UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2006
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission File Number 333-125121
VESTIN REALTY MORTGAGE II, INC. |
| (Exact name of registrant as specified in its charter) |
| MARYLAND | | 61-1502451 |
| (State or Other Jurisdiction of | | (I.R.S. Employer |
| Incorporation or Organization) | | Identification No.) |
8379 WEST SUNSET ROAD, LAS VEGAS, NEVADA 89113
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code 702.227.0965
Securities registered pursuant to Section 12(b) of the Act:
| None | | None |
| (Title of each class) | | (Name of each exchange on which registered) |
Securities registered pursuant to Section 12(g) of the Act:
| Common Stock, $0.0001 Par Value |
| (Title of class) |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Sec 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer [ ] | Accelerated filer [X] | Non-accelerated filer [ ] |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes [ ] No [X]
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.
Class | | | Market Value as of June 30, 2006 |
| Common Stock, $0.0001 Par Value | | $ | |
| | | | |
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
Class | | | Number of Shares Outstanding As of March 9, 2007 |
| Common Stock, $0.0001 Par Value | | | 38,862,128 |
| | | | |
Note Regarding Forward Looking Statements
This report and other written reports and oral statements made from time to time by us may contain forward-looking statements. Such forward looking statements may be identified by the use of such words as “expects,” “plans,” “estimates,” “intend,” “might,” “may,” “could,” “will,” “feel,” “forecasts,” “projects,” “anticipates,” “believes” and words of similar expression. Forward-looking statements are likely to address such matters as our business strategy, future operating results, future sources of funding for real estate loans brokered by us, future economic conditions and pending litigation involving us. Some of the factors which could affect future results are set forth in the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Factors Affecting Our Operating Results.”
General
Vestin Fund II, LLC (“Fund II”) was organized in December 2000 as a Nevada limited liability company for the purpose of investing in real estate loans. Vestin Realty Mortgage II, Inc. (“VRM II”) was organized in January 2006 as a Maryland corporation for the sole purpose of effecting a merger with Fund II. On March 31, 2006, Fund II merged into VRM II and the members of Fund II received one share of VRM II’s common stock for each membership unit of Fund II. References in this report to the “Company”, “we”, “us” or “our” refer to Fund II with respect to the period prior to April 1, 2006 and to VRM II with respect to the period commencing on April 1, 2006. Because we were a limited liability company (“LLC”) during the prior periods reflected in this report, we make reference to Fund II’s “members” rather than “stockholders” in reporting our financial results
We invest in loans secured by real estate through deeds of trust or mortgages (hereafter referred to collectively as “deeds of trust” and as defined in our Management Agreement as “Mortgage Assets”). We commenced operations in June 2001.
We operate as a real estate investment trust (“REIT”). We are not a mutual fund or an investment company within the meaning of the Investment Company Act of 1940, nor are we subject to any regulation thereunder. As a REIT, we are required to have a December 31 fiscal year end.
Our manager is Vestin Mortgage, Inc. (the “manager” or “Vestin Mortgage”), a Nevada corporation, which is a wholly owned subsidiary of Vestin Group, Inc. (“Vestin Group”), a Delaware corporation. Michael Shustek, the CEO and director of the manager and CEO, President and a director of us, wholly owns Vestin Group, Inc., which is engaged in asset management, real estate lending and other financial services though its subsidiaries. Our manager, prior to June 30, 2006, also operated as a licensed Nevada mortgage broker and was engaged in the business of brokerage, placement and servicing of commercial loans secured by real property. On July 1, 2006, the mortgage broker license was issued to an affiliated company, Vestin Originations, Inc. (“Vestin Originations”), which has continued the business of brokerage, placement and servicing of commercial real estate loans. Vestin Originations is a wholly owned subsidiary of Vestin Group.
Pursuant to our management agreement, our manager shall implement our business strategies on a day-to-day basis, manage and provide services to us, and shall provide similar services to any of our subsidiaries. Without limiting the foregoing, our manager shall perform other services as may be required from time to time for management and other activities relating to our assets, as our manager shall deem appropriate under the particular circumstances. Consequently, our operating results are dependent upon our manager’s ability and performance in managing our operations and servicing our assets.
Vestin Mortgage, Inc. is also the manager of Vestin Realty Mortgage I, Inc., as the successor by merger to Vestin Fund I, LLC, referred to as “VRM I”, Vestin Fund III, LLC (“Fund III”) and inVestin Nevada, Inc., a company wholly owned by our manager’s CEO. These entities also invest in real estate loans.
The consolidated financial statements include the accounts of the Company and our wholly owned taxable REIT subsidiary, TRS II, Inc. All significant inter-company transactions and balances have been eliminated in consolidation.
Real Estate Loan Objectives
As of December 31, 2006, our loans were in the following states: Arizona, California, Hawaii, Nevada, New York, Oklahoma, Oregon, Texas and Washington. The loans we invest in are selected for us by our manager from among loans originated by Vestin Originations or non-affiliated mortgage brokers. When Vestin Originations or a non-affiliated mortgage broker originates a loan for us, that entity identifies the borrower, processes the loan application, makes or invests in the loan and brokers or sells the loan to us. We believe that our loans are attractive to borrowers because of the expediency of our manager’s loan approval process, which takes about ten to twenty days.
As a non-conventional lender, we are more willing to invest in real estate loans to borrowers that conventional lenders might not deem to be creditworthy. Because of our increased willingness to fund riskier loans, borrowers are generally willing to pay us an interest rate that is two to five points above the rates generally charged by conventional lenders. We invest a significant amount of our funds in loans in which the real property, held as collateral, is not generating any income to the borrower. The loans in which we invest are riskier because the borrower’s repayment depends on its ability to refinance the loan or develop the property so it can refinance the loan.
Our principal investment objectives are to maintain and grow shareholder value by:
| · | Producing revenues from the interest income on our real estate loans, |
| · | Providing cash distributions from the net income generated by our real estate loans, |
| · | Reinvesting, to the extent permissible, payments of principal and sales (net of expenses). |
Acquisition and Investment Policies
We seek to invest approximately 97% of our assets in real estate loans. Approximately 3% will be held as a working capital cash reserve. As of December 31, 2006, approximately 73% of our assets, net of allowance for loan losses, are classified as investments in real estate loans.
Generally, the collateral on our real estate loans is the real property that the borrower is purchasing or developing with the funds that we make available. We sometimes refer to these real properties as the security properties. While we may invest in other types of loans, most of the loans in which we invest have been made to real estate developers.
Our real estate investments are not insured or guaranteed by any government agency.
Our manager continuously evaluates prospective investments, selects the loans in which we invest and makes all investment decisions on our behalf in its sole discretion. In evaluating prospective real estate loan investments, our manager considers such factors as the following:
| · | The ratio of the amount of the investment to the value of the property by which it is secured, or the loan-to-value ratio, |
| · | The potential for capital appreciation or depreciation of the property securing the investment, |
| · | Expected levels of rental and occupancy rates, if applicable, |
| · | Potential for rental increases, if applicable, |
| · | Current and projected revenues from the property if applicable, |
| · | The status and condition of the record title of the property securing the investment, |
| · | Geographic location of the property securing the investment, and |
| · | The financial condition of the borrowers and their principals, if any, who guarantee the loan. |
Our manager may obtain our loans from an affiliated or non-affiliated mortgage broker who may solicit previous or new borrowers in those states where permissible. We may purchase existing loans that were originated by third party lenders and acquired by Vestin Originations to facilitate our purchase of the loans. Vestin Originations will sell the loans to us for no greater than the par value of the loan, not including its service fees and compensation.
When selecting real estate loans for us, our manager adheres to the following guidelines, which are intended to control the quality of the collateral given for our loans:
1. Priority of Loans. Generally, our assets are secured by first deeds of trust. First deeds of trust are loans secured by a full or divided interest in a first deed of trust secured by the property. Other loans (on the security property) that we invest in will not be junior to more than one other loan. As of December 31, 2006, approximately 98.91% of the principal amount of our outstanding interest in loans was secured by first deeds of trust.
2. Loan-to-Value Ratio. The amount of our loan combined with the outstanding debt secured by a senior loan on a security property generally does not exceed the following percentage of the appraised value of the security property at origination:
Type of Secured Property | Loan-to-Value Ratio |
| | |
| Residential | 75% |
| Unimproved Land | 60% (of anticipated as-if developed value) |
| Acquisition and Development | 60% (of anticipated as-if developed value) |
| Commercial Property | 75% (of anticipated as-if developed value) |
| Construction | 75% (of anticipated post- developed value) |
| Leasehold Interest | 75% (of value of leasehold interest) |
We may deviate from these guidelines under certain circumstances. For example, our manager, in its discretion, may increase any of the above loan-to-value ratios if a given loan is supported by credit adequate to justify a higher loan-to-value ratio, including personal guarantees. Occasionally, our collateral may include personal property attached to the real property as well as real property. We do not have specific requirements with respect to the projected income or occupancy levels of a property securing our investment in a particular loan. These loan-to-value ratios will not apply to financing offered to the purchaser of any real estate acquired through foreclosure or to refinance an existing loan that is in default when it matures. In those cases, our manager, in its sole discretion, shall be free to accept any reasonable financing terms that it deems to be in our best interest. The target loan-to-value ratio for our loan portfolio, including loans related to seller financed real estate held for sale, as a whole is approximately 70%. As of December 31, 2006, our actual loan to value ratio for our loan portfolio, including loans related to seller financed real estate held for sale, as a whole was 69.97% on a weighted average basis.
Loan to value ratios are based on appraisals that the manager receives at the time of loan underwriting and may not reflect subsequent changes in value estimates. Such appraisals, which may have been commissioned by the borrower and may precede the placement of the loan with us, are generally dated no greater than 12 months prior to the date of loan origination. The appraisals may be for the current estimate of the “as-if developed” value of the property, which approximates the post-construction value of the collateralized property assuming that such property is developed. “As-if developed” values on raw land loans or acquisition and development loans often dramatically exceed the immediate sales value and may include anticipated zoning changes, and successful development by the purchaser; upon which development is dependent on availability of financing. As most of the appraisals will be prepared on an “as-if developed” basis, if a loan goes into default prior to any development of a project, the market value of the property may be substantially less than the appraised value. As a result, there may be less security than anticipated at the time the loan was originally made. If there is less security and a default occurs, we may not recover the full amount of the loan.
We or the borrower retain appraisers who are state certified or licensed appraisers and/or hold designations from one or more of the following organizations: the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, the National Association of Review Appraisers, the Appraisal Institute, the National Society of Real Estate Appraisers, American Society of Real Estate Appraisers, or from among appraisers with other qualifications acceptable to Vestin Originations and/or our manager. However, appraisals are only estimates of value and cannot be relied on as measures of realizable value. An employee or agent of Vestin Originations or our manager will review each appraisal report and will conduct a physical inspection for each property. A physical inspection includes an assessment of the subject property, the adjacent properties and the neighborhood, but generally does not include entering any structures on the property.
3. Terms of Real Estate Loans. Our loans as of December 31, 2006 had original terms of six months to thirty-six months, excluding approved extensions. Most of our loans are for a term of 12 months. Generally, our original loan agreements permit extensions to the term of the loan by mutual consent. Such extensions are generally provided on loans where the original term was 12 months or less and where a borrower requires additional time to complete a construction project or negotiate take out financing.
As of December 31, 2006, all of our loans provided for payments of interest only with a “balloon” payment of principal payable in full at the end of the term, with the exception of two of our loans that have both principal and interest payments along with a “balloon” payment at the end of the term. As of December 31, 2006, these two loans had a balance of approximately $18.5 million and had original terms of twelve and thirty-six months. In addition, we invest in real estate loans that require borrowers to maintain interest reserves funded from the principal amount of the loan for a period of time. At December 31, 2006, we had approximately $71.5 million in investments in real estate loans that had interest reserves where the total outstanding principal due to us and our co-lenders was approximately $120.3 million. These loans had interest reserves of approximately $5.6 million, of which our portion was approximately $4.3 million. At December 31, 2005, we had approximately $17.7 million in investments in real estate loans that had interest reserves where the total outstanding principal due to us and our co-lenders was approximately $25.1 million. These loans had interest reserves of approximately $2.4 million, of which our portion was approximately $1.3 million.
4. Escrow Conditions. Our loans will often be funded by us through an escrow account held by a title insurance company, subject to the following conditions:
| · | Borrowers will obtain title insurance coverage for all loans, providing title insurance in an amount at least equal to the principal amount of the loan. Title insurance insures only the validity and priority of our deed of trust, and does not insure us against loss by other causes, such as diminution in the value of the security property. |
| · | Borrowers will obtain liability insurance coverage for all loans. |
| · | Borrowers will obtain fire and casualty insurance for all loans secured by improved real property, covering us in an amount sufficient to cover the replacement cost of improvements. |
| · | All insurance policies, notes, deeds of trust or loans, escrow agreements, and any other loan documents for a particular transaction will cover us as a beneficiary. |
5. Purchase of Real Estate Investments from Affiliates. We may acquire real estate loans from our affiliates, including our manager, for a price not in excess of the par value of the loan, plus allowable fees and expenses, but without allowance of any other compensation for the loans.
6. Note Hypothecation. We may also acquire real estate loans secured by assignments of secured promissory notes. These real estate loans must satisfy our stated investment standards, including our loan-to-value ratios, and may not exceed 80% of the principal amount of the assigned note upon acquisition. For example, if the property securing a note we acquire is commercial property, the total amount of outstanding debts secured by the property must not exceed 75% of the appraised value of the property, and the real estate loan will not exceed 80% of the principal amount of the assigned note. For real estate loans secured by promissory notes, we will rely on the appraised value of the underlying property, as determined by an independent written appraisal that was conducted within the then-preceding twelve months. If an appraisal was not conducted within that period, then we will arrange for a new appraisal to be prepared for the property prior to acquisition of the loan.
7. Participation. We participate in loans with other lenders, including affiliates as permitted by the North American Securities Administrators Association (“NASAA”) Guidelines, by providing funds for or purchasing an undivided interest in a loan meeting our investment guidelines described above. Typically, we participate in loans if:
| · | We did not have sufficient funds to invest in an entire loan; |
| · | We are seeking to increase the diversification of our loan portfolio; or |
| · | A loan fits within our investment guidelines, however it would constitute more than 20% of our anticipated capital contribution or otherwise be disproportionately large given our then existing portfolio. |
Loans in which unaffiliated investors have participated through inter-creditor agreements (“Inter-creditor Agreements”) are accounted for as secured borrowings in accordance with Statement of Financial Accounting Standards (“FAS”) 140 - Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“FAS 140”). The Inter-creditor Agreements provide us additional funding sources for real estate loans whereby an unaffiliated investor (the “Investor”) may participate on a non-pari passu basis in certain real estate loans with us and/or VRM I and/or Fund III (collectively, the “Lead Lenders”). In the event of borrower non- performance, the Inter-creditor Agreements generally provide that the Lead Lenders must repay the Investor’s loan amount either by (i) continuing to remit to the Investor the interest due on the participated loan amount; (ii) substituting an alternative loan acceptable to the Investor; or (iii) repurchasing the participation from the Investor for the outstanding balance plus accrued interest.
An Investor may participate in certain loans with the Lead Lenders through participation agreements. In the event of borrower non-performance, the participation agreement may allow the Investor to be repaid up to the amount of the Investor’s investment prior to the Lead Lenders being repaid.
As of December 31, 2006, 92% of our loans were loans in which we participated with other lenders, most of whom are our affiliates.
8. Diversification. We voluntarily comply with NASAA Guidelines, which provide that we neither invest in or make real estate loans on any one property which would exceed, in the aggregate, an amount equal to 20% of our capital nor may we invest in or make real estate loans to or from any one borrower which would exceed, in the aggregate, an amount greater than 20% of our capital. As of December 31, 2006, our single largest loan accounted for 9% of our stockholders’ equity. The loan yields interest at 13% per annum and, as of December 31, 2006, our portion of the outstanding balance of the loan was approximately $25.3 million.
9. Reserve Fund. We have established contingency working capital reserves of approximately 3% of our capital to cover our unexpected cash needs.
10. Credit Evaluations. When reviewing a loan proposal, our manager determines whether a borrower has sufficient equity in the security property. Our manager may also consider the income level and creditworthiness of a borrower to determine its ability to repay the real estate loan.
11. Sale of Real Estate Loan Investments. Although our manager has no plans to do so, our manager may sell our real estate loans or interest in our loans to either affiliates or non-affiliated parties when our manager believes that it is advantageous to us to do so. However, we do not expect that the loans will be marketable or that a secondary market will ever develop for them.
Real Estate Loans to Affiliates
We will not invest in real estate loans made to our manager, Vestin Group or any of our affiliates. However, we may acquire an investment in a real estate loan payable by our manager when our manager has assumed the obligations of the borrower under that loan, through a foreclosure on the property.
Purchase of Loans from our manager and Its Affiliates
In addition to those loans our manager selects for us, we purchase loans that were originated by Vestin Originations or other parties and first held for Vestin Originations’ own portfolio, as long as the loan is not in default and otherwise satisfies all of our lending criteria. However, we will not acquire a loan from or sell a loan to a real estate program in which our manager or an affiliate has an interest except in compliance with NASAA Guidelines or otherwise approved by our Board of Directors. We voluntarily comply with NASAA Guidelines.
Types of Loans We Invest In
We primarily invest in loans that are secured by first or second trust deeds on real property. Such loans fall into the following categories: raw and unimproved land, acquisition and development, construction, commercial and residential loans. The following discussion sets forth certain guidelines our manager intends to follow in allocating our investments among the various types of loans. Our manager, however, may change these guidelines at its discretion, subject to review by our board of directors. Actual investments will be determined by our manager pursuant to the terms of the management agreement, and the actual percentages invested among the various loan categories may vary from the guidelines below.
Raw and Unimproved Land Loans
Generally, 15% to 25% of the loans invested in by us may be loans made for the purchase or development of raw, unimproved land. Generally, we determine whether to invest in these loans based upon the appraised value of the property and the borrower’s actual capital investment in the property. We will generally invest in loans for up to 60% of the as-if developed appraised value of the property and we generally require that the borrower has invested in the property actual capital expenditures of at least 25% of the property’s value. As-if developed values on raw and unimproved land loans often dramatically exceed the immediate sales value and may include anticipated zoning changes, and successful development by the purchaser, upon which development is dependent on availability of financing. As of December 31, 2006, approximately 21.43% of our loans were in this category.
Acquisition and Development Loans
Generally, 10% to 25% of the loans invested in by us may be acquisition and development loans. Such loans enable borrowers to acquire and/or complete the basic infrastructure and development of their property prior to the construction of buildings or structures. Such development may include installing utilities, sewers, water pipes, and/or streets. We will generally invest in loans with a face value of up to 60% of the appraised value of the property. Loan to value ratios on acquisition and development loans are calculated using as-if developed appraisals. Such appraisals have the same valuation limitations as raw and unimproved land loans, described above. As of December 31, 2006, approximately 3.54% of our loans were in this category.
Construction Loans
Generally, 10% to 70% of our loans may be construction loans. Such loans provide funds for the construction of one or more structures on developed land. Funds under this type of loan will generally not be forwarded to the borrower until work in the previous phase of the project has been completed and an independent inspector has verified certain aspects of the construction and its costs. We will typically require material and labor lien releases by the borrower per completed phase of the project. We will review the appraisal of the value of the property and proposed improvements, and will generally finance up to 75% of the appraised value of the property and proposed improvements. Such appraisals have the same valuation limitations as raw and unimproved land loans, described above. As of December 31, 2006, approximately 17.87% of our loans were in this category.
Commercial Property Loans
Generally, 20% to 50% of the loans we invest in may be commercial property loans. Such loans provide funds to allow commercial borrowers to acquire income-producing property or to make improvements or renovations to the property in order to increase the net operating income of the property so that it may qualify for institutional refinancing. Generally, we review the property appraisal and generally invest in loans for up to 75% of such appraised value of the property. As of December 31, 2006, approximately 57.16% of our loans were in this category.
Residential Loans
A small percentage of the loans invested in by us may be residential loans. Such loans facilitate the purchase or refinance of one to four family residential property units provided the borrower uses one of the units on the property as such borrower’s principal residence. We will generally invest in loans for up to 75% of the value of the property. As of December 31, 2006, we did not have any loans in this category.
Collateral
The types of collateral that will secure the loans include first deeds of trust, second deeds of trust or a leasehold interest.
First Deed of Trust
Most of our loans are secured by first deeds of trust. Thus as a lender, we will have rights as a first priority lender of the collateralized property. As of December 31, 2006, approximately 98.91% of our loans were secured by first deeds of trust.
Second Deed of Trust
Up to 10% of our loans may be secured by second deeds of trust. In a second priority loan, the rights of the lender (such as the right to receive payment on foreclosure) will be subject to the rights of the first priority lender. In a wraparound loan, the lender’s rights will be comparably subject to the rights of a first priority lender, but the aggregate indebtedness evidenced by the loan documentation will be the first priority loan plus the new funds the lender invests. The lender would receive all payments from the borrower and forward to the senior lender its portion of the payments the lender receives. As of December 31, 2006, approximately 1.09% of our loans were secured by a second deed of trust.
Prepayment Penalties and Exit Fees
Generally, the loans we invest in will not contain prepayment penalties but may contain exit fees. If our loans are at a high rate of interest in a market of falling interest rates, the failure to have a prepayment penalty provision or exit fee in the loan allows the borrower to refinance the loan at a lower rate of interest, thus providing a lower yield to us on the reinvestment of the prepayment proceeds. However, these loans will usually be written with relatively high minimum interest rates, which we would expect to minimize the risk of lower yields. As of December 31, 2006, none of our loans had a prepayment penalty and ten of our loans had an exit fee.
Extensions to Term of Loan
Our original loan agreements generally permit extension to the term of the loan by mutual consent. Such extension is generally provided on loans where the original term was 12 months or less and where a borrower requires additional time to complete a construction project or negotiate take out financing. However, we only grant extensions when a borrower is in full compliance with the terms of the loan, including, but not limited to, the borrower’s obligation to make interest payments on the loan. As of December 31, 2006, approximately 27% of our loans had received an extension to terms of the loan.
Interest Reserves
We may invest in loans that include a commitment for an interest reserve, which is usually established at loan closing. The interest reserve may be advanced by us or other lenders with the amount of the borrower’s indebtedness increased by the amount of such advances. At December 31, 2006, we had approximately $71.5 million in investments in real estate loans that had interest reserves where the total outstanding principal due to us and our co-lenders was approximately $120.3 million. These loans had interest reserves of approximately $5.6 million, of which our portion was approximately $4.3 million.
Balloon Payment
As of December 31, 2006, all of our loans provided for payments of interest only with a “balloon” payment of principal payable in full at the end of the term, with the exception of two of our loans that have both principal and interest payments along with a “balloon” payment at the end of the term. As of December 31, 2006, these two loans had a balance of approximately $18.5 million and had terms ranging from twelve to thirty-six months. There are no specific criteria used in evaluating the credit quality of borrowers for real estate loans requiring balloon payments. Furthermore, a substantial period of time may elapse between the review of the financial statements of the borrower and the date when the balloon payment is due. As a result, there is no assurance that a borrower will have sufficient resources to make a balloon payment when due. To the extent that a borrower has an obligation to pay real estate loan principal in a large lump sum payment, its ability to repay the loan may be dependent upon its ability to sell the property, obtain suitable refinancing or otherwise raise a substantial amount of cash. As a result, these loans can involve a higher risk of default than loans where the principal is paid at the same time as the interest payments.
Repayment of Loans on Sale of Properties
We may require a borrower to repay a real estate loan upon the sale of the property rather than allow the buyer to assume the existing loan. We will require repayment if we determine that repayment appears to be advantageous to us based upon then-current interest rates, the length of time that the loan has been held by us, the creditworthiness of the buyer and our objectives.
Variable Rate Loans
Occasionally we may acquire variable rate loans. Variable rate loans originated by Vestin Originations may use as indices the one and five year Treasury Constant Maturity Index, the Prime Rate Index and the Monthly Weighted Average Cost of Funds Index for Eleventh District Savings Institutions (Federal Home Loan Bank Board). As of December 31, 2006, all of the loans in the real estate loans portfolio were fixed rate loans, with the exception of one loan with a variable interest rate. This loan has a term of 18 months, with a maturity date of December 30, 2007 and a balance of $18.0 million, of which our portion was approximately $12.9 million as of December 31, 2006. The interest rate on this loan started at 10.5% and increases every six months until it reaches the maximum interest rate of 11.5%.
It is possible that the interest rate index used in a variable rate loan will rise (or fall) more slowly than the interest rate of other loan investments available to us. Our manager and Vestin Originations attempt to minimize this interest rate differential by tying variable rate loans to indices that are sensitive to fluctuations in market rates. Additionally, most variable rate loans originated by Vestin Originations contain provisions under which the interest rate cannot fall below the initial rate.
Variable rate loans generally have interest rate caps. For these loans, there is the risk that the market rate may exceed the interest cap rate.
Borrowing
We may incur indebtedness to:
| · | Make distributions to enable us to comply with REIT distribution requirements; |
| · | Finance our investments in real estate loans; |
| · | Prevent a default under real estate loans that are senior to our real estate loans; |
| · | Discharge senior real estate loans if this becomes necessary to protect our investment in real estate loans; or |
| · | Operate or develop a property that we acquired under a defaulted loan. |
Our indebtedness will not exceed 70% of the fair market value of our real estate loans. This indebtedness may be with recourse to our assets.
In addition, we may enter into structured arrangements with other lenders in order to provide them with a senior position in real estate loans that we might jointly fund. For example, we might establish a wholly owned special purpose corporation that would borrow funds from an institutional lender under an arrangement where the resulting real estate loans would be assigned to a trust, and the trust would issue a senior certificate to the institutional lender and a junior certificate to the special purpose corporation. This would assure the institutional lender of repayment in full prior to our receipt of any repayment on the jointly funded real estate loans.
Competition
Generally, real estate developers depend upon the timely completion of a project to obtain a competitive advantage when selling their properties. We have sought to attract real estate developers by offering expedited loan processing, which generally provides quick loan approval and funding of a loan. As a result, we have established a market niche as a non-conventional real estate lender.
We consider our direct competitors to be the providers of real estate loans, that is non-conventional lenders who offer short-term, equity-based loans on an expedited basis for higher fees and rates than those charged by conventional lenders. In addition, we compete with conventional lenders such as commercial banks, insurance companies, mortgage brokers, pension funds and other institutional lenders. Many of the companies against which we compete have substantially greater financial, technical and other resources than either our company or our manager. Competition in our market niche depends upon a number of factors, including price and interest rates of the loan, speed of loan processing, cost of capital, reliability, quality of service and support services.
Regulation
We are managed by Vestin Mortgage, subject to the oversight of our board of directors, pursuant to the terms and conditions of our Management Agreement. Vestin Originations, an affiliate of Vestin Mortgage, operates as a mortgage broker and is subject to extensive regulation by federal, state and local laws and governmental authorities. Vestin Originations conducts its real estate loan business under a license issued by the State of Nevada Mortgage Lending Division. Under applicable Nevada law, the division has broad discretionary authority over Vestin Originations’ activities, including the authority to conduct periodic regulatory audits of all aspects of Vestin Originations’ operations.
We and Vestin Originations are also subject to the Equal Credit Opportunity Act of 1974, which prohibits creditors from discriminating against loan applicants on the basis of race, color, sex, age or marital status, and the Fair Credit Reporting Act of 1970, which requires lenders to supply applicants with the name and address of the reporting agency if the applicant is denied credit. We are also subject to various other federal and state securities laws regulating the issuance and sale of securities, as well as the Employee Retirement Income Security Act of 1974.
The NASAA Guidelines have been adopted by various state agencies charged with protecting the interest of the investors. Administrative fees, loan fees, and other compensation paid to our manager and its affiliates would be generally limited by the NASAA Guidelines. These guidelines also include certain investment procedures and criteria, which are required for new loan investments. We are not required to comply with NASAA Guidelines; however, we voluntarily do so unless a majority of our unaffiliated directors determine that it is in our best interest to diverge from NASAA Guidelines.
Because our business is regulated, the laws, rules and regulations applicable to us are subject to regular modification and change. There can be no assurance that laws, rules or regulations will not be adopted in the future that could make compliance much more difficult or expensive, restrict our ability to broker or service loans, further limit or restrict the amount of commissions, interest and other charges earned on loans brokered by us, or otherwise adversely affect our business or prospects.
Employees
We have no employees. Our manager (Vestin Mortgage), Vestin Originations and their parent company, Vestin Group, Inc., have provided and will continue to provide all of the employees necessary for our operations. As of December 31, 2006, those entities had a total of 23 full-time and no part-time employees. All employees are at-will employees and none are covered by collective bargaining agreements, except John Alderfer our manager’s CFO. Mr. Alderfer is a party to an employment, non-competition and confidentiality contract with Vestin Group, Inc., the parent company of our manager, through December 31, 2008.
Available Information
Our Internet website address is www.vestinrealtymortgage2.com. We make available free of charge through www.vestinrealtymortgage2.com our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports as soon as reasonably practical after such material is electronically filed with or furnished to the United States Securities and Exchange Commission (“SEC”). Information contained on our website does not constitute a part of this Report on Form 10-K.
In considering our future performance and any forward-looking statements made in this report, the material risks described below should be considered carefully. These factors should be considered in conjunction with the other information included elsewhere in this report.
RISKS RELATED TO OUR BUSINESS
We rely on our manager to manage our day-to-day operations and select our loans for investment.
Our ability to achieve our investment objectives and to make distributions depends upon our manager’s and its affiliate’s performance in obtaining, processing, making and brokering loans for us to invest in and determining the financing arrangements for borrowers. Stockholders have no opportunity to evaluate the financial information or creditworthiness of borrowers, the terms of mortgages, the real property that is our collateral or other economic or financial data concerning our loans. We pay our manager an annual management fee of up to 0.25% of our aggregate capital received by us and Fund II from the sale of shares or membership units. This fee is payable regardless of the performance of our loan portfolio. Our manager has no fiduciary obligations to our stockholders, is not required to devote its employees’ full time to our business and may devote time to business interests competitive to our business.
Our manager’s lack of experience with certain real estate markets could impact its ability to make prudent investments on our behalf.
As of December 31, 2006, our loans were in the following states: Arizona, California, Hawaii, Nevada, New York, Oklahoma, Oregon, Texas and Washington. Depending on the market and on our company’s performance, we plan to expand our investments throughout the United States. However, our manager has limited experience outside of the Western and Southern United States. Real estate markets vary greatly from location to location and the rights of secured real estate lenders vary considerably from state to state. Our manager’s limited experience in most U.S. real estate markets may impact its ability to make prudent investment decisions on our behalf. Accordingly, where our manager deems it necessary, it plans to utilize independent real estate advisors and local legal counsel located in markets where it lacks experience for consultation prior to making investment decisions. Stockholders will not have an opportunity to evaluate the qualifications of such advisors and no assurance can be given that they will render prudent advice to our manager.
Our success depends on key personnel of our manager, the loss of whom could adversely affect our operating results, and on our manager’s ability to attract and retain qualified personnel.
Our success depends in part upon the continued contributions of certain key personnel of our manager, including; Michael V. Shustek (Chief Executive Officer and President), John W. Alderfer (Chief Financial Officer), James M. Townsend (Chief Operating Officer), Daniel B. Stubbs (Senior Vice President, Underwriting), and Maria Rocio Revollo (Corporate Controller) some of whom would be difficult to replace because of their extensive experience in the field, extensive market contacts and familiarity with our company. If any of these key employees were to cease employment, our operating results could suffer. Mr. Alderfer is a party to an employment, non-competition and confidentiality contract with Vestin Group, Inc., the parent company of our manager, through December 31, 2008. None of the other key personnel of our manager is subject to an employment, non-competition or confidentiality agreement with our manager, or us and we do not maintain “key man” life insurance policies on any of them. Our future success also depends in large part upon our manager’s ability to hire and retain additional highly skilled managerial, operational and marketing personnel. Our manager may require additional operations and marketing people who are experienced in obtaining, processing, making and brokering loans and who also have contacts in the relevant markets. Competition for personnel is intense, and we cannot be assured that we will be successful in attracting and retaining skilled personnel. If our manager were unable to attract and retain key personnel, the ability of our manager to make prudent investment decisions on our behalf may be impaired.
Any borrowing by us will increase risk and may reduce the amount we have available to distribute to stockholders.
We may borrow funds to expand our capacity to invest in real estate loans. We may borrow up to 70% of the fair market value of our outstanding real estate loans at any time. Any such borrowings will require us to carefully manage our cost of funds. No assurance can be given that we will be successful in this effort. Should we be unable to repay the indebtedness and make the interest payments on the loans, the lender will likely declare us in default and require that we repay all amounts owing under the loan facility. Even if we are repaying the indebtedness in a timely manner, interest payments owing on the borrowed funds may reduce our income and the distributions.
We may borrow funds from several sources, and the terms of any indebtedness we incur may vary. However, some lenders may require as a condition of making a loan to us that the lender will receive a priority on loan repayments received by us. As a result, if we do not collect 100% on our investments, the first dollars may go to our lenders and we may incur a loss that will result in a decrease of the amount available for distribution. In addition, we may enter into securitization arrangements in order to raise additional funds. Such arrangements could increase our leverage and adversely affect our cash flow and our ability to make distributions. As of December 31, 2006, we had secured borrowings equal to approximately 6% of our net investment in real estate loans, as compared to secured borrowings equal to approximately 9% or our net investment in real estate loans as of December 31, 2005.
We may need cash to meet our minimum REIT distribution requirements and limit U.S. federal income taxation. Because we are required to distribute annually to our stockholders at least 90% of our REIT taxable income (determined without regard to the dividends paid deduction and by excluding net capital gains) to qualify as a REIT and because we intend to distribute substantially all of our REIT taxable income and net capital gain, our ability to expand our loan portfolio will depend in large part on external sources of capital. In addition, if our minimum distribution requirements to maintain our REIT status and minimize U.S. federal income taxation become large relative to our cash flow as a result of our taxable income exceeding our cash flow from operations, then we may be required to borrow funds or raise capital by selling assets to meet those distribution requirements. Any equity financing may result in substantial dilution to our stockholders, and any debt financing may include restrictive covenants. We may not be able to raise capital on reasonable terms, if at all.
Defaults on our real estate loans will decrease our revenues and distributions.
We are in the business of investing in real estate loans and, as such, we are subject to risk of defaults by borrowers. Our performance will be directly impacted by any defaults on the loans in our portfolio. As a non-conventional lender willing to invest in loans to borrowers who may not meet the credit standards of conventional lenders, the rate of default on our loans could be higher than those generally experienced in the real estate lending industry. Any sustained period of increased defaults could adversely affect our business, financial condition, liquidity and the results of our operations. We seek to mitigate the risk by estimating the value of the underlying collateral and insisting on adequate loan-to-value ratios. However, we cannot be assured that these efforts will fully protect us against losses on defaulted loans. Any subsequent decline in real estate values on defaulted loans could result in less security than anticipated at the time the loan was originally made, which may result in our not recovering the full amount of the loan. Any failure of a borrower to repay loans or interest on loans will reduce our revenues and distributions and the value of common stock. Our weighted average loan-to-value ratio, including loans related to seller financed real estate held for sale, as of December 31, 2006 was 69.97% as compared to 63.31% as of December 31, 2005. Our appraisals are generally dated within 12 months of the date of loan origination and may not reflect a decrease in the value of the real estate due to events subsequent to the date of the appraisals.
As of December 31, 2006, we had in our portfolio approximately $19.5 million in delinquent loans, net of allowance for loan losses, and approximately $30.1 million of real estate held for sale not sold through seller financed for a total of approximately $49.6 million in non-performing assets, which represented approximately 17.8% of our stockholders’ equity. As of December 31, 2006, we also had approximately $14.8 million of seller financed real estate held for sale and had received approximately $5.5 million in payments from borrowers on the loans associated with these properties. We do not believe that a rising interest rate environment will increase or accelerate our delinquency rate because all of our loans are short term.
Our underwriting standards and procedures are more lenient than conventional lenders, which may result in a higher level of non-performing assets and less amounts available for distribution.
Our underwriting standards and procedures are more lenient than conventional lenders in that we will invest in loans to borrowers who may not be required to meet the credit standards of conventional real estate lenders, which may lead to greater non-performing assets in our loan portfolio and create additional risks of return. We approve real estate loans more quickly than other lenders. We rely heavily on third-party reports and information such as appraisals and environmental reports. Because of our accelerated due diligence process, we may accept documentation that was not specifically prepared for us or commissioned by us. This creates a greater risk of the information contained therein being out of date or incorrect. Generally, we will not spend more than 20 days assessing the character and credit history of our borrowers. Due to the nature of loan approvals, there is a risk that the credit inquiry we perform will not reveal all material facts pertaining to the borrower and the security. There may be a greater risk of default by our borrowers, which may impair our ability to make timely distributions and which may reduce the amount we have available to distribute.
We depend upon our real estate security to secure our real estate loans, and we may suffer a loss if the value of the underlying property declines.
We depend upon our real estate security to protect us on the loans that we make. We depend upon the skill of independent appraisers to value the security underlying our loans. However, notwithstanding the experience of the appraisers, they may make mistakes, or the value of the real estate may decrease due to subsequent events. Our appraisals are generally dated within 12 months of the date of loan origination and may have been commissioned by the borrower. Therefore, the appraisals may not reflect a decrease in the value of the real estate due to events subsequent to the date of the appraisals. In addition, most of the appraisals are prepared on an as-if developed basis, which approximates the post-construction value of the collateralized property assuming such property is developed. As-if developed values on raw land loans or acquisition and development loans often dramatically exceed the immediate sales value and may include anticipated zoning changes and successful development by the purchaser upon which development is dependent on availability of financing. As most of the appraisals will be prepared on an as-if developed basis, if the loan goes into default prior to completion of the project, the market value of the property may be substantially less than the appraised value. As a result, there may be less security than anticipated at the time the loan was originally made. If there is less security and a default occurs, we may not recover the full amount of our loan, thus reducing the amount of funds available to distribute.
We typically make “balloon payment” loans, which are riskier than loans with payments of principal over an extended period of time.
The loans we invest in or purchase generally require the borrower to make a “balloon payment” on the principal amount upon maturity of the loan. A balloon payment is a large principal balance that is payable after a period of time during which the borrower has repaid none or only a small portion of the principal balance. As of December 31, 2006, all of our loans provided for payments of interest only with a “balloon” payment of principal payable in full at the end of the term, with the exception of two of our loans that have both principal and interest payments along with a “balloon” payment at the end of the term. Loans with balloon payments are riskier than loans with even payments of principal over an extended time period such as 15 or 30 years because the borrower’s repayment depends on its ability to sell the property profitably, obtain suitable refinancing or otherwise raise a substantial amount of cash when the loan comes due. There are no specific criteria used in evaluating the credit quality of borrowers for loans requiring balloon payments. Furthermore, a substantial period of time may elapse between the review of the financial statements of the borrower and the date when the balloon payment is due. As a result, there is no assurance that a borrower will have sufficient resources to make a balloon payment when due.
Our loans are not guaranteed by any governmental agency.
Our loans are not insured or guaranteed by a federally owned or guaranteed mortgage agency. Consequently, our recourse, if there is a default, may be to foreclose upon the real property securing a loan and/or pursuing the borrower’s guarantee of the principal. The value of the foreclosed property may have decreased and may not be equal to the amount outstanding under the corresponding loan, resulting in a decrease of the amount available to distribute.
Our real estate loans may not be marketable, and we expect no secondary market to develop.
We do not expect our real estate loans to be marketable, and we do not expect a secondary market to develop for them. As a result, we will generally bear all the risk of our investment until the loans mature. This will limit our ability to hedge our risk in changing real estate markets and may result in reduced returns to our investors.
We may have difficulty protecting our rights as a secured lender.
We believe that our loan documents will enable us to enforce our commercial arrangements with borrowers. However, the rights of borrowers and other secured lenders may limit our practical realization of those benefits. For example:
| · | Judicial foreclosure is subject to the delays of protracted litigation. Although we expect non-judicial foreclosure to be quicker, our collateral may deteriorate and decrease in value during any delay in foreclosing on it; |
| · | The borrower’s right of redemption during foreclosure proceedings can deter the sale of our collateral and can for practical purposes require us to manage the property; |
| · | Unforeseen environmental hazards may subject us to unexpected liability and procedural delays in exercising our rights; |
| · | The rights of senior or junior secured parties in the same property can create procedural hurdles for us when we foreclose on collateral; |
| · | Required licensing and regulatory approvals may complicate our ability to foreclose or to sell a foreclosed property where our collateral includes an operating business. We have recently experienced difficulties in foreclosing on the RightStar loans discussed in Item 3 Legal Proceedings to this report Form 10-K because of the need to obtain a license from the State of Hawaii to operate funeral homes and cemeteries; |
| · | We may not be able to pursue deficiency judgments after we foreclose on collateral; and |
| · | State and federal bankruptcy laws can prevent us from pursuing any actions, regardless of the progress in any of these suits or proceedings. |
By becoming the owner of property, we may incur additional obligations, which may reduce the amount of funds available for distribution.
We intend to own real property only if we foreclose on a defaulted loan and purchase the property at the foreclosure sale. Acquiring a property at a foreclosure sale may involve significant costs. If we foreclose on the security property, we expect to obtain the services of a real estate broker and pay the broker’s commission in connection with the sale of the property. We may incur substantial legal fees and court costs in acquiring a property through contested foreclosure and/or bankruptcy proceedings. In addition, significant expenditures, including property taxes, maintenance costs, mortgage payments, insurance costs and related charges, must be made on any property we own regardless of whether the property is producing any income.
Under applicable environmental laws, any owner of real property may be fully liable for the costs involved in cleaning up any contamination by materials hazardous to the environment. Even though we might be entitled to indemnification from the person that caused the contamination, there is no assurance that the responsible person would be able to indemnify us to the full extent of our liability. Furthermore, we would still have court and administrative expenses for which we may not be entitled to indemnification.
A prolonged economic slowdown, lengthy or severe recession or significant increase in interest rates could harm our business.
The risks associated with our business are more acute during periods of economic slowdown or recession because these periods can be accompanied by decreased demand for consumer credit and declining real estate values. As a non-conventional lender willing to invest in riskier loans, rates of delinquencies, foreclosures and losses on our loans could be higher than those generally experienced in the mortgage lending industry during periods of economic slowdown or recession. Furthermore, if interest rates were to increase significantly, the costs of borrowing may become too expensive, which may negatively impact the refinance market by reducing demand for real estate lending. For the twelve months ended December 31, 2006, loan originations accounted for all but one loan funded during that period as there was one loan refinanced during the period. Any sustained period of increased delinquencies, foreclosures or losses or a significant increase in interest rates could adversely affect our ability to originate, purchase and securitize loans, which could significantly harm our business, financial condition, liquidity and results of operations.
Our results are subject to fluctuations in interest rates and other economic conditions.
As of December 31, 2006, none of our loans had a prepayment penalty and ten loans had an exit fee. Based on our manager’s historical experience, we expect that our loans will continue to not have a prepayment penalty. Should interest rates decrease, our borrowers may prepay their outstanding loans with us in order to receive a more favorable rate. This may reduce the amount of funds we have available to distribute.
Our results of operations will vary with changes in interest rates and with the performance of the relevant real estate markets. If the economy is healthy, we expect that more people will be borrowing money to acquire, develop or renovate real property. However, if the economy grows too fast, interest rates may increase too much and the cost of borrowing may become too expensive. Alternatively, if the economy enters a recession, real estate development may slow. A slowdown in real estate lending may mean we will have fewer loans to acquire, thus reducing our revenues and the distributions.
One of the results of interest rate fluctuations is that borrowers may seek to extend their low-interest-rate loans after market interest rates have increased. This creates two risks for us:
| · | If interest rates rise, borrowers under loans with monthly or quarterly principal payments may be compelled to extend their loans to decrease the principal paid with each payment because the interest component has increased. If this happens, we are likely to be at a greater risk of the borrower defaulting on the extended loan, and the increase in the interest rate on our loan may not be adequate compensation for the increased risk. Additionally, any fees paid to extend the loan are paid to Vestin Originations, not to us. Our revenues and distributions will decline if we are unable to reinvest at higher rates or if an increasing number of borrowers default on their loans; and |
| · | If, at a time of relatively low interest rates, a borrower should prepay obligations that have a higher interest rate from an earlier period, we will likely not be able to reinvest the funds in real estate loans earning that higher rate of interest. In the absence of a prepayment fee, we will receive neither the anticipated revenue stream at the higher rate nor any compensation for its loss. This is a risk if the loans we invest in do not have prepayment penalties or exit fees. |
Our results will also reflect other economic conditions, such as a particular industry migrating to or from one of the states into which we make loans.
Legal actions seeking damages and appraisal rights could harm our operating results and financial condition.
We have recently been named in several legal actions seeking damages and appraisal rights in connection with the REIT conversion. See Item 3. Legal Proceedings below. While we believe these actions are without merit, the defense of such actions could materially increase our legal costs and may require the substantial attention of our management. This in turn might adversely impact our operating results. Moreover, any adverse outcome in such actions could result in our having to pay substantial damages which would reduce our cash resources and harm our financial condition.
We face competition for real estate loans that may reduce available yields and fees available.
We consider our direct competitors to be the providers of real estate loans, that is non-conventional lenders who offer short-term, equity-based loans on an expedited basis for higher fees and rates than those charged by conventional lenders. In addition, we compete with conventional lenders such as commercial banks, insurance companies, mortgage brokers, pension funds and other institutional lenders. Many of the companies against which we compete have substantially greater financial, technical and other resources than either our company or our manager. Competition in our market niche depends upon a number of factors, including price and interest rates of the loan, speed of loan processing, cost of capital, reliability, quality of service and support services. If our competition decreases interest rates on their loans or makes funds more easily accessible, yields on our loans could decrease and the costs associated with making loans could increase, both of which would reduce our revenues and the distributions.
Vestin Mortgage serves as our manager pursuant to a long-term management agreement that may be difficult to terminate and does not reflect arm’s length negotiations.
We have entered into a long-term management agreement with Vestin Mortgage to act as our manager. The term of the management agreement is for the duration of our existence. The management agreement may only be terminated upon the affirmative vote of a majority in interest of stockholders entitled to vote on the matter or by our board of directors for cause upon 90 days’ written notice of termination. Consequently, it may be difficult to terminate our management agreement and replace our manager in the event that our performance does not meet expectations or for other reasons unless the conditions for termination of the management agreement are satisfied. The management agreement was negotiated by related parties and may not reflect terms as favorable as those subject to arm’s length bargaining.
Our manager will face conflicts of interest concerning the allocation of its personnel’s time.
Our manager is also the manager of VRM I, Fund III and inVestin Nevada, companies with investment objectives similar to ours. Our manager and Mr. Shustek, who indirectly owns 100% of our manager, anticipate that they may also sponsor other real estate programs having investment objectives similar to ours. As a result, our manager and Mr. Shustek may have conflicts of interest in allocating their time and resources between our business and other activities. During times of intense activity in other programs and ventures, our manager and its key people will likely devote less time and resources to our business than they ordinarily would. Our management agreement with our manager does not specify a minimum amount of time and attention that our manager and its key people are required to devote to our company. Thus, our manager may not spend sufficient time managing our operations, which could result in our not meeting our investment objectives.
Our manager and its affiliates will face conflicts of interest arising from our fee structure.
Vestin Originations, an affiliate of our manager, will receive substantial fees from borrowers for transactions involving real estate loans. Many of these fees are paid on an up-front basis. In some cases, Vestin Originations is entitled to additional fees for loan extensions or modifications and loan assumptions and reconveyances. These and other fees are quantified and described in greater detail under “Management Agreement — Compensation.” Vestin Originations’ compensation is based on the volume and size of the real estate loans selected for us, regardless of their performance, which could create an incentive to make or extend riskier loans. Our interests may diverge from those of our manager, Vestin Originations and Mr. Shustek to the extent that Vestin Originations benefits from up-front fees that are not shared with us.
Vestin Originations will be receiving fees from borrowers that would otherwise increase our returns. Because Vestin Originations receives all of these fees, our interests will diverge from those of our manager, Vestin Originations and Mr. Shustek when our manager decides whether we should charge the borrower higher interest rates or our manager’ affiliates should receive higher fees from borrowers.
We paid our manager a total of approximately $1.1 million for the twelve months ended December 31, 2006 for managing us and Fund II. In addition, Vestin Mortgage and Vestin Originations received a total of approximately $8.5 million and $7.4 million, respectively in fees directly from borrowers for the twelve months ended December 31, 2006. The amounts received from borrowers represent fees earned by Vestin Mortgage and Vestin Originations for loans originated for all funds managed by Vestin Mortgage, including us, VRM I, Fund III and inVestin Nevada. Our assets represented approximately 70% of the assets managed by Vestin Mortgage as of December 31, 2006.
Our manager will face conflicts of interest relating to other investments in real estate loans.
We expect to invest in real estate loans when one or more other companies managed by our manager are also investing in real estate loans. There is a risk that our manager may select for us a real estate loan investment that provides lower returns than a real estate loan investment purchased by another program or entity managed by our manager. Our manager also serves as the manager for VRM I, Fund III and inVestin Nevada, which have the same investment objectives as our company. There are no restrictions or guidelines on how our manager will determine which loans are appropriate for us and which are appropriate for VRM I, Fund III, inVestin Nevada or another company that our manager manages. Moreover, our manager has no obligation to provide us with any particular opportunities or even a pro rata share of opportunities afforded to other companies it manages.
UNITED STATES FEDERAL INCOME TAX RISKS RELATING TO OUR REIT QUALIFICATION
Our failure to qualify as a REIT would subject us to U.S. federal income tax, which would reduce amounts available for distribution to our stockholders.
We have elected to be taxed as a REIT under the Code. Our qualification as a REIT requires us to satisfy numerous requirements (some on an annual and quarterly basis) established under highly technical and complex Code provisions for which there are only limited judicial or administrative interpretations, and involves the determination of various factual matters and circumstances not entirely within our control. We intend that our organization and method of operation will enable us to qualify as a REIT, but we may not so qualify or we may not be able to remain so qualified in the future. Future legislation, new regulations, administrative interpretations or court decisions could adversely affect our ability to qualify as a REIT or adversely affect our stockholders.
If we fail to qualify as a REIT in any taxable year, we would be subject to U.S. federal income tax (including any applicable alternative minimum tax) on our taxable income at corporate rates, and we would not be allowed to deduct distributions made to our stockholders in computing our taxable income. We may also be disqualified from treatment as a REIT for the four taxable years following the year in which we failed to qualify. The additional tax liability would reduce our net earnings available for investment or distribution to stockholders. In addition, we would no longer be required to make distributions to our stockholders. Even if we continue to qualify as a REIT, we will continue to be subject to certain U.S. federal, state and local taxes on our income and property.
Distributions from a REIT are currently taxed at a higher rate than corporate distributions.
Under the Tax Relief and Reconciliation Act of 2003, the maximum U.S. federal income tax rate on both distributions from certain domestic and foreign corporations and net long-term capital gain for individuals was reduced to 15% until 2008. The Tax Increase Prevention and Reconciliation Act of 2005, which signed into law on May 17, 2006, extended the 15% long-term net capital gain rate to 2010. However, this reduced rate of tax on distributions generally will not apply to our distributions (except those distributions identified by the company as “capital gain dividends” which are taxable as long-term capital gain) and therefore such distributions generally will be taxed as ordinary income. Ordinary income generally is subject to U.S. federal income tax rate at a rate of up to 35% for individuals. The higher tax rate on our distributions may cause the market to devalue our common stock relative to stock of those corporations whose distributions qualify for the lower rate of taxation. Please note that, as a general matter, distributions from a REIT will be taxed at the same rate as stockholders’ share of Vestin Realty Mortgage II’s taxable income attributable to its realized net interest income.
A portion of our business is potentially subject to prohibited transactions tax.
As a REIT, we are subject to a 100% tax on our net income from “prohibited transactions.” In general, prohibited transactions are sales or other dispositions of property to customers in the ordinary course of business. Sales by us of property in the course of our business will generally constitute prohibited transactions.
We intend to avoid the 100% prohibited transactions tax on property foreclosed upon by Fund II prior to the REIT conversion by holding and selling such properties through one or more wholly-owned taxable REIT subsidiaries. However, under the Code, no more than 20% of the value of the assets of a REIT may be represented by securities of one or more taxable REIT subsidiaries and a taxable REIT subsidiary generally cannot operate a lodging or health care facility.
As of December 31, 2006, we held two properties with a total carrying value of approximately $30.1 million recorded as investments in real estate held for sale. As of December 31, 2006, we also held interests in two properties with a total carrying value of approximately $14.8 million, which were sold in transactions in which we or an affiliate provided the financing and which were recorded as seller financed real estate held for sale. United States generally accepted accounting principals (“GAAP”) requires us to include these properties in real estate held for sale until the borrower has met and maintained certain requirements. The real estate held for sale and the seller financed real estate held for sale collectively constituted approximately 14.8% of our assets as of December 31, 2006. In addition, both of the seller financed real estate held for sale properties are assisted living facilities, which cannot be operated by a taxable REIT subsidiary.
Taxable REIT subsidiaries are subject to corporate-level tax, which may devalue our common stock relative to other companies.
Taxable REIT subsidiaries are corporations subject to corporate-level tax. Our use of taxable REIT subsidiaries may cause the market to value its common stock lower than the stock of other publicly traded REITs which may not use taxable REIT subsidiaries and lower than the equity of mortgage pools taxable as non-publicly traded partnerships such as Fund II’s intended qualification prior to the REIT conversion, which generally are not subject to any U.S. federal income taxation on their income and gain.
Our use of taxable REIT subsidiaries may have adverse U.S. federal income tax consequences.
We must comply with various tests to continue to qualify as a REIT for U.S. federal income tax purposes, and our income from and investments in taxable REIT subsidiaries generally do not constitute permissible income and investments for purposes of the REIT qualification tests. While we will attempt to ensure that our dealings with our taxable REIT subsidiaries will not adversely affect our REIT qualification, we cannot be assured that we will successfully achieve that result. Furthermore, we may be subject to a 100% penalty tax, or our taxable REIT subsidiaries may be denied deductions, to the extent our dealings with our taxable REIT subsidiaries are not deemed to be arm’s length in nature.
We may endanger our REIT status if the distributions we receive from our taxable REIT subsidiaries exceed applicable REIT gross income tests.
The annual gross income tests that must be satisfied to ensure REIT qualification may limit the amount of distributions that we can receive from our taxable REIT subsidiaries and still maintain our REIT status. Generally, not more than 25% of our gross income can be derived from non-real estate related sources, such as distributions from a taxable REIT subsidiary. If, for any taxable year, the distributions we received from our taxable REIT subsidiaries, when added to our other items of non-real estate related income, represent more than 25% of our total gross income for the year, we could be denied REIT status, unless we were able to demonstrate, among other things, that our failure of the gross income test was due to reasonable cause and not willful neglect.
We may lose our REIT status if we issue shares under our stockholders’ rights plan.
Under Section 562(c) of the Code, a REIT generally cannot make a distribution unless the distribution is pro rata, with no preference to any share of stock as compared to other shares of the same class of stock. A REIT that is not in compliance with this requirement may lose its REIT status. Under our stockholders’ rights plan, upon certain events, some holders of our common stock and not others will have the right to acquire shares of Series A preferred stock. When effective, this right could be treated as a deemed distribution to those holders of our common stock entitled to the right with no distribution to other such holders. Thus, this right, when effective, could be treated as a distribution that is not consistent with the requirements of Section 562(c) of the Code, which could result in the loss of our REIT qualification.
RISK OF OWNERSHIP OF OUR COMMON STOCK
The market price and trading volume of our common stock may be volatile.
The market price of our common stock since trading commenced on May 1, 2006 to December 31, 2006 has ranged from $0.77 to $5.76 (adjusted for the 30% stock dividend paid in December 2006). We believe the price of our stock has been affected by, among other things, selling pressure from stockholders seeking immediate liquidity and the level of non-performing assets, which we own. Our stock price may be highly volatile and subject to wide fluctuations. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. Our Company will be dissolved on December 31, 2020 unless the holders of a majority of our common stock determine otherwise. As we move closer to the dissolution date, we expect to stop making new loans and we expect that our stock price will approach our book value per share.
We cannot be assured that the market price of our common stock will not fluctuate or decline significantly in the future. Some of the factors, many of which are beyond our control, that could negatively affect our stock price or result in fluctuations in the price or trading volume of our common stock include:
| · | increases in loans defaulting or becoming non-performing or being written off; |
| · | actual or anticipated variations in our quarterly operating results or distributions; |
| · | publication of research reports about us or the real estate industry; |
| · | changes in market valuations of similar companies; |
| · | changes in tax laws affecting REITs; |
| · | adverse market reaction to any increased indebtedness we incur in the future; and |
| · | general market and economic conditions. |
Market interest rates could have an adverse effect on our stock price.
One of the factors that will influence the price of our common stock will be the dividend yield on our common stock (as a percentage of the price of our common stock) relative to market interest rates. Thus, an increase in market interest rates may lead prospective purchasers of our common stock to expect a higher dividend yield, a lack of which could adversely affect the market price of our common stock.
We are the subject of shareholder litigation which may depress the price of our stock.
A number of lawsuits have been filed against us by shareholders who claim, among other things, that they were improperly denied dissenter’s rights in connection with the conversion of Fund II into a REIT. We believe the suits are without merit and we intend to vigorously defend against such claims. Nonetheless, the outcome of the lawsuits cannot be predicted at this time, nor can a meaningful evaluation be made of the potential impact upon us if the plaintiffs were to prevail in their claims. The resulting uncertainty may depress the price of our stock. Moreover, concerns about the potential diversion of our manager’s time to deal with these lawsuits may have an adverse effect upon the price of our stock.
Our charter documents and Maryland law contain provisions that may delay, defer or prevent a change of control transaction.
Our charter and bylaws and Maryland corporate law contain a number of provisions (as further described in exhibit 3.2 Bylaws of the Registrant under the Exhibit Index included in Part IV, Item 15 Exhibits and Financial Statement Schedules of this Report Form 10-K) that could delay, defer or prevent a transaction or a change in control of us that might involve a premium price for holders of our common stock or otherwise be in their best interests, including:
| · | Ownership Limit. Our articles of incorporation, subject to certain exceptions, authorizes our board of directors to take such actions as are necessary and desirable to preserve our qualification as a REIT and to limit any person to actual or constructive ownership of no more than a 9.8% of the number or value, whichever is more restrictive, of the outstanding shares of our stock, unless our board of directors waives this ownership limit. However, our board of directors may not grant a waiver of the ownership limit that would permit a person to acquire more than 15% of our stock without exception. The ownership limit may have the effect of precluding a change in control of us by a third party, even if such change in control would be in the interest of the our stockholders (and even if such change in control would not reasonably jeopardize our REIT status). |
| · | Staggered Board. Our board of directors is divided into three classes, with each class serving staggered three-year terms. This classification of our board of directors may have the effect of delaying or preventing changes in our control or management. |
| · | Removal of Directors. Directors may be removed only for cause and only by the affirmative vote of stockholders holding at least a majority of the shares then outstanding and entitled to be cast for the election of directors. |
| · | Stockholders’ Rights Plan. We have a stockholders’ rights plan that enables our board of directors to deter coercive or unfair takeover tactics and to prevent a person or a group from gaining control of us without offering a fair price to all stockholders. Unless our board of directors approves the person’s or group’s purchase, after that person gains control of us, all other stockholders will have the right to purchase securities from us at a price that is less than their then fair market value. Purchases by other stockholders would substantially reduce the value and influence of the shares of our common stock owned by the acquiring person or group. Our board of directors, however, can prevent the stockholders’ rights plan from operating in this manner. This gives our board of directors’ significant discretion to approve or disapprove a person’s or group’s efforts to acquire a large interest in us. |
| · | Duties of Directors with Respect to Unsolicited Takeovers. Under Maryland law, a director is required to perform his or her duties (a) in good faith, (b) in a manner he or she believes to be in the best interests of the corporation and (c) with the care that an ordinarily prudent person in a like position would use under similar circumstances. Maryland law provides protection for Maryland corporations against unsolicited takeovers by, among other things, retaining the same standard of care in the performance of the duties of directors in unsolicited takeover situations. The duties of directors of Maryland corporations do not require them to (a) accept, recommend or respond to any proposal by a person seeking to acquire control of the corporation, (b) authorize the corporation to redeem any rights under, or modify or render inapplicable, any stockholders rights plan, (c) make a determination under Maryland Business Combination Act or Maryland Control Share Acquisition Act or (d) act or fail to act solely because of the effect of the act or failure to act may have on an acquisition or potential acquisition of control of the corporation or the amount or type of consideration that may be offered or paid to the stockholders in an acquisition. Moreover, under Maryland law the act of the directors of a Maryland corporation relating to or affecting an acquisition or potential acquisition of control is not subject to any higher duty or greater scrutiny than is applied to any other act of a director. Maryland law also contains a statutory presumption that an act of a director of a Maryland corporation satisfies the applicable standards of conduct for directors under Maryland law. |
| · | Maryland General Corporation Law. Certain provisions of the MGCL may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change of control under circumstances that otherwise could provide the holders of shares of our common stock with the opportunity to realize a premium over the then-prevailing market price of such shares, including: |
| · | “business combination” provisions that, subject to limitations, prohibit certain business combinations between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of the voting power of our shares or an affiliate or associate of ours who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of our then outstanding voting shares) or an affiliate thereof for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter imposes special appraisal rights and special stockholder voting requirements on these combinations; and |
| · | “control share” provisions that provide that “control shares” of our company (defined as shares which, when aggregated with other shares controlled by the stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares. |
We have opted out of the control share provisions of the MGCL pursuant to a provision in our bylaws. However, our board of directors may by amendment to our bylaws opt in to the control share provisions of the MGCL in the future.
| · | Advance Notice of Director Nominations and Stockholder Proposals. Our bylaws impose certain advance notice requirements that must be met for nominations of persons for election to the board of directors and the proposal of business to be considered by stockholders. |
Our rights and the rights of our stockholders to take action against our directors and officers are limited.
Maryland law provides that a director has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. Our charter limits the liability of our directors and officers to us and our stockholders for money damages, except for liability resulting from:
| · | actual receipt of an improper benefit or profit in money, property or services; or |
| · | a final judgment based upon a finding of active and deliberate dishonesty by the director or officer that was material to the cause of action adjudicated. |
In addition, our articles of incorporation authorize us to obligate our company, and our bylaws require us, to indemnify our directors and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist under common law. Accordingly, in the event that actions taken in good faith by any of our directors or officers impede the performance of our company, stockholders’ ability to recover damages from such director or officer will be limited.
None.
Our manager, Vestin Mortgage, operates from its executive offices at 8379 West Sunset Road, Las Vegas, Nevada 89113. We do not have any separate offices.
Our manager shares office facilities of approximately 42,000 square feet with its parent corporation, Vestin Group, which in turn leases its principal executive offices from an unrelated third party. The lease agreement governing this property expires in March 2014. The building was previously owned by Fund III and subsequently was sold to an unrelated third party during November 2006.
Legal Matters Involving Our Manager
The United States Securities and Exchange Commission (the “Commission”), conducted an investigation of certain matters related to us, our manager, Vestin Capital, VRM I and Fund III. We fully cooperated during the course of the investigation. On September 27, 2006, the investigation was resolved through the entry of an Administrative Order by the Commission (the “Order”). Our manager, Vestin Mortgage and its Chief Executive Officer, Michael Shustek, as well as Vestin Capital (collectively, the “Respondents”), consented to the entry of the Order without admitting or denying the findings therein. In the Order, the Commission finds that the Respondents violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 through the use of certain slide presentations in connection with the sale of units in Fund III and in our predecessor, Vestin Fund II, LLC. The Respondents consented to the entry of a cease and desist order, the payment by Mr. Shustek of a fine of $100,000 and Mr. Shustek’s suspension from association with any broker or dealer for a period of six months, which expires in March 2007. In addition, the Respondents agreed to implement certain undertakings with respect to future sales of securities. We are not a party to the Order and we do not expect that the sanctions imposed upon the Respondents will have any material affect upon our operations.
Vestin Group, Vestin Mortgage, and Del Mar Mortgage, Inc., a company wholly owned by Michael V. Shustek, the sole stockholder and CEO of Vestin Group, are defendants in a civil action entitled Desert Land, LLC et al. v. Owens Financial Group, Inc. et al (the “Action”). The Action is based upon allegations that Del Mar Mortgage, Inc. and/or Vestin Mortgage charged unlawful fees on various loans arranged by them in 1999, prior to the formation of Vestin Fund II, LLC. Desert Land sought in excess of $10 million in monetary damages. On April 10, 2003, the United States District Court for the District of Nevada (the “Court”) entered judgment jointly and severally in favor of Desert Land against Vestin Group, Vestin Mortgage and Del Mar Mortgage, Inc. Judgment was predicated upon the Court’s finding that Del Mar Mortgage, Inc. received an unlawful penalty fee from the plaintiffs.
The defendants subsequently filed a motion for reconsideration. The Court denied the motion and, on August 13, 2003, held that Vestin Group, Vestin Mortgage, and Del Mar Mortgage, Inc. were jointly and severally liable for the judgment in the amount of $5,683,312 (which amount includes prejudgment interest and attorney’s fees). On August 27, 2003, the Court stayed execution of the judgment against Vestin Group and Vestin Mortgage based upon the posting of a bond in the amount of $5,830,000. Mr. Shustek personally posted a cash bond without any cost or obligation to Vestin Group and Vestin Mortgage. Additionally, Del Mar Mortgage, Inc. had indemnified Vestin Group and Vestin Mortgage for any losses and expenses in connection with the Action, and Mr. Shustek had guaranteed the indemnification with his cash bond. On September 12, 2003, all of the defendants held liable to Desert Land appealed the judgment to the United States Court of Appeals for the Ninth Circuit, which heard the case on October 18, 2005. On November 15, 2005, the Ninth Circuit vacated the judgment of the District Court and dismissed the state law claims against the defendants without prejudice on the basis that the District Court lacked subject matter jurisdiction in the case. On November 29, 2005, Desert Land petitioned the Ninth Circuit Court for rehearing with a suggestion that the matter be heard en banc. On December 16, 2005, the District Court issued an Order releasing the bond, and on January 6, 2006, the Ninth Circuit denied Desert Land’s petition and the matter remains dismissed.
On or about April 6, 2006, Desert Land filed a Writ of Certiorari seeking review of the 9th Circuit’s decision by the United States Supreme Court. The U.S. Supreme Court denied Desert Land’s Writ of Certiorari on June 12, 2006, effectively ending this action.
On November 21, 2005, Desert Land filed a complaint in the state courts of Nevada, which complaint is substantially similar to the original complaint previously filed by Desert Land in the United States District Court, with the exception of claiming Nevada State Law violations and seeking Nevada State Law remedies rather than claiming Federal Law violations and seeking Federal Law remedies. On March 6, 2006, Desert Land amended the state court complaint to name VRM I. Desert Land alleges that one or more of the defendants have transferred assets to other entities without receiving reasonable value therefore; alleges plaintiffs are informed and believe that defendants have made such transfers with the actual intent to hinder, delay or defraud Desert Land; that such transfers made the transferor insolvent and that sometime between February 27 and April 1, 2003, Vestin Group transferred $1.6 million to VRM I for that purpose. The state court complaint further alleges that Desert Land is entitled to avoid such transfers and that pursuant to NRS 112.20, Desert Land is entitled to an injunction to enjoin defendants from further disposition of assets. Additionally, Del Mar Mortgage, Inc. has indemnified Vestin Group and Vestin Mortgage for any losses and expenses in connection with the Action, and Mr. Shustek has guaranteed the indemnification. The Defendants believe that the allegations are without merit and that they have adequate defenses. The Defendants intend to undertake a vigorous defense.
VRM I and Vestin Mortgage, Inc. (“Defendants”) are defendants in a breach of contract action filed in San Diego Superior Court by certain plaintiffs who allege, among other things, that they were wrongfully denied appraisal rights in connection with the merger of Fund I into Vestin Realty Mortgage I, Inc. The action has been removed to the United States District Court for the Southern District of California, but the Company has agreed to stipulate to remand this action to San Diego Superior Court. The action is being brought as a purported class action on behalf of all members of Vestin Fund I who did not vote in favor of the merger. The Defendants believe that the allegations are without merit and that they have adequate defenses. The Defendants intend to undertake a vigorous defense. The terms of our management agreement and Fund I’s Operating Agreement contain indemnity provisions whereby, Vestin Mortgage and Michael V. Shustek may be eligible for indemnification by the Company with respect to the above actions.
In addition to the matters described above, our manager is involved in a number of legal proceedings concerning matters arising in connection with the conduct of its business activities. Our manager believes it has meritorious defenses to each of these actions and intends to defend them vigorously. Other than the matters described above, our manager believes that it is not a party to any pending legal or arbitration proceedings that would have a material adverse effect on our manager’s financial condition or results of operations or cash flows, although it is possible that the outcome of any such proceedings could have a material impact on our manager’s net income in any particular period.
Legal Matters Involving the Company
In April 2006, the lenders filed suit against the State of Hawaii listing 26 causes of action, including allegations that the State of Hawaii has illegally blocked the lender’s right to foreclose and take title to its collateral by inappropriately attaching conditions to the granting of licenses needed to operate the business, the pre-need trust funds and the perpetual care trust funds and that the State of Hawaii has attempted to force the lenders to accept liability for any statutory trust fund deficits while no such lender liability exists under the laws of the State of Hawaii. The State of Hawaii responded by filing allegations against Vestin Mortgage, Inc. and us alleging that these Vestin entities improperly influenced the former RightStar trustees to transfer trust funds to us. We believe the State’s claims to be without merit and intend to vigorously pursue our remedies while defending against any allegations made by the State.
In October 2006, a Judge of the Circuit Court of the First Circuit in Hawaii imposed new restrictions upon our right to foreclose and denied any subsequent owner the licensing necessary to operate the funeral service until the alleged pre-need and perpetual care trust funds shortages are cured. We believe these restrictions are both unauthorized under state law and unconstitutional under federal law. In January 2007, the Lenders filed a petition with the Supreme Court of Hawaii seeking mandamus relief from that ruling. As of March 9, 2007, the Supreme Court of Hawaii has not ruled on the lender’s petition, but has requested briefing from the State of Hawaii regarding the petition. The outcome of this litigation is unforeseeable at this time. We cannot estimate when the foreclosure will ultimately be completed or when the lenders may obtain title to the underlying properties.
We, Vestin Mortgage, Inc. and Michael V. Shustek (“Defendants”) are defendants in a civil action filed by 88 separate plaintiffs (“Plaintiffs”) in Superior Court for Clark County, Nevada. The Plaintiffs allege, among other things, that Defendants: breached certain alleged contractual obligations owed to Plaintiffs; breached fiduciary duties supposedly owed to Plaintiffs; and misrepresented or omitted material facts regarding the conversion of Fund II into VRM II. The Action seeks monetary damages and a rescission of the REIT conversion. The Defendants believe that the allegations are without merit and that they have adequate defenses. The Defendants intend to undertake a vigorous defense. The terms of our management agreement and Fund II’s operating agreement contain indemnity provisions whereby, Vestin Mortgage and Michael V. Shustek may be eligible for indemnification by the Company with respect to the above actions.
We and Vestin Mortgage, Inc. (“Defendants”) are defendants in a breach of contract action filed in San Diego Superior Court by certain plaintiffs who allege, among other things, that they were wrongfully denied appraisal rights in connection with the merger of Fund II into Vestin Realty Mortgage II, Inc. The action is being brought as a purported class action on behalf of all members of Vestin Fund II who did not vote in favor of the merger. The Defendants believe that the allegations are without merit and that they have adequate defenses. The Defendants intend to undertake a vigorous defense. The terms of our management agreement and Fund II’s Operating Agreement contain indemnity provisions whereby, Vestin Mortgage and Michael V. Shustek may be eligible for indemnification by the Company with respect to the above actions.
In addition to the matters described above, we are involved in a number of other legal proceedings concerning matters arising in connection with the conduct of our business activities. We believe we have meritorious defenses to each of these actions and intend to defend them vigorously. Other than the matters described above, we believe that we are not a party to any pending legal or arbitration proceedings that would have a material adverse effect on our financial condition or results of operations or cash flows, although it is possible that the outcome of any such proceedings could have a material impact on our net income in any particular period.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
Our common stock is traded on the Nasdaq National Market under the symbol VRTB and began trading on May 1, 2006. The price per share of common stock presented below represents the highest and lowest sales price for our common stock on the Nasdaq National Market during each quarter since it began trading, as adjusted for the 30% stock dividend issued on December 15, 2006.
2006 | | High | | Low | |
| | | | | | |
| First Quarter | | $ | N/A | | $ | N/A | |
| Second Quarter | | $ | 5.38 | | $ | 0.77 | |
| Third Quarter | | $ | 5.76 | | $ | 3.47 | |
| Fourth Quarter | | $ | 5.57 | | $ | 5.13 | |
On December 15, 2006, a 30% stock dividend was issued to shareholders on record as of November 30, 2006, effectively increasing the outstanding common shares from 29,870,943 to 38,832,402. All share, per share, membership unit and per membership unit information in this Report has been retroactively adjusted to reflect the stock dividend.
On December 18, 2006, our Board of Directors declared a cash dividend of $0.105 per common share for the months ended November 30, 2006 and December 31, 2006 combined. The dividend was paid on January 26, 2007 to shareholders of record as of December 31, 2006.
On January 22, 2007, our Board of Directors declared a cash dividend of $0.05 per common share for the month ended January 31, 2007, payable on February 26, 2007 to shareholders of record as of February 8, 2007.
On February 20, 2007, our Board of Directors declared a cash dividend of $0.05 per common share for the month ended February 28, 2007, payable on March 26, 2007 to shareholders of record as of March 9, 2007.
On March 7, 2007, the common stock closed at $5.26 per share.
Holders
As of March 7, 2007, 1,926 accounts held 38,862,128 of our common shares.
Dividend Policy
In order to maintain its qualification as a REIT under the Code, we are required to distribute (within a certain period after the end of each year) at least 90% of our REIT taxable income for such year (determined without regard to the distributions made deduction and by excluding net capital gain). We currently intend, to the extent practicable, to distribute substantially all of our REIT taxable income and net capital gain each year. We may distribute an amount in excess of our REIT taxable income, which amount will be treated as a return of capital to the shareholder. We anticipate that distributions generally will be paid from cash available for distribution (generally equal to cash from operations other than repayments of mortgage loan principal less an amount set aside for creation or restoration of reserves during the quarter). However, the actual amount and timing of the dividends will be as determined and declared by our board of directors and will depend on our financial condition, earnings and other factors. In August 2006, our Board of Directors voted to authorize a Dividend Declaration Policy that allows, at the Company’s discretion, for dividends to be declared monthly instead of quarterly. Cash distributions per membership unit and dividends declared per share for the twelve months ended December 31, 2006 are listed below:
| | | Distributions During: | Cash Distribution to Members Per Membership Unit |
| | | January 2006 | $0.04 |
| | | February 2006 | $0.04 |
| | | March 2006 | $0.08 |
| | | | |
| Total Cash Distributions to Members During Three Months Ended March 31, 2006 | $0.16 |
| | | | |
| | | | |
Date of Declaration | Record Date | Date Paid | Dividend Per Share |
| *July 27, 2006 | August 7, 2006 | August 21, 2006 | $0.123 |
| *August 25, 2006 | September 12, 2006 | September 27, 2006 | $0.046 |
| *September 25, 2006 | October 12, 2006 | October 27, 2006 | $0.046 |
| *October 24, 2006 | November 13, 2006 | November 29, 2006 | $0.050 |
| November 22, 2006 | December 11, 2006 | December 27, 2006 | $0.050 |
| December 18, 2006 | December 31, 2006 | January 26, 2007 | $0.105 |
| | | | |
| Total Dividends Declared During the Nine Months Ended December 31, 2006 | $0.420 |
| | | | |
| Dividends Declared Per Common Share / Cash Distributions to Members Per Membership Unit for The Twelve Months Ended December 31, 2006 | $0.58 |
* The dividend per share prices have been adjusted to reflect the 30% stock dividend paid on December 15, 2006.
Recent Sales of Unregistered Securities
None.
Equity Compensation Plan Information
None.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None.
| | | Balance at | |
Vestin Realty Mortgage II, Inc. | | 12/31/2006 | | 12/31/2005 | | 12/31/2004 | | 6/30/2005 | | 6/30/2004 | | 6/30/2003 | |
| | | | | | | (Unaudited) | | | | | | | |
| Balance Sheet Data: | | | | | | | | | | | | | |
| Investments in real estate loans (net of allowance) | | $ | 221,849,000 | | $ | 227,875,000 | | $ | 222,716,000 | | $ | 217,553,000 | | $ | 303,853,000 | | $ | 338,681,000 | |
| Cash, cash equivalents, certificates of deposits and short-term investments | | | 19,178,000 | | | 47,893,000 | | | 78,690,000 | | | 11,566,000 | | | 14,362,000 | | | 16,816,000 | |
| Interest and other receivables | | | 2,709,000 | | | 3,079,000 | | | 2,495,000 | | | 3,234,000 | | | 4,224,000 | | | 3,898,000 | |
| Investment in Local Agency Bonds | | | -- | | | -- | | | -- | | | 15,701,000 | | | -- | | | -- | |
| Due from Manager | | | -- | | | 325,000 | | | | | | -- | | | -- | | | -- | |
| Due from VRM I | | | -- | | | -- | | | 1,504,000 | | | 1,560,000 | | | 2,987,000 | | | 216,000 | |
| Due from Vestin Originations | | | 31,000 | | | -- | | | -- | | | -- | | | -- | | | -- | |
| Real estate held for sale | | | 30,079,000 | | | 38,639,000 | | | 39,805,000 | | | 51,215,000 | | | 28,264,000 | | | 13,696,000 | |
| Real estate held for sale-seller financed | | | 14,774,000 | | | 22,887,000 | | | 13,131,000 | | | 12,631,000 | | | 5,708,000 | | | 2,137,000 | |
| Note receivable | | | 282,000 | | | 810,000 | | | 328,000 | | | 328,000 | | | -- | | | -- | |
| Note receivable form Manager | | | -- | | | -- | | | 1,000,000 | | | -- | | | -- | | | -- | |
| Note receivable VRM I | | | -- | | | -- | | | -- | | | -- | | | 4,278,000 | | | 4,599,000 | |
| Assets under secured borrowing | | | 13,796,000 | | | 19,754,000 | | | 25,689,000 | | | 25,655,000 | | | 61,924,000 | | | 26,730,000 | |
| Other assets | | | 344,000 | | | 687,000 | | | -- | | | 27,000 | | | -- | | | -- | |
| Total assets | | $ | 303,042,000 | | $ | 361,949,000 | | $ | 385,358,000 | | $ | 339,470,000 | | $ | 425,600,000 | | $ | 406,773,000 | |
| Liabilities | | | 24,556,000 | | | 46,809,000 | | | 28,316,000 | | | 28,390,000 | | | 64,531,000 | | | 31,583,000 | |
| Stockholders' equity | | | 278,486,000 | | | -- | | | -- | | | -- | | | -- | | | -- | |
| Members’ equity | | | -- | | | 315,140,000 | | | 357,042,000 | | | 311,080,000 | | | 361,069,000 | | | 375,190,000 | |
| Total liabilities and stockholders' / members’ equity | | $ | 303,042,000 | | $ | 361,949,000 | | $ | 385,358,000 | | $ | 339,470,000 | | $ | 425,600,000 | | $ | 406,773,000 | |
| | | For the Twelve Months Ended | | For the Six Months Ended | | For the Six Months Ended | | For the Year Ended | |
| | | 12/31/2006 | | 12/31/2005 | | 12/31/2004 | | 6/30/2005 | | 6/30/2004 | | 6/30/2003 | |
| | | | | | | (Unaudited) | | | | | | | |
| Income Statement Data: | | | | | | | | | | | | | |
| Revenues | | $ | 23,479,000 | | | 12,228,000 | | $ | 16,199,000 | | $ | 27,958,000 | | $ | 41,136,000 | | $ | 40,313,000 | |
| Operating expenses | | | 10,624,000 | | | 1,514,000 | | | 3,410,000 | | | 8,730,000 | | | 10,169,000 | | | 14,468,000 | |
| Income (loss) from real estate held for sale | | | 2,996,000 | | | (170,000 | ) | | (903,000 | ) | | (10,340,000 | ) | | 764,000 | | | (2,073,000 | ) |
| | | | | | | | | | | | | | | | | | | | |
| Income before provision for income taxes | | | 15,851,000 | | | 10,544,000 | | | 11,886,000 | | | 8,888,000 | | | 31,731,000 | | | 23,772,000 | |
| | | | | | | | | | | | | | | | | | | | |
| Provision for income taxes | | | -- | | | -- | | | -- | | | -- | | | -- | | | -- | |
| | | | | | | | | | | | | | | | | | | | |
| Net income | | $ | 15,851,000 | | | 10,544,000 | | $ | 11,886,000 | | $ | 8,888,000 | | $ | 31,731,000 | | $ | 23,772,000 | |
| Basic and diluted earnings per common share | | $ | 0.41 | | | | | | | | | | | | | | | | |
| Dividends declared per common share / cash distributions per membership units | | $ | 0.58 | | | | | | | | | | | | | | | | |
| Net income allocated to Members | | | | | | 10,544,000 | | $ | 11,886,000 | | $ | 8,888,000 | | $ | 31,731,000 | | $ | 23,772,000 | |
Annualized Rate of Return to Members (a) | | | | | | 4.89 | % | | 4.94 | % | | 1.97 | % | | 6.63 | % | | 5.82 | % |
| Net income allocated to Members per weighted average membership units | | | | | | 0.25 | | $ | 0.25 | | $ | 0.20 | | $ | 0.66 | | $ | 0.58 | |
| Cash distributions to Members | | $ | 6,073,000 | | $ | 8,586,000 | | $ | 11,160,000 | | $ | 20,113,000 | | $ | 29,097,000 | | $ | 34,688,000 | |
| Cash distributions per weighted average membership units | | | | | $ | 0.20 | | $ | 0.23 | | $ | 0.45 | | $ | 0.61 | | $ | 0.85 | |
| Weighted average common shares / membership units | | | 38,832,458 | | | 42,747,725 | | | 47,756,928 | | | 45,188,004 | | | 47,729,256 | | | 40,860,031 | |
Weighted Average Term of Outstanding Loans (b) | | | 19 months | | | 22 months | | | 20 months | | | 24 months | | | 20 months | | | 13 months | |
| (a) | The annualized rate of return to members is calculated based upon the net GAAP income allocated to members per weighted average units, divided by the number of days during the period and multiplied by three hundred sixty five (365) days, then divided by the cost per unit ($10.00). |
| (b) | The weighted average term of our outstanding loans , including loans related to seller financed real estate held for sale, |
The information in this table should be read in conjunction with the accompanying audited consolidated financial statements and notes to the consolidated financial statements included elsewhere in this document.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a financial review and analysis of our financial condition and results of operations for the twelve months ended December 31, 2006, the six months ended December 31, 2005 and 2004, the fiscal year ended June 30, 2005 and the fiscal year ended June 30, 2004. This discussion should be read in conjunction with our financial statements and accompanying notes and other detailed information regarding us appearing elsewhere in this report on Form 10-K and our reports on Form 10-Q, Part I, Item 2 Management’s Discussion and Analysis of Financial Conditions and Results of Operations for the periods ended June 30, 2006 and September 30, 2006.
FORWARD LOOKING STATEMENTS
Certain statements in this report, including, without limitation, matters discussed under this Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” should be read in conjunction with the financial statements, related notes, and other detailed information included elsewhere in this report on Form 10-K. We are including this cautionary statement to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Statements that are not historical fact are forward-looking statements. Certain of these forward-looking statements can be identified by the use of words such as “believes,” “anticipates,” “expects,” “intends,” “plans,” “projects,” “estimates,” “assumes,” “may,” “should,” “will,” or other similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors, which could cause actual results, performance or achievements to differ materially from future results, performance or achievements. These forward-looking statements are based on our current beliefs, intentions and expectations. These statements are not guarantees or indicative of future performance. Important assumptions and other important factors that could cause actual results to differ materially from those forward-looking statements include, but are not limited to, those factors, risks and uncertainties described in Item 1A of this report on Form 10-K for the twelve months ended December 31, 2006 and in our other securities filings with the Securities and Exchange Commission. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to change and involve inherent risks and uncertainties. The forward-looking statements contained in this report are made only as of the date hereof. We undertake no obligation to update or revise information contained herein to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
RESULTS OF OPERATIONS
OVERVIEW
Our primary business objective is to generate income by investing in real estate loans. We believe there is a significant market opportunity to make real estate loans to owners and developers of real property whose financing needs are not met by traditional real estate lenders. The loan underwriting standards utilized by our manager and Vestin Originations are less strict than traditional real estate lenders. In addition, one of our competitive advantages is our ability to approve loan applications more quickly than traditional lenders. As a result, in certain cases, we make real estate loans that are riskier than real estate loans made by commercial banks. However, in return, we seek a higher interest rate and our manager takes steps to mitigate the lending risks such as imposing a lower loan to value ratio. While we may assume more risk than traditional real estate lenders, in return, we seek to generate higher yields from our real estate loans.
Our operating results are affected primarily by: (i) the amount of capital we have to invest in real estate loans, (ii) the level of real estate lending activity in the markets we service, (iii) our ability to identify and work with suitable borrowers, (iv) the interest rates we are able to charge on our loans and (v) the level of non-performing assets, foreclosures and related loan losses which we may experience. Our capital, subject to a 3% reserve, will constitute the bulk of the funds we have available for investment in real estate loans. We do not have any arrangements in place to materially increase the funds we will have available to invest from any other sources. See discussion under - “Capital and Liquidity.”
Our operating results during the past several years have been adversely affected by allowances for non-performing loans. At December 31, 2006, the following loans were non-performing (based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due); RightStar (Part I & Part II), Monterrey Associates LP, Forest Development LLC and Babuski LLC. These loans are currently carried on our books at a value of approximately $19.5 million, net of allowance for loan losses of approximately $9.3 million for the RightStar loans. These loans have been placed on non-accrual of interest status and are the subject of pending foreclosure proceedings. In addition to the RightStar allowance, we have also provided $500,000 for an impairment on a restructured loan. For additional information see “Specific Loan Allowance” in Note D - Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part IV, Item 15 Exhibits and Financial Statement Schedules of this report Form 10-K. Non-performing assets, net of allowance for loan losses, totaled approximately $49.6 million or 16.4% of our total assets as of December 31, 2006 as compared to approximately $70.2 million or 19.4% of our total assets as of December 31, 2005. At December 31, 2006, non-performing assets consisted of approximately $30.1 million of real estate held for sale not sold through seller financing and approximately $19.5 million of non-performing loans, net of allowance for loan losses. During the twelve months ended December 31, 2006, we completed the following transactions related to our real estate held for sale:
| · | During March 2006, we sold the parcel in Cedar Park, Texas. Our net proceeds were $260,000, resulting in a gain of $60,000. |
| · | During June 2006, we sold the parcel in Austin, Texas. Our net proceeds were $550,000, resulting in a gain of $252,000. |
| · | During July 2006, we sold a 504 unit apartment complex in Austin, Texas, for approximately $16.1 million. This resulted in a net gain of approximately $1.6 million. |
| · | During July 2006, we and VRM I sold the land containing residential lots in Henderson, NV, for approximately $3.8 million, of which we received approximately $1.3 million, which resulted in a net gain of $21,000. |
| · | During September 2006, we sold the “Windrush” property in Fort Worth, Texas, for a sales price of $8,019,000, resulting in net proceeds of $7,885,000. During the three months ended December 31, 2006, we received an additional payment of $230,000 from cash reserves held by the apartment manager, which resulted in a net gain of $56,000 on the sale of the property. |
| · | During December 2006, we sold the 150 unit condominium conversion in Houston, TX “The Club at Stablechase” for a sales price of approximately $8.5 million, with net proceeds of approximately $8.2 million, which resulted in a net loss of approximately $0.5 million. |
| · | During November 2006, we, VRM I and Fund III acquired the collateral of a loan, 480 residential building lots and two single family dwellings in Rio Vista Village Subdivision in Cathedral City, CA, through foreclosure. Our manager has evaluated the carrying value of the property and based on its estimate, no valuation allowance was deemed necessary as of December 31, 2006. The property is currently under a purchase agreement for a total sales price of approximately $29.9 million, of which our portion will be approximately $25.6 million. |
The level of non-performing assets may reflect the continuing weakness in certain sectors of the economy and the risk inherent in our business strategy that entails more lenient underwriting standards and expedited loan approval procedures. If the economy weakens and our borrowers who develop and sell commercial real estate projects are unable to complete their projects or obtain takeout financing or are otherwise adversely impacted, we may experience an increase in loan defaults, which may reduce the amount of funds we have to pay dividends to our stockholders. Such conditions may also require us to restructure loans. The weighted average term of our outstanding loans, including extensions and loans related to seller financed real estate held for sale, as of December 31, 2006 and 2005 were 19 months and 22 months, respectively.
Uncertain economic conditions during the next year could have a material impact on the collectibility of our loans. A downturn in the real estate markets where we conduct business might increase defaults on our loans and might require us to record additional reserves with respect to non-performing loans. Recognizing the risk, we seek to maintain an adequate loan-to-value ratio, including loans related to seller financed real estate held for sale, which, as of December 31, 2006, was 69.97% on a weighted average basis, generally using appraisals prepared on an “as-if developed basis” in connection with the loan origination. The increase in the weighted average loan to value ratio from 63.31%, as of December 31, 2005, to 69.97%, as of December 31, 2006, is primarily due to 14 loans that were funded during the twelve-month period, totaling approximately $103.4 million, with a loan to value ratios ranging from 67.52% to 80.00%. The majority of these loans were to repeat borrowers with a history of good standing with us. In addition, the original terms of these loans were 18 months or less. We hope to retain sufficient cushion in the underlying equity position to protect the value of our loans in the event of a default. Nevertheless, no assurances can be given that a marked increase in loan defaults accompanied by a rapid decline in real estate values will not have a material adverse effect upon our financial condition and operating results.
From time to time, we may acquire or sell investments in real estate loans from/to our manager or other related parties pursuant to the terms of our Management Agreement provided the price does not exceed the par value of the loan. No gain or loss is recorded on these transactions, as it is not our intent to make a profit on the purchase or sale of such investments. The purpose is generally to diversify our portfolio by syndicating loans, thereby providing us with additional capital to make additional loans. For further information regarding related party transactions, refer to Item 13. Certain Relationships and Related Transactions, and Director Independence in Part III of this report Form 10-K.
As of December 31, 2006, our loans were in the following states: Arizona, California, Hawaii, Nevada, New York, Oklahoma, Oregon, Texas and Washington.
The Twelve Months Ended December 31, 2006
Total Revenues: For the twelve months ended December 31, 2006 total revenues were approximately $23.5 million due in significant part to the following factors:
| · | We recognized interest income from investments in real estate loans of approximately $21.7 million. Our revenue is dependent upon the balance of our investment in real estate loans and the interest earned on these loans. As of December 31, 2006, our investment in real estate loans, including loans related to seller financed real estate held for sale, was approximately $242.4 million with a weighted average interest rate of 10.94%. As of December 31, 2005, our investment in real estate loans, including loans related to seller financed real estate held for sale, was approximately $256.5 million with a weighted average interest rate of 10.06%. The decline in investments in real estate loans is attributable to a decline in the capital we had available for investments. Our capital was reduced by redemptions of approximately $30.5 million paid to our members during the three months ended March 31, 2006. |
In addition, our interest income was affected by the performances of our loans. During the twelve months ended December 31, 2006, four loans totaling approximately $37.0 million became non-performing. In addition, one of the non-performing loans, with a balance of approximately $25.6 million was foreclosed upon and reclassified to real estate held for sale. For additional information see Note D - Investment Real Estate Loans and Note F - Real Estate Held For Sale of the Notes to the Consolidated Financial Statements included in Part IV of this Report on Form 10-K.
| · | We earned approximately $1.3 million in bank interest income on certificates of deposits held at banking institutions. This was attributable to the purchase of investments in certificates of deposits of approximately $17.1 million during the twelve months ended December 31, 2006. |
Total Operating Expenses: For the twelve months ended December 31, 2006, total operating expenses were approximately $10.6 million. Expenses were primarily affected by the following factors:
| · | Recognition of provisions for loan loss of $5.5 million related to the loans secured by 4 cemeteries and 8 mortuaries in Hawaii. See “Specific Loan Allowance” in Note D - Investment Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part IV of this Report on Form 10-K. |
| · | Interest expense was approximately $1.4 million primarily due to $906,000 of interest expenses related to secured borrowings. In addition, we incurred $522,000 of expense related to notes payable on three real estate owned apartment properties. These notes were paid in full in April 2006. |
| · | Professional fees of approximately $1.3 million include $720,000 of accounting fees related to our public filings during the twelve months ended December 31, 2006. In addition, we incurred legal expense of $587,000 due in part to several legal actions, seeking damages and appraisal rights in connection with the REIT conversion, during the twelve months ended December 31, 2006. For additional information see Item 3 - Legal Proceedings included in Part I of this Report on Form 10-K. |
| · | We recognized a provision for doubtful receivable relating to a note receivable in default of $329,000 during the twelve months ended December 31, 2006. See Note I - Note Receivables of the Notes to the Consolidated Financial Statements included in Part IV of this Report on Form 10-K. |
| · | Included in other expenses are expenses totaling $371,000 related to the liability insurance expense for our directors and officers and expenses relating to investor services for the twelve months ended December 31, 2006. |
Total Income(Loss) from Real Estate Held for Sale: For the twelve months ended December 31, 2006, total income from real estate held for sale was approximately $3 million.
| · | During the twelve months ended December 31, 2006, we recorded approximately $4.1 million in rental revenue related to three apartment complexes that were classified as real estate held for sale. During the twelve months ended December 31, 2006, we sold these properties as described below. |
| · | The sale of the apartment complex in Austin, TX, resulted in a gain of approximately $1.6 million. In addition, we sold the 278- unit apartment complex in Fort Worth, TX “Windrush” during September 2006, which resulted in a net gain of $56,000. These gains were offset by a loss of approximately $0.5 million recognized on the sale of a 150 unit condominium conversion complex in Houston, TX “The Club at Stablechase” during December 2006. |
| · | In addition to the gain and losses on the sale of real estate held for sale referred above, we recorded a gain of $60,000 on the sale of a real estate parcel in Cedar Park, TX. |
| · | During the twelve months ended December 31, 2006, we incurred expenses related to real estate held for sale not sold through seller financed of approximately $4.9 million, primarily related to the three apartment complexes referred to above. |
| · | We recorded a gain on sale of real estate held for sale because of the recognition of approximately $2.3 million of deposit liabilities received from seller financed loans during the twelve months ended December 31, 2006. As of December 31, 2006, we had approximately $14.8 million, in real estate held for sale - seller financed. Upon the sale of real estate held for sale where we provide the financing, GAAP requires the new borrower to have a certain percentage equity ownership (ranging from 10% to 25%) to allow us to record the sale of property. In addition, the borrower must maintain a minimum commitment in the property on a continuing basis. Therefore, until the borrower meets these requirements, the proceeds received from the borrower are recorded as a deposit liability or applied to the balance of the real estate held for sale - seller finance, depending on the guidelines established by GAAP. Our revenues will continue to be impacted until we are able to convert these assets into investment in real estate loans or the loans are paid in full and we reinvest the proceeds into new loans. |
Dividends: To maintain our status as a REIT, we are required to make distributions, other than capital gain dividends, to our stockholders each year in an amount at least equal to (1) the sum of (a) 90% of our taxable income, computed without regards to the dividends paid deduction and our net capital gain, and (b) 90% of the net income, after tax, from foreclosure property, minus (2) the sum of certain specified items of non-cash income over 5% of our REIT taxable income. From April 1 through December 31, 2006, we declared dividends to our shareholders of approximately $16.3 million.
Distributions to Members: During the three months ended March 31, 2006, we distributed approximately $6.1 million to Fund II’s members, resulting in a distribution in excess of net income available for distribution of approximately $2.4 million. Distributions made during this period included approximately $2.1 million in respect of net income available for distribution generated during the six months ended December 31, 2005.
The Six Months Ended December 31, 2005 Compared to Six Months Ended December 31, 2004
Revenues: Revenues for the six months ended December 31, 2005 decreased compared to the same period in 2004 by approximately $4 million or 25.5% primarily due to the following:
| · | Decrease in interest income of approximately $3.1 million is related to the decrease in investments in real estate loans and secured borrowings of approximately $7.2 million and $27.8 million, respectively, from September 30, 2004 to September 30, 2005. This decrease was partially offset by the increase in real estate loans during the three months ended December 31, 2005. |
| · | Included in other income for the six months ended December 31, 2004 is an insurance settlement we received of approximately $0.8 resulting from deficient procedures performed by the voucher control company we used for construction control on a golf course in Austin, Texas. |
Non-performing assets include loans in non-accrual status of approximately $36.4 million as of December 31, 2005 compared to approximately $34.4 million as of December 31, 2004 and real estate held for sale not sold through seller financed of approximately $38.6 million as of December 31, 2005 compared to approximately $39.8 million as of December 31, 2004.
Total Operating Expenses: For the six months ended December 31, 2005 and 2004, total expenses were approximately $1.5 million and $3.4 million, a decrease of approximately $1.9 million or 55.6%. Expenses were affected by the following factors:
| · | Interest expense decreased by approximately $2 million due to the decrease in secured borrowing of approximately $5.9 million for the six months ended December 31, 2005 compared to the same period in 2004. |
| · | For the six months ended December 31, 2004, we recorded approximately $0.2 million in provision for loan losses. No provision for loan losses was recorded during the same period in 2005. |
These decreases were partially offset by the following increases:
| · | Included in other expenses for the six months ended December 31, 2005 is allowance for bad debt of $183,000 related to an accounts receivable balance from a third party for reimbursement of expenses incurred by us related to the loan secured by 4 cemeteries and 8 mortuaries in Hawaii. |
| · | Also included in other expenses during the six months ended December 31, 2005, is a loan fee of $100,000 related to two loans which a third party investor participated through an Inter-creditor Agreement. |
Total Loss from real estate held for sale: For the six months ended December 31, 2005 and 2004, total loss from real estate held for sale was approximately $0.2 million and $0.9 million, respectively.
| · | Gain on sale of real estate held for sale related to seller financed loans, which were paid during the six months ended December 31, 2005 of approximately $1.1 million. |
| · | For the six months ended December 31, 2005, we recorded operating income of approximately $2.3 million related to the three real estate owned apartment complexes, which were acquired through foreclosure during 2005. We had no similar income during the same period in 2004. |
| · | During the six months ended December 31, 2004, we recorded a gain on sale of real estate held for sale relating to raw land in Mesquite, Nevada. The transaction resulted in a gain of approximately $0.8 million. |
| · | During the six months ended December 31, 2004, we recorded approximately $0.1 million in write downs on real estate held for sales as a result of a reassessment of the value of two of our real estate properties based on purchase offers received. |
| · | We incurred expenses related to real estate held for sale for the six months ended December 31, 2005 of approximately $3.6 million related to the three real estate owned apartment complexes, which were acquired through foreclosure during 2005 |
As of December 31, 2005 and 2004, we had approximately $22.9 million and $13.1 million, respectively, in real estate held for sale-seller financed. As of December 31, 2005 and 2004, we had approximately $0.9 million and $0.8 million, respectively, in deposit liability.
Annualized Rate of Return to Members. For the six months ended December 31, 2005 and 2004, the annualized rate of return to members, as calculated in accordance with GAAP, was 4.89% and 4.94%, respectively
Distributions to Members. The following is a schedule of distributions made to members for the six months ended December 31, 2005 and 2004.
| | | For the Six Months Ended December 31, 2005 | | For the Six Months Ended December 31, 2004 | |
| | | | | (Unaudited) | |
| Distributions of Net Income Available for Distribution | | $ | 8,586,000 | | $ | 11,160,000 | |
| Distributions in Excess of Net Income Available for a Distribution Generated During the Period | | | -- | | | -- | |
| Total Distributions | | $ | 8,586,000 | | $ | 11,160,000 | |
Net Income Available for Distributions is a non-GAAP financial measure that is defined in the operating agreement, which governed Fund II as cash flows from operations, less certain reserves, and may exceed net income as calculated in accordance with GAAP. We have presented net income available for distribution because management believes this financial measure is useful and important to members as net income available for distribution is the minimum amount required to be distributed to members pursuant to our operating agreement. Although we generally do not plan to make distributions in excess of net income available for distribution, we may do so from time to time. Any such distribution will be treated as a return of capital for income tax purposes. In addition, cash flows from operations, which are the significant component of net income available for distribution, affect the capital available for investment in new loans. This non-GAAP financial measure should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP or as an alternative to cash flows from operating activities as a measure of our liquidity. We compensate for these limitations by relying primarily on our GAAP results and using net income available for distribution only supplementally.
The most directly comparable GAAP measure to net income available for distribution is cash flows from operating activities. The following table reconciles net income available for distribution to cash flows from operating activities and presents the two other major categories of our statement of cash flows:
| | | For the Six Months Ended December 31, 2005 | | For the Six Months Ended December 31, 2004 | |
| | | | | (Unaudited) | |
| | | | | | |
| Distribution of Net Income Available for Distribution | | $ | 8,586,000 | | $ | 11,160,000 | |
| Additions to Working Capital Reserves (Amount Not Distributed) | | | 2,052,000 | | | 1,016,000 | |
| Gain on Sale of Marketable Securities | | | (203,000 | ) | | -- | |
| Gain on Real Estate Held for Sale | | | (47,000 | ) | | (758,000 | ) |
| Gain on Real Estate Held for Sale - Seller Financed | | | (1,079,000 | ) | | -- | |
| Amortized Interest Income | | | (272,000 | ) | | -- | |
| Interest Income Accrued to Loan Balance | | | -- | | | 280,000 | |
| Change in Operating Assets and Liabilities: | | | | | | | |
| Net Change in Amounts Due from Fund I | | | 1,560,000 | | | 5,761,000 | |
| Net Change in Other Operating Assets | | | (247,000 | ) | | 680,000 | |
| Net Change in Accounts Payable and Accrued Liabilities | | | (842,000 | ) | | 143,000 | |
| Net Change in Amounts Due to Related Parties | | | (540,000 | ) | | (553,000 | ) |
| Net Cash Provided by Operating Activities | | $ | 8,968,000 | | $ | 17,729,000 | |
| Net Cash Provided by Investing Activities | | $ | 1,521,000 | | $ | 39,928,000 | |
| Net Cash Provided (Used) in Financing Activities | | $ | 18,578,000 | | $ | (16,827,000 | ) |
Fiscal Year Ended June 30, 2005 Compared To June 30, 2004
Total Revenues. For the fiscal year ended June 30, 2005, total revenues were approximately $28.0 million compared to approximately $41.1 million for the fiscal year ended June 30, 2004, a decrease of approximately $13.2 million or 32.04%. The decline in revenue was primarily due to the following:
| · | A decrease in interest income of approximately $13.5 million related to a decrease in investments in real estate loans and secured borrowings of approximately $83.7 million and $36.3 million, respectively, as of June 30, 2005. The decrease is primarily related to non-performing assets and member redemptions for the year ended June 30, 2005. In addition, the average interest rate on our loans as of June 30, 2005 was 9.95%, compared to 10.9% at June 30, 2004. While there has been some movement in the economy towards higher interest rates, it is not clear if or when any such rate increases will impact our business. |
| · | We recognized approximately $2.3 million in revenue related to a finder’s fee on the sale of real estate in the City of Mesquite, Nevada during the fiscal year ended June 30, 2004. We had no such comparable revenue for the fiscal year ended June 30, 2005. Our company and Fund I were presented with an opportunity to purchase the property but were prohibited by their respective operating agreements from purchasing the property. Instead, our manager facilitated the purchase and subsequent sale of the property. The subsequent sale of the property was made possible due to buyer financing provided by our company and Fund I. Our manager negotiated that the buyer (an unaffiliated third party) pay a finder’s fee in the form of a approximately $2.3 million promissory note to our company and a approximately $4.7 million promissory note to Fund I to reflect the fact that the transaction was made possible by financing provided by our company and Fund I. The total $7.0 million finder’s fee was allocated to our company and Fund I based on the same ratio of the financing that each provided in the transaction. We received a promissory note in lieu of cash from an unaffiliated party in connection with the sale. The note required monthly interest payments at a rate of 8.5% per annum and had an original maturity date of June 13, 2005. We were using the cost recovery method of accounting for the transaction. Accordingly, we did not recognize any income on the $2.3 million note until the principal balance of both notes was paid in full. Under the cost recovery method, interest payments received by our company in excess of the principal balance are not recorded as income until such time as the note is paid in full, which occurred in the first calendar quarter of 2004. In February 2004, both notes were paid in full and we recorded the $2.3 million as revenue related to the sale of real estate related to the original note and approximately $0.3 million in interest income related to interest payments received prior to loan payoff. |
Non-performing assets include loans in non-accrual status totaling approximately $36.0 million as of June 30, 2005 compared to $46.0 million as of June 30, 2004 and real estate held for sale not sold through seller financed totaling approximately $51.2 million as of June 30, 2005 compared to $28.3 million as of June 30, 2004. The amount of non-performing assets may reflect the risks inherent in our business strategy that entails more lenient underwriting standards and expedited loan approvals procedures, as well as the effects of a weakening economy. Our revenues will continue to be impacted until we are able to convert these non-performing assets into interest paying real estate loans. We will attempt to accomplish this by working with the borrower where possible and by foreclosing on the underlying property where necessary. We intend to sell properties acquired through foreclosure as soon as practicable, consistent with its objective of avoiding a loss of principal on our loans. However, we cannot predict how quickly we will be able to sell foreclosed properties.
As of June 30, 2005, our manager had granted extensions on nine loans pursuant to the terms of the original loan agreements, which permit extensions by mutual consent. Such extensions are generally provided on loans where the original term was 12 months or less and where a borrower requires additional time to complete a construction project or negotiate take out financing. However, our manager only grants extensions when a borrower is in full compliance with the terms of the loan, including, but not limited to the borrower’s obligation to make interest payments on the loan. The aggregate amount due to us from borrowers whose loans had been extended as of June 30, 2005 was approximately $76.0 million. At June 30, 2005, an extended loan of approximately $1.5 million was a non-performing loan. Our manager concluded that no additional allowance for loan losses was necessary with respect to such loans.
Total Operating Expenses. For the year ended June 30, 2005, total expenses were approximately $8.7 million compared to $10.2 million for the year ended June 30, 2004, a decrease of approximately $1.5 million or 14.15%. The decrease is primarily related to the following:
| · | We recognized an impairment value of $500,000 due to a restructured loan. |
| · | We recognized professional fees related to a restructured loan in the amount of $590,000. |
| · | The increase in expenses was partially offset by a decrease in interest expense of approximately $2.2 million due to a decrease in the amount of secured borrowings. As of June 30, 2005 and 2004, secured borrowings were approximately $25.7 million and $61.9 million, respectively, representing a decrease of approximately $36.2 million. |
| · | We recognized an allowance for loan loss of approximately $2.3 million, for the year ended June 30, 2005, on a loan secured by 4 cemeteries and 8 mortuaries in Hawaii (RightStar). |
Total Income (Loss) from Real Estate Held for Sale: For the year ended June 30, 2005, total loss from real estate held for sale totaled approximately $10.3 million, compared to total income of approximately $0.8 million for the year ended June 30, 2004, a decrease in income of approximately 1,453.40% due in significant part to the following factors:
| · | We wrote down the carrying value of a 126 unit assisted living facility located in Phoenix, Arizona by approximately $5.9 million during the year ended June 30, 2005. |
| · | We wrote down the carrying value of the 166 residential lots located in Henderson, Nevada by $179,000 during the year ended June 30, 2005. |
| · | We wrote down the carrying value of two real estate parcels located in Austin and Cedar Park, Texas by approximately $1.0 million during the year ended June 30, 2005. |
| · | We wrote down the carrying value of the 74 unit (90 beds) assisted living facility located in San Bernardino, California by $282,000 during the year ended June 30, 2005. |
| · | We sold a 126 unit hotel in Mesquite, Nevada and sustained a loss of $829,000 during the year ended June 30, 2005. |
| · | For the year ended June 30, 2005 and 2004, we recognized expenses related to the maintenance of real estate held for sale of approximately $2.8 million and $1.6 million, respectively, which was an increase of approximately $1.2 million. The increase in these expenses is related to the increase in real estate held for sale at June 30, 2005 of approximately $51.2 million compared to $28.3 million at June 30, 2004, an increase of approximately $22.9 million. |
Annualized Rate of Return to Members. For the year ended June 30, 2005, the annualized rate of return to members, as calculated in accordance with GAAP, was 1.97% compared to 6.63% for fiscal 2004.
Distributions to Members. The following is a schedule of distributions made to members for the years ended June 30, 2005 and 2004.
| | | For the Year Ended June 30, 2005 | | For the Year Ended June 30, 2004 | |
| | | | | | |
| Distributions of Net Income Available for Distribution | | $ | 19,006,000 | | $ | 29,097,000 | |
| Distributions in Excess of Net Income Available for a Distribution Generated During the Period | | | 1,107,000 | | | -- | |
| Total Distributions | | $ | 20,113,000 | | $ | 29,097,000 | |
Net income available for distribution is a non-GAAP financial measure that is defined in our operating agreement as cash flows from operations, less certain reserves, and may exceed net income as calculated in accordance with GAAP. We have presented net income available for distribution because management believes this financial measure is useful and important to members as net income available for distribution is the minimum amount required to be distributed to members pursuant to our operating agreement. In addition, cash flows from operations, which are the significant component of net income available for distribution, affect the capital available for investment in new loans. This non-GAAP financial measure should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP or as an alternative to cash flows from operating activities as a measure of our liquidity. We compensate for these limitations by relying primarily on our GAAP results and using net income available for distributions only supplementally.
The most directly comparable GAAP measure to net income available for distribution is cash flows from operating activities. The following table reconciles net income available for distribution to cash flows from operating activities and presents the two other major categories of our statement of cash flows.
| | | For the Year Ended June 30, 2005 | | For the Year Ended June 30, 2004 | |
| | | | | | |
| Distribution of Net Income Available for Distribution | | $ | 19,006,000 | | $ | 29,097,000 | |
| Additions to Working Capital Reserves (Amount Not Distributed) | | | -- | | | 5,249,000 | |
| Gain on sale of real estate held for sale | | | (760,000 | ) | | -- | |
| Loss on sale of real estate held for sale | | | 932,000 | | | -- | |
| Interest income accrued to loan balance | | | 402,000 | | | -- | |
| Change in operating assets and liabilities: | | | | | | | |
| Interest and other receivables | | | 216,000 | | | (444,000 | ) |
| Due to Manager | | | (289,000 | ) | | (1,072,000 | ) |
| Due to Vestin Group | | | (384,000 | ) | | (23,000 | ) |
| Due to/from VRM I | | | 1,427,000 | | | (2,771,000 | ) |
| Note receivable from VRM I | | | 4,278,000 | | | -- | |
| Prepaid expenses | | | (20,000 | ) | | -- | |
| Accounts payable and accrued liabilities | | | 811,000 | | | 219,000 | |
| Net cash provided by operating activities | | $ | 25,619,000 | | $ | 30,255,000 | |
| Net cash provided by investing | | $ | 33,067,000 | | $ | 23,792,000 | |
| Net cash (used) by financing | | $ | (60,057,000 | ) | $ | (47,851,000 | ) |
CAPITAL AND LIQUIDITY
Liquidity is a measure of a company’s ability to meet potential cash requirements, including ongoing commitments to fund lending activities and general operating purposes. Subject to a 3% reserve, we generally use all of our available funds to invest in real estate loans. Distributable cash flow generated from such loans is paid out to our stockholders, in the form of a dividend. We do not anticipate the need for hiring any employees, acquiring fixed assets such as office equipment or furniture, or incurring material office expenses during the next twelve months because our manager will manage our affairs. We may pay our manager an annual management fee of up to 0.25% of our aggregate capital received by us and Fund II from the sale of shares or membership units.
During the twelve months ended December 31, 2006, cash flows provided by operating activities approximated $18.1 million. Investing activities consisted of cash provided by loan payoffs of approximately $203.1 million. Cash used for new investments and purchases of real estate loans totaled approximately $234.6 million, proceeds from the sale of real estate held for sale totaled approximately $35.6 million and proceeds from full payment of loans related to real estate held for sale - seller financed totaled approximately $8.1 million. In addition, investing activities consisted of the purchase of approximately $17.1 million in certificates of deposit and proceeds from maturities of certificates of deposit totaling approximately $17.8 million. Financing activities consisted of payments on notes payable in the amount of approximately $26.1 million and dividends to stockholders, net of reinvestment, of approximately $12.0 million. In addition, financing activities consisted of members’ redemptions in the amount of approximately $30.5 million and distributions of approximately $5.3 million, net of reinvestments.
At December 31, 2006, we had approximately $16.8 million in cash, $0.25 million in certificates of deposit, $2.1 million in marketable securities - related party and approximately $303 million in total assets. We intend to meet short-term working capital needs through a combination of proceeds from loan payoffs, loan sales and/or borrowings. We believe we have sufficient working capital to meet our operating needs in the near term.
Since we distribute most or all of our distributable cash generated by operations, our sources of liquidity include repayments of outstanding loans, dividend reinvestments by our stockholders, arrangements with third parties to participate in our loans and proceeds from issuance of note payable and secured borrowings.
We have no current plans to sell any new shares except through our dividend reinvestment program. As of February 26, 2007, approximately 8% of our shareholders owning less than 1% our outstanding shares have elected to reinvest their dividends. The level of dividend reinvestment in the future will depend upon our performance, as well as the number of our stockholders who prefer to reinvest rather than receive current dividends.
We rely primarily upon repayment of outstanding loans to provide capital for investment in new loans. Any significant level of defaults on outstanding loans could reduce the funds we have available for investment in new loans. Resulting foreclosure proceedings may not generate full repayment of our loans and may result in significant delays in the return of invested funds. This would diminish our capital resources and would impair our ability to invest in new loans. Non-performing assets included loans in non-accrual status, net of allowance for loan losses, and real estate held for sale not sold through seller financing totaling approximately $19.5 million and $30.1 million, respectively, as of December 31, 2006 compared to approximately $31.7 million and $38.6 million, respectively, as of December 31, 2005. It is possible that no earnings will be recognized from these assets until they are disposed of, or that no earnings will be recognized at all, and the time it will take to dispose of these assets cannot be predicted. Our manager believes that these non-performing assets are a result of factors unique to specific borrowers and properties. Because of the estimated value of the underlying properties, we do not currently believe that any losses beyond those already recognized will be incurred from these assets upon final disposition. However, it is possible that we will not be able to realize the full estimated carrying values upon disposition.
To maintain our status as a REIT, we will be required to make distributions, other than capital gain dividends, to our stockholders each year in an amount at least equal to (1) the sum of (a) 90% of our taxable income, computed without regards to the dividends paid deduction and our net capital gain, and (b) 90% of the net income, after tax, from foreclosure property, minus (2) the sum of certain specified items of noncash income over 5% of our REIT taxable income.
Loans in which unaffiliated investors have participated through inter-creditor agreements (“Inter-creditor Agreements”) are accounted for as secured borrowings in accordance with Statement of Financial Accounting Standards (“FAS”) 140 - Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“FAS 140”). The Inter-creditor Agreements provide us additional funding sources for real estate loans whereby an unaffiliated investor (the “Investor”) may participate on a non-pari passu basis in certain real estate loans with us and/or VRM I and/or Fund III (collectively, the “Lead Lenders”). In the event of borrower non- performance, the Inter-creditor Agreements generally provide that the Lead Lenders must repay the Investor’s loan amount either by (i) continuing to remit to the Investor the interest due on the participated loan amount; (ii) substituting an alternative loan acceptable to the Investor; or (iii) repurchasing the participation from the Investor for the outstanding balance plus accrued interest.
During October 2006, we, our manager, Vestin Origination, Inc., VRM I and Fund III entered into an intercreditor agreement with an unrelated third party related to the funding of a construction real estate loan. (See exhibit 10.8 Intercreditor Agreement under the Exhibit Index included in Part IV, Item 15 Exhibits and Financial Statement Schedules of this Report Form 10-K). The secured borrowing will be recognized pro rata between us, VRM I and Fund III for the amount each entity has funded for the loan. As of December 31, 2006, approximately $24.3 million has been funded on this loan, of which our portion was approximately $4.3 million. As of December 31, 2006, this secured borrowing totaled approximately $18.5 million, of which our portion was approximately $13.8 million. In the event VRM I and Fund III were unable to pay their pro rata share of the secured borrowing, we would be liable for the full outstanding balance. As of December 31, 2005, we had approximately $19.8 million in funds being used under Inter-creditor Agreements.
We maintain working capital reserves of approximately 3% in cash and cash equivalents, certificates of deposits and short-term investments or liquid marketable securities. This reserve is available to pay expenses in excess of revenues, satisfy obligations of underlying properties, expend money to satisfy our unforeseen obligations and for other permitted uses of working capital.
Investments in Real Estate Loans Secured by Real Estate Portfolio
We offer five real estate loan products consisting of commercial, construction, acquisition and development, land, and residential loans. The effective interest rates on all product categories range from 5% to 14%. Revenue by product will fluctuate based upon relative balances during the period. We had investments in 37 real estate loans, including loans related to seller financed real estate held for sale, as of December 31, 2006, with a balance of approximately $242.4 million as compared to investments in 34 real estate loans as of December 31, 2005, with a balance of approximately $256.5 million.
At December 31, 2006, the following loans were non-performing (based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due); RightStar (Part I & Part II), Monterrey Associates LP, Forest Development LLC and Babuski LLC. These loans are currently carried on our books at a value of approximately $19.5 million, net of allowance for loan losses of approximately $9.3 million for the RightStar loans. These loans have been placed on non-accrual of interest status and are the subject of pending foreclosure proceedings.
On May 1, 2006, the bankruptcy plan of Mid-State Raceway, Inc. for Vernon Downs became effective. As a result of the bankruptcy plan, we and VRM I received the following:
| · | A new first deed of trust was received from the buyer, Vernon Downs Acquisition, LLC, approximating $22.8 million, of which our portion is approximately $19.6 million. The new terms included a $1.2 million principal payment, reducing our principal balance by approximately $1.0 million. This transaction resulted in us recording unearned revenue of approximately $1.0 million, to be recognized through March 2007, the maturity of the loan. The terms of the loan are 9% due in 6 months, with an option to extend, which was granted in September 2006, for an additional 6 months. |
| · | The loan is secured by a first deed of trust on Vernon Downs properties and a 150% personal guarantee by the borrowers. |
| · | Prepayment of interest in the aggregate amount of $500,000, of which our portion was $429,000. |
| · | Delay fees from the date of the bankruptcy confirmation until the effective date in the aggregate amount of $282,000 of which our portion was $242,000. |
| · | Payment of past due forbearance fees of $555,000 of which our portion was $476,000, to be recognized as unearned revenue and amortized through March 2007. |
Our manager periodically reviews and makes a determination as to whether the allowance for loan losses is adequate to cover any potential losses. Additions to the allowance for loan losses are made by charges to the provision for loan losses. Recoveries of previously charged off amounts are credited to the allowance for loan losses or included as income when the asset is disposed. As of December 31, 2006, we have provided a specific reserve related to the 4 cemeteries and 8 mortuaries in Hawaii, of which our portion of the specific reserve is approximately $9.3 million. In addition, our manager recognized a specific reserve for the impairment of a restructured loan in the amount of $500,000. Our manager evaluated the loans and concluded that the remaining underlying collateral was sufficient to protect us against further losses of principal or interest. Our manager will continue to evaluate these loans in order to determine if any other allowance for loan losses should be recorded. For additional information on our investments in real estate loans, refer to Note D - Investments In Real Estate Loans of the Notes to the Financial Statements included in Part IV, Item 15 Exhibits and Financial Statement Schedules of this Annual Report Form 10-K.
Asset Quality and Loan Reserves
Losses may occur from investing in real estate loans. The amounts of losses will vary as the loan portfolio is affected by changing economic conditions and the financial condition of borrowers.
The conclusion that a real estate loan is uncollectible or that collectibility is doubtful is a matter of judgment. On a quarterly basis, the manager evaluates our real estate loan portfolio for impairment. The fact that a loan is temporarily past due does not necessarily mean that the loan is impaired. Rather, all relevant circumstances are considered by our manager to determine impairment and the need for specific reserves. Such evaluation, which includes a review of all loans on which full collectibility may not be reasonably assured, considers among other matters:
| · | Prevailing economic conditions; |
| · | The nature and volume of the loan portfolio; |
| · | The borrowers’ financial condition and adverse situations that may affect the borrowers’ ability to pay; |
| · | Evaluation of industry trends; and |
| · | Estimated net realizable value of any underlying collateral in relation to the real estate loan amount. |
Based upon this evaluation, a determination is made as to whether the allowance for loan losses is adequate to cover any potential losses. Additions to the allowance for loan losses are made by charges to the provision for loan losses. Recoveries of previously charged off amounts are credited to the allowance for loan losses. For additional information regarding the roll-forward of the allowance for loan losses for the twelve months ended December 31, 2006, refer to Note D - Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part IV, Item 15 Exhibits and Financial Statement Schedules of this Annual Report Form 10-K.
Investments in Real Estate Held for Sale
At December 31, 2006, we held two properties with a total carrying value of approximately $30.1 million, which were acquired through foreclosure and recorded as investments in real estate held for sale. Our investments in real estate held for sale are accounted for at the lower of cost or fair value less costs to sell with fair value based on appraisals and knowledge of local market conditions. It is not our intent to invest in or own real estate as a long-term investment. We seek to sell properties acquired through foreclosure as quickly as circumstances permit. During the twelve months ended December 31, 2006, we completed the following transactions related to our real estate held for sale:
| · | During March 2006, we sold the parcel in Cedar Park, Texas. Our net proceeds were $260,000, resulting in a gain of $60,000. |
| · | During June 2006, we sold the parcel in Austin, Texas. Our net proceeds were $550,000, resulting in a gain of $252,000. |
| · | During July 2006, we sold a 504 unit apartment complex in Austin, Texas, for approximately $16.1 million. This resulted in a net gain of approximately $1.6 million. |
| · | During July 2006, we and VRM I sold the land containing residential lots in Henderson, NV, for approximately $3.8 million, of which we received approximately $1.3 million, which resulted in a net gain of $21,000. |
| · | During September 2006, we sold the “Windrush” property in Fort Worth, Texas, for a sales price of $8,019,000, resulting in net proceeds of $7,885,000. During the three months ended December 31, 2006, we received an additional payment of $230,000 from cash reserves held by the apartment manager, which resulted in a net gain of $56,000 on the sale of the property. |
| · | During December 2006, we sold the 150 unit condominium conversion in Houston, TX “The Club at Stablechase” for a sales price of approximately $8.5 million, with net proceeds of approximately $8.2 million, which resulted in a net loss of approximately $0.5 million. |
| · | During November 2006, we, VRM I and Fund III acquired the collateral of a loan, 480 residential building lots and two single family dwellings in Rio Vista Village Subdivision in Cathedral City, CA, through foreclosure. Our manager has evaluated the carrying value of the property and based on its estimate, no valuation allowance was deemed necessary as of December 31, 2006. The property is currently under a purchase agreement for a total sales price of approximately $29.9 million, of which our portion will be approximately $25.6 million. |
For additional information on our investments in real estate held for sale, refer to Note F -Real Estate Held for Sale of the Financial Statements included in Part IV, Item 15 Exhibits and Financial Statement Schedules of this Annual Report Form 10-K.
Investments in Real Estate Held for Sale — Seller Financed
At December 31, 2006, we held an interest in two properties with a total carrying value of approximately $14.8 million, which have sold in transactions where we provided the financing to the purchaser. GAAP requires us to include these properties in real estate held for sale until the borrower has met and maintained certain requirements. We may share ownership of such properties with VRM I, Fund III, the manager, or other related and/or unrelated parties. These investments in real estate held for sale are accounted for at the lower of cost or fair value less costs to sell with fair value based on appraisals and knowledge of local market conditions. For additional information on our investments in real estate loans, refer to Note G -Real Estate Held for Sale-Seller Financed of the Notes to the Financial Statements included in Part IV, Item 15 Exhibits and Financial Statement Schedules of this Annual Report Form 10-K.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any interests in off-balance sheet special purpose entities nor do we have any interests in non-exchange traded commodity contracts.
CONTRACTUAL OBLIGATIONS
The following summarizes our contractual obligations at December 31, 2006:
| | | | | | | | | | | | |
Contractual Obligation | | Total | | Less Than 1 Year | | 1-3 Years | | 3-5 Years | | More Than 5 Years | |
| Secured borrowings (1) | | $ | 13,796,000 | | $ | 13,796,000 | | $ | -- | | $ | -- | | $ | -- | |
| Note Payable (2) | | | 27,000 | | | 27,000 | | | -- | | | -- | | | -- | |
| Total | | $ | 13,823,000 | | $ | 13,823,000 | | $ | -- | | $ | -- | | $ | -- | |
| (1) | In the event VRM I and Fund III were unable to pay their pro rata share of the secured borrowings, we would be liable for the full outstanding balance, which was approximately $18.5 million as of December 31, 2006. |
| (2) | During January 2007, the note payable was paid in full. |
CRITICAL ACCOUNTING ESTIMATES
Revenue Recognition
Interest income on loans is accrued by the effective interest method. We do not accrue interest income from loans once they are determined to be impaired. A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due.
The following table presents a sensitivity analysis to show the impact on our financial condition at December 31, 2006 from fluctuations in weighted average interest rate charged on loans as a percentage of the loan portfolio:
Changed Assumption | | Increase (Decrease) in Interest Income | |
| Weighted average interest rate assumption increased by 1.0% or 100 basis points | | $ | 2,424,000 | |
| Weighted average interest rate assumption increased by 5.0% or 500 basis points | | $ | 12,122,000 | |
| Weighted average interest rate assumption decreased by 1.0% or 100 basis points | | $ | (2,424,000 | ) |
| Weighted average interest rate assumption decreased by 5.0% or 500 basis points | | $ | (12,122,000 | ) |
The purpose of this analysis is to provide an indication of the impact that the weighted average interest rate fluctuations would have on our financial results. It is not intended to imply our expectation of future revenues or to estimate earnings. We believe that the assumptions used above are appropriate to illustrate the possible material impact on the financial statements.
Allowance for Loan Losses
We maintain an allowance for loan losses on our investments in real estate loans for estimated credit impairment in our investment in real estate loans portfolio. The manager’s estimate of losses is based on a number of factors including the types and dollar amounts of loans in the portfolio, adverse situations that may affect the borrower’s ability to repay, prevailing economic conditions and the underlying collateral securing the loan. Additions to the allowance are provided through a charge to earnings and are based on an assessment of certain factors, which may indicate estimated losses on the loans. Actual losses on loans are recorded as a charge-off or a reduction to the allowance for loan losses. Subsequent recoveries of amounts previously charged off are added back to the allowance or included as income.
The following table presents a sensitivity analysis to show the impact on our financial condition at December 31, 2006 from increases and decreases to our allowance for loan losses as a percentage of the loan portfolio:
Changed Assumption | | Increase (Decrease) in Allowance for Loan Losses | |
| Allowance for loan losses assumption increased by 1.0% of loan portfolio | | $ | 2,424,000 | |
| Allowance for loan losses assumption increased by 5.0% of loan portfolio | | $ | 12,120,000 | |
| Allowance for loan losses assumption decreased by 1.0% of loan portfolio | | $ | (2,424,000 | ) |
| Allowance for loan losses assumption decreased by 4.1% of loan portfolio | | $ | (9,828,000 | ) |
Estimating allowances for loan losses requires significant judgment about the underlying collateral, including liquidation value, condition of the collateral, competency and cooperation of the related borrower and specific legal issues that affect loan collections or taking possession of the property. As a non-conventional lender willing to invest in loans to borrowers who may not meet the credit standards of conventional lenders, the default rate on our loans could be higher than those generally experienced in the mortgage lending industry. We, our manager and Vestin Originations generally approves loans more quickly than other real estate lenders and, due to our expedited underwriting process, there is a risk that the credit inquiry we perform will not reveal all material facts pertaining to a borrower and the security.
We may discover additional facts and circumstances as we continue our efforts in the collection and foreclosure processes. This additional information often causes management to reassess its estimates. In recent years, we have revised estimates of our allowance for loan losses. Circumstances that may cause significant changes in our estimated allowance include, but not limited to:
| · | Declines in real estate market conditions that can cause a decrease in expected market value; |
| · | Discovery of undisclosed liens for community improvement bonds, easements and delinquent property taxes; |
| · | Lack of progress on real estate developments after we advance funds. We customarily utilize disbursement agents to monitor the progress of real estate developments and approve loan advances. After further inspection of the related property, progress on construction occasionally does not substantiate an increase in value to support the related loan advances; |
| · | Unanticipated legal or business issues that may arise subsequent to loan origination or upon the sale of foreclosed upon property; and |
| · | Appraisals, which are only opinions of value at the time of the appraisal, may not accurately reflect the value of the property. |
Real Estate Held For Sale
Real estate held for sale includes real estate acquired through foreclosure and will be carried at the lower of the recorded amount, inclusive of any senior indebtedness, or the property's estimated fair value, less estimated costs to sell, with fair value based on appraisals and knowledge of local market conditions. While pursuing foreclosure actions, the Company seeks to identify potential purchasers of such property. It is not the Company's intent to invest in or own real estate as a long-term investment. In accordance with FAS 144 - Accounting for the Impairment or Disposal of Long Lived Assets, the Company seeks to sell properties acquired through foreclosure as quickly as circumstances permit. The carrying values of real estate held for sale are assessed on a regular basis from updated appraisals, comparable sales values or purchase offers.
Management classifies real estate held for sale when the following criteria are met:
| · | Management commits to a plan to sell the properties; |
| · | The property is available for immediate sale in its present condition subject only to terms that are usual and customary; |
| · | An active program to locate a buyer and other actions required to complete a sale have been initiated; |
| · | The sale of the property is probable; |
| · | The property is being actively marketed for sale at a reasonable price; and |
| · | Withdrawal or significant modification of the sale is not likely. |
Real Estate Held For Sale - Seller Financed
We occasionally finance sales of foreclosed properties to independent third parties. In order to record a sale of real estate when the seller is providing continued financing, FAS 66 - Accounting for Sales of Real Estate ("FAS 66'') requires the buyer of the real estate to make minimum initial and continuing investments. Minimum initial investments as defined by FAS 66 range from 10% to 25% based on the type of real estate sold. In addition, FAS 66 limits commitments and contingent obligations incurred by a seller in order to record a sale.
Because we occasionally foreclose on loans with raw land or developments in progress, available financing for such properties is often limited and we frequently provide financing up to 100% of the selling price on these properties. In addition, we may make additional loans to the buyer to continue development of a property. Although sale agreements are consummated at closing, they lack adequate initial investment by the buyer to qualify as a sales transaction as defined in FAS 66. These sale agreements are not recorded as a sale until the requirements of FAS 66 are met.
These sales agreements are recorded under the deposit method or cost recovery method as defined in FAS 66. Under the deposit method, no profit is recognized and any cash received from the buyer is reported as a deposit liability on the balance sheet. Under the cost recovery method, no profit is recognized until payments by the buyer exceed the carrying basis of the property sold. Principal payments received will reduce the related receivable, and interest collections will be recorded as unrecognized gross profit on the balance sheet. The carrying values of these properties are included in real estate held for sale on the accompanying consolidated balance sheets.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk, primarily from changes in interest rates. We do not deal in any foreign currencies and do not own any options, futures or other derivative instruments. We do not have a significant amount of debt.
Most of our assets consisted of investments in real estate loans, which from time to time include those that are financed under Inter-creditor Agreements. At December 31, 2006, our aggregate investment in real estate loans was approximately $221.8 million, net of allowance, with a weighted average effective interest rate of 10.94%. We had one loan financed under an Inter-creditor Agreement at December 31, 2006, which was classified as assets under secured borrowing totaling approximately $13.8 million. Most of the real estate loans had an initial term of 12 months. The weighted average term of outstanding loans, including extensions and loans related to seller financed real estate held for sale, at December 31, 2006 was 19 months. All but one of the outstanding real estate loans at December 31, 2006 were fixed rate loans. All of the real estate loans are held for investment purposes; none are held for sale. We intend to hold such real estate loans to maturity. None of the real estate loans had prepayment penalties and ten had an exit fee.
Market fluctuations in interest rates generally do not affect the carrying value of our investment in real estate loans. However, significant and sustained changes in interest rates could affect our operating results. If interest rates decline significantly, some of the borrowers could prepay their loans with the proceeds of a refinancing at lower interest rates. This would reduce our earnings and funds available for dividend distribution to stockholders. On the other hand, a significant increase in interest rates could result in a slowdown in real estate development activity that would reduce the demand for commercial real estate loans. As a result, we might encounter greater difficulty in identifying appropriate borrowers. We are not in a position to quantify the potential impact on our operating results from a material change in interest rates.
The following table contains information about the investment in real estate loans, including loans related to seller financed real estate held for sale held, in our portfolio as of December 31, 2006. The presentation aggregates the investment in real estate loans by their maturity dates for maturities occurring in each of the years 2007 through 2010 and thereafter and separately aggregates the information for all maturities arising after 2010. The carrying values of these assets approximate their fair value as of December 31, 2006.
| | | Interest Earning Assets Aggregated by Maturity at December 31, 2006 | |
Interest Earning Assets | | 2007 | | 2008 | | 2009 | | 2010 | | Thereafter | | Total | |
| | | | | | | | | | | | | | |
| Investments In Real Estate Loans | | $ | 242,395,000 | | $ | -- | | $ | -- | | $ | -- | | $ | -- | | $ | 242,395,000 | |
| | | | | | | | | | | | | | | | | | | | |
| Weighted Average Interest Rates | | | 10.94% | | | --% | | | --% | | | --% | | | --% | | | 10.94% | |
At December 31, 2006, we also had approximately $19.2 million invested in cash, cash equivalents, certificates of deposit, and marketable securities - related party (VRM I). Approximately 3% of our assets will be held in such accounts as a cash reserve; additional deposits in such accounts will be made as funds are received from investors and repayment of loans pending the deployment of such funds in new real estate loans. We believe that these financial assets do not give rise to significant interest rate risk due to their short-term nature.
The financial statements and supplementary data are indexed in Part IV, Item 15 Exhibits and Financial Statement Schedules of this Report Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required financial disclosure. In connection with the preparation of this Report on Form 10-K, our management carried out an evaluation, under the supervision and with the participation of the our management, including the CEO and CFO, as of December 31, 2006, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) under the Exchange Act. Based upon this evaluation, our CEO and CFO believe that these controls and procedures are adequate to ensure we are able to collect, process and disclose the information we are required to disclose in the reports it files with the SEC within the required time periods.
The certifications of the our Chief Executive Officer and Chief Financial Officer required under Section 302 of the Sarbanes-Oxley Act have been filed as Exhibits 31.1 and 31.2 to this report.
Management's Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for our Company, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes those policies and procedures that: pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of our Company; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of our Company are being made only in accordance with authorizations of management and directors of our Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our Company's assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management has conducted an assessment, including testing, of the effectiveness of our internal control over financial reporting as of December 31, 2006. In making its assessment of internal control over financial reporting, management used the criteria in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this assessment, management, with the participation of the Chief Executive and Chief Financial Officers, believes that, as of December 31, 2006, the Company’s internal control over financial reporting is effective based on those criteria.
Management's assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006 has been audited by Moore Stephens Wurth Frazer and Torbet, LLP, our independent registered public accounting firm, as stated in its report, which appears below in this Item 9A.
Changes in Internal Control Over Financial Reporting
Our management has not identified any changes in our internal controls over financial reporting during the Quarter ended December 31, 2006, that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting, except as discussed above.
Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within our company have been or will be detected. Even effective internal control over financial reporting can only provide reasonable assurance with respect to financial statement preparation. Furthermore, because of changes in conditions, the effectiveness of internal control over financial reporting may vary over time. Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our controls and procedures will prevent all errors.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Vestin Realty Mortgage II, Inc.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Vestin Realty Mortgage II, Inc., (the Company) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Vestin Realty Mortgage II’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Vestin Realty Mortgage II, Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Vestin Realty Mortgage II, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006 based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Vestin Realty Mortgage II, Inc., as of December 31, 2006 and 2005, and the related consolidated statements of operations, equity and other comprehensive income and its cash flows for the twelve months ended December 31, 2006, the six months ended December 31, 2005, and the years ended June 30, 2005 and 2004 and our report dated March 12, 2007 expressed an unqualified opinion on those consolidated financial statements.
/s/Moore Stephens Wurth Frazer and Torbet, LLP
Orange, California
March 12, 2007
None.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
We are managed on a day to day basis by Vestin Mortgage, a privately held company wholly owned by Vestin Group.
Directors and Executive Officers
The following table sets forth the names, ages as of December 31, 2006 and positions of the individuals who serve as our directors and executive officers:
Name | Age | Title |
| | | |
| Michael V. Shustek | 48 | President, Chief Executive Officer and Director |
| John W. Alderfer | 62 | Chief Financial Officer and Director |
| Robert J. Aalberts(1)(2)(3) | 55 | Director |
| Fredrick J. Zaffarese Leavitt(1)(2)(3) | 36 | Director |
| Roland M. Sansone(1)(2)(3) | 51 | Director |
| (1) | Member of the audit committee. |
| (2) | Member of the nominating committee. |
| (3) | Member of the compensation committee. |
The following table sets forth the names, ages as of January 31, 2007 and positions of the individuals who serve as directors and executive officers of Vestin Mortgage (our manager), Vestin Group, Vestin Originations or our affiliates:
Name | Age | Title |
| | | |
| Michael V. Shustek | 48 | President, Chief Executive Officer and Chairman |
| John W. Alderfer | 62 | Chief Financial Officer |
| James M. Townsend | 37 | Chief Operating Officer |
| Michael J. Whiteaker | 57 | Vice President of Regulatory Affairs |
| Daniel B. Stubbs | 45 | Senior Vice President |
| Maria Rocio Revollo | 45 | Corporate Controller |
Directors and Executive Officers of Vestin Realty Mortgage II, Vestin Mortgage (our manager), Vestin Group, Vestin Originations or our affiliates
Michael V. Shustek has been our Chief Executive Officer and Chairman of our Board of Directors since January 2006. He has been a director of our manager and Chairman of the Board of Directors, Chief Executive Officer and a director of Vestin Group since April 1999. In addition, Mr. Shustek has been the Direct and CEO of VRM II since January 2006. In February 2004, Mr. Shustek became the President of Vestin Group. Mr. Shustek also serves on the loan committee of our manager and its affiliates. In 2003, Mr. Shustek became the Chief Executive Officer of our manager. In 1995, Mr. Shustek founded Del Mar Mortgage, and has been involved in various aspects of the real estate industry in Nevada since 1990. In 1993, he founded Foreclosures of Nevada, Inc., a company specializing in non-judicial foreclosures. In 1993, Mr. Shustek also started Shustek Investments, a company that originally specialized in property valuations for third-party lenders or investors and which continues today as the primary vehicle for his private investment portfolio. In 1997, Mr. Shustek was involved in the initial founding of Nevada First Bank, with the largest initial capital base of any new state charter in Nevada’s history. Mr. Shustek has co-authored two books, entitled “Trust Deed Investments,” on the topic of private mortgage lending, and “If I Can Do It, So Can You.” Mr. Shustek is a guest lecturer at the University of Nevada, Las Vegas, where he also has taught a course in Real Estate Law and Ethics. Mr. Shustek received a Bachelor of Science degree in Finance at the University of Nevada, Las Vegas. See Item 3 Legal Proceedings, regarding legal matters involving our manager and Mr. Shustek.
John W. Alderfer has been our Chief Financial Officer and member of our Board of Directors since January 2006. He has served as the Chief Financial Officer of Vestin Group effective January 2005. In addition, Mr. Alderfer has been a Director and the CFO of VRM I since January 2006. Mr. Alderfer previously served as Chief Financial Officer of Vestin Group from September 2002 to February 2004. From February 2004 to December 2004, Mr. Alderfer served as a consultant to Vestin Group. From October 1998 to September 2002, Mr. Alderfer was retired. From September 1996 to October 1998, Mr. Alderfer was a Director, Vice President, Treasurer, and Chief Financial Officer of Interactive Flight Technologies, Inc. From September 1990 to June 1996, Mr. Alderfer was Senior Vice President, Treasurer, and Chief Financial Officer of Alliance Gaming Corporation. Mr. Alderfer is the former Senior Vice President, Corporate Controller and Chief Accounting Officer of Summa Corporation and The Hughes Corporation, 100% owned by the Estate of Howard R. Hughes. Mr. Alderfer received his BBA degree in accounting from Texas Tech University. He is a Certified Public Accountant.
James M. Townsend has served as the Chief Operating Officer of Vestin Group since January 2007. Mr. Townsend also serves on the loan committee of Vestin Mortgage and its affiliates. Mr. Townsend has over 15 years of experience in the securities industry. From February 2004 to September 2006, Mr. Townsend was the National Sales Manager of Samco Financial Services, Inc. From November 2003 to February 2004, Mr. Townsend was employed by Vestin Group as Manager of the Wholesale Division. From September 2002 to October of 2004, Mr. Townsend was National Sales Manager of Samco Financial Services, Inc. From February 1997 to July 2002, Mr. Townsend was employed by Donald & Co. Securities, Inc., as both a Sales Manager and the National Sales Manager. Mr. Townsend received a Bachelor of Science degree in Business Administration from The University of Texas at Dallas.
Michael J. Whiteaker has been Vice President of Regulatory Affairs of our manager and Vestin Group since May 1999. Mr. Whiteaker is experienced in the banking and finance regulatory fields, having most recently served with the State of Nevada, Financial Institution Division from 1982 to 1999 as its Supervisory Examiner, responsible for the financial and regulatory compliance audits of all financial institutions in Nevada. Mr. Whiteaker has worked extensively on matters pertaining to both state and federal statutes, examination procedures, policy determination and credit administration for commercial and real estate loans. From 1973 to 1982, Mr. Whiteaker was Assistant Vice President of Nevada National Bank, responsible for a variety of matters including loan review.
Daniel B. Stubbs has been the Senior Vice President of Underwriting and Secretary of our manager from January 2000 to July 2006, and has continued in that capacity in Vestin Originations since July 2006. Mr. Stubbs heads the loan department for our manager’s affiliates and is responsible for reviewing loan requests and performs due diligence necessary for risk analysis in connection with the underwriting process. In addition, Mr. Stubbs serves on the loan committee and acts as liaison for our manager and its affiliates with the various commercial loan participants. Mr. Stubbs has 15 years experience in the title insurance industry and has received a Bachelor of Arts degree in Communication Studies from the University of Nevada, Las Vegas.
Maria Rocio Revollo has been Corporate Controller of Vestin Group since June 2005. Ms. Revollo previously served as Corporate Controller for Sobel Westex from January 2002 through May 2005. From April 1999 to December 2001, Ms. Revollo was a financial consultant for Re:Source Connections. Ms. Revollo is a Certified Public Accountant and worked for the accounting firm of KPMG LLP. She received a Bachelor of Business Administration degree in Accounting and a Bachelor of Arts degree in Communication Studies from the University of Nevada, Las Vegas.
Unaffiliated Directors of Vestin Realty Mortgage II
The principal occupation and business experience for the independent and unaffiliated directors of Vestin Realty Mortgage II are as follows:
Robert J. Aalberts was a director of Vestin Group from April 1999 to December 2005. He has been a director of us and VRM I since January 2006. Since 1991, Professor Aalberts has held the Ernst Lied Professor of Legal Studies professorship in the College of Business at the University of Nevada, Las Vegas. From 1984 to 1991, Professor Aalberts was an Associate Professor of Business Law at Louisiana State University in Shreveport, Louisiana. From 1982 through 1984, he served as an attorney for Gulf Oil Company. Professor Aalberts has co-authored a book relating to the regulatory environment, law and business of real estate; including Real Estate Law 6th Ed. (2006) published by the Thomson/West Company. He is also the author of numerous legal articles, dealing with various aspects of real estate, business and the practice of law. Since 1992, Professor Aalberts has been the Editor-in-chief of the Real Estate Law Journal. Professor Aalberts received his Juris Doctor degree from Loyola University, in New Orleans, Louisiana, a Masters of Arts from the University of Missouri, Columbia, and received a Bachelor of Arts degree in Social Sciences, Geography from the Bemidji State University in Bemidji, Minnesota. He was admitted to the State Bar of Louisiana in 1982 (currently inactive status).
Fredrick J. Zaffarese Leavitt was a director for Vestin Group from November 2004 to December 2005. He has been a director of us and VRM I since January 2006. Since August of 1993 Mr. Zaffarese Leavitt has been an accountant for the United States Department of the Interior where his responsibilities include the review and audit of various states, local and municipality governments for compliance with federal laws and regulations as well as preparation of financial statements for Executive Branch and Congressional review. Additionally, Mr. Zaffarese Leavitt sits on various audit committees involving the utility industry. Mr. Zaffarese Leavitt is a CPA and a graduate of University of Nevada Las Vegas.
Roland M. Sansone was a director for Vestin Group from December 2004 to December 2005. He has been a director of us and VRM I since January 2006 and has served as President of Sansone Development, Inc. since 2002. Sansone Development, Inc. is a real estate development company. Mr. Sansone has been self-employed as a Manager and developer of real estate since 1980. Mr. Sansone is currently the president of several companies that develop, own and manage commercial and residential property. Mr. Sansone attended Mt. San Antonio College.
Board Composition
Our board of directors is authorized to have up to 15 directors. Our board of directors is currently comprised of five directors. In accordance with our articles of charter and bylaws, our board of directors is divided into three classes, class I, class II and class III, with each class serving staggered three-year terms. The members of the classes are divided as follows:
| · | The class I director is Mr. Zaffarese, and his term will expire at the 2007 annual meeting of stockholders; |
| · | The class II directors are Messrs, Alderfer and Sansone, and their terms will expire at the 2008 annual meeting of stockholders; and |
| · | The class III directors are Messrs, Aalberts and Shustek, and their terms will expire at the 2009 annual meeting of stockholders. |
The authorized number of directors may be changed only by resolution of the board of directors. Any additional directors resulting from an increase in the number of directors will be distributed between the three classes so that, as nearly as possible, each class will consist of one third of the directors. This classification of our board of directors may have the effect of delaying or preventing changes in our control or management. Our directors will hold office until their successors have been elected and qualified or until their earlier death, resignation, disqualification or removal for cause by the affirmative vote of the holders of at least a majority of our outstanding stock entitled to vote on election of directors.
Board Committees
Our board of directors have an audit committee, a nominating committee and a compensation committee. There are no family relationships among any of our directors or executive officers.
Audit Committee. The audit committee consists of Messrs, Aalberts, Zaffarese and Sansone. Our board of directors has determined that Mr. Zaffarese is an audit committee financial expert as defined under the applicable rules of the SEC and has the requisite financial sophistication as defined under the applicable Nasdaq stock market rules. Mr. Zaffarese is the Audit Committee Chairman. We believe the composition of our audit committee meets the criteria for independence under, and the functioning of our audit committee complies with applicable requirements of, the Sarbanes-Oxley Act of 2002, the current rules of the Nasdaq Stock Market and SEC rules and regulations. We intend to comply with future audit committee requirements as they become applicable to us.
Our audit committee oversees our accounting and financial reporting processes, internal systems of control, independent auditor relationships and the audits of our financial statements. This committee’s responsibilities include, among other things:
| · | selecting and hiring our independent auditors; |
| · | evaluating the qualifications, independence and performance of our independent auditors; |
| · | approving the audit and nonaudit services to be performed by our independent auditors; |
| · | reviewing the design, implementation, adequacy and effectiveness of our internal controls and our critical accounting policies; |
| · | overseeing and monitoring the integrity of our financial statements and our compliance with legal and regulatory requirements as they relate to financial statements or accounting matters; and |
| · | reviewing with management and our auditors any earnings announcements and other public announcements regarding our results of operations. |
Our independent auditors and internal financial personnel regularly meet privately with our audit committee and have unrestricted access to this committee.
Nominating Committee. The nominating committee consists of Messrs, Aalberts, Zaffarese and Sansone. Mr. Aalberts is the Nomination Chairman. We believe the composition of our nominating committee meets the criteria for independence under, and the functioning of our nominating committee complies with applicable requirements of, the Sarbanes-Oxley Act of 2002, the current rules of the Nasdaq Stock Market and SEC rules and regulations. There were no material changes to the procedures by which security holders may recommend nominees to our Board of Directors. We intend to comply with future nominating committee requirements as they become applicable to us.
Our nominating committee’s purpose is to assist our board of directors by identifying individuals qualified to become directors. This committee’s responsibilities include, among other things:
| · | evaluating the composition, size and governance of our board of directors and making recommendations regarding future planning and the appointment of directors; |
| · | establishing a policy for considering stockholder nominees for election to our board of directors; and |
| · | evaluating and recommending candidates for election to our board of directors. |
Compensation Committee The compensation committee consists of Messer, Aalberts, Zaffarese and Sansone. Mr. Sansone is the Compensation Chairman. We believe the composition of our compensation committee meets the criteria for independence under, and the functioning of our compensation committee complies with applicable requirements of, the Sarbanes-Oxley Act of 2002, the current rules of the Nasdaq Stock Market and SEC rules and regulations. We intend to comply with future compensation committee requirements as they become applicable to us.
Our compensation committee’s purpose is to assist our board of directors relating to compensation of the Company’s directors, executive officers and its sole manager, Vestin Mortgage, Inc.; and to produce as may be required an annual report on executive officer compensation. Subject to applicable provisions of our bylaws and the Management Agreement with our manager, the compensation committee is responsible for reviewing and approving compensation paid by us to our manager.
Director Compensation
Currently, our directors who are also employees of our manager receive no additional compensation for their services as directors. Our non-employee directors receive $500 for each board meeting and committee meeting they attend, whether in person or by phone, and are reimbursed for travel expenses and other out-of-pocket costs of attending board and committee meetings.
Code of Ethics
Our Board of Directors has adopted a Code of Business Conduct and Ethics that applies to all of our directors, officers and employees of our manager. The Code of Business Conduct and Ethics may be found on our web site at www.vestinrealtymortgage2.com.
We do not pay any compensation to our executive officers. We pay a management fee of up to 0.25% of the amounts raised by us and Fund II through the sale of shares or units. Payment of the management fee is reviewed by and subject to approval of our Compensation Committee. For the twelve months ended December 31, 2006, we paid our manager approximately $1.1 million for its management services, which represented less than 10% of the revenues received by our manager and its affiliates in 2006.
Our independent directors receive $500 for each board meeting and committee meeting they attend, whether in person or by phone, and are reimbursed for travel expenses and other out-of-pocket costs of attending board and committee meetings.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Shown below is certain information as of March 9, 2007, with respect to beneficial ownership, as that term is defined in Rule 13d-3 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), of shares of common stock by the only persons or entities known to us to be a beneficial owner of more than 5% of the outstanding shares of common stock. Unless otherwise noted, the percentage ownership is calculated based on 38,862,128 shares of our common stock as of March 9, 2007.
Name and Address of Beneficial Owner | | Amount and Nature of Beneficial Ownership | | Percent of Class |
| | | | | |
Comerica Bank One Detroit Center Detroit, MI 48275 | | Sole voting power of 2,720,606 shares with no dispositive power (1) | | 7.00% |
| (1) | Based upon a Schedule 13G, dated February 13, 2007, filed with the SEC by Comerica Bank, which is deemed to be the beneficial owner of 2,720,606 shares with sole voting power and no dispositive power. |
The following table sets forth the total number and percentage of our common stock beneficially owned as of March 9, 2007 by:
| · | our chief executive officer and our other executive officers; and |
| · | all executive officers and directors as a group. |
Unless otherwise noted, the percentage ownership is calculated based on 38,862,128 shares of our total outstanding common stock as of March 9, 2007.
| | | Common Shares Beneficially Owned |
Beneficial Owner | | Number | | Percent |
| | | | | |
| Michael V. Shustek (1) | | 330,717 | | ** |
| John W. Alderfer (3) | | 2,569 | | ** |
| James M. Townsend (2) (3) | | 307,558 | | ** |
| Robert J. Aalberts (3) | | 494 | | ** |
| Frederick J. Zaffarese Leavitt | | -- | | -- |
| Roland M. Sansone | | -- | | -- |
| All directors and executive officers as a group (6 persons) | | 641,338 | | 1.65% |
** Less than one percent of our total outstanding common stock.
| (1) | Includes 241,020 shares held by our manager and 89,697 shares held by Michael Shustek. Mr. Shustek is the Chairman, President and Chief Executive Officer of Vestin Mortgage and indirectly owns all of the capital stock of our manager through Vestin Group. Mr. Shustek has sole voting and investment power in all these shares. |
| (2) | Mr. Townsend became an officer of Vestin Group in January 2007. Mr. Townsend directly owns 139,074 shares and indirectly owns 168,484 shares through FMR Holdings, Inc., which is wholly owned by Mr. Townsend. |
| (3) | Except as otherwise indicated, and subject to applicable community property and similar laws, the persons listed as beneficial owners of the shares have sole voting and investment power with respect to such shares. |
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
From time to time, we may acquire or sell investments in real estate loans from/to our manager or other related parties pursuant to the terms of our Management Agreement provided the price does not exceed the par value. No gain or loss is recorded on these transactions, as it is not our intent to make a profit on the purchase or sale of such investments. The purpose is generally to diversify our portfolio by syndicating loans, thereby providing us with additional capital to make additional loans.
Transactions with the Manager
Our manager is entitled to receive from us an annual management fee of up to 0.25% of our aggregate capital contributions received by us and Fund II from the sale of shares or membership units, paid monthly. The amount of management fees paid to our manager for the twelve months ended December 31, 2006 was approximately $1.1 million.
As of December 31, 2006, our manager owned 241,020 of our common shares. For the twelve months ended December 31, 2006, we incurred $46,000 in dividends payable to our manager based on the number of shares they held on the dividend record dates and we recorded pro-rata distributions owed to our manager of $16,000.
Transactions with Other Related Parties
As of December 31, 2006, we owned 407,485 common shares of VRM I, representing approximately 5.93% of their total outstanding common stock. On November 29, 2006, we filed the required Schedule 13D with the SEC. For the twelve months ended December 31, 2006 we recognized $72,000 in dividends from VRM I based on the number of shares we held on the dividend record dates.
As of December 31, 2006, VRM I owned 372,655 of our common shares, representing approximately 0.96% of our total outstanding common stock. For the twelve months ended December 31, 2006, we incurred $151,000 in dividends payable to VRM I based on the number of shares they held on the dividend record dates.
During the twelve months ended December 31, 2006 we bought approximately $1.4 million in real estate loans from VRM I and sold approximately $0.5 million in real estate loans to VRM I. No gain or loss resulted from these transactions.
As of December 31, 2006, Fund III owned 158,191 of our common shares. For the twelve months ended December 31, 2006, we incurred $47,000 in dividends payable to Fund III based on the number of shares they held on the dividend record dates.
During the twelve months ended December 31, 2006, we purchased $4.9 million in real estate loans from Fund III. In addition, during the twelve months period ended December 31 2006, we sold $6.0 million in real estate loans to Fund III. No gain or loss resulted from these transactions.
During January 2006, Michael V. Shustek, the manager’s CEO, purchased a $2 million trust deed investment from us, of which, the total balance of $2 million was repurchased by us. No gain or loss resulted from these transactions.
During the twelve months ended December 31, 2006, we purchased $556,000 in performing real estate loans from LTD, a company wholly owned by our CEO Michael V. Shustek. No gain or loss resulted from these transactions.
As of December 31, 2006, Vestin Originations owed us $31,000 related to a loan payment by a borrower. We received the payment from Vestin Originations on January 2, 2007.
For the twelve months ended December 31, 2006, we incurred $88,000 for legal fees to the law firm of Levine, Garfinkel & Katz in which the Secretary of Vestin Group has an equity ownership interest in the law firm.
During the twelve months ended December 31, 2006 and 2005, Moore Stephens Wurth Frazer and Torbet, LLP (“Moore Stephens”) provided various audit, audit related and non-audit services to us as follows:
| | | December 31, 2006 | | December 31, 2005 | |
| Audit Fees | | $ | 412,000 | | $ | 455,000 | |
| Audit Related Fees | | $ | -- | | $ | -- | |
| Tax Fees | | $ | -- | | $ | -- | |
| All Other Fees | | $ | -- | | $ | -- | |
Our Audit Committee has considered whether provision of the services described regarding audit related fees, tax fees and all other fees above were compatible with maintaining the independent accountant’s independence and has determined that such services did not adversely affect Moore Stephens’ independence.
The Audit Committee has direct responsibility to review and approve the engagement of the independent auditors to perform audit services or any permissible non-audit services. All audit and non-audit services to be provided by the independent auditors must be approved in advance by the Audit Committee. The Audit Committee may not engage the independent auditors to perform specific non-audit services proscribed by law or regulation. All services performed by our independent auditors under engagements entered into on or after May 6, 2003, were approved by the Audit Committee or, prior to April 1, 2006, by the Audit Committee of Vestin Group, pursuant to our pre-approval policy, and none was approved pursuant to the de minimus exception to the rules and regulations of the Securities Exchange Act of 1934, Section 10A(i)(1)(B), on pre-approval.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) 1. Financial Statements
The financial statement are contained on Pages F-2 through F-31 on this Annual Report on Form 10-K, and the list of the financial statements contained herein is set forth on page F-1, which is hereby incorporated by reference.
(a) 2. Financial Statement Schedules
(a) 3. Exhibits
Exhibit No. | | Description of Exhibits |
| 2.1(3) | | Agreement and Plan of Merger between Vestin Fund II, LLC and the Registrant |
| 3.1(3) | | Articles of Incorporation of the Registrant |
| 3.2(3) | | Bylaws of the Registrant |
| 3.3(3) | | Form of Articles Supplementary of the Registrant |
| 4.1(3) | | Reference is made to Exhibits 3.1, 3.2 and 3.3 |
| 4.2(4) | | Specimen Common Stock Certificate |
| 4.3(3) | | Form of Rights Certificate |
| 10.1(3) | | Form of Management Agreement between Vestin Mortgage, Inc. and the Registrant |
| 10.2(3) | | Form of Rights Agreement between the Registrant and the rights agent |
| 10.3(1) | | Assignment Agreement, dated January 23, 2004, by and between Vestin Mortgage, Inc., Vestin Fund I, LLC, Vestin Fund III, LLC, Owens Financial Group, Inc. and Owens Mortgage Investment Fund |
| 10.4(1) | | Intercreditor Agreement, dated January 17, 2003, by and among Vestin Mortgage, Inc., Vestin Fund I, LLC, Vestin Fund III, LLC and Western United Life Assurance Company |
| 10.5(1) | | Intercreditor Agreement, dated April 22, 2004, by and between Vestin Mortgage, Inc. and Owens Mortgage Investment Fund |
| 10.6(1) | | Intercreditor Agreement, dated June 24, 2004, by and between Vestin Mortgage, Inc. and Owens Mortgage Investment Fund |
| 10.7(1) | | Participation Agreement, dated May 13, 2004, by and among the Registrant, Vestin Fund I, LLC, Vestin Fund III, LLC and Royal Bank of America |
| 10.8(6) | | Intercreditor Agreement, dated October 13, 2006, by and between Vestin Originations, Inc., Vestin Mortgage, Inc. Vestin Realty Mortgage I, Inc., Vestin Realty Mortgage II, Inc., Vestin Fund III, LLC, Owens Financial Group, Inc. and Owens Mortgage Investment Fund |
| 21.1(4) | | List of subsidiaries of the Registrant |
| | |
| | |
| | |
| 99.2R(5) | | Vestin Realty Mortgage II, Inc. Code of Business Conduct and Ethics |
| (1) | | Incorporated herein by reference to our Form S-4 Registration Statement filed on May 20, 2005 (File No. 333-125121). | |
| (2) | | Incorporated herein by reference to Post-Effective Amendment No. 5 to our Form S-4 Registration Statement filed on December 20, 2005 (File No. 333-125121). | |
| (3) | | Incorporated herein by reference to Post-Effective Amendment No. 6 to our Form S-4 Registration Statement filed on January 4, 2006 (File No. 333-125121). | |
| (4) | | Incorporated herein by reference to Post-Effective Amendment No. 7 to our Form S-4 Registration Statement filed on January 13, 2006 (File No. 333-125121). | |
| (5) | | Incorporated herein by reference to the Transition Report on Form 10-K for the nine month transition period ended March 31, 2006 filed on September 7, 2006 (File No. 000-51892) | |
| (6) | | Incorporated herein by reference to the Quarterly Report on Form 10-Q for the three months ended September 30, 2006 filed on October 26, 2006 (File No. 000-51892) | |
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | Vestin Realty Mortgage II, Inc. (successor to Vestin Fund II, LLC) |
| | | |
| | By: | /s/ Michael V. Shustek |
| | | Michael V. Shustek |
| | | President and Chief Executive Officer |
| | Date: | March 13, 2007 |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | | Capacity | | Date |
| | | | | |
/s/ Michael V. Shustek | | President and Chief Executive Officer and Director | | March 13, 2007 |
| Michael V. Shustek | | (Principal Executive Officer) | | |
| | | | | |
/s/ John W. Alderfer | | Chief Financial Officer and Director | | March 13, 2007 |
| John W. Alderfer | | (Principal Financial and Accounting Officer) | | |
| | | | | |
/s/ Robert J. Aalberts | | Director | | March 13, 2007 |
| Robert J. Aalberts | | | | |
| | | | | |
/s/ Fredrick J. Zaffarese Leavitt | | Director | | March 13, 2007 |
| Fredrick J. Zaffarese Leavitt | | | | |
| | | | | |
/s/ Roland M. Sansone | | Director | | March 13, 2007 |
| Roland M. Sansone | | | | |
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To Board of Directors and Stockholders of Vestin Realty Mortgage II, Inc.
We have audited the accompanying consolidated balance sheets of Vestin Realty Mortgage II, Inc., (“the Company”) as of December 31, 2006 and 2005 and related consolidated statements of operations, equity and other comprehensive income and its cash flows for the twelve months ended December 31, 2006, the six months ended December 31, 2005, and the years ended June 30, 2005 and 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vestin Realty Mortgage II, Inc. as of December 31, 2006 and 2005 and the results of its operations and its cash flows for the twelve months ended December 31, 2006, the six months ended December 31, 2005, and for the years ended June 30, 2005 and 2004 in conformity with accounting principles generally accepted in the United States of America. Our audits were conducted for the purpose of forming an opinion on the consolidated financial statements taken as a whole. The supplemental schedules are presented for purposes of additional analysis and are not a required part of the consolidated financial statements. Such information has been subjected to the auditing procedures applied in our audits of the consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the consolidated financial statements taken as a whole.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Vestin Realty Mortgage II, Inc’s. internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 12, 2007, expressed an unqualified opinion thereon.
/s/Moore Stephens Wurth Frazer and Torbet, LLP
Orange, California
March 12, 2007
| |
(SUCCESSOR TO VESTIN FUND II, LLC) | |
| | |
CONSOLIDATED BALANCE SHEETS | |
| | |
ASSETS | |
| | |
| | | December 31, 2006 | | December 31, 2005 | |
| | | | | | |
| Assets | | | | | |
| Cash | | $ | 16,841,000 | | $ | 39,633,000 | |
| Certificates of deposit | | | 250,000 | | | 1,000,000 | |
| Investment in marketable securities | | | -- | | | 7,260,000 | |
| Investment in marketable securities - related party | | | 2,087,000 | | | -- | |
| Interest and other receivables, net of allowance of $160,000 at December 31, 2006 and $693,000 at December 31, 2005 | | | 2,709,000 | | | 3,079,000 | |
| Note receivable, net of allowance of $2,000,000 at December 31, 2006 and $2,158,000 at December 31, 2005 | | | 282,000 | | | 810,000 | |
| Real estate held for sale | | | 30,079,000 | | | 38,639,000 | |
| Real estate held for sale - seller financed | | | 14,774,000 | | | 22,887,000 | |
| Investment in real estate loans, net of allowance for loan losses of $9,828,000 at December 31, 2006 and $4,724,000 at December 31, 2005 | | | 221,849,000 | | | 227,875,000 | |
| Due from Manager - related party | | | -- | | | 325,000 | |
| Due from Vestin Originations - related party | | | 31,000 | | | -- | |
| Assets under secured borrowings | | | 13,796,000 | | | 19,754,000 | |
| Other assets | | | 344,000 | | | 687,000 | |
| | | | | | | | |
| Total assets | | $ | 303,042,000 | | $ | 361,949,000 | |
| |
LIABILITIES, STOCKHOLDERS' EQUITY & MEMBERS' EQUITY |
| |
| Liabilities | | | | | | | |
| Accounts payable and accrued liabilities | | $ | 687,000 | | $ | 306,000 | |
| Secured borrowings | | | 13,796,000 | | | 19,754,000 | |
| Note payable | | | 27,000 | | | 25,884,000 | |
| Deposit liability | | | 5,514,000 | | | 865,000 | |
| Unearned revenue | | | 454,000 | | | -- | |
| Dividend payable | | | 4,078,000 | | | -- | |
| | | | | | | | |
| Total liabilities | | | 24,556,000 | | | 46,809,000 | |
| | | | | | | | |
| Commitments and Contingences | | | | | | | |
| | | | | | | | |
| Members’ equity - authorized 50,000,000 units at $10 per unit, 32,937,162 units issued and outstanding at December 31, 2005 | | | -- | | | 315,122,000 | |
| Stockholders' equity | | | | | | | |
| Preferred stock, $0.0001 par value; 1,000,000 shares authorized; none issued | | | -- | | | -- | |
| Common stock, $0.0001 par value; 100,000,000 shares authorized; 38,839,710 shares issued and outstanding at December 31, 2006 | | | 4,000 | | | -- | |
| Additional paid in capital | | | 277,853,000 | | | -- | |
| Retained earnings | | | 1,242,000 | | | -- | |
| Accumulated other comprehensive income (loss) | | | (613,000 | ) | | 18,000 | |
| | | | | | | | |
| Total stockholders' equity & members' equity | | | 278,486,000 | | | 315,140,000 | |
| | | | | | | | |
| Total liabilities and stockholders' equity & members’ equity | | $ | 303,042,000 | | $ | 361,949,000 | |
The accompanying notes are an integral part of these consolidate statements.
VESTIN REALTY MORTGAGE II, INC. | |
(SUCCESSOR TO VESTIN FUND II, LLC) | |
| | |
CONSOLIDATED STATEMENTS OF INCOME | |
| | |
| | | For the Twelve Months Ended | | For the Six Months Ended | | For the Six Months Ended | | For the Year Ended | | For the Year Ended | |
| | | 12/31/2006 | | 12/31/2005 | | 12/31/2004 | | 6/30/2005 | | 6/30/2004 | |
| | | | | | | (Unaudited) | | | | | |
Revenues | | | | | | | | | | | |
| Interest income from investment in real estate loans | | $ | 21,718,000 | | $ | 11,301,000 | | $ | 14,388,000 | | $ | 25,301,000 | | $ | 38,825,000 | |
| Adjustment to allowance for loan losses | | | -- | | | | | | -- | | | 41,000 | | | -- | |
| Gain on sale marketable securities | | | 21,000 | | | 203,000 | | | -- | | | -- | | | -- | |
| Dividend income - related party | | | 72,000 | | | -- | | | -- | | | -- | | | -- | |
| Interest income from banking institutions | | | 1,333,000 | | | 287,000 | | | 249,000 | | | 409,000 | | | 365,000 | |
| Other income | | | 335,000 | | | 437,000 | | | 1,562,000 | | | 2,207,000 | | | 1,946,000 | |
| Total revenues | | | 23,479,000 | | | 12,228,000 | | | 16,199,000 | | | 27,958,000 | | | 41,136,000 | |
| | | | | | | | | | | | | | | | | |
Operating expenses | | | | | | | | | | | | | | | | |
| Management fees - related party | | | 1,096,000 | | | 546,000 | | | 515,000 | | | 1,060,000 | | | 1,025,000 | |
| Provision for loan loss | | | 5,500,000 | | | -- | | | 167,000 | | | 2,775,000 | | | 2,605,000 | |
| Interest expense | | | 1,446,000 | | | 412,000 | | | 2,441,000 | | | 3,526,000 | | | 5,681,000 | |
| Professional fees | | | 1,219,000 | | | 116,000 | | | 154,000 | | | 996,000 | | | 626,000 | |
| Professional fees - related party | | | 88,000 | | | 127,000 | | | 108,000 | | | 206,000 | | | 50,000 | |
| Provision of doubtful accounts related to receivable | | | 329,000 | | | 183,000 | | | -- | | | -- | | | 80,000 | |
| Other | | | 946,000 | | | 130,000 | | | 25,000 | | | 167,000 | | | 102,000 | |
| Total operating expenses | | | 10,624,000 | | | 1,514,000 | | | 3,410,000 | | | 8,730,000 | | | 10,169,000 | |
| | | | | | | | | | | | | | | | | |
Income from Operations | | | 12,855,000 | | | 10,714,000 | | | 12,789,000 | | | 19,228,000 | | | 30,967,000 | |
| | | | | | | | | | | | | | | | | |
Income from real estate held for sale | | | | | | | | | | | | | | | | |
| Revenue related to real estate held for sale | | | 4,101,000 | | | 2,311,000 | | | -- | | | -- | | | 2,333,000 | |
| Net gain (loss) on sale of real estate held for sale | | | 1,517,000 | | | 47,000 | | | 758,000 | | | (172,000 | ) | | -- | |
| Gain on sale of real estate held for sale - seller financed | | | 2,293,000 | | | 1,079,000 | | | -- | | | -- | | | -- | |
| Expenses related to real estate held for sale | | | (4,915,000 | ) | | (3,607,000 | ) | | (1,538,000 | ) | | (2,784,000 | ) | | (1,559,000 | ) |
| Write downs on real estate held for sale | | | -- | | | -- | | | (123,000 | ) | | (7,384,000 | ) | | (10,000 | ) |
| Total income (loss) from real estate held for sale | | | 2,996,000 | | | (170,000 | ) | | (903,000 | ) | | (10,340,000 | ) | | 764,000 | |
| | | | | | | | | | | | | | | | | |
| Income before provision for income taxes | | | 15,851,000 | | | 10,544,000 | | | 11,886,000 | | | 8,888,000 | | | 31,731,000 | |
| | | | | | | | | | | | | | | | | |
| Provision for income taxes | | | -- | | | -- | | | -- | | | -- | | | -- | |
| | | | | | | | | | | | | | | | | |
NET INCOME | | $ | 15,851,000 | | $ | 10,544,000 | | $ | 11,886,000 | | $ | 8,888,000 | | $ | 31,731,000 | |
| | | | | | | | | | | | | | | | | |
| Basic and diluted earnings per common weighted average share / membership unit | | $ | 0.41 | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Dividends declared per common share / cash distributions per membership unit | | $ | 0.58 | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Net income per weighted average membership unit | | | | | $ | 0.25 | | $ | 0.25 | | $ | 0.20 | | $ | 0.66 | |
| | | | | | | | | | | | | | | | | |
| Weighted average common shares / membership units | | | 38,832,458 | | | 42,747,725 | | | 47,756,928 | | | 45,188,004 | | | 47,729,256 | |
The accompanying notes are an integral part of these consolidate statements.
|
(SUCCESSOR TO VESTIN FUND II, LLC) |
| |
CONSOLIDATED STATEMENTS OF EQUITY & OTHER COMPREHENSIVE INCOME |
| |
| | | | | Common Stock | | | | | | | | | | |
| | | Membership Units | | Number of Shares | | Amount | | Additional Paid-in-Capital | | Retained Earnings | | Accumulated Other Comprehensive Loss | | Members' Equity | | Total |
Members' Equity at June 30, 2003 | | 50,183,702 | | -- | $ | -- | $ | -- | $ | -- | $ | -- | $ | 375,189,000 | $ | 375,189,000 |
| | | | | | | | | | | | | | | | | |
| Net Income | | | | | | | | | | | | | | 31,731,000 | | 31,731,000 |
| Issuance of Units | | 3,468,010 | | | | | | | | | | | | 26,677,000 | | 26,677,000 |
| Distributions to Members | | | | | | | | | | | | | | (29,097,000) | | (29,097,000) |
| Reinvestment of Distributions | | 1,016,990 | | | | | | | | | | | | 7,823,000 | | 7,823,000 |
| Members' Redemptions | | (6,823,282) | | | | | | | | | | | | (51,254,000) | | (51,254,000) |
| | | | | | | | | | | | | | | | | |
Members' Equity at June 30, 2004 | | 47,845,420 | | -- | $ | -- | $ | -- | $ | -- | $ | -- | $ | 361,069,000 | $ | 361,069,000 |
| | | | | | | | | | | | | | | | | |
| Comprehensive Income: | | | | | | | | | | | | | | | | |
| Net Income | | | | | | | | | | | | | | 8,888,000 | | 8,888,000 |
| Unrealized Loss on Marketable Securities | | | | | | | | | | | | (804,000) | | | | (804,000) |
| Total Comprehensive Income | | | | | | | | | | | | | | | | 8,084,000 |
| | | | | | | | | | | | | | | | | |
| Capital Contribution from Manager | | | | | | | | | | | | | | 1,984,000 | | 1,984,000 |
| Distributions to Members | | | | | | | | | | | | | | (20,113,000) | | (20,113,000) |
| Reinvestment of Distributions | | 515,600 | | | | | | | | | | | | 3,966,000 | | 3,966,000 |
| Members' Redemptions | | (5,707,304) | | | | | | | | | | | | (43,910,000) | | (43,910,000) |
| | | | | | | | | | | | | | | | | |
Members' Equity at June 30, 2005 | | 42,653,716 | | -- | $ | -- | $ | -- | $ | -- | $ | (804,000) | $ | 311,884,000 | $ | 311,080,000 |
| | | | | | | | | | | | | | | | | |
| Comprehensive Income: | | | | | | | | | | | | | | | | |
| Net Income | | | | | | | | | | | | | | 10,544,000 | | 10,544,000 |
| Reversal of Unrealized Loss on Marketable Securities | | | | | | | | | | | | 804,000 | | | | 804,000 |
| Unrealized Gain on Marketable Securities | | | | | | | | | | | | 18,000 | | | | 18,000 |
| Total Comprehensive Income | | | | | | | | | | | | | | | | 11,366,000 |
| | | | | | | | | | | | | | | | | |
| Distributions to Members | | | | | | | | | | | | | | (8,586,000) | | (8,586,000) |
| Reinvestment of Distributions | | 164,729 | | | | | | | | | | | | 1,281,000 | | 1,281,000 |
| Members' Redemptions | | (135) | | | | | | | | | | | | (1,000) | | (1,000) |
| | | | | | | | | | | | | | | | | |
Members' Equity at December 31, 2005 | | 42,818,310 | | -- | $ | -- | $ | -- | $ | -- | $ | 18,000 | $ | 315,122,000 | $ | 315,140,000 |
| | | | | | | | | | | | | | | | | |
| Comprehensive Income: | | | | | | | | | | | | | | | | |
| Net Income (Loss) | | | | | | | | | | 17,561,000 | | | | (1,710,000) | | 15,851,000 |
| Reversal of Unrealized Gain on Marketable Securities | | | | | | | | | | | | (18,000) | | | | (18,000) |
| Unrealized Loss on Marketable Securities - Related Party | | | | | | | | | | | | (613,000) | | | | (613,000) |
| Total Comprehensive Income | | | | | | | | | | | | | | | | 15,220,000 |
| | | | | | | | | | | | | | | | | |
| Distributions to Members | | | | | | | | | | | | | | (6,073,000) | | (6,073,000) |
| Reinvestment of Distributions | | 98,489 | | | | | | | | | | | | 742,000 | | 742,000 |
| Members' Redemptions | | (4,126,824) | | | | | | | | | | | | (30,459,000) | | (30,459,000) |
| | | | | | | | | | | | | | | | | |
| Reclassify members' equity to stockholders' equity | | (38,789,975) | | 38,789,975 | | 3,000 | | 277,619,000 | | | | | | (277,622,000) | | -- |
| | | | | | | | | | | | | | | | | |
| Dividends to Stockholder | | | | | | | | | | (16,319,000) | | | | | | (16,319,000) |
| Reinvestment of Dividends | | | | 49,735 | | 1,000 | | 234,000 | | | | | | | | 235,000 |
| | | | | | | | | | | | | | | | | |
Stockholders' Equity at December 31, 2006 | | -- | | 38,839,710 | $ | 4,000 | $ | 277,853,000 | $ | 1,242,000 | $ | (613,000) | $ | -- | $ | 278,486,000 |
The accompanying notes are an integral part of these consolidate statements.
VESTIN REALTY MORTGAGE II, INC. | |
(SUCCESSOR TO VESTIN FUND II, LLC) | |
| | |
CONSOLIDATED STATEMENTS OF CASH FLOWS | |
| | |
| | | For the Twelve Months Ended | | For the Six Months Ended | | For the Six Months Ended | | For the Year Ended | | For the Year Ended | |
| | | 12/31/2006 | | 12/31/2005 | | 12/31/2004 | | 6/30/2005 | | 6/30/2004 | |
| | | | | | | (Unaudited) | | | | | |
Cash flows from operating activities: | | | | | | | | | | | |
| Net income | | $ | 15,851,000 | | $ | 10,544,000 | | $ | 11,886,000 | | $ | 8,888,000 | | $ | 31,731,000 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | -- | | | | | | | | | | | | | |
| Provision of doubtful accounts related to receivable | | | 329,000 | | | 183,000 | | | 167,000 | | | -- | | | -- | |
| Gain /loss on sale of marketable securities | | | (21,000 | ) | | (203,000 | ) | | -- | | | -- | | | -- | |
| Write down of real estate held for sale | | | -- | | | -- | | | 123,000 | | | 7,384,000 | | | 10,000 | |
| Gain on sale of real estate held for sale | | | (2,014,000 | ) | | (47,000 | ) | | (758,000 | ) | | (760,000 | ) | | -- | |
| Loss on sale of real estate held for sale | | | 497,000 | | | -- | | | -- | | | 932,000 | | | -- | |
| Gain on sale of real estate held for sale - seller financed | | | (2,293,000 | ) | | (1,079,000 | ) | | -- | | | -- | | | -- | |
| Provision for loan loss | | | 5,500,000 | | | -- | | | -- | | | 2,775,000 | | | 2,605,000 | |
| Adjustment to allowance for loan losses | | | -- | | | -- | | | -- | | | (41,000 | ) | | -- | |
| Amortized interest income | | | (1,328,000 | ) | | (272,000 | ) | | -- | | | 402,000 | | | -- | |
| Interest income accrued to loan balance | | | -- | | | -- | | | 280,000 | | | -- | | | -- | |
| Change in operating assets and liabilities: | | | -- | | | | | | | | | | | | | |
| Interest and other receivables | | | 273,000 | | | 420,000 | | | 680,000 | | | 216,000 | | | (444,000 | ) |
| Due to/from Manager | | | 325,000 | | | (539,000 | ) | | (199,000 | ) | | (289,000 | ) | | (1,072,000 | ) |
| Due to/from Vestin Group | | | -- | | | (1,000 | ) | | (354,000 | ) | | (384,000 | ) | | (23,000 | ) |
| Due to/from Vestin Originations | | | (31,000 | ) | | -- | | | -- | | | -- | | | -- | |
| Due to/from VRM I | | | -- | | | 1,560,000 | | | 1,483,000 | | | 1,427,000 | | | (2,771,000 | ) |
| Note receivable from VRM I | | | -- | | | -- | | | 4,278,000 | | | 4,278,000 | | | -- | |
| Prepaid expenses | | | 343,000 | | | (667,000 | ) | | -- | | | (20,000 | ) | | -- | |
| Accounts payable and accrued liabilities | | | 381,000 | | | (842,000 | ) | | 143,000 | | | 811,000 | | | 219,000 | |
| Net cash provided by operating activities | | | 17,812,000 | | | 9,057,000 | | | 17,729,000 | | | 25,619,000 | | | 30,255,000 | |
The accompanying notes are an integral part of these consolidate statements.
VESTIN REALTY MORTGAGE II, INC. | |
(SUCCESSOR TO VESTIN FUND II, LLC) | |
| | |
CONSOLIDATED STATEMENTS OF CASH FLOWS | |
| | |
| | | For the Twelve Months Ended | | For the Six Months Ended | | For the Six Months Ended | | For the Year Ended | | For the Year Ended | |
| | | 12/31/2006 | | 12/31/2005 | | 12/31/2004 | | 6/30/2005 | | 6/30/2004 | |
| | | | | | | (Unaudited) | | | | | |
Cash flows from investing activities: | | | | | | | | | | | |
| Investments in real estate loans | | $ | (202,748,000 | ) | $ | (104,346,000 | ) | $ | (42,380,000 | ) | $ | (77,218,000 | ) | $ | (215,225,000 | ) |
| Purchase of investments in real estate loans including interest receivable | | | -- | | | (10,065,000 | ) | | -- | | | -- | | | -- | |
| Purchase of investments in real estate loans from: | | | -- | | | | | | | | | | | | | |
| VRM I | | | (1,350,000 | ) | | (7,600,000 | ) | | -- | | | -- | | | (10,000,000 | ) |
| Fund III | | | (4,900,000 | ) | | (500,000 | ) | | (5,000,000 | ) | | (10,000,000 | ) | | -- | |
| Other related parties | | | (2,556,000 | ) | | (11,824,000 | ) | | -- | | | (2,700,000 | ) | | -- | |
| Third Party | | | (23,000,000 | ) | | (1,334,000 | ) | | (11,000,000 | ) | | (27,058,000 | ) | | (32,653,000 | ) |
| Proceeds from loan payoff | | | 203,106,000 | | | 103,858,000 | | | 105,546,000 | | | 136,158,000 | | | 183,048,000 | |
| Sale of investments in real estate loans to: | | | -- | | | | | | | | | | | | | |
| VRM I | | | 500,000 | | | -- | | | -- | | | 600,000 | | | 806,000 | |
| Fund III | | | 6,000,000 | | | -- | | | -- | | | 5,000,000 | | | 10,000,000 | |
| Other related parties | | | 2,000,000 | | | 7,000,000 | | | -- | | | 4,000,000 | | | -- | |
| Third party | | | 175,000 | | | 10,000,000 | | | 4,533,000 | | | 17,033,000 | | | 77,928,000 | |
| Proceeds from investment in real estate held for sale | | | 35,553,000 | | | 4,767,000 | | | 12,542,000 | | | 16,397,000 | | | 3,754,000 | |
| Principal payments on real estate held for sale - seller financed | | | 8,113,000 | | | 9,635,000 | | | -- | | | -- | | | -- | |
| Allowance for investment in real estate loan losses, related to legal expense | | | (906,000 | ) | | -- | | | -- | | | -- | | | -- | |
| Repayment of secured borrowings | | | -- | | | -- | | | -- | | | -- | | | (2,442,000 | ) |
| Proceeds from note receivable | | | 686,000 | | | 89,000 | | | -- | | | -- | | | -- | |
| Notes receivable | | | -- | | | (154,000 | ) | | | | | | | | | |
| Recovery of allowance for doubtful notes receivable | | | (487,000 | ) | | (89,000 | ) | | | | | | | | | |
| Purchase of marketable securities | | | -- | | | (14,827,000 | ) | | (25,993,000 | ) | | (31,942,000 | ) | | -- | |
| Purchase of marketable securities - related party | | | (2,700,000 | ) | | -- | | | -- | | | 565,000 | | | -- | |
| Proceeds from sale of marketable securities | | | 7,263,000 | | | 16,354,000 | | | -- | | | -- | | | -- | |
| Purchase of fixed asset | | | -- | | | -- | | | -- | | | (7,000 | ) | | -- | |
| Purchase of investments in certificates of deposit | | | (17,061,000 | ) | | -- | | | -- | | | -- | | | (265,000 | ) |
| Proceeds from investments in certificates of deposit | | | 17,811,000 | | | -- | | | 1,425,000 | | | 1,425,000 | | | 8,915,000 | |
| Cash outlays for real estate held for sale | | | -- | | | -- | | | (177,000 | ) | | (177,000 | ) | | (455,000 | ) |
| Unearned revenue proceeds related to loan restructuring | | | 608,000 | | | -- | | | -- | | | -- | | | -- | |
| Deposit liability | | | 6,942,000 | | | 468,000 | | | 432,000 | | | 991,000 | | | 381,000 | |
| Net cash provided by investing activities | | $ | 33,049,000 | | $ | 1,432,000 | | $ | 39,928,000 | | $ | 33,067,000 | | $ | 23,792,000 | |
The accompanying notes are an integral part of these consolidate statements.
VESTIN REALTY MORTGAGE II, INC. | |
(SUCCESSOR TO VESTIN FUND II, LLC) | |
| | |
CONSOLIDATED STATEMENTS OF CASH FLOWS | |
| | |
| | | For the Twelve Months Ended | | For the Six Months Ended | | For the Six Months Ended | | For the Year Ended | | For the Year Ended | |
| | | 12/31/2006 | | 12/31/2005 | | 12/31/2004 | | 6/30/2005 | | 6/30/2004 | |
Cash flows from financing activities: | | | | | | (Unaudited) | | | | | |
| Payment on line of credit | | $ | -- | | $ | -- | | $ | -- | | $ | -- | | $ | (2,000,000 | ) |
| Payment on note payable | | | (25,857,000 | ) | | -- | | | -- | | | -- | | | -- | |
| Proceeds from issuance of note payable | | | -- | | | 25,884,000 | | | -- | | | -- | | | -- | |
| Dividends to stockholders, net of reinvestments | | | (11,906,000 | ) | | -- | | | -- | | | -- | | | -- | |
| Dividends to stockholders - related party | | | (100,000 | ) | | -- | | | -- | | | -- | | | -- | |
| Proceeds from issuance of membership units | | | -- | | | -- | | | -- | | | -- | | | 26,677,000 | |
| Members' distributions, net of reinvestments | | | (5,315,000 | ) | | (7,276,000 | ) | | (8,722,000 | ) | | (16,086,000 | ) | | (21,195,000 | ) |
| Members' distributions - related party | | | (16,000 | ) | | (29,000 | ) | | (15,000 | ) | | (61,000 | ) | | (79,000 | ) |
| Members' redemptions | | | (30,459,000 | ) | | (1,000 | ) | | (8,090,000 | ) | | (43,910,000 | ) | | (51,254,000 | ) |
| Net cash used in financing activities | | | (73,653,000 | ) | | 18,578,000 | | | (16,827,000 | ) | | (60,057,000 | ) | | (47,851,000 | ) |
| | | | | | | | | | | | | | | | | |
NET CHANGE IN CASH | | | (22,792,000 | ) | | 29,067,000 | | | 40,830,000 | | | (1,371,000 | ) | | 6,196,000 | |
| | | | | | | | | | | | | | | | | |
Cash, beginning of period | | | 39,633,000 | | | 10,566,000 | | | 11,937,000 | | | 11,937,000 | | | 5,741,000 | |
| | | | | | | | | | | | | | | | | |
Cash, end of period | | $ | 16,841,000 | | $ | 39,633,000 | | $ | 52,767,000 | | $ | 10,566,000 | | $ | 11,937,000 | |
| | | | | | | | | | | | | | | | | |
Supplemental disclosures of cash flows information: |
| | | | | | | | | | | | | | | | | |
| Interest paid | | $ | 1,446,000 | | $ | 412,000 | | $ | 2,441,000 | | $ | 3,526,000 | | $ | 5,681,000 | |
| Non-cash investing and financing activities: | | | | | | | | | | | | | | | | |
| Dividend liability | | $ | 4,078,000 | | $ | -- | | $ | -- | | $ | -- | | $ | -- | |
| Reinvestment of dividends | | $ | 235,000 | | $ | -- | | $ | -- | | $ | -- | | | -- | |
| Reinvestment of member distributions | | $ | 742,000 | | $ | 1,281,000 | | $ | 2,423,000 | | $ | 3,966,000 | | $ | 7,823,000 | |
| Capital contribution from Manager related to sale of rights to receive proceeds of guarantee | | $ | -- | | $ | -- | | $ | 1,984,000 | | $ | 1,984,000 | | $ | -- | |
| Investment in real estate held for sale reclassified from interest receivable | | $ | -- | | $ | -- | | $ | -- | | $ | 9,000 | | $ | -- | |
| Loan payoffs of loans funded through secured borrowings | | $ | 23,518,000 | | $ | 22,037,000 | | $ | 42,294,000 | | $ | 14,837,000 | | $ | 42,343,000 | |
| Loans funded through secured borrowing | | $ | 17,560,000 | | $ | 16,136,000 | | $ | 6,058,000 | | $ | 51,106,000 | | $ | 79,979,000 | |
| Note payable relating to prepaid E & O insurance | | $ | 238,000 | | $ | -- | | $ | -- | | $ | -- | | $ | -- | |
| Note receivable from Vestin Mortgage paid off through relief of Due to Manager | | $ | -- | | $ | -- | | $ | 1,000,000 | | $ | 1,000,000 | | $ | -- | |
| Note receivable received from guarantor in exchange from release of guarantee | | $ | -- | | $ | -- | | $ | 328,000 | | $ | 328,000 | | $ | -- | |
| Other receivable related to local agency bond liquidation | | $ | -- | | $ | -- | | $ | -- | | $ | 446,000 | | $ | -- | |
| Ownership of real estate held for sale assigned from Fund I | | $ | -- | | $ | -- | | $ | 7,424,000 | | $ | 7,424,000 | | $ | -- | |
| Real estate held for sale acquired through foreclosure | | $ | 25,476,000 | | $ | 7,939,000 | | $ | 27,638,000 | | $ | 37,627,000 | | $ | 15,456,000 | |
| Receivable related to loan rewritten with same or similar property, net of allowance, as collateral applied to unearned income | | $ | 127,000 | | $ | -- | | $ | -- | | $ | -- | | $ | -- | |
| Sale of real estate held for sale where we provided the financing | | $ | -- | | $ | 15,464,000 | | $ | -- | | $ | -- | | $ | -- | |
| Unearned revenue from loans rewritten with same or similar property as collateral | | $ | 27,000 | | $ | -- | | $ | -- | | $ | -- | | $ | 41,331,000 | |
| Unrealized gain (loss) on marketable securities | | $ | -- | | | 822,000 | | $ | (123,000 | ) | $ | (804,000 | ) | $ | -- | |
| Unrealized loss on marketable securities - related party | | $ | (613,000 | ) | $ | -- | | $ | -- | | $ | -- | | $ | -- | |
The accompanying notes are an integral part of these consolidate statements.
(SUCCESSOR TO VESTIN FUND II, LLC)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
NOTE A — ORGANIZATION
Vestin Fund II, LLC (“Fund II”) was organized in December 2000 as a Nevada limited liability company for the purpose of investing in real estate loans. Vestin Realty Mortgage II, Inc. (“VRM II”) was organized in January 2006 as a Maryland corporation for the sole purpose of effecting a merger with Fund II. On March 31, 2006, Fund II merged into VRM II and the members of Fund II received one share of VRM II’s common stock for each membership unit of Fund II. References in this report to the “Company”, “we”, “us” or “our” refer to Fund II with respect to the period prior to April 1, 2006 and to VRM II with respect to the period commencing on April 1, 2006. Because we were a limited liability company (“LLC”) during the prior periods reflected in this report, we make reference to Fund II’s “members” rather than “stockholders” in reporting our financial results
We invest in loans secured by real estate through deeds of trust or mortgages (hereafter referred to collectively as “deeds of trust” and as defined in our Management Agreement as “Mortgage Assets”). We commenced operations in June 2001.
We operate as a real estate investment trust (“REIT”). We are not a mutual fund or an investment company within the meaning of the Investment Company Act of 1940, nor are we subject to any regulation thereunder. As a REIT, we are required to have a December 31 fiscal year end.
Our manager is Vestin Mortgage, Inc. (the “manager” or “Vestin Mortgage”), a Nevada corporation, which is a wholly owned subsidiary of Vestin Group, Inc. (“Vestin Group”), a Delaware corporation. Michael Shustek, the CEO and director of the manager and CEO, President and a director of us, wholly owns Vestin Group, Inc., which is engaged in asset management, real estate lending and other financial services though its subsidiaries. Our manager, prior to June 30, 2006, also operated as a licensed Nevada mortgage broker and was engaged in the business of brokerage, placement and servicing of commercial loans secured by real property. On July 1, 2006, the mortgage broker license was issued to an affiliated company, Vestin Originations, Inc. that has continued the business of brokerage, placement and servicing of commercial real estate loans. Vestin Originations, Inc. is a wholly owned subsidiary of Vestin Group.
Pursuant to our management agreement, our manager shall implement our business strategies on a day-to-day basis, manage and provide services to us, and shall provide similar services to any of our subsidiaries. Without limiting the foregoing, our manager shall perform other services as may be required from time to time for management and other activities relating to our assets, as our manager shall deem appropriate under the particular circumstances. Consequently, our operating results are dependent upon our manager’s ability and performance in managing our operations and servicing our assets.
Vestin Mortgage, Inc. is also the manager of Vestin Realty Mortgage I, Inc., as the successor by merger to Vestin Fund I, LLC, referred to as “VRM I”, Vestin Fund III, LLC (“Fund III”) and inVestin Nevada, Inc., a company wholly owned by our manager’s CEO. These entities also invest in real estate loans.
The consolidated financial statements include the accounts of the Company and our wholly owned taxable REIT subsidiary, TRS II, Inc. All significant inter-company transactions and balances have been eliminated in consolidation.
NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Management Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include interest-bearing and non-interest-bearing bank deposits, money market accounts, short-term certificates of deposit with original maturities of three months or less, and short-term instruments with a liquidation provision of one month or less.
Revenue Recognition
Interest is recognized as revenue when earned according to the terms of the loans, using the effective interest method. We do not accrue interest income on loans once they are determined to be impaired. A loan is impaired when based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due. Cash receipts will be allocated to interest income, except when such payments are specifically designated by the terms of the loan as principal reduction or when management does not believe our investment in the loan is fully recoverable.
Investments in Real Estate Loans
We may from time to time acquire or sell investments in real estate loans from or to the manager or other related parties pursuant to the terms of our Management Agreement provided the price does not exceed the par value of the loan. The primary purpose is to either free up capital to provide liquidity for various reasons, such as loan diversification, or place excess capital in investments to maximize the use of our capital. Selling or buying loans allows us to diversify our loan portfolio within these parameters. Due to the short-term nature of the loans we make and the similarity of interest rates in loans we normally would invest in, the fair value of a loan typically approximates its carrying value. Accordingly, discounts or premiums typically do not apply upon sales of loans and therefore, generally no gain or loss is recorded on these transactions, regardless of whether to a related or unrelated party.
Investments in real estate loans are secured by deeds of trust or mortgages. Generally, our real estate loans require interest only payments with a balloon payment of the principal at maturity. We have both the intent and ability to hold real estate loans until maturity and therefore, real estate loans are classified and accounted for as held for investment and are carried at amortized cost. Loans sold to or purchased from affiliates are accounted for at the principal balance and no gain or loss is recognized by us or any affiliate. Loan to value ratios are based on appraisals obtained at the time of loan origination and may not reflect subsequent changes in value estimates. Such appraisals are generally dated within 12 months of the date of loan origination and may be commissioned by the borrower. The appraisals may be for the current estimate of the “as-if developed” value of the property, which approximates the post-construction value of the collateralized property assuming that such property is developed. As-if developed values on raw land loans or acquisition and development loans often dramatically exceed the immediate sales value and may include anticipated zoning changes and timely successful development by the purchaser. As most of the appraisals will be prepared on an as-if developed basis, if a loan goes into default prior to any development of a project, the market value of the property may be substantially less than the appraised value. As a result, there may be less security than anticipated at the time the loan was originally made. If there is less security and a default occurs, we may not recover the full amount of the loan.
As of December 31, 2006, all of our loans provided for payments of interest only with a “balloon” payment of principal payable in full at the end of the term, with the exception of two of our loans that have both principal and interest payments along with a “balloon” payment at the end of the term. As of December 31, 2006, these two loans had a balance of approximately $18.5 million and had original terms of twelve and thirty-six months. In addition, we invest in real estate loans that require borrowers to maintain interest reserves funded from the principal amount of the loan for a period of time. At December 31, 2006, we had approximately $71.5 million in investments in real estate loans that had interest reserves where the total outstanding principal due to us and our co-lenders was approximately $120.3 million. These loans had interest reserves of approximately $5.6 million, of which our portion was approximately $4.3 million. At December 31, 2005, we had approximately $17.7 million in investments in real estate loans that had interest reserves where the total outstanding principal due to us and our co-lenders was approximately $25.1 million. These loans had interest reserves of approximately $2.4 million, of which our portion was approximately $1.3 million.
Allowance for Loan Losses
We maintain an allowance for loan losses on our investments in real estate loans for estimated credit impairment. The manager’s estimate of losses is based on a number of factors including the types and dollar amounts of loans in the portfolio, adverse situations that may affect the borrower’s ability to repay, prevailing economic conditions and the underlying collateral securing the loan. Additions to the allowance are provided through a charge to earnings and are based on an assessment of certain factors, which may indicate estimated losses on the loans. Actual losses on loans are recorded as a charge-off or a reduction to the allowance for loan losses. Subsequent recoveries of amounts previously charged off are added back to the allowance or included as income.
Estimating allowances for loan losses requires significant judgment about the underlying collateral, including liquidation value, condition of the collateral, competency and cooperation of the related borrower and specific legal issues that affect loan collections or taking possession of the property. As a non-conventional lender willing to invest in loans to borrowers who may not meet the credit standards of conventional lenders, the default rate on our loans could be higher than those generally experienced in the real estate lending industry. We, our manager and Vestin Originations generally approves loans more quickly than other real estate lenders and, due to our expedited underwriting process, there is a risk that the credit inquiry we perform will not reveal all material facts pertaining to a borrower and the security.
Additional facts and circumstances are discovered as we continue our efforts in the collection and foreclosure processes. This additional information often causes management to reassess its estimates. In recent years, we have revised estimates of our allowance for loan losses. Circumstances that may cause significant changes in our estimated allowance include, but are not limited to:
| · | Declines in real estate market conditions, which can cause a decrease in expected market value; |
| · | Discovery of undisclosed liens for community improvement bonds, easements and delinquent property taxes; |
| · | Lack of progress on real estate developments after we advance funds. We customarily utilize disbursement agents to monitor the progress of real estate developments and approve loan advances. After further inspection of the related property, progress on construction occasionally does not substantiate an increase in value to support the related loan advances; |
| · | Unanticipated legal or business issues that may arise subsequent to loan origination or upon the sale of foreclosed upon property; and |
| · | Appraisals, which are only opinions of value at the time of the appraisal, may not accurately reflect the value of the property. |
Real Estate Held For Sale
Real estate held for sale includes real estate acquired through foreclosure and will be carried at the lower of the recorded amount, inclusive of any senior indebtedness, or the property's estimated fair value, less estimated costs to sell, with fair value based on appraisals and knowledge of local market conditions. While pursuing foreclosure actions, the Company seeks to identify potential purchasers of such property. It is not the Company's intent to invest in or own real estate as a long-term investment. In accordance with Statement of Financial Accounting Standards (���FAS”) 144 - Accounting for the Impairment or Disposal of Long Lived Assets (“FAS 144”), the Company seeks to sell properties acquired through foreclosure as quickly as circumstances permit. The carrying values of real estate held for sale are assessed on a regular basis from updated appraisals, comparable sales values or purchase offers.
Management classifies real estate held for sale when the following criteria are met:
| · | Management commits to a plan to sell the properties; |
| · | The property is available for immediate sale in its present condition subject only to terms that are usual and customary; |
| · | An active program to locate a buyer and other actions required to complete a sale have been initiated; |
| · | The sale of the property is probable; |
| · | The property is being actively marketed for sale at a reasonable price; and |
| · | Withdrawal or significant modification of the sale is not likely. |
Real Estate Held For Sale - Seller Financed
We occasionally finance sales of foreclosed properties to independent third parties. In order to record a sale of real estate when the seller is providing continued financing, FAS 66 - Accounting for Sales of Real Estate ("FAS 66'') requires the buyer of the real estate to make minimum initial and continuing investments. Minimum initial investments as defined by FAS 66 range from 10% to 25% based on the type of real estate sold. In addition, FAS 66 limits commitments and contingent obligations incurred by a seller in order to record a sale.
Because we occasionally foreclose on loans with raw land or developments in progress, available financing for such properties is often limited and we frequently provide financing up to 100% of the selling price on these properties. In addition, we may make additional loans to the buyer to continue development of a property. Although sale agreements are consummated at closing, they lack adequate initial investment by the buyer to qualify as a sales transaction as defined in FAS 66. These sale agreements are not recorded as a sale until the requirements of FAS 66 are met.
These sale agreements are recorded under the deposit method or cost recovery method as defined in FAS 66. Under the deposit method, no profit is recognized and any cash received from the buyer is reported as a deposit liability on the balance sheet. Under the cost recovery method, no profit is recognized until payments by the buyer exceed the carrying basis of the property sold. Principal payments received will reduce the related receivable, and interest collections will be recorded as unrecognized gross profit on the balance sheet. The carrying values of these properties are included in real estate held for sale on the accompanying consolidated balance sheets.
In cases where the investment by the buyer is significant (generally 20% or more) and the buyer has an adequate continuing investment, the purchase money debt is not subject to future subordination, and a full transfer of risks and rewards has occurred, we will use the full accrual method. Under the full accrual method, a sale is recorded and the balance remaining to be paid is recorded as a normal note. Interest is recorded as income when received.
Classification of Operating Results from Real Estate Held for Sale
FAS 144 - Accounting for the Impairment or Disposal of Long-Lived Assets ("FAS 144'') generally requires operating results from long lived assets held for sale to be classified as discontinued operations as a separately stated component of net income. The Company's operations related to real estate held for sale are separately identified in the accompanying consolidated statements of income.
Secured Borrowings
Secured borrowings provide an additional source of capital for our lending activity. Secured borrowings allow us to increase the diversification of our loan portfolio and to invest in loans that we might not otherwise invest in. We do not receive any fees for entering into secured borrowing arrangements; however, we may receive revenue in any differential of the interest spread. Loans in which unaffiliated investors have participated through inter-creditor agreements (“Inter-creditor Agreements”) are accounted for as secured borrowings in accordance with Statement of Financial Accounting Standards (“FAS”) 140 - Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“FAS 140”). The Inter-creditor Agreements provide us additional funding sources for real estate loans whereby an unaffiliated investor (the “Investor”) may participate on a non-pari passu basis in certain real estate loans with us and/or VRM I and/or Fund III (collectively, the “Lead Lenders”). In the event of borrower non- performance, the Inter-creditor Agreements generally provide that the Lead Lenders must repay the Investor’s loan amount either by (i) continuing to remit to the Investor the interest due on the participated loan amount; (ii) substituting an alternative loan acceptable to the Investor; or (iii) repurchasing the participation from the Investor for the outstanding balance plus accrued interest.
Additionally, an Investor may participate in certain loans with the Lead Lenders through Participation Agreements. In the event of borrower non-performance, the Participation Agreement may allow the Investor to be repaid up to the amount of the Investor’s investment prior to the Lead Lender being repaid. Real estate loan financing under the Participation Agreements are also accounted for as a secured borrowing in accordance with FAS 140. We do not receive any revenues for entering into secured borrowing arrangements. As of December 31, 2006, we had approximately $13.8 million in outstanding secured borrowing arrangements.
Investment in Marketable Securities - Related Party
Investment in marketable securities - related party consists of stock in VRM I. The securities are stated at fair value as determined by the market price as of December 31, 2006. All securities are classified as available-for-sale under the provisions of FAS 115 - Accounting for Certain Investments in Debt and Equity Securities.
Fair Value of Financial Instruments
FAS 107 - Disclosures about Fair Value of Financial Instruments (“FAS 107”) requires the determination of fair value of the Company’s financial assets. The following methods and assumptions were used to estimate the fair value of financial instruments included in the following categories:
| (a) | Certificate of Deposits and Short-Term Investments: The carrying amounts of these instruments are at amortized cost, which approximates fair value. |
| (b) | Investment in Real Estate Loans: The carrying value of these instruments, net of the allowance for loan losses, approximates the fair value due to their short-term maturities. Fair values for loans, which are delinquent and/or in foreclosure are determined by underlying collateral securing the loans. |
| (c) | Assets under Secured Borrowing: The carrying amount of these instruments approximate fair value. The fair value is estimated based upon projected cash flows discounted at the estimated current interest rates at which similar loans would be made. |
At December 31, 2006 and 2005, the estimated fair values of the real estate loans, including seller financed loans, were approximately $227.9 million and $249.8 million, respectively. At December 31, 2006 and 2005, we had approximately $13.8 million and $19.7 million, respectively, in assets under secured borrowings. These estimates were based upon the present value of expected cash flows discounted at rates currently available for similar loans. Fair value estimates are made at a specific point in time; based on relevant market information; are subjective in nature; and involve uncertainties and matters of significant judgment. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that would be collected upon maturity or disposition of the loans.
Basic and Diluted Earnings Per Common Share
Basic earnings per share (“EPS”) is computed, in accordance with FAS 128 - Earnings per Share (“FAS 128”), by dividing net income available to common stockholders by the weighted average number of common shares outstanding. Diluted EPS is similar to basic EPS except that the weighted average number of common shares outstanding is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been exercised. We had no outstanding common shares equivalents during the twelve months ended December 31, 2006. The following is a computation of the EPS data for the twelve months ended December 31, 2006:
| | | For the Three Months Ended March 31, 2006 | | For the Nine Months Ended December 31, 2006 | | For the Twelve Months Ended December 31, 2006 | |
| | | | | | | | |
| Net income available to common stockholders / members | | $ | (1,710,000 | ) | $ | 17,561,000 | | $ | 15,851,000 | |
| | | | | | | | | | | |
| Weighted average number of common shares / units outstanding during the period | | | 38,915,994 | | | 38,805,119 | | | 38,832,458 | |
| | | | | | | | | | | |
| Basic and diluted earnings per common share / membership unit | | $ | (0.04 | ) | $ | 0.45 | | $ | 0.41 | |
Net Income Allocated to Members Per Weighted Average Membership Unit
Because Fund II was an LLC prior to the merger, it stated net income allocated to members per weighted average membership unit, which is computed by dividing net income calculated in accordance with GAAP by the weighted average number of membership units outstanding for the period. The following is a computation of the net income per weighted average unit for the six months ended December 31, 2005:
| | | For the Six Months Ended December 31, 2005 | |
| | | | |
| Net income available to members | | $ | 10,544,000 | |
| | | | | |
| Weighted average number of membership units outstanding during the period | | | 42,747,725 | |
| | | | | |
| Net income per weighted average membership unit | | $ | 0.25 | |
Common Stock Dividends
Cash dividends declared during the twelve months ended December 31, 2006, were $0.42 per common share. Included in the $0.42 was a cash dividend of $0.105 per common share declared on December 18, 2006, by our Board of Directors for the months ended November 30, 2006 and December 31, 2006 combined. The dividend was paid on January 26, 2007 to shareholders of record as of December 31, 2006.
On December 15, 2006, a 30% common stock dividend was issued to shareholders on record as of November 30, 2006, effectively increasing the outstanding common shares from 29,870,943 to 38,832,402. All share, per share, membership unit and per membership unit information in this Report has been retroactively adjusted to reflect the stock dividend.
On January 22, 2007, our Board of Directors declared a cash dividend of $0.05 per common share for the month ended January 31, 2007, payable on February 26, 2007 to shareholders of record as of February 8, 2007.
On February 20, 2007, our Board of Directors declared a cash dividend of $0.05 per common share for the month ended February 28, 2007, payable on March 26, 2007 to shareholders of record as of March 9, 2007.
Segments
We operate as one business segment.
Income Taxes
The Company is organized and conducts its operations to qualify as a real estate investment trust (“REIT”) under Sections 856 to 860 of the Internal Revenue Code of 1986, as amended (the “Code”) and to comply with the provisions of the Internal Revenue Code with respect thereto. A REIT is generally not subject to federal income tax on that portion of its REIT taxable income (“Taxable Income”) which is distributed to its stockholders, provided that at least 90% of Taxable Income is distributed and provided that certain other requirements are met.
Certain assets of the Company are held in a taxable REIT subsidiary (“TRS”). The income of a TRS is subject to federal and state income taxes. The net income tax provision after net loss carryfowards for the twelve months ended December 31, 2006 was approximately zero.
Reclassifications
Certain reclassifications have been made to the prior periods’ financial statements to conform to the current period presentation.
NOTE C — FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
Financial instruments with concentration of credit and market risk include cash and loans secured by trust deeds.
We maintain cash deposit accounts and certificates of deposit, which at times may exceed federally insured limits. We have not experienced any losses in such accounts and believe we are not exposed to any significant credit risk related to cash deposits. As of December 31, 2006 and 2005, we had approximately $17.0 million and $39.9 million, respectively, in excess of the federally insured limits.
As of December 31, 2006, 26%, 18%, 11% and 10% of our loans were in Nevada, Oregon, Arizona and California, respectively, compared to 13%, 2%, 18% and 27%, at December 31, 2005, respectively. As a result of this geographical concentration of our real estate loans, a downturn in the local real estate markets in these states could have a material adverse effect on us.
At December 31, 2006, the aggregate amount of loans to our three largest borrowers represented 26.29% of our total investment in real estate loans, including loans related to seller financed real estate held for sale. These real estate loans consisted of commercial and construction loans, located in Oregon, New York and Washington with a first lien position, interest rates between 9% and 13%, with an aggregate outstanding balance of approximately $63.7 million and maturing from March 2007 through June 2007. At December 31, 2005, the aggregate amount of loans to our three largest borrowers represented 30.10% of our total investment in real estate loans. These real estate loans consisted of land, commercial, and acquisition and development loans, located in Arizona and California, with a first lien position, interest rates between 8% and 10.25%, with an aggregate outstanding balance of approximately $77.2 million and maturing from March 2006 through August 2006. The California loan “Rio Vista” was foreclosed upon during the three months ended December 31, 2006 and reclassified as a real estate held for sale. Refer to Note F - Real Estate Held for Sale in the notes to these financial statements for further information. Because we have a significant concentration of credit risk with our three largest borrowers, a default by any of such borrowers could have a material adverse effect on us.
As of December 31, 2006, all of our loans provided for payments of interest only with a “balloon” payment of principal payable in full at the end of the term, with the exception of two of our loans that have both principal and interest payments along with a “balloon” at the end of the term. The success of a borrower’s ability to repay its real estate loan obligation in a large lump-sum payment may be dependent upon the borrower’s ability to refinance the obligation or otherwise raise a substantial amount of cash. An increase in interest rates over the loan rate applicable at origination of the loan may have an adverse effect on the borrower’s ability to refinance.
NOTE D — INVESTMENTS IN REAL ESTATE LOANS
As of December 31, 2006 and 2005, we had four real estate loan products consisting of commercial, construction, acquisition and development, and land. The effective interest rates on all product categories range from 5% to 14%. Revenue by product will fluctuate based upon relative balances during the period.
Investments in real estate loans, including loans related to seller financed real estate held for sale, as of December 31, 2006 were as follows:
Loan Type | | Number Of Loans | | Balance (2) | | Weighted Average Interest Rate | | Portfolio Percentage | | Weighted Average Loan To Value (1) | |
| | | | | | | | | | | | |
| Acquisition and development | | | 4 | | $ | 8,569,000 | | | 12.54% | | | 3.54% | | | 54.58% | |
| Commercial | | | 17 | | | 138,556,000 | | | 10.31% | | | 57.16% | | | 76.87% | |
| Construction | | | 6 | | | 43,319,000 | | | 11.48% | | | 17.87% | | | 67.24% | |
| Land | | | 10 | | | 51,951,000 | | | 11.92% | | | 21.43% | | | 56.38% | |
| | | | 37 | | $ | 242,395,000 | | | 10.94% | | | 100.00% | | | 69.97% | |
Investments in real estate loans, including loans related to seller financed real estate held for sale, as of December 31, 2005 were as follows:
Loan Type | | Number Of Loans | | Balance (2) | | Weighted Average Interest Rate | | Portfolio Percentage | | Weighted Average Loan To Value (1) | |
| | | | | | | | | | | | |
| Acquisition and development | | | 3 | | $ | 43,275,000 | | | 9.52% | | | 16.87% | | | 52.93% | |
| Commercial | | | 24 | | | 158,746,000 | | | 9.67% | | | 61.91% | | | 67.66% | |
| Construction | | | 3 | | | 11,128,000 | | | 12.00% | | | 4.34% | | | 63.14% | |
| Land | | | 4 | | | 43,301,000 | | | 11.31% | | | 16.88% | | | 56.10% | |
| | | | 34 | | $ | 256,450,000 | | | 10.06% | | | 100.00% | | | 63.31% | |
| (1) | Loan to value ratios are based on the most recent appraisals and may not reflect subsequent changes in value estimates. Such appraisals, which may be commissioned by the borrower, are generally dated no greater than 12 months prior to the date of loan origination. The appraisals may be for the current estimate of the “as-if developed” value of the property, which approximates the post-construction value of the collateralized property assuming that such property is developed. “As-if developed” values on raw land loans or acquisition and development loans often dramatically exceed the immediate sales value and may include anticipated zoning changes, and successful development by the purchaser; upon which development is dependent on availability of financing. As most of the appraisals will be prepared on an “as-if developed” basis, if a loan goes into default prior to completion of the development of the project, the market value of the property may be substantially less than the appraised value. As a result, there may be less security than anticipated at the time the loan was originally made. If there is less security and a default occurs, we may not recover the full amount of the loan. |
| (2) | The following table reconciles the balance of the loan portfolio to the amount shown on the accompanying Consolidated Balance Sheet. The contra accounts represent the amount of real estate held for sale sold to third parties where the Company provided financing. GAAP requires the borrower to have a certain percentage equity ownership (ranging from 10% to 25%) to allow the Company to record the sale of a property. In addition, the borrower must maintain a minimum commitment in the property on a continuing basis. Therefore, until the borrower meets this requirement, the investment in the new loan is reduced by the amount originally invested in the real estate held for sale. |
| | | December 31, 2006 Balance | | December 31, 2005 Balance | |
| Balance Per Loan Portfolio | | $ | 242,395,000 | | $ | 256,450,000 | |
| Less: | | | | | | | |
| Seller Financed Loans Included in Real Estate Held for Sale | | | (14,774,000 | ) | | (22,887,000 | ) |
| Proceeds of Principal on Seller Financed Loans Included in Deposit Liability | | | 4,056,000 | | | 392,000 | |
| Unrealized Gain on Seller Financed Loans | | | -- | | | (1,356,000 | ) |
| Allowance for Loan Losses | | | (9,828,000 | ) | | (4,724,000 | ) |
| Balance per Balance Sheet | | $ | 221,849,000 | | $ | 227,875,000 | |
The following is a schedule of priority of real estate loans, including loans related to seller financed real estate held for sale, as of December 31, 2006 and 2005:
Loan Type | | Number of Loans | | December 31, 2006 Balance* | | Portfolio Percentage | | Number of Loans | | December 31, 2005 Balance* | | Portfolio Percentage | |
| | | | | | | | | | | | | | |
| First Deeds of Trust | | | 35 | | $ | 239,748,000 | | | 98.91% | | | 33 | | $ | 256,241,000 | | | 99.92% | |
| Second Deeds of Trust** | | | 2 | | | 2,647,000 | | | 1.09% | | | 1 | | | 209,000 | | | 0.08% | |
| | | | 37 | | $ | 242,395,000 | | | 100.00% | | | 34 | | $ | 256,450,000 | | | 100.00% | |
* Please see (2) above
** Generally, our second trust deeds are junior to first trust deed positions held by either us or our manager.
The following is a schedule of contractual maturities of investments in real estate loans, including loans related to seller financed real estate held for sale, as of December 31, 2006:
| January 2007 - March 2007 | | $ | 69,842,000 | |
| April 2007 - June 2007 | | | 77,410,000 | |
| July 2007 - September 2007 | | | 51,074,000 | |
| October 2007 - December 2007 | | | 44,069,000 | |
| Thereafter | | | -- | |
| | | | | |
| Total | | $ | 242,395,000 | |
The following is a schedule by geographic location of investments in real estate loans, including loans related to seller financed real estate held for sale, as of December 31, 2006 and 2005:
| | | December 31, 2006 Balance* | | Portfolio Percentage | | December 31, 2005 Balance* | | Portfolio Percentage | |
| | | | | | | | | | |
| Arizona | | $ | 27,827,000 | | | 11.48% | | $ | 44,869,000 | | | 17.50% | |
| California | | | 24,167,000 | | | 9.97% | | | 68,819,000 | | | 26.84% | |
| Hawaii | | | 17,291,000 | | | 7.13% | | | 34,811,000 | | | 13.57% | |
| Nevada | | | 62,215,000 | | | 25.67% | | | 33,830,000 | | | 13.19% | |
| New York | | | 19,554,000 | | | 8.07% | | | 19,571,000 | | | 7.63% | |
| North Carolina | | | -- | | | --% | | | 1,560,000 | | | 0.61% | |
| Oklahoma | | | 5,237,000 | | | 2.16% | | | 2,155,000 | | | 0.84% | |
| Oregon | | | 44,423,000 | | | 18.33% | | | 5,193,000 | | | 2.02% | |
| Texas | | | 22,812,000 | | | 9.41% | | | 37,528,000 | | | 14.63% | |
| Washington | | | 18,869,000 | | | 7.78% | | | 4,900,000 | | | 1.91% | |
| Wisconsin | | | -- | | | --% | | | 3,214,000 | | | 1.26% | |
| Total | | $ | 242,395,000 | | | 100.00% | | $ | 256,450,000 | | | 100.00% | |
* Please see (2) above
At December 31, 2006, the following loans were non-performing (based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due); RightStar (Part I & Part II), Monterrey Associates LP, Forest Development LLC and Babuski LLC. These loans are currently carried on our books at a value of approximately $19.5 million, net of allowance for loan losses of approximately $9.3 million for the RightStar loans. These loans have been placed on non-accrual of interest status and are the subject of pending foreclosure proceedings.
| · | RightStar (Part I & Part II) are loans secured by a lien on the business and virtually all of the property of RightStar, which includes 4 cemeteries and 8 mortuaries in Hawaii with an outstanding balance of approximately $32.3 million of which our portion is approximately $17.3 million ($8.2 million for Part I and $9.1 million for Part II). The lenders have commenced a judicial foreclosure on the loans, Part I and Part II. |
| · | Monterrey Associates, L.P., a loan secured by a 248 Unit apartment complex in Oklahoma City, OK, along with other real estate collateral, with an outstanding balance of approximately $4.4 million of which our portion is approximately $2.2 million. The loan is four months in arrears in payments of interest. Our manager has commenced foreclosure proceedings and is filing litigation to enforce the personal guarantee on the loan. Our manager has evaluated this loan and concluded that the value of the underlying collateral is sufficient to protect us from loss of principal. No specific allowance was deemed necessary. In addition, our manager commenced foreclosure proceedings on a second mortgage on a 233 unit apartment complex that was additional collateral for the loan. Subsequent to December 31, 2006, we completed the foreclosure of the second mortgage and took title to the property subject to a non-recourse first mortgage, which is held by an unrelated third party. We sold this property to an unrelated third party who will assume the non-recourse first mortgage. This transaction did not result in any gain or loss. |
| · | Forest Development, LLC, a loan secured by two 4,000 square foot single family residences, together with the four remaining lots in the subdivision, located in Mt. Charleston, NV with an outstanding balance of approximately $2.6 million of which our portion is approximately $1.7 million. The loan is two months in arrears in payment of interest. Our manager has commenced foreclosure proceedings and is filing litigation to enforce the personal guarantee on the loan. Our manager has evaluated this loan and concluded that the value of the underlying collateral is sufficient to protect us from loss of principal. No specific allowance was deemed necessary. |
| · | Babuski, LLC, a loan secured by 9.23 +/- acres of land at the northeast corner of the I-215 and Russell Road in Las Vegas, NV, with an outstanding balance of approximately $9.5 million of which our portion is approximately $7.7 million. The loan is one month in arrears in payments of interest. Our manager has commenced foreclosure proceedings and is filing litigation to enforce the personal guarantee on the loan. Our manager has evaluated this loan and concluded that the value of the underlying collateral is sufficient to protect us from loss of principal. No specific allowance was deemed necessary. |
The following schedule summarizes the non-performing loans as of December 31, 2006:
Description of Collateral | | Balance at December 31, 2006 | | Maturity Date | | Number of Months Non-Performing | | Percentage of Total Loan Balance | |
| 4 cemeteries and 8 mortuaries in Hawaii Part I*** | | $ | 8,183,000 | | | 3/31/2004 | | | 33 | | | 45% of Part I | |
| 4 cemeteries and 8 mortuaries in Hawaii Part II*** | | | 9,108,000 | | | 3/31/2004 | | | 33 | | | 65% of Part II | |
| 248-unit apartment complex in Oklahoma City, OK | | | 2,155,000 | | | 9/1/2006 | | | 4 | | | 49% | |
| 2 single family residences, with 4 remaining lots in the subdivision in Mt. Charleston, NV | | | 1,681,000 | | | 10/27/2006 | | | 2 | | | 64% | |
| 9.23 +- acres of land in Las Vegas, NV | | | 7,707,000 | | | 3/17/2007 | | | 1 | | | 81% | |
| | | $ | 28,834,000 | | | | | | | | | | |
*** Please refer to (3) Specific Reserve Allowance below.
On May 1, 2006, the bankruptcy plan of Mid-State Raceway, Inc. for Vernon Downs became effective. As a result of the bankruptcy plan, we and VRM I received the following:
| · | A new first deed of trust was received from the buyer, Vernon Downs Acquisition, LLC, approximating $22.8 million, of which our portion is approximately $19.6 million. The new terms included a $1.2 million principal payment, reducing our principal balance by approximately $1.0 million. This transaction resulted in us recording unearned revenue of approximately $1.0 million, to be recognized through March 2007, the maturity of the loan. The terms of the loan are 9% due in 6 months, with an option to extend, which was granted in September 2006, for an additional 6 months. |
| · | The loan is secured by a first deed of trust on Vernon Downs properties and a 150% personal guarantee by the borrowers. |
| · | Prepayment of interest in the aggregate amount of $500,000, of which our portion was $429,000. |
| · | Delay fees from the date of the bankruptcy confirmation until the effective date in the aggregate amount of $282,000 of which our portion was $242,000. |
| · | Payment of past due forbearance fees of $555,000 of which our portion was $476,000, to be recognized as unearned revenue and amortized through March 2007, the maturity of the loan. |
Our manager periodically reviews and makes a determination as to whether the allowance for loan losses is adequate to cover any potential losses. Additions to the allowance for loan losses are made by charges to the provision for loan losses. Recoveries of previously charged off amounts are credited to the allowance for loan losses or included as income when the asset is disposed. As of December 31, 2006, we have provided a specific reserve related to the two loans secured by 4 cemeteries and 8 mortuaries in Hawaii (“RightStar loans”), of which our portion of the specific reserve is approximately $9.3 million. In addition, our manager recognized a specific reserve for the impairment of a restructured loan in the amount of $500,000. Our manager evaluated the loans and concluded that the remaining underlying collateral was sufficient to protect us against further losses of principal. Our manager will continue to evaluate these loans in order to determine if any other allowance for loan losses should be recorded.
Because any decision regarding the allowance for loan losses reflects a judgment about the probability of future events, there is an inherent risk that such judgments will prove incorrect. In such event, actual losses may exceed (or be less than) the amount of any reserve. To the extent that we experience losses greater than the amount of our reserves, we may incur a charge to our earnings that will adversely affect our operating results and the amount of any distributions payable to our stockholders.
The following is a roll-forward of the allowance for loan losses for the twelve months ended December 31, 2006:
Description | | Balance at December 31, 2005 | | Specific Reserve Allocation | | RightStar Legal Reserve | | Balance at December 31, 2006 | |
| General allowance | | $ | 1,949,000 | | $ | (1,949,000 | ) | $ | -- | | $ | -- | |
| Specific allowance (3) | | | 2,775,000 | | | 6,959,000 | | | 94,000 | | | 9,828,000 | |
| Total | | $ | 4,724,000 | | $ | 5,010,000 | | $ | 94,000 | | $ | 9,828,000 | |
| (3) | Specific Reserve Allowance |
RightStar Loan Allowance -RightStar, Inc. (“RightStar”) defaulted on our loans in the fall of 2004. The lenders commenced a judicial foreclosure on the loans, part I and part II, which is secured by a lien on the business and virtually all of the property of RightStar, which includes 4 cemeteries and 8 mortuaries in Hawaii. The aggregate principal balance of the loan is approximately $32.3 million. The loans, part I and part II, are owned as follows:
| | | Senior Principal Amount (Part II) | | Junior Principal Amount (Part I) | | Total | |
| VRM I | | $ | 4,892,000 | | $ | 4,415,000 | | $ | 9,307,000 | |
| VRM II | | | 9,108,000 | | | 8,183,000 | | | 17,291,000 | |
| Unrelated Third Party | | | -- | | | 5,657,000 | | | 5,657,000 | |
Total | | $ | 14,000,000 | | $ | 18,255,000 | | $ | 32,255,000 | |
The loans are subject to an inter-creditor agreement which states the order of priority for any payments received are disbursed as follows:
| · | First to reimburse collection and foreclosure expenses advanced by the lenders; |
| · | Second to pay past due interest on the Senior Principal (including default rate interest); |
| · | Third to pay past due interest on the Junior Principal (including default rate interest); |
| · | Fourth to pay Senior Principal; and |
| · | Fifth to pay Junior Principal. |
We and VRM I acquired the senior portion of the loan on July 14, 2005 for approximately $15.5 million of which our portion was approximately $10.1 million (including accrued interest of approximately $1.0 million). We and VRM I acquired this balance to expedite the foreclosure process and remove the prior senior lender from its priority position, which had the potential to impair the value we may receive at the time the property is sold. In exchange for assistance in expediting the foreclosure process, the lenders jointly agreed to release the guarantors from their guaranty of the loan. Subsequent to December 31, 2006, Vestin Mortgage, Inc. purchased the junior principal amount owned by the unrelated third party for $500,000 cash. Vestin Mortgage, Inc. has agreed that any monies it receives as a result of payment of the notes or proceeds from a foreclosure sale are limited to its $500,000 investment in the notes plus expenses.
RightStar is currently being operated by a Court appointed Receiver, installed at the request of the lenders.
Foreclosure proceedings are being delayed by the State of Hawaii, which has refused to issue licenses to potential buyers or the lenders to: (1) operate the facility, (2) operate a pre-need program and (3) operate a perpetual care program. During the three months ended March 31, 2006, the State of Hawaii notified the lenders of a potential statutory trust fund deficiency, estimated to be between $20 million and $30 million and claimed that this balance has priority over all lenders. The lenders dispute the amount and priority of this deficit.
In April 2006, the lenders filed suit against the State of Hawaii listing 26 causes of action, including allegations that the State of Hawaii has illegally blocked the lender’s right to foreclose and take title to its collateral by inappropriately attaching conditions to the granting of licenses needed to operate the business, the pre-need trust funds and the perpetual care trust funds and that the State of Hawaii has attempted to force the lenders to accept liability for any statutory trust fund deficits while no such lender liability exists under the laws of the State of Hawaii. The State of Hawaii responded by filing allegations against Vestin Mortgage, Inc. and us alleging that these Vestin entities improperly influenced the former RightStar trustees to transfer trust funds to us. We believe the State’s claims to be without merit and intend to vigorously pursue our remedies while defending against any allegations made by the State.
In October 2006, a Judge of the Circuit Court of the First Circuit in Hawaii imposed new restrictions upon our right to foreclose and denied any subsequent owner the licensing necessary to operate the funeral service until the alleged pre-need and perpetual care trust funds shortages are cured. We believe these restrictions are both unauthorized under state law and unconstitutional under federal law. In January 2007, the Lenders filed a petition with the Supreme Court of Hawaii seeking mandamus relief from that ruling. As of February 2, 2007, the Supreme Court of Hawaii has not ruled on the Lender’s petition, but has requested briefing from the State of Hawaii regarding the petition. The outcome of this litigation is unforeseeable at this time. We cannot estimate when the foreclosure will ultimately be completed or when the lenders may obtain title to the underlying properties.
We have evaluated the estimated value of the underlying collateral, the potential trust fund deficit, and the expected cost and length of litigation. Based on this estimate we increased our total specific reserve allowance for loss by approximately $5.0 million during the twelve months ended December 31, 2006 and specifically allocated our general allowance of approximately $1.9 million to the RightStar loans. The increase in the reserve allowance included approximately $1.0 million for estimated litigation fees and expenses which we anticipate incurring in enforcing our rights against the underlying collateral. We will continue to evaluate our position in the RightStar loan as the situation progresses. As of December 31, 2006, our specific reserve allowance on the RightStar loans totaled approximately $9.3 million, which includes a legal reserve balance of $94,000.
Impairment on Restructured Loan— As of December 31, 2006, included in the specific reserve allowance is an impairment of $500,000 on a restructured loan.
In addition, our manager had granted extensions on ten loans pursuant to the terms of the original loan agreements, which permit extensions by mutual consent. Such extensions are generally provided on loans where the original term was 12 months or less and where a borrower requires additional time to complete a construction project or negotiate take-out financing. However, our manager only grants extensions when a borrower is in full compliance with the terms of the loan, including, but not limited to the borrower’s obligation to make interest payments on the loan. The aggregate amount due from borrowers whose loans had been extended as of December 31, 2006 was approximately $53.2 million. Our manager concluded that no allowance for loan loss was necessary with respect to these loans as of December 31, 2006.
Asset Quality and Loan Reserves
Losses may occur from investing in real estate loans. The amount of losses will vary as the loan portfolio is affected by changing economic conditions and the financial condition of borrowers.
The conclusion that a real estate loan is uncollectible or that collectibility is doubtful is a matter of judgment. On a quarterly basis, the manager evaluates our real estate loan portfolio for impairment. The fact that a loan is temporarily past due does not necessarily mean that the loan is impaired. Rather, all relevant circumstances are considered by our manager to determine impairment and the need for specific reserves. Such evaluation, which includes a review of all loans on which full collectibility may not be reasonably assured, considers among other matters:
| · | Prevailing economic conditions; |
| · | The nature and volume of the loan portfolio; |
| · | The borrowers’ financial condition and adverse situations that may affect the borrowers’ ability to pay; |
| · | Evaluation of industry trends; and |
| · | Estimated net realizable value of any underlying collateral in relation to the loan amount. |
Based upon this evaluation, a determination is made as to whether the allowance for loan losses is adequate to cover any potential losses. Additions to the allowance for loan losses are made by charges to the provision for loan losses. As of December 31, 2006 and 2005 approximately $11.5 million and $19.6 million, respectively, in non-performing loans had no specific allowance for loan losses. As of December 31, 2006 and 2005, approximately $17.3 million and $16.8 million, respectively, in non-performing loans had a specific allowance for loan losses of approximately $9.3 million and 4.2 million, respectively. At December 31, 2006, the following loans were non-performing (based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due); RightStar (Part I & Part II), Monterrey Associates LP, Forest Development LLC and Babuski LLC. These loans are currently carried on our books at a value of approximately $19.5 million, net of allowance for loan losses of approximately $9.3 million for the RightStar loans. These loans have been placed on non-accrual of interest status and are the subject of pending foreclosure proceedings. Our manager evaluated the loans and concluded that the underlying collateral was sufficient to protect us against further losses of principal or interest. Our manager will continue to evaluate these loans in order to determine if any other allowance for loan losses should be recorded.
NOTE E — INVESTMENT IN MARKETABLE SECURITIES - RELATED PARTY
During the twelve months ended December 31, 2006, we purchased 407,485 shares of VRM I’s common stock, representing approximately 5.93% of their total outstanding common stock. On November 29, 2006, we filed the required Schedule 13D with the SEC.
NOTE F — REAL ESTATE HELD FOR SALE
At December 2006, we held two properties with a total carrying value of approximately $30.1 million, which were acquired through foreclosure and recorded as investments in real estate held for sale. The summary below includes our percentage ownership in each property. These investments in real estate held for sale are accounted for at the lower of cost or fair value less costs to sell with fair value based on appraisals and knowledge of local market conditions. It is not our intent to invest in or own real estate as a long-term investment. We seek to sell properties acquired through foreclosure as quickly as circumstances permit. The following is a roll-forward of investments in real estate held for sale during the twelve months ended December 31, 2006:
Description | Date Acquired | Percentage of Ownership | | Balance December 31, 2005 | | Acquisitions (Reductions) | | Seller Financed Sales | | Proceeds from Sales | | Gain (Loss) on Sale of Real Estate | | Balance at December 31, 2006 |
| | | | | | | | | | | | | | | |
Land containing (82) residential lots in Henderson, NV (1) | 2/28/2003 | 34% | $ | 1,262,000 | $ | (13,000) | $ | -- | $ | (1,270,000) | $ | 21,000 | $ | -- |
| | | | | | | | | | | | | | | |
278 unit apartment complex in Fort Worth, TX “Windrush” (1) | 8/2/2005 | 100% | | 8,059,000 | | -- | | -- | | (8,115,000) | | 56,000 | | -- |
| | | | | | | | | | | | | | | |
One real estate parcel in Austin, TX (1) | 3/2/2004 | 100% | | 298,000 | | -- | | -- | | (550,000) | | 252,000 | | -- |
| | | | | | | | | | | | | | | |
One real estate parcel in Cedar Park, TX (1) | 3/2/2004 | 100% | | 200,000 | | -- | | -- | | (260,000) | | 60,000 | | -- |
| | | | | | | | | | | | | | | |
| Partially completed golf course on 570 acres of land near Austin, TX | 8/3/2004 | 100% | | 5,333,000 | | (645,000) | | -- | | -- | | -- | | 4,688,000 |
| | | | | | | | | | | | | | | |
150 unit condominium conversion in Houston, TX “The Club at Stablechase” (1) | 6/15/2005 | 100% | | 9,019,000 | | (317,000) | | -- | | (8,205,000) | | (497,000) | | -- |
| | | | | | | | | | | | | | | |
504 unit apartment complex in Austin, TX “Lakeview” (1) | 6/7/2005 | 100% | | 14,468,000 | | -- | | -- | | (16,093,000) | | 1,625,000 | | -- |
| | | | | | | | | | | | | | | |
480 residential building lots & 2 single family dwellings in Rio Vista Village Subdivision in Cathedral City, CA (2) | 12/21/2006 | 86% | | -- | | 25,391,000 | | -- | | -- | | -- | | 25,391,000 |
| | | | | | | | | | | | | | | |
| | | | $ | 38,639,000 | $ | 24,416,000 | $ | -- | $ | (34,493,000) | $ | 1,517,000 | $ | 30,079,000 |
During the twelve months ended December 31, 2006, we receive $650,000 from an account held in escrow related to the partially completed golf course on 570 acres of land near Austin, Texas.
(1) | Sales of Real Estate Held for Sale for the Twelve Months Ended December 31, 2006: |
During March 2006, we sold the parcel in Cedar Park, Texas. Our net proceeds were $260,000, resulting in a gain of $60,000.
During June 2006, we sold the parcel in Austin, Texas. Our net proceeds were $550,000, resulting in a gain of $252,000.
During July 2006, we sold a 504 unit apartment complex in Austin, Texas, for approximately $16.1 million. This resulted in a net gain of approximately $1.6 million.
During July 2006, we and VRM I sold the land containing residential lots in Henderson, NV, for approximately $3.8 million, of which we received approximately $1.3 million, which resulted in a net gain of $21,000.
During September 2006, we sold the “Windrush” property in Fort Worth, Texas, for a sales price of $8,019,000, resulting in net proceeds of $7,885,000. During the three months ended December 31, 2006, we received an additional payment of $230,000 from cash reserves held by the apartment manager, which resulted in a net gain of $56,000 on the sale of the property.
During December 2006, we sold the 150 unit condominium conversion in Houston, TX “The Club at Stablechase” for a sales price of approximately $8.5 million, with net proceeds of approximately $8.2 million, which resulted in a net loss of approximately $0.5 million.
(2) | Acquisitions of Real Estate Held for Sale for the Twelve Months Ended December 31, 2006: |
During November 2006, we, VRM I and Fund III acquired the collateral of a loan, 480 residential building lots and two single family dwellings in Rio Vista Village Subdivision in Cathedral City, CA, through foreclosure. Our manager has evaluated the carrying value of the property and based on its estimate, no valuation allowance was deemed necessary as of December 31, 2006. The property is currently under a purchase agreement for a total sales price of approximately $29.9 million, of which our portion will be approximately $25.6 million.
Subsequent to December 31, 2006, we entered into a sales contract for the partially completed golf course near Austin, Texas at a price that would not result in a material gain or loss. The sale contract requires that the buyer complete the purchase on or before June 29, 2007, however there can be no assurance that the sales contract will actually be completed.
NOTE G — REAL ESTATE HELD FOR SALE - SELLER FINANCED
At December 31, 2006, we held an interest in two properties with a total carrying value of approximately $14.8 million, which have been sold in transactions where we provided the financing to the purchaser. GAAP requires us to include these properties in real estate held for sale until the borrower has met and maintained certain requirements. We may share ownership of such properties with VRM I, Fund III, the manager, or other related and/or unrelated parties. The summary below includes our percentage of ownership in each property. These investments in real estate held for sale are accounted for at the lower of cost or fair value less costs to sell with fair value based on appraisals and knowledge of local market conditions. The following is a roll-forward of seller financed real estate held for sale for the twelve months ended December 31, 2006:
Description | Date Acquired | Percentage of Ownership | | Balance at December 31, 2005 | | Acquisitions | | Sales | | Gain (Loss) on Sale | | Balance at December 31, 2006 |
| | | | | | | | | | | | | |
74 unit (90) bed assisted living facility in San Bernardino, CA (1) | 4/6/2004 | 100% | $ | 7,350,000 | $ | -- | $ | -- | $ | -- | $ | 7,350,000 |
| | | | | | | | | | | | | |
126 unit (207) bed assisted living facility in Phoenix, AZ (2) | 9/8/2004 | 90% | | 8,113,000 | | -- | | (10,406,000) | | 2,293,000 | | -- |
| | | | | | | | | | | | | |
Assisted living facility in Las Vegas, Nevada (3) | 9/23/2004 | 48% | | 7,424,000 | | -- | | -- | | -- | | 7,424,000 |
| | | | | | | | | | | | | |
| | | | $ | 22,887,000 | $ | -- | $ | (10,406,000) | $ | 2,293,000 | $ | 14,774,000 |
| (1) | During October 2005, we sold the 74 unit (90 bed) assisted living facility in San Bernardino, CA and financed 97% of the purchased price of approximately $7.6 million maturing in November 2006, which resulted in a $200,000 deferred gain. Recorded as a deposit liability are approximately $4.3 million in payments we received from the borrower. The unrealized gain and payments received from the borrower will be recognized as income once the equity requirement has been met or the loan is paid in full. |
| (2) | During August 2005, we and VRM I sold the 126 unit (207 bed) assisted living facility in Phoenix, AZ and financed 100% of the purchased price of approximately $10.5 million maturing in January 2007. The transaction resulted in a $1.4 million deferred gain. In December 2006, the borrower paid the loan in full resulting in us recognizing a gain on sale of approximately $2.3 million, which included the deferred gain and payments received from the borrower during the life of the loan. |
| (3) | During September 2004, we and VRM I sold an assisted living facility in Las Vegas, NV and financed 100% of the purchased price of approximately $15.3 million maturing in September 2007. The transaction resulted in no gain or loss. As of December 31, 2006, we had received approximately $1.2 million in payments from the borrower. These payments are recorded as a deposit liability and will be recognized as income once the equity requirement has been met or the loan is paid in full. |
Until borrowers have met the minimum equity ownership requirement to allow us to record a sale, we will record payments received under the deposit method or the cost recovery method, which ever is applicable in accordance with FAS 66.
NOTE H — RELATED PARTY TRANSACTIONS
From time to time, we may acquire or sell investments in real estate loans from/to our manager or other related parties pursuant to the terms of our Management Agreement provided the price does not exceed the par value. No gain or loss is recorded on these transactions, as it is not our intent to make a profit on the purchase or sale of such investments. The purpose is generally to diversify our portfolio by syndicating loans, thereby providing us with additional capital to make additional loans.
Transactions with the Manager
Our manager is entitled to receive from us an annual management fee of up to 0.25% of our aggregate capital contributions received by us and Fund II from the sale of shares or membership units, paid monthly. The amount of management fees paid to our manager for the twelve months ended December 31, 2006 was approximately $1.1 million.
As of December 31, 2006, our manager owned 241,020 of our common shares. For the twelve months ended December 31, 2006, we incurred $46,000 in dividends payable to our manager based on the number of shares they held on the dividend record dates and we recorded pro-rata distributions owed to our manager of approximately $16,000.
Transactions with Other Related Parties
As of December 31, 2006, we owned 407,485 common shares of VRM I, representing approximately 5.93% of their total outstanding common stock. On November 29, 2006, we filed the required Schedule 13D with the SEC. For the twelve months ended December 31, 2006 we recognized $72,000 in dividends from VRM I based on the number of shares we held on the dividend record dates.
As of December 31, 2006, VRM I owned 372,655 of our common shares, representing approximately 0.96% of our total outstanding common stock. For the twelve months ended December 31, 2006, we incurred $151,000 in dividends payable to VRM I based on the number of shares they held on the dividend record dates.
During the twelve months ended December 31, 2006 we bought $1.4 million in real estate loans from VRM I and sold $0.5 million in real estate loans to VRM I. No gain or loss resulted from these transactions.
As of December 31, 2006, Fund III owned 158,191 of our common shares. For the twelve months ended December 31, 2006, we incurred $47,000 in dividends payable to Fund III based on the number of shares they held on the dividend record dates.
During the twelve months ended December 31, 2006, we purchased $4.9 million in real estate loans from Fund III. In addition, during the twelve months period ended December 31 2006, we sold $6.0 million in real estate loans to Fund III. No gain or loss resulted from these transactions.
During January 2006, Michael V. Shustek, the manager’s CEO, purchased a $2 million trust deed investment from us, of which, the total balance of $2 million was repurchased by us. No gain or loss resulted from these transactions.
During the twelve months ended December 31, 2006, we purchased $556,000 in performing real estate loans from LTD, a company wholly owned by our CEO Michael V. Shustek. No gain or loss resulted from these transactions.
As of December 31, 2006, Vestin Originations owed us $31,000 related to a loan payment by a borrower. We received the payment from Vestin Originations on January 2, 2007.
During the twelve months ended December 31, 2006 , we incurred $88,000, for legal fees to the law firm of Levine, Garfinkel & Katz in which the Secretary of Vestin Group has an equity ownership interest in the law firm.
NOTE I — NOTES RECEIVABLE
During October 2004, we and VRM I sold the Castaways Hotel/Casino in Las Vegas, Nevada of which our portion of the net cash proceeds was approximately $5.8 million. We originally sold this property under a 100% seller financing arrangement. The borrowers then sold the property to an unrelated third party that resulted in a payoff of the note and also allowed us to record the sale and remove the asset from seller financed real estate held for sale. In addition, during September 2004, we received a promissory note from the guarantors of the loan in the amount of $440,000 in exchange for a release of their personal guarantees. Since payments on the note did not begin for 18 months from the date of the note, we discounted the face value of the note to $328,000, which is based on a discount rate of 8% as of that date. For the twelve months ended December 31, 2006, we received $46,000 in principal payments. The outstanding balance as of December 31, 2006 was $282,000, net of allowance.
During March 2005, we and VRM I sold the 126 unit hotel in Mesquite, Nevada for $5,473,000 of which our share of the proceeds were approximately $3.8 million, which resulted in a loss of $829,000. In addition, during September 2005, we and VRM I entered into a settlement agreement with the guarantors of the loan in the amount of $2,000,000 in exchange for a release of their personal guarantees of which our share was $1,350,000. The balance is secured by a second trust deed and is payable in a first installment of $100,000 due in July 2005 and monthly interest only payments of 5% on $1,100,000 from July 2005 through July 2008, at which time the entire balance is due. The guarantors were entitled to a discount of $782,000 from the principal balance in the event the entire balance was paid by December 2006. The first installment was received and recognized as income in July 2005, of which our portion was $68,000. Payments will be recognized as income when received. This note is fully reserved.
During June 2005, we took title to 133 units of a 150 unit condominium conversion know as “The Club at Stablechase” located in Houston, Texas. Our manager has evaluated the carrying value of approximately $9.0 million and based on its estimated value and the underlying personal guarantee from the borrower, no valuation allowance was deemed necessary as of September 30, 2006. Additionally, the guarantor entered into an unsecured promissory note totaling $375,000 bearing an annual interest rate of 8.0%, payable in monthly payments of principal of $6,000 plus interest and maturing during September 2010. This note is fully reserved. In addition, the guarantors entered into a second unsecured note totaling $125,000. These notes were paid in full during October 2006.
During November 2004, we and VRM I sold the 140 Unit/224 beds senior facility in Mesa, Arizona of which our portion of the consideration received totaled $6,043,000. We and VRM I received a promissory note from the original guarantor in the amount of $478,000 of which our portion was $409,000. The promissory note is payable in interest only payments of 8% on the principal balance outstanding. Commencing June 25, 2005 through May 25, 2006, monthly payments shall increase to $15,000 and be applied to principal and accrued interest. Beginning June 25, 2006 through May 25, 2009, payments are to increase to $20,000 monthly. Due to the uncertainty of collectibility, we have provided a valuation allowance for the entire remaining balance of the promissory note. Income will be recognized when payments are received. As of December 31, 2006, we received $220,000 in payments. This note is fully reserved.
During December 2005, we and VRM I sold the 460 acre residential subdivision in Lake Travis, TX for approximately $5.5 million, of which our portion was approximately $3.5 million. The purchase price included cash proceeds of $5 million and a $500,000 note receivable, with an imputed interest rate of 8% in July 2006. A net gain of $71,000 resulted in this transaction, of which our portion was $47,000. The purchaser has defaulted on the note and our manager is pursuing litigation. Our portion of the outstanding balance as of December 31, 2006 was $329,000. This note is fully reserved.
NOTE J— SECURED BORROWINGS
Secured borrowings provide an additional source of capital for our lending activity. Secured borrowings allow us to increase the diversification of our loan portfolio and to invest in loans that we might not otherwise invest in. We do not receive any fees for entering into secured borrowing arrangements; however, we may receive revenue in any differential of the interest spread. Loans in which unaffiliated investors have participated through inter-creditor agreements (“Inter-creditor Agreements”) are accounted for as secured borrowings in accordance with Statement of Financial Accounting Standards (“FAS”) 140 - Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“FAS 140”). The Inter-creditor Agreements provide us additional funding sources for real estate loans whereby an unaffiliated investor (the “Investor”) may participate on a non-pari passu basis in certain real estate loans with us and/or VRM I and/or Fund III (collectively, the “Lead Lenders”). In the event of borrower non- performance, the Inter-creditor Agreements generally provide that the Lead Lenders must repay the Investor’s loan amount either by (i) continuing to remit to the Investor the interest due on the participated loan amount; (ii) substituting an alternative loan acceptable to the Investor; or (iii) repurchasing the participation from the Investor for the outstanding balance plus accrued interest.
Additionally, an Investor may participate in certain loans with the Lead Lenders through Participation Agreements. In the event of borrower non-performance, the Participation Agreement may allow the Investor to be repaid up to the amount of the Investor’s investment prior to the Lead Lender being repaid. Real estate loan financing under the Participation Agreements are also accounted for as a secured borrowing in accordance with FAS 140. The Company does not receive any revenues for entering into secured borrowings arrangements.
During October 2006, we, our manager, Vestin Origination, Inc., VRM I and Fund III entered into an intercreditor agreement with an unrelated third party related to the funding of a construction real estate loan. (See exhibit 10.8 Intercreditor Agreement under the Exhibit Index included in Part IV, Item 15 Exhibits and Financial Statement Schedules of this Report Form 10-K). The secured borrowing will be recognized pro rata between us, VRM I and Fund III for the amount each entity has funded for the loan. As of December 31, 2006, approximately $24.3 million has been funded on this loan, of which our portion was approximately $4.3 million. As of December 31, 2006, this secured borrowing totaled approximately $18.5 million, of which our portion was approximately $13.8 million. In the event VRM I and Fund III were unable to pay their pro rata share of the secured borrowing, we would be liable for the full outstanding balance. As of December 31, 2005, we had approximately $19.8 million in funds being used under Inter-creditor Agreements.
NOTE K — NOTE PAYABLE
During the twelve months ended December 31, 2006, three notes payable totaling approximately $23 million were paid in full.
In May 2006, we financed a 12-month insurance policy for Directors and Officers liability, with an annual interest rate of 6.92%. The agreement required a down payment of $60,000 and nine monthly payments of $27,000 beginning on May 27, 2006. As of December 31, 2006, the outstanding balance of the note was approximately $27,000, which was subsequently paid in full.
In addition, during the twelve months ended December 31, 2006, we paid in full, borrowings from a margin account collateralized by securities held at a brokerage firm totaling approximately $2.9 million.
NOTE L — RECENT ACCOUNTING PRONOUNCEMENTS
In July 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). This interpretation, among other things, creates a two-step approach for evaluating uncertain tax positions. Recognition (step one) occurs when an enterprise concludes that a tax position, based solely on its technical merits, is more-likely-than-not to be sustained upon examination. Measurement (step two) determines the amount of benefit that more-likely-than-not will be realized upon settlement. Derecognition of a tax position that was previously recognized would occur when a company subsequently determines that a tax position no longer meets the more-likely-than-not threshold of being sustained. FIN 48 specifically prohibits the use of a valuation allowance as a substitute for derecognition of tax positions, and it has expanded disclosure requirements. FIN 48 is effective for fiscal years beginning after December 15, 2006, in which the impact of adoption should be accounted for as a cumulative - effect adjustment to the beginning balance of retained earnings. The Company is evaluating FIN 48 and has not yet determined the impact the adoption will have on the consolidated financial statements, but it is not expected to be significant.
On September 13, 2006, the SEC issued Staff Accounting Bulletin 108 (“SAB 108”), “Considering the Effects of Prior Year Misstatements when Qualifying Misstatements in Current Year Financial Statements,” which provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108 is effective for companies with fiscal years ending after November 15, 2006 and is required to be adopted by the Company in its fiscal year ending December 31, 2006. The adoption of this bulletin did not have a significant impact on the consolidated financial statements.
In September 2006, the Financial Accounting Standards Board (FASB) issued FAS 158 - Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R). FAS 58 requires an employer to: (a) recognize in its statement of financial position the funded status of a benefit plan; (b) measure defined benefit plan assets and obligations as of the end of the employer’s fiscal year (with limited exceptions); and (c) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise but are not recognized as components of net periodic benefit costs pursuant to prior existing guidance. The provisions governing recognition of the funded status of a defined benefit plan and related disclosures are effective as of the end of fiscal years ending after December 15, 2006. The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. Because we currently do not have defined benefit or other post retirement plans, the standard will have no effect on us.
In September 2006, the FASB issued FAS 157 - Fair Value Measurements (“FAS 157”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. This Statement is required to be adopted by the Company in the first quarter of its fiscal year 2008. The Company is currently assessing the impact of the adoption of this Statement.
NOTE M — LEGAL MATTERS INVOLVING THE MANAGER
The United States Securities and Exchange Commission (the “Commission”), conducted an investigation of certain matters related to us, our manager, Vestin Capital, VRM I and Fund III. We fully cooperated during the course of the investigation. On September 27, 2006, the investigation was resolved through the entry of an Administrative Order by the Commission (the “Order”). Our manager, Vestin Mortgage and its Chief Executive Officer, Michael Shustek, as well as Vestin Capital (collectively, the “Respondents”), consented to the entry of the Order without admitting or denying the findings therein. In the Order, the Commission finds that the Respondents violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 through the use of certain slide presentations in connection with the sale of units in Fund III and in our predecessor, Vestin Fund II, LLC. The Respondents consented to the entry of a cease and desist order, the payment by Mr. Shustek of a fine of $100,000 and Mr. Shustek’s suspension from association with any broker or dealer for a period of six months, which expires in March 2007. In addition, the Respondents agreed to implement certain undertakings with respect to future sales of securities. We are not a party to the Order and we do not expect that the sanctions imposed upon the Respondents will have any material affect upon our operations.
Vestin Group, Vestin Mortgage, and Del Mar Mortgage, Inc., a company wholly owned by Michael V. Shustek, the sole stockholder and CEO of Vestin Group, are defendants in a civil action entitled Desert Land, LLC et al. v. Owens Financial Group, Inc. et al (the “Action”). The Action is based upon allegations that Del Mar Mortgage, Inc. and/or Vestin Mortgage charged unlawful fees on various loans arranged by them in 1999, prior to the formation of Vestin Fund II, LLC. Desert Land sought in excess of $10 million in monetary damages. On April 10, 2003, the United States District Court for the District of Nevada (the “Court”) entered judgment jointly and severally in favor of Desert Land against Vestin Group, Vestin Mortgage and Del Mar Mortgage, Inc. Judgment was predicated upon the Court’s finding that Del Mar Mortgage, Inc. received an unlawful penalty fee from the plaintiffs.
The defendants subsequently filed a motion for reconsideration. The Court denied the motion and, on August 13, 2003, held that Vestin Group, Vestin Mortgage, and Del Mar Mortgage, Inc. were jointly and severally liable for the judgment in the amount of $5,683,312 (which amount includes prejudgment interest and attorney’s fees). On August 27, 2003, the Court stayed execution of the judgment against Vestin Group and Vestin Mortgage based upon the posting of a bond in the amount of $5,830,000. Mr. Shustek personally posted a cash bond without any cost or obligation to Vestin Group and Vestin Mortgage. Additionally, Del Mar Mortgage, Inc. had indemnified Vestin Group and Vestin Mortgage for any losses and expenses in connection with the Action, and Mr. Shustek had guaranteed the indemnification with his cash bond. On September 12, 2003, all of the defendants held liable to Desert Land appealed the judgment to the United States Court of Appeals for the Ninth Circuit, which heard the case on October 18, 2005. On November 15, 2005, the Ninth Circuit vacated the judgment of the District Court and dismissed the state law claims against the defendants without prejudice on the basis that the District Court lacked subject matter jurisdiction in the case. On November 29, 2005, Desert Land petitioned the Ninth Circuit Court for rehearing with a suggestion that the matter be heard en banc. On December 16, 2005, the District Court issued an Order releasing the bond, and on January 6, 2006, the Ninth Circuit denied Desert Land’s petition and the matter remains dismissed.
On or about April 6, 2006, Desert Land filed a Writ of Certiorari seeking review of the 9th Circuit’s decision by the United States Supreme Court. The U.S. Supreme Court denied Desert Land’s Writ of Certiorari on June 12, 2006, effectively ending this action.
On November 21, 2005, Desert Land filed a complaint in the state courts of Nevada, which complaint is substantially similar to the original complaint previously filed by Desert Land in the United States District Court, with the exception of claiming Nevada State Law violations and seeking Nevada State Law remedies rather than claiming Federal Law violations and seeking Federal Law remedies. On March 6, 2006, Desert Land amended the state court complaint to name VRM I. Desert Land alleges that one or more of the defendants have transferred assets to other entities without receiving reasonable value therefore; alleges plaintiffs are informed and believe that defendants have made such transfers with the actual intent to hinder, delay or defraud Desert Land; that such transfers made the transferor insolvent and that sometime between February 27 and April 1, 2003, Vestin Group transferred $1.6 million to VRM I for that purpose. The state court complaint further alleges that Desert Land is entitled to avoid such transfers and that pursuant to NRS 112.20, Desert Land is entitled to an injunction to enjoin defendants from further disposition of assets. Additionally, Del Mar Mortgage, Inc. has indemnified Vestin Group and Vestin Mortgage for any losses and expenses in connection with the Action, and Mr. Shustek has guaranteed the indemnification. The Defendants believe that the allegations are without merit and that they have adequate defenses. The Defendants intend to undertake a vigorous defense.
VRM I and Vestin Mortgage, Inc. (“Defendants”) are defendants in a breach of contract action filed in San Diego Superior Court by certain plaintiffs who allege, among other things, that they were wrongfully denied appraisal rights in connection with the merger of Fund I into Vestin Realty Mortgage I, Inc. The action has been removed to the United States District Court for the Southern District of California, but the Company has agreed to stipulate to remand this action to San Diego Superior Court. The action is being brought as a purported class action on behalf of all members of Vestin Fund I who did not vote in favor of the merger. The Defendants believe that the allegations are without merit and that they have adequate defenses. The Defendants intend to undertake a vigorous defense. The terms of our management agreement and Fund I’s Operating Agreement contain indemnity provisions whereby, Vestin Mortgage and Michael V. Shustek may be eligible for indemnification by the Company with respect to the above actions.
In addition to the matters described above, our manager is involved in a number of legal proceedings concerning matters arising in connection with the conduct of its business activities. Our manager believes it has meritorious defenses to each of these actions and intends to defend them vigorously. Other than the matters described above, our manager believes that it is not a party to any pending legal or arbitration proceedings that would have a material adverse effect on our manager’s financial condition or results of operations or cash flows, although it is possible that the outcome of any such proceedings could have a material impact on our manager’s net income in any particular period.
NOTE N — LEGAL MATTERS INVOLVING THE COMPANY
In April 2006, the lenders filed suit against the State of Hawaii listing 26 causes of action, including allegations that the State of Hawaii has illegally blocked the lender’s right to foreclose and take title to its collateral by inappropriately attaching conditions to the granting of licenses needed to operate the business, the pre-need trust funds and the perpetual care trust funds and that the State of Hawaii has attempted to force the lenders to accept liability for any statutory trust fund deficits while no such lender liability exists under the laws of the State of Hawaii. The State of Hawaii responded by filing allegations against Vestin Mortgage, Inc. and us alleging that these Vestin entities improperly influenced the former RightStar trustees to transfer trust funds to us. We believe the State’s claims to be without merit and intend to vigorously pursue our remedies while defending against any allegations made by the State.
In October 2006, a Judge of the Circuit Court of the First Circuit in Hawaii imposed new restrictions upon our right to foreclose and denied any subsequent owner the licensing necessary to operate the funeral service until the alleged pre-need and perpetual care trust funds shortages are cured. We believe these restrictions are both unauthorized under state law and unconstitutional under federal law. In January 2007, the Lenders filed a petition with the Supreme Court of Hawaii seeking mandamus relief from that ruling. As of March 9, 2007, the Supreme Court of Hawaii has not ruled on the Lender’s petition, but has requested briefing from the State of Hawaii regarding the petition. The outcome of this litigation is unforeseeable at this time. We cannot estimate when the foreclosure will ultimately be completed or when the lenders may obtain title to the underlying properties.
We, Vestin Mortgage, Inc. and Michael V. Shustek (“Defendants”) are defendants in a civil action filed by 88 separate plaintiffs (“Plaintiffs”) in Superior Court for Clark County, Nevada. The Plaintiffs allege, among other things, that Defendants: breached certain alleged contractual obligations owed to Plaintiffs; breached fiduciary duties supposedly owed to Plaintiffs; and misrepresented or omitted material facts regarding the conversion of Fund II into VRM II. The Action seeks monetary damages and a rescission of the REIT conversion. The Defendants believe that the allegations are without merit and that they have adequate defenses. The Defendants intend to undertake a vigorous defense. The terms of our management agreement and Fund II’s operating agreement contain indemnity provisions whereby, Vestin Mortgage and Michael V. Shustek may be eligible for indemnification by the Company with respect to the above actions.
We and Vestin Mortgage, Inc. (“Defendants”) are defendants in a breach of contract action filed in San Diego Superior Court by certain plaintiffs who allege, among other things, that they were wrongfully denied appraisal rights in connection with the merger of Fund II into Vestin Realty Mortgage II, Inc. The action is being brought as a purported class action on behalf of all members of Vestin Fund II who did not vote in favor of the merger. The Defendants believe that the allegations are without merit and that they have adequate defenses. The Defendants intend to undertake a vigorous defense. The terms of our management agreement and Fund II’s Operating Agreement contain indemnity provisions whereby, Vestin Mortgage and Michael V. Shustek may be eligible for indemnification by the Company with respect to the above actions.
In addition to the matters described above, we are involved in a number of other legal proceedings concerning matters arising in connection with the conduct of our business activities. We believe we have meritorious defenses to each of these actions and intend to defend them vigorously. Other than the matters described above, we believe that we are not a party to any pending legal or arbitration proceedings that would have a material adverse effect on our financial condition or results of operations or cash flows, although it is possible that the outcome of any such proceedings could have a material impact on our net income in any particular period.
NOTE O — DIVIDEND REQUIREMENT
To maintain our status as a REIT, we are required to make dividend distributions, other than capital gain dividends, to our stockholders each year in an amount at least equal to (1) the sum of (a) 90% of our taxable income, computed without regards to the dividends paid deduction and our net capital gain, and (b) 90% of the net income, after tax, from foreclosure property, minus (2) the sum of certain specified items of non-cash income over 5% of our REIT taxable income. All dividend distributions will be made at the discretion of our Board of Directors and will depend on our earnings, both tax and GAAP, financial condition, maintenance of REIT status and such other factors as the Board of Directors deems relevant.
NOTE P — SUBSEQUENT EVENTS
On January 22, 2007, our Board of Directors declared a cash dividend of $0.05 per common share for the month ended January 31, 2007, payable on February 26, 2007 to shareholders of record as of February 8, 2007.
On February 20, 2007, our Board of Directors declared a cash dividend of $0.05 per common share for the month ended February 28, 2007, payable on March 26, 2007 to shareholders of record as of March 9, 2007.
Subsequent to December 31, 2006, we entered into a sales contract for the partially completed golf course near Austin, Texas at a price that would not result in a material gain or loss. The sale contract requires that the buyer complete the purchase on or before June 29, 2007, however there can be no assurance that the sales contract will actually be completed.
Our manager commenced foreclosure proceedings on a second mortgage on a 233 unit apartment complex that was additional collateral for the Monterrey Associates, L.P. loan. Subsequent to December 31, 2006, we completed the foreclosure of the second mortgage and took title to the property subject to a non-recourse first mortgage, which is held by an unrelated third party. We sold this property to an unrelated third party who will assume the non-recourse first mortgage. This transaction did not result in any gain or loss.
Subsequent to December 31, 2006, Vestin Mortgage, Inc. purchased the junior principal amount owned by the unrelated third party for $500,000 cash. Vestin Mortgage, Inc. has agreed that any monies it receives as a result of payment of the notes or proceeds from a foreclosure sale are limited to its $500,000 investment in the notes plus expenses.
NOTE Q — SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following schedule is a selected quarterly financial data for the twelve months ended December 31, 2006:
| | | For the 12 Months Ended December 31, 2006 | |
| | | | |
| | | 1st Quarter | | 2nd Quarter | | 3rd Quarter | | 4th Quarter | | Year | |
| | | | | | | | | | | | |
| Total Revenues | | $ | 6,111,000 | | $ | 5,306,000 | | $ | 5,645,000 | | $ | 6,417,000 | | $ | 23,479,000 | |
| Total Operating Expenses | | | 7,233,000 | | | 922,000 | | | 806,000 | | | 1,663,000 | | | 10,624,000 | |
| Total Income from Real Estate Held for Sale | | | (588,000 | ) | | 354,000 | | | 1,561,000 | | | 1,669,000 | | | 2,996,000 | |
| | | | | | | | | | | | | | | | | |
| Income before provision for income taxes | | | (1,710,000 | ) | | 4,738,000 | | | 6,400,000 | | | 6,423,000 | | | 15,851,000 | |
| | | | | | | | | | | | | | | | | |
| Provision for income taxes | | | -- | | | -- | | | 452,000 | | | (452,000 | ) | | -- | |
| | | | | | | | | | | | | | | | | |
NET INCOME (LOSS) | | $ | (1,710,000 | ) | $ | 4,738,000 | | $ | 5,948,000 | | $ | 6,875,000 | | $ | 15,851,000 | |
| | | | | | | | | | | | | | | | | |
| Basic and diluted earnings per common share / membership unit | | $ | (0.04 | ) | $ | 0.12 | | $ | 0.15 | | $ | 0.18 | | $ | 0.41 | |
| | | | | | | | | | | | | | | | | |
| Dividends declared per common share / cash distributions per membership unit | | $ | 0.16 | | $ | -- | | $ | 0.215 | | $ | 0.205 | | $ | 0.58 | |
| | | | | | | | | | | | | | | | | |
| Weighted average common shares / membership units | | | 38,915,994 | | | 38,789,975 | | | 38,799,550 | | | 38,825,669 | | | 38,805,119 | |
| | | | | | | | | | | | | | | | | |
Weighted Average Term of Outstanding Loans (b) | | | 23 months | | | 25 months | | | 22 months | | | 19 months | | | 19 months | |
The following schedule is a selected quarterly financial data for the six months ended December 31, 2005.
| | | For The Three Months Ended September 30, 2005 | | For The Three Months Ended December 31, 2005 | | For The Six Months Ended December 31, 2005 | |
| | | | | | | | |
| Total Revenues | | $ | 6,971,000 | | $ | 5,257,000 | | $ | 12,228,000 | |
| Total Operating Expenses | | $ | 528,000 | | $ | 986,000 | | $ | 1,514,000 | |
| Total Income from Real Estate Held for Sale | | $ | (633,000 | ) | $ | 463,000 | | $ | (170,000 | ) |
| | | | | | | | | | | |
NET INCOME | | $ | 5,810,000 | | $ | 4,734,000 | | $ | 10,544,000 | |
| | | | | | | | | | | |
| Net Income Allocated to Members | | $ | 5,810,000 | | $ | 4,734,000 | | $ | 10,544,000 | |
| | | | | | | | | | | |
| Net Income Allocated to Members Per Weighted Average Membership Units | | $ | 0.14 | | $ | 0.11 | | $ | 0.25 | |
| | | | | | | | | | | |
| Weighted Average Membership Units | | | 42,706,872 | | | 42,788,578 | | | 42,747,725 | |
| | | | | | | | | | | |
Annualized Rate of Return to Members (a) | | | 5.40% | | | 4.39% | | | 9.79% | |
| | | | | | | | | | | |
| Cash Distributions | | $ | 4,230,000 | | $ | 4,356,000 | | $ | 4,356,000 | |
| | | | | | | | | | | |
| Cash Distributions Per Weighted Average Membership Units | | $ | 0.10 | | $ | 0.10 | | $ | 0.10 | |
| | | | | | | | | | | |
Weighted Average Term of Outstanding Loans (b) | | | 22 months | | | 22 months | | | 22 months | |
| (a) | The annualized rate of return to members is calculated based upon the net GAAP income allocated to members per weighted average units, divided by the number of days during the period and multiplied by three hundred sixty five (365) days, then divided by the cost per unit ($10.00). |
| (b) | The weighted average term of our outstanding loans includes extensions and loans related to seller financed real estate held for sale. |
| |
VESTIN REALTY MORTGAGE II, INC. | |
REAL ESTATE LOANS ON REAL ESTATE * | |
REAL ESTATE LOAN ROLL FORWARD | |
| | | | |
| | | | |
Balance, June 30, 2004 | | $ | 319,061,000 | |
| | | | | |
| Additions during the period | | | | |
| New real estate loans and additions | | | 72,219,000 | |
| Real estate loans bought | | | 39,758,000 | |
| Deductions during the period | | | | |
| Collections of principal and reductions | | | 135,959,000 | |
| Foreclosed loans (Real estate held for sale) | | | 37,627,000 | |
| Real estate loans sold | | | 22,034,000 | |
| | | | | |
| Net Change in 2004 - 2005 | | | (83,643,000 | ) |
| | | | | |
Balance, June 30, 2005 | | $ | 235,418,000 | |
| | | | | |
| Additions during the period | | | | |
| New real estate loans and additions | | | 121,406,000 | |
| Real estate loans bought | | | 30,365,000 | |
| Deductions during the period | | | | |
| Collections of principal and reductions | | | 113,739,000 | |
| Real estate loans sold | | | 17,000,000 | |
| | | | | |
| Net Change in 2005 | | | 21,032,000 | |
| | | | | |
Balance, December 31, 2005 | | $ | 256,450,000 | |
| | | | | |
| Additions during the period | | | | |
| New real estate loans and additions | | | 204,497,000 | |
| Real estate loans bought | | | 31,806,000 | |
| Deductions during the period | | | | |
| Collections of principal and reductions | | | 216,207,000 | |
| Foreclosed loans (Real estate held for sale) | | | 25,476,000 | |
| Real estate loans sold | | | 8,675,000 | |
| | | | | |
| Net Change in 2006 | | | (14,055,000 | ) |
| | | | | |
Balance, December 31, 2006 | | $ | 242,395,000 | |
* Includes loans related to seller financed real estate held for sale.
| |
VESTIN REALTY MORTGAGE II, INC. | |
REAL ESTATE LOANS ON REAL ESTATE * | |
REAL ESTATE LOANS BY TYPE OF PROPERTY | |
| | |
| | |
As of December 31, 2006: | | | | | | | | | | | |
Type of Property | | Interest Rate | | Face Amount of Loan | | Carrying Amount of Loan | | Maturity Date | | Amount Subject to Delinquency | |
| | | | | | | | | | | | |
| Commercial | | | 5%-14% | | $ | 204,285,000 | | $ | 138,556,000 | | | 03/04-12/07 | | $ | 19,446,000 | |
| Construction | | | 10%-12% | | $ | 100,466,000 | | $ | 43,319,000 | | | 10/06-11/07 | | $ | 1,681,000 | |
| Acquisition and Development | | | 12%-13% | | $ | 18,932,000 | | $ | 8,569,000 | | | 01/07-07/07 | | $ | -- | |
| Land | | | 10%-13% | | $ | 82,475,000 | | $ | 51,951,000 | | | 03/07-12/07 | | $ | 7,707,000 | |
| | | | | | | | | | 242,395,000 | | | | | | | |
| | | | | | | | | | | | | | | | | |
As of December 31, 2005: | | | | | | | | | | | | | | | | |
Type of Property | | | Interest Rate | | | Face Amount of Loan | | | Carrying Amount of Loan | | | Maturity Date | | | Amount Subject to Delinquency | |
| | | | | | | | | | | | | | | | | |
| Commercial | | | 5% - 14% | | $ | 234,185,000 | | $ | 158,746,000 | | | 03/04 - 12/07 | | $ | 36,382,000 | |
| Construction | | | 12% | | $ | 42,050,000 | | $ | 11,128,000 | | | 03/06 - 07/06 | | $ | -- | |
| Acquisition and Development | | | 8% - 12% | | $ | 75,662,000 | | $ | 43,275,000 | | | 04/06 - 05/06 | | $ | -- | |
| Land | | | 10% - 14% | | $ | 72,557,000 | | $ | 43,301,000 | | | 02/06 - 10/06 | | $ | -- | |
| | | | | | | | | | 256,450,000 | | | | | | | |
| |
VESTIN REALTY MORTGAGE II, INC. | |
REAL ESTATE LOANS ON REAL ESTATE * | |
REAL ESTATE LOANS BY LIEN POSITION | |
| | |
| | |
As of December 31, 2006: | | | | | | | | | | | |
Lien Position | | Face Amount of Loan | | Interest Rate | | Carrying Amount of Loan | | Maturity Date | | Amount Subject to Delinquency | |
| | | | | | | | | | | | |
1st | | $ | 397,496,000 | | | 5%-14% | | $ | 239,748,000 | | | 03/04-12/07 | | $ | 28,834,000 | |
2nd | | $ | 8,662,000 | | | 10.5%-13% | | $ | 2,647,000 | | | 01/07-12/07 | | $ | -- | |
| | | | | | | | | | 242,395,000 | | | | | | | |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
As of December 31, 2005: | | | | | | | | | | | | | | | | |
Lien Position | | | Face Amount of Loan | | | Interest Rate | | | Carrying Amount of Loan | | | Maturity Date | | | Amount Subject to Delinquency | |
| | | | | | | | | | | | | | | | | |
1st | | $ | 416,092,000 | | | 5% - 14% | | $ | 256,241,000 | | | 03/04 - 12/07 | | $ | 36,382,000 | |
2nd | | $ | 8,362,000 | | | 12% - 14% | | $ | 209,000 | | | 03/06 - 04/06 | | $ | -- | |
| | | | | | | | | | 256,450,000 | | | | | | | |
* Includes loans related to seller financed real estate held for sale.
| |
VESTIN REALTY MORTGAGE II, INC. | |
REAL ESTATE LOANS ON REAL ESTATE * | |
REAL ESTATE LOANS THAT EXCEED THREE PERCENT OF THE PORTFOLIO | |
| | |
| | |
As of December 31, 2006: | | | | | | | | | | | | | |
Description of Loan | | Interest Rate | | Maturity Date | | Lien Position | | Face Amount of Loan | | Carrying Amount of Loan | | Amount Subject to Delinquency | |
| | | | | | | | | | | | | | |
| Commercial | | | 11.50% | | | 10/05/07 | | | 1st | | $ | 18,000,000 | | $ | 10,760,000 | | $ | -- | |
| Commercial | | | 10.00% | | | 06/30/07 | | | 1st | | $ | 16,000,000 | | $ | 11,549,000 | | $ | -- | |
| Commercial | | | 9.00% | | | 07/12/07 | | | 1st | | $ | 23,900,000 | | $ | 17,177,000 | | $ | -- | |
| Commercial | | | 13.00% | | | 06/28/07 | | | 1st | | $ | 26,400,000 | | $ | 25,304,000 | | $ | -- | |
| Commercial | | | 6.25% | | | 12/25/07 | | | 1st | | $ | 12,500,000 | | $ | 11,404,000 | | $ | -- | |
| Commercial | | | 14.00% | | | 03/31/04 | | | 1st | | $ | 34,000,000 | | $ | 17,291,000 | | $ | 17,291,000 | |
| Commercial | | | 9.00% | | | 03/31/07 | | | 1st | | $ | 24,500,000 | | $ | 19,554,000 | | $ | -- | |
| Construction | | | 12.00% | | | 05/16/07 | | | 1st | | $ | 26,000,000 | | $ | 18,869,000 | | $ | -- | |
| Construction | | | 10.00% | | | 05/28/07 | | | 1st | | $ | 21,166,000 | | $ | 10,529,000 | | $ | -- | |
| Land | | | 12.00% | | | 03/17/07 | | | 1st | | $ | 9,500,000 | | $ | 7,707,000 | | $ | 7,707,000 | |
| Land | | | 10.00% | | | 12/30/07 | | | 1st | | $ | 18,000,000 | | $ | 12,945,000 | | $ | -- | |
| Land | | | 13.00% | | | 07/28/07 | | | 1st | | $ | 15,000,000 | | $ | 9,771,000 | | $ | -- | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
As of December 31, 2005: | | | | | | | | | | | | | | | | | | | |
Description of Loan | | | Interest Rate | | | Maturity Date | | | Lien Position | | | Face Amount of Loan | | | Carrying Amount of Loan | | | Amount Subject to Delinquency | |
| | | | | | | | | | | | | | | | | | | | |
| A/D | | | 12.00% | | | 05/10/06 | | | 1st | | $ | 33,000,000 | | $ | 16,025,000 | | $ | -- | |
| A/D | | | 8.00% | | | 04/25/06 | | | 1st | | $ | 35,000,000 | | $ | 26,840,000 | | $ | -- | |
| Commercial | | | 7.50% | | | 07/15/06 | | | 1st | | $ | 10,500,000 | | $ | 9,470,000 | | $ | -- | |
| Commercial | | | 10.25% | | | 08/18/06 | | | 1st | | $ | 24,500,000 | | $ | 21,750,000 | | $ | -- | |
| Commercial | | | 13.00% | | | 09/30/06 | | | 1st | | $ | 19,500,000 | | $ | 13,832,000 | | $ | -- | |
| Commercial | | | 6.25% | | | 12/25/07 | | | 1st | | $ | 12,500,000 | | $ | 11,477,000 | | $ | -- | |
| Commercial | | | 14.00% | | | 03/31/04 | | | 1st | | $ | 34,000,000 | | $ | 16,811,000 | | $ | 16,811,000 | |
| Commercial | | | 8.00% | | | 05/20/06 | | | 1st | | $ | 18,000,000 | | $ | 18,000,000 | | $ | -- | |
| Commercial | | | 11.00% | | | 06/30/05 | | | 1st | | $ | 26,000,000 | | $ | 19,571,000 | | $ | 19,571,000 | |
| Land | | | 10.00% | | | 03/30/06 | | | 1st | | $ | 35,000,000 | | $ | 28,598,000 | | $ | -- | |
| Land | | | 14.00% | | | 02/15/06 | | | 1st | | $ | 21,632,000 | | $ | 10,419,000 | | $ | -- | |
* Includes loans related to seller financed real estate held for sale.
