provide certain services at the property, for example, audio visual services. We evaluate each of these contracts to determine if the hotel is the principal or the agent in the transaction, and record the revenue as appropriate (i.e., gross vs. net).

Other revenue consists of ancillary revenue at the property, including attrition and cancellation fees, resort fees, spa and other guest services. Attrition and cancellation fees are recognized for non-cancellable deposits when the customer provides notification of cancellation within established management policy time frames. Taxes collected from customers and submitted to taxing authorities are not recorded in revenue.

We identified the following performance obligations in connection with our hotel revenues, for which revenue is recognized as the respective performance obligations are satisfied, which results in recognizing the amount we expect to be entitled to for providing the goods or services:

services provided over time and are satisfied as each distinct good or service is provided, which is reflected by the duration of the room reservation.

Material rights for free or discounted goods or services are satisfied at the earlier point in time when the material right expires or the underlying free or discounted good or service is provided to the hotel guest.

Hotel revenues primarily consist of hotel room rentals, F&B sales, and other ancillary goods and services. Revenue is recognized when rooms are occupied or goods and services have been delivered or rendered, respectively. Payment terms typically align with when the goods and services are provided.

Although the transaction prices of room rentals, goods and other services are generally fixed and based on the respective room reservation or other agreement, an estimate to reduce the transaction price is required if a discount is expected to be provided to the customer. For corporate customers, the hotel offers discounts on goods and services sold in package reservations, and the corresponding transaction price is allocated to the performance obligations within the package based on the estimated standalone selling prices of each component. On occasion, the hotel may also provide the customer with a material right to a free or discounted good or service in conjunction with a room reservation or banquet contract. These material rights are considered separate performance obligations to which a portion of the transaction price is allocated based on the estimated standalone selling prices of the good or service, adjusted for the likelihood the hotel guest will exercise the right.

The Company derives revenues from Broadway Tower, which, was acquired in May 2019 (Note 5) and subsequently sold in January 2020 (Note 1). Rental revenue, which is reflected as operating property revenue in the accompanying condensed consolidated statements of operations and is presented in the Mortgage and REO Legacy portfolio and other operations segment, represents revenue from the leasing of commercial office space at Broadway Tower to tenants, common area maintenance charges and parking space rental. Leases with tenants are classified as operating leases and revenue is recognized on a straight-line basis over the term of the respective leases.

Management fees are typically composed of a base fee, which typically is a percentage of the hotel revenues, plus an incentive fee, which is generally based on hotel profitability. We recognize base management fees as revenue when we earn them under the contracts. In interim periods and at year-end, we recognize incentive management fees that would be due as if the contracts were to terminate at that date, exclusive of any termination fees payable or receivable by us.

Interest on mortgage loans is recognized as revenue when earned using the interest method based on a 360- or 365-day year, in accordance with the related mortgage loan terms. We do not recognize interest income on loans once they are deemed to be impaired and placed in non-accrual status. Generally, a loan is placed in non-accrual status when it is past its scheduled maturity by more than 90 days, when it becomes delinquent as to interest due by more than 90 days or when the related fair value of the collateral is less than the total principal, accrued interest and related costs. We may determine that a loan, while delinquent in payment status, should not be placed in non-accrual status in instances where the fair value of the loan collateral significantly exceeds the principal and the accrued interest, as we expect that income recognized in such cases is probable of collection. Unless and until we have determined that the value of underlying collateral is insufficient to recover the total contractual amounts due under the loan term, generally our policy is to continue to accrue interest until the loan is more than 90 days delinquent with respect to accrued, uncollected interest or more than 90 days past scheduled maturity, whichever comes first. Mortgage loans classified as held for sale are recorded on the lower of carrying value or fair value less cost to sell.

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

We do not generally reverse accrued interest on loans once they are deemed to be impaired and placed in non-accrual status. In conducting our periodic valuation analysis, we consider the total recorded investment for a particular loan, including outstanding principal, accrued interest, anticipated protective advances for estimated outstanding property taxes for the related property and estimated foreclosure costs, when computing the amount of valuation allowance required. As a result, our valuation allowance may increase based on interest income recognized in prior periods, but subsequently deemed to be uncollectible as a result of our valuation analysis.

We generally allocate cash receipts first to interest, except when such payments are specifically designated by the terms of the loan as a principal reduction. Loans with a principal or interest payment one or more days delinquent are in technical default and are subject to various fees and charges including default interest rates, penalty fees and reinstatement fees. Often these fees are negotiated in the normal course of business and, therefore, not subject to estimation. Accordingly, revenue for such fees is recognized over the remaining life of the loan as an adjustment to the interest income yield.

We defer fees for loan originations, processing and modifications, net of direct origination costs, at origination and amortize such fees as an adjustment to interest income using the effective interest method. Revenue for non-refundable commitment fees is recognized over the remaining life of the loan as an adjustment to the interest income yield.

We defer premiums or discounts arising from acquired loans at acquisition and amortize such premiums or discounts as an adjustment to interest income over the contractual term of the related loan using the effective interest method. We include the unamortized portion of the premium or discount as a part of the net carrying value of the loan on the accompanying condensed consolidated

balance sheets. Costs not directly paid to the seller of the loan are expensed as incurred and not amortized, except for any fees paid directly to the seller.

As of March 31, 2020 and December 31, 2019, the Company had two loans outstanding with an aggregate average principal and interest balance of $6.3 million, both of which were non-performing and have been fully reserved with a zero carrying value. The Company did not originate any new loans on its own behalf during the three months ended March 31, 2020 or 2019.

During the three months ended March 31, 2020, and 2019, we recorded mortgage interest income of $0.0 and $0.7 million, respectively.

As of March 31, 2020, we held total REO assets of $86.2 million, of which $7.4 million were held for sale, $45.5 million were held as operating properties, and $33.3 million were classified as other real estate owned. As of December 31, 2019, we held total REO assets of $104.0 million, of which $25.5 million were held for sale, $45.2 million were held as operating properties and $33.3 million were classified as other real estate owned.

On May 29, 2019, the Company foreclosed on the membership interests of a commercial office building in St Louis, Missouri, known as Broadway Tower, which were pledged as collateral on a mezzanine note held by the Company. On January 22, 2020, the Company completed the sale of Broadway Tower for a selling price of $19.5 million, net of purchase price adjustments, and paid off at closing the $11.0 million note held by Chase Funding securing the property. Subsequent to payment of closing costs and the Chase Funding indebtedness, the Company’s net proceeds were $8.0 million. While the Company did not record a loss on sale during the three months ended March 31, 2020, the disposal of Broadway Tower resulted in a loss on sale of $1.5 million, which was recorded as an impairment charge during the year ended December 31, 2019 when the impairment was determinable. The Company had no other asset sales during the three months ended March 31, 2020 or 2019.

Costs related to the development, renovation or improvements of the Company’s real estate assets are generally capitalized, while costs and expenses related to operating, holding and maintaining our operating properties and REO assets are expensed as incurred. Costs that are expensed as incurred are included in operating property direct expenses and as expenses for non-operating real estate owned in the accompanying unaudited condensed consolidated statements of operations. For the three months ended March 31, 2020 and 2019, these costs and expenses were $3.5 million and $2.4 million, respectively. Cash outlays for capitalized costs totaled $0.7 million and $4.7 million during the three months ended March 31, 2020 and 2019, respectively, and consisted primarily of renovation costs for MacArthur Place.

As of March 31, 2020 and December 31, 2019, we consolidated multiple variable interest entities (“VIEs”) relating to two primary projects: 1) various partnerships which own land and water rights located in New Mexico for which the Company retains both general partner and limited partner interests, and 2) the L’Auberge de Sonoma Resort Fund (the “Hotel Fund”) for which the Company is the sponsor and its subsidiary is the common member that owns MacArthur Place. We are deemed to be the primary beneficiaries of these consolidated VIEs as we have the power to direct the activities that most significantly affect their economic performance and we have the obligation to absorb their losses and the right to receive benefits that could be significant to them. The assets of these consolidated VIEs are only available to settle the obligations of the respective entities.

The following table summarizes the carrying amounts of the above-referenced entities’ assets and liabilities included in the Company’s accompanying condensed consolidated balance sheets at March 31, 2020 and December 31, 2019 (in thousands):

The following table summarizes the consolidated VIEs results of operations for the three months ended March 31, 2020 and 2019, net of intercompany eliminations (in thousands):

The Company’s maximum exposure to loss of its combined equity in those entities totaled $28.1 million as of March 31, 2020.

In the second quarter of 2019, the Company entered into a joint venture agreement with Juniper New Mexico, LLC and Juniper Bishops Manager, LLC (both related parties of Jay Wolf, a director of the Company) to participate in a $10.0 million mezzanine loan to be used to finance the renovation of a luxury resort located in Santa Fe, New Mexico. The mezzanine loan is secondary to a senior mortgage loan funded by an unrelated party. The joint venture is named Juniper Bishops, LLC (“Juniper Bishops” or the “JV”), and is sponsored and managed by Juniper Bishops Manager, LLC, which manages and controls the joint venture. IMH’s subsidiary, IMH Bishops Lodge Mezz Lender, LLC (“IMH BL Mezz Lender”), is a limited member in the joint venture and does not manage, control or have any decision-making powers nor is it the primary beneficiary, and therefore, it is not consolidated. As such, we have accounted for this investment using the equity method of accounting. IMH BL Mezz Lender’s maximum commitment under this investment is $3.9 million, (or 39% of the $10.0 million loan), all of which was funded as of March 31, 2020. Under the terms of the mezzanine loan agreement, the interest rate of the loan is based on the one-month LIBOR plus 15% with a LIBOR floor of 2.4%, and of which 6.0% is accrued and deferred, and the balance is paid on a current basis. While the Company is entitled to a 7% return under the terms of the JV agreement, the Company expects to receive a total preferred annualized return of 11.4%, less a management fee of 1.5%, of which 5.4% is payable quarterly in arrears, with the remaining 6.0% accrued

Our valuation analysis process and procedures are disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. We perform a valuation analysis of our loans, REO held for sale, and other REO on a quarterly basis. We consider all relevant, material circumstances to determine if, and the extent to which, a valuation allowance is required.

Impairment for collateral dependent loans is measured at the balance sheet date based on the then fair value of the collateral in relation to contractual amounts due under the terms of the applicable loan if foreclosure is probable. Substantially all of our loans in default are deemed to be collateral dependent.

REO assets that are classified as held for sale and other REO are measured at the lower of carrying amount or fair value, less estimated cost to sell. If an asset is considered impaired, an impairment loss is recognized for the difference between the asset’s carrying amount and its fair value, less estimated cost to sell. If we elect to change the disposition strategy for our other REO, and such assets were deemed to be held for sale, we may record additional impairment charges, and the amounts could be significant.

The results of our valuation efforts generally provide a range of values for the collateral valued or REO assets rather than a single value. The selection of a value from within a range of values depends upon general overall market conditions as well as specific market conditions for each property valued and its stage of entitlement or development. In selecting the single best estimate of value, we consider the information in any relevant valuation reports, credible purchase offers received and agreements executed, as well as multiple observable and unobservable inputs.

Based on the results of our evaluation and analysis, we recorded no non-cash provision for credit losses or impairment losses during the three months ended March 31, 2020 or 2019. However, we recorded recoveries of investment and credit losses totaling $1.8 million during the three months ended March 31, 2020, resulting from the collection of cash and other assets recovered from certain guarantors on certain mezzanine loans. No recoveries were recorded during the three months ended March 31, 2019.

As of March 31, 2020 and December 31, 2019, the valuation allowance on our mortgage loans totaled $12.7 million, representing 100.0% of the total outstanding loan principal and accrued interest balances. With the existing valuation allowance recorded as of March 31, 2020, we believe that, as of that date, the fair value of our loans, REO assets held for sale, and other REO is adequate in relation to the net carrying value of the related assets and that no additional valuation allowance or impairment is considered necessary. While the above results reflect management’s assessment of fair value as of March 31, 2020, based on currently available data, we will continue to evaluate our loans and REO assets to determine the appropriateness of the carrying value of such assets. Depending on market conditions, such updates may yield materially different values and potentially increase or decrease the valuation allowance for loans or impairment charges for REO assets.

As of March 31, 2020 and December 31, 2019, our notes payable and special assessment obligations consisted of the following (in thousands):

In connection with our purchase and renovation of MacArthur Place, we secured a $32.3 million acquisition and construction loan, which was subsequently increased to $37.0 million, from MidFirst Bank (the “MacArthur Loan”), of which (i) $19.4 million was utilized for the purchase of MacArthur Place, (ii) $13.5 million was used to fund planned hotel improvements, and (iii) the balance was used to fund interest reserves and operating capital. The MidFirst Loan also required the establishment of certain additional reserve accounts in the amount of $2.0 million for anticipated future spa renovations.

The MacArthur Loan is secured by a deed of trust on all MacArthur Place real property and improvements, and a security interest in all furniture, fixtures and equipment, licenses and permits, and MacArthur Place related revenues. The Company agreed to provide a construction completion guaranty which shall be released upon payment of all project costs and receipt of a certificate of occupancy. In addition, the Company provided a loan repayment guaranty equal to 50% of the loan principal along with a guaranty of interest and operating deficits, as well as other customary carve-out matters such as bankruptcy and environmental

matters. Under the guarantees, the Company is required to maintain a minimum tangible net worth of $50.0 million and minimum liquidity of $5.0 million throughout the term of the loan. The Company was in compliance with these covenants and guarantees at March 31, 2020. The Company is required to establish various operating and reserve accounts at MidFirst Bank which are subject to a cash management agreement. In the event of default, MidFirst Bank has the ability to take control of such accounts for the allocation and distribution of proceeds in accordance with the cash management agreement.

As of March 31, 2020, the Company had an outstanding note payable in the amount of $4.9 million, secured by certain real estate located in New Mexico with a carrying value of $6.8 million. The note bears interest at the Prime Rate as reported by The Wall Street Journal plus 3% and requires interest only payments payable on December 31 of each year with the principal balance and any accrued unpaid interest due upon the earlier of 1) December 31, 2022, or 2) sale of the underlying collateral property. The note may be prepaid in whole or in part without penalty, and includes certain maturity extension provisions which the Company may choose to exercise.

In connection with the purchase of the $13.2 million first mortgage note secured by Broadway Tower in May 2019, we obtained an $11.0 million loan (under a master repurchase agreement) from Chase Funding. In January 2020, the Company sold Broadway Tower and paid off the related Chase Funding indebtedness.

Our notes payable and special assessment obligations have the following scheduled maturities as of March 31, 2020 (in thousands):

Operating segments are defined as components of an enterprise that engage in business activity from which revenues are earned and expenses incurred for which discrete financial information is available that is evaluated regularly by our chief operating decision makers in deciding how to allocate resources and in assessing performance.

The information presented in our reportable segments tables that follow are based in part on internal allocations which involve management judgment. Substantially all revenues recorded are from external customers. There is no material intersegment activity.

As of and for the three months ended March 31, 2020 and 2019, the Company’s reportable segments consisted of the following:

Condensed consolidated financial information for our reportable operating segments as of March 31, 2020 and December 31, 2019, and for the three months ended March 31, 2020 and 2019, is summarized as follows (in thousands):

Shares of Common Stock, Class B Common Stock, Class C Common Stock, and Class D Common Stock share proportionately in our earnings and losses attributable to common shareholders. There are no shares of Class D Common Stock outstanding as of March 31, 2020 or December 31, 2019.

In July 2014, the Company issued a total of 8,200,000 shares of the Company’s Series B-1 and B-2 Cumulative Convertible Preferred Stock (“Series B-1 Preferred Stock” and “Series B-2 Preferred Stock,” respectively) to certain investor groups in exchange for $26.4 million. Except for certain voting and transfer rights, the rights and obligations of the Series B-1 Preferred Stock and Series B-2 Preferred Stock are substantially the same.

On February 9, 2018, Chase Funding purchased 2,352,941 shares of the Company’s Series B-3 Cumulative Convertible Preferred Stock (“Series B-3 Preferred Stock”) for a total purchase price of $8.0 million. The Series B-3 Preferred Stock contains redemption features similar in all material respects to those of all Series B-1 Preferred Stock and Series B-2 Preferred Stock.

On September 25, 2019, Chase Funding purchased 1,875,000 shares of our Series B-4 Cumulative Convertible Preferred Stock (“Series B-4 Preferred Stock” and collectively with the Series B-1 Preferred Stock, Series B-2 Preferred Stock, and Series B-3 Preferred Stock, the “Series B Preferred Stock”), at a purchase price of $3.20 per share, for a total purchase price of $6.0 million. The Series B-4 Preferred Stock contains redemption features similar in all material respects to the other Series B Preferred Stock.

On July 23, 2019, with an effective date of April 1, 2019, we entered into a Deferral and Consent Agreement with the holders of our Series B Preferred Stock pursuant to which they agreed to a one-year extension of the redemption date for shares of our Series

B-1 Preferred Stock and Series B-2 Preferred Stock they respectively hold. A cash payment in the aggregate amount of $2.6 million is due and payable to the holders of these shares on July 24, 2020, whether or not a redemption is requested.

In addition to various other rights and preferences belonging to the holders of the Series B Preferred Stock, the following provides a summary of certain financial obligations relating to the Series B Preferred Stock:

At any time after (i) July 24, 2020 for the Series B-1 and B-2 Preferred Stock, (ii) February 9, 2023 for the Series B-3 Preferred Stock, and (iii) September 25, 2024 for the Series B-4 Preferred Stock, each holder of Series B Preferred Stock may require the Company to redeem, out of legally available funds, the shares of Series B Preferred Stock held by such holder at the a price (the “Redemption Price”) equal to the greater of (i) 150% of the sum of the original price per share of the Series B-1 and B-2 Preferred Stock, and 145% of the sum of the original price per share of the Series B-3 and B-4 Preferred Stock, plus all accrued and unpaid dividends or (ii) the sum of the tangible book value of the Company per share of voting Common Stock plus all accrued and unpaid dividends, as of the date of redemption. Based on the initial investment of $26.4 million, the Redemption Price for the Series B-1 and B-2 Stock would presently be $39.6 million, resulting in a redemption premium of $13.2 million, in addition to a cash payment in the aggregate amount of $2.6 million. The Redemption Price for the Series B-3 Preferred Stock would be $11.6 million, resulting in a redemption premium of $3.6 million, and the Redemption Price for the Series B-4 Preferred Stock would be $8.7 million, resulting in a redemption premium of $2.7 million. In accordance with applicable accounting standards, we have elected to amortize the redemption premiums using the effective interest method as an imputed dividend over the holding term of the preferred stock. During the three months ended March 31, 2020 and 2019, we recorded amortization of the redemption premium of $0.3 million and $0.9 million, respectively, as a deemed dividend.

Concurrent with Chase Funding’s purchase of our Series B-3 Cumulative Convertible Preferred Stock, the Company issued to Chase Funding a warrant to acquire up to 600,000 shares of the Company’s common stock (the “JPM Warrant”). The JPM Warrant is exercisable at any time on or after February 9, 2021, for a two (2) year period, and has an exercise price of $2.25 per share. The JPM Warrant provides for certain adjustments that may be made to the exercise price and the number of shares issuable upon exercise due to customary anti-dilution provisions based on future corporate events. The JPM Warrant is exercisable in cash, and subject to certain conditions, may also be exercised on a cashless basis. The JPM Warrant is classified in stockholders’ equity on the accompanying condensed consolidated balance sheets under the applicable guidance and was recorded at relative fair value at issuance.

On May 31, 2018, Chase Funding purchased 22,000 shares of the Company’s Series A Senior Redeemable Preferred Stock (the “Series A Preferred Stock”) at a purchase price of $1,000 per share, for a total purchase price of $22.0 million.

The Series A Preferred Stock ranks senior with respect to dividend and redemption rights and rights upon liquidation, dissolution or winding up of the Company to all other classes or series of shares of the Company’s preferred and common stock and to all other equity securities issued by the Company from time to time. The Series A Preferred Stock is non-voting stock. Holders of the Series A Preferred Stock are entitled to receive a liquidation preference equal to the sum of the initial purchase price of the Series A Preferred Stock plus all accrued and unpaid dividends. Dividends on the Series A Preferred Stock are cumulative and accrue from the issue date at the rate of 7.5% of the issue price per year, payable quarterly in arrears on or before the last day of each calendar quarter. The Company has certain call rights with respect to the Series A Preferred Stock and the holders of Series A Preferred Stock have certain put rights which includes an acceleration of the put right if the Company is required to redeem any shares of junior securities in the event of certain non-compliance events as described in the Company’s Second Amended and Restated Certificate of Designation of Series B-1 Cumulative Convertible Preferred Stock, Series B-2 Cumulative Convertible Preferred Stock and Series B-3 Cumulative Convertible Preferred Stock.

Our Series B Preferred Stock and Series A Preferred Stock are classified as mezzanine equity in the accompanying condensed consolidated balance sheets.

On January 11, 2019, the Company concluded a tender offer to purchase up to 477,170 shares of Class B Common Stock and 22,830 shares of Class C common stock for $2.00 per share. The repurchase of these shares was treated as a treasury stock repurchase as reflected in the accompanying condensed consolidated balance sheet. During the three months ended March 31, 2020, an aggregate of 4,618 shares of Class B common stock and 2,203 shares of Class C common stock were relinquished to the Company for no consideration to the shareholders.

During the three months ended March 31, 2020, the Company issued 60,356 shares of common stock pursuant to previous restricted stock awards. The Company did not grant any shares of restricted stock or stock options during the three months ended March 31, 2020, nor were any stock options or warrants exercised or forfeited during that period.

As of March 31, 2020, there were (i) 1,093,562 outstanding stock options that were fully vested, (ii) 2,600,000 unvested stock warrants outstanding; and (iii) 554,452 shares of unvested restricted stock grants outstanding, net of tax elections taken.

Net stock-based compensation expense was $0.1 million for each of the three months ended March 31, 2020 and 2019. We did not receive any cash from option or warrant exercises during the three months ended March 31, 2020 or 2019. As of March 31, 2020, there was $0.8 million of unrecognized compensation expense related to all unvested equity-based awards that are expected to be recognized as a charge to earnings over a weighted-average vesting period of 1.25 years.

The Company has adopted the two-class computation method, and thus includes all participating securities in the computation of basic shares for the periods in which the Company has net income available to common shareholders. A participating security is defined as an unvested share-based payment award containing non-forfeitable rights to dividends regardless of whether or not the awards ultimately vest or expire. Net losses are not allocated to participating securities unless the holder has a contractual obligation to share in the losses.

The following table presents a reconciliation of net loss to net loss attributable to common shareholders used in the basic and diluted earnings per share calculations for the three months ended March 31, 2020 and 2019 (amounts in thousands, except for per share data):

The following securities were not included in the computation of diluted net loss per share as their effect would have been anti-dilutive (presented on a weighted average balance):

In connection with the purchase of MacArthur Place, we allocated a portion of the total purchase price to certain intangible assets and goodwill. Of the total $16.3 million allocated to purchased intangibles, $15.4 million, $0.8 million, and $0.1 million, were allocated to goodwill, customer relationships, and trade name and other, respectively.

The changes in the carrying amount of intangibles and goodwill allocated to our Hospitality and Entertainment Operations segment for the three months ended March 31, 2020 is as follows (in thousands):

Trade name and other, and customer relationships have weighted-average useful lives from the date of purchase of 7.0 years and 3.0 years, respectively. Goodwill and our liquor license are not subject to amortization due to the indeterminable life of such assets. Amortization expense relating to our purchased intangible assets was $0.1 million for each of the three months ended March 31, 2020 and 2019, respectively.

The full impact of the COVID-19 outbreak continues to evolve as of the date of our quarterly reporting. The extent to which the Company’s business may be affected by the current outbreak of the COVID-19 outbreak will largely depend on both current and future developments, including its duration, spread and treatment, and related travel advisories and restrictions, which could impact overall demand in the hospitality industry, all of which are highly uncertain and cannot be reasonably predicted at this time. Management will continue to monitor the situation as events unfold and assess any potential further impairment triggers.

As described in Note 8, the Company agreed to provide MidFirst Bank with a loan repayment guaranty equal to 50% of the sum of the outstanding principal and accrued and unpaid interest on the MacArthur Loan, plus a guaranty of 50% of hotel operating costs, enforcement costs under the loan (if any), and recourse amounts that may come due (if any). The Company has also provided a construction completion guaranty with respect to the planned renovations of MacArthur Place. The construction completion guaranty will be released upon payment of all project costs and receipt of a certificate of occupancy, which occurred subsequent to March 31, 2020. The MidFirst Bank loan documents also require that the loan remain “in balance” throughout its term, such that the sum of all remaining undisbursed loan funds exceed the aggregate of (i) future expenditures necessary to complete the renovations in accordance with the approved construction budget and (ii) loan interest. If the loan becomes “out of balance,” the Company must fund the difference. Excess costs incurred to date have been funded by the Hotel Fund or the Company, and management expects that the Hotel Fund or the Company will continue to fund any further excess costs.

We have pursued and periodically receive favorable judgments against guarantors in connection with their personal guarantees of certain legacy loans on which we previously foreclosed. Similarly, we have filed claims against certain insurance providers and other parties for reimbursement of amounts we believe are due to the Company under such policies. Due to the uncertainty of the nature and extent of the available assets of these guarantors to pay the judgment amounts or amounts collectible under insurance claims, we do not record recoveries for any amounts due under such judgments or claims, except to the extent we have received assets without contingencies.

We continue to pursue, investigate and evaluate the assets available of guarantors to collect all amounts due under judgments received in our favor. However, to the extent that such amounts are not determinable, they have not been recognized as recovery income in the accompanying condensed consolidated statements of operations. Further recoveries under this and other judgments received in our favor will be recognized when realization of the recovery is deemed probable and when all contingencies relating to recovery have been resolved. We recorded recoveries during the three months ended March 31, 2020, of $1.8 million relating to cash collected on a guarantor claim, and none during the three months ended March 31, 2019.

The Company, through its human resource provider, participates in a 401(k) retirement savings plan that allows for eligible participants to defer compensation, subject to certain limitations imposed by the Internal Revenue Code of 1986, as amended. The Company may provide a discretionary matching contribution of up to 4% of each participant’s eligible compensation. During each of the three months ended March 31, 2020 and 2019, the Company’s matching contribution was $0.1 million, which is included in general and administrative expenses in the accompanying condensed consolidated statements of operations.

    

The Company maintains a non-qualified deferred compensation plan (the “Plan”), which allows a select group of executive employees to defer a portion of their compensation. Such deferred compensation is distributable in cash in accordance with the rules of the Plan. Deferred compensation amounts under such plan as of March 31, 2020, totaled approximately $0.1 million and are included in other accrued expenses in the accompanying condensed consolidated balance sheets. Distributions to participants can be either in one lump sum payment or annual installments as elected by the participants. During the three months ended March 31, 2020, we distributed $0.2 million to the former CEO in accordance with his termination agreement.

We may be a party to litigation as the plaintiff or defendant in the ordinary course of business. While various asserted and unasserted claims may exist, resolution of these matters cannot be predicted with certainty. We establish reserves for legal claims when payments associated with the claims become probable and the payments can be reasonably estimated. Given the uncertainty of predicting the outcome of litigation and regulatory matters, it is generally difficult to predict what the eventual outcome will be, and when the matter will be resolved. The actual costs of resolving legal claims may be materially higher or lower than any amounts reserved for the claims.

In the first fiscal quarter of 2017, Recorp-New Mexico Associates Limited Partnership (“RNMA I”) conducted a capital call pursuant to its organizational documents.  As a result of the capital call, certain limited partnership interests in RNMA I were transferred to various subsidiaries of the Company.  One of the limited partners in RNMA I whose limited partnership interests were transferred instigated the State Partnership Litigation challenging the effectiveness of the transfer and forfeiture of his limited partnership interests. In a November 2019 ruling in the State Partnership Litigation, the court held that (i) the limited partners of RNMA I properly noticed the removal of Recorp Partners, Inc. (“RPI”) as the general partner effective as of December 2017 which rendered all actions taken by RPI from and after that date “ultra vires” or ineffective - including the purported capital call in the first quarter of 2017 and the resulting transfer and forfeiture of the limited partnership interest of all limited partners, and (ii) Stockholder, LLC, a wholly owned subsidiary of the Company, is the sole owner of all of the stock of RPI as the corporate general partner of RNMA I. The Company has appealed these rulings to the state appellate court, and RPI has made demand on the RNMA I limited partners pursuant to the governing partnership documents for a separate arbitration to challenge the merits of the notice of RPI’s removal as the general partner.

During the three months ended March 31, 2020, the Company commenced negotiations to settle the State Partnership Litigation pursuant to which, the Company offered to buy the interests of the limited partners for a cash payment of $1.3 million. The limited partners did not respond to the settlement offer and as of the date of this report there are no ongoing settlement discussions.

In September 2017, the court hearing the State Partnership Litigation (the “State Court”) terminated the receivership over Stockholder, LLC, a wholly-owned subsidiary of the Company (“Stockholder”) and owner of all of the shares of stock in certain corporations that act as the general partner or the limited liability company manager of several entities that own land and/or certain water interests in New Mexico. David Maniatis (“Maniatis”) timely filed a notice of appeal of this order to the State Court of Appeals. That appeal is currently pending.

In December 2017, the State Court entered an interim “stay” order in the Company’s collection case against Maniatis and his affiliates enjoining the Company from taking any further collection action against Maniatis and his associates pending an accounting of all previous debt collection activities and a trial on certain limited issues involving the calculation of interest and penalties on the original defaulted debt guaranteed by Maniatis. The stay order also temporarily inhibited the Company from effecting the sale or transfer of all or any part of the property previously acquired by the Company through prior litigation involving Maniatis, including approximately 7,000 acres of land and related water interests in New Mexico, and 111 acres of land in Texas. Subsequent to March 31, 2019, the State Court lifted the stay on all property previously acquired by the Company through litigation involving Maniatis except for the ownership interests in, and property held by, RNMA I which remain subject to the stay until the date that

is 30 days after the resolution of the State Partnership Litigation. Management does not believe that loss is probable and, accordingly, no amounts have been accrued for this matter in the accompanying unaudited condensed consolidated financial statements.

If the Hotel Fund has insufficient operating cash flow to pay the Preferred Distribution in a given month, the Company is obligated under the Hotel Fund’s operating agreement to provide the funds necessary to pay the Preferred Distribution for such month, such payments to be treated as an additional capital contribution to the Hotel Fund by the Company. During the three months ended March 31, 2020, the Company funded $0.4 million of Preferred Distributions, and from inception through March 31, 2020, the Company has funded $2.4 million. The Company also agreed to fund, in the form of common capital contributions, up to 6.0% of the Hotel Fund offering’s gross proceeds as selling commissions and up to 1.0% of the gross proceeds raised in the offering as nonaccountable expense reimbursements to broker-dealers based on the capital raised by them for the Hotel Fund. During the three months ended March 31, 2020, and from inception through March 31, 2020, the Company paid $0.1 million to the Hotel Fund pursuant to these obligations. In addition to these payments, the Company has funded cash deficits for various operating and related costs which are treated as non-interest bearing advances (which are eliminated in consolidation). Through March 31, 2020, the Company had funded such operating shortfalls in the amount of $12.9 million.

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

On May 29, 2019, we foreclosed on all of the membership interests of Hertz Broadway Tower, LLC, (“Hertz Broadway”), the owner of Broadway Tower. As a result, we acquired Broadway Tower, its related assets and business operations and assumed related liabilities, including 51 commercial office leases. The Company sold Broadway Tower inclusive of these commercial office leases in January 2020, which is more fully described in Note 5.

The following table presents minimum lease revenues and variable lease revenue for the three months ended March 31, 2020 and 2019 (in thousands).

Variable rent includes costs reimbursed related to property operating expenses, common area maintenance, insurance and property taxes.

We have operating leases for our corporate headquarters office space and certain office equipment. Our leases have remaining lease terms of between one to four years. The lease for our corporate office includes an option to extend the lease term for up to five years. This option is not included in the calculation of the right-of-use (“ROU”) assets and lease liabilities because the Company is not reasonably certain that it will exercise the option. Lease expense was $0.1 million for the three months ended March 31, 2020 and 2019, respectively, which is included in general and administrative expenses in the accompanying condensed consolidated statements of operations. As disclosed in Note 14, JIA has sublet a portion of the Company’s office space. During the three months ended March 31, 2020, we recorded expense reimbursements from JIA for the sublease of office space and certain overhead charges of $33,000.

Variable lease payments are not included in the calculation of the ROU asset and lease liability due to uncertainty of the payment amount and were $0.1 million and $0.1 million for the three months ended March 31, 2020 and 2019, respectively.

Supplemental balance sheet information related to leases as of March 31, 2020, was as follows (thousands, except lease term and discount rate):

    

During the three months ended March 31, 2020, the Company paid Mr. Bain $15,000 under the New Mexico Asset Consulting Agreement.

In July 2014, the Company and JCP Realty Partners, LLC, a Delaware limited liability company (“JCP”) entered into a consulting services agreement (the “JCP Consulting Agreement”) pursuant to which JCP agreed to perform various services for the Company. Our director, Jay Wolf, is the Managing Member of Juniper Capital Partners, LLC, the parent company of JCP. The Company and JCP entered into an amendment of the JCP Consulting Agreement dated October 17, 2017 pursuant to which: (i) the term was extended for two years; (ii) the annual base consulting fee was reduced from $0.6 million to $0.5 million (subject to possible upward adjustment based on an annual review by our board of directors); and (iii) JCP is entitled to receive an origination fee of up to 1.25% on any loans or investments in real estate, preferred equity or mezzanine securities that are originated or identified by JCP (subject to a reduced fee based on the increasing size of the loan or investment). JCP is also entitled to legacy fee payments derived from the disposition of certain assets held by the Company as of December 31, 2010, to persons or opportunities arising through the efforts of JCP equal to 5.5% of the positive difference derived by subtracting (i) 110% of our December 31, 2010, valuation mark of that asset from (ii) the gross sales proceeds (on a legacy asset by asset basis without any offset for losses realized on any individual asset sales). The JCP Consulting Agreement terminated on July 24, 2019 and no amounts were incurred under this agreement during the three months ended March 31, 2020. During the three months ended March 31, 2019, we incurred base consulting fees to JCP of $0.1 million.

On August 14, 2019, the Company and JIA entered into the Advisory Agreement pursuant to which JIA agreed to manage, on a non-discretionary basis, certain assets of the Company, including the Company’s loan portfolio and certain of its legacy real-estate owned properties. Under the terms of the Advisory Agreement, the Company will pay JIA a management fee between 1.0% to 1.5% of the net asset value of certain assets under management, as well as a performance fee equal to 20% of the net profits from those assets upon disposition after the Company has received an annualized 7% return on its investment from those assets and recovery of the Company’s basis in such assets. In connection with the Advisory Agreement, certain employees of the Company have transitioned to become employees of JIA, and JIA has also sublet a portion of the Company��s office space. During the three months ended March 31, 2020, we incurred base consulting fees to JIA of $67,000 and recorded expense reimbursements from JIA for the sublease of office space and certain overhead charges of $33,000. In addition, we paid $0.2 million in performance

fees to JIA in connection with the disposal of Broadway Tower and collection of recoveries from the former borrower under the related mezzanine loan. Jay Wolf, a director of the Company, and Lawrence D. Bain, the former CEO of the Company, are managing partners of JIA.

On February 14, 2019, the Company entered into an asset management agreement with Juniper Time Investor, LLC (“JTI”), an affiliate of JCP and Jay Wolf to provide certain asset management and related services in connection with JTI’s ownership and operation of The Time Hotel Nyack in Nyack, New York, which agreement was amended on April 1, 2019 (the “Nyack Asset Management Agreement”). Under the terms of the Nyack Asset Management Agreement, the Company is entitled to a monthly base asset management fee of $38,000, reimbursement of expenses, and a one-time exit fee of $0.25 million, payable within five business days following the sale of the property. The Nyack Asset Management Agreement was terminated during the three months ended March 31, 2020. During the three months ended March 31, 2020 and 2019, the Company earned base asset management fees of $0.1 million and $0.1 million, respectively. As of March 31, 2020, the Company was due $0.1 million under this agreement.

A subsidiary of the Company has entered into a lending facility with certain consolidated partnerships to lend up to a maximum of $5.0 million to cover the partnerships’ anticipated operating and capital expenditures. As of March 31, 2020, the total principal advanced was $5.6 million, including $0.5 million of protective advances in excess of the facility’s maximum face amount. The promissory notes earn interest at rates ranging from the JP Morgan Chase Prime Rate plus 2.0% (7.50% at March 31, 2020) to 8.0% and have maturity dates which are the earliest to occur of: (1) the date of transfer of the partnerships’ real estate assets; (2) the date on which the current general partner of those partnerships resigns, withdraws or is removed as general partner; or (3) July 31, 2018. As the maturity date of these promissory notes have expired, the notes are in default and the Company is exploring its enforcement options. The promissory notes are cross collateralized and secured by real estate and other assets owned by such partnerships. These promissory notes and the related accrued interest receivable have been eliminated in consolidation.

Investment in Unconsolidated Entities

Coronavirus Aid, Relief, and Economic Security (CARES) Act

On March 26, 2020, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was signed into federal law to respond to the economic hardships caused by increased unemployment due to COVID-19 shelter in place orders. Among other forms of economic relief, the CARES Act allows qualifying small businesses to apply for the Paycheck Protection Program (“PPP”) which provides a federally-guaranteed loan, under the U.S. Small Business Administration, of up to $10.0 million with a two-year repayment term accruing at 1% annually. The loan may be forgivable provided that the Company uses at least 75% of the proceeds on payroll and the remaining 25% on other qualified expenses, in addition to meeting other guidelines. The Company applied for two (2) PPP loans, one on behalf of the Company’s corporate offices and the other for MacArthur Place, both of which were approved and funded in April 2020 for approximately $1.8 million in the aggregate.

The application for these funds requires the Company to, in good faith, certify that the current economic uncertainty made the loan request necessary to support the ongoing operations of the Company. This certification further requires the Company to take into account our current business activity and our ability to access other sources of liquidity sufficient to support ongoing operations in a manner that is not significantly detrimental to the business. The receipt of these funds, and the forgiveness of the loan attendant

to these funds, is dependent on the Company having initially qualified for the loan and qualifying for the forgiveness of such loan based on our future adherence to the forgiveness criteria.

The following discussion should be read in conjunction with our Management’s Discussion and Analysis of Financial Condition and Results of Operations and the audited financial statements and accompanying notes as of and for the year ended December 31, 2019 included in our Annual Report on Form 10-K (“Form 10-K”), and with the unaudited condensed consolidated financial statements and accompanying notes included in this Quarterly Report on Form 10-Q (“Form 10-Q”).

This Form 10-Q contains forward-looking statements which relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward looking statements by terms such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “likely,” “may,” “will,” “plan,” “potential,” “should” and “would” or the negative of these terms or other comparable terminology. Forward-looking statements in this Form 10-Q include: our business strategy and liquidity plan, including our intention to dispose of a majority of the balance of our real estate assets in the next 12 months, and assuming adequate liquidity, our goals and plans to invest in different real estate platforms, including consideration of opportunities to act as a sponsor and co-investor in real estate mortgages, hospitality assets, and other real estate-based vehicles, diversify our investments geographically and expand our investment capital base and pursue development activities with certain REO properties; the outcome of actions we may take, or fail to take, that result in defaults of obligations that have liens or collateral interest in our commercial mortgage loan and REO properties, including our ability to cure such defaults; our plans and the anticipated timing and results relating to our actions to foreclose on defaulted mortgage loans; trends and expectations relating to the real estate, hospitality and lending markets we operate in; expected amortization period of unrecognized compensation costs; that future mortgage income will remain at minimal levels; that property taxes, costs and expenses relating to REO assets and other operating expenses may increase; that we may modify existing loans and/or subordinate our first lien position on our mortgage loans to protect our collateral and maximize our opportunity for recovery; that the concentration of our current loan portfolio will not materially change until we resume significant lending activities; our sources and the sufficiency of liquidity in the next twelve months; that our financial assets do not give rise to significant interest rate risk; that we may sell whole loans or participations in loans to increase our liquidity; expectations about future derivative investments; recent trends and expectations relating to rental and hospitality and entertainment activities; that changes in our disposition strategy and related changes in classifications of such assets under GAAP could result in material impairment charges; our future liability relating to community facility district (“CFD”) and special assessment obligations; that the fair value of the collateral underlying our mortgage loans is sufficient in relation to the current carrying value of the related loans; and that we may further increase our leverage.

We are a real estate investment and finance company focusing on the commercial, hospitality, industrial and residential real estate markets.

Our current business focus is to re-establish the Company’s access to significant investment capital in order to improve the performance of our portfolio. By increasing the level and quality of the assets in our portfolio, we believe that the Company can grow and ultimately provide its shareholders with favorable risk-adjusted returns and enhanced opportunity for liquidity to satisfy near-term financial obligations that are expected to come due.

As of March 31, 2020, we held real estate assets with a carrying value of $86.2 million. We expect that our REO held for sale and other REO will be marketed for disposition within the next twelve months. With cash and cash equivalents of $9.9 million at March 31, 2020, and anticipated proceeds from asset sales and third-party financing, our objective is to redeploy available amounts into income-producing investments, such as mortgage loans, joint ventures and the acquisitions of hospitality and other attractive other real estate assets. However, our ability to implement our investment strategy in dependent on the Company’s ability to generate sufficient liquidity.

The recent and rampant spread of the coronavirus (COVID-19) has caused businesses, restaurants, bars, entertainment centers and other public places across the country to shutter their operations. California has been particularly impacted by the spread of this virus. States, counties, and cities across the United States, including the State of California, have enacted “stay in place” orders that restrict anything other than essential travel. On March 17, 2020, by Order of the Health Officer of the County of Sonoma, California, Order No. C19-03 (the “Order”), all businesses with a facility in Sonoma County were required to “cease all activities.” All travel in Sonoma County, except for Essential Travel and Essential Activities, is prohibited. The Order became effective at 12:00 a.m. on March 18, 2020 and will continue in effect until the Governor’s office releases guidelines for the reopening of restaurants, hotels, and spas. The Company’s lone operating asset, a hospitality asset relying on room, event and restaurant revenue, is located in Sonoma County. While the Company is managing this asset prudently under these conditions, including by terminating non-essential vendor services and reducing other expenses where feasible, the continuance of the Company’s ongoing operations are at substantial risk barring immediate fiscal policy relief coming from the federal or California state government.

Prior to the outbreak of this virus in the United States, the Board of Directors of the Company independently determined that it would be in the best interests of the shareholders of the Company to consider, evaluate and possibly take action with respect to a re-capitalization of the Company. Accordingly, the Board appointed a Special Committee consisting exclusively of independent members of the Board of Directors to formulate, establish, oversee and direct a process for the identification, evaluation and negotiation of any proposed recapitalization or alternative transaction. The Special Committee has retained outside advisors to assist the members of the Special Committee in carrying out these responsibilities. It is possible that the Special Committee will recommend that the Company enter into a recapitalization or other transaction or set of transactions that, among other things, would: (i) constitute an event of default or termination event, and cause the automatic and immediate acceleration of all debt outstanding under or in respect of instruments and agreements relating to direct financial obligations of the Company, including

the mortgage loan on the Company’s lone operating asset, the MacArthur Place Hotel and Spa; (ii) permit holders of the Company’s preferred shares to exercise their rights to require the Company to redeem a portion or all of their preferred shares; (iii) constitute a breach under various agreements to which the Company is a party and which are materially important to the operations of the Company. and (iv) accelerate payments made to the Company’s CEO under his employment agreement. This evaluation process is on-going and no recommendations or determinations have been reached by the Special Committee and there can be no assurance that the Special Committee will recommend any such recapitalization or other transaction.

Historically, we have used proceeds from the issuance of preferred equity and/or debt, proceeds from the sale of our REO assets, and the liquidation of mortgages and related investments to satisfy our working capital requirements. During the three months ended March 31, 2020, we sold our Broadway Tower commercial office building, netting $8.0 million in cash to the Company after payment of closing costs and related debt. We also are in discussions with the holders of our Series B-1 and B-2 Preferred Stock regarding a potential restructuring or modification of those securities and our obligations, thereunder. There can be no assurance that these efforts will be successful, that we will sell our remaining REO assets in a timely manner, or that we will obtain additional or replacement financing, if needed, to sufficiently fund our future operations, redeem our Series B-1 and B-2 Preferred Stock if so required, repay existing debt, or to implement our investment strategy. In the event we are unsuccessful in negotiating a deferral or restructuring of the terms of our Series B-1 and B-2 Preferred Stock, we will be required to fund the redemption of $39.6 million. In the absence of proceeds from asset sales, equity issuances or borrowings to fund the Redemption Price, the required redemption would likely render the Company insolvent. Moreover, our failure to generate sustainable earning assets and to successfully liquidate a significant portion of our REO assets will have a material adverse effect on our business, results of operations and financial position. In the absence of favorably resolving the matters described above, the collective nature of these uncertainties create substantial doubt about our ability to continue as a going concern for a period beyond one year from the date of issuance of this Form 10-Q.

The following discussion compares historical results of operations on a GAAP basis for three months ended March 31, 2020 and 2019. Unless otherwise noted, all comparative performance data included below reflects year-over-year comparisons.

Our operating segments reflect the distinct business activities from which revenues are earned and expenses incurred that are evaluated regularly by our executive management team in assessing performance and in deciding how to allocate resources. As of and for the three months ended March 31, 2020 and 2019, the Company’s reportable segments consisted of the following:

A summary of the financial results for each of our operating segments during the three months ended March 31, 2020 and 2019 follows (in thousands):

For the three months ended March 31, 2020 and 2019, the hospitality and entertainment operations segment generated revenues of $1.8 million and $0.3 million, respectively, which contributed 85.6% and 30.4%, respectively, of total consolidated revenues. The year-over-year increase in hospitality and entertainment operations revenues is attributable to MacArthur Place operating at full capacity during the first three months of 2020, prior to temporary closure of the hotel in mid-March 2020 resulting from the COVID-19 pandemic. The MacArthur Place renovation project was completed in late fiscal 2019. During the three months ended

March 31, 2019, the majority of the rooms and F&B operations at the hotel were closed due to the renovation project. During the three months ended March 31, 2020, our results were based on a 46% room occupancy rate, with an average daily rate (“ADR”) of $315 and Revenue Per Available Room (“RevPAR”) of $146. For the three months ended March 31, 2019, our results were based on a 14% room occupancy rate, with an ADR of $235 and RevPAR of $33.

During the three months ended March 31, 2020 and 2019, the hospitality and entertainment operations segment constituted the majority of our consolidated operating property direct expenses. The increase in net loss for the three months ended March 31, 2020, as compared to the same period in 2019, was primarily attributed to an increase in operating property direct expenses, professional fees, interest expense, and depreciation expense as the hotel was fully operational for the majority of the 1st quarter of 2020, prior to the COVID-19 related closure. The increase in professional fees is primarily attributable to litigation with the general contractor overseeing the renovation, which has since been settled. A portion of interest incurred during the three months ended March 31, 2019, was capitalized, and therefore, not included in interest expense during that period. No interest was capitalized during the three months ended March 31, 2020. Depreciation expense increased year over year due to the renovation expenses that were incurred during 2019 and that the hotel was placed in service during the 3rd quarter of 2019. The hospitality and entertainment operations segment contributed $3.2 million and $2.9 million of the total consolidated net loss for the three months ended March 31, 2020 and 2019, respectively.

For the three months ended March 31, 2020 and 2019, the Mortgage and REO - Legacy Portfolio and Other Operations segment revenues were $0.3 million and $0.7 million, respectively, which contributed 11.8% and 63.2%, respectively, of total consolidated revenues. The decrease in mortgage and REO revenues on a year-over-year basis, and as a percentage of total revenues, is attributed to the Company having no performing loans in 2020. All mortgage and REO revenues for the three months ended March 31, 2020 were generated from Broadway Tower operations, which building was sold in January 2020. For the three months ended March 31, 2020 and 2019, the Mortgage and REO - Legacy Portfolio and Other Operations segment recorded total condensed consolidated (income) expenses, net of recoveries and gains, of $(1.0) million and $0.5 million, respectively. The year-over-year increase in net Mortgage and REO income for the three months ended March 31, 2020, as compared to the same period in 2019, was primarily due to the Company’s receipt in the first quarter of 2020 of $1.8 million from the guarantor on the former mezzanine loan for Broadway Tower.