NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1—description of the business and BASIS OF PRESENTATION

Except as expressly indicated or unless the context otherwise requires, the “Company,” “MuniMae,” “we,” “our” or “us” means Municipal Mortgage & Equity, LLC a Delaware limited liability company, and its majority owned subsidiaries.

Overview

Beginning with the capital crisis that started in late 2007, our business has changed dramatically because of market conditions in general and liquidity issues in our business in particular. As a result of these conditions, we sold various operating businesses at significant losses and dramatically cut our operating expenses in order to reduce our need for capital and create liquidity.  Today, our primary business is the management of our bond portfolio which consists primarily of investments in tax exempt bonds secured by affordable housing.

The steps we have taken were not adequate to address all of our liquidity issues and we continue to have certain senior debt obligations that have come due and remain payable. However, we have in place various forbearance agreements with our senior debt holders such that none of them are currently pursuing any remedies. While we expect to have adequate liquidity to operate our business and pay our senior debt obligations under these forbearance agreements through June 2013, our ability to pay our senior debt obligations beyond June 2013 is highly dependent on future negotiations with certain of our creditors as well as our ability to continue to generate adequate cash flows from our operating, financing and investing activities. In addition, we do not have adequate liquidity to pay our subordinate debt obligations in full if we are not able to extend the interest pay rate concessions with these lenders including those that expired in the second quarter of 2012. Because our subordinate debt is junior in right of payment to our senior debt obligations, as long as certain senior debt obligations that have come due remain payable, we do not believe the subordinate debt holders can pursue any remedies against us if we do not pay them.

The net interest income generated by our bond portfolio is dependent on the performance of the real estate assets which serve as collateral for these bonds and on interest rates, as our bond portfolio is primarily long-term fixed rate and our debt financing for the portfolio is primarily short-term variable rate debt.

The bond portfolio is owned by various subsidiaries of the Company, and distributions of the net interest income generated by the Company’s bond portfolio, when made, are used primarily to fund our operating expenses and make payments on our senior debt and on our other debt obligations. There are contractual restrictions in place which limit the ability of our subsidiaries to distribute cash flow and other assets to us. Furthermore, the common stock of our most significant subsidiary is pledged to a senior creditor as collateral.

Our bond portfolio is leveraged, and the cash generated by the portfolio is subject to interest rate and debt roll-over risk. See Note 6, “Debt” for more information. If short-term rates rise, we will have lower cash distributions from the subsidiaries that own the bond portfolio. A significant increase in short-term rates could immediately impair our ability to pay even the senior debt of the Company. In addition to the leverage on our bond portfolio, our non-bond assets are also substantially leveraged.   As a result of these encumbrances, our ability to raise additional capital or issue additional debt to generate liquidity is very limited.

Since 2008, the Company has operated under various forbearance agreements with its senior lenders. As these forbearances near expiration in June of 2013, our goal is to extend these agreements, as necessary, possibly with a provision to amortize some of our remaining senior debt. Given the cash flow risks described above, there can be no assurances on how long it will take to repay our remaining senior debt, if we will have adequate cash to make all of the payments due to our senior lenders or that we can successfully obtain future concessions. Our senior creditors are under no obligation to accept any payment plans we may offer and our forbearance agreements could lapse if we do not perform.  The success of our business going forward is largely dependent on our ability to continue to obtain forbearance agreements and other creditor concessions and generate sufficient net interest income from our bond portfolio. More specifically, there is uncertainty as to whether we will be able to restructure or settle our non-bond related debt to both senior and subordinate creditors in a manner sufficient to allow our cash flow to service our debt obligations.

We have, through MMA Financial Holdings, Inc. (“ MFH ”), a wholly owned subsidiary of the Company, $153.4 million of subordinated debt (principal) at June 30, 2012 of which $45.1 million has an interest rate concession in place that provides for a reduced rate of 75 basis points (“ bps ”) until February 2014 when the pay rate will increase, see Note 6, “Debt”.  The interest rate concession on the remaining $108.3 million expired during second quarter 2012 resulting in the average pay rate increasing from 75 bps to 7.9%.  We have not made the second quarter interest payment as we continue to negotiate with the holders of this debt.  We expect to settle on an agreement with the holders of this debt which would most likely include both a discounted buy back for a portion of the debt as well as an interest rate concession on the remaining balance; however, we can provide no assurance that we will be successful.  We do not currently have the liquidity to meet the increased payments on this debt as well as the increased payments on the $45.1 million subordinated debt once existing concessions expire. See Note 6, “Debt” for more information.

The difficulty in managing all of the issues described above raises substantial doubt about the Company’s ability to continue as a going concern.

Description of the Business

We were organized in 1996 as a Delaware limited liability company and are classified as a partnership for federal income tax purposes. We have essentially the same limited liability, governance and management structures as a corporation, but we are regarded as a pass-through entity for federal income tax purposes. Thus, our shareholders include their distributive shares of our income, deductions and credits on their individual tax returns. Many of our subsidiaries also are pass-through entities, and the taxable income, deductions and credits of those subsidiaries are passed through to our shareholders for inclusion on their tax returns. However, other of our subsidiaries are corporations that pay taxes on their own taxable income. The income, deductions and credits of those subsidiaries are not passed through to our shareholders for inclusion on their tax returns, but any taxable dividends or other taxable distributions we receive from those subsidiaries are passed through. Tax information is provided to our shareholders on Schedule K-1 rather than on Form 1099.

Our primary business is the management of our bond portfolio, which consists primarily of tax-exempt bonds issued by state and local government authorities to finance multifamily rental housing developments (including affordable housing, student housing and senior living facilities) and community development districts. Substantially all of the Company’s operating cash flow is generated from the Company’s bond portfolio, which is owned by MuniMae TE Bond Subsidiary, LLC (“ TEB ”), which held 93.8% of the carrying value of the Company’s bonds at June 30, 2012. TEB’s common stock is wholly owned by MuniMae TEI Holdings, LLC (“ TEI ”), which is ultimately wholly owned by MuniMae. At June 30, 2012 and December 31, 2011 our unrestricted cash included TEB’s unrestricted cash of $24.3 million and $24.7 million, respectively. These subsidiaries have certain compliance requirements that may limit or restrict their ability to distribute cash or other assets to MuniMae. TEB’s operating agreement with its preferred shareholders contains covenants restricting the type of assets in which TEB can invest, the incurrence of leverage, the issuance of additional preferred equity interests, and the distributions of cash and assets to MuniMae, and impose certain requirements in the event of merger, sale or consolidation.

Pursuant to TEB’s operating agreement, distributions from TEB to TEI can be made in the form of Distributable Cash Flows (TEB’s net income adjusted to exclude the impact of non-cash items) or distributions other than Distributable Cash Flows (“ Restricted Payments ”). TEB is not permitted to redeem common stock or to distribute Restricted Payments to TEI if after such Restricted Payment is made TEB’s leverage ratio would be above the incurrence limit of 60% or TEB’s liquidation preferences ratios are not at amounts that would allow it to raise additional preferred equity senior to, or on parity with, the existing Series A, B, C and D preferred shares outstanding. TEB was below its maximum incurrence leverage and liquidation preference ratios at June 30, 2012.

All of TEB’s common stock is pledged to a creditor to support the Company’s collateral requirements related to certain debt and derivative agreements. During 2011, the Company operated under a forbearance agreement that was entered into in December 2009 with this creditor (“ Counterparty ”) which restricted the Company’s ability to utilize common distributions from TEB. On February 2, 2012, the Company entered into a further forbearance agreement with the Counterparty, which provides forbearance from a minimum net asset value requirement and a related certification requirement contained in the Company’s interest rate swap agreements until the earlier of June 30, 2013 or the date on which the Company satisfies the forbearance release terms. See Note 5, “Derivative Financial Instruments.”

We have a majority interest in International Housing Solutions S.à r.l. (“ IHS ”), a company that was formed to raise funds to invest in affordable housing in overseas markets. IHS’s primary activity to date has been to sponsor, raise capital for and manage the business of the South Africa Workforce Housing Fund SA I (“ SA Fund ”) as the general partner of the SA Fund. The SA Fund invests directly or indirectly in housing development projects and housing sector companies in South Africa. We expect IHS to sponsor, raise capital for and manage additional funds similar to the SA Fund in the future. See Note 15, “Consolidated Funds and Ventures.”

We expect the management of our bond portfolio to remain our primary business even as we invest in the growth of other businesses such as IHS.

As more fully described below we have sold, liquidated or closed down substantially all of our non-bond related businesses and have residual assets and obligations in the following former business segments:

Basis of Presentation and Significant Accounting Policies

The accompanying consolidated financial statements represent the consolidation of Municipal Mortgage & Equity, LLC and all companies that we directly or indirectly control, either through majority ownership or otherwise, and all companies we are required to consolidate. See Note 1, “Description of the Business and Basis of Presentation” to the consolidated financial statements in our 2011 Form 10-K, which discusses our consolidation presentation and our significant accounting policies.

Use of Estimates

The preparation of the Company’s financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, commitments and contingencies and revenues and expenses. Management has made significant estimates in certain areas, including the determination of fair values for bonds, derivative financial instruments, guarantee obligations, and certain other assets and liabilities of consolidated funds and ventures. Management has made significant estimates in the determination of impairment on bonds and real estate investments. Actual results could differ materially from these estimates.

Changes in Presentation

We have revised the presentation of our prior period consolidated statement of cash flows to conform with the current period presentation whereby we now reconcile net loss to net cash provided by operating activities without an adjustment for net loss attributable to noncontrolling interests. This presentation change had no impact on cash provided by operating activities.

Interim Period Presentation

The unaudited consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“ SEC ”). Certain information and note disclosures normally included in annual financial statements prepared in accordance with United States generally accepted accounting principles (“ GAAP ”) have been condensed or omitted pursuant to those rules and regulations.

The consolidated financial statements are unaudited. These statements include all adjustments (consisting of normal recurring accruals) that we considered necessary to present a fair statement of our results of operations, financial position and cash flows. These condensed consolidated financial statements should be read in conjunction with the financial statements included in our 2011 Form 10-K. The results of operations for any interim period are not necessarily indicative of the results to be expected for the full year.

Note 2—BONDS AVAILABLE-FOR-SALE

Bonds available-for-sale includes mortgage revenue bonds and other bonds.

The following table summarizes the investment in bonds and the related unrealized losses and unrealized gains at June 30, 2012 and December 31, 2011:

Mortgage Revenue Bonds

Mortgage revenue bonds are issued by state and local governments or their agencies or authorities to finance multifamily housing; however, the only source of recourse on these bonds is the collateral, which is a first mortgage or a subordinate mortgage on the underlying properties. The Company’s rights under the mortgage revenue bonds are defined by the contractual terms of the underlying mortgage loans, which are pledged to the bond issuer and assigned to a trustee for the benefit of bondholders to secure the payment of debt service (any combination of interest and/or principal as laid out in the trust indenture) on the bonds. The mortgage loans are not assignable unless the bondholder has consented.

For subordinate mortgages, the payment of debt service on the bonds occurs only after payment of senior obligations which have priority to the cash flow of the underlying collateral. The Company’s subordinate bonds had an aggregate fair value of $11.2 million and $9.6 million at June 30, 2012, and December 31, 2011, respectively.

A small portion of our mortgage revenue bonds (“ Participating Bonds ”) allow the Company to receive additional interest from net property cash flows in addition to the base interest rate. The Company’s Participating Bonds had an aggregate fair value of $6.3 million and $14.4 million at June 30, 2012 and December 31, 2011, respectively. Both the stated and participating interest on the Company’s Participating Bonds are exempt from federal income tax. However, a significant portion of the tax exempt income generated by the Company’s mortgage revenue bonds is subject to inclusion in a shareholder’s alternative minimum tax (“ AMT ”) calculation for federal income tax purposes.

Other Bonds

Other bonds are primarily municipal bonds issued by community development districts or other municipal issuers to finance the development of community infrastructure supporting single-family housing and mixed-use and commercial developments such as storm water management systems, roads and community recreational facilities. In some cases these bonds are secured by specific payments or assessments pledged by the issuers or incremental tax revenue generated by the underlying properties. The income on these bonds is exempt from federal income tax and is generally not included in shareholders’ AMT calculation.

Maturity

Principal payments on bonds are based on amortization tables set forth in the bond documents. If no principal amortization is required during the bond term, the outstanding principal balance is required to be paid in a lump sum payment at maturity or at such earlier time as defined under the bond documents. The following table summarizes, by contractual maturity, the amortized cost and fair value of bonds available-for-sale at June 30, 2012.

Bonds with Lockouts, Prepayment Premiums or Penalties

Substantially all of the Company’s bonds include provisions that allow the borrowers to prepay the bonds at a premium or at par after a specified date that is prior to the stated maturity date.  The following table provides the amount of bonds that are prepayable without restriction, premium or penalty at June 30, 2012, as well as the year in which the remaining portfolio becomes prepayable without restriction, premium or penalty.

Non-Accrual Bonds

The carrying value of bonds on non-accrual was $98.0 million and $65.9 million at June 30, 2012 and December 31, 2011, respectively.  During the period in which these bonds were on non-accrual, the Company recognized interest income on a cash basis of $0.9 million and $1.9 million for the six months ended June 30, 2012 and 2011, respectively. Interest income not recognized on the non-accrual bonds was $3.0 million and $4.4 million for the six months ended June 30, 2012 and 2011, respectively.

The following table provides an aging analysis for the carrying value of bonds available-for-sale at June 30, 2012 and December 31, 2011.

Bond Sales

The Company recorded cash proceeds on sales and redemptions of bonds of $8.2 million and $36.1 million for the six months ended June 30, 2012 and 2011, respectively. The Company did not use any cash from the 2012 bond redemption to pay down bond related debt. In connection with the 2011 sales, the Company used cash of $22.6 million to pay down its bond related debt.

Provided in the table below are unrealized losses and realized gains and losses recorded through “Impairment on bonds” and “Net gains on bonds” for bonds sold or redeemed during the three months and six months ended June 30, 2012 and 2011, as well as for bonds still in the Company’s portfolio at June 30, 2012 and 2011, respectively.

Unfunded Bond Commitments

Unfunded bond commitments are agreements to fund construction or renovation of properties securing the bonds over the construction or renovation period. Since September 30, 2010 there have been no unfunded bond commitments.

Note 3—INVESTMENTS IN PREFERRED STOCK

As partial consideration for the Company’s sale of its Agency Lending business in May 2009, the Company received three series of preferred stock from the purchaser with a par amount of $47.0 million: Series A Preferred units of $15.0 million, Series B Preferred units of $15.0 million and Series C Preferred units of $17.0 million, which entitles the Company to receive cumulative quarterly cash distributions at annualized rates of 17.5%, 14.5% and 11.5%, respectively.  As part of the sale, the Company agreed to reimburse the purchaser up to a maximum of $30.0 million over the first four years after the sale date (expiring May 15, 2013), for payments the purchaser may be required to make under loss sharing arrangements with Federal National Mortgage Association (“ Fannie Mae ”) and other government-sponsored enterprises or agencies with regard to loans they purchased from us.  The Series B and Series C preferred stock agreements have a provision that provides for this loss sharing reimbursement to be satisfied, if necessary, by cancellation of Series C Preferred units and then Series B Preferred units, rather than by cash.  On the Agency Lending business sale date, the Company recorded the estimated fair value of the preferred stock of $37.7 million.

The Company accounts for the preferred stock using the historical cost approach and tests for impairment at each balance sheet date. An impairment loss is recognized if the carrying amount of the preferred stock is not recoverable and exceeds its fair value. The carrying value of the preferred stock was $36.4 million at June 30, 2012 and December 31, 2011. The estimated fair value of the preferred stock was $39.8 million and $39.3 million at June 30, 2012 and December 31, 2011, respectively. The Company did not record impairment charges on the preferred stock for the six months ended June 30, 2012 and 2011. Since the inception date and through June 30, 2012, the Company redeemed $3.0 million in Series C Preferred units to settle realized losses under the loss sharing arrangement. In May 2010, pursuant to the Series C agreement, $2.0 million of Series C Preferred units were redeemed as a result of the release of certain of the Company’s letters of credit. At June 30, 2012, the unpaid principal amount on the preferred stock was $42.0 million. On July 10, 2012, 5,000 Series A Preferred units were redeemed at par for $5.0 million bringing the unpaid principal amount to $37.0 million.

The Company is also obligated to fund losses on specific loans identified at the sale date that are not part of the $30.0 million loss reimbursement.  The Company accounts for this obligation as a guarantee obligation and at June 30, 2012 and December 31, 2011 the fair value of this obligation was zero. See Note 9, “Guarantees and Collateral.” Since the sale of the Agency Lending business and through June 30, 2012, the Company incurred $1.7 million in realized losses related to these specific loans.

Loans Receivable

Loans receivable are classified as either held for sale (“ HFS ”) or held for investment (“ HFI ”). The majority of the Company’s loans are classified as HFS, as the Company believes it no longer has the ability and intent to hold its loans for the foreseeable future or until maturity due to the Company’s liquidity concerns. HFS loans are carried at the lower of cost or market (“ LOCOM ”) with the excess of the loan’s cost over its fair value recognized as a reduction to income through “Net (losses) gains on loans” and an offsetting reduction to the loan’s carrying amount. The Company’s loans that are classified as HFI represent loans that were legally transferred to third parties; however, these transfers did not meet the requirements for sale accounting under GAAP in light of guarantees or other forms of continuing involvement between the Company and the purchaser. HFI loans are reported at their cost basis, less any specific loan loss reserves.

At June 30, 2012 and December 31, 2011, HFS loan carry values were $0.3 million and $0.5 million, respectively. At June 30, 2012, the Company’s cost basis of HFS loans was $9.2 million, with offsetting LOCOM adjustments of $8.9 million. At December 31, 2011, the cost basis of HFS loans was $10.3 million, with offsetting LOCOM adjustments of $9.8 million. For the six months ended June 30, 2012 the Company recorded LOCOM gains of $0.3 million and charge-offs of $0.6 million. For the six months ended June 30, 2011 the Company recorded LOCOM losses of $0.7 million and no charge-offs.

At June 30, 2012 and December 31, 2011, HFI loan carry values were $5.1 million and $10.4 million, respectively. At June 30, 2012, the Company’s cost basis of HFI loans was $23.5 million, with specific loan loss reserves of $18.4 million. At December 31, 2011, the cost basis of HFI loans was $44.1 million, with specific loan loss reserves of $33.7 million. For the six months ended June 30, 2012 the Company recorded recoveries of $4.3 million and charge-offs of $11.0 million. For the six months ended June 30, 2011 the Company recorded provisions of $0.9 million and charge-offs of $0.6 million.

Real Estate Owned, Held For Use

Real estate owned represents foreclosed properties or properties acquired through a deed in lieu of foreclosure as a result of borrower defaults on debt owed to the Company. At June 30, 2012 and December 31, 2011, the Company had two investments in undeveloped land with a carrying value of $5.3 million. On January 20, 2012, the Company took a deed in lieu of foreclosure on a real estate housing operation as a result of a borrower default on debt owned by the Company with a carrying value of $10.1 million at June 30, 2012.

Investments in Unconsolidated Ventures

Investments in unconsolidated ventures represents a 33.3% interest in a partnership that was formed to take a deed-in-lieu of foreclosure on land that was collateral for a loan held by the Company. The remaining interest in the partnership is held by a third party who had also loaned money to the developer on the same land parcel. The ownership interests in the partnership were determined based on the relative loan amounts provided by the Company and the third party lender. This third party interest holder is the primary beneficiary of the partnership. At December 31, 2011, we also held an equity interest in a real estate fund, which was sold in the second quarter of 2012. The Company’s carry value of its interest was immaterial, but the assets and liabilities of the fund itself were more significant and drove the decreases reflected in the table below.

The following table displays the net income or loss for the three months and six months ended June 30, 2012 and 2011 for the ventures in which the Company holds an equity investment:

State Tax Receivables, net

State tax receivables represent the net refund position as reflected on the Company’s various state tax returns. A portion of these receivables may be subject to challenge by the relevant tax authority and therefore a liability for uncertain tax positions of $2.3 million at June 30, 2012 and December 31, 2011, has been recorded through other liabilities.

The following table summarizes the derivative notional amounts at June 30, 2012 and December 31, 2011.

The following table summarizes derivative activity for the three months and six months ended June 30, 2012 and 2011.

Interest Rate Swaps

Interest rate swaps are executed to reduce the interest rate risk associated with the variable rate interest on the debt owed to senior interests in securitization trusts. Under the interest rate swap contracts, the Company typically receives a variable rate and pays a fixed rate. The rate that the Company receives from the counterparty will generally offset the rate that the Company pays on its debt instruments. Therefore, interest rate swaps effectively convert variable rate debt to fixed rate debt. The Company’s remaining interest rate swaps are indexed on a variable rate based on the weekly Securities Industry and Financial Markets Association Municipal Swap Index (an index of weekly tax-exempt variable rates (“ SIFMA ”)) or the London Interbank Offer Rate (“ LIBOR ”), and the fixed rate is set at inception based on the SIFMA or LIBOR yield curve for the specific term of the swap.

All of the Company’s interest rate swap agreements were entered into under the International Swap Dealers Association’s standard master agreements (“ ISDAs ”), including supplemental schedules and confirmations to these agreements. At June 30, 2012, the Company had interest rate swap contracts and other derivative contracts with the Counterparty totaling $80.0 million (notional) with a fair value liability of $13.7 million. The supplemental schedules to the ISDAs require the Company to maintain a minimum net asset value, which the Company has not done. Without a forbearance agreement, the lack of compliance with this covenant permits the Counterparty to terminate the interest rate swaps . On February 2, 2012, the Company entered into a second amended and restated forbearance agreement with the Counterparty, which provides forbearance from a minimum net asset value requirement and a related certification requirement contained in the Company’s interest rate swap agreements to the earlier of June 30, 2013 or the date on which the Company satisfies the forbearance release terms.

The key forbearance release terms include:

As part of the forbearance agreement and until satisfaction of the forbearance release terms, the Company cannot permit TEB to declare or make a Restricted Payment distribution to the Company without prior written consent of the Counterparty.

Upon satisfaction of the forbearance release terms, the Counterparty shall transfer the guaranty obligation from MuniMae to TEI and reduce the minimum net asset value requirement from $475.0 million to $225.0 million. A further condition will be for TEB to maintain common shareholder equity of not less than $200.0 million, calculated pursuant to the methodology set forth in the agreement.

On February 2, 2012, the Company entered into an amended pledge agreement with the Counterparty whereby TEI continues to pledge its 100% common equity in TEB to the Counterparty. The amendment provides for a release of the pledged common stock of TEB once the forbearance release terms have been satisfied and certain guarantee exposure and other obligations of the Company have been fully collateralized with cash and cash equivalents. An additional release condition is that TEI must in the future obtain the written consent of the Counterparty before pledging, selling or transferring TEB’s common equity.

Covenant Compliance and Debt Maturities

We are in default on $31.4 million of debt that has previously come due.  We have forbearance agreements pursuant to which our lenders have agreed not to exercise remedies if we meet various performance criteria.  We have obtained regular extensions of these forbearance agreements, the most recent of which are currently scheduled to expire on June 30, 2013.  If we do not perform or the lenders do not renew, the lenders could demand payment in full and we would not be able to make that payment.

The following table summarizes the annual principal payment commitments at June 30, 2012:

At June 30, 2012, the Company and/or its wholly owned subsidiaries are parties to a debt agreement (" Credit Facilities ") with an outstanding principal balance of $1.1 million that contains cross-default provisions under which defaults could be declared as a result of the occurrence of defaults under certain other obligations of the Company, its subsidiaries and affiliates, and other parties. This debt agreement, however, is not in default under any cross-default provisions.

Senior Interests in and Debt Owed to Securitization Trusts

The Company securitizes bonds through several programs and under each program the Company transfers bonds into a trust, receives cash proceeds from the sales of the senior interests and retains the residual interests. Substantially all of the senior interests are variable rate debt. The residual interests the Company retains are subordinated securities entitled to the net cash flow of each trust after the payment of trust expenses and interest on the senior certificates. To increase the attractiveness of the senior interests to investors, the senior interests are credit enhanced or insured by a third party. For certain programs, a liquidity provider agrees to acquire the senior certificates upon a failed remarketing. The senior interest holders have recourse to the third party credit enhancer or insurance provider, while the credit enhancer or insurance provider has recourse to the bonds deposited in the trusts and to additional collateral we have pledged. In certain cases, the credit enhancer or insurance provider may also have recourse to the Company to satisfy the outstanding debt balance to the extent the bonds deposited in the trust and the additional collateral pledged are not sufficient to satisfy the debt. The Company’s total senior interests in and debt owed to securitization trusts balance was $623.6 million at June 30, 2012, of which $50.3 million has annually renewing credit enhancement and/or liquidity facilities, $549.2 million has credit enhancement and liquidity facilities that mature on March 31, 2013, and $24.1 million has maturing credit enhancement and liquidity facilities in 2016 and beyond.

The Company is currently pursuing several alternatives to extend or replace the $549.2 million of credit enhancement and liquidity facilities maturing in 2013 with the goal of reaching such an agreement before the end of in 2012. If we were unable to renew or replace our third party credit enhancement and liquidity facilities, we might not be able to extend or refinance our bond related debt.  In this instance, an investor holding the debt issued by the securitization trust could tender its investment to the third party liquidity provider who in turn could liquidate both the bonds within the securitization trust and the bonds pledged as collateral to the securitization trust in order to satisfy the outstanding debt balance. Whether or not we are able to extend or replace the third party credit enhancement and liquidity facilities, we could experience higher bond related interest expense upon the refinancing of our bond debt. In addition, if our counterparties were to experience a ratings downgrade we could be subject to the termination of a financing facility and/or higher financing costs.

Interest expense on the senior interests in and debt owed to securitization trusts totaled $6.5 million and $7.9 million for the six months ended June 30, 2012 and 2011, respectively.

Mandatorily Redeemable Preferred Shares

TEB has mandatorily redeemable preferred shares outstanding. These shares have quarterly distributions that are payable (based on the stated distribution rate) to the extent of TEB’s net income. For this purpose, net income is defined as TEB’s taxable income, as determined in accordance with the United States Internal Revenue Code, plus any income that is exempt from federal taxation, but excluding gains from the sale of assets. In addition to quarterly distributions, the holders of the cumulative mandatorily redeemable preferred shares may receive an annual capital gains distribution equal to an aggregate of 10.0% of any realized net capital gains during the immediately preceding taxable year.

The table below summarizes the terms of the cumulative mandatorily redeemable preferred shares issued by TEB at June 30, 2012:

The Series A cumulative mandatorily redeemable preferred shares and the Series A-2, A-3 and A-4 cumulative perpetual preferred shares are all of equal priority. See Note 11, “Equity,” for the terms related to the perpetual preferred shares. Series B subordinate cumulative mandatorily redeemable preferred shares and the Series B-2 and B-3 subordinate cumulative perpetual preferred shares are all of equal priority and are junior to Series A cumulative mandatorily redeemable preferred shares and the Series A-2, A-3, and A-4 cumulative perpetual preferred shares. Unlike the cumulative mandatorily redeemable preferred shares, the cumulative perpetual preferred shares are included in equity.

The cumulative mandatorily redeemable preferred shares are currently subject to annual remarketing on the dates specified in the table above. The holders of a majority of the outstanding Series A cumulative mandatorily redeemable preferred shares, elected to waive the June 30, 2012 remarketing requirement.  The distribution rate continues to be 7.5% and, assuming no repurchases and retirements in 2012, TEB will make approximately $2.3 million in principal redemptions during the second half of 2012. The next mandatory remarketing date for the Series A cumulative mandatorily redeemable preferred shares will occur on June 30, 2013.

The Series B subordinate cumulative mandatorily redeemable preferred shares were subject to a remarketing on November 1, 2011.  Effective November 1, 2011, the holders of the majority of the outstanding Series B subordinate cumulative mandatorily redeemable preferred shares, elected to waive the November 1, 2011 remarking requirement and to allow the distribution rate to reset to two times the 15 year BAA municipal bond yield. As a result, effective November 1, 2011, the distribution rate on the Series B subordinate cumulative mandatorily redeemable preferred shares increased from 9.56% to 9.64% for one year. The next mandatory remarketing date for the Series B subordinate cumulative mandatorily redeemable preferred shares will occur on November 1, 2012.

On each remarketing date, the remarketing agent will seek to remarket the shares at the lowest distribution rate that would result in a resale of the mandatorily redeemable preferred shares at a price equal to par plus all accrued but unpaid dividends, subject to a cap described herein. If the remarketing agent is unable to remarket these shares successfully, distributions (interest expense) could increase and this increase could adversely impact the Company’s financial condition and results of operations. The distribution rate on the Series B shares could, at most, reset to two times the 15 year BAA municipal bond yield if the November 1, 2012 remarketing were to fail. However, the 7.5% distribution rate and scheduled redemptions on the Series A cumulative mandatorily redeemable preferred shares would continue until there is a remarketing that is not a failed remarketing.

On February 13, 2012 the Company repurchased $6.0 million of the original par amount of the 7.75% Series B Subordinate Cumulative Mandatorily Redeemable Preferred Shares at 88.0% of face value and recognized a gain on debt extinguishment of $0.5 million.

Interest expense on mandatorily redeemable preferred shares totaled $4.3 million and $5.8 million for the six months ended June 30, 2012 and 2011, respectively. The mandatorily redeemable preferred shares had a weighted average distribution rate of 8.6% on an outstanding carrying amount of $90.9 million at June 30, 2012. The Series A mandatorily redeemable preferred shares that had a liquidation amount of $46.7 million at June 30, 2012, also had principal redemptions requirements, which resulted in an overall average annual distribution and redemption rate of 13.4% for the six months ended June 30, 2012.

Notes Payable and Other Debt

This debt is primarily related to secured borrowings collateralized primarily with the Company’s bond assets. In most cases, the Company has guaranteed the debt or is the direct borrower.

Interest expense on the subordinate debt totaled $7.6 million and $8.0 million for the six months ended June 30, 2012 and 2011, respectively.

TEI entered into an agreement on December 30, 2011, which settled on January 30, 2012, with the holders of then $58.4 million of MFH’s subordinate debt to buy $20.0 million of their holdings for a cash payment of $5.0 million. The holders also agreed on February 2, 2012 to an amendment to the subordinate debt agreement which extended the period during which interest is payable on the debt at the reduced rate of 75 bps per annum to February 2014. An amount equal to the interest foregone as a result of the extension was added to the principal amount outstanding. MFH’s principal amount outstanding increased by $10.2 million of which $3.5 million represents an intercompany payable to TEI and $6.7 million is payable to the third party holder. The $15.0 million reduction in the Company’s subordinate debt principal balance, resulting from the discounted purchase, as well as the $6.7 million increase in principal to the third party holder will for financial reporting purposes be recognized over the remaining life of the securities in accordance with the rules for debt modifications that are considered troubled debt restructurings. Over time this will bring the carrying value down to the principal balance outstanding of $45.1 million. After the interest payment date in February 2014, the reduced interest rate will reset to a rate of 9.5% until May 5, 2014 and after May 5, 2014 a rate, determined on each interest payment date for the period ending on the next interest payment date, which is equal to the greater of (a) 9.5% or (b) the rate which is equal to 6.0% plus the 10-year U.S. Treasury Rate.

Separate from the $45.1 million of subordinate debt (principal) discussed above , the interest rate concession on $108.3 million of subordinated debt expired during second quarter 2012 resulting in the average pay rate increasing from 75 bps to 7.9%.  We have not made the second quarter interest payment as we continue to negotiate with the holders of this debt.  We expect to settle on an agreement with the holders of this debt which would most likely include both a discounted buy back for a portion of the debt as well as an interest rate concession on the remaining balance; however, we can provide no assurance that we will be successful.  We do not currently have the liquidity to meet the increased payments on this debt as well as the increased payments on the $45.1 million subordinated debt once existing concessions expire.

Letters of Credit

The Company has letter of credit facilities, generally with institutional investors that are used as a means to pledge collateral to support Company obligations. At June 30, 2012, the Company had $25.1 million in outstanding letters of credit posted as collateral on the Company’s behalf, of which $6.1 million have maturity dates in 2013 and the remaining $19.0 million will mature in 2014. Although we currently expect that we will be able to renew our expiring letters of credit at reduced amounts or otherwise extend their maturities, if we are unable to do so our liquidity and financial condition may be adversely affected.

Note 7—Financial Instruments

The following table provides information about financial assets and liabilities not carried at fair value in the consolidated balance sheets. This table excludes non-financial assets and liabilities.

The fair value estimates are made at a discrete point in time based on relevant market information and information about the financial instruments. A description of how the Company estimates fair values is provided below. These estimates are subjective in nature, involve uncertainties and significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

As required by GAAP, assets and liabilities are classified into levels based on the lowest level of input that is significant to the fair value measurement. The determination of which level an asset or liability gets classified into is based on the following fair value hierarchy:

Loans held for investment –The Company estimates fair value by discounting the expected cash flows using current market yields for similar loans. Loans held for investment are recorded through “Other assets”.

Investment in preferred stock – The fair value of the preferred stock was determined based on the terms and conditions of the preferred stock as compared to other, best available market benchmarks, as well as determining the fair value of the embedded loss-sharing feature that is contained in the Series B and C preferred stock agreements.

Senior interests in and debt owed to securitization trusts – The carrying value approximates fair value for weekly reset variable rate senior certificates as these are variable interest rate securities with indexes and spreads that approximate market. The fair value of senior interests in securitization trusts for fixed rate senior securities was estimated by discounting contractual cash flows using current market rates for comparable debt.

Notes payable and other debt – The fair value was estimated based on discounting contractual cash flows using a market rate of interest, taking into account credit risk and collateral values.

Subordinate debt and mandatorily redeemable preferred shares – The fair value of the subordinate debt and mandatorily redeemable preferred shares was estimated using current market prices for comparable instruments and best available market benchmarks, taking into account credit risk.

Liabilities of consolidated funds and ventures – The fair value was estimated by discounting contractual cash flows incorporating market yields for comparable debt, taking into account credit risk and collateral values.

Note 8—FAIR VALUE MEASUREMENTS

As required by GAAP, assets and liabilities are classified into levels based on the lowest level of input that is significant to the fair value measurement. The determination of which level an asset or liability gets classified into is based on the following fair value hierarchy:

The following tables present assets and liabilities that are measured at fair value on a recurring basis at June 30, 2012 and December 31, 2011.

The following table presents activity for assets and liabilities measured at fair value on a recurring basis using Level 3 inputs for the three months ended June 30, 2012:

The following table provides the amount included in earnings related to the activity presented in the table above, as well as additional realized losses recognized at settlement for the three months ended June 30, 2012.

The following table presents activity for assets and liabilities measured at fair value on a recurring basis using Level 3 inputs for the three months ended June 30, 2011:

The following table provides the amount included in earnings related to the activity presented in the table above, as well as additional realized gains (losses) recognized at settlement for the three months ended June 30, 2011.

The following table presents activity for assets and liabilities measured at fair value on a recurring basis using Level 3 inputs for the six months ended June 30, 2012:

The following table provides the amount included in earnings related to the activity presented in the table above, as well as additional realized gains (losses) recognized at settlement for the six months ended June 30, 2012.

The following table presents activity for assets and liabilities measured at fair value on a recurring basis using Level 3 inputs for the six months ended June 30, 2011:

The following table provides the amount included in earnings related to the activity presented in the table above, as well as additional realized gains (losses) recognized at settlement for the six months ended June 30, 2011.

The following methods or assumptions were used to estimate the fair value of these recurring financial instruments:

Bonds Available-for-Sale – For most of our performing bonds, the Company estimates fair value based on discounted cash flows based on the expected bond payments, by discounting contractual principal and interest payments, adjusted for expected prepayments. The discount rate for each bond is based on expected investor yield requirements adjusted for bond attributes such as the expected term of the bond, debt service coverage ratios, geographic location and bond size.  The weighted average discount rate for the performing bond portfolio was 6.60% and 6.69% at June 30, 2012 and December 31, 2011, respectively. If observable market quotes are available, the Company will estimate the fair value based on that quoted price. The fair value for the non-performing bond portfolio and collateral dependent bonds is based on an estimate of the collateral value. The Company estimates fair value by discounting the property’s expected cash flows and residual proceeds using estimated market discount and capitalization rates, less estimated selling costs. The discount rate averaged 8.7% and 9.3% at June 30, 2012 and December 31, 2011, respectively. The capitalization rate averaged 7.8% and 7.9% at June 30, 2012 and December 31, 2011, respectively. If an estimated sale price is readily available from a sale agreement, an appraisal or a broker opinion of value, then the Company will estimate fair value based on that information.

The discount rates and capitalization rates as discussed above are significant inputs to bond valuations and are unobservable in the market.  To the extent discount rates and capitalization rates were to increase (decrease) in isolation the corresponding estimated bond values would decrease (increase).

Derivative Financial Instruments – The fair value of derivatives was based on dealer quotes, where available, or estimated using valuation models incorporating current market assumptions. The Company’s interest rate swap agreements have collateral posting requirements that are considered in determining the fair value of these instruments.

The following table presents assets that were measured at fair value in 2012 on a non-recurring basis and still held at June 30, 2012.

The following table presents assets that were measured at fair value in 2011 on a non-recurring basis and still held at December 31, 2011.

The following methods or assumptions were used to estimate the fair value of these nonrecurring financial and non-financial instruments:

Loans Held for Investment and Loans Held for Sale – For non-performing loans, given that the Company has the right to foreclose on the underlying real estate which is collateral for the loan, the Company estimates the fair value by using an estimate of sales price, if available, less estimated selling costs. Estimates of sales prices are derived from a number of sources including current bids, appraisals and/or broker opinions of value. If the sales price is not readily estimable from such sources, as well as for all performing loans, the Company estimates fair value by discounting the expected cash flows using current market yields for similar loans. Loans held for investment and loans held for sale are recorded through “Other assets”.

Investment in an unconsolidated venture – This is the Company’s 33.3% interest in an investment in a real estate partnership that was formed to take a deed-in-lieu of foreclosure on land that was collateral for a loan held by the Company.  This investment is valued based on a third party appraisal.

Note 9—GUARANTEES AND COLLATERAL

Guarantees

Guarantee obligations are recorded through “Other liabilities”.

The following table summarizes guarantees, by type, at June 30, 2012 and December 31, 2011:

Indemnification Contracts

The Company has entered into indemnification contracts with the purchaser of the TCE business related to the guarantees of the investor yields on their investment in certain LIHTC Funds and indemnifications related to property performance on certain Lower Tier Property Partnerships. The Company has not made any cash payments related to these indemnification agreements for the six months ended June 30, 2012 and 2011. The carrying amount represents the amount of unamortized fees received related to these guarantees with no additional amounts recognized as management does not believe it is probable that it will have to make payments under these indemnifications. However, it is possible that one of the specific property performance guarantees could result in the Company having to pay up to $1.0 million between now and 2016.

The maximum exposure declined during the first quarter as the Company’s methodology for measuring maximum exposure now takes into consideration the amount of investor yield already delivered.  The Company’s maximum exposure under its indemnification contracts represents the maximum loss the Company could incur under its guarantee agreements and is not indicative of the likelihood of the expected loss under the guarantee.  The Company also has guarantees associated with the LIHTC funds that were not sold to the purchaser of the TCE business.  See Note 15, “Consolidated Funds and Ventures” for information on these guarantees.

Other Guarantees

The Company has entered into arrangements that require it to make payments in the event that a third party fails to perform on its financial obligations. Generally, the Company provides these guarantees in conjunction with the sale or placement of an asset with a third party or, in one case, as part of an indemnification related to the sale of a business segment. The terms of such guarantees vary based on the performance of the asset. The Company’s maximum exposure under these guarantee obligations represents the maximum loss the Company could incur under its guarantee agreements and is not indicative of the likelihood of the expected loss under the guarantees.

Collateral and restricted assets

The following table summarizes the Company’s pledged assets at June 30, 2012 and December 31, 2011: 

Note 10—Commitments and Contingencies

Operating Leases

The Company has various operating leases that expire at various dates through 2017. These leases require the Company to pay property taxes, maintenance and other costs.

The following table summarizes rental expense and rental income from operating leases for the six months ended June 30, 2012 and 2011:

The following table summarizes the future minimum rental commitments on non-cancelable operating leases at June 30, 2012:

The Company expects to receive $7.0 million in future rental payments from non-cancelable subleases, which is not netted against the commitments above.

Litigation

From time to time, the Company and its subsidiaries are named as defendants in various litigation matters arising in the ordinary course of business. These proceedings may include claims for substantial or indeterminate compensatory or punitive damages, or for injunctive relief. At June 30, 2012, there were no such proceedings

The Company establishes reserves for litigation matters when those matters present loss contingencies that are probable and can be reasonably estimated. Once established, reserves may be adjusted when new information is obtained.

It is the opinion of the Company’s management that adequate provisions have been made for losses with respect to litigation matters and other claims that existed at June 30, 2012. Management believes the ultimate resolution of these matters is not likely to have a material effect on its financial position, results of operations or cash flows. Assessment of the potential outcomes of these matters involves significant judgment and is subject to change, based on future developments, which could result in significant changes.

Shareholder Matters

The Company is a defendant in a purported class action lawsuit and two derivative suits originally filed in 2008. The plaintiffs in the class action lawsuit claim to represent a class of investors in the Company’s shares who allegedly were injured by misstatements in press releases and SEC filings between May 3, 2004, and January 28, 2008.  The plaintiffs seek unspecified damages for themselves and the shareholders of the class they purport to represent.  In the derivative suits, the plaintiffs claim, among other things, that the Company was injured because its directors and certain named officers did not fulfill duties regarding the accuracy of its financial disclosures.  Both the class action and the derivative cases are pending in the United States District Court for the District of Maryland. The Company filed a motion to dismiss the class action and in June 2012, the Court issued a ruling dismissing all of the counts alleging any knowing or intentional wrongdoing by the Company or its affiliates, directors and officers. The only remaining counts relate to the Company’s dividend reinvestment plan. As of June 30, 2012, the Company believes it is probable that it will settle this case for at least $0.5 million and has recorded a contingent obligation for this amount (reported through other liabilities) with a corresponding loss recognized through other expenses. If the plaintiffs are successful on appeal, then it is possible that the Company could incur additional losses, which could be significant; however, these losses cannot be estimated at this time. The Company expects any settlement and any other future losses related to this case (including the $0.5 million, mentioned above) to be covered by insurance proceeds.

Note 11—Equity

Income (Loss) Per Common Share

The following table provides a summary of net income (loss) to common shareholders as well as information pertaining to weighted average shares used in the per share calculations as presented on the consolidated statements of operations for the three months and six months ended June 30, 2012 and 2011: