SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549 

 (Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every

Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to post such files).

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ 

This Annual Report on Form 10-K (“Annual Report” or “Form 10-K”) contains forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve risks and uncertainties. Many of the forward-looking statements are located in Part II, Item 7 of this Form 10-K under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Forward-looking statements can also be identified by words such as “future,” “anticipates,” “believes,” “estimates,” “expects,” “intends,” “will,” “would,” “could,” “can,” “may,” and similar terms. Forward-looking statements are not guarantees of future performance and the Company’s actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part I, Item 1A of this Form 10-K under the heading “Risk Factors,” which are incorporated herein by reference. All information presented herein is based on the Company’s fiscal calendar. Unless otherwise stated, references to particular years, quarters, months or periods refer to the Company’s fiscal years ended in SeptemberDecember and the associated quarters, months and periods of those fiscal years. Each of the terms the “Company,” “IMHFC,” “we,” “us,” and “our,” as used herein refers collectively to IMH Financial Corporation and its consolidated subsidiaries, unless otherwise stated. The Company assumes no obligation to revise or update any forward-looking statements for any reason, except as required by law.

We are a real estate investment and finance company. We focus on investments in commercial, hospitality, industrial and residential real estate and mortgages secured by those assets. The Company seeks opportunities to invest in real estate-related platforms and projects in partnership with other experienced real estate investment firms, and to sponsor and co-invest in real estate mortgages and other real estate-based investment vehicles. In addition, the Company intends to expand its hospitality footprint through the acquisition or management of other luxury boutique hotels.

During 2018, theThe Company continued to aggressively pursue enforcement against currentstruggle financially and former defaulted borrowers through foreclosure actions and recovery of other guarantor assets.operationally during 2019. As of December 31, 2018, substantially all of the Company’s non-operating REO assets (assets held for sale and other real estate owned) were obtained through foreclosure or related processes.

While the Company did not originate any new loan investments during 2019, it made one mortgage investment in a lending joint venture with Juniper New Mexico, LLC and Juniper Bishops Manager, LLC (both related parties of Jay Wolf, a director of the offering are beingCompany) to participate in a $10.0 million mezzanine loan to be used (i) to redeemfinance the renovation of a luxury resort located in Santa Fe, New Mexico. The Company’s initial contributionstotal commitment under this investment is $3.9 million, of which $3.8 million was funded as of December 31, 2019 and the remaining commitment of $0.1 million was funded subsequent to December 31, 2019. With respect to its remaining mortgage investment portfolio, the Company sold one of its mortgage investments and received payoffs of two loans in 2019. The Company continued to pursue enforcement actions on defaulted loans through foreclosure actions and recovery of guarantor assets. In May 2019, we foreclosed on the membership interests of a limited liability company that was pledged as collateral on a defaulted $7.6 million mezzanine loan. As a result, the Company took ownership of a commercial office building known as Broadway Tower, located in St. Louis, Missouri (“Broadway Tower”).

In January 2020, the Company sold Broadway Tower for $19.5 million and repaid the $11.0 million JPM Funding loan. The Company also pursued a deficiency claim against first mortgage loan the borrower and guarantors. As a result of our enforcement efforts, the claim was settled in January 2020 for a payment to the Hotel FundCompany of $17.8 million and (ii) to support the renovations to MacArthur Place. To date, the Company has raised approximately $21.0 million in Preferred Interests (including the Company’s Preferred Interest of $2.1 million). The Company is expected to retain a 10.0% Preferred Interest in the Fund. The Hotel Fund intends to pursue a liquidity event in approximately four to five years.$1.75 million.

In connection with the acquisition and renovation of MacArthur Place,our efforts to reduce Company overhead costs, in August 2019, the Company closed onentered into a $32.3 millionnon-discretionary investment advisory agreement (the “JIA 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 facility (the “MacArthur Loan”) from MidFirst Bank,portfolio and certain of which approximately $19.4 million was utilized forits legacy real-estate owned properties. Under the purchase of MacArthur Place, with the balance set aside to fund planned hotel improvements, interest reserves and operating capital. Subsequent to December 31, 2018, the MacArthur Loan was modified to, among other things, increase the total loan facility to $37.0 million, increase our equity requirement from $17.4 million to $27.7 million, and increase the amount of interest and other reserves, to correspond with the increased renovation budget. All other terms of the MacArthur Loan remained substantially unchanged. The loanJIA Advisory Agreement, the Company is paying JIA management fees ranging from 0.5% to 1.5% of the net asset value of the 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 initial termannualized 7% return on its investment from those assets and recovery of three years endingthe Company’s basis in October 2020such assets. In connection with the JIA Advisory Agreement, certain employees of the Company have transitioned to become employees of JIA, and subject to certain conditions being metJIA has also subleased a portion of the Company’s office space. Jay Wolf, a director of the Company, is one of the managing partners of JIA and Juniper Capital Partners, LLC, the sole member of Juniper NVM, LLC, (“JNVM”) and the paymentmanager of certain fees, may be extended byJCP Realty Partners, LLC (“JCP Realty”). JCP Realty and JNVM hold shares of the Company for two (2) one-year periods. The MacArthur Loan requires interest-only payments during the initial three-year term and bears floating interest equal to the 30-day LIBOR rate plus 3.75% subject to certain adjustments.Company’s Series B-1 Preferred Stock.

In February 2018,September 2019, the Company issued 2,352,9411,875,000 shares of its newly-authorized Series B-3 Cumulative ConvertibleB-4 Preferred Stock (the “Series B-3B-4 Preferred Stock”) to JPMorgan ChaseJPM Funding Inc., a Delaware corporation (“Chase Funding”), an affiliate of JPMorgan Chase & Co., at a purchase price of $3.40$3.20 per share, for a total purchase price of $8.0$6.0 million. Dividends on the Series B-3B-4 Preferred Stock are cumulative and compound quarterly at the annual rate of 5.65% of the issue price per year, and are payable quarterly in arrears. Concurrent with its issuance of these shares, the Company issued to Chase Funding a warrant to acquire up to 600,000 sharesHolders of the Company’s common stock (the “Chase Warrant”). The Chase 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.

Under the terms of our 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 (the “Second Amended and Restated Certificate of Designation”), each holder of our Series B-1 and B-2 Cumulative Convertible Preferred Stock (“Series B-1 and B-2 Preferred Stock”, and collectively with our Series B-3 Preferred Stock, (“Series B Preferred Stock”), at any time after July 24, 2019, each holder of Series B-1 and B-2 Preferred Stock maycould 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 plus all accrued and unpaid dividends, as of the date of redemption. AsEffective as of December 31, 2018, the Redemption Price would presently be approximately $39.6 million. Subsequent to December 31, 2018, we entered into an agreement withApril 1, 2019, the holders of theour Series B-1 and B-2 Preferred Stock agreed to defer the redemption period for one year, or July 24, 2020, to allow the Company ample time to restructure the termsa one-year extension of the existing securities and/or to generate the liquidity necessaryoptional redemption date for such repayment. In exchange for this extension, the Company agreed to increase Redemption Price described above from 150%shares of the sum of the original price per share of theour Series B-1 and B-2 Preferred Stock in exchange for $2.6 million payable to 160%the holders of those securities on July 24, 2020, whether or not a redemption is requested. As of December 31, 2019, the sumRedemption Price would be approximately $39.6 million. We are unable to determine with certainty whether the holders of the original price per share of theour Series B-1 and B-2 Preferred Stock plus all accrued and unpaid dividends aswill agree to further extend the redemption date and/or otherwise modify the terms of those securities. However, in the dateabsence of redemption.a restructuring of such securities or a material liquidity event to fund a full redemption, a full required redemption would likely render the Company insolvent.

As previously reported, the Employment Agreement between the Company and Mr. Lawrence Bain, the Company’s former Chairman of the Board and Chief Executive Officer, expiresexpired on July 24, 2019 (the “Expiration Date”). Since Mr. Bain intends to affiliate with Juniper Investment Advisors, an affiliate2019. During the third quarter of Juniper Capital and Jay Wolf, one of the Company’s directors, which is entering into an asset management agreement with the Company, the Company and Mr. Bain have mutually agreed not to renew or extend Mr. Bain’s employment agreement. Accordingly, on April 11, 2019, the Company entered into a Termination of Employment Agreement, Release and Additional Compensation Agreement with Mr. Bain (the “Bain Termination Agreement”). as well as certain other agreements. Effective November 1, 2019, Chadwick Parson was appointed as Chief Executive Officer and Chairman of the Board of Directors of the Company. The material terms of this agreementthe Bain Termination Agreement and related agreements are summarized below.

We are a Delaware corporation formed in 2010 as a result of the conversion of our predecessor entity, IMH Secured Loan Fund, LLC (“Fund”), from a Delaware limited liability company into a Delaware corporation.corporation (the “Conversion Transactions”). The primary business of the Fund, which was organized in May 2003, was making 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”), an Arizona-licensed mortgage banker. In 2012, IMH Holdings, LLC, a Delaware limited liability company and a wholly-owned subsidiary of the Company (“Holdings”), obtained its mortgage banker’s license in the State of Arizona.

Prior to 2017,Following the credit and real estate crisis of 2008, our commercial mortgage lending activities were limited to originating seller carryback loans in connection with our disposition of certain REO assets.severely limited. However, we re-initiated our commercial mortgage investment activities in 2017recent years and, expectassuming we have sufficient liquidity to do so, intend to expand these activities as we generate additional liquidity.

The Company will seekintends to continue the process of disposing of our remaining legacy loan portfolio, REO assets, and other real estate related assets, individually or in bulk, and to reinvest the proceeds from those dispositions in our target assets. We may also attempt

Although we have historically focused on the origination of senior short-term commercial bridge loans with maturities of 12 to 36 months, we intendassuming sufficient liquidity to expandexecute our business strategy, our business focus to include:may include, among other things, other categories of target assets, as well as: (a) purchasing or investing in commercial and other mortgage and mezzanine loans, individually or in pools (b) originating mortgage loans that are collateralized by real property located throughout the United States, and (c) pursuing, in an opportunistic manner, other real estate investments such as participation interests in loans, whole and bridge loans, commercial or residential mortgage-backed securities, equity or other ownership interests in entities that are the direct or indirect owners of real property, and direct or indirect investments in real property, such as those that may be obtained in a joint venture or by acquiring the securities of other entities which own real property. In addition, as we endeavor to expand our hospitality footprint, we are seeking to acquire and/or manage boutique hotel properties in unique locations that have significant potential for value appreciation through renovation and improved management. We refer to the assets we will target for acquisition or origination as our “target assets.”

WeAssuming sufficient liquidity to execute our business strategy, we intend to diversify our target asset acquisitions across selected asset classes: inclasses, such as: interim loans or other short-term loans originated by us; performing whole or participating interests in commercial real estate mortgage loans we acquire; whole performing and non-performing commercial real estate loans we acquire; and in other types of real estate-related assets and real estate-related debt instruments (which may include the acquisition of or financing of the acquisition of residential mortgage-backed securities (“RMBS”), commercial mortgage-backed securities (“CMBS”), and operating properties). Assuming sufficient liquidity and other capital resources, we expect the diversification of

our portfolio to continue to evolve in response to market conditions, including consideration of factors such as asset class, borrower group, geography, transaction size, and investment terms.

In July 2014, our Board created an Investment Committee to assist the Board in (i) reviewing our investment policies, strategies, and performance and (ii) overseeing our capital and financial resources. Other than with respect to transactions that are carried out in substantial accordance with an approved annual budget and certain other transactions and actions specified in the charter of the Investment Committee, no investment may be made without approval of the Investment Committee or of a delegate of the Investment Committee pursuant to an appropriate delegation of the Investment Committee’s authority. The Investment Committee does not participate in matters such as corporate or property financings that involve “day-to-day” cash management decisions or treasury functions. The Investment Committee consists of three members, two of whom are the Series B-1 Director and the Series B-2 Director and the other of whom is a director then serving as the Company’s chief executive officer. The current members of the Investment Committee are Jay Wolf (as the Series B-1 Director), Lawrence D. BainChadwick Parson (as our CEO), and Chad ParsonDaniel Rood (as the Series B-2 Director).

Our revenues are derived from hospitality operations and management, and mortgage and related loan investments. Revenues from our hospitality properties are generally seasonal in nature, which may vary in significance depending on the micro climate weather patterns and timing of seasonal events that spur demand. Based on our current hotel asset holdings, revenues are typically highest in the second and third quarters, with modest reductions during the fourth quarter, and lowest in the first quarter of the year. Revenues from traditional mortgage and related investments are not seasonal in nature and are generally recognized more evenly during the term of the investment.

As of December 31, 2018,2019, we had 2116 full-time employees and 2 full-time outside consultants working in our corporate offices, and 98133 full-time and 1450 part-time employees working at MacArthur Place. We consider relations with our employees to be good.

The lending industry in which we operate is serviced primarily by commercial banks, insurance companies, mortgage brokers, pension funds, and private and other institutional lenders. There are also a relatively smaller number of non-conventional lenders that are similar to us.

Our operations are subject to oversight by various state and federal regulatory authorities, including, without limitation, the Arizona Corporation Commission, the Arizona Department of Revenue, the Arizona Department of Financial Institutions (Banking), and the Securities and Exchange Commission (“SEC”).

WeWhile we believe we are not an investment company, we seek to manage our operations and expectendeavor to deploy our capital in a manner tothat will qualify for an exemption from registration as an “investment company” under the Investment Company Act of 1940, as amended (the “Investment Company Act”).

Usury laws in some states limit the interest that lenders are entitled to receive on a mortgage loan. State law and court interpretations thereof applicable to determining whether the interest rate on a loan is usurious and the consequences for exceeding the maximum rate vary. For example, we may be required to forfeit interest above the applicable limit or to pay a specified penalty. In such a situation, the borrower may have the recorded mortgage or deed of trust canceled upon paying its debt with lawful interest, or the lender may foreclose, but only for the debt plus lawful interest. In the alternative, a violation of some usury laws results in the invalidation of the transaction, thereby permitting the borrower to have the recorded mortgage or deed of trust cancelled without any payment and prohibiting the lender from foreclosing.

Our REO assets and the operations conducted on real property are subject to federal, state, and local laws and regulations relating to environmental protection and human health and safety. Under these laws, courts and government agencies may have the authority under certain circumstances to require us, as the owner of a contaminated property, to clean up the property even if we did not know of or were not responsible for the contamination. These laws also apply to persons who owned a property at the time it became contaminated. In addition to the costs of cleanup, environmental contamination can affect the value of a property and, therefore, an owner’s ability to borrow funds using the property as collateral or to sell the property. These laws and regulations generally govern wastewater discharges, air emissions, the operation and removal of underground and above-ground storage tanks, the use, storage, treatment, transportation, and disposal of solid and hazardous materials, and the remediation of contamination associated with disposals. State and federal laws in this area are constantly evolving and we intend to take commercially reasonable steps to protect ourselves from the impact of these laws, including obtaining environmental assessments of most properties that we acquire. As of the date of this filing, we are unaware of any significant environmental issues affecting the properties we own or properties that serve as collateral under our loans. In addition, we maintain environmental insurance coverage on all properties, subject to certain exclusions, that we believe would limit the amount of liability if such matters were discovered.

Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Exchange Act are available on our website at http://www.imhfc.com as soon as reasonably practicable after we electronically file such reports with, or furnish those reports to, the SEC. The other information on our website is not a part of or incorporated into this Annual Report. Stockholders may request free copies of these documents from:

IMH Financial Corporation

Attention: Investor Relations

7001 N. Scottsdale Road - Suite 2050

Scottsdale, AZ 85253

(480) 840-8400

Risks Related to Our Business Strategy and Our Operations:

We have continued to record losses as a result of limited income-producing assets, significant operating and overhead costs, significant interest and dividend expenses,costs, provisions for credit losses, and impairment losses which may continue to harm our results of operations.operations and raise substantial doubt about our ability to continue as a going concern.

In addition, we reported net losses of $12.2$24.3 million and $1.6$12.2 million for the years ended December 31, 20182019 and 2017,2018, respectively, due primarily to the limited number of our income producing assets coupled with (i) significant operating and overhead cost,costs, (ii) the cost of our debt financing, (iii) significant dividend payments to the holders of our preferred shares, and (iv) professional fees we incurred in connection with loan and guarantee enforcement activities. As of December 31, 2018,2019, our accumulated deficit aggregated $692.9$718.8 million. We may continue to record net losses in the future as a result of a lack of income-producing assets, significant operating and overhead costs, significant interest and dividend expenses, provisions for credit losses, and impairment losses on real estate owned, which may further harm our results of operations.

While we have, to date, been able to secure the necessary debt or equity financing to provide us with sufficient working capital and have generated additional liquidity through asset sales and mortgage receivable collections, there is no assurance that we will be successful in selling our remaining loan and REO assets in a timely manner or in obtaining additional financing to sufficiently fund future operations, repay existing debt, or to implement our investment strategy. Furthermore, under the Second Amended and Restated Certificate of Designation forand the Certificate of Designation of Series BB-4 Cumulative Convertible Preferred SharesStock of IMH Financial Corporation (the “Second“Series B-4 Certificate of Designation,” and with the Second Amended and Restated Certificate of Designation, the “Preferred Stock Certificates of Designation”), the holders of our Series B Preferred Stock (the “Series B Investors”) of our Series B-1, B-2. B-3 and B-4 Preferred Stock (collectively, “Series B Preferred Stock”) have significant approval rights over asset sales. Our failure to (x) generate sustainable earning assets, (y) sufficiently reduce our expenses, and/or (z) successfully liquidate a sufficient number of our loans and REO assets may have a material adverse effect on our business, results of operations and financial position. Under the Second Amended CertificatePreferred Stock Certificates of Designation, we cannot exceed 103% of the aggregate line item expenditures in our annual operating budget approved by the Series B Investors without their prior written approval. We were in breach of this covenant for the year ended December 31, 2018.2019.  However, subsequent to December 31, 2018,2019, we obtained a waiver of this breach from the Series B Investors.

Our business model and investment strategies involve substantial risk and may not be successful.

We have made certain recent changes to our business strategy. Initiating new business activities and significantly expanding existing business activities are two waysstrategy to grow our business and respond to changing circumstances in our industry. However, theyindustry, assuming we have sufficient liquidity to do so. If we initiate new business activities or significantly expand existing business activities, we may expose usbe exposed to new risks and regulatory compliance requirements. We cannot be certain that we will be able to manage these risks and compliance requirements effectively. Furthermore, our efforts may not succeed and any revenues we earn from any new or expanded business initiative may not be sufficient to offset the initial and ongoing costs of that initiative, which would result in a loss with respect to that initiative. In particular, a change in our business strategy, including the manner in which we allocate our resources across our commercial mortgage loans, or the types of assets we seek to acquire, may increase our exposure to certain risks, including, but not limited to, interest rate risk, default risk, and real estate market fluctuations. Efforts we have made and continue to make to significantly expand our investing activity in commercial real-estate related assets and to develop new methods and channels for acquiring and selling residential and commercial real estate-related investment assets may expose us to new risks, may not succeed, and may not generate sufficient revenue to offset our related costs. In addition, we may in the future use leverage at times and in amounts deemed prudent by our management in its discretion, and such decisions would not be subject to stockholder approval. Any new activities that we engage in may increase our fiduciary responsibilities, result in conflicts of interest arising from our investment activities and the activities of the entities we manage, increase our exposure to litigation, and expose us to other risks.

Our operating results could fluctuate to the extent that our business relies on leisure travel.travel and corporate events.

Our operating results could fluctuate because our hospitality business relies on revenue generated by leisure travelers.travelers and corporate event-driven business. Therefore, there are numerous factors beyond our control that affect our operating results. For any of the reasons listed below, or for other reasons we do not presently anticipate, it is possible that our operating results will be below market or our expectations. Until such time as we are able to geographically diversify our hospitality assets, the impact of any one or more of these factors will be greater than otherwise, as demonstrated by the affects that the California wildfires in 2018over the last three years had on our operations. Leisure travelers are typically sensitive to discretionary spending levels, tend to curtail travel during general economic downturns, and are affected by other trends or events that may include:

Other factors that may adversely affect our operating results include:

We are required to fund certain amounts for the Hotel Fund if the hotel does not achieve specified levels of operating profit and cash flows.

Under the terms of the limited liability company operating agreement of the Hotel Fund, Preferred Investors are entitled to a monthly distribution equal to 7.0% per annum of their invested capital, on a cumulative and non-compounding basis. In the event that the hotel is unable to generate sufficient cash flow to pay the preferred distribution in a given month, the Company is obligated to fund the amount of any such shortfall via a common capital contribution to the Hotel Fund. During the years endedAs of December 31, 20182019 and 2017,2018, the Company funded an aggregate $0.4of $2.0 million and $0.5 million, respectively, pursuant to this obligation. Moreover, the Company has agreed to assume, via a common capital contribution obligation, responsibility for the payment of certain selling commissions and non-accountable expense obligations relating to the offering of the Preferred Interests. During the years endedAs of December 31, 20182019 and 2017,2018, the Company had funded an aggregate $0.1 million pursuant to this commitment. In addition, we provided a loan repayment guaranty of 50% of the MacArthur Loan outstanding loan principal and accrued unpaid interest, as well as a guarantee with respect to other customary carve-out matters such as bankruptcy and environmental matters. At December 31, 2019, the MacArthur Loan balance was $35.5 million resulting in a loan repayment guarantee of $17.8 million. Management has not recorded a liability for this amount as the fair value of the underlying asset is in excess of the MacArthur Loan balance at December 31, 2019. As a result of operating shortfalls incurred by MacArthur Place, the Company has provided non-interest advances for operating costs of $8.4 million as of December 31, 2019.

To the extent that the hotel does not generate sufficient operating profit or cash flows to fully fund the required distributions to holders of the Preferred Interests, the Company would have to use cash that it might otherwise have used to carry out our investment strategy and thereby negatively impact our ability to successfully implement such investment strategy and/or cause the Company to seek other sources of capital to fund such required distributions, which might not be available at the time needed or, if available, be on terms that are not attractive to the Company. Furthermore, if we are unable to dispose of MacArthur Place at a price sufficient to return our common capital contributions, we may not be able to recover some or all of our common capital contributions which could cause us to suffer a loss and reduce our cash flows.

 

We anticipate that our future portfolio will continue to include non-performing and distressed commercial and residential real estate mortgage loans, or loans that may become non-performing and distressed. These loans may already be, or may become, non-performing or distressed for a variety of reasons, including, without limitation, because the underlying property is too highly leveraged, the borrower is or becomes financially distressed, or the borrower is unable to obtain takeout financing prior to loan maturity, in any case, resulting in the borrower being unable to meet its debt service or repayment obligations to us. These non-performing or distressed loans may require a substantial amount of workout negotiations or restructuring, which may divert the attention of our management from other activities and entail, among other things, a substantial reduction in the interest rate, capitalization of interest payments, and a substantial write-down of the principal and interest of our loans. However, even if we successfully accomplish these restructurings, our borrowers may not be able or willing to maintain the restructured payments or refinance the restructured loans upon maturity. In addition, claims may be assessed against us on account of our position as mortgage holder or property owner, including responsibility for tax payments, environmental contamination, and other liabilities, which could harm our results of operations and financial condition.

 

In addition, certain non-performing or distressed loans that we acquire may have been originated by financial institutions that are or may become insolvent, suffer from serious financial stress, or are no longer in existence. As a result, the recourse to the selling institution or the standards by which these loans are being serviced or operated may be adversely affected. Further, loans on properties operating under the close supervision of a mortgage lender are, in certain circumstances, subject to certain additional potential liabilities that may exceed the value of our investment.

We may continue to foreclose on the remaining loans in our portfolio, which could harm our results of operations and financial condition.

 

We may find it necessary or desirable to foreclose on loans we originate or acquire. The foreclosure process can be lengthy and expensive. We cannot be assured as to the adequacy of the protection of the terms of the applicable loan, including the validity or enforceability of the loan, the maintenance of the anticipated priority, and perfection of the applicable security interests. Furthermore, claims may be asserted by other lenders that might interfere with enforcement of our rights. Borrowers may resist mortgage foreclosure actions by asserting numerous claims, counterclaims, and defenses against us, including, without limitation, lender liability claims and defenses, even when the assertions may have no basis in fact, in an effort to prolong the foreclosure action and seek to force us to modify the terms of the loan or buy-out the borrower’s position in the loan on terms more favorable to the borrower than would otherwise be the case. In some states, foreclosure actions can take several years or more to litigate. At any time prior to or during the foreclosure proceedings, the borrower may file for bankruptcy, which would have the effect of staying the foreclosure actions and further delaying the foreclosure process and potentially result in a reduction or discharge of a borrower’s mortgage debt. Foreclosure may create a negative public perception of the related mortgaged property, resulting in a diminution of its value. Even if we are successful in foreclosing on a loan, the liquidation proceeds upon sale of the underlying real estate may not be sufficient to recover our cost basis in the loan, resulting in a loss to us. Furthermore, any costs or delays involved in the foreclosure of the loan or a liquidation of the underlying property will further reduce the net proceeds and, thus, increase the loss.

 

If our exposure to a particular borrower or borrower group increases, the failure by that borrower or borrower group to perform on its loan obligations could harm our results of operations and financial condition.

 

Our investment policy provides that aggregate loans outstanding to a single borrower or group of affiliated borrowers should not exceed 20% of the Company’s investment portfolio. Given the relatively small number of loans in our loan portfolio, following the origination of a loan, however, the aggregate loans outstanding to a borrower or affiliated borrowers may exceed those thresholds as a result of changes in the size and composition of our overall investment portfolio. When loans outstanding to a single borrower or a group of affiliated borrowers exceed these thresholds, the failure of athat borrower or group of affiliated borrowers (as opposed to a diversified group of borrowers) to perform its or their loan obligations could harm our results of operations and financial condition. As of December 31, 2018,2019, we have exceeded this loan concentration threshold.threshold as we held only one active investment as of December 31, 2019.

 

If we are unable to properly analyze potential investment opportunities for our assets, we may incur losses that could further impair our financial condition and results of operations.

 

Our success depends, in part, on our ability to properly analyze the potential investment opportunities of our assets in order to assess the level of risk-adjusted returns that we should expect from any particular asset. To estimate the value of a particular asset, we may use historical assumptions that may or may not be appropriate. To the extent that we use historical assumptions that are inappropriate under then-current market conditions, we may lend on a real estate asset that we otherwise might not lend against, overpay for an asset or acquire an asset that we otherwise might not acquire, or be required to later write-down the value of assets acquired on the basis of such assumptions, which may harm our financial condition and results of operations.

We have limited personnel with experience in developing real estate and we may not be able to solely manage the real estate we acquire or foreclose upon or develop the underlying projects in a timely or cost-effective manner, or at all, which could harm our financial condition and results of operations.

 

Because we have limited personnel with experience in developing real estate, we occasionally engage external professionals to assist us. We may, however, be unable to obtain such assistance at an attractive cost or at all. Even if we are able to obtain such assistance, we may be exposed to the risks associated with the failure to complete the development of the project as expected or desired.

When we acquire real estate through purchase or foreclosure on one of our loans or otherwise, we may seek to complete the underlying projects, either alone or through joint ventures. We may not be able to manage the development process in a timely or cost-effective manner or at all.

 

If we enter into joint ventures to manage or develop projects, such joint ventures involve certain risks, including, without limitation, that:

Any one or more of these risks could harm our financial condition and results of operations.

Acquiring ownership of property, through foreclosure or otherwise, subjects us to the various risks of owning real property and we could incur unexpected costs and expenses, which could harm our business.

 

The supply of commercial mortgage loans available at significant discounts will likely decrease as the economy improves, which could prevent us from implementing our business strategies or maximizing our returns on such investments.

 

Part of our business strategy includes, among other things, the acquisition and origination of mortgage loans, mezzanine loans, and other debt instruments, as well as equity and preferred equity interests or investments. Conditions in the commercial mortgage market, the financial markets, and the overall economy may reduce the availability of borrowers and projects meeting our underwriting criteria and current business objectives and strategies. We also may face increasing competition from other capital sources. As a result, we may be unable to successfully pursue any of our current or future investment strategies. Additionally, the manner in which we compete and the types of assets we seek to acquire may be affected by sudden changes in our industry, the regulatory environment, the role of government-sponsored entities, the role of credit rating agencies or their rating criteria or process, or the U.S. and global economies generally. If we do not effectively respond to these changes, or if our strategies to respond to these changes are not successful, our financial condition and results of operations may be harmed.

 

A secondary market for our loans or other assets we acquire may not develop, in which case we may not be able to diversify our assets in response to changes in economic and other conditions, and we may be forced to bear the risk of deteriorating real estate markets, which could increase borrower defaults on our loans and cause us to experience losses.

 

Many of our target assets, including commercial mortgage loan related assets, generally experience periods of illiquidity. In the event that a secondary market for our portfolio loans or other assets does not develop, we may be required to bear all the risk of our assets until the loans mature, are repaid, or are sold. A lack of liquidity may result from the absence of a willing buyer or an established market for these assets, as well as legal or contractual restrictions on resale, or the unavailability of financing for these assets. In addition, certain of our target assets, such as bridge loans and other commercial real estate mortgage loans, may also be particularly illiquid assets due to their short life, their potential unsuitability for securitization, and the greater difficulty of recovery in the event of a borrower’s default. There is generally a very limited secondary market for the loan assets we hold.

 

 

 

Our ability to manage our portfolio of loans and other investments may be limited by the form in which they are made. We may purchase commercial mortgage loans jointly with other lenders, acquire investments subject to rights of senior classes and servicers under inter-creditor or servicing agreements; acquire only a participation interest in an underlying investment; or rely on independent third-party management or strategic partners with respect to the management of an asset. Therefore, we may not be able to exercise control over the loan or investment. Such financial assets may involve risks not present in investments where senior creditors, servicers or third-party controlling investors are not involved. Our rights to enforcement following a borrower default may be subject to the rights of senior creditors or servicers or third-party partners with economic, business, or other interests or goals which may be inconsistent with ours. In addition, we may, in certain circumstances, be liable for the actions of our third-party partners. These decisions and judgments may be different than those we would make and may be adverse to us.

 

Short-term loans that we may originate or acquire may involve a greater risk of loss than traditional investment-grade mortgage loans with fully insured borrowers, which could result in greater losses.

 

We have historically originated or acquired commercial real estate-bridge (i.e., short-term) loans secured by first lien mortgages on properties of borrowers who are typically seeking short-term capital to be used in the acquisition, construction, or rehabilitation of properties, and we may continue to do so. The borrower may believe that the property underlying the short-term loan is undervalued, has been under-managed or is located in a recovering market. If the market in which the property is located fails to recover according to the borrower’s projections, or if the borrower fails to improve the quality of the property’s management, or the value of the asset, the borrower may not receive a sufficient return on the asset to satisfy the short-term loan, and we bear the risk that our loan may not be fully and/or timely repaid.

 

In addition, borrowers under a bridge loan usually use the proceeds of a conventional mortgage loan to repay the bridge loan. Thus, the repayment of a bridge loan is subject to the risk that the borrower will be unable to obtain permanent financing. Bridge loans are also subject to the risk associated with all commercial mortgage loans — borrower defaults, bankruptcies, fraud, losses and “special hazard” losses that are not covered by standard hazard insurance. In the event of a default, we bear the risk of loss of principal and non-payment of interest and fees to the extent of any deficiency between the value of the mortgage collateral and the principal amount and unpaid interest accrued under the loan. Our results of operations and financial condition would be adversely affected by any such losses we were to suffer with respect to these loans.

The subordinated loan assets that we may acquire, which involve greater risks of loss than senior loans secured by income-producing properties, could result in losses that could harm our results of operations and financial condition.

We have historically, and may in the future, acquire subordinated loans secured by junior mortgages on the underlying property or by a pledge of the ownership interests of either the entity owning the property or the entity that owns the interest in the entity owning the property. These types of assets involve a higher degree of risk than long-term senior mortgage lending secured by income-producing real property because the loan may become unsecured as a result of foreclosure by the senior lender. In addition, these loans may have higher loan-to-value ratios than conventional mortgage loans, resulting in less equity in the property and increasing the risk of loss of principal, particularly to the junior lender. If a borrower defaults on our subordinated loan or on debt senior to our loan, or in the event of a borrower bankruptcy, our subordinated loan will be satisfied only after the senior debt is paid in full or otherwise to the satisfaction of the senior lender. Where debt senior to our portfolio loan exists, intercreditor arrangements may limit our ability to amend our loan documents, assign our loans, accept prepayments, exercise our remedies, and control decisions made in bankruptcy proceedings relating to borrowers. As a result, we may not recover some or all of our investment, which could result in losses to us. Our willingness to acquire such loans also may be negatively affected by our need

 

Our due diligence may not reveal all of a borrower’s assets or liabilities or other investment risks or weaknesses in a business which could result in loan losses.

 

Before acquiring an asset or making a loan to a borrower, we assess the asset strength and skills of the prospective borrower and other factors that we believe are material to the performance of the asset. In making this assessment and otherwise conducting customary due diligence, we rely on numerous resources reasonably available to us and, in some cases, an investigation by third parties. This process is particularly subjective, and of lesser value than would otherwise be the case, with respect to newly organized entities because there may be little or no information publicly available about those entities. There can be no assurance that our due diligence processes will uncover all relevant facts or issues, or that any particular asset will be a successful investment.

 

Legislative and regulatory initiatives could harm our business.

 

The U.S., state, and foreign governments may take certain legislative and regulatory actions which could result in unintended consequences or new regulatory requirements which may be difficult or costly to comply with and could have a significant impact on our business, financial condition, and results of operations. Additionally, we cannot predict whether there will be additional proposed laws or reforms that would affect the U.S. financial system or financial institutions, whether or when such changes may be adopted, how such changes may be interpreted and enforced, or how such changes may affect us. For example, bankruptcy legislation could be enacted that would hinder the ability to foreclose promptly on defaulted mortgage loans or permit limited assignee liability for certain violations in the mortgage origination process, any or all of which could adversely affect our business or result in us being held responsible for violations in the mortgage loan origination process even when we were not the originator of the loan. Other laws, regulations, and programs at the federal, state, and local levels are under consideration that seek to address real estate and other markets, and may impose new regulations on various participants in the financial system. These or other actions could harm our business, results of operations, and financial condition.

 

Our business is subject to regulation by several government agencies and a disciplinary or civil action that occurs as a result of an actual or alleged violation of any rules or regulations to which we are subject could harm our business.

 

We are subject to extensive regulation and oversight by various state and federal regulatory authorities, including, without limitation, the Arizona Corporation Commission, the Arizona Department of Financial Institutions (Banking), and the SEC. Many of these authorities have generally increased their scrutiny of the entities they regulate following recent events in the homebuilding, finance, and capital markets sectors. We are also subject to various federal and state securities laws regulating the issuance and sale of securities. In the future, we may be required to obtain various approvals and/or licenses from federal or state governmental authorities, or government sponsored entities in connection with our mortgage-related or real estate development activities. There is no assurance that we will be able to obtain or maintain any or all of the approvals that we need in a timely manner. In the event that we do not adhere to these license and approval requirements and other laws and regulations which apply to us, we could face potential fines, disciplinary action, or other regulatory and judicial action that could restrict or otherwise harm our business.

Our prior or future loan agreements have contained or may contain restrictive covenants relating to our operations that could materially adversely affect our business, results of operations, and financial condition. A breach of any of these restrictive covenants that results in an event of default under the applicable loan agreement could result in, among other things, accelerated maturity of the applicable loan, early redemption of our Series B Preferred Shares, and other ramifications that could be detrimental to our financial position and liquidity.

 

We have previously entered into loan agreements which contained certain restrictive covenants that had the effect of requiring us to obtain the lender’s consent prior to taking certain actions, including the sale, encumbering, or transfer of certain assets, declaring or paying dividends, or incurring additional indebtedness. We also have entered into various loan guaranty agreements, including a construction completion guaranty with respect to the hotel improvement project at MacArthur Place equal to fifty percent (50%) of the MacArthur Loan outstanding principal along with a guaranty of interest and operating deficits, containing various financial and operating covenants, including minimum liquidity covenants and minimum net worth covenants. If we fail to meet or satisfy such covenants, we could be in default under those agreements, and the lender could elect to declare the full amount outstanding under those loans due and payable, require the posting of additional collateral, and/or enforce their respective interests against existing collateral from us. A default also could limit significantly our financing alternatives, which could cause us to curtail our investment activities or prematurely dispose of assets, any of which could have a material adverse effect on our business, results of operations, and financial condition. Also, a default under these loans or guarantees could trigger a non-compliance event under our Second Amended CertificatePreferred Stock Certificates of Designation which could result in, among other things, early redemption of our Series B Preferred Shares, and other ramifications that could be detrimental to our financial position and liquidity.

Any borrowing by us will increase our risk, which may reduce the return on our assets, reduce cash available for distribution to our stockholders, and increase losses.

 

Subject to market conditions and availability, we have historically used, and may continue to use borrowings to provide us with the necessary cash to pay our operating expenses, pay the principal and interest due under our loans, make dividend payments to our Series B preferred shareholders, finance our assets, or make other investments. Any such borrowings will require us to carefully manage our cost of funds and we may not be successful in this effort. To the extent we are permitted under our existing loan or other agreements, we may borrow funds from a number of sources, including through repurchase agreements, re-securitizations, securitizations, warehouse facilities, and bank credit facilities (including term loans and revolving facilities), and the terms of any indebtedness we incur may vary. Although we are not currently required to maintain any particular assets-to-equity leverage ratio, the amount of leverage we may deploy will depend on our available capital, our ability to access financing arrangements, the stability of cash flows generated from the assets in our portfolio, our assessment of the risk-adjusted returns associated with those assets, our ability to enter into repurchase agreements, re-securitizations, securitizations, warehouse facilities and bank credit facilities (including term loans and revolving facilities), available credit limits and financing rates, the type or amount of collateral required to be pledged, and our assessment of the appropriate amount of leverage for the particular assets we are funding.

 

Borrowing subjects us to a number of other risks, including, among others, the following:

 

Any of the foregoing events could materially harm our business, results of operations, and financial condition.

 

Any repurchase agreements and bank credit facilities into which we may enter in the future to finance our operations may require us to provide additional collateral or pay down debt which could have the effect of reducing the capital that might otherwise be available to be used to fund our operations or expand our business.

We have used, and may continue to utilize, repurchase agreements and bank credit facilities (including term loans and revolving facilities) to finance our operations, assuming such financing is available to us on acceptable terms. Such financing arrangements involve the risk that the market value of the loans pledged or sold by us to the counter-party of the repurchase agreement counter-party or provider of the bank credit facility may decline in value, in which case the counter-party or lender may require us to provide additional collateral or to repay all or a portion of the funds advanced. We may not have the funds available to repay our debt at that time, which would likely result in defaults unless we are able to raise the funds from alternative sources, which we may not be able to do on favorable terms or at all. A lender’s or counter-party’s requirement that we post additional collateral would reduce our liquidity and limit our ability to leverage our assets. If we cannot meet these requirements, the lender or counter-party could accelerate our indebtedness, increase the interest rate on advanced funds, and terminate our ability to borrow funds from it, which could harm our financial condition and ability to implement our business plan. In addition, in the event that a lender or counter-party files for bankruptcy or becomes insolvent, the loans to us may become subject to bankruptcy or insolvency proceedings, thus depriving us, at least temporarily, of the benefit of these assets. Such an event could restrict our access to bank credit facilities and increase our cost of capital. The providers of repurchase agreement financing and bank credit facilities may also require us to maintain a certain amount of cash or set aside assets sufficient to maintain a specified liquidity position that would allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our assets as fully as we would choose which could reduce our return on assets. In the event that we are unable to meet these collateral obligations, our financial condition and prospects could deteriorate rapidly.

 

Our loans may contain restrictive covenants relating to our operations which could harm our business, results of operations, and financial condition.

 

To the extent we borrow funds pursuant to loan or similar agreements, these agreements may impose restrictions on us with respect to our ability to: (i) incur additional debt; (ii) make acquisitions; (iii) reduce liquidity below certain levels; (iv) pay dividends to our stockholders; (v) redeem debt or equity securities; or (vi) conduct the operation of our business and the carrying out of our investment strategy as determined by management. If we fail to meet or satisfy any of the covenants in our current or future loan agreements, we would be in default under these agreements, and our lenders could, among other things, elect to declare loans outstanding to us due and payable, terminate their commitments to provide future funding, require the posting of additional collateral, and enforce their respective interests against existing collateral from us, or any combination of the foregoing. Also, a default could constitute a Noncompliance Event under our Second Amended CertificatePreferred Stock Certificates of Designation which could result in, among other things, accelerated maturity under our loan agreements, early redemption of our Series B Preferred Shares, and other ramifications that could be detrimental to our financial position and liquidity. We also may be subject to cross-default and acceleration rights and, with respect to collateralized debt, requirements for us to post additional collateral, and foreclosure rights upon default. A default also could significantly limit our financing alternatives, which could cause us to curtail or suspend all of our investment activities or prematurely dispose of assets.

We have experienced defaults on our commercial mortgage loan assets and expect to experience such defaults in the future, which may harm our business.

We are in the business of acquiring, originating, marketing and selling commercial mortgage loans and, as such, we are at risk of default by borrowers. Any failure of a borrower to repay the mortgage loans or to pay interest on such loans will reduce our revenue and have an adverse effect on our results of operations and financial condition. AtAs of December 31, 2018, three of our six2019, we had two loans with outstanding principal and interest balances totaling $20.6 million which were in default and past their respective scheduled maturity dates.dates, and were fully reserved.

 

 

Our borrowers are subject to risks, expenses, and liabilities associated with owning real estate including, among others:

 

Any or all of these risks, if not properly managed by the borrower, could impose substantial costs or other burdens on our borrower, or result in a reduction in the value of the real estate underlying our loan to the borrower, thereby increasing the likelihood of default by the borrower. In addition, to the extent we foreclose on any such real estate securing that loan, we would become directly subject to the same risks.

If commercial property borrowers are unable to generate net income from operating the property, we may experience losses on those loans.

 

The ability of a commercial mortgage loan borrower to repay a loan secured by an income-producing property, such as a multi-family or commercial office building, typically is dependent primarily upon the successful operation of the property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower’s ability to repay our loan may be impaired. Net operating income of an income producing property can be affected by, among other things, tenant mix, success of tenant businesses, property management decisions, property location and condition, competition from comparable types of properties, changes in laws that increase operating expenses or limit rents that may be charged, any need to address environmental contamination at the property, the occurrence of any uninsured casualty at the property, changes in national, regional, or local economic conditions or specific industry segments, declines in regional or local real estate values, declines in regional or local rental or occupancy rates, increases in interest rates, real estate tax rates and other operating expenses, changes in governmental rules, regulations and fiscal policies, including environmental legislation, acts of God, terrorism, social unrest, and civil disturbances.

In the event of any default under a recourse or non-recourse commercial mortgage loan held directly by us, we generally bear a risk of loss of principal to the extent of any deficiency between the value of the collateral (or our ability to realize such value through foreclosure or otherwise) and the principal and accrued interest on the mortgage loan. In the event of the bankruptcy of a commercial mortgage loan borrower, the mortgage loan to such borrower will be deemed to be secured only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court), and the lien securing the commercial mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law. Foreclosure of a commercial mortgage loan can be an expensive and lengthy process and could have a substantial negative effect on our anticipated return on the foreclosed commercial mortgage loan.

We rely on the value of our real estate collateral to help protect us from incurring losses on our commercial mortgage loans, and the realizable value of that real estate collateral is subject to appraisal errors and events beyond our control.

 

We often rely on third-party appraisers to value the real estate used as collateral for the loans that we make. Any errors or mistakes in judgment by such appraisers may cause an over-valuation of such real estate collateral. Also, the realizable value of the real estate securing our loans may decrease due to a general downturn in the real estate market. As a result, the value of the collateral securing our mortgage loans may be less than anticipated at the time the applicable commercial mortgage loan was originated or acquired. If the value of the collateral supporting our commercial mortgage loans declines and a foreclosure sale occurs, we may not recover the full amount of our commercial mortgage loan.

Our underwriting standards and procedures may not adequately protect us from loan defaults, which could harm our business.

 

Due to the nature of our business model, we believe the underwriting standards and procedures we use are different from conventional lenders. Accordingly, there is a risk that the underwriting we performed did not, and the underwriting we perform in the future may not, reveal all material facts pertaining to the borrower and the collateral, and there may be a greater risk of default by our borrowers which, as described above, could harm our business.

Guarantors of our loans may not have sufficient assets to support their guarantees, which, in the event of a loan default where the realizable value of the underlying collateral is insufficient to fully amortize our loan.

 

Our commercial mortgage loans are not insured or guaranteed by any federal, state or local government agency. Our loans are generally guaranteed by individuals or entities affiliated with the borrower. These guarantors may not have sufficient assets to back up their guarantees, in whole or in part, and collections pursuant to any such guarantees may be difficult and costly. Consequently, if there is a default on a particular commercial mortgage loan and guarantee, our only practical recourse may be to foreclose upon the mortgaged real property. If the value of the foreclosed property is less than the amount outstanding under the corresponding loan, we may incur losses.

We may experience a further decline in the fair value of our assets, which could harm our results of operations and our financial condition.

 

 

Many of our assets are recorded at the lower of cost or fair value assessments, and as a result, there may be uncertainty as to the value of these assets.

 

The fair value of many of our assets may not be readily determinable, requiring us to make certain estimates and adjustments. We value certain of these investments quarterly at fair value, as determined in accordance with applicable accounting guidance, which may include unobservable inputs. Because such valuations are subjective, the fair value of certain of our assets may fluctuate over short periods of time and our determinations of fair value may differ materially from the values that would have been used if a ready market for these assets existed. Moreover, even if the fair values of our REO assets increase, we are generally unablenot permitted to reflect the value of those assets on our balance sheet above their REO carrying values. As such, the value of such an increase would only be recognized upon disposition of the asset, if any.

Valuations of certain assets may be difficult to obtain or unreliable. When appropriate, the Company will obtain information from third-party valuation specialists and real estate brokers to assist us in valuing our assets. These valuations are often subject to various disclaimers and conditions. Depending on the complexity and lack of liquidity of an asset, valuations of the same asset can vary substantially from one third party valuation provider to another. In certain circumstances, we may be required to determine the fair value of our investments based on our own judgment. Our results of operations for a given period could be harmed if our determinations regarding the fair value of our investments were materially higher than the values that we ultimately realize upon their disposal.

 

Competition for buyers of real estate that we own, or for permanent take-out financing for our borrowers, places severe pressure on asset values, and we may not be able to realize the full value of any of our assets as a result.

 

The industry in which we operate is serviced primarily by conventional mortgage lenders and loan investors, which include commercial banks, insurance companies, mortgage brokers, pension funds, and private and other institutional lenders. AsIn the event that we resume active lending operations, we expect to compete with these lenders as well as new entrants to the competitive landscape who are also focused on originating and acquiring commercial mortgage loans. Additionally, as we seek to locate purchasers for real estate or loans we have acquired, we compete with other real estate owners seeking to sell property or loans acquired through foreclosure or otherwise. Many of these market participants are willing to sell their property or accept permanent take-out financing in amounts

estate marketplace, our ability to realize value from our existing REO and loans may be harmed or delayed, and we may not be able to grow our asset portfolio.

Our historical focus on originating and acquiring construction loans exposes us to risks associated with the uncertainty of completion of the underlying project, which may result in losses on those loans.

 

We have historicallypreviously originated and acquired, and may continue toin the future originate and acquire, construction loans, which are inherently risky because the collateral securing the loan typically has not been built or is only partially built. As a result, if we do not fund our entire commitment on a construction loan, or if a borrower otherwise fails to complete the construction of a project, there could be adverse consequences to us associated with the loan, including: a loss of the potential value of the property securing the loan, especially if the borrower is unable to raise funds to complete it from other sources; claims against us for failure to perform our obligations as a lender under the loan documents; increased costs for the borrower that the borrower is unable to pay which could lead to default on the loan; a bankruptcy filing by the borrower, which could make it difficult to collect on the loan on a timely basis, if at all; and abandonment by the borrower of the collateral for our loan, which could significantly decrease the value of the collateral.

Risks of cost overruns and non-completion of renovation of the properties underlying rehabilitation loans may result in losses.

 

We may continue to originate and acquire rehabilitation loans. The renovation, refurbishment, or expansion of assets which underlie loans that we make involves risks of cost overruns and non-completion. Estimates of the costs of improvements to bring a property up to standards established for the market position intended for that property may prove inaccurate. Other risks may include: rehabilitation costs exceeding original estimates, possibly making a project uneconomical; environmental risks; and rehabilitation and subsequent leasing of the property not being completed on schedule. If such renovation is not completed in a timely manner, or if renovation costs are more than expected, the borrower may experience a prolonged impairment of net operating income and may not be able to make payments to us on our loan on a timely basis or at all, which could result in significant losses to us.

Our loans and real estate assets are concentrated geographically and a downturn in the economies or markets in which we operate could harm our asset values.

 

We have commercial mortgage loans and own real property (or hold interests in entities that own real property) in the following states: Arizona, California, New Mexico, Minnesota, Missouri, and New York.Missouri. Because we are not diversified geographically and are not required to observe any specific geographic diversification criteria, a downturn in the economies of the states or regions in which we own real estate or have commercial mortgage loans, could harm our loan, real estate or investment portfolio.

We may have difficulty protecting our rights as a secured lender, which could reduce the value or amount of collateral available to us upon foreclosure and harm our business.

 

While our loan documents provide us with certain enforcement rights with respect to those loans, the manner in which the foreclosure process is conducted and the rights of borrowers and the rights of other secured lenders may prevent or limit our ability to realize substantial benefits from these enforcement rights. For example:

 

 

A number of judicial decisions have upheld the right of borrowers to sue lending institutions on the basis of various evolving legal theories, collectively termed “lender liability.” Generally, lender liability is based on the premise that a lender has either violated a duty, whether implied or contractual, of good faith and fair dealing owed to the borrower or has assumed a degree of control over the borrower resulting in the creation of a fiduciary duty by the lender to the borrower or its other creditors or stockholders. We may be required to incur substantial legal and other defense costs in the event such a claim is made against us, and if such a claim were to be ultimately successful or resolved through settlement, subject us to significant liability.

If any of the real estate upon which we have foreclosed were to suffer an uninsured loss, we could lose the capital invested in such properties as well as the anticipated future cash flows from the loans secured by those properties.

 

Through foreclosure, we have acquired a substantial number of real property assets. We carry comprehensive liability, fire, extended coverage, earthquake, business interruption, and rental loss insurance covering all of these properties under various insurance policies. We also maintain title insurance to protect us against defects affecting these real property assets. We select policy specifications and insured limits which we believe to be appropriate given the perceived relative risk of loss, the cost of the coverage and our understanding of industry practice. We do not carry insurance for certain uninsured losses such as loss from riots, war, or nuclear reactions. Our policies are insured subject to certain limitations, including, among others, large deductibles or co-payments and policy limits which may not be sufficient to cover all our losses. In addition, we may discontinue certain policies on some or all of our properties in the future if the cost of premiums for any of these policies exceeds, in our judgment, the value of the coverage relative to the perceived risk of loss. If we, or one or more of our borrowers, experiences a loss which is uninsured or which exceeds policy limits or which the applicable insurance policy does not cover, we could lose the capital invested in those real property assets or in loans secured by such properties as well as the anticipated future cash flows from the assets or loans secured by those properties (or, in the event of foreclosure, from those properties themselves).

Our development activities expose us to project cost, completion, and resale risks.

As part of our business strategy, we willmay occasionally develop or renovate hotel and residential properties, both directly and through partnerships, joint ventures, and other business structures with third parties. Our ongoingAny involvement in the development of such properties presents a number of risks, including that: (1) we may be unable to raise sufficient capital for completion of projects that have commenced or for development of future properties; (2) properties that we develop could become less attractive due to decreases in demand for hotel and residential properties, market absorption or oversupply, with the result that we may not be able to sell such properties for a profit or at the prices or selling pace we anticipate, potentially requiring additional changes inus to change our pricing strategy that could result in impairment charges; (3) construction delays or cost overruns, including those due to a shortage of skilled labor, lender financial defaults, or so calledso-called “Acts of God” such as earthquakes, hurricanes, floods, or fires may increase overall project costs or result in project cancellations; and (4) we may be unable to recover development costs we incur for any projects that we do not pursue to completion.

In connection with the MacArthur Loan, the Company has agreed to provide a construction completion guaranty with respect to the planned hotel improvementrenovation project which shall be released upon payment of all project costs and receipt of a certificate of occupancy.  In addition, the Company has provided a loan repayment guaranty equal to fifty percent (50%) of the MacArthur Loan unpaid principal along with a guaranty of unpaid interest and hotel operating expenses, as well as other customary non-recourse carve-out matters such as bankruptcy and environmental matters.  If the Hotel Fund is unable to raise adequate debt or equity capital to fund unanticipated excess renovation costs, it would cause the Company to utilize its resources to meet such requirements which could have a detrimental material effect on our liquidity.

We may be exposed to liabilities for risks associated with the use of hazardous substances on any of our properties.

 

Under various federal, state, and local laws, an owner or operator of real property may become liable for the costs of removal of certain hazardous substances released on its property. These laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances. The presence of hazardous substances may harm an owner’s ability to sell real estate or borrow using real estate as collateral. To the extent that an owner of a property underlying one of our loans becomes liable for removal costs, the ability of the owner to make payments to us may be reduced, which in turn may diminish the value of the relevant mortgage asset held by us. If we acquire a property through foreclosure or otherwise, the presence of hazardous substances on such property may harm our ability to sell the property and we may incur substantial remediation costs, which could harm our results of operations and financial condition.

Other Risk Factors:

 

We may not be able to utilize our net operating loss carryforwards and built-in tax losses as anticipated, which could result in greater than anticipated tax liabilities.

 

We have accumulated net operating loss carryforwards of approximately $446.2$474.8 million as of December 31, 2018.2019. In addition, we have built-in unrealized tax losses in our portfolio of loans and REO assets, as well as other deferred tax assets, totaling approximately $61.8$58.9 million. Subject to certain limitations, such net operating loss carryforwards and unrealized built-in losses may be available to offset future taxable income and gain from our existing assets as well as any income and gain from new assets we acquire. Our ability to use our net operating loss carryforwards and built-in losses is dependent upon our ability to generate taxable income in future periods. In addition, the use of our net operating loss carryforwards and built-in losses is subject to various limitations, including possible changes in the tax laws or regulations relating to the use of these potential tax benefits.limitations. For example, there will be limitations on our ability to use our built-in losses or other net operating losses if we undergo a “change in ownership” for U.S. federal income tax purposes. In addition, it is possible that our built-in losses may not be fully available or usable in the manner anticipated. To the extent these limitations occurred or governmental challenges were asserted and sustained with respect to such built-in losses, we may not be permitted to use our built-in losses to offset our taxable income, in which case our tax liabilities could be greater than anticipated.

Uncertainties in the interpretation and application of the 2017 Tax Cuts and Jobs Act could materially affect our tax obligations and effective tax rate.

On December 22, 2017, the U.S. enacted comprehensive tax legislation, commonly referred to as the 2017 Tax Cuts and Jobs Act (the “2017 Tax Act”), which significantly affected U.S. tax law by changing how the U.S. imposes income tax on corporations. The 2017 Tax Act requires complex computations not previously required by U.S. tax law. As such, the application of accounting guidance for such items is currently uncertain. Further, compliance with the 2017 Tax Act and the accounting for such provisions require preparation and analysis of information not previously required or regularly produced. In addition, the U.S. Department of Treasury has broad authority to issue regulations and interpretative guidance that may significantly impact how we will apply the law and impact our results of operations in future periods.

Our decisions about raising capital may adversely affect our business and financial results. Furthermore, our growth may be limited if we are not able to raise additional capital.

We rely on our ability to raise capital to fund our continuing operations and achieve our investment objectives. We may raise capital through a variety of methods, including, but not limited to, issuing new shares of our common stock or preferred stock, and issuing convertible and non-convertible debt securities. The number of our unissued shares of stock authorized for issuance establishes a limit on the amount of capital we can raise through issuances of shares of stock unless we seek and receive approval from our stockholders to increase the authorized number of our shares in our charter. Also, certain “change of ownership” tests under U.S. federal income tax laws may limit our ability to raise needed equity capital and/or could limit our future use of tax losses to offset any income tax obligations we may incur in the future.

 

In addition, we may not be able to raise capital when needed or desired. As a result, we may not be able to finance our continuing operations or growth in our business and in our portfolio of assets. If we are unable to raise capital and expand our business and our portfolio of investments, we may have to forgo attractive business and investment opportunities, and our operating expenses may increase significantly relative to our capital base, adversely affecting our business and financial condition.

To the extent we have capital that is available for investment, we have broad discretion over how to invest that capital and you will be relying on the judgment of our management regarding its use. To the extent we invest capital in our business or in portfolio assets, we may not be successful in achieving favorable returns.

A financial downturn, recession or other declines in the U.S. real estate market could further adversely affect our operating results and liquidity.

If the financial or real estate markets were to experience a decline, we could experience additional losses and write-downs of assets, and could face serious capital and liquidity constraints and other business challenges.

We depend on key personnel and an error in judgment or the loss of their services could harm our business.

 

Our success depends upon the experience, skills, resources, relationships, contacts and continued efforts of certain key personnel. If any of these individuals were to make an error in judgment in conducting our operations, our business could be harmed. If any

Our risk management efforts may not be effective.

We could incur substantial losses and our business operations could be disrupted if we are unable to effectively identify, manage, monitor, and mitigate financial risks, such as credit risk, interest rate risk, prepayment risk, liquidity risk, and other market-related risks, as well as operational risks related to our business, assets, and liabilities. Our risk management policies, procedures, and techniques may not be sufficient to identify all of the risks we are exposed to, mitigate the risks we have identified, or to identify additional risks to which we may become subject in the future. Expansion of our business activities may also result in our being exposed to risks thatto which we have not previously been exposed to or may increase our exposure to certain types of risks and werisks. We may not effectively identify, manage, monitor, and mitigate these risks as our business activity changes or increases.

Our technology infrastructure and systems are important and any significant disruption or breach of the security of this infrastructure or these systems could have an adverse effect on our business. We also rely on technology infrastructure and systems of third parties who provide services to us and with whom we transact business.

In order to analyze, acquire, and manage our investments, manage the operations and risks associated with our business, assets, and liabilities, and prepare our financial statements, we rely upon computer hardware and software systems. Some of these systems are located at our offices and some are maintained by third party vendors or located at facilities maintained by third parties. We also rely on technology infrastructure and systems of third parties who provide services to us and with whom we transact business. Any significant interruption in the availability or functionality of these systems could impair our access to liquidity, damage our reputation, and have an adverse effect on our operations and on our ability to timely and accurately report our financial results. In addition, any breach of the security of these systems could have an adverse effect on our operations and the preparation of our financial statements. Steps we have taken to provide for the security of our systems and data may not effectively prevent others from obtaining improper access to our systems data. Improper access could expose us to risks of data loss, litigation, and liabilities to third parties, and otherwise disrupt our operations. For example, our systems and the systems of third parties who provide services to us and with whom we transact business may contain non-public personal information that an identity thief could utilize in engaging in fraudulent activity or theft. We may be liable for losses suffered by individuals whose identities are stolen as a result of a breach of the security of these systems, and any such liability could be material.

Failure to prevent or detect a malicious cyber-attack on our systems and databases could result in a misappropriation of confidential information or access to highly sensitive information.  

Cyber-attacks are becoming more sophisticated and pervasive. Across our business we hold large volumes of personally identifiable information including that of our employees and customers. Individuals may try to gain unauthorized access to our data in order to misappropriate such information for potentially fraudulent purposes, and our security measures may fail to prevent such unauthorized access. A significant breach could have a material adverse effect on our operations, reputation, and financial condition. In addition, if we were unable to prove that our systems are properly designed to detect an intrusion, we could be subject to severe penalties and loss of existing or future business. Further, third parties, such as hosted solution providers, that provide services to us, could also be a source of security risk in the event of a failure of their own security systems and infrastructure. The costs to mitigate or address security threats and vulnerabilities before or after a cyber incident could be significant. Our remediation efforts may not be successful and could result in interruptions, delays or cessation of service, and loss of business. As threats related to cyber attackscyber-attacks develop and grow, we may also find it necessary to make further investments to protect our data and infrastructure, which may impact our profitability.

 

Conducting our business in a manner so that we are exempt from registration under the Investment Company Act may reduce our flexibility and could limit our ability to pursue certain opportunities. At the same time, failure to continue to qualify for exemption from the Investment Company Act could adversely affect us.

Under the Investment Company Act, an investment company is required to register with the SEC and is subject to extensive restrictive and potentially adverse regulations relating to, among other things, operating methods, management, capital structure, dividends, and transactions with affiliates. However, companies primarily engaged in the business of acquiring mortgages and other liens on and interests in real estate are exempt from the requirements of the Investment Company Act. We believe that we have conducted our business so that we are exempt from the Investment Company Act. Rapid changes in the values of assets we own, however, can disrupt our efforts to conduct our business to meet the requirements of these exemptions.

If we failed to meet these requirements, we could, among other things, be required either (i) to change the manner in which we conduct our operations to avoid being required to register as an investment company or (ii) to register as an investment company, either of which could adversely affect us by, among other things, requiring us to dispose of certain assets or to change the structure of our business in ways that we may not believe to be in our best interests. Legislative or regulatory changes relating to the Investment Company Act or which affect our efforts to comply with the exemption requirements could also result in these adverse effects on us.

If we were deemed an unregistered investment company, we could be subject to monetary penalties and injunctive relief and we could be unable to enforce contracts with third parties, and third parties could seek to obtain rescission of transactions undertaken during the period we were deemed an unregistered investment company, unless the court found that under the circumstances, enforcement (or denial of rescission) would produce a more equitable result than no enforcement (or grant of rescission) and would not be inconsistent with the Investment Company Act.

The Company, JCP Realty Partners, LLC, Juniper NVM, LLC, and ChaseJPM Funding have entered into an Investment Agreement (“Series B Investment Agreement”) pursuant to which the Company made certain representations and covenants, including, but

not limited to, a covenant that the Company take all commercially reasonable actions as are reasonably necessary for the Company to be eligible to rely on the exemption provided by Section 3(c)(5)(C) of the Investment Company Act of 1940, as amended, commonly referred to as the “Real Estate Exemption,” and to remain eligible to rely on that exemption at all times thereafter. Furthermore, under the Series B-2 Purchase Agreement, the Company is obligated not to take any action, the result of which would reasonably be expected to cause the Company to become ineligible for the Real Estate Exemption without the prior written consent of ChaseJPM Funding.

We do not believe that we are an investment company under the Investment Company Act. Nevertheless, it is possible that we will not be eligible for exemption under the Investment Company Act which, in such event, could require us to redeem our Series B Preferred Stock at a time which is prior to such time as is otherwise required under the Second Amended CertificatePreferred Stock Certificates of Designation. Such a required redemption could force us to sell our assets at below their fair value or to borrow funds at rates higher than would ordinarily be the case in order to have the funds to redeem such shares, and could even force the liquidation of the Company.

Risks Related to our Common Stock:

 

Under our Second Amended CertificatePreferred Stock Certificates of Designation, we are not permitted to pay dividends on our common stock and we may not meet Delaware law requirements or have sufficient cash to pay dividends in the future.

We are not required to pay dividends to the holders of our Common Stock and the holders of our Common Stock do not have contractual or other rights to receive them other than certain dividends payable in connection with an “initial public offering” as set forth in our Certificate of Incorporation. Under our Second Amended CertificatePreferred Stock Certificates of Designation, we are allowed to pay dividends to the holders of our Common Stock only under limited circumstances.

In addition, under Delaware law, our board of directors may not authorize a dividend unless it is paid out of our surplus (calculated in accordance with the Delaware General Corporation law), or, if we do not have a surplus, it is paid out of our net profits for the fiscal year in which the dividend is declared and the preceding fiscal year.

Any and all dividends will be paid at the discretion of our board of directors. Our ability to pay dividends in the future will depend on numerous factors, including:

Under the terms of our Second Amended CertificatePreferred Stock Certificates of Designation, no dividends may be paid on our Common Stock during any fiscal year unless all accrued dividends on the Series B-1, Series B-2, Series B-3B Preferred Shares and Series A preferred stockPreferred Shares have been paid in full.

 

A limited number of shareholders own shares of our Series B Preferred Stock that are convertible into a significant percentage of our fully-diluted Common Stock, which could have adverse consequences to other holders of our Common Stock.

As of December 31, 2018,2019, based on filings of Schedules 13D with the SEC, our Series B Investors own shares of our Series B Preferred Stock that are convertible into 38%43%, in the aggregate, of our outstanding Common Stock. Significant ownership stakes held by the holders of our Series B Preferred Stock could have adverse consequences for other stockholders because the holders of our Series B Preferred Stock have a significant influence over the outcome of matters submitted to a vote of our stockholders, including the election of our directors and transactions involving a change in control, and in the investment strategies pursued by the Company.

 

 

In the future, we may attempt to increase our capital resources by making additional offerings of debt or equity securities, including commercial paper, medium-term notes, senior or subordinated notes, preferred stock or common stock. The terms of our charter

documents do not preclude us from issuing additional debt or equity securities. Our certificate of incorporation permits our board of directors, without the approval of the holders of our Common Stock, to authorize the issuance of common or preferred stock in connection with equity offerings, acquisitions of securities or other assets of companies, divide and issue shares of preferred stock in series and fix the voting power and any designations, preferences, and relative, participating, optional or other special rights of any preferred stock, including the issuance of shares of preferred stock that have preference rights over the common stock with respect to dividends, liquidation, voting and other matters or shares of common stock that have preference rights over your common stock with respect to voting. We have issued shares of our Series B Preferred Stock which accounted for 38%43% of our capital stock as of December 31, 2018.2019. We are not required to offer any such shares to existing stockholders on a preemptive basis. Therefore, it may not be possible for existing stockholders to participate in future stock issuances. Additional equity offerings by us may dilute your interest in us. Our Series B Preferred Stock have a preference on distribution payments that could limit our ability to make a distribution to the holders of our common stock. If we issue additional debt securities, we could become more highly leveraged, resulting in (i) an increase in debt service that could harm our ability to make dividends to our stockholders, and (ii) an increased risk of default on our obligations. If we were to liquidate, holders of our debt and shares of preferred stock and lenders with respect to other borrowings will receive a distribution of our available assets before the holders of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Further, market conditions could require us to accept less favorable terms for the issuance of our securities in the future. Thus, you will bear the risk that any future offerings by us could dilute your interest in us.

 

Certain provisions of our certificate of incorporation, bylaws, debt instruments and the Delaware General Corporation Law could make it more difficult for a third-party to acquire us, even if doing so would benefit our stockholders.

 

Certain provisions of the Delaware General Corporation Law, (“DGCL”), may have the effect of deterring hostile takeovers or otherwise delaying or preventing changes in our management or in the control of our company, including transactions in which our stockholders might otherwise receive a premium over the fair market value of their securities. In particular, Section 203 of the DGCL may, under certain circumstances, make it more difficult for a person who would be an “interested stockholder” (defined generally as a person with 15% or more of a corporation’s outstanding voting stock) to effect a “business combination” (defined generally as mergers, consolidations and certain other transactions, including sales, leases or other dispositions of assets with an aggregate market value equal to 10% or more of the aggregate market value of the corporation) with the corporation for a three-year period. Under Section 203 of the DGCL, a corporation may under certain circumstances avoid the restrictions imposed by Section 203. Moreover, a corporation’s certificate of incorporation or bylaws may exclude a corporation from the restrictions imposed by Section 203. We have not made this election, and accordingly, we are subject to the restrictions of Section 203 of the DGCL. Furthermore, upon any “change of control” transaction, the restrictions on transfer applicable to the shares of our Class B and Class C common stock will terminate, which could act to discourage certain change of control transactions.

Shares of our Common Stock are subject to certain restrictions on transfer under Article V of the Company’s Bylaws, which could restrict your ability to sell your shares in certain circumstances.

In order to preserve our significant net operating loss carryforward, we have adopted certain restrictions on the transfer of shares of our common stock. Under section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), our ability to utilize our net operating loss carryforward and certain other tax benefits would be severely curtailed upon the occurrence of a “change

The ability to take action against our directors and officers is limited by our charter and bylaws and provisions of Delaware law and we may (or, in some cases, are obligated to) indemnify our current and former directors and officers against certain losses relating to their service to us.

Our charter limits the liability of our directors and officers to us and to shareholders for pecuniary damages to the fullest extent permitted by Delaware law. In addition, our charter authorizes our Board of Directors to indemnify our officers and directors (and those of our subsidiaries or affiliates) for losses relating to their service to us to the full extent required or permitted by Delaware law. In addition, we have entered into, and may in the future enter into, indemnification agreements with our directors and certain of our officers and the directors which obligate us to indemnify them against certain losses relating to their service to us and the related costs of defense.

 

None.