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, 2008
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.) |
6149 SOUTH RAINBOW BOULEVARD, LAS VEGAS, NEVADA 89118
(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:
| Common Stock, $0.0001 Par Value | | Nasdaq Global Select Market |
| (Title of each class) | | (Name of each exchange on which registered) |
Securities registered pursuant to Section 12(g) of the Act:
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 (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of 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, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer [ ] | Accelerated filer [ ] |
Non-accelerated filer [X] (Do not check if a smaller reporting company) | Smaller reporting company [ ] |
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, 2008 |
| Common Stock, $0.0001 Par Value | | $ | 44,663,186 |
| | | | |
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 4, 2009 |
| Common Stock, $0.0001 Par Value | | | 13,785,040 |
| | | | |
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 commercial real estate loans (hereafter referred to as “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 our manager and CEO, President and a director of us, wholly owns Vestin Group, which is engaged in asset management, real estate lending and other financial services through its subsidiaries. Our manager, prior to June 30, 2006, also operated as a licensed Nevada mortgage broker and was generally engaged in the business of brokerage, placement and servicing of commercial loans secured by real property. On July 1, 2006, a mortgage broker license was issued to an affiliated company, Vestin Originations, Inc. (“Vestin Originations”) that has continued the business of brokerage, placement and servicing of real estate loans. Vestin Originations is a wholly owned subsidiary of Vestin Group. On September 1, 2007, the servicing of real estate loans was assumed by our manager.
Pursuant to our management agreement, our manager implements our business strategies on a day-to-day basis, manages and provides services to us, and provides similar services to our subsidiaries. Without limiting the foregoing, our manager performs 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. Consequently, our operating results are dependent upon our manager’s ability and performance in managing our operations and servicing our assets.
Vestin Mortgage is also the manager of Vestin Realty Mortgage I, Inc. (“VRM I”), as the successor by merger to Vestin Fund I, LLC (“Fund I”), Vestin Fund III, LLC (“Fund III”) and inVestin Nevada, Inc. (“inVestin”), a company wholly owned by our manager’s CEO. These entities have been formed to invest in real estate loans.
The consolidated financial statements include the accounts of us and our wholly owned taxable REIT subsidiary, TRS II, Inc. All significant inter-company transactions and balances have been eliminated in consolidation.
On June 22, 2007, we completed the issuance of $60.1 million in unsecured trust preferred securities through Vestin II Capital Trust I (“VCT I”), a special purpose business trust. VCT I, is a Delaware statutory trust. Our interest in VCT I is accounted for using the equity method and the assets and liabilities are not consolidated into our financial statements due to our determination that VCT I is a variable interest entity in which we are not the primary beneficiary under Financial Accounting Standards Board Interpretation No. 46R (“FIN 46R”).
Segments
We operate as one business segment.
Real Estate Loan Objectives
As of December 31, 2008, our loans were in the following states: Arizona, California, Hawaii, Nevada, 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, brokers and sells, assigns, transfers or conveys 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 commercial real estate lender willing to invest in loans to borrowers who may not meet the credit standards of other financial institutional lenders, the default rate on our loans could be higher than those generally experienced in the mortgage lending industry. Because of our increased willingness to fund riskier loans, borrowers are generally willing to pay us an interest rate that is above the rates generally charged by other commercial 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 generally riskier because the borrower’s repayment depends on their ability to refinance the loan or develop the property so they can refinance the loan.
Our principal investment objectives are to maintain and grow stockholder value by:
| | · | Producing revenues from the interest income on our real estate loans; |
| | · | Providing cash dividends from the net income generated by our real estate loans; and |
| | · | 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, 2008, approximately 74% 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, along with a guarantee of the main principal of the borrower, 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 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 or brokered by Vestin Originations to facilitate our purchase of the loans. Vestin Originations and/or our manager will sell, assign, transfer or convey the loans to us without a premium, but may include its service fees and compensation.
When selecting real estate loans for us, our manager generally 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. We will not invest in any loan that is junior to more than one loan. As of December 31, 2008, approximately 84% of the principal amount of our outstanding investments 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 it believes 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. As of December 31, 2008, our actual loan-to-value ratio for our loan portfolio as a whole, including allowances for loan losses based on the most recent updated appraisals obtained and our manager’s analysis was 84.01% on a weighted average basis.
Loan-to-value ratios are initially based on appraisals obtained at the time of loan origination. 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. Current loan-to-value ratios are generally based on the most recent appraisals and include allowances for loan losses. Recognition of allowance for loan losses will result in a maximum loan-to-value ratio of 100% per loan.
Appraisals may not reflect subsequent changes in value and 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 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 outstanding balance 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 generally 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, 2008, had original terms of 2 months to 24 months, excluding extensions. Most of our loans are for an initial 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. However, our manager generally grants extensions when a borrower is in compliance with the material terms of the loan, including, but not limited to the borrower’s obligation to make interest payments on the loan. In addition, if circumstances warrant, our manager may extend a loan that is in default as part of a work out plan to collect interest and principal. The weighted average term of outstanding loans, including extensions, at December 31, 2008, was 20 months.
As of December 31, 2008, 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. 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, 2008, we had approximately $52.7 million in investments in real estate loans that had interest reserves where the total outstanding principal due to our co-lenders and us was approximately $60.0 million. These loans had interest reserves of approximately $5.7 million, of which our portion was approximately $4.9 million. As of December 31, 2008, two of these loans, totaling approximately $18.8 million, which had interest reserves, were considered non-performing. These loans’ interest reserves, totaling approximately $3.2 million, have been suspended as of December 31, 2008 and we no longer draw monthly interest income from them. At December 31, 2007, we had approximately $108.8 million in investments in real estate loans that had interest reserves where the total outstanding principal due to our co-lenders and us was approximately $128.6 million. These loans had interest reserves of approximately $10.4 million, of which our portion was approximately $8.8 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, that are accounted for at the principal balance and no gain or loss is recognized by us or any affiliate. These purchases may include allowable fees and expenses, but no other compensation for the loans. Excluding the compensation paid to our manager, all income generated and expense associated with the loans so acquired shall be treated as belonging to us.
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 by providing funds for or purchasing an undivided interest in a loan meeting our investment guidelines described above. We participate in loans with our affiliates, subject to our voluntary compliance with the guidelines of the North American Securities Administrators Association (“NASAA Guidelines”). The independent directors on our Board may authorize a departure from NASAA Guidelines. 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.
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 fees for entering into secured borrowing arrangements; however, we may receive revenue in any differential of the interest spread, if applicable.
As of December 31, 2008, 68% 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, unless otherwise approved by the independent members of our board of directors, 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, 2008, our single largest loan, accounted for approximately 9.9% of our stockholders’ equity. The loan’s interest was at 12% per annum and as of December 31, 2008, our portion of the outstanding balance of the loan was approximately $16.0 million. As of March 4, 2009, this loan was non-performing. For additional information regarding the above non-performing loan see “Non-Performing Loans” in Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Report Form 10-K.
As of December 31, 2008, we had loans with common guarantors. For additional information regarding loans with common guarantors see Note C – Financial Instruments and Concentrations of Credit Risk of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Report Form 10-K.
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. 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 for us to do so. However, we do not believe that the loans will be marketable or that a secondary market will 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.
Investment of Loans from our manager and Its Affiliates
In addition to those loans our manager selects for us, we invest in loans that were originated by Vestin Originations or other parties as long as the loan(s) 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 as otherwise approved by the independent members of our board of directors.
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 property 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, due to, but not limited to, investment opportunities and subsequent sales and foreclosures.
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 initial 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, 2008, approximately 34% 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, together with the costs associated with obtaining entitlements, including zoning, mapping and other required governmental approvals. We will generally invest in loans with an initial 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, 2008, approximately 6% 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 initial 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, 2008, approximately 12% 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 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 initial property appraisal and generally invest in loans for up to 75% of such appraised value of the property. As of December 31, 2008, approximately 48% 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 initial value of the property. As of December 31, 2008, none of our loans were in this category.
Collateral
Each loan is secured by a lien on either a fee simple or leasehold interest in real property as evidenced by a first deed of trust or a second deed of trust.
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, 2008, approximately 84% of our loans were secured by first deeds of trust.
Second Deed of Trust
Up to 10% of our loan portfolio may be secured by second deeds of trust; however, a higher percentage of loans secured by second deeds of trust may be approved by our board. During September 2008, the board authorized us to allow loans secured by second deeds of trust to constitute up to 15% of our loans, due to loan restructuring and current business opportunities. 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, 2008, approximately 16% of our loans were secured by a second deed of trust. When funded, such loans constituted less then 15% or our loans. Subsequent decreases in the value of loans secured by first deeds of trust, due to sales and foreclosures, resulted in an increase in the percentage of our portfolio secured by second deeds of trust.
Prepayment Penalties and Exit Fees
Generally, the loans we invest in will not contain prepayment penalties but may contain exit fees payable when the loan is paid in full, by the borrower, to Vestin Originations or its affiliates as part of their compensation. If interest rates decline, the amount we can charge as interest on our loans will also likely decline. Moreover, if 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. As of December 31, 2008, none of our loans had a prepayment penalty, although 25 of our loans, totaling approximately $129.0 million, had an exit fee. Out of the 25 loans with an exit fee, 12 loans, totaling approximately $65.1 million, were considered non-performing as of December 31, 2008. However, depending upon the amount by which interest rates decline, the amount of the exit fees is generally not significant in relation to the potential savings borrowers may realize as a result of prepaying their loans.
Extensions to Term of Loan
Our original loan agreements generally 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. However, our manager generally grants extensions when a borrower is in compliance with the material terms of the loan, including, but not limited to the borrower’s obligation to make interest payments on the loan. In addition, if circumstances warrant, our manager may extend a loan that is in default as part of a work out plan to collect interest and principal. As of December 31, 2008, our manager had granted extensions on 18 loans, totaling approximately $157.1 million, of which our portion was approximately $114.0 million. Subsequent to their extension, 9 of the 18 loans have become non-performing. The loans, which became non-performing after their extension, had a total principal amount at December 31, 2008 of approximately $104.0 million, of which our portion is approximately $79.4 million.
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, 2008, we had approximately $52.7 million in investments in real estate loans that had interest reserves where the total outstanding principal due to our co-lenders and us was approximately $60.0 million. These loans had interest reserves of approximately $5.7 million, of which our portion was approximately $4.9 million. As of December 31, 2008, two of these loans, totaling approximately $18.8 million, which had interest reserves, were considered non-performing. These loans’ interest reserves, totaling approximately $3.2 million, have been suspended as of December 31, 2008 and we no longer draw monthly interest income from them.
Balloon Payment
As of December 31, 2008, 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. 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, 2008, all of the loans in our real estate loan portfolio were fixed rate loans, with the exception of one loan with a variable interest rate, totaling approximately $14.8 million. This loan was non-performing as of December 31, 2008, see Peoria 180, LLC under “Non-Performing Loans” in Note D – Investments in Real Estate Loans in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K for more information.
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:
| | · | Declare dividends 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 should 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.
In June 2007, we completed the issuance of $60.1 million of trust preferred securities through a special purpose business trust in order 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 and consequently, subject to the terms of the trust preferred securities, we may borrow additional funds in order to further expand our loan portfolio. These borrowings will require us to carefully manage our cost of funds. The junior subordinated notes sold in June 2007 in connection with the trust preferred financing bear interest at a fixed rate of 8.75% through July 2012; thereafter the interest rate is LIBOR plus 3.5%, resetting quarterly. In order to benefit from this arrangement, we need to loan the proceeds at rates in excess of the rates payable on the junior subordinated notes. No assurance can be given that we will be successful in this effort, particularly if non-performing loans reduce our effective rate of return on our outstanding loans.
On November 7, 2008, we entered into an agreement with Taberna Capital Management, LLC (“Taberna”), in its capacity as collateral manager for certain collateral debt obligation vehicles that are the holders of the junior subordinated notes, providing for an amendment of the tangible net worth covenant (the “First Supplemental Indenture”). On December 31, 2008, we were not in compliance with the revised tangible net worth covenant and the debt to tangible net worth covenant in the First Supplemental Indenture. On March 25, 2009, we entered into a letter agreement with Taberna providing for a waiver of all financial covenants effective December 31, 2008 through June 30, 2009. In addition, pursuant to the letter agreement we will exchange $20 million of the junior subordinated notes for certain replacement securities, which we expect to acquire for approximately $10 million of cash. This will reduce our obligation on the junior subordinated notes to approximately $36.3 million, which should facilitate future compliance with financial covenants set forth in the First Supplemental Indenture. This transaction would result in a net gain of approximately $9 million including transaction costs. In addition, we are to pay additional interest equal to $250,000 per year, payable quarterly on the same payment dates as the current terms of the Junior Subordinated Notes. We agreed to make a nonrefundable payment of $200,000 to Taberna to cover its costs related to the waiver and exchange arrangement. For additional information regarding the First Supplemental Indenture see Note I – Junior Subordinated Notes of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Report Form 10-K.
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 who offer short-term, equity-based loans on an expedited basis for higher fees and rates than those charged by other financial institutional lenders such as commercial banks, insurance companies, mortgage brokers and pension funds. 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, our manager 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 our activities. In addition, our manager is subject to 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 determines 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, Vestin Originations, our manager, or otherwise adversely affect our business or prospects.
Employees
We have no employees. Our manager, 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, 2008, those entities had a total of 21 full-time and no part-time employees. Except as hereinafter noted, all employees are at-will employees and none are covered by collective bargaining agreements. John Alderfer, our former CFO, is a party to an employment, non-competition, confidentiality and consulting contract with Vestin Group, Inc., the parent company of our manager, through December 31, 2016.
Available Information
Our Internet website address is www.vestinrealtymortgage2.com. We make available free of charge through http://phx.corporate-ir.net/phoenix.zhtml?c=193758&p=irol-sec 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, pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, to the United States Securities and Exchange Commission (“SEC”). Further, a copy of this annual report on Form 10-K is located at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operations of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov. 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
Defaults on our real estate loans will decrease our revenues and our dividends to shareholders. Current economic conditions increase the risk of defaults on our loans.
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 commercial real estate lender willing to invest in loans to borrowers who may not meet the credit standards of other financial institutional 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.
As of December 31, 2008, our non-performing assets were approximately $98.1 million, representing approximately 75% of our stockholders’ equity. Non-performing assets included approximately $73.7 million in non-performing loans, net of allowance for non-performing loan losses of approximately $71.2 million, and approximately $24.4 million of real estate held for sale. We believe that the level of non-performing assets is largely attributable to difficulties in the real estate and credit markets. At this time, we are not able to predict how long such difficult economic conditions will continue.
As of December 31, 2008 and 2007, we had approximately $78.2 million and $12.9 million in allowances for loan losses, respectively, resulting in net weighted average loan-to-value ratios of 84.01% and 68.52%, respectively. Not including allowance for loan losses, our weighted average loan-to-value ratio, as of December 31, 2008 and 2007, was 175.12%, and 72.64%, respectively, primarily as a result of declining real estate values that have eroded the market value of our collateral. As a result, we may not be able to recover the full amount of our loans if the borrower defaults. Moreover, any failure of a borrower to pay interest on loans will reduce our revenues, the dividends we pay to stockholders and, most likely, the value of our stock. Similarly, any failure of a borrower to repay loans when due may reduce the capital we have available to make new loans, thereby adversely affecting our operating results.
The current recession and constraints in the credit markets are adversely affecting our operating results and financial condition.
The risks associated with our business are more acute during periods of economic slowdown or recession because these periods can be accompanied by illiquid credit markets and declining real estate values. During the year ended December 31, 2008, we conducted updated appraisals on 29 properties securing our loans, representing approximately 81% of our total loan portfolio value as of December 31, 2008, which negatively impacted our weighted average loan to value ratio. Based on these updated appraisals and our manager’s analysis, we recognized in 2008 approximately $83.7 million in provisions for loan losses. As a commercial real estate 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 commercial mortgage lending industry during periods of economic slowdown or recession. Problems in the sub-prime residential mortgage market have adversely affected the general economy and the availability of funds for commercial real estate developers. We believe this lack of available funds has led to an increase in defaults on our loans. Furthermore, problems experienced in U.S. credit markets since the summer of 2007 have reduced the availability of credit for many prospective borrowers. These problems have made it more difficult for our borrowers to obtain the anticipated re-financing necessary in many cases to pay back our loans. Thus, an extended period of illiquidity in the credit markets has resulted in a material increase in the number of our loans that are not paid back on time. Any sustained period of increased delinquencies, defaults or foreclosures will have an adverse affect upon our ability to originate, purchase and securitize loans, which could significantly harm our business, financial condition, liquidity and results of operations.
Our underwriting standards and procedures are more lenient than many institutional lenders, which may result in a higher level of non-performing assets and less amounts available for distribution.
There may be a greater risk of default by our borrowers, which may impair our ability to declare timely dividends and which may reduce the amount we have available to distribute. Our underwriting standards and procedures are more lenient than many institutional lenders in that we will invest in loans to borrowers who may not be required to meet the credit standards of other financial institutional real estate lenders. This may lead to an increase in 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.
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 are currently experiencing a trend of declining real estate values, which increases the risk that our collateral will prove insufficient to protect our loans.
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. During the past 12 months, there has been a significant decline in real estate values in many of the markets where we operate, resulting in a decline in the estimated value of the real estate securing our loans.
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, 2008, 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. Loans with balloon payments are riskier than loans with 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, obtain suitable refinancing or otherwise raise a substantial amount of cash when the loan comes due. The borrower’s ability to achieve a successful sale or refinancing of the property may be adversely impacted by deteriorating economic conditions or illiquidity in the credit markets. 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 not be able to maintain compliance with all of the financial covenants contained in the indenture governing our junior subordinated notes. Failure to comply could result in acceleration of all amounts due under such notes, resulting in severe disruption of our operations.
In June 2007, we completed the issuance of $60.1 million of trust preferred securities through a special purpose business trust in order to expand our capacity to invest in real estate loans. The amount currently due on such notes is approximately $56.4 million. The junior subordinated notes sold in June 2007 in connection with the trust preferred financing bear interest at a fixed rate of 8.75% through July 2012; thereafter the interest rate is LIBOR plus 3.5%, resetting quarterly. The First Supplemental Indenture governing the junior subordinated notes sets forth a number of financial covenants. On December 31, 2008, we were not in compliance with the revised tangible net worth covenant and the debt to tangible net worth covenant in the First Supplemental Indenture. On March 25, 2009, we entered into a letter agreement with Taberna providing for a waiver of all financial covenants effective December 31, 2008 through June 30, 2009. In addition, pursuant to the letter agreement we will exchange $20 million of the junior subordinated notes for certain replacement securities, which we expect to acquire for approximately $10 million of cash. This will reduce our obligation on the junior subordinated notes to approximately $36.3 million, which should facilitate future compliance with financial covenants set forth in the First Supplemental Indenture. In addition, we are to pay additional interest equal to $250,000 per year, payable quarterly on the same payment dates as the current terms of the Junior Subordinated Notes. We agreed to make a nonrefundable payment of $200,000 to Taberna to cover its costs related to the waiver and exchange arrangement. This transaction would result in a net gain of approximately $9 million including transaction costs. If we fail to perform our obligations under the letter agreement or if we are unable to comply with the financial covenants after July 1, 2009, then, absent another waiver from the note holders, the lenders could declare an event of default and could seek to accelerate all amounts due under the junior subordinated notes. We might not have cash resources sufficient to pay the amounts due in the event of acceleration. As a result, our business operations would suffer severe disruption if the lenders sought to accelerate payment of the junior subordinated notes. In addition, an unresolved event of default under the indenture would prevent us from paying any dividends or other dividends to our shareholders.
The terms of our indebtedness increase our operating risk and may reduce the amount we have available to distribute to stockholders.
We may borrow up to 70% of the fair market value of our outstanding real estate loans at any time. We currently have outstanding approximately $56.4 million of trust preferred securities bearing interest at 8.75%. These borrowings will require us to carefully manage our cost of funds. In order to benefit from the trust preferred securities, we need to loan the proceeds at rates in excess of the rates payable on the junior subordinated notes. No assurance can be given that we will be successful in making loans at rates in excess of our cost of funds, particularly if non-performing loans reduce our effective rate of return on our outstanding loans or if there is a continuing decline in interest rates.
In addition, the financial covenants in the indenture governing the junior subordinated notes may constrain our flexibility in operating our business. Should we breach a material covenant or if we are unable to meet our payment obligations on the junior subordinated notes, the purchasers of the trust preferred securities may declare us in default, resulting in acceleration of the principal sums due on the notes and restrictions on the payment of dividends to our stockholders.
During June 2008, we, our manager, and Vestin Originations entered into an intercreditor agreement with an unrelated third party related to the funding of six real estate loans. (See exhibit 10.11 Intercreditor Agreement under the Exhibit Index included in Part IV, Item 15 of this Report Form 10-K). The participation interest is at 11% on the outstanding balance. We incurred approximately $0.9 million in finance costs related to the secured borrowings, these costs are being amortized to interest expense over the term of the agreements. As of December 31, 2008, we had $10.6 million in funds, including approximately $0.7 million in interest reserves, used under Inter-creditor Agreements as compared to none as of December 31, 2007.
The terms of any additional 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 declare dividends.
There is a substantial risk that we would be unable to raise additional funding if needed to meet our obligations or expand our loan portfolio.
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.
Our ability to borrow funds for this purpose, or to expand our loan portfolio, is doubtful in light of current market conditions. In addition, our ability to raise funds through an equity financing would be hindered by the current price of our stock. If we raise capital through an equity offering, this may result in substantial dilution to our current stockholders. Any debt financing may be expensive and might include restrictive covenants that would constrain our ability to declare dividends to our shareholders. We may not be able to raise capital on reasonable terms, if at all, in the current market environment.
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. See Note O – Legal Matters Involving The Company in the notes to the consolidated financial statement under Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K. |
| | · | 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. See Note F – Real Estate Held for Sale in the notes to the consolidated financial statement under Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
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.
Our results are subject to fluctuations in interest rates and other economic conditions.
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 dividends to stockholders. As a result of the current economic recession, our revenues and dividends have been reduced.
Interest rate fluctuations may affect our operating results as follows:
| | · | 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 or our manager, not to us. Our revenues and dividends will decline if we are unable to reinvest at higher rates or if an increasing number of borrowers default on their loans; and |
| | · | If interest rates decline, the amount we can charge as interest on our loans will also likely decline. Moreover, if 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. As of December 31, 2008, none of our loans had a prepayment penalty, although 25 of our loans, totaling approximately $129.0 million, had an exit fee. Out of the 25 loans with an exit fee, 12 loans, totaling approximately $65.1 million, were considered non-performing as of December 31, 2008 However, depending upon the amount by which interest rates decline, the amount of the exit fees is generally not significant in relation to the potential savings borrowers may realize as a result of prepaying their loans. |
Investments in second deeds of trust and wraparound loans are subject to the rights of the first deed of trust.
We invest in second deeds of trust and, in rare instances, wraparound, or all-inclusive, real estate loans. Our board is required to approve our investing more than 10% of our assets in second deeds of trust. During September 2008, the board authorized us to allow loans secured by second deeds of trust to constitute up to 15% of our loans, due to loan restructuring and current business opportunities. In a second deed of trust, our rights as a lender, including our rights to receive payment on foreclosure, will be subject to the rights of the first deed of trust. In a wraparound real estate loan, our rights will be similarly subject to the rights of a first deed of trust, but the aggregate indebtedness evidenced by our loan documentation will be the first deed of trust plus the new funds we invest. We would receive all payments from the borrower and forward to the senior lender its portion of the payments we receive. Because both of these types of loans are subject to the first deed of trust’s right to payment on foreclosure, we incur a greater risk when we invest in each of these types of loans. As of December 31, 2008, approximately 16% of our loans were secured by a second deed of trust. When funded, such loans constituted less then 15% or our loans. Subsequent decreases in the value of loans secured by first deeds of trust, due to sales and foreclosures, resulted in an increase in the percentage of our portfolio secured by second deeds of trust.
Our loan portfolio may exhibit greater risk if it is not diversified geographically.
As of December 31, 2008, our loans were in the following states: Arizona, California, Hawaii, Nevada, Oklahoma, Oregon, Texas and Washington, with approximately 40% of our loans in Nevada. Depending on the market and on our company’s performance, we may expand our investments throughout the United States. However, our manager has limited experience outside of the Western and Southwestern 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.
Legal actions seeking damages and appraisal rights could harm our operating results and financial condition.
We are a party in several legal actions seeking damages and appraisal rights in connection with the REIT conversion. See Note N – Legal Matters Involving The Manager and Note O – Legal Matters Involving The Company in the notes to the consolidated financial statement under Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K. While we believe these actions are without merit, the defense of such actions has materially increased our legal costs and may require the substantial attention of our management. The increased legal costs have adversely impacted our operating results. As of December 31, 2008, we have incurred legal expenses of approximately $2.7 million related to such actions. 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 may have a lack of control over participations.
We will consider investing in or purchasing loans jointly with other lenders and purchasers, some of whom might be affiliates of Vestin Mortgage. We will initially have, and will maintain a controlling interest as lead lender in participations with non-affiliates. Although it is not our intention to lose control, there is a risk that we will be unable to remain as the lead lender in the loans in which we participate in the future. In the event of participation with a publicly registered affiliate, the investment objectives of the participants shall be substantially identical. There shall be no duplicate fees. The compensation to the sponsors must be substantially identical, and the investment of each participant must be on substantially the same terms and conditions.
Each participant shall have a right of first refusal to buy the other's interest if the co-participant decides to sell its interest. We will not participate in joint ventures or partnerships with affiliates that are not publicly registered except as permitted in the NASAA Guidelines or otherwise approved by the independent members of our board of directors. If our co-participant affiliate determines to sell its interest in the loan, there is no guarantee that we will have the resources to purchase such interest and we will have no control over a sale to a third party purchaser.
MANAGEMENT AND CONFLICTS OF INTEREST RISKS
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 declare dividends 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’s duties to our stockholders are generally governed by the terms of the management contract, rather than by common law principles of fiduciary duty. Moreover, our manager 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, 2008, our loans were in the following states: Arizona, California, Hawaii, Nevada, Oklahoma, Oregon, Texas and Washington. Depending on the market and on our company’s performance, we may expand our investments throughout the United States. However, our manager has limited experience outside of the Western and Southwestern 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), Rocio Revollo (Chief Financial Officer), and Daniel B. Stubbs (Senior Vice President, Underwriting) 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 individuals were to cease their employment with our manager, our operating results could suffer. None of the 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.
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, 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 or our manager may be entitled to additional fees for loan extensions or modifications and loan assumptions, reconveyances and exit fees. These and other fees are quantified and described in greater detail in our management agreement 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 management fee of approximately $1.1 million for the year ended December 31, 2008. We paid our manager approximately $0.6 million for unpaid fees owed to our manager from our borrowers. These unpaid fees became due and payable on demand from us. In addition, Vestin Mortgage and Vestin Originations received a total of approximately $4.1 million and $5.2 million, respectively, in fees directly from borrowers for the year ended December 31, 2008. 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. Our assets represented approximately 75% of the assets managed by Vestin Mortgage as of December 31, 2008.
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, which have similar 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 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 dividends 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 declare dividends 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.
Dividends from a REIT are currently taxed at a higher rate than corporate dividends.
Under the Tax Relief and Reconciliation Act of 2003, the maximum U.S. federal income tax rate on both dividends 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 dividends generally will not apply to our dividends (except those dividends identified by the company as “capital gain dividends” which are taxable as long-term capital gain) and therefore such dividends 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 dividends may cause the market to devalue our common stock relative to stock of those corporations whose dividends qualify for the lower rate of taxation. Please note that, as a general matter, dividends 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, 2008, we held 11 properties with a total carrying value of approximately $24.4 million recorded as investments in real estate held for sale and no properties in which we or an affiliate provided the financing, recorded as real estate held for sale – seller financed. United States generally accepted accounting principals (“GAAP”) requires us to include real estate held for sale – seller financed until the borrower has met and maintained certain requirements. The real estate held for sale collectively constituted approximately 12% of our assets as of December 31, 2008.
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 dividends 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 dividends 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 dividends from a taxable REIT subsidiary. If, for any taxable year, the dividends 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, 2008, has ranged from $2.00 to $15.96 (adjusted for the 1-for-2.6 reverse stock split in December 2007). We believe the price of our stock in the months after we were listed was affected by, among other things, selling pressure from stockholders seeking immediate liquidity and the level of non-performing assets, which we own. We continue to own a significant level of non-performing assets and our sector of the market has suffered from the problems encountered by sub-prime lenders. Our stock price may continue to 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 our stock price could approach our book value per share. However, no assurance can be given that the stock price will approach book value and then prevailing market conditions may affect the price of our stock even as we near 2020.
The market price of our common stock may 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 dividends; |
| | · | 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 stockholder litigation, which may depress the price of our stock.
A number of lawsuits have been filed against us by stockholders 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 costs of defense and 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 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 shares office facilities, in Las Vegas, Nevada, with its parent corporation, Vestin Group, in a building that a company wholly owned by our CEO holds the majority interest and an unrelated third party holds the minority interest. Our manager believes that this facility is adequate for their foreseeable office space needs. We do not have any separate offices.
Please refer to Note N - Legal Matters Involving The Manager and Note O - Legal Matters Involving The Company in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information regarding legal proceedings, which discussion is incorporated herein by reference.
| 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 Global Select 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 Global Select Market during each quarter since it began trading, as adjusted for the 1-for-2.6 reverse stock split issued on December 31, 2007.
| 2007 | | High | | | Low | |
| | | | | | | |
| First Quarter | | $ | 14.66 | | | $ | 13.00 | |
| Second Quarter | | $ | 15.44 | | | $ | 13.13 | |
| Third Quarter | | $ | 15.96 | | | $ | 10.30 | |
| Fourth Quarter | | $ | 13.39 | | | $ | 9.26 | |
| 2008 | | High | | | Low | |
| | | | | | | |
| First Quarter | | $ | 13.50 | | | $ | 7.23 | |
| Second Quarter | | $ | 8.94 | | | $ | 2.78 | |
| Third Quarter | | $ | 5.27 | | | $ | 2.55 | |
| Fourth Quarter | | $ | 5.05 | | | $ | 2.06 | |
Holders
As of March 4, 2009, there were approximately 1,470 holders of record of 13,785,040 shares of our common stock.
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 dividends 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 stockholder. We anticipate that dividends 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. During June 2008, our Board of Directors decided to suspend the payment of dividends. We will continue to comply with the REIT requirements and will distribute at least ninety percent (90%) of our annual taxable income. Our Board of Directors will closely monitor our operating results in order to determine when dividends should be reinstated. Dividends declared per share for the year ended December 31, 2008 and December 31, 2007, are listed below:
| Date of Declaration | Record Date | Date Paid | | Dividend Per Share ** | |
| January 16, 2008 | February 8, 2008 | February 28, 2008 | | $ | 0.11 | |
| February 21, 2008 | March 7, 2008 | March 28, 2008 | | | 0.11 | |
| March 19, 2008 | April 4, 2008 | April 25, 2008 | | | 0.11 | |
| April 24, 2008 | May 12, 2008 | May 30, 2008 | | | 0.09 | |
| May 22, 2008 | June 9, 2008 | June 27, 2008 | | | 0.08 | |
| | | | | | | |
| Dividends declared per common share for year ended December 31, 2008 | | $ | 0.49 | |
| Date of Declaration | Record Date | Date Paid | | Dividend Per Share ** | |
| January 22, 2007 | February 8, 2007 | February 26, 2007 | | $ | 0.13 | |
| February 20, 2007 | March 9, 2007 | March 26, 2007 | | | 0.13 | |
| March 21, 2007 | April 9, 2007 | April 26, 2007 | | | 0.13 | |
| April 19, 2007 | May 9, 2007 | May 30, 2007 | | | 0.13 | |
| May 8, 2007 | June 7, 2007 | June 26, 2007 | | | 0.14 | |
| June 7, 2007 | July 9, 2007 | July 26, 2007 | | | 0.14 | |
| July 24, 2007 | August 9, 2007 | August 30, 2007 | | | 0.13 | |
| August 20, 2007 | September 10, 2007 | September 28, 2007 | | | 0.13 | |
| September 19, 2007 | October 10, 2007 | October 30, 2007 | | | 0.12 | |
| October 16, 2007 | November 9, 2007 | November 29, 2007 | | | 0.12 | |
| November 15, 2007 | December 3, 2007 | December 28, 2007 | | | 0.10 | |
| December 11, 2007 | December 31, 2007 | January 29, 2008 | | | 0.10 | |
| | | | | | | |
| Dividends declared per common share for year ended December 31, 2007 * | | $ | 1.50 | |
* The dividend per share prices have been adjusted to reflect the 1-for-2.6 reverse stock split issued on December 31, 2007.
** Dividends are rounded to two decimal places.
Performance Graph
The following graph, provided by Research Data Group, Inc., compares the cumulative total return to stockholders of our common stock for the period from May 1, 2006, the date our stock began trading to December 31, 2008 under the symbol VRTB, to the cumulative total return of the Nasdaq Composite Index (U.S.) and the NAREIT Mortgage Index for the same period. This graph assumes the investment of $100.00 on May 1, 2006 in our common stock, the Nasdaq Composite Index (U.S.) and NAREIT Mortgage Index (published by the National Association of REITs) and assumes any dividends are reinvested.
| Date | | Vestin Realty Mortgage II, Inc | | | NASDAQ Composite | | | FTSE NAREIT Mortgage | |
| May 1, 2006 | | $ | 100.00 | | | $ | 100.00 | | | $ | 100.00 | |
| June 30, 2006 | | $ | 95.04 | | | $ | 93.78 | | | $ | 101.54 | |
| September 30, 2006 | | $ | 116.50 | | | $ | 97.82 | | | $ | 101.47 | |
| December 31, 2006 | | $ | 121.83 | | | $ | 105.28 | | | $ | 108.32 | |
| March 31, 2007 | | $ | 124.59 | | | $ | 105.76 | | | $ | 92.87 | |
| June 30, 2007 | | $ | 140.55 | | | $ | 113.22 | | | $ | 86.69 | |
| September 30, 2007 | | $ | 123.49 | | | $ | 117.98 | | | $ | 62.29 | |
| December 31, 2007 | | $ | 97.92 | | | $ | 114.95 | | | $ | 62.45 | |
| March 31, 2008 | | $ | 91.00 | | | $ | 98.79 | | | $ | 49.12 | |
| June 30, 2008 | | $ | 31.87 | | | $ | 99.80 | | | $ | 46.88 | |
| September 30, 2008 | | $ | 41.33 | | | $ | 88.56 | | | $ | 43.09 | |
| December 31, 2008 | | $ | 33.46 | | | $ | 66.97 | | | $ | 38.86 | |
Recent Sales of Unregistered Securities
On June 22, 2007, as reported in our 8-K filed June 27, 2007, we completed the issuance of $60.1 million in unsecured trust preferred securities through the special purpose business trust, VCT I to Merrill Lynch International, Bear Stearns & Co. Inc. and Taberna Funding LLC. We are obligated to pay the trust preferred securities with respect to dividends and amounts payable upon liquidation, redemption or repayment. The securities were sold to three institutional investors in a non-public offering pursuant to Section 4(2) of the Securities Act of 1933.
Equity Compensation Plan Information
None.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
On March 21, 2007, our board of directors authorized the repurchase of up to $10 million worth of our common stock. Depending upon market conditions, shares may be repurchased from time to time at prevailing market prices through open market or privately negotiated transactions.
We are not obligated to purchase any shares. Subject to applicable securities laws repurchases may be made at such times and in such amounts, as our management deems appropriate. The share repurchase program may be discontinued or terminated at any time and we have not established a date for completion of the share repurchase program. The repurchases will be funded from our available cash. As of December 31, 2008, we had purchased 1,198,573 shares as treasury stock through the repurchase program noted above. These shares are carried on our books at cost totaling approximately $5.7 million.
The following is a summary of our stock purchases during the three months ended December 31, 2008, as required by Regulation S-K, Item 703.
| Period | | (a) Total Number of Shares Purchased | | | (b) Average Price Paid per Share | | | (c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | | (d) Maximum Number of (or Approximate Dollar Value) of Shares that May Yet Be Purchase Under the Plans or Programs | |
| October 1 – October 31, 2008 | | | -- | | | $ | -- | | | | -- | | | $ | 6,996,000 | |
| November 1 – November 30, 2008 | | | 556,507 | | | | 3.09 | | | | 556,507 | | | | 5,278,000 | |
| December 1 – December 31, 2008 | | | 214,655 | | | | 4.52 | | | | 214,655 | | | | 4,308,000 | |
| | | | | | | | | | | | | | | | | |
| Total | | | 771,162 | | | $ | 7.38 | | | | 771,162 | | | $ | 4,308,000 | |
| | | Balance at | |
| Vestin Realty Mortgage II, Inc. | | 12/31/2008 | | | 12/31/2007 | | | 12/31/2006 | | | 12/31/2005 | | | 12/31/2004 | | | 6/30/2005 | |
| | | | | | | | | | | | | | | (Unaudited) | | | | |
| Balance Sheet Data: | | | | | | | | | | | | | | | | | | |
| Investments in real estate loans (net of allowance) | | $ | 146,834,000 | | | $ | 278,190,000 | | | $ | 221,849,000 | | | $ | 227,875,000 | | | $ | 222,716,000 | | | $ | 217,553,000 | |
| Cash, cash equivalents, certificates of deposits and marketable securities – related party | | $ | 13,522,000 | | | $ | 22,803,000 | | | $ | 19,178,000 | | | $ | 47,893,000 | | | $ | 78,690,000 | | | $ | 11,566,000 | |
| Real estate held for sale | | $ | 24,433,000 | | | $ | 28,563,000 | | | $ | 30,079,000 | | | $ | 38,639,000 | | | $ | 39,805,000 | | | $ | 51,215,000 | |
| Real estate held for sale-seller financed | | $ | -- | | | $ | -- | | | $ | 14,774,000 | | | $ | 22,887,000 | | | $ | 13,131,000 | | | $ | 12,631,000 | |
| Assets under secured borrowing | | $ | 10,600,000 | | | $ | -- | | | $ | 13,796,000 | | | $ | 19,754,000 | | | $ | 25,689,000 | | | $ | 25,655,000 | |
| Total assets | | $ | 199,482,000 | | | $ | 336,168,000 | | | $ | 303,042,000 | | | $ | 361,949,000 | | | $ | 385,358,000 | | | $ | 339,470,000 | |
| Long term liabilities | | $ | 56,350,000 | | | $ | 60,100,000 | | | $ | -- | | | $ | -- | | | $ | -- | | | $ | -- | |
| Total liabilities | | $ | 68,957,000 | | | $ | 64,409,000 | | | $ | 24,556,000 | | | $ | 46,809,000 | | | $ | 28,316,000 | | | $ | 28,390,000 | |
| Stockholders' equity | | $ | 130,525,000 | | | $ | 271,759,000 | | | $ | 278,486,000 | | | $ | -- | | | $ | -- | | | $ | -- | |
| Members’ equity | | $ | -- | | | $ | -- | | | $ | -- | | | $ | 315,140,000 | | | $ | 357,042,000 | | | $ | 311,080,000 | |
| | | For the Year Ended | | | For the Year Ended | | | For the Twelve Months Ended | | | For the Six Months Ended | | | For the Six Months Ended | | | For the Year Ended | |
| | | 12/31/2008 | | | 12/31/2007 | | | 12/31/2006 | | | 12/31/2005 | | | 12/31/2004 | | | 6/30/2005 | |
| | | | | | | | | | | | | | | (Unaudited) | | | | |
| Income Statement Data: | | | | | | | | | | | | | | | | | | |
| Revenues | | $ | 19,307,000 | | | $ | 29,010,000 | | | $ | 22,053,000 | | | | 11,738,000 | | | $ | 15,950,000 | | | $ | 27,549,000 | |
| Operating expenses | | | 97,652,000 | | | | 11,879,000 | | | | 10,624,000 | | | | 1,514,000 | | | | 3,410,000 | | | | 8,730,000 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Operating income (loss) | | | (78,345,000 | ) | | | 17,131,000 | | | | 11,429,000 | | | | 10,224,000 | | | | 12,540,000 | | | | 18,819,000 | |
| Non-operating income (loss) | | | (2,970,000 | ) | | | 1,843,000 | | | | 1,426,000 | | | | 490,000 | | | | 249,000 | | | | 409,000 | |
| Income (loss) from real estate held for sale | | | (48,854,000 | ) | | | (2,046,000 | ) | | | 2,996,000 | | | | (170,000 | ) | | | (903,000 | ) | | | (10,340,000 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income (loss) | | $ | (130,169,000 | ) | | $ | 16,928,000 | | | $ | 15,851,000 | | | | 10,544,000 | | | $ | 11,886,000 | | | $ | 8,888,000 | |
| Income (loss) from operations per common share / membership unit | | $ | (5.33 | ) | | $ | 1.15 | | | $ | 0.77 | | | $ | 0.62 | | | $ | 0.68 | | | $ | 1.08 | |
| Basic and diluted earnings (loss) per common share / membership unit | | $ | (8.86 | ) | | $ | 1.14 | | | $ | 1.06 | | | | 0.64 | | | $ | 0.65 | | | $ | 0.51 | |
| Cash dividends declared per common share / cash distributions per membership unit | | $ | 0.49 | | | $ | 1.50 | | | $ | 1.51 | | | $ | 0.52 | | | $ | 0.61 | | | $ | 1.16 | |
| Weighted average common shares / membership units | | | 14,695,756 | | | | 14,909,651 | | | | 14,935,585 | | | | 16,441,433 | | | | 18,370,442 | | | | 17,382,394 | |
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 year ended December 31, 2008, December 31, 2007, and the twelve months ended December 31, 2006. 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 quarters ended March 31, 2008, June 30, 2008 and September 30, 2008.
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 consolidated 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 Part I Item 1A Risk Factors of this Annual Report on Form 10-K and in our other securities filings with the Securities and Exchange Commission (“SEC”). 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. Our estimates of the value of collateral securing our loans may change, or the value of the underlying property could decline subsequent to the date of our evaluation. As a result, such estimates are not guarantees of the future value of the collateral. 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 while preserving principal 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 other real estate lenders. The loan underwriting standards utilized by our manager and Vestin Originations are less strict than those used by many institutional real estate lenders. In addition, one of our competitive advantages is our ability to approve loan applications more quickly than many institutional lenders. As a result, in certain cases, we may make real estate loans that are riskier than real estate loans made by many institutional lenders such as 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 many institutional 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 recent operating results have been adversely affected by increases in allowances for loan losses and increases in non-performing assets. This negative trend accelerated sharply during the year ended December 31, 2008. We recognized a provision for loan losses of approximately $83.7 million for the year ended December 31, 2008. Recognition of this provision was driven largely by the increase in non-performing assets, coupled with the deteriorating economic situation that has driven down real estate values and limited the availability of credit to our borrowers who had anticipated securing take-out financing to repay our loan. As of December 31, 2008, we had 20 loans considered non-performing (i.e., 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). These loans are currently carried on our books at a value of approximately $73.7 million, net of allowance for loan losses of approximately $71.2 million. These loans have been placed on non-accrual of interest status and are the subject of pending foreclosure proceedings.
Non-performing assets, net of allowance for loan losses, totaled approximately $98.1 million or 49% of our total assets as of December 31, 2008, as compared to approximately $48.0 million or 14% of our total assets as of December 31, 2007. At December 31, 2008, non-performing assets consisted of approximately $24.4 million of real estate held for sale and approximately $73.7 million of non-performing loans, net of allowance for loan losses. None of the real estate held for sale as of December 31, 2008 was generating any income from rentals or other sources. See Note F – Real Estate Held for Sale and Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
We believe that the significant increase in the level of our non-performing assets is a direct result of the deterioration of the economy and credit markets. As the economy has weakened and credit has become more difficult to obtain, many of our borrowers who develop and sell commercial real estate projects have been unable to complete their projects, obtain takeout financing or have been otherwise adversely impacted. Our exposure to the negative developments in the credit markets and general economy has likely been increased by our business strategy, which entails more lenient underwriting standards and expedited loan approval procedures. Moreover, declining real estate values in the principal markets in which we operate has in many cases eroded the current value of the security underlying our loans.
We expect that the weakness in the credit markets and the weakness in lending will continue to have an adverse impact upon our markets for the foreseeable future. This may result in a further increase in defaults on our loans and we might be required to record additional reserves based on decreases in market values or we may be required to restructure loans. This increase in loan defaults has materially harmed our operating results and led to the suspension of dividends to our stockholders. For additional information regarding our non-performing loans see “Non-Performing Loans” in Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Report Form 10-K.
As of December 31, 2008, we had loans with common guarantors. For additional information regarding loans with common guarantors see Note C – Financial Instruments and Concentrations of Credit Risk of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Report Form 10-K.
As of March 4, 2009, one performing loan, totaling $12.6 million, subsequently became delinquent in interest payments. Our manager has commenced foreclosure proceedings, and is proceeding with legal action to enforce the personal guarantees. However, no assurance can be given at this time that full payment will be received on this newly delinquent loan.
As of December 31, 2008, our loan-to-value ratio was 84.01%, net of allowances for loan losses, on a weighted average basis generally using appraisals prepared on an “as-if developed basis” in connection with the loan origination. Additional marked increases in loan defaults accompanied by a rapid decline in real estate values, as evidenced by updated appraisals generally prepared on an “as-is-basis,” will have a material adverse effect upon our financial condition and operating results. The current loan-to-value ratio is primarily a result of declining real estate values, which have eroded the market value of our collateral.
As of December 31, 2008, we have provided a specific reserve allowance for 17 non-performing loans and 7 performing loans based on updated appraisals of the underlying collateral and our evaluation of the borrower for these loans, obtained by our manager. For further information regarding allowance for loan losses, refer to Note D – Investments in Real Estate Loans in the notes to our consolidated financials statements in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
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, except for the funds we received pursuant to the VCT I closing and through our secured borrowing agreements, to materially increase the funds we will have available to invest from any other sources. See discussion under – “Capital and Liquidity.”
As of December 31, 2008, our loans were in the following states: Arizona, California, Hawaii, Nevada, Oklahoma, Oregon, Texas and Washington.
SUMMARY OF FINANCIAL RESULTS
The Year Ended December 31, 2008
Total Revenues: For the year ended December 31, 2008, total revenues were approximately, $19.3 million compared to approximately $29.0 million during the year ended December 31, 2007, a decrease of approximately $9.7 million or 33%. Revenues were primarily affected by the following factors:
| | · | Interest income from investments in real estate loans decreased to approximately $18.6 million during the year ended December 31, 2008, compared to approximately $27.0 million during the same period in 2007, primarily due to the increase in non-performing loans referred to above. Our revenue is also dependent upon the balance of our investment in real estate loans and the interest earned on these loans. As of December 31, 2008, our investment in real estate loans was approximately $225.0 million compared to our investment in real estate loans of approximately $291.1 million as of December 31, 2007. This decline is largely attributable to the increase in non-performing assets, which has reduced the amount of cash available for investment in new loans and the increase of real estate owned properties acquired through the foreclosures of our investments in real estate loans. For additional information see Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Report Form 10-K. |
| | · | During the year ended December 31, 2007, we recognized a gain of approximately $1.0 million related to an impaired real estate loan that was paid in full. We had no comparable gain during the same period in 2008. |
| | · | During the year ended December 31, 2007, we earned $0.6 million in other income from principal payments on notes receivable that were fully reserved, compared to $0.1 million during the same period in 2008. |
Total Operating Expenses: For the year ended December 31, 2008, total operating expenses were approximately $97.7 million compared to approximately $11.9 million during the year ended December 31, 2007, an increase of approximately $85.8 million or 722%. Expenses were primarily affected by the following factors:
| | · | Operating expenses increased primarily as a result of the recognition of provisions for loan losses. During the year ended December 31, 2008, we recognized provisions for loan losses totaling approximately $83.7 million, compared to $3.1 million for the same period in 2007. See “Specific Loan Allowance” in Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Report Form 10-K. During the year ended December 31, 2008, we foreclosed upon ten loans, totaling approximately $44.9 million with expenses of approximately $0.3 million, and classified the collateralized properties as real estate held for sale. See Note F – Real Estate Held for Sale of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Report Form 10-K. |
| | · | We recognized approximately $5.3 million of interest expense during the year ended December 31, 2008 related to the junior subordinated notes issued, during June 2007, in connection with the trust preferred financing, compared to approximately $2.7 million during the same period in 2007. During the year ended December 31, 2008, we recognized approximately $1.1 million of interest expenses related to secured borrowings held during the period compared to approximately $0.5 million of the same period in 2007. |
| | · | Professional fees increased approximately $0.8 million during the year ended December 31, 2008 compared to the same period in 2007, primarily due to the legal fees relating to the legal actions that have been filed against us in connection with the REIT conversion. See Note O – Legal Matters Involving The Company of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Report Form 10-K. |
| | · | During the year ended December 31, 2008, we recognized approximately $0.8 million in provision for doubtful accounts related to receivables from borrowers for reimbursement of property taxes, accrued interest and other related expenses in connection with our investment in real estate loans. |
| | · | Other expenses increased approximately $0.8 million for the year ended December 31, 2008, as a result of expenses related to non-performing loans. |
Total Non-Operating Income (Loss): For the year ended December 31, 2008 total non-operating loss was approximately $3.0 million compared to non-operating income of approximately $1.8 million during the year ended December 31, 2007, a decline of approximately $4.8 million or 261%. This is decline is primarily due to the following factors:
| | · | During the year ended December 31, 2008, we recorded a loss on sale of real estate loan of approximately $2.8 million as a result of the sale a non performing loan, Silver Star Destinations, LLC, to an unrelated third party for approximately $9.9 million, of which our portion was approximately $9.5 million. At the time of the sale, the loan was carried at approximately $12.3 million, which included an allowance for loan loss of approximately $13.4 million. |
| | · | We recognized an other-than-temporary impairment of our marketable securities – related party, totaling approximately $2.2 million, for the year ended December 31, 2008. In addition, we experienced a decrease of approximately $1.2 million of interest income from banking institutions due to a decrease in cash balances referred to above. |
| | · | This decrease was partially off set by a gain of approximately $1.6 million, relating to the purchase of outstanding debt at a discount to the face amount of such debt. No assurances can be given that any additional purchases of debt at a discount will occur in future periods. |
Total Loss from Real Estate Held for Sale: For the year ended December 31, 2008, total losses from real estate held for sale were approximately $48.9 million compared to approximately $2.0 million during the year ended December 31, 2007, an increase of approximately $46.8 million or 2288% due in significant part to the following factors:
| | · | We wrote down approximately $47.2 million on 12 properties held for sale during the year ended December 31, 2008. These write downs resulted from declining real estate values which adversely impacted the value of the properties we acquired through foreclosure. For additional information see Note F – Real Estate Held For Sale of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Report Form 10-K. As of December 31, 2008, we had 11 properties held for sale totaling approximately $24.4 million compared to two properties held for sale as of December 31, 2007 totaling approximately $28.6 million. |
| | · | We recorded a gain on sale of real estate held for sale related to seller financed loans of approximately $2.0 million during the year ended December 31, 2007, as a result of two seller financed loans being paid in full. 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 financed, 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. We have no real estate held for sale – seller financed as of December 31, 2008 and no related income during the year ended December 31, 2008. |
Dividends to Stockholders; Reliance on Non-GAAP Financial Measurements: To maintain our status as a REIT, we are required to declare dividends, 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 regard 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, determined without regard to the dividends paid and our net capital gain. Because we expect to declare dividends based on these requirements, and not based on our earnings computed in accordance with GAAP, we expect that our dividends may at times be more or less than our reported earnings as computed in accordance with GAAP. During the year ended December 31, 2008, we declared cash dividends approximately $0.49 per common share. For tax purposes, approximately $0.03 per common share is classified as ordinary dividends and the balance of approximately $0.46 per common share is classified as non-dividend distributions.
Total taxable income and REIT taxable income are non-GAAP financial measurements, and do not purport to be an alternative to reported net income or cash flow from operations determined in accordance with GAAP as a measure of operating performance. Our total taxable income represents the aggregate amount of taxable income generated by us and our wholly owned taxable REIT subsidiary, TRS II, Inc. REIT taxable income is calculated under U.S. federal tax laws in a manner that, in certain respects, differs from the calculation of net income pursuant to GAAP. REIT taxable income excludes the undistributed taxable income of TRS II, Inc., which is not included in REIT taxable income until distributed to us. Subject to certain TRS value limitations, there is no requirement that the TRS II, Inc. distribute their earnings to us. Since we are structured as a REIT and the Internal Revenue Code requires that we distribute substantially all of our net taxable income in the form of dividends to our stockholders, we believe that presenting investors with the information management uses to calculate our taxable income is useful to investors in understanding the amount of the minimum dividends that we must declare to our stockholders so as to comply with the rules set forth in the Internal Revenue Code. Because not all companies have identical calculations, this presentation of total taxable income and REIT taxable income may not be comparable to those reported by other companies.
In addition to satisfying the 90% taxable income distribution rule referred to above, the amount of distribution we make is ultimately based on distributing 100% of the REIT taxable income in order to limit any tax liability. The distribution of this additional 10% of REIT taxable income is typically made in the following tax year as IRC section 858 allows us to carry back dividends made, for example, in 2008 to 2007, for the purposes of zeroing out our 2007 REIT taxable income. As a result, included in the dividends of approximately $7.3 million declared during the year ended December 31, 2008 is approximately $0.4 million that was used to reduce our 2007 REIT taxable income to zero.
The table below reconciles the differences between reported net income and total estimated taxable income and estimated REIT taxable income for the year ended December 31, 2008:
| | | For the Year Ended | |
| | | December 31, 2008 | |
| Net loss, as reported | | $ | (130,169,000 | ) |
| Add (deduct): | | | | |
| Provision for loan losses | | | 83,712,000 | |
| Write down on real estate held for sale | | | 47,225,000 | |
| Net tax loss on foreclosure of real estate loans | | | (18,896,000 | ) |
| Book loss on sale of real estate held for sale | | | 259,000 | |
| Tax loss on sale of real estate held for sale | | | (756,000 | ) |
| Book loss on sale of real estate loan | | | 2,760,000 | |
| Tax loss on sale of real estate loan | | | (16,190,000 | ) |
| Recovery of allowance for doubtful notes receivable | | | (86,000 | ) |
| Provision for doubtful accounts related to receivable | | | 754,000 | |
| Payment on accrued legal expenses | | | (1,049,000 | ) |
| Non-dividend distribution from VRM I | | | (75,000 | ) |
| Book tax difference of TRS II, Inc Income | | | 500,000 | |
| Taxable distribution VRM II received from TRS II, Inc. | | | 551,000 | |
| Tax loss on note receivable deemed worthless which was fully reserved | | | (505,000 | ) |
| Impairment of marketable securities-related party | | | 2,228,000 | |
| Total taxable loss | | | (29,737,000 | ) |
| Less : Taxable Income attributable to TRS II, Inc. | | | (551,000 | ) |
| | | | | |
| Estimated REIT taxable loss (prior to deductions for dividends paid) | | $ | (30,288,000 | ) |
The Year Ended December 31, 2007
Total Revenues: For the year ended December 31, 2007, total revenues increased by approximately $6.9 million or 31.5% compared to the same period in 2006, due in significant part to the following factors:
| | · | Interest income from investments in real estate loans totaled approximately $27.0 million during the year ended December 31, 2007, compared to approximately $21.7 million during 2006. This increase was primarily due to the increase in investment in real estate loans to approximately $48.9 million and the increase in the weighted average interest rate from 10.9% as of December 31, 2006 to 12.0% as of December 31, 2007. The increase in real estate loans resulted in part from the availability of additional funds raised in the trust preferred financing consummated in June 2007. |
| | · | During the year ended December 31, 2007, we recognized a gain of approximately $1.0 million related to an impaired real estate loan that was paid in full. |
| | · | During the year ended December 31, 2007, we earned approximately $0.6 million in other income from principal payments on notes receivable that were fully reserved. |
Total Operating Expenses: For the year ended December 31, 2007, total operating expenses were approximately $11.9 million compared to approximately $10.6 million during the twelve months ended December 31, 2006, an increase of approximately $1.3 million or 11.8%. Expenses were primarily affected by the following factors:
| | · | Our operating expenses are impacted materially by the recognition of loan losses. During the year ended December 31, 2007, we recognized provisions for loan losses of approximately $3.1 million related to the following; a performing land loan for property located in Glendale, Arizona, a performing commercial loan on a 100 unit condominium/apartment project in North Las Vegas, Nevada, a non-performing loan secured by various real estate collateral, including a 248 unit apartment complex in Oklahoma City, Oklahoma, and a non-performing loan secured by 25 acres for proposed 122 single-family subdivision in Brawley, California. During the twelve months ended December 31, 2006, we recognized a provision for loan loss of $5.5 million related to the loans secured by four cemeteries and eight mortuaries in Hawaii. |
| | · | We recognized approximately $2.7 million of interest expense during the year ended December 31, 2007 related to the junior subordinated notes issued in connection with the trust preferred financing. During the twelve months ended December 31, 2006, we recognized approximately $0.9 million of interest expense related to secured borrowings held during the period compared to approximately $0.5 million for the year ended December 31, 2007. We had no secured borrowings as of December 31, 2007. |
| | · | Professional fees increased approximately $1.8 million during the year ended December 31, 2007, compared to the same period in 2006, primarily due to the accrual of approximately $1.2 million in legal fees relating to the legal actions that have been filed against us in connection with the REIT conversion and RightStar. |
Non-operating income: For the year ended December 31, 2007, total income from other non-operating income totaled approximately $1.8 million, primarily consisting of approximately $1.5 million in bank interest income.
Total Income (Loss) from Real Estate Held for Sale: For the year ended December 31, 2007, a loss was incurred from real estate held for sale of approximately $2.0 million compared to income of approximately $3.0 million during 2006. This decline was primarily due to the following factors:
| | · | During the year ended December 31, 2007, our manager evaluated the carrying value and estimated liabilities associated with the real estate acquired through foreclosure located in Cathedral City, CA and based on these updated estimates, concluded that a write down of approximately $1.3 million was appropriate with respect to this property. We also recognized expenses related to real estate held for sale for this property, which totaled approximately $2.8 million for the year ended December 31, 2007. |
| | · | During the twelve months ended December 31, 2006, we recorded approximately $4.1 million in rental revenue related to three apartment complexes, which were classified as real estate held for sale. |
| | · | The sale of the apartment complex in Austin, Texas in July 2006, 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, Texas during December 2006. There was no gain on sale of real estate held for sale during 2007. |
| | · | During the twelve months ended December 31, 2006, we incurred expenses related to real estate held for sale not sold through seller financing of approximately $4.9 million, primarily related to the three apartment complexes referred to above. There were no similar expenses incurred during the year ended December 31, 2007. |
| | · | We recorded a gain on sale of real estate held for sale related to seller financed loans of approximately $2.0 million during year ended December 31, 2007, as a result of two seller financed loans being paid in full. |
Dividends to Stockholders; Reliance on Non-GAAP Financial Measurements: To maintain our status as a REIT, we are required to declare dividends, 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 regard 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, determined without regard to the dividends paid and our net capital gain. Because we expect to declare dividends based on these requirements, and not based on our earnings computed in accordance with GAAP, we expect that our dividends may at times be more or less than our reported earnings as computed in accordance with GAAP.
Total taxable income and REIT taxable income are non-GAAP financial measurements, and do not purport to be an alternative to reported net income or cash flow from operations determined in accordance with GAAP as a measure of operating performance. Our total taxable income represents the aggregate amount of taxable income generated by us and our wholly owned taxable REIT subsidiary, TRS II, Inc. REIT taxable income is calculated under U.S. federal tax laws in a manner that, in certain respects, differs from the calculation of net income pursuant to GAAP. REIT taxable income excludes the undistributed taxable income of TRS II, Inc., which is not included in REIT taxable income until distributed to us. Subject to certain TRS value limitations, there is no requirement that the TRS II, Inc. distribute their earnings to us. Since we are structured as a REIT and the Internal Revenue Code requires that we distribute substantially all of our net taxable income in the form of dividends to our stockholders, we believe that presenting investors with the information management uses to calculate our taxable income is useful to investors in understanding the amount of the minimum dividends that we must declare to our stockholders so as to comply with the rules set forth in the Internal Revenue Code. Because not all companies have identical calculations, this presentation of total taxable income and REIT taxable income may not be comparable to those and reported by other companies.
In addition to satisfying the 90% taxable income distribution rule referred to above, the amount of distribution we make is ultimately based on distributing 100% of the REIT taxable income in order to limit any tax liability. The distribution of this additional 10% of REIT taxable income is typically made in the following tax year as IRC section 858 allows us to carryback dividends made, for example, in 2007 to 2006, for the purposes of zeroing out our REIT taxable income. As a result, included in the $22.4 million in dividends made during the year ended December 31, 2007 is approximately $1.8 million that was used to zero out our 2006 REIT taxable income.
The table below reconciles the differences between reported net income and total estimated taxable income and estimated REIT taxable income for the year ended December 31, 2007:
| | | For the Year Ended | |
| | | December 31, 2007 | |
| Net income, as reported | | $ | 16,928,000 | |
| Add (deduct): | | | | |
| Provision for loan losses | | | 3,116,000 | |
| Gain on sale of real estate held for sale-seller financed | | | (2,003,000 | ) |
| Capitalization of REO expenditures on a tax basis | | | 2,025,000 | |
| Write down on real estate held for sale | | | 1,266,000 | |
| Gain related to pay off of real estate loan, including recovery of allowance for loan loss | | | (1,044,000 | ) |
| Provision for doubtful accounts related to receivable | | | 235,000 | |
| Recovery of allowance for doubtful notes receivable | | | (594,000 | ) |
| Accrued legal reserve | | | 982,000 | |
| Other book to tax differences | | | 90,000 | |
| Total estimated taxable income | | | 21,001,000 | |
| Less: Estimated taxable income attributable to TRS II, Inc. | | | (17,000 | ) |
| | | | | |
| Estimated REIT taxable income (prior to deductions for dividends paid) | | $ | 20,984,000 | |
The Twelve Months Ended December 31, 2006
Total Revenues: For the twelve months ended December 31, 2006, total revenues were approximately $22.1 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.
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 four cemeteries and eight mortuaries in Hawaii. |
| | · | 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. |
| | · | 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. |
| | · | 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. |
Non-operating income: 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 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: From April 1 through December 31, 2006, we declared dividends to our stockholders 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.
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 seek to 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 Fund II and us from the sale of shares or membership units.
During the year ended December 31, 2008, net cash flows provided by operating activities approximated $7.8 million. Operating cash flows were adversely impacted by the payment of approximately $2.1 million in legal fees relating to legal actions that have been filed against us in connection with the REIT conversion and RightStar. In addition, we incurred approximately $47.2 million in write-downs on real estate held for sale and approximately $83.7 million in provisions for loan losses, during the year ended December 31, 2008. These write-downs and provisions represent the decreases in the fair value of these properties, which will affect the amount of proceeds we will receive from future sales of these assets. Cash flows related to investing activities consisted of cash provided by loan payoffs and sales of real estate loans of approximately $103.1 million and cash used for new investments and purchases of real estate loans totaling approximately $103.6 million. Cash flows used for financing activities consisted of dividends to stockholders, net of reinvestment, of approximately $8.6 million and the purchase of debt totaling approximately $2.2 million. Financing activities also consisted of cash flows used for the purchase of our own stock totaling approximately $4.3 million.
At December 31, 2008, we had approximately $8.0 million in cash, $0.5 million in marketable securities – related party and approximately $199.5 million in total assets. We intend to meet short-term working capital needs through a combination of proceeds from loan payoffs, loan sales, sales of real estate held for sale and/or borrowings. We believe we have sufficient working capital to meet our operating needs in the near term, provided that payment on the junior subordinated notes discussed below is not accelerated. In the event that our current cash resources prove insufficient, we have no facility in place to raise additional funds and we believe that, given current market conditions, it might be very difficult for us to increase our capital resources, either from lenders or equity investors. In addition to the foregoing assets, as of December 31, 2008, we had approximately $5.0 million in restricted cash, which relates related to the First Supplemental Indenture, where by Taberna is entitled to draw upon such letters of credit to pay principal and interest on the junior subordinated notes if an Event of Default has occurred. The letters of credit may not be subordinated to any of our Senior Debt.
Since we comply with the REIT requirements and distribute at least ninety percent (90%) of our annual taxable income, 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 rely primarily upon repayment of outstanding loans and proceeds from sales of real estate held for sale to provide capital for investment in new loans. The significant level of defaults on outstanding loans has reduced 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 has diminished our capital resources and impaired our ability to invest in new loans. During June 2008, our Board of Directors decided to suspend the payment of dividends. Our Board of Directors will closely monitor our operating results in order to determine when dividends should be reinstated. We will continue to comply with the REIT requirements and will distribute at least ninety percent (90%) of our annual taxable income.
Non-performing assets included loans in non-accrual status, net of allowance for loan losses, and real estate held for sale totaling approximately $73.7 million and $24.4 million, respectively, as of December 31, 2008, compared to approximately $19.4 million and $28.6 million, respectively, as of December 31, 2007. 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 have increased in significant part as a result of conditions in the real estate and credit markets. We believe that the continued weakness in real estate markets may result in additional losses on our real estate held for sale.
As of March 4, 2009, one performing loan, totaling $12.6 million, subsequently became delinquent in interest payments. Our manager has commenced foreclosure proceedings, and is proceeding with legal action to enforce the personal guarantees. However, no assurance can be given at this time that full payment will be received on this newly delinquent loan.
As a commercial real estate 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 commercial mortgage lending industry during periods of economic slowdown or recession. Problems in the sub-prime residential mortgage market have adversely affected the general economy and the availability of funds for commercial real estate developers. We believe this lack of available funds has led to an increase in defaults on our loans. Furthermore, problems experienced in U.S. credit markets since the summer of 2007 have reduced the availability of credit for many prospective borrowers. These problems have made it more difficult for our borrowers to obtain the anticipated re-financing necessary in many cases to pay back our loans. Thus, we have had to work with some of our borrowers to either: modify, restructure and/or extend their loans in order to keep or restore the loans to performing status. Our manager will continue to evaluate our loan portfolio in order to minimize risk associated with current market conditions.
We have no current plans to sell any new shares except through our dividend reinvestment program. As of March 4, 2009, approximately 10% of our stockholders 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.
On June 22, 2007 we completed the issuance of $60.1 million in unsecured trust preferred securities through the special purpose business trust, VCT I to Merrill Lynch International, Bear Stearns & Co. Inc. and Taberna Funding LLC. These securities have a fixed interest rate equal to 8.75% through July 2012, and thereafter are subject to a variable rate equal to LIBOR plus 3.5% per annum, resetting quarterly. VCT I used the proceeds from the sale of the trust preferred securities and the common securities to purchase our junior subordinated notes. The terms of the junior subordinated notes match the terms of the trust preferred securities. The notes are subordinated and junior in right of payment to all present and future senior indebtedness and certain other of our financial obligations.
The original indenture governing the notes included a number of covenants including the following financial covenants: (i) we were required to maintain a Tangible Net Worth of not less than $225 million, (ii) our trailing twelve months EBITDA was required to be not less than 2.5 times our Interest Expense and (iii) our ratio of Total Debt to Tangible Net Worth must not exceed 0.5 to 1.00. All defined terms are set forth in the indenture.
As of September 30, 2008, we were not in compliance with the tangible net worth covenant included in the indenture. On November 7, 2008, we entered into an agreement with Taberna Capital Management, LLC (“Taberna”), in its capacity as collateral manager for certain collateral debt obligation vehicles that are the holders of the junior subordinated notes, providing for an amendment of the tangible net worth covenant (the “First Supplemental Indenture”). As amended, the tangible net worth covenant will require us to maintain Tangible Net Worth of not less than the lesser of $150 million or 2.5 times the then outstanding principal balance of junior subordinated notes (which amount is currently approximately $56.4 million.) Pursuant to the Taberna Letter Agreement and First Supplemental Indenture agreement, the EBITDA covenant in the indenture was also amended to provide that our EBITDA for the four preceding quarters shall not be less than 1.5 times Interest Expense for such period, provided that, for one quarter only, EBITDA shall not be less than 1.2 times Interest Expense for the four quarters ending June 30, 2009. The First Supplemental Indenture also requires us to post a $3,750,000 letter of credit by November 12, 2008 and a $1,250,000 letter of credit by April 12, 2009. Taberna would be entitled to draw upon such letters of credit to pay principal and interest due on the junior subordinated notes if we are subject to an Event of Default under the indenture. For further information about the First Supplemental Indenture, see Note I to our financial statements.
On December 31, 2008, we were not in compliance with the revised tangible net worth covenant and the debt to tangible net worth covenant in the First Supplemental Indenture. On March 25, 2009, we entered into a letter agreement with Taberna providing for a waiver of all financial covenants effective December 31, 2008 through June 30, 2009. In addition, pursuant to the letter agreement we will exchange $20 million of the junior subordinated notes for certain replacement securities, which we expect to acquire for approximately $10 million of cash. This will reduce our obligation on the junior subordinated notes to approximately $36.3 million, which should facilitate future compliance with financial covenants set forth in the First Supplemental Indenture. In addition, we are to pay additional interest equal to $250,000 per year, payable quarterly on the same payment dates as the current terms of the Junior Subordinated Notes. We agreed to make a nonrefundable payment of $200,000 to Taberna to cover its costs related to the waiver and exchange arrangement. This transaction would result in a net gain of approximately $9 million including transaction costs. The replacement securities will be acquired with funds consisting of $5 million from our operating funds and $5 million from the $5 million letter of credit. For additional information regarding the First Supplemental Indenture see Note I – Junior Subordinated Notes of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Report Form 10-K.
On March 25, 2009, we entered into an unsecured promissory note for $3 million payable on or before May 8, 2009, with an exit fee of $0.6 million due on or before May 26, 2009. We intend to use these funds to purchase a portion of the junior subordinated notes referred to above. Per the terms of the loan, all subsequent proceeds from loan repayments and sales of property will be used to pay down the note. We are currently anticipating receipt of proceeds from the sale of properties, which will meet our on-going obligations. No assurance can be made that these sales will be completed.
On March 21, 2007, our board of directors authorized the repurchase of up to $10 million worth of our common stock. Depending upon market conditions, shares may be repurchased from time to time at prevailing market prices through open market or privately negotiated transactions. We are not obligated to purchase any shares. Subject to applicable securities laws repurchases may be made at such times and in such amounts, as our management deems appropriate. The share repurchase program may be discontinued or terminated at any time and we have not established a date for completion of the share repurchase program. The repurchases will be funded from our available cash. As of December 31, 2008, we had purchased 1,198,573 shares as treasury stock through the repurchase program noted above. These shares are carried on our books at cost totaling approximately $5.7 million.
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.
We may seek to expand our capital resources through borrowings from institutional lenders or through securitization of our loan portfolio or similar arrangements. No assurance can be given that, if we should seek to borrow additional funds or to securitize our assets we would be able to do so on commercially attractive terms. Our ability to expand our capital resources in this manner is subject to many factors, some of which are beyond our control, including the state of the economy, the state of the capital markets and the perceived quality of our loan portfolio.
Investments in Real Estate Loans Secured by Real Estate Portfolio
We offer five real estate loan products consisting of commercial property, construction, acquisition and development, land, and residential loans. The effective interest rates on all product categories range from 6% to 15%. Revenue by product will fluctuate based upon relative balances during the period. We had investments in 39 real estate loans, as of December 31, 2008, with a balance of approximately $225.0 million as compared to investments in 46 real estate loans as of December 31, 2007, with a balance of approximately $291.1 million.
As of December 31, 2008, we had 20 loans considered non-performing (i.e., 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). These loans are currently carried on our books at a value of approximately $73.7 million, net of allowance for loan losses of approximately $71.2 million, which does not include the allowances of approximately $7.0 million relating to the decrease in the property value for performing loans as of December 31, 2008. These loans have been placed on non-accrual of interest status and are the subject of pending foreclosure proceedings. Our manager has evaluated these loans and, based on current estimates, believes that the value of the underlying collateral is sufficient to protect us from loss of principal. However, such estimates may change, or the value of the underlying collateral may deteriorate, in which case further losses may be incurred. During January and February 2009, we foreclosed upon one non-performing loan, Redwood Place, LLC, and sold two non-performing loans, Preston Hollow Assisted Living, L.P. and Trinity Theo, LLC, to unrelated third parties, no gain or loss was recognized on these sales. As of March 4, 2009, we had 17 loans considered non-performing.
During March 2007, our manager extended the Mid-State Raceway loan from March 31, 2007 to March 31, 2008. As of March 31, 2008, this loan had a balance of approximately $19.8 million, of which our portion was approximately $17.0 million. This loan was paid in full on April 10, 2008.
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, 2008, we have provided a specific reserve related to 17 non-performing loans and 7 performing loans, based on updated appraisals and evaluation of the borrower obtained by our manager. Our manager evaluated these 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 Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on 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, our 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 year ended December 31, 2008, refer to Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Investments in Real Estate Held for Sale
At December 31, 2008, we held 11 properties with a total carrying value of approximately $24.4 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. For additional information on our investments in real estate held for sale, refer to Note F – Real Estate Held for Sale of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any interests in off-balance sheet special purpose entities, other than the interest in VCT I as discussed in Note I – Junior Subordinated Notes of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K. nor do we have any interests in non-exchange traded commodity contracts.
CONTRACTUAL OBLIGATIONS
The following summarizes our contractual obligations at December 31, 2008:
| | | | | | | | | | | | | | | | |
| Contractual Obligation | | Total | | | Less Than 1 Year | | | 1-3 Years | | | 3-5 Years | | | More Than 5 Years | |
| | | | | | | | | | | | | | | | |
Junior subordinated notes payable (1) | | $ | 56,350,000 | | | $ | -- | | | $ | -- | | | $ | -- | | | $ | 56,350,000 | |
Secured borrowings (2) | | | 9,907,000 | | | | 9,907,000 | | | | -- | | | | -- | | | | -- | |
Notes payable (3) | | | 24,000 | | | | 24,000 | | | | -- | | | | -- | | | | -- | |
| Total | | $ | 66,281,000 | | | $ | 9,931,000 | | | $ | -- | | | $ | -- | | | $ | 56,350,000 | |
| (1) | See Note I – Junior Subordinated Notes of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K. |
| (2) | See Note J – Secured Borrowings of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K. |
| (3) | See Note K – Notes Payable of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K. |
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 without a premium. 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 Note G – Related Party Transactions in the notes to our consolidated financials statements in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
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 non-performing. A loan is considered non-performing 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, averaging the balance of our loan portfolio at the end of the last six quarters, to show the impact on our financial condition at December 31, 2008, 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 | | $ | 2,669,000 | |
| Weighted average interest rate assumption increased by 5.0% or 500 basis points | | $ | 13,344,000 | |
| Weighted average interest rate assumption decreased by 1.0% or 100 basis points | | $ | (2,669,000 | ) |
| Weighted average interest rate assumption decreased by 5.0% or 500 basis points | | $ | (13,344,000 | ) |
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 consolidated 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. Our 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, 2008, 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 | | $ | 2,250,000 | |
| Allowance for loan losses assumption increased by 5.0% of loan portfolio | | $ | 11,252,000 | |
| Allowance for loan losses assumption decreased by 1.0% of loan portfolio | | $ | (2,250,000 | ) |
| Allowance for loan losses assumption decreased by 5.0% of loan portfolio | | $ | (11,252,000 | ) |
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 commercial real estate lender willing to invest in loans to borrowers who may not meet the credit standards of other financial institutional 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 approve 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 are 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, we seek to identify potential purchasers of such property. It is not our 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, we seek 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 sales 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 sales 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.
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, 2008, our aggregate investment in real estate loans was approximately $146.8 million, net of allowance of approximately $78.2 million, with a weighted average effective interest rate of 12.14%. The weighted average interest rate of 12.14% is based on the contractual terms of the loans for the entire portfolio including non-performing loans. The weighted average interest rate on performing loans only, as of December 31, 2008, was 10.4%. Most of the real estate loans had an initial term of 12 months. The weighted average term of outstanding loans, including extensions, at December 31, 2008, was 20 months. All but one of the outstanding real estate loans at December 31, 2008, was a fixed rate loan. The variable interest rate loan was considered non-performing as of December 31, 2008, see Note D – Investments in Real Estate Loans in the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K. 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. As of December 31, 2008, none of our loans had a prepayment penalty, although 25 of our loans, totaling approximately $129.0 million, had an exit fee. Out of the 25 loans with an exit fee, 12 loans, totaling approximately $65.1 million, were considered non-performing as of December 31, 2008.
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 of real estate loans in our portfolio as of December 31, 2008. The presentation aggregates the investment in real estate loans by their maturity dates for maturities occurring in each of the years 2009 through 2013 and thereafter and separately aggregates the information for all maturities arising after 2013. The carrying values of these assets approximate their fair value as of December 31, 2008.
| | | Interest Earning Assets Aggregated by Maturity at December 31, 2008 | |
| Interest Earning Assets | | 2009 | | | 2010 | | | 2011 | | | 2012 | | | 2013 | | | Thereafter | | | Total | |
| | | (a) | | | | | | | | | | | | | | | | | | | |
| Investments In Real Estate Loans | | $ | 205,186,000 | | | $ | 19,856,000 | | | $ | -- | | | $ | -- | | | $ | -- | | | $ | -- | | | $ | 225,042,000 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Weighted Average Interest Rates | | | 12.20 | % | | | 11.54% | | | | --% | | | | --% | | | | --% | | | | --% | | | | 12.14% | |
| (a) | Amounts include the balance of non-performing loans and loans that have been extended subsequent to December 31, 2008. |
At December 31, 2008, we also had approximately $8.5 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.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY INFORMATION
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, 2008 and 2007 and related consolidated statements of operations, equity and other comprehensive income (loss) and cash flows for the years ended December 31, 2008 and 2007 and for the twelve months ended December 31, 2006. Our audits also included the financial statement schedules listed in the Index at Item 15. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
We conducted our audits 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 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, 2008 and 2007 and the results of its operations and its cash flows for the years ended December 31, 2008 and 2007 and for the twelve months ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2008, 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 26, 2009, expressed an unqualified opinion thereon.
/s/ Moore Stephens Wurth Frazer and Torbet, LLP
Orange, California
March 26, 2009
| |
| | |
| CONSOLIDATED BALANCE SHEETS | |
| | |
| ASSETS | |
| | |
| | | December 31, 2008 | | | December 31, 2007 | |
| | | | | | | |
| Assets | | | | | | |
| Cash | | $ | 8,026,000 | | | $ | 20,241,000 | |
| Cash - restricted | | | 5,000,000 | | | | -- | |
| Certificates of deposit | | | -- | | | | 102,000 | |
| Investment in marketable securities - related party | | | 496,000 | | | | 2,460,000 | |
| Interest and other receivables, net of allowance of $593,000 at December 31, 2008 and $160,000 at December 31, 2007 | | | 1,345,000 | | | | 4,162,000 | |
| Notes receivable, net of allowance of $2,340,000 at December 31, 2008 and $2,619,000 at December 31, 2007 | | | -- | | | | -- | |
| Real estate held for sale | | | 24,433,000 | | | | 28,563,000 | |
| Investment in real estate loans, net of allowance for loan losses of $78,208,000 at December 31, 2008 and $12,873,000 at December 31, 2007 | | | 146,834,000 | | | | 278,190,000 | |
| Investment in equity affiliate | | | 100,000 | | | | 100,000 | |
| Assets under secured borrowings | | | 10,600,000 | | | | -- | |
| Deferred financing costs | | | 2,504,000 | | | | 2,213,000 | |
| Other assets | | | 144,000 | | | | 137,000 | |
| | | | | | | | | |
| Total assets | | $ | 199,482,000 | | | $ | 336,168,000 | |
| | | | | | | | | |
| LIABILITIES AND STOCKHOLDERS' EQUITY | |
| | | | | | | | | |
| Liabilities | | | | | | | | |
| Accounts payable and accrued liabilities | | $ | 2,154,000 | | | $ | 2,641,000 | |
| Due to related parties | | | 522,000 | | | | 122,000 | |
| Secured borrowings | | | 9,907,000 | | | | -- | |
| Junior subordinated notes payable | | | 56,350,000 | | | | 60,100,000 | |
| Note payable | | | 24,000 | | | | -- | |
| Dividend payable | | | -- | | | | 1,546,000 | |
| | | | | | | | | |
| Total liabilities | | | 68,957,000 | | | | 64,409,000 | |
| | | | | | | | | |
| Commitments and contingencies | | | | | | | | |
| | | | | | | | | |
| Stockholders' equity | | | | | | | | |
| Preferred stock, $0.0001 par value; 1,000,000 shares authorized; none issued | | | -- | | | | -- | |
| Treasury stock, at cost 1,198,573 shares at December 31, 2008 and 109,634 at December 31, 2007 | | | (5,692,000 | ) | | | (1,440,000 | ) |
| Common stock, $0.0001 par value; 100,000,000 shares authorized; 13,798,790 shares issued and outstanding at December 31, 2008 and 14,866,219 shares issued and outstanding at December 31, 2007 | | | 1,000 | | | | 1,000 | |
| Additional paid in capital | | | 278,550,000 | | | | 278,367,000 | |
| Accumulated deficit | | | (141,627,000 | ) | | | (4,198,000 | ) |
| Accumulated other comprehensive loss | | | (707,000 | ) | | | (971,000 | ) |
| | | | | | | | | |
| Total stockholders' equity | | | 130,525,000 | | | | 271,759,000 | |
| | | | | | | | | |
| Total liabilities and stockholders' equity | | $ | 199,482,000 | | | $ | 336,168,000 | |
The accompanying notes are an integral part of these consolidated statements.
| |
| | |
| CONSOLIDATED STATEMENTS OF OPERATIONS | |
| | |
| | | For the Year Ended | | | For the Year Ended | | | For the Twelve Months Ended | |
| | | 12/31/2008 | | | 12/31/2007 | | | 12/31/2006 | |
| | | | | | | | | | |
| Revenues | | | | | | | | | |
| Interest income from investment in real estate loans | | $ | 18,604,000 | | | $ | 26,982,000 | | | $ | 21,718,000 | |
| Gain related to pay off of real estate loan, including recovery of allowance for loan loss | | | -- | | | | 1,044,000 | | | | -- | |
| Other income | | | 703,000 | | | | 984,000 | | | | 335,000 | |
| Total revenues | | | 19,307,000 | | | | 29,010,000 | | | | 22,053,000 | |
| | | | | | | | | | | | | |
| Operating expenses | | | | | | | | | | | | |
| Management fees - related party | | | 1,098,000 | | | | 1,097,000 | | | | 1,096,000 | |
| Provision for loan loss | | | 83,712,000 | | | | 3,116,000 | | | | 5,500,000 | |
| Interest expense | | | 6,421,000 | | | | 3,367,000 | | | | 1,446,000 | |
| Professional fees | | | 3,714,000 | | | | 3,004,000 | | | | 1,219,000 | |
| Professional fees - related party | | | 236,000 | | | | 138,000 | | | | 88,000 | |
| Provision for doubtful accounts related to receivable | | | 754,000 | | | | 235,000 | | | | 329,000 | |
| Loan fees – related party | | | 594,000 | | | | -- | | | | -- | |
| Other | | | 1,123,000 | | | | 922,000 | | | | 946,000 | |
| Total operating expenses | | | 97,652,000 | | | | 11,879,000 | | | | 10,624,000 | |
| | | | | | | | | | | | | |
| Income (loss) from operations | | | (78,345,000 | ) | | | 17,131,000 | | | | 11,429,000 | |
| | | | | | | | | | | | | |
| Non-operating income (loss) | | | | | | | | | | | | |
| Gain on sale of marketable securities | | | -- | | | | -- | | | | 21,000 | |
| Gain on purchase of debt | | | 1,556,000 | | | | -- | | | | -- | |
| Dividend income - related party | | | 86,000 | | | | 308,000 | | | | 72,000 | |
| Interest income from banking institutions | | | 376,000 | | | | 1,535,000 | | | | 1,333,000 | |
| Loss on sale of investment in real estate loan | | | (2,760,000 | ) | | | -- | | | | -- | |
| Impairment on marketable securities - related party | | | (2,228,000 | ) | | | -- | | | | -- | |
| Total other non-operating income (loss) | | | (2,970,000 | ) | | | 1,843,000 | | | | 1,426,000 | |
| | | | | | | | | | | | | |
| Income (loss) from real estate held for sale | | | | | | | | | | | | |
| Revenue related to real estate held for sale | | | -- | | | | 86,000 | | | | 4,101,000 | |
| Net gain (loss) on sale of real estate held for sale | | | (259,000 | ) | | | -- | | | | 1,517,000 | |
| Gain on sale of real estate held for sale - seller financed | | | -- | | | | 2,003,000 | | | | 2,293,000 | |
| Expenses related to real estate held for sale | | | (1,370,000 | ) | | | (2,869,000 | ) | | | (4,915,000 | ) |
| Write downs on real estate held for sale | | | (47,225,000 | ) | | | (1,266,000 | ) | | | -- | |
| Total income (loss) from real estate held for sale | | | (48,854,000 | ) | | | (2,046,000 | ) | | | 2,996,000 | |
| | | | | | | | | | | | | |
| Income (loss) before provision for income taxes | | | (130,169,000 | ) | | | 16,928,000 | | | | 15,851,000 | |
| | | | | | | | | | | | | |
| Provision for income taxes | | | -- | | | | -- | | | | -- | |
| | | | | | | | | | | | | |
| NET INCOME (LOSS) | | $ | (130,169,000 | ) | | $ | 16,928,000 | | | $ | 15,851,000 | |
| | | | | | | | | | | | | |
| Basic and diluted earnings (loss) per weighted average common share / membership unit | | $ | (8.86 | ) | | $ | 1.14 | | | $ | 1.06 | |
| | | | | | | | | | | | | |
| Dividends declared per common share / cash distribution to members per membership unit | | $ | 0.49 | | | $ | 1.50 | | | $ | 1.51 | |
| | | | | | | | | | | | | |
| Weighted average common shares / membership units | | | 14,695,756 | | | | 14,909,651 | | | | 14,935,585 | |
The accompanying notes are an integral part of these consolidated statements.
| |
| | |
| CONSOLIDATED STATEMENTS OF EQUITY AND OTHER COMPREHENSIVE INCOME (LOSS) | |
| FOR THE YEAR ENDED DECEMBER 31, 2008 | |
| | |
| | | | | | Treasury Stock | | | Common Stock | | | | | | | | | | | | | | | | |
| | | Units | | | Shares | | | Amount | | | Shares | | | Amount | | | Additional Paid-in- Capital | | | Retained Earnings (Accumulated Deficit) | | | Accumulated Other Comprehensive Income (Loss) | | | Members' Equity | | | Total | |
Members' Equity at December 31, 2005 | | | 16,468,581 | | | | -- | | | $ | -- | | | | -- | | | $ | -- | | | $ | -- | | | $ | -- | | | $ | 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 | | | 37,880 | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 742,000 | | | | 742,000 | |
| Members' Redemptions | | | (1,587,240 | ) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (30,459,000 | ) | | | (30,459,000 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Reclassify members' equity to stockholders' equity | | | (14,919,221 | ) | | | | | | | | | | | 14,919,221 | | | | 3,000 | | | | 277,619,000 | | | | | | | | | | | | (277,622,000 | ) | | | -- | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Dividends Declared to Stockholder, $1.09 per common share | | | | | | | | | | | | | | | | | | | | | | | | | | | (16,319,000 | ) | | | | | | | | | | | (16,319,000 | ) |
| Reinvestment of Dividends | | | | | | | | | | | | | | | 19,129 | | | | 1,000 | | | | 234,000 | | | | | | | | | | | | | | | | 235,000 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Stockholders' Equity at December 31, 2006 | | | -- | | | | -- | | | $ | -- | | | | 14,938,350 | | | $ | 4,000 | | | $ | 277,853,000 | | | $ | 1,242,000 | | | $ | (613,000 | ) | | $ | -- | | | $ | 278,486,000 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Comprehensive Income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net Income | | | | | | | | | | | | | | | | | | | | | | | | | | | 16,928,000 | | | | | | | | | | | | 16,928,000 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Unrealized Loss on Marketable Securities - Related Party | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (358,000 | ) | | | | | | | (358,000 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Comprehensive Income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 16,570,000 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Purchase of Treasury Stock | | | | | | | 109,634 | | | | (1,440,000 | ) | | | (109,634 | ) | | | -- | | | | | | | | | | | | | | | | | | | | (1,440,000 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Dividends Declared to Stockholder, $1.50 per common share | | | | | | | | | | | | | | | | | | | | | | | | | | | (22,368,000 | ) | | | | | | | | | | | (22,368,000 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Reinvestment of Dividends | | | | | | | | | | | | | | | 37,503 | | | | (3,000 | ) | | | 514,000 | | | | | | | | | | | | | | | | 511,000 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Stockholders' Equity at December 31, 2007 | | | -- | | | | 109,634 | | | $ | (1,440,000 | ) | | | 14,866,219 | | | $ | 1,000 | | | $ | 278,367,000 | | | $ | (4,198,000 | ) | | $ | (971,000 | ) | | $ | -- | | | $ | 271,759,000 | |
The accompanying notes are an integral part of these consolidated statements.
| VESTIN REALTY MORTGAGE II, INC. | |
| | |
| CONSOLIDATED STATEMENTS OF EQUITY AND OTHER COMPREHENSIVE LOSS | |
| FOR THE YEAR ENDED DECEMBER 31, 2008 | |
| (CONTINUED) | |
| | |
| | | | | | Treasury Stock | | | Common Stock | | | | | | | | | | | | | | | | |
| | | Units | | | Shares | | | Amount | | | Shares | | | Amount | | | Additional Paid-in- Capital | | | Retained Earnings (Accumulated Deficit) | | | Accumulated Other Comprehensive Income (Loss) | | | Members' Equity | | | Total | |
Stockholders' Equity at December 31, 2007 | | | -- | | | | 109,634 | | | $ | (1,440,000 | ) | | | 14,866,219 | | | $ | 1,000 | | | $ | 278,367,000 | | | $ | (4,198,000 | ) | | $ | (971,000 | ) | | $ | -- | | | $ | 271,759,000 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Comprehensive Loss: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net Loss | | | | | | | | | | | | | | | | | | | | | | | | | | | (130,169,000 | ) | | | | | | | | | | | (130,169,000 | ) |
| Recognition of Unrealized Loss on Marketable Securities – Related Party | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 971,000 | | | | | | | | 971,000 | |
| Unrealized Loss on Marketable Securities - Related Party | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (707,000 | ) | | | | | | | (707,000 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Comprehensive Loss | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | (129,905,000 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Purchase of Treasury Stock | | | | | | | 1,088,939 | | | | (4,252,000 | ) | | | (1,088,939 | ) | | | -- | | | | | | | | | | | | | | | | | | | | (4,252,000 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Dividends Declared to Stockholder, $0.49 per common share | | | | | | | | | | | | | | | | | | | | | | | | | | | (7,260,000 | ) | | | | | | | | | | | (7,260,000 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Reinvestment of Dividends | | | | | | | | | | | | | | | 21,510 | | | | -- | | | | 183,000 | | | | | | | | | | | | | | | | 183,000 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Stockholders' Equity at December 31, 2008 | | | -- | | | | 1,198,573 | | | $ | (5,692,000 | ) | | | 13,798,790 | | | $ | 1,000 | | | $ | 278,550,000 | | | $ | (141,627,000 | ) | | $ | (707,000 | ) | | $ | -- | | | $ | 130,525,000 | |
The accompanying notes are an integral part of these consolidated statements.
| |
| | |
| CONSOLIDATED STATEMENTS OF CASH FLOWS | |
| | |
| | | For the Year Ended | | | For the Year Ended | | | For the Twelve Months Ended | |
| | | 12/31/2008 | | | 12/31/2007 | | | 12/31/2006 | |
| Cash flows from operating activities: | | | | | | | | | |
| Net income (loss) | | $ | (130,169,000 | ) | | $ | 16,928,000 | | | $ | 15,851,000 | |
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | | | | | | | | | | | | |
| Provision for doubtful accounts related to receivable | | | 754,000 | | | | 235,000 | | | | 329,000 | |
| Loss on sale of investment in real estate loan | | | 2,760,000 | | | | -- | | | | -- | |
| Gain /loss on sale of marketable securities | | | -- | | | | -- | | | | (21,000 | ) |
| Impairment of marketable securities - related party | | | 2,228,000 | | | | -- | | | | -- | |
| Write downs on real estate held for sale | | | 47,225,000 | | | | 1,266,000 | | | | -- | |
| Gain on sale of real estate held for sale | | | -- | | | | -- | | | | (2,014,000 | ) |
| Loss on sale of real estate held for sale | | | 259,000 | | | | -- | | | | 497,000 | |
| Gain on sale of real estate held for sale - seller financed | | | -- | | | | (2,003,000 | ) | | | (2,293,000 | ) |
| Gain on purchase of debt | | | (1,556,000 | ) | | | -- | | | | -- | |
| Recovery of allowance for doubtful notes receivable included in other income | | | (87,000 | ) | | | (594,000 | ) | | | (487,000 | ) |
| Provision for loan loss | | | 83,712,000 | | | | 3,116,000 | | | | 5,500,000 | |
| Gain related to pay off of real estate loan, including recovery of allowance for loan loss | | | -- | | | | (1,044,000 | ) | | | -- | |
| Amortized interest income | | | (155,000 | ) | | | (1,323,000 | ) | | | (1,328,000 | ) |
| Amortized financing costs, included in interest expense | | | 607,000 | | | | 88,000 | | | | -- | |
| Change in operating assets and liabilities: | | | | | | | | | | | | |
| Interest and other receivables | | | 2,063,000 | | | | (1,330,000 | ) | | | 273,000 | |
| Due to/from related parties | | | 400,000 | | | | 153,000 | | | | 294,000 | |
| Other assets | | | 160,000 | | | | 434,000 | | | | 343,000 | |
| Accounts payable and accrued liabilities | | | (446,000 | ) | | | 2,354,000 | | | | 381,000 | |
| Net cash provided by operating activities | | | 7,755,000 | | | | 18,280,000 | | | | 17,325,000 | |
| | | | | | | | | | | | | |
| Cash flows from investing activities: | | | | | | | | | | | | |
| Investments in real estate loans | | $ | (91,592,000 | ) | | $ | (141,384,000 | ) | | $ | (202,748,000 | ) |
| Purchase of investments in real estate loans from: | | | | | | | | | | | | |
| VRM I | | | (3,300,000 | ) | | | -- | | | | (1,350,000 | ) |
| Fund III | | | -- | | | | (1,300,000 | ) | | | (4,900,000 | ) |
| Other related parties | | | -- | | | | (661,000 | ) | | | (2,556,000 | ) |
| Third parties | | | (8,745,000 | ) | | | (14,246,000 | ) | | | (23,000,000 | ) |
| Proceeds from loan payoffs | | | 50,900,000 | | | | 90,712,000 | | | | 203,106,000 | |
| Sale of investments in real estate loans to: | | | | | | | | | | | | |
| VRM I | | | 500,000 | | | | 4,434,000 | | | | 500,000 | |
| Fund III | | | -- | | | | 1,153,000 | | | | 6,000,000 | |
| Other related parties | | | -- | | | | -- | | | | 2,000,000 | |
| Third party | | | 51,669,000 | | | | 3,319,000 | | | | 175,000 | |
| Proceeds related to investment in real estate held for sale | | | 635,000 | | | | 250,000 | | | | 35,553,000 | |
| Proceeds from sale of real estate held for sale | | | 925,000 | | | | -- | | | | -- | |
| Principal payments on real estate held for sale-seller financed | | | -- | | | | 10,598,000 | | | | 8,113,000 | |
| Legal expenses paid and applied against loan allowance | | | -- | | | | (94,000 | ) | | | (906,000 | ) |
| Proceeds from note receivable | | | 87,000 | | | | 641,000 | | | | 686,000 | |
| Purchase of marketable securities - related parties | | | -- | | | | (731,000 | ) | | | (2,700,000 | ) |
| Proceeds from sale of marketable securities | | | -- | | | | -- | | | | 7,263,000 | |
| Purchase of investments in certificates of deposit | | | (2,000 | ) | | | (1,027,000 | ) | | | (17,061,000 | ) |
| Proceeds from investments in certificates of deposit | | | 104,000 | | | | 1,175,000 | | | | 17,811,000 | |
| Unearned revenue proceeds related to loan restructuring | | | -- | | | | -- | | | | 608,000 | |
| Deposit liability | | | -- | | | | 665,000 | | | | 6,942,000 | |
| Cash - restricted | | | (5,000,000 | ) | | | -- | | | | -- | |
| Net cash provided (used) by investing activities | | $ | (3,819,000 | ) | | $ | (46,496,000 | ) | | $ | 33,536,000 | |
The accompanying notes are an integral part of these consolidated statements.
| VESTIN REALTY MORTGAGE II, INC. | |
| | |
| CONSOLIDATED STATEMENTS OF CASH FLOWS | |
| | |
| | | For the Year Ended | | | For the Year Ended | | | For the Twelve Months Ended | |
| | | 12/31/2008 | | | 12/31/2007 | | | 12/31/2006 | |
| Cash flows from financing activities: | | | | | | | | | |
| Principal payments on notes payable | | $ | (184,000 | ) | | $ | (256,000 | ) | | $ | (25,857,000 | ) |
| Proceeds from issuance of notes payable | | | -- | | | | 2,000 | | | | -- | |
| Proceeds from issuance of debt | | | -- | | | | 60,000,000 | | | | -- | |
| Cash used for purchase of debt | | | (2,194,000 | ) | | | -- | | | | -- | |
| Deferred financing costs | | | (898,000 | ) | | | (2,301,000 | ) | | | -- | |
| Dividends paid to stockholders, net of reinvestments | | | (8,367,000 | ) | | | (23,776,000 | ) | | | (11,906,000 | ) |
| Dividends paid to stockholders - related party | | | (256,000 | ) | | | (613,000 | ) | | | (100,000 | ) |
| Purchase of treasury stock at cost | | | (4,252,000 | ) | | | (1,440,000 | ) | | | -- | |
| Members' distributions, net of reinvestments | | | -- | | | | -- | | | | (5,315,000 | ) |
| Members' distributions - related party | | | -- | | | | -- | | | | (16,000 | ) |
| Members' redemptions | | | -- | | | | -- | | | | (30,459,000 | ) |
| Net cash provided (used) in financing activities | | | (16,151,000 | ) | | | 31,616,000 | | | | (73,653,000 | ) |
| | | | | | | | | | | | | |
| NET CHANGE IN CASH | | | (12,215,000 | ) | | | 3,400,000 | | | | (22,792,000 | ) |
| | | | | | | | | | | | | |
| Cash, beginning of period | | | 20,241,000 | | | | 16,841,000 | | | | 39,633,000 | |
| | | | | | | | | | | | | |
| Cash, end of period | | $ | 8,026,000 | | | $ | 20,241,000 | | | $ | 16,841,000 | |
| | | | | | | | | | | | | |
| Supplemental disclosures of cash flows information: | | | | | | | | | | | | |
| Interest paid | | $ | 6,421,000 | | | $ | 3,367,000 | | | $ | 1,446,000 | |
| | | | | | | | | | | | | |
| Non-cash investing and financing activities: | | | | | | | | | | | | |
| Dividend payable | | $ | -- | | | $ | 1,546,000 | | | $ | 4,078,000 | |
| Reinvestment of dividends | | $ | 183,000 | | | $ | 514,000 | | | $ | 235,000 | |
| Reinvestment of member distributions | | $ | -- | | | $ | -- | | | $ | 742,000 | |
| Adjustment to allowance for loan loss related to sale of investment in real estate loan | | $ | 13,430,000 | | | $ | -- | | | $ | -- | |
| Payoff of loans funded through secured borrowings | | $ | 10,400,000 | | | $ | 13,796,000 | | | $ | 23,518,000 | |
| Loans funded through secured borrowing | | $ | 19,982,000 | | | $ | -- | | | $ | 17,560,000 | |
| Interest reserves related to secured borrowings | | $ | 1,018,000 | | | $ | -- | | | $ | -- | |
| Repurchase of interest reserves related to secured borrowings | | $ | 325,000 | | | $ | -- | | | $ | -- | |
| Note payable relating to prepaid E & O insurance | | $ | 208,000 | | | $ | -- | | | $ | -- | |
| Real estate held for sale acquired through foreclosure, net of prior allowance | | $ | 44,915,000 | | | $ | -- | | | $ | 25,476,000 | |
| Loan rewritten with same or similar collateral | | $ | 3,301,000 | | | $ | 30,918,000 | | | $ | -- | |
| Purchase of equity investment related to junior subordinated notes payable | | $ | -- | | | $ | 100,000 | | | $ | -- | |
| Receivable related to loan rewritten with same or similar property, net of allowance, as collateral applied to unearned income | | $ | -- | | | $ | -- | | | $ | 127,000 | |
| Write off of interest receivable and related allowance | | $ | 321,000 | | | $ | -- | | | $ | -- | |
| Unearned revenue from loans rewritten with same or similar property as collateral | | $ | -- | | | $ | 454,000 | | | $ | 27,000 | |
| Decrease in deposit liability related to pay off of real estate held for sale - seller financed | | $ | -- | | | $ | 6,179,000 | | | $ | -- | |
| Adjustment to note receivable and related allowance | | $ | 192,000 | | | $ | 978,000 | | | $ | -- | |
| Settlement for reimbursement of legal fees, including amount applied towards related loan loss | | $ | -- | | | $ | 523,000 | | | $ | -- | |
| Prepaid amount applied to accounts payable | | $ | 41,000 | | | $ | -- | | | $ | -- | |
| Recognition of unrealized loss on marketable securities – related party | | $ | 971,000 | | | $ | -- | | | $ | -- | |
| Unrealized gain (loss) on marketable securities - related party | | $ | (707,000 | ) | | $ | (358,000 | ) | | $ | (613,000 | ) |
The accompanying notes are an integral part of these consolidated statements.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2008
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 commercial real estate loans (hereafter referred to as “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 our manager and CEO, President and a director of us, wholly owns Vestin Group, which is engaged in asset management, real estate lending and other financial services through its subsidiaries. Our manager, prior to June 30, 2006, also operated as a licensed Nevada mortgage broker and was generally engaged in the business of brokerage, placement and servicing of commercial loans secured by real property. On July 1, 2006, a mortgage broker license was issued to an affiliated company, Vestin Originations, Inc. (“Vestin Originations”) that has continued the business of brokerage, placement and servicing of real estate loans. Vestin Originations is a wholly owned subsidiary of Vestin Group. On September 1, 2007, the servicing of real estate loans was assumed by our manager.
Pursuant to our management agreement, our manager implements our business strategies on a day-to-day basis, manages and provides services to us, and provides similar services to our subsidiaries. Without limiting the foregoing, our manager performs 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. Consequently, our operating results are dependent upon our manager’s ability and performance in managing our operations and servicing our assets.
Vestin Mortgage is also the manager of Vestin Realty Mortgage I, Inc. (“VRM I”), as the successor by merger to Vestin Fund I, LLC (“Fund I”), Vestin Fund III, LLC (“Fund III”) and inVestin Nevada, Inc. (“inVestin”), a company wholly owned by our manager’s CEO. These entities have been formed to invest in real estate loans.
The consolidated financial statements include the accounts of us and our wholly owned taxable REIT subsidiary, TRS II, Inc. All significant inter-company transactions and balances have been eliminated in consolidation.
On June 22, 2007, we completed the issuance of $60.1 million in unsecured trust preferred securities through Vestin II Capital Trust I (“VCT I”), a special purpose business trust. VCT I, is a Delaware statutory trust. Our interest in VCT I is accounted for using the equity method and the assets and liabilities are not consolidated into our financial statements due to our determination that VCT I is a variable interest entity in which we are not the primary beneficiary under Financial Accounting Standards Board Interpretation No. 46R (“FIN 46R”).
NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Management Estimates
The preparation of consolidated financial statements in conformity with 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 consolidated 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.
Restricted Cash
On November 7, 2008, we entered into an agreement with Taberna Capital Management, LLC (“Taberna”), in its capacity as collateral manager for certain collateral debt obligation vehicles that are the holders of the junior subordinated notes, providing for an amendment of the tangible net worth covenant (the “First Supplemental Indenture”). We have restricted cash of $5.0 million related to the First Supplemental Indenture, where by Taberna is entitled to draw upon such letters of credit to pay principal and interest on the junior subordinated notes if an Event of Default has occurred. The letters of credit may not be subordinated to any of our Senior Debt.[conform] On December 31, 2008, we were not in compliance with the revised tangible net worth covenant and the debt to tangible net worth covenant in the First Supplemental Indenture. On March 25, 2009, we entered into a letter agreement with Taberna providing for a waiver of all financial covenants effective December 31, 2008 through June 30, 2009. In addition, pursuant to the letter agreement we will exchange $20 million of the junior subordinated notes for certain replacement securities, which we expect to acquire for approximately $10 million of cash. This will reduce our obligation on the junior subordinated notes to approximately $36.3 million, which should facilitate future compliance with financial covenants set forth in the First Supplemental Indenture. This transaction would result in a net gain of approximately $9 million including transaction costs. In addition, we are to pay additional interest equal to $250,000 per year, payable quarterly on the same payment dates as the current terms of the Junior Subordinated Notes. We agreed to make a nonrefundable payment of $200,000 to Taberna to cover its costs related to the waiver and exchange arrangement. The replacement securities will be acquired with funds consisting of $5 million from our operating funds and $5 million from the $5 million letter of credit. For additional information regarding the First Supplemental Indenture see Note I – Junior Subordinated Notes of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Report Form 10-K.
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 our manager or other related parties pursuant to the terms of our Management Agreement without a premium. 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 initially based on appraisals obtained at the time of loan origination and are updated, when new appraisals are received or when management’s assessment of the value has changed, to 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.
Allowance for Loan Losses
We maintain an allowance for loan losses on our investments in real estate loans for estimated credit impairment. Our 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. Generally, subsequent recoveries of amounts previously charged off are added back to the allowance and 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 commercial real estate lender willing to invest in loans to borrowers who may not meet the credit standards of other financial institutional 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 approve 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 may be 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 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, we seek to identify potential purchasers of such property. It is not our 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”), we seek 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 foreclose on non-performing 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 sales 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 sales 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.
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 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. Our 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 for any differential of the interest spread, if applicable. 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.
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 closing market price as of December 31, 2008. All securities are classified as available-for-sale under the provisions of FAS 115 – Accounting for Certain Investments in Debt and Equity Securities (“FAS 115”).
We evaluate our available-for-sale investment for other-than-temporary impairment charges in accordance with Emerging Issues Task Force, or EITF 03-1, The Meaning of Other-Than-Temporary Impairment and it’s Application to Certain Investments. FAS 115 and EITF 03-1 require us to determine when an investment is considered impaired (i.e., decline in fair value below its amortized cost), and evaluate whether the impairment is other than temporary (i.e., investment value will not be recovered over its remaining life), and, if the impairment is other than temporary, recognize an impairment loss equal to the difference between the investment’s cost and its fair value.
According to the SEC Staff Accounting Bulletin, Topic 5: Miscellaneous Accounting, M - Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities, there are numerous factors to be considered in such an evaluation and their relative significance will vary from case to case. The following are a few examples of the factors that individually or in combination, indicate that a decline is other than temporary and that a write down of the carrying value is required:
| | · | The length of the time and the extent to which the market value has been less than cost; |
| | · | The financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology that may impair the earnings potential of the investment or the discontinuance of a segment of the business that may affect the future earnings potential; or |
| | · | The intent and ability of the holder to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value. |
Fair Value Disclosures
On January 1, 2008, we adopted FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115 (“FAS 159”). FAS 159 permits companies to choose to measure certain financial assets and liabilities at fair value (the “fair value option”). If the fair value option is elected, any upfront costs and fees related to the item must be recognized in earnings and cannot be deferred, e.g. debt issue costs. The fair value election is irrevocable and may generally be made on an instrument-by-instrument basis, even if a company has similar instruments that it elects not to fair value. At the adoption date, unrealized gains and losses on existing items for which fair value has been elected are reported as a cumulative adjustment to beginning retained earnings.
We chose not to elect the fair value option for our financial assets and liabilities existing on January 1, 2008, and did not elect the fair value option for financial assets and liabilities transacted during the year ended December 31, 2008. Therefore, the adoption of FAS 159 had no impact on our consolidated financial statements.
On January 1, 2008, we also adopted FAS No. 157, Fair Value Measurement (“FAS 157”), as required for financial assets and liabilities, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position No. 157-2, a one-year deferral of FAS 157’s fair value measurement requirements for non-financial assets and liabilities that are not required or permitted to be measured at fair value on a recurring basis. The adoption of FAS 157 for our financial assets and liabilities did not have a material impact on our consolidated financial statements. We do not expect the adoption of FAS 157 as it pertains to non-financial assets and liabilities to have a material impact on our consolidated financial statements.
Under FAS 157, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e. “the exit price”) in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various valuation approaches, including quoted market prices and discounted cash flows. FAS 157 also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from independent sources. Unobservable inputs are inputs that reflect a company’s judgment concerning the assumptions that market participants would use in pricing the asset or liability developed based on the best information available under the circumstances. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:
| | · | Level 1 – Valuations based on quoted prices in active markets for identical instruments that the Company is able to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment. |
| | · | Level 2 – Valuations based on quoted prices in active markets for instruments that are similar, or quoted prices in markets that are not active for identical or similar instruments, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. |
| | · | Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement, which utilize the Company’s estimates and assumptions. |
Basic and Diluted Earnings Per Common Share
Basic earnings per share (“EPS”) is computed, in accordance with FAS 128 – Earnings per Share, 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 share equivalents during the years ended December 31, 2008 and 2007. The following is a computation of the EPS data for the years ended December 31, 2008 and 2007:
| | | For the Year Ended December 31, | |
| | | 2008 | | | 2007 | |
| | | | | | | |
| Net income (loss) to common stockholders | | $ | (130,169,000 | ) | | $ | 16,928,000 | |
| | | | | | | | | |
| Weighted average number of common shares outstanding during the period | | | 14,695,756 | | | | 14,909,651 | |
| | | | | | | | | |
| Basic and diluted earnings (loss) per weighted average common share | | $ | (8.86 | ) | | $ | 1.14 | |
Net Income (Loss) Allocated to Members Per Weighted Average Membership Unit
Fund II was an LLC prior to the merger, which stated net income allocated to members per weighted average membership unit that is computed by dividing net income calculated in accordance with GAAP by the weighted average number of membership units outstanding for the period. We had no outstanding common shares equivalents during the twelve months ended December 31, 2006. The following is a computation of the net income (loss) per weighted average membership unit for the three months ended March 31, 2006, basic earnings per share for the nine months ended December 31, 2006 and total earnings per weighted average share/membership unit 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 (loss) 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 | | | 14,967,788 | | | | 14,933,838 | | | | 14,935,585 | |
| | | | | | | | | | | | | |
| Basic and diluted earnings per common share / membership unit | | $ | (0.11 | ) | | $ | 1.18 | | | $ | 1.06 | |
Common Stock Dividends
During the year ended December 31, 2007, we declared cash dividends approximately $1.50 per common share, representing ordinary income.
During the year ended December 31, 2008, we declared cash dividends approximately $0.49 per common share. For tax purposes, approximately $0.03 per common share is classified as ordinary dividends and the balance of approximately $0.46 per common share is classified as non-dividend distributions.
During June 2008, our Board of Directors decided to suspend the payment of dividends. We will continue to comply with the REIT requirements and will distribute at least ninety percent (90%) of our annual taxable income. Our Board of Directors will closely monitor our operating results in order to determine when dividends should be reinstated.
Treasury Stock
On March 21, 2007, our board of directors authorized the repurchase of up to $10 million worth of our common stock. Depending upon market conditions, shares may be repurchased from time to time at prevailing market prices through open market or privately negotiated transactions. We are not obligated to purchase any shares. Subject to applicable securities laws, repurchases may be made at such times and in such amounts, as our management deems appropriate. The share repurchase program may be discontinued or terminated at any time and we have not established a date for completion of the share repurchase program. The repurchases will be funded from our available cash. As of December 31, 2007, we had purchased 109,634 shares of treasury stock through the repurchase program noted above. These shares are carried on our books at a cost totaling approximately $1.4 million. As of December 31, 2008, we had purchased a total of 1,198,573 shares of treasury stock through the repurchase program noted above. These shares are carried on our books at a cost totaling approximately $5.7 million.
Segments
We operate as one business segment.
Principles of Consolidation
The accompanying consolidated financial statements include, on a consolidated basis, our accounts, the accounts of our wholly-owned subsidiaries and our interests in variable interest entities in which we are the primary beneficiary. All significant intercompany balances and transactions have been eliminated in consolidation. Our interest in VCT I (see Note I – Junior Subordinated Notes) is accounted for using the equity method and the assets and liabilities are not consolidated into our financial statements due to our determination that VCT I is a variable interest entity in which we are not the primary beneficiary under FIN 46R.
Income Taxes
We are organized and conduct our 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. Our taxable income may substantially exceed or be less than our net income as determined based on GAAP, because, differences in GAAP and taxable net income consist primarily of allowances for loan losses or doubtful account, write downs on real estate held for sale, amortization of deferred financing cost, capital gains and losses, and deferred income. Certain assets of ours 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 for the year ended December 31, 2008, and 2007, was approximately zero.
Reclassifications
Certain reclassifications have been made to the prior periods’ consolidated 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, marketable securities related party and loans secured by deeds of trust.
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 based on management review of these financial institutions. As of December 31, 2008 and December 31, 2007, we had approximately $11.4 million and $19.7 million, respectively, in excess of the federally insured limits.
As of December 31, 2008, 40%, 26%, 11% and 8% of our loans were in Nevada, Arizona, California and Hawaii, respectively, compared to 45%, 15%, 7% and 6%, at December 31, 2007, respectively. As a result of this geographical concentration of our real estate loans, the downturn in the local real estate markets in these states has had a material adverse effect on us.
At December 31, 2008, the aggregate amount of loans to our three largest borrowers represented approximately 15% of our total investment in real estate loans. These real estate loans consisted of commercial loans, located in Oregon and Hawaii, with first lien positions, interest rates between 12% and 14%, with an aggregate outstanding balance of approximately $33.3 million. As of December 31, 2008, our three largest loans were considered non-performing. At December 31, 2007, the aggregate amount of loans to our three largest borrowers represented approximately 22% of our total investment in real estate loans. These real estate loans consisted of commercial loans, located in Hawaii and Oregon with first lien positions, interest rates between 10.5% and 14.0%, with an aggregate outstanding balance of approximately $63.9 million. The loans in Hawaii described above referred to the RightStar loans discussed in Note D – Investments in Real Estate Loans. We have a significant concentration of credit risk with our largest borrowers. Any additional defaults could have a material adverse effect on us.
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. As the economy weakens and credit has become more difficult to obtain, many of our borrowers who develop and sell commercial real estate projects have been unable to complete their projects, obtain takeout financing or have been otherwise adversely impacted. In addition, an increase in interest rates over the loan rate applicable at origination of the loan may have an adverse effect on our borrower’s ability to refinance.
Common Guarantors
As of December 31, 2008, three loans totaling approximately $23.0 million, representing approximately 10.2% of our portfolio’s total value, had a common guarantor. All three loans were considered non-performing as of December 31, 2008. As of December 31, 2007, these three loans represented approximately 7.9% of our portfolio’s total value. All three loans were considered performing as of December 31, 2007.
As of December 31, 2008, six loans totaling approximately $23.6 million, representing approximately 10.5% of our portfolio’s total value, had a common guarantor, of these six loans; three loans were related to our secured borrowings of approximately $10.6 million, including approximately $0.7 million in interest reserves. One of the six loans, totaling approximately $7.2 million, was considered non-performing as of December 31, 2008. Subsequent to December 31, 2008, these loans have been modified, whereby the interest rate was reduced to 8% starting in January 2009. Interest payments will be payable monthly, ranging from 3.0% to 4.25%, beginning January 25, 2009, and accrued at a range of 3.75% to 5.0% payable at the end of the loan for five of the six loans. The remaining loan’s interest payments will be payable quarterly at 3.0% beginning March 25, 2009, and accrued at 5.0% payable at the end of the loan. All these loans required payments have been received as of March 11, 2009, and are considered performing. As of December 31, 2007, we had six loans totaling approximately $26.8 million with this guarantor, representing approximately 9.2% of our portfolio’s total value. All six loans were considered performing as of December 31, 2007.
As of December 31, 2008, five loans totaling approximately $23.7 million, representing approximately 10.5% of our portfolio’s total value, had a common guarantor. All five loans were considered non-performing as of December 31, 2008. As of December 31, 2007, we had six loans totaling approximately $54.8 million with this guarantor, representing approximately 18.8% of our portfolio’s total value, had a common guarantor. All six loans were considered performing as of December 31, 2007.
For additional information regarding the above non-performing loans see “Non-Performing Loans” in Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Report Form 10-K.
NOTE D — INVESTMENTS IN REAL ESTATE LOANS
As of December 31, 2008, and 2007, 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.
In addition, we may 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, 2008, we had approximately $52.7 million in investments in real estate loans that had interest reserves where the total outstanding principal due to our co-lenders and us was approximately $60.0 million. These loans had interest reserves of approximately $5.7 million, of which our portion was approximately $4.9 million. As of December 31, 2008, two of these loans, totaling approximately $18.8 million, which had interest reserves, were considered non-performing. These loans’ interest reserves, totaling approximately $3.2 million, have been suspended as of December 31, 2008 and we no longer draw monthly interest income from them. At December 31, 2007, we had approximately $108.8 million in investments in real estate loans that had interest reserves where the total outstanding principal due to our co-lenders and us was approximately $128.6 million. These loans had interest reserves of approximately $10.4 million, of which our portion was approximately $8.8 million.
On December 12, 2008, we, VRM I, and Fund III, sold the Silver Star Destinations, LLC loan, which was considered non-performing, to an unrelated third party for approximately $9.9 million, of which our portion was approximately $9.5 million. At the time of the sale, the loan was carried at approximately $12.3 million, which included an allowance for loan loss of approximately $13.4 million. The sale resulted in us recognizing a net loss of approximately $2.8 million.
As of December 31, 2008, we had five real estate loan products consisting of commercial, construction, acquisition and development, land and residential. The effective interest rates on all product categories range from 6% to 15%. Revenue by product will fluctuate based upon relative balances during the period.
Loan Portfolio
Investments in real estate loans as of December 31, 2008, were as follows:
| Loan Type | | Number of Loans | | | Balance * | | | Weighted Average Interest Rate | | | Portfolio Percentage | | | Current Weighted Average Loan-To-Value, Net of Allowance for Loan Losses | |
| | | | | | | | | | | | | | | | |
| Acquisition and Development | | | 1 | | | $ | 13,000,000 | | | | 13.00% | | | | 5.78% | | | | 92.00% | |
| Commercial | | | 20 | | | | 107,456,000 | | | | 12.64% | | | | 47.75% | | | | 81.09% | |
| Construction | | | 7 | | | | 27,612,000 | | | | 10.55% | | | | 12.27% | | | | 103.26% | |
| Land | | | 11 | | | | 76,974,000 | | | | 11.87% | | | | 34.20% | | | | 78.59% | |
| Total | | | 39 | | | $ | 225,042,000 | | | | 12.14% | | | | 100.00% | | | | 84.01% | |
Investments in real estate loans as of December 31, 2007, were as follows:
| Loan Type | | Number of Loans | | | Balance * | | | Weighted Average Interest Rate | | | Portfolio Percentage | | | Current Weighted Average Loan-To-Value, Net of Allowance for Loan Losses | |
| | | | | | | | | | | | | | | | |
| Acquisition and Development | | | 4 | | | $ | 18,338,000 | | | | 12.85% | | | | 6.30% | | | | 46.75% | |
| Commercial | | | 19 | | | | 131,257,000 | | | | 12.12% | | | | 45.10% | | | | 74.57% | |
| Construction | | | 9 | | | | 45,883,000 | | | | 11.04% | | | | 15.76% | | | | 73.84% | |
| Land | | | 14 | | | | 95,585,000 | | | | 12.12% | | | | 32.84% | | | | 62.41% | |
| Total | | | 46 | | | $ | 291,063,000 | | | | 12.00% | | | | 100.00% | | | | 68.52% | |
| * | Please see Balance Sheet Reconciliation below. |
The “Weighted Average Interest Rate” as shown above is based on the contractual terms of the loans for the entire portfolio including non-performing loans. The weighted average interest rate on performing loans only, as of December 31, 2008 and December 31, 2007, was 12.42% and 11.84%, respectively. Please see “Non-Performing Loans” and “Asset Quality and Loan Reserves” below for further information regarding performing and non-performing loans.
Loan-to-value ratios are generally based on the most recent appraisals and may not reflect subsequent changes in value and include allowances for loan losses. Recognition of allowance for loan losses will result in a maximum loan-to-value ratio of 100% per loan.
The following is a schedule of priority of real estate loans as of December 31, 2008 and December 31, 2007:
Loan Type | | Number of Loans | | | December 31, 2008 Balance* | | | Portfolio Percentage | | | Number of Loans | | | December 31, 2007 Balance* | | | Portfolio Percentage | |
| | | | | | | | | | | | | | | | | | | |
| First deeds of trust | | | 31 | | | $ | 188,219,000 | | | | 83.64% | | | | 44 | | | $ | 288,665,000 | | | | 99.18% | |
| Second deeds of trust | | | 8 | | | | 36,823,000 | | | | 16.36% | | | | 2 | | | | 2,398,000 | | | | 0.82% | |
| Total | | | 39 | | | $ | 225,042,000 | | | | 100.00% | | | | 46 | | | $ | 291,063,000 | | | | 100.00% | |
| * | Please see Balance Sheet Reconciliation below. |
The following is a schedule of contractual maturities of investments in real estate loans as of December 31, 2008:
Non-performing and past due loans (a) | | $ | 162,768,000 | |
| January 2009 – March 2009 | | | 8,671,000 | |
| April 2009 - June 2009 | | | 12,600,000 | |
| July 2009 - September 2009 | | | 5,265,000 | |
| October 2009 - December 2009 | | | 15,882,000 | |
| January 2010 – March 2010 | | | 4,448,000 | |
| Thereafter | | | 15,408,000 | |
| | | | | |
| Total | | $ | 225,042,000 | |
| (a) | Amounts include the balance of non-performing loans and loans that have been extended subsequent to December 31, 2008. |
The following is a schedule by geographic location of investments in real estate loans as of December 31, 2008 and December 31, 2007:
| | | December 31, 2008 Balance * | | | Portfolio Percentage | | | December 31, 2007 Balance * | | | Portfolio Percentage | |
| | | | | | | | | | | | | |
| Arizona | | $ | 59,628,000 | | | | 26.50% | | | $ | 43,865,000 | | | | 15.07% | |
| California | | | 24,298,000 | | | | 10.80% | | | | 19,673,000 | | | | 6.76% | |
| Hawaii | | | 17,291,000 | | | | 7.68% | | | | 17,291,000 | | | | 5.94% | |
| Nevada | | | 89,917,000 | | | | 39.95% | | | | 132,000,000 | | | | 45.35% | |
| New York | | | -- | | | | --% | | | | 16,981,000 | | | | 5.83% | |
| Oklahoma | | | 2,155,000 | | | | 0.96% | | | | 5,051,000 | | | | 1.74% | |
| Oregon | | | 16,048,000 | | | | 7.13% | | | | 46,620,000 | | | | 16.02% | |
| Texas | | | 13,904,000 | | | | 6.18% | | | | 7,924,000 | | | | 2.72% | |
| Washington | | | 1,801,000 | | | | 0.80% | | | | 1,658,000 | | | | 0.57% | |
| Total | | $ | 225,042,000 | | | | 100.00% | | | $ | 291,063,000 | | | | 100.00% | |
| * | Please see Balance Sheet Reconciliation below. |
| | Balance Sheet Reconciliation |
The following table reconciles the balance of the loan portfolio to the amount shown on the accompanying Consolidated Balance Sheets.
| | | December 31, 2008 Balance (a) | | | December 31, 2007 Balance | |
| Balance per loan portfolio | | $ | 225,042,000 | | | $ | 291,063,000 | |
| Less: | | | | | | | | |
Allowance for loan losses (b) | | | (78,208,000 | ) | | | (12,873,000 | ) |
| Balance per consolidated balance sheet | | $ | 146,834,000 | | | $ | 278,190,000 | |
| (a) | We recognized an impairment loss of approximately $0.6 million, which was applied to the 2503 Panorama, LLC loan balance, related to the restructuring of a loan, whereby the interest rate was reduced from 12% to 6% starting in May 2008. As of December 31, 2008, we, VRM I and Fund III recognized an allowance for loan loss of approximately $4.0 million, of which our portion was approximately $3.1 million, related to this loan. In addition, we recognized an impairment loss of approximately $0.5 million, which was applied to the VBP Partners, LLC loan balance, related to the modification of the loan, whereby the interest rate was reduced from 11.5% to 8% starting in October 2008. Interest payments will be payable semi-annually at 3% beginning March 25, 2009, and accrued at 5% payable at the end of the loan. As of December 31, 2008, we and VRM I recognized an allowance for loan loss of approximately $3.7 million, of which our portion was approximately $3.4 million, related to this loan. |
| (b) | Please refer to Specific Reserve Allowance below. |
Non-Performing Loans
As of December 31, 2008, we had 20 loans considered non-performing (i.e., 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). These loans are currently carried on our books at a value of approximately $73.7 million, net of allowance for loan losses of approximately $71.2 million, which does not include the allowances of approximately $7.0 million relating to the decrease in the property value for performing loans as of December 31, 2008. These loans have been placed on non-accrual of interest status and are the subject of pending foreclosure proceedings. At December 31, 2008, the following loans were non-performing:
| | · | RightStar, Inc. (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. As of December 31, 2008, based on our manager’s evaluation and an updated appraisal, our manager has provided a specific allowance of approximately $14.4 million, of which our portion is approximately $9.8 million. See Note O – Legal Matters Involving The Company for further information. |
| | · | Monterrey Associates, L.P. is a non-performing loan, which was originally secured by various real estate collateral, including a 248 unit apartment complex in Oklahoma City, Oklahoma. The outstanding balance on the loan is approximately $4.4 million, of which our portion is approximately $2.2 million. As of December 31, 2008, this loan has been considered non-performing for the last twenty-eight months. Our manager brought foreclosure and other legal proceedings to protect our interest in the collateral. The borrowers have alleged that our lien on the Oklahoma City apartment complex was extinguished as a result of our foreclosure of a Deed of Trust and sale of other collateral located in Kansas City, Missouri securing the non-performing loan. We filed a Petition to set aside the sale of the Missouri collateral, which the court dismissed. We appealed the dismissal and are awaiting a decision. We are vigorously contesting Monterrey’s position; however, we cannot determine at this time the outcome of these legal proceedings. As of December 31, 2008, based on our manager’s evaluation, our manager has provided a specific allowance for the full amount of the loan totaling approximately $4.4 million, of which our portion is approximately $2.2 million. |
| | · | 3900, LLC, is a second position loan that provided bridge financing for an approximate 7.66 acre neighborhood retail center, located in Tempe, Arizona. The loan is secured by a second position lien, junior to a first position lien in the amount of $6.0 million. In addition, the loan is guaranteed by principals of the borrower. The outstanding balance of the loan is approximately $3.3 million. On April 5, 2008, this loan was considered to be in default due to the default of the Redwood Place, LLC loan, as a result of cross-default provisions. Our manager has commenced foreclosure, and is proceeding with legal action to enforce the personal guarantees. On October 17, 2008, the borrower filed for bankruptcy protection. A settlement agreement was negotiated with the borrower and guarantors; however, they are currently in default under the settlement agreement. We intend to proceed against them; however, it cannot be determined at this time how much, if any, will be collected. As of December 31, 2008, this loan has been considered non-performing for the last eight months, and based on our manager’s evaluation and an updated appraisal, our manager has provided a specific allowance for the full amount of the loan totaling approximately $3.3 million. |
| | · | World Capital La Piazza, LLC, is a loan to provide financing for the development of 8.44 net acres of land located in Henderson, NV. The loan is secured by a first lien on the property, and is guaranteed by principals of the borrower. The outstanding balance on the loan is approximately $13.0 million. As of December 31, 2008, this loan has been considered non-performing for the last eight months. The loan matured on June 29, 2008, and the borrower failed to either payoff the loan or extend the term. On October 29, 2008, the borrower filed for bankruptcy protection. Our manager was successful in lifting the automatic stay from bankruptcy, and has commenced both foreclosure proceedings, and litigation to enforce the personal guarantees. The foreclosure sale is scheduled for March 30, 2009. As of December 31, 2008, based on our manager’s evaluation and an updated appraisal, our manager has provided a specific allowance of approximately $6.8 million. |
| | · | World Capital Durango Alpha is a loan to provide financing for the development of 9.27 acres of land located in Las Vegas, NV with an outstanding balance of approximately $7.1 million of which our portion is approximately $4.8 million and is secured by a first lien on the property and guaranteed by the principals of the borrower. As of December 31, 2008, this loan has been considered non-performing for the last eight months. On October 29, 2008, the borrower filed for bankruptcy protection. Our manager was successful in lifting the automatic stay from bankruptcy, and has commenced both foreclosure proceedings and litigation against the personal guarantors in order to enforce the personal guarantees. The foreclosure sale is scheduled for March 30, 2009. As of December 31, 2008, based on our manager’s evaluation and an updated appraisal, our manager has provided a specific allowance totaling approximately $2.0 million, of which our portion is approximately $1.4 million. |
| | · | Peoria 180, LLC is a loan, with a variable interest rate, to provide financing for the development of 171 acres located in Glendale, Arizona with an outstanding balance of $18.0 million of which our portion is approximately $14.8 million and is secured by a first lien on the property and guaranteed by the principals of the borrower. As of December 31, 2008, this loan has been considered non-performing for the last eight months. Our manager has commenced foreclosure proceedings and has been awarded a default judgment against the guarantors for approximately $24.4 million, although it cannot be determined at this time how much, if any, can be recovered from the guarantors. On September 26, 2008, the borrower filed for bankruptcy protection. As of December 31, 2008, based on our manager’s evaluation and an updated appraisal, our manager has provided a specific allowance of approximately $15.0 million, of which our portion is approximately $12.3 million. On March 23, 2008, we, VRM I and Fund III, sold the Peoria 180, LLC loan to an unrelated third party for $3.0 million. The sale resulted in no gain or loss. |
| | · | Redwood Place, LLC is a loan that provided for the acquisition and conversion to condominiums of a 186-unit apartment complex located in Phoenix, Arizona. The loan is secured by a first lien on the property, and is guaranteed by principals of the borrower. The outstanding balance on the loan is approximately $15.0 million, of which our portion is approximately $11.4 million. The loan matured on April 5, 2008, and the borrower failed to either pay the loan or extend the term. As of December 31, 2008, this loan has been considered non-performing for the last eight months. Our manager has commenced both foreclosure proceedings and litigation against the personal guarantors in order to enforce the personal guarantees. On August 27, 2008, the borrower filed for bankruptcy protection. On September 30, 2008, we, VRM I, and Fund III reached a tentative settlement agreement with the borrower to foreclose upon the property. The guarantors entered into a confession of judgment for an amount of $1.1 million and agreed to pay annual deficiency payments starting on September 30, 2009, monthly interest payments starting on November 1, 2008 and accrued property taxes due on or before November 28, 2008. The guarantors are currently in default under the settlement agreement, and we intend to proceed against them, however it cannot be determined at this time how much, if any, will be collected. As of December 31, 2008, based on our manager’s evaluation and pending sales agreement, our manager has provided a specific allowance of approximately $7.0 million, of which our portion is approximately $5.3 million. On January 16, 2009, we, VRM I, and Fund III foreclosed upon Redwood Place, LLC and classified the property as real estate held for sale. During February 2009, our manager received a sales agreement to purchase the property for approximately $8.7 million, of which our portion would be approximately $6.7 million. There can be no assurance that the sale will be completed. |
| | · | WCP Warm Springs Holdings 1, LLC is a loan to provide financing for 10 acres of vacant land located in Las Vegas, NV. The loan is secured by a first lien on the property, and is guaranteed by principals of the borrower. The outstanding balance on the loan is $8.5 million, of which our portion is approximately $5.1 million. As of December 31, 2008, this loan has been considered non-performing for the last seven months. On October 29, 2008, the borrower filed for bankruptcy protection. Our manager was successful in lifting the automatic stay, and has commenced both foreclosure proceedings and litigation to enforce the personal guarantees. As of December 31, 2008, based on our manager’s evaluation and an updated appraisal, our manager has provided a specific allowance of approximately $4.1 million, of which our portion is approximately $2.5 million. |
| | · | Babuski, LLC is a loan to provide financing for 9.23 acres of land in Las Vegas, NV. The loan is secured by a first lien on the property, and is guaranteed by principals of the borrower. The outstanding balance on the loan is $9.5 million, of which our portion is approximately $7.7 million. The borrowers defaulted and the loan became non-performing. On October 16, 2008, we, VRM I and Fund III entered into a forbearance agreement to postpone the foreclosure date on the property. The guarantor paid $250,000 for cost and interest due related to the loan. As of December 31, 2008, this loan has been considered non-performing for the last seven months. Our manager has commenced foreclosure proceedings, and is proceeding with legal action to enforce the personal guarantees. As of December 31, 2008, based on our manager’s evaluation and an updated appraisal, our manager has concluded that the current value of the underlying collateral should be sufficient to protect us from loss of principal. No specific allowance was deemed necessary as of December 31, 2008 |
| | · | Bright Haven Builders, LLC is a construction loan to provide financing for 10 single family residential lots (lots 74 and 169-177) located within Cherry Meadows Subdivision located in Yelm, WA. The loan is secured by a first lien on the property, and is guaranteed by principals of the borrower. The outstanding balance on the loan is approximately $2.2 million, of which our portion is approximately $1.8 million. As of December 31, 2008, this loan has been considered non-performing for the last seven months. Our manager has commenced foreclosure proceedings, and is proceeding with legal action to enforce the personal guarantees. As of December 31, 2008, based on our manager’s evaluation and an updated appraisal, our manager has provided a specific allowance of approximately $0.8 million, of which our portion is approximately $0.6 million. On March 6, 2009, we and, VRM I foreclosed upon Bright Haven Builders, LLC and classified the property as real estate held for sale. |
| | · | South Bay Villas, LLC is a construction loan to provide financing for a 48 unit condominium building which is part of the Desert Sands Condominiums Phase 2 located in Laughlin, NV. The loan is secured by a first lien on the property, and is guaranteed by principals of the borrower. The outstanding balance on the loan is $6.0 million, of which our portion is approximately $5.8 million. As of December 31, 2008, this loan has been considered non-performing for the last seven months. A settlement agreement has been negotiated with the borrower, wherein they will be responsible for the completion of the property at the borrower’s expense, with the lenders to receive 100% of the net sales proceeds from the sale of condominiums units until the loan has been repaid in full. As of December 31, 2008, based on our manager’s evaluation of completion costs for the project and an updated appraisal, our manager has provided a specific allowance of approximately $1.2 million, of which our portion is approximately $1.2 million. |
| | · | Preston Hollow Assisted Living, L.P. is a commercial loan to provide financing for the Preston Hollow Assisted Living Facility located in Dallas, TX. The loan is secured by a first lien on the property, and is guaranteed by principals of the borrower. The outstanding balance on the loan is $3.6 million. As of December 31, 2008, this loan has been considered non-performing for the last seven months. Our manager has commenced foreclosure proceedings, and is proceeding with legal action to enforce the personal guarantees. As of December 31, 2008, based on our manager’s evaluation and an updated appraisal, our manager has provided a specific allowance of approximately $2.5 million. On January 7, 2009, this loan was sold to an unaffiliated third party for approximately $1.1 million, which approximated our book value of the loan, net of allowances. |
| | · | Barger Road Cottages, LLC is a commercial loan to provide financing for the Alpine Meadow Retirement Community, consisting of 23 cottage units with garages, community building and surplus land, located in Eugene, OR. The loan is secured by a first lien on the property, and is guaranteed by principals of the borrower. The outstanding balance on the loan is $6.0 million, of which our portion is $46,000. As of December 31, 2008, this loan has been considered non-performing for the last seven months. Our manager has commenced foreclosure proceedings, and is proceeding with legal action to enforce the personal guarantees. On January 7, 2009, the main principal of the borrower filed for bankruptcy protection and has filed a motion to enjoin us from proceeding to foreclose. Our legal counsel is opposing the motion and is confident that we will prevail in our position. As of December 31, 2008, based on our manager’s evaluation and an updated appraisal, our manager has concluded that the current value of the underlying collateral should be sufficient to protect us from loss of principal. No specific allowance was deemed necessary as of December 31, 2008. |
| | · | Lohrey Investments, LLC is a commercial loan to provide financing for income producing property located in Gilroy, CA. The loan is secured by a first lien on the property, and is guaranteed by principals of the borrower. The outstanding balance on the loan is $16.0 million, of which our portion is $11.6 million. As of December 31, 2008, this loan has been considered non-performing for the last six months. Our manager has commenced foreclosure proceedings, and has been awarded a default judgment against the guarantors for approximately $21.3 million, although it cannot be determined at this time how much, if any, can be recovered from the guarantors. During October 2008, the tenant, who is a related party to the borrower, filed for bankruptcy protection and then on January 6, 2009 the borrower filed for bankruptcy protection. On February 11, 2009, the guarantors filed for bankruptcy protection. The property is not currently generating any income. As of December 31, 2008, based on our manager’s evaluation and an updated appraisal, our manager has provided a specific allowance of approximately $7.2 million, of which our portion is approximately $5.2 million. |
| | · | Cascadia Canyon, LLC is a commercial loan to provide financing for 12.39 acres of land plus the SUMCO North Campus, SUMCO South Campus located in Salem, OR. The loan is secured by a first lien on the property, and is guaranteed by principals of the borrower. The outstanding balance on the loan is approximately $19.5 million, of which our portion is approximately $16.0 million. As of December 31, 2008, this loan has been considered non-performing for the last five months. Our manager has commenced foreclosure proceedings, and is proceeding with legal action to enforce the personal guarantees. As of December 31, 2008, based on our manager’s evaluation, an updated appraisal and current sales price, our manager has provided a specific allowance totaling approximately $10.3 million, of which our portion is approximately $8.4 million. |
| | · | Trinity Theo, LLC is a land loan to provide bridge financing for a 1.86 acre single family development custom home lot located in Las Vegas, NV. The loan is secured by a first lien on the property, and is guaranteed by principals of the borrower. The outstanding balance on the loan is approximately $1.5 million. As of December 31, 2008, this loan has been considered non-performing for the last four months. Our manager has commenced foreclosure proceedings, and is proceeding with legal action to enforce the personal guarantees. As of December 31, 2008, based on our manager’s evaluation and an updated appraisal, our manager has concluded that the current value of the underlying collateral should be sufficient to protect us from loss of principal. No specific allowance was deemed necessary as of December 31, 2008. On February 11, 2009, this loan was sold to an unaffiliated third party for approximately $1.6 million, which included accrued interest of approximately $0.1 million, no gain or loss was recognized on this transaction. |
| | · | VBP Partners, LLC is a land loan to provide financing for approximately 4.14 acres of land located in Las Vegas, NV. The loan is secured by a first lien on the property and is guaranteed by the principals of the borrower. The outstanding balance on the loan is approximately $7.9 million, of which our portion is $7.2 million. As of December 31, 2008, this loan has been considered non-performing for the last three months. As of December 31, 2008, based on our manager’s evaluation and an updated appraisal, our manager has provided a specific allowance of approximately $3.7 million, of which our portion is approximately $3.4 million. In addition, we recognized an impairment loss of approximately $0.5 million, which was applied to the loan balance, related to the modification of the loan, whereby the interest rate was reduced from 11.5% to 8% starting in October 2008. Interest payments will be payable semi-annually at 3% beginning March 25, 2009, and accrued at 5% payable at the end of the loan. As of March 25, 2009, this loan was considered performing. Our manager will continue to evaluate our position in the loan. |
| | · | WHM Copper Mountain Investments, LLC is a land loan to provide financing for various parcels of land within Copper Mountain Ranch Master Planned Community totaling approximately 2,330 acres lying within sections 15, 16, 21, 28 & 33 of the Copper Mountain Ranch Master Planned Community located in Casa Grande, AZ. The loan is secured by a first lien on the property and is guaranteed by the principals of the borrower. The outstanding balance on the loan is $22.3 million, of which our portion is approximately $15.6 million. As of December 31, 2008, this loan has been considered non-performing for the last three months. On October 31, 2008, the borrower filed for bankruptcy protection. Our manager has commenced legal action to enforce the personal guarantees. As of December 31, 2008, based on our manager’s evaluation and an updated appraisal, our manager has provided a specific allowance of approximately $4.9 million, of which our portion is approximately $4.1 million. |
| | · | Meadowlark Assisted Living Community, LLC is a commercial loan to provide financing for a 74 bed Assisted Living/Memory Care residential facility, located on approximately 4.35 acres of land, located in the Yreka, CA. The loan is secured by a second lien on the property, with a preexisting first lien of approximately $3.5 million, and is guaranteed by the principals of the borrower. The outstanding balance on the second lien loan is approximately $3.8 million, of which our portion is approximately $2.2 million. As of December 31, 2008, this loan has been considered non-performing for the last three months. Our manager has commenced foreclosure proceedings, and is proceeding with legal action to enforce the personal guarantees. As of December 31, 2008, based on our manager’s evaluation and foreclosure of the first lien position, our manager has provided a specific allowance for the full amount of the loan totaling approximately $3.8 million, of which our portion is approximately $2.2 million. |
The following schedule summarizes the non-performing loans as of December 31, 2008:
| Loan Name | | Balance at December 31, 2008 | | Allowance for Loan Loss * | | Net Balance at December 31, 2008 | | Maturity Date | | Number of Months Non-Performing | | Percentage of Total Loan Balance |
| RightStar, Inc. (Part I & Part II) | $ | 17,291,000 | $ | (9,757,000) | $ | 7,534,000 | | 3/31/2004 | | 57 | | 45% of Part I 65% of Part II |
| Monterrey Associates, L.P. | | 2,155,000 | | (2,155,000) | | -- | | 9/1/2006 | | 28 | | 49% |
| 3900 LLC | | 3,276,000 | | (3,276,000) | | -- | | 6/10/2008 | | 8 | | 100% |
| World Capital La Piazza, LLC | | 13,000,000 | | (6,836,000) | | 6,164,000 | | 6/29/2008 | | 8 | | 100% |
| World Capital Durango Alpha (2) | | 4,846,000 | | (1,364,000) | | 3,482,000 | | 5/16/2008 | | 8 | | 68% |
| Peoria 180, LLC | | 14,806,000 | | (12,337,000) | | 2,469,000 | | 6/30/2008 | | 8 | | 82% |
| Redwood Place, LLC | | 11,350,000 | | (5,284,000) | | 6,066,000 | | 4/5/2008 | | 8 | | 76% |
| WCP Warm Springs Holdings 1, LLC | | 5,114,000 | | (2,457,000) | | 2,657,000 | | 5/10/2008 | | 7 | | 60% |
| Babuski, LLC | | 7,707,000 | | -- | | 7,707,000 | | 6/17/2008 | | 7 | | 81% |
| Bright Haven Builders, LLC | | 1,801,000 | | (628,000) | | 1,173,000 | | 3/28/2008 | | 7 | | 82% |
| South Bay Villas, LLC | | 5,800,000 | | (1,188,000) | | 4,612,000 | | 5/6/2008 | | 7 | | 97% |
| Preston Hollow Assisted Living, L.P. | | 3,600,000 | | (2,501,000) | | 1,099,000 | | 12/31/2008 | | 7 | | 100% |
| Barger Road Cottages, LLC | | 46,000 | | -- | | 46,000 | | 12/5/2008 | | 7 | | 1% |
| Lohrey Investments, LLC | | 11,600,000 | | (5,223,000) | | 6,377,000 | | 10/29/2008 | | 6 | | 73% |
| Cascadia Canyon, LLC | | 16,002,000 | | (8,434,000) | | 7,568,000 | | 2/12/2009 | | 5 | | 82% |
| Trinity Theo, LLC | | 1,477,000 | | -- | | 1,477,000 | | 1/28/2009 | | 4 | | 100% |
| VBP Partners, LLC | | 7,218,000 | | (3,430,000) | | 3,788,000 | | 9/26/2008 | | 3 | | 92% |
| WHM Copper Mountain Investments, LLC | | 15,555,000 | | (4,093,000) | | 11,462,000 | | 12/11/2009 | | 3 | | 83% |
| Meadowlark Assisted Living Community, LL | | 2,217,000 | | (2,217,000) | | -- | | 8/7/2009 | | 3 | | 59% |
| | $ | 144,861,000 | $ | (71,180,000) | $ | 73,681,000 | | | | | | |
| * | Please refer to Specific Reserve Allowances below. |
Our manager periodically reviews and makes a determination as to whether the allowance for loan losses is adequate to cover any potential losses. Management’s evaluation may include, but is not limited to, appraisals, real estate broker comps, the borrower’s current financial standing and other market conditions. 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, 2008, we have provided specific reserves, related to 17 non-performing loans and 7 performing loans, of approximately $78.2 million. Our manager evaluated the loans and, based on current estimates regarding the value of the remaining underlying collateral or the borrowers’ ability to pay, believes that such collateral is sufficient to protect us against further losses of principal. However, such estimates could change or the value of underlying real estate could decline. Our manager will continue to evaluate these loans in order to determine if any other allowance for loan losses should be recorded in future periods.
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 dividends payable to our stockholders.
| | Specific Reserve Allowances |
The following table is a roll-forward of the allowance for loan losses for the year ended December 31, 2008. Following the table is a discussion of the status of each identified loan and the reasons for the recording of additional reserves during the year ended December 31, 2008.
| Description | | Balance at December 31, 2007 | | | Specific Reserve Allocation | | | Sales & Transfers to REO | | | Balance at December 31, 2008 | |
| RightStar, Inc. (Part I & Part II) | | $ | 9,757,000 | | | $ | -- | | | $ | -- | | | $ | 9,757,000 | |
| Monterrey Associates, L.P. | | | 1,174,000 | | | | 981,000 | | | | -- | | | | 2,155,000 | |
| Brawley CA 122, LLC | | | 256,000 | | | | -- | | | | (256,000 | ) | | | -- | |
| Peoria 180, LLC | | | 1,309,000 | | | | 11,028,000 | | | | -- | | | | 12,337,000 | |
Terravita, LLC (a) | | | 377,000 | | | | -- | | | | -- | | | | 377,000 | |
| V & M Homes at the Palms, Inc. | | | -- | | | | 913,000 | | | | (913,000 | ) | | | -- | |
| Redwood Place, LLC | | | -- | | | | 5,284,000 | | | | -- | | | | 5,284,000 | |
| The Laurels at Mesquite Estates, LLC | | | -- | | | | 358,000 | | | | (358,000 | ) | | | -- | |
2503 Panorama, LLC (a) | | | -- | | | | 3,051,000 | | | | -- | | | | 3,051,000 | |
| 3900, LLC | | | -- | | | | 3,276,000 | | | | -- | | | | 3,276,000 | |
| MRPE, LLC | | | -- | | | | 2,086,000 | | | | (2,086,000 | ) | | | -- | |
| VBP, LLC | | | -- | | | | 3,430,000 | | | | -- | | | | 3,430,000 | |
| The Orleans at Mesquite Estates, LLC | | | -- | | | | 380,000 | | | | (380,000 | ) | | | -- | |
| Silver Star Destinations, LLC | | | -- | | | | 13,430,000 | | | | (13,430,000 | ) | | | -- | |
| WCP Warm Springs Holdings 1, LLC | | | -- | | | | 2,457,000 | | | | -- | | | | 2,457,000 | |
| Bright Haven Builders, LLC | | | -- | | | | 628,000 | | | | -- | | | | 628,000 | |
| Lohrey Investments, LLC | | | -- | | | | 5,223,000 | | | | -- | | | | 5,223,000 | |
| South Bay Villas, LLC | | | -- | | | | 1,188,000 | | | | -- | | | | 1,188,000 | |
| World Capital La Piazza, LLC | | | -- | | | | 6,836,000 | | | | -- | | | | 6,836,000 | |
| Meadowlark Assisted Living Community, LLC | | | -- | | | | 2,217,000 | | | | -- | | | | 2,217,000 | |
| WHM Copper Mountain Investments, LLC | | | -- | | | | 4,093,000 | | | | -- | | | | 4,093,000 | |
| Preston Hollow Assisted Living, L.P. | | | -- | | | | 2,501,000 | | | | -- | | | | 2,501,000 | |
| World Capital Durango Alpha (2) | | | -- | | | | 1,364,000 | | | | -- | | | | 1,364,000 | |
Wolfpack Properties, LLC (a) | | | -- | | | | 1,082,000 | | | | -- | | | | 1,082,000 | |
ExecuSuite Properties, LLC (a) | | | -- | | | | 528,000 | | | | -- | | | | 528,000 | |
SE Property Investments, LLC (a) | | | -- | | | | 407,000 | | | | -- | | | | 407,000 | |
Devonshire, LLC (a) | | | -- | | | | 1,493,000 | | | | -- | | | | 1,493,000 | |
| Building A, LLC & Building C, LLC | | | -- | | | | 90,000 | | | | -- | | | | 90,000 | |
| Cascadia Canyon, LLC | | | -- | | | | 8,434,000 | | | | -- | | | | 8,434,000 | |
| Total | | $ | 12,873,000 | | | $ | 82,758,000 | | | $ | (17,423,000 | ) | | $ | 78,208,000 | |
| | (a) | As of December 31, 2008, these loans were considered performing. |
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 | |
| Vestin Mortgage | | | -- | | | | 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 Amount (Part II) (including default rate interest); |
| | · | Third to pay past due interest on the Junior Principal Amount (Part I) (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. In March 2007, Vestin Mortgage purchased the junior principal amount owned by the unrelated third party for $500,000. Vestin Mortgage 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.
In early 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 State of Hawaii is pursuing approximately $30 million in recoveries from the former trustees, prior owners of the property and other parties. The proceeds from these recoveries, if any, will be used to fund the potential deficiency in the statutory trust. 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 and us alleging that these Vestin entities improperly influenced the former RightStar trustees to transfer trust funds to us.
On May 9, 2007, we, VRM I, Vestin Mortgage, the State of Hawaii and Comerica Incorporated announced that an arrangement had been reached to auction the RightStar assets. On June 12, 2007, the court approved the resolution agreement, which provides that the proceeds of the foreclosure sale will be allocated in part to VRM I, Vestin Mortgage and us and in part to fund the trust’s statutory minimum balances. We, VRM I, Vestin Mortgage, the State of Hawaii and Comerica have pledged to cooperate to recover additional amounts owed to the trusts and the creditors from others, while mutually releasing each other and RightStar from all claims. We, VRM I, Vestin Mortgage and the State of Hawaii have received offers and are currently requesting, entertaining, and reviewing bids on the RightStar properties. The outcome of this auction cannot be determined at this time.
During December 2007, we, VRM I, and the statutory trust fund received a settlement totaling $2.8 million, of which approximately $2.0 million was applied against outstanding trust obligations. Approximately $0.8 million, of which our portion totaling approximately $0.5 million, was applied towards the allowance for doubtful accounts on this loan and was recorded as a reimbursement of legal fees totaling approximately $0.4 million.
In June 2008, the State of Hawaii allowed us and the other lenders to put in place a new management team that replaced the previous receiver.
We have evaluated the estimated value of the underlying collateral and the expected cost and length of litigation. Based on this estimate we have maintained our total specific reserve allowance for loss. The reserve allowance includes approximately $1.0 million for estimated litigation fees and expenses that we have incurred in enforcing our rights against the underlying collateral, which were fully consumed as of December 31, 2007. We will continue to evaluate our position in the RightStar loan as the situation progresses. As of December 31, 2008, our specific reserve allowance on the RightStar loans totaled approximately $9.8 million.
Monterrey Associates, L.P. – As of December 31, 2008, our manager has provided a specific reserve allowance for the outstanding balance of the loan, related to a non-performing commercial loan on a 248-unit apartment complex in Oklahoma City, OK, of approximately $4.4 million, of which our portion was approximately $2.2 million. This specific reserve allowance was based on our manager’s evaluation and an updated appraisal of the underlying collateral for this loan, obtained by our manager during January 2008, and our manager’s evaluation. Our manager will continue to evaluate our position in the loan.
Peoria 180, LLC – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a land loan on property located in Glendale, AZ, of approximately $15.0 million, of which our portion was approximately $12.3 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan obtained by our manager during February 2009. As of December 31, 2008, the loan was considered non-performing. On March 23, 2008, we, VRM I and Fund III, sold the Peoria 180, LLC loan to an unrelated third party for $3.0 million. The sale resulted in no gain or loss.
Terravita, LLC – During the year ended December 31, 2007, our manager provided a specific reserve allowance, related to a commercial loan on a 100 unit condominium/apartment project in North Las Vegas, NV, totaling approximately $0.7 million, of which our portion was approximately $0.4 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan and evaluation of the borrower, obtained by our manager during January 2008. During February 2008, the loans on the Terravita LLC property, with first and second positions were rewritten into one loan, which included a principal pay down of $6.6 million, with a second position totaling approximately $3.1 million of which our portion is approximately $1.7 million. The terms of the rewritten loan remain the same as those of the original loans and the loan was performing as required as of December 31, 2008. Our manager will continue to evaluate our position in the loan.
Redwood Place, LLC – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a non-performing loan for the acquisition and conversion to condominiums of a 186-unit apartment complex located in Phoenix, Arizona, of approximately $7.0 million, of which our portion was approximately $5.3 million. This specific reserve allowance was based on our manager’s evaluation and pending sales agreement, obtained by our manager during February 2009. On January 16, 2009, we, VRM I, and Fund III foreclosed upon Redwood Place, LLC and classified the property as real estate held for sale. During February 2009, our manager received a sales agreement to purchase the property for approximately $8.7 million, of which our portion would be approximately $6.7 million. There can be no assurance that the sale will be completed.
2503 Panorama, LLC – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a performing loan for a 5,700 square foot penthouse located on the 25th floor of Panorama Towers I in Las Vegas, NV, of approximately $4.0 million, of which our portion is approximately $3.1 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan, obtained by our manager during February 2009. In addition, we recognized an impairment loss of approximately $0.6 million, which was applied to the loan balance, related to the restructuring of the loan, whereby the interest rate was reduced from 12% to 6% starting in May 2008. Our manager will continue to evaluate our position in the loan.
3900, LLC – As of December 31, 2008, our manager has provided a specific reserve allowance for the outstanding balance of the loan, related to a non-performing loan on 7.66 acre neighborhood retail center, located in Tempe, AZ, of approximately $3.3 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan, obtained by our manager during July 2008. Our manager will continue to evaluate our position in the loan.
VBP Partners, LLC – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a non-performing loan for the development of 4.14 acres of land located in Las Vegas, NV, of approximately $3.7 million, of which our portion is approximately $3.4 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan, obtained by our manager during January 2009. Our manager will continue to evaluate our position in the loan. In addition, we recognized an impairment loss of approximately $0.5 million, which was applied to the loan balance, related to the modification of the loan, whereby the interest rate was reduced from 11.5% to 8% starting in October 2008. Interest payments will be payable semi-annually at 3% beginning Mach 25, 2009, and accrued at 5% payable at the end of the loan. As of March 25, 2009, this loan was considered performing. Our manager will continue to evaluate our position in the loan.
WCP Warm Springs Holdings 1, LLC – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a non-performing loan on 10 acres of vacant land located in Las Vegas, NV, of approximately $4.1 million, of which our portion is approximately $2.5 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan, obtained by our manager during September 2008. Our manager will continue to evaluate our position in the loan.
Bright Haven Builders, LLC – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a non-performing loan on 10 single family residential lots (lots 74 and 169-177) located within Cherry Meadows Subdivision located in Yelm, WA, of approximately $0.8 million, of which our portion is approximately $0.6 million. This specific reserve allowance was based on our manager’s evaluation of the underlying collateral for this loan during January 2009. On March 6, 2009, we and, VRM I foreclosed upon Bright Haven Builders, LLC and classified the property as real estate held for sale.
Lohrey Investments, LLC – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a non-performing loan on income producing property located in Gilroy, CA, of approximately $7.2 million, of which our portion is approximately $5.2 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan, obtained by our manager during October 2008. Our manager will continue to evaluate our position in the loan.
South Bay Villas, LLC – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a non-performing loan on a 48 unit condominium building part of the Desert Sands Condominiums Phase 2 located in Laughlin, NV, of approximately $1.2 million, of which our portion is approximately $1.2 million. This specific reserve allowance was based on completion costs of the property evaluated by our manager during October 2008 and updated appraisal. Our manager will continue to evaluate our position in the loan.
World Capital La Piazza, LLC – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a non-performing loan on approximately 8.44 net acres of land located in Henderson, NV, of approximately $6.8 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan, obtained by our manager during December 2008. Our manager will continue to evaluate our position in the loan.
Meadowlark Assisted Living Community, LLC – As of December 31, 2008, our manager has provided a specific reserve allowance for the outstanding balance of the loan, which is a second lien position on a 74 bed Assisted Living/Memory Care residential facility, located on approximately 4.35 acres of land in the Yreka, CA, of approximately $3.8 million, of which our portion is approximately $2.2 million. This specific reserve allowance was based on our manager’s evaluation, which included the foreclosure of the property by the first lien holder. Our manager will continue to evaluate our position in the loan.
WHM Copper Mountain Investments, LLC – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a non-performing loan on approximately 2,330 acres lying within sections 15, 16, 21, 28 & 33 of the Copper Mountain Ranch Master Planned Community located in Casa Grande, AZ, of approximately $4.9 million, of which our portion is approximately $4.1 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan, obtained by our manager during January 2009. Our manager will continue to evaluate our position in the loan.
Preston Hollow Assisted Living, L.P. – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a non-performing loan on the Preston Hollow Assisted Living Facility located in Dallas, TX, of approximately $2.5 million. This specific reserve allowance was based on our manager’s evaluation and current purchase agreement. On January 7, 2009, this loan was sold to an unaffiliated third party for approximately $1.1 million, which approximated our book value of the loan, net of allowances.
World Capital Durango Alpha, – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a non-performing loan on 9.27 acres of land located in Las Vegas, NV, of approximately $2.0 million, of which our portion is approximately $1.4 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan, obtained by our manager during January 2009. Our manager will continue to evaluate our position in the loan.
Casciadia Canyon, LLC, – As of December 31, 2008, our manager has provided a specific reserve allowance, related to an non-performing loan on 12.39 acres of land plus the SUMCO North Campus, SUMCO South Campus located in Salem, OR, of approximately $10.3 million, of which our portion is approximately $8.4 million. This specific reserve allowance was based on the current sales price of the underlying collateral for this loan. Our manager will continue to evaluate our position in the loan.
Wolfpack Properties, LLC, – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a performing loan on a 22,000 SqFt Class A Office Building "B" of Village Business Park located on 1.48 acres of land located in Las Vegas, NV, of approximately $1.2 million, of which our portion is approximately $1.1 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan, obtained by our manager during January 2009. Our manager will continue to evaluate our position in the loan.
ExecuSuite Properties, LLC, – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a performing loan on 22,000 SqFt Class A Office Building "D" of Village Business Park located on 1.48 acres of land located in Las Vegas, NV, of approximately $0.6 million, of which our portion is approximately $0.5 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan, obtained by our manager during January 2009. Our manager will continue to evaluate our position in the loan.
SE Property Investments, LLC, – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a performing loan on 22,000 SqFt Class A Office Building "E" of Village Business Park located on 1.48 acres of land located in Las Vegas, NV, of approximately $0.4 million, of which our portion is approximately $0.4 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan, obtained by our manager during January 2009. Our manager will continue to evaluate our position in the loan.
Devonshire, LLC, – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a performing loan on 22,000 SqFt Class A Office Building "F" of Village Business Park located on 1.48 acres of land located in Las Vegas, NV, of approximately $1.6 million, of which our portion is approximately $1.5 million. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan, obtained by our manager during January 2009. Our manager will continue to evaluate our position in the loan.
Building A, LLC & Building C, LLC, – As of December 31, 2008, our manager has provided a specific reserve allowance, related to a second lien position performing loan on 3.18 acres of land lying within the Village Business Park and a 45,622 SqFt Office Building "C" of Village Business Park located on 1.48 acres of land located in Las Vegas, NV, of $106,000, of which our portion is $90,000. This specific reserve allowance was based on an updated appraisal of the underlying collateral for this loan, obtained by our manager during January 2009. Our manager will continue to evaluate our position in the loan.
As of December 31, 2008, our manager had granted extensions on 18 loans, totaling approximately $157.1 million, of which our portion was approximately $114.0 million, 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 generally grants extensions when a borrower is in compliance with the material terms of the loan, including, but not limited to the borrower’s obligation to make interest payments on the loan. In addition, if circumstances warrant, our manager may extend a loan that is in default as part of a work out plan to collect interest and principal. Subsequent to their extension, 9 of the 18 loans have become non-performing. The loans, which became non-performing after their extension, had a total principal amount at December 31, 2008, of approximately $104.0 million, of which our portion is approximately $79.4 million. Subsequent to December 31, 2008, we modified six loans with a common guarantor, one of which was non-performing. As part of the modifications, these loans were extended. For further information regarding these loans, see Common Guarantors in Note C – Financial Instruments and Concentrations of Credit Risk.
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, our 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. The following is a breakdown of allowance for loan losses related to performing and non-performing loans as of December 31, 2008 and December 31, 2007:
| | | As of December 31, 2008 | |
| | | Balance | | | Allowance for loan losses * | | | Balance, net of allowance | |
| | | | | | | | | | |
| Non-performing loans – no related allowance | | $ | 9,230,000 | | | $ | -- | | | $ | 9,230,000 | |
| Non-performing loans – related allowance | | | 135,631,000 | | | | (71,180,000 | ) | | | 64,451,000 | |
| Subtotal nonperforming loans | | | 144,861,000 | | | | (71,180,000 | ) | | | 73,681,000 | |
| | | | | | | | | | | | | |
| Performing loans – no related allowance | | | 57,666,000 | | | | -- | | | | 57,666,000 | |
| Performing loans – related allowance | | | 22,515,000 | | | | (7,028,000 | ) | | | 15,487,000 | |
| Subtotal performing loans | | | 80,181,000 | | | | (7,028,000 | ) | | | 73,153,000 | |
| | | | | | | | | | | | | |
| Total | | $ | 225,042,000 | | | $ | (78,208,000 | ) | | $ | 146,834,000 | |
| * | Please refer to Specific Reserve Allowances above. |
| | | As of December 31, 2007 | |
| | | Balance | | | Allowance for loan losses | | | Balance, net of allowance | |
| | | | | | | | | | |
| Non-performing loans – no related allowance | | $ | 10,364,000 | | | $ | -- | | | $ | 10,364,000 | |
| Non-performing loans – related allowance | | | 20,201,000 | | | | (11,187,000 | ) | | | 9,014,000 | |
| Subtotal nonperforming loans | | | 30,565,000 | | | | (11,187,000 | ) | | | 19,378,000 | |
| | | | | | | | | | | | | |
| Performing loans – no related allowance | | | 240,603,000 | | | | -- | | | | 240,603,000 | |
| Performing loans – related allowance | | | 19,895,000 | | | | (1,686,000 | ) | | | 18,209,000 | |
| Subtotal performing loans | | | 260,498,000 | | | | (1,686,000 | ) | | | 258,812,000 | |
| | | | | | | | | | | | | |
| Total | | $ | 291,063,000 | | | $ | (12,873,000 | ) | | $ | 278,190,000 | |
Our manager evaluated our loans and, based on current estimates with respect to the value of the underlying collateral, believes that such collateral is sufficient to protect us against further losses of principal or interest. However, such estimates could change or the value of the underlying real estate could decline. Our manager will continue to evaluate our loans in order to determine if any other allowance for loan losses should be recorded.
NOTE E — INVESTMENT IN MARKETABLE SECURITIES – RELATED PARTY
As of December 31, 2008, we owned 533,675 shares of VRM I’s common stock, representing approximately 8.05% of their total outstanding common stock.
During the year ended December 31, 2008, in accordance with FAS 115 and FSP FAS 115-1 and FAS 124-1, we evaluated our investment in VRM I’s common stock and determined there was an other-than-temporary impairment as of September 30, 2008. Based on this evaluation we have reversed our unrealized other comprehensive losses and realized losses on our investment to its fair value, as of September 30, 2008, to $2.25 per share totaling approximately $1.2 million dollars and recognizing an impairment of approximately $2.2 million.
As of December 31, 2008, our manager evaluated the near-term prospects of VRM I in relation to the severity and duration of the unrealized loss since September 30, 2008. Based on that evaluation and our ability and intent to hold this investment for a reasonable period of time sufficient for a forecasted recovery of fair value, we do not consider our investment in VRM I to be other-than-temporarily impaired at December 31, 2008. We will continue to evaluate our investment in marketable securities on a quarterly basis. There were no other-than-temporary impairments made during the year ended December 31, 2007.
NOTE F — REAL ESTATE HELD FOR SALE
At December 31, 2008, we held 11 properties with a total carrying value of approximately $24.4 million, which were acquired through foreclosure and recorded as investments in real estate held for sale. None of these properties generated income from rentals or other sources during the year ended December 31, 2008. Expenses incurred during the year ended December 31, 2008, related to our real estate held for sale totaled approximately $48.9 million. These expenses included approximately $47.2 million in write downs on real estate held for sale. The summary below includes our percentage of ownership in each of the properties. 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. Set forth below is a roll-forward of investments in real estate held for sale during the year ended December 31, 2008, followed by a discussion of the basis for recording additional write-downs during the year ended December 31, 2008:
| Description | Date Acquired | | Percentage of Ownership | | | Balance at December 31, 2007 | | | Acquisitions | | | Write Downs | | | Cash Reductions | | | Net Cash Proceeds on Sales | | | Gain (Loss) on Sale of Real Estate | | | Balance at December 31, 2008 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Marshall's Vista, LTD (1) | 8/3/2004 | | | 100% | | | $ | 4,438,000 | | | $ | -- | | | $ | (1,128,000 | ) | | $ | (550,000 | ) | | $ | -- | | | $ | -- | | | $ | 2,760,000 | |
Rio Vista Nevada, LLC (2) | 12/21/2006 | | | 86% | | | | 24,125,000 | | | | -- | | | | (22,180,000 | ) | | | -- | | | | -- | | | | -- | | | | 1,945,000 | |
Pirates Lake, LTD (3) | 2/5/2008 | | | 48% | | | | -- | | | | 4,100,000 | | | | (3,127,000 | ) | | | (86,000 | ) | | | -- | | | | -- | | | | 887,000 | |
Forest Development, LLC (4) | 3/7/2008 | | | 64% | | | | -- | | | | 1,681,000 | | | | (497,000 | ) | | | -- | | | | (925,000 | ) | | | (259,000 | ) | | | -- | |
Brawley CA 122, LLC (5) | 5/1/2008 | | | 33% | | | | -- | | | | 499,000 | | | | (191,000 | ) | | | -- | | | | -- | | | | -- | | | | 308,000 | |
V & M Homes at the Palms, Inc. (6) | 7/15/2008 | | | 39% | | | | -- | | | | 597,000 | | | | (142,000 | ) | | | -- | | | | -- | | | | -- | | | | 455,000 | |
The Orleans at Mesquite Estates, LLC (7) | 8/8/2008 | | | 100% | | | | -- | | | | 1,946,000 | | | | (1,118,000 | ) | | | -- | | | | -- | | | | -- | | | | 828,000 | |
MRPE, LLC (8) | 8/11/2008 | | | 72% | | | | -- | | | | 10,100,000 | | | | (5,483,000 | ) | | | -- | | | | -- | | | | -- | | | | 4,617,000 | |
The Laurels at Mesquite Estates, LLC (9) | 8/11/2008 | | | 100% | | | | -- | | | | 2,432,000 | | | | (1,512,000 | ) | | | -- | | | | -- | | | | -- | | | | 920,000 | |
Jeffrey's Court, LLC (10) | 9/3/2008 | | | 61% | | | | -- | | | | 3,073,000 | | | | (844,000 | ) | | | -- | | | | -- | | | | -- | | | | 2,229,000 | |
Cliff Shadows Properties, LLC (11) | 9/8/2008 | | | 95% | | | | -- | | | | 16,118,000 | | | | (8,014,000 | ) | | | -- | | | | -- | | | | -- | | | | 8,104,000 | |
The Sycamore Glenn at Mesquite Estates, LLC (12) | 9/8/2008 | | | 100% | | | | -- | | | | 4,369,000 | | | | (2,989,000 | ) | | | -- | | | | -- | | | | -- | | | | 1,380,000 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Total | | | | | | | $ | 28,563,000 | | | $ | 44,915,000 | | | $ | (47,225,000 | ) | | $ | (636,000 | ) | | $ | (925,000 | ) | | $ | (259,000 | ) | | $ | 24,433,000 | |
| (1) | Marshall's Vista, LTD – During the year ended December 31, 2007, we entered into a sales contract for the sale of a partially completed golf course near Austin, Texas at a price that would not result in a material gain or loss. The sales contract required that the buyer complete the purchase on or before June 29, 2007; however, the buyer chose to extend the closing date multiple times by paying a non-refundable extension fee that was applied to the property value recorded on our books. The first extension was in June 2007, at which time we received a $100,000 non-refundable extension fee from the buyer to extend the closing date to October 2007. Since then the buyer had elected to extend the closing date to December 2008, by paying a non-refundable extension fee of $50,000 every 30 days until closing. As of December 31, 2008, we had received a total of $800,000 in extension fees. In January 2009, the potential buyer informed us that they were not in a position to close and that they could no longer continue to make extension payments. Subsequently, the sale has cancelled. Our manager has evaluated the carrying value of the property and based on the current sales price, the property was written down approximately $1.1 million. The property is currently listed for sale at approximately $3.0 million, which approximates the total book value, plus selling costs, for this property. |
| (2) | Rio Vista Nevada, LLC – During December 2006, we, VRM I and Fund III acquired through foreclosure proceedings 480 residential building lots and two single family dwellings in Rio Vista Village Subdivision in Cathedral City, CA. During the year ended December 31, 2008, our manager evaluated the carrying value of real estate acquired through foreclosure located in Cathedral City, California. Based on our manager’s evaluation and an updated appraisal obtained during February 2009, the property was written down approximately $25.9 million, of which our portion was approximately $22.2 million, during the year ended December 31, 2008. |
| (3) | Pirates Lake, LTD – During February 2008, we, VRM I and Fund III acquired through foreclosure proceedings approximately 46.75 acres of land in Galveston, TX. Our manager has evaluated the carrying value of the property and based on an updated appraisal obtained in October 2008 and the current sales price, the property was written down approximately $6.5 million, of which our portion was approximately $3.1 million. During June 2008, we received a deposit refund totaling $86,000. The property is currently listed for sale at $1.8 million, which approximates the total book value, plus selling costs, for this property held by us, VRM I and Fund III. |
| (4) | Forest Development, LLC – During March 2008, we, VRM I and Fund III acquired through foreclosure proceedings two 4,000 square foot single family residences, together with the four remaining lots in a subdivision, located on Mt. Charleston, NV. Our manager has evaluated the carrying value of the property and based on that evaluation the property was written down approximately $0.8 million, of which our portion was approximately $0.5 million. During September 2008, we, VRM I and Fund III sold this property for approximately $1.4 million, of which our portion was approximately $0.9 million. The sale resulted in a net loss of approximately $0.4 million, of which our portion was approximately $0.3 million. |
| (5) | Brawley CA 122, LLC – During May 2008, we, VRM I, and Fund III acquired through foreclosure proceedings a 25 acre proposed 122 single-family subdivision to be known as River Drive Subdivision in Brawley, CA. Our manager has evaluated the carrying value of the property and based on an updated appraisal obtained in December 2008, the property was written down approximately $0.6 million, of which our portion was approximately $0.2 million, during the year ended December 31, 2008. The property is currently listed for sale. |
| (6) | V & M Homes at the Palms, Inc. – During July 2008, we, VRM I, and Fund III acquired through foreclosure proceedings an 80 acre parcel of land in Florence, AZ. Our manager has evaluated the carrying value of the property and based on an updated appraisal obtained in February 2009, the property was written down approximately $0.4 million, of which our portion was approximately $0.1 million, during the year ended December 31, 2008. The property is currently listed for sale. |
| (7) | The Orleans at Mesquite Estates, LLC – During August 2008, we acquired through foreclosure proceedings 21.7 gross acres of Mesquite Estates Planned Unit Development with 65 "paper" lots, located in Mesquite, NV. Our manager has evaluated the carrying value of the property and based on its estimate, updated appraisal obtained in January 2009, and current sales price, the property was written down approximately $1.1 million, during the year ended December 31, 2008. The property is currently listed for sale at approximately $0.9 million, which approximates the total book value, plus selling costs, for this property. |
| (8) | MRPE, LLC – During August 2008, we, VRM I, and Fund III acquired through foreclosure proceedings 132.03 acres of land within the Wolf Creek Estates Master Planned Community, located in Mesquite, NV. Our manager has evaluated the carrying value of the property and based on its analysis, updated appraisal obtained in January 2009, and current sales price, the property was written down approximately $7.6 million, of which our portion was approximately $5.5 million, during the year ended December 31, 2008. The property is currently listed for sale at approximately $7.0 million, which approximates the total book value, plus selling costs, for this property held by us, VRM I and Fund III. |
| (9) | The Laurels at Mesquite Estates, LLC – During August 2008, we acquired through foreclosure proceedings 26.5 gross acres of Mesquite Estates Planned Unit Development with 60 "paper" lots, located in Mesquite, NV. Our manager has evaluated the carrying value of the property and based on its estimate, updated appraisal obtained in August 2008, and current sales price, the property was written down approximately $1.5 million, during the year ended December 31, 2008. The property is currently listed for sale at approximately $1.0 million, which approximates the total book value, plus selling costs, for this property. |
| (10) | Jeffrey's Court, LLC – During September 2008, we, VRM I, and Fund III acquired through foreclosure proceedings 4.92 acres of land to be developed into 119 condominium units in Las Vegas, NV. Our manager has evaluated the carrying value of the property and based on its analysis, updated appraisal obtained in January 2009, and current sales price, the property was written down approximately $1.4 million, of which our portion is approximately $0.8 million, during the year ended December 31, 2008. The property is currently listed for sale. |
| (11) | Cliff Shadows Properties, LLC – During September 2008, we, VRM I, and Fund III acquired through foreclosure proceedings a 106 Unit Townhouse Project known as Cliff Shadows Townhomes located in Las Vegas, NV. Our manager has evaluated the carrying value of the property and based on an updated appraisal obtained in September 2008 and the current purchase agreement, the property was written down approximately $8.4 million, of which our portion was approximately $8.0 million, during the year ended December 31, 2008. During January 2009, our manager received a sales agreement to purchase the property for approximately $9.6 million, of which our portion would be approximately $9.1 million. On March 6, 2009, we, VRM I, and Fund III completed the sale of 98 units, with the remaining units pending final escrow. |
| (12) | The Sycamore Glenn at Mesquite Estates, LLC – During September 2008, we acquired through foreclosure proceedings 32.3 gross acres of Mesquite Estates Planned Unit Development with 180 "paper" lots, located in Mesquite, NV. Our manager has evaluated the carrying value of the property and based on its estimate, the property was written down approximately $3.0 million, during the year ended December 31, 2008. The property is currently listed for sale at approximately $1.5 million, which approximates the total book value, plus selling costs, for this property. |
NOTE G — 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, such acquisitions and sales are made without any mark up or mark down. 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 years ended December 31, 2008, 2007 and the twelve months ended December 31, 2006, were $1.1 million, $1.1 million and $1.1 million, respectively. We paid our manager approximately $0.6 million for unpaid fees owed to our manager from our borrowers. These unpaid fees became due and payable on demand from us.
As of December 31, 2008, our manager owned 92,699 of our common shares. For the years ended December 31, 2008, 2007 and the nine months ended December 31, 2006, we declared $45,000, $139,000, and $92,000, respectively, in dividends payable to our manager based on the number of shares our manager held on the dividend record dates. During the three months ended March 31, 2006, we recorded pro-rata distributions owed to our manager of $16,000.
During September 2008, we, VRM I and Fund III sold the Forest Development, LLC property to an unrelated third party. As part of the sale, we, VRM I and Fund III paid our manager a commission of $46,000, shared pro-rata between us, VRM I and Fund III.
As of December 31, 2008, we owed our manager $623,000. As of December 31, 2007, we had receivables from our manager of $1,000.
Transactions with Other Related Parties
As of December 31, 2008, we owned 533,675 common shares of VRM I, representing approximately 8.05% of their total outstanding common stock. For the years ended December 31, 2008, 2007 and the twelve months ended December 31, 2006, we recognized $86,000, $308,000 and $72,000, respectively, in dividend income from VRM I based on the number of shares we held on the dividend record dates.
As of December 31, 2008, VRM I owned 225,134 of our common shares, representing approximately 1.63% of our total outstanding common stock. For the years ended December 31, 2008, 2007 and the twelve months ended December 31, 2006, we declared $110,000, $294,000 and $154,000, respectively, in dividends payable to VRM I based on the number of shares VRM I held on the dividend record dates.
During the year ended December 31, 2008, we sold approximately $0.5 million in real estate loans to VRM I and purchased $1.8 million in real estate loans from VRM I. During the year ended December 31, 2007 we sold approximately $4.4 million in real estate loans to VRM I. During the twelve months ended December 31, 2006 we bought approximately $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, 2008, we had receivables from VRM I of $92,000. As of December 31, 2007, we owed VRM I $123,000.
As of December 31, 2008, Fund III owned 114,117 of our common shares, representing approximately 0.83% of our total outstanding common stock. For the years ended December 31, 2008, 2007 and the twelve months ended December 31, 2006, we declared $56,000, $143,000 and $47,000, respectively, in dividends payable to Fund III based on the number of shares Fund III held on the dividend record dates.
During the year ended December 31, 2007, we purchased $1.3 million in real estate loans from Fund III. During the year ended December 31, 2007, we purchased $1.3 million in real estate loans from Fund III and sold approximately $1.2 million in real estate loans to Fund III. During the twelve months ended December 31, 2006, we purchased $4.9 million in real estate loans from Fund III and sold $6.0 million in real estate loans to Fund III. No gain or loss resulted from this transaction.
As of December 31, 2008, we had receivables from Fund III of $9,000. As of December 31, 2007, and 2006, we did not have a balance due to or due from Fund III.
During the year ended December 31, 2007, we purchased $0.7 million in real estate loans from inVestin. No gain or loss resulted from this transaction. No similar transactions occurred during the year ended December 31, 2008 and the twelve months ended December 31, 2006.
During January 2006, Michael V. Shustek, our CEO, purchased a $2.0 million deed of trust investment from us, of which, the total balance of $2.0 million was repurchased by us. No gain or loss resulted from these transactions. No similar transactions occurred during the years ended December 31, 2008 and 2007.
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. No similar transactions occurred during the years ended December 31, 2008 and 2007.
During the years ended December 31, 2008, 2007 and the twelve months ended December 31, 2006, we incurred $236,000, $138,000 and $88,000, respectively, 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.
On March 23, 2009, our board of directors authorized us to enter into a consulting agreement with the previous COO of the Manager to assist us in the repurchase of the Junior Subordinated Notes. The consulting fee paid will be up to three and half percent of the discounted amount of the repurchase
NOTE H — 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 real estate held for sale – seller financed. 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. As of December 31, 2008, we have received $104,000 in principal payments. Payments will be recognized as income when received. The balance of $336,000 was fully reserved as of December 31, 2008.
During March 2005, we and VRM I sold the 126 unit hotel in Mesquite, Nevada for approximately $5.5 million of which our share of the proceeds were approximately $3.8 million, which resulted in a loss of approximately $0.8 million. In addition, during June 2005, we and VRM I entered into a settlement agreement with the guarantors of the loan in the amount of $2.0 million in exchange for a release of their personal guarantees, of which our share was approximately $1.4 million. The balance is secured by a second deed of trust, with a first installment of $100,000 due in July 2005 and monthly interest only payments of 5% on $1.1 million from July 2005 through July 2008, at which time the entire balance is due. As of December 31, 2008, we have received $616,000 in principal payments. Payments will be recognized as income when received. The balance of $745,000 was fully reserved as of December 31, 2008.
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 approximately $6.0 million. 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. From June 25, 2005 through May 25, 2006, monthly payments increased to $15,000 and were applied to principal and accrued interest. From June 25, 2006 through May 25, 2009, payments increase to $20,000 monthly. As of December 31, 2007, we received $234,000 in principal payments and the balance of $184,000 was fully reserved. Due to the uncertainty of collectability, the balance for the entire remaining balance of the promissory note was fully reserved.
On August 7, 2007, we and VRM I filed a complaint against the guarantor in the U.S. District Court for District of Nevada, seeking to recover the amounts due pursuant to the promissory note. The guarantor did not answer or otherwise respond to the lawsuit. We and VRM I were granted a default judgment for all the amounts due. However, due to the current financial position of the guarantor, our Manager has determined that we would not be able to recover any amounts due from the guarantor. As of March 31, 2008, the note was fully written off.
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 from this transaction, of which our portion was $47,000. The purchaser defaulted on the note and our manager pursued litigation. During June 2007, we and VRM I entered into a settlement agreement, which reduced the note to $175,000, of which our portion is $115,000. On July 16, 2007, we and VRM I received a payment totaling $50,000, of which our portion was $33,000. On July 1, 2008, we and VRM I received a $113,000 payment, of which our portion was $74,000. The payment represented full settlement of the note and the remaining balance of $8,000 was written off.
During 2006, we and VRM I entered into a settlement agreement in the amount of $1.5 million with the guarantors of a loan collateralized by a 126 unit (207 bed) assisted living facility in Phoenix, AZ, which we had foreclosed on. Our portion was approximately $1.3 million. The promissory note is payable in seven annual installments of $100,000 with an accruing interest rate of 7%, with the remaining note balance due in April 2013. As of December 31, 2008, we had received $2,000 in principal payments. Payments will be recognized as income when received. The balance of approximately $1.3 million was fully reserved as of December 31, 2008.
NOTE I — JUNIOR SUBORDINATED NOTES
On June 22, 2007, we completed the issuance of $60.1 million in unsecured trust preferred securities through the special purpose business trust, VCT I to Merrill Lynch International, Bear Stearns & Co. Inc. and Taberna Funding LLC. These securities have a fixed interest rate equal to 8.75% through July 2012, and thereafter are subject to a variable rate equal to LIBOR plus 3.5% per annum, resetting quarterly. The securities mature on July 30, 2020 and may be called at par by us any time after July 30, 2012. We incurred approximately $2.3 million in financing costs relating to the notes. These costs are being amortized to interest expense over the term of the notes. We are obligated to pay the trust preferred securities with respect to distributions and amounts payable upon liquidation, redemption or repayment.
VCT I issued $100,000 of common securities, representing 100% of the voting common stock of VCT I to us. VCT I used the proceeds from the sale of the trust preferred securities and the common securities to purchase our junior subordinated notes. The terms of the junior subordinated notes matches the terms of the trust preferred securities. The notes are subordinated and junior in right of payment to all present and future senior indebtedness and certain other of our financial obligations.
The junior subordinated notes require quarterly interest distributions beginning July 31, 2007. For the years ended December 31, 2008 and 2007, interest expense on the junior subordinated notes totaled approximately $5.0 million and $2.7 million, respectively. As of December 31, 2008, the balance outstanding was approximately $56.4 million.
Our interest in VCT I is accounted for using the equity method and the assets and liabilities of VCT I are not consolidated into our financial statements, in accordance with FIN 46R. Interest on the junior subordinated notes is included in interest expense on our consolidated income statement while the junior subordinated notes are presented as a separate item on our consolidated balance sheet.
On November 7, 2008, we entered into an agreement with Taberna Capital Management, LLC (“Taberna”), in its capacity as collateral manager for certain collateral debt obligation vehicles that are the holders of the junior subordinated notes, providing for an amendment of the tangible net worth covenant (the “First Supplemental Indenture”). On December 31, 2008, we were not in compliance with the revised tangible net worth covenant and the debt to tangible net worth covenant in the First Supplemental Indenture.
The First Supplemental Indenture provides as follows (defined terms refer to the definitions in the indenture):
| | · | The tangible net worth covenant was changed from not less than $225 million to not less than the lesser of $150 million or 2.5 times the then outstanding principal balance of the junior subordinated notes. |
| | · | The EBITDA covenant was changed from 2.5 times Interest Expense to 1.5 times Interest Expense, provided that, for one quarter only, the requirement will be 1.2 times Interest Expense for the four quarter period ending June 30, 2009. |
| | · | The restriction on the Company redeeming notes at par prior to July 30, 2012 were removed and no pre-payment penalty will be applied to such redemptions. |
| | · | We were required to post a $3,750,000 letter of credit by November 12, 2008 and a $1,250,000 letter of credit by April 12, 2009. Taberna is entitled to draw upon such letters of credit to pay principal and interest on the junior subordinated notes if an Event of Default has occurred. The letters of credit may not be subordinated to any of our Senior Debt. During November 2008, we posted the entire $5,000,000 letter of credit. |
| | · | The notice and cure provisions in the indenture were changed from 30 days to 15 days. |
| | · | Taberna was granted expanded rights to examine our books and records. |
| | · | We agreed to reimburse Taberna’s fees related to the First Supplemental Indenture in an amount not to exceed $50,000. |
On December 31, 2008, we were not in compliance with the revised tangible net worth covenant and the debt to tangible net worth covenant in the First Supplemental Indenture. On March 25, 2009, we entered into a letter agreement with Taberna providing for a waiver of all financial covenants effective December 31, 2008 through June 30, 2009. In addition, pursuant to the letter agreement we will exchange $20 million of the junior subordinated notes for certain replacement securities, which we expect to acquire for approximately $10 million of cash. This will reduce our obligation on the junior subordinated notes to approximately $36.3 million, which should facilitate future compliance with financial covenants set forth in the First Supplemental Indenture. This transaction would result in a net gain of approximately $9 million including transaction cost. The replacement securities will be acquired with funds consisting of $5 million from our operating funds and $5 million from the $5 million letter of credit referred to above. The funds shall be deposited on or before April 2, 2009. In addition, we are to pay additional interest equal to $250,000 per year, payable quarterly on the same payment dates as the current terms of the Junior Subordinated Notes. We agreed to make a nonrefundable payment of $200,000 to Taberna to cover its costs related to the waiver and exchange arrangement.
During May 2008, we acquired debt securities resulting in a gain on extinguishment of debt totaling approximately $1.6 million.
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, if applicable. 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 borrowings arrangements.
During June 2008, we, our manager, and Vestin Originations entered into an intercreditor agreement with an unrelated third party related to the funding of six real estate loans. (See exhibit 10.11 Intercreditor Agreement under the Exhibit Index included in Part IV, Item 15 of this Report Form 10-K). The participation interest is at 11% on the outstanding balance. We incurred approximately $0.9 million in finance costs related to the secured borrowings, these costs are being amortized to interest expense over the term of the agreements. As of December 31, 2008, we had $10.6 million in funds, including approximately $0.7 million in interest reserves, used under Inter-creditor Agreements as compared to none as of December 31, 2007. During the year ended December 31, 2008, we paid down approximately $10.4 million of the $21.0 million in funds used under Inter-creditor Agreements.
NOTE K — NOTE PAYABLE
In May 2008, we financed a 12-month insurance policy for Directors and Officers liability, with an annual interest rate of 4.9%. The agreement required a down payment of $38,000 and nine monthly payments of $23,000 beginning on May 27, 2008. As of December 31, 2008, the outstanding balance of the note was $24,000.
On March 25, 2009, we entered into a promissory note for $3 million payable on or before May 8, 2009, with an exit fee of $0.6 million due on or before May 26, 2009. We intend to use these funds to purchase a portion of the junior subordinated notes.
NOTE L — FAIR VALUE
As of December 31, 2008, financial assets and liabilities utilizing Level 1 inputs included investment in marketable securities - related party. We had no assets or liabilities utilizing Level 2 inputs and assets and liabilities utilizing Level 3 inputs included investments in real estate loans, secured borrowings and junior subordinated notes payable.
To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, our degree of judgment exercised in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, FAS 157 requires that an asset or liability be classified in its entirety based on the lowest level of input that is significant to the measurement of fair value.
Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, our own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. We use prices and inputs that are current as of the measurement date, including during periods of market dislocation, such as the recent illiquidity in the auction rate securities market. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition may cause our financial instruments to be reclassified from Level 1 to Level 2 or Level 3 and/or vice versa.
FAS 157 requires that the valuation techniques used by us be consistent with at least one of the three possible approaches: the market approach, income approach and/or cost approach. Our Level 1 inputs are based on the market approach and consist primarily of quoted prices for identical items on active securities exchanges.
Our Level 2 inputs are primarily based on the market approach of quoted prices in active markets or current transactions in inactive markets for the same or similar collateral that do not require significant adjustment based on unobservable inputs. Our Level 3 inputs are primarily based on the income and cost approaches, specifically, discounted cash flow analyses, which utilize significant inputs based on our estimates and assumptions.
The following table presents the valuation of our financial assets and liabilities as of December 31, 2008 measured at fair value on a recurring basis by the input levels prescribed by FAS 157:
| | | Quoted Prices in Active Markets For Identical Assets (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | | | Balance at 12/312008 | |
| Assets | | | | | | | | | | | | |
| Investment in marketable securities - related party | | $ | 496,000 | | | $ | -- | | | $ | -- | | | $ | 496,000 | |
| Investment in real estate loans | | $ | -- | | | $ | -- | | | $ | 145,959,000 | | | $ | 145,959,000 | |
| Assets under secured borrowings | | $ | -- | | | $ | -- | | | $ | 10,600,000 | | | $ | 10,600,000 | |
| | | | | | | | | | | | | | | | | |
| Liabilities | | | | | | | | | | | | | | | | |
| Secured borrowings | | $ | -- | | | $ | -- | | | $ | 9,907,000 | | | $ | 9,907,000 | |
| Junior subordinated notes payable | | $ | -- | | | $ | -- | | | $ | 28,600,000 | | | $ | 28,600,000 | |
The following table presents the changes in our financial assets and liabilities that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) from January 1, 2008 to December 31, 2008:
| | | Assets | |
| | | Investment in real estate loans | | | Assets under secured borrowings | |
| | | | | | | |
| Balance on January 1, 2008 | | $ | 278,005,000 | | | $ | -- | |
| Change in temporary valuation adjustment included in net loss | | | | | | | | |
| Increase in allowance for loan losses | | | (82,758,000 | ) | | | -- | |
| Change in impairment on restructured loans | | | (954,000 | ) | | | -- | |
| Loss on sale of investment in real estate loan | | | (2,760,000 | ) | | | -- | |
| Purchase and additions of assets | | | | | | | | |
| Transfer of real estate loans to real estate held for sale | | | (48,907,000 | ) | | | -- | |
| Transfer of allowance on real estate loans to real estate held for sale | | | 3,992,000 | | | | -- | |
| New mortgage loans and mortgage loans bought | | | 93,854,000 | | | | -- | |
| Payment on assets under secured borrowings | | | 10,400,000 | | | | (10,400,000 | ) |
| Sales, pay downs and reduction of assets | | | | | | | | |
| Collections of principal and sales of investment in real estate loans | | | (96,653,000 | ) | | | -- | |
| Reduction of allowance for loan loss related to sale of investment in real estate loan | | | 13,430,000 | | | | -- | |
| Payment on assets under secured borrowings | | | (21,000,000 | ) | | | 21,000,000 | |
| Temporary change in estimated fair value based on future cash flows | | | (690,000 | ) | | | -- | |
| Transfer to Level 1 | | | -- | | | | -- | |
| Transfer to Level 2 | | | -- | | | | -- | |
| | | | | | | | | |
| Balance on December 31, 2008, net of temporary valuation adjustment | | $ | 145,959,000 | | | $ | 10,600,000 | |
| | | Liabilities | |
| | | Secured borrowings | | | Junior subordinated notes payable | |
| | | | | | | |
| Balance on January 1, 2008 | | $ | -- | | | $ | 60,100,000 | |
| Purchase of liabilities | | | | | | | | |
| Secured borrowings | | | 21,000,000 | | | | -- | |
| Reduction of interest reserves related to secured borrowings | | | (693,000 | ) | | | -- | |
| Repurchase junior subordinated notes payable on open market | | | -- | | | | (2,194,000 | ) |
| Gain on repurchase of junior subordinated notes payable | | | -- | | | | (1,556,000 | ) |
| Payment of liabilities | | | | | | | | |
| Payments on secured borrowings | | | (10,400,000 | ) | | | -- | |
| Temporary change in estimated fair value | | | -- | | | | (27,750,000 | ) |
| Transfer to Level 1 | | | -- | | | | -- | |
| Transfer to Level 2 | | | -- | | | | -- | |
| | | | | | | | | |
| Balance on December 31, 2008, net of temporary valuation adjustment | | $ | 9,907,000 | | | $ | 28,600,000 | |
NOTE M — RECENT ACCOUNTING PRONOUNCEMENTS
In January 2009, the FASB issued FASB Staff Position (“FSP”) EITF 99-20-1 – Amendments to the Impairment Guidance of EITF Issue No. 99-20. This FSP affects all entities with certain beneficial interests in securitized financial assets within the scope of EITF Issue No. 99-20. In determining other-than-temporary-impairment, Issue 99-20 requires reliance on market participant assumptions about future cash flows. While FAS 115 – Accounting for Certain Investments in Debt and Equity Securities” (“FAS 115”) uses these same assumptions, it permits the use of reasonable management judgment on the probability that the holder will be unable to collect all amounts due. This FSP brings the impairment model on beneficial interest held by a transferor in securitized financial assets, to be similar to the impairment model of FAS 115. The FSP is effective for interim and annual reporting periods ending after December 15, 2008. The adoption of this standard did not have a material impact on our financial position or results of operations.
In December 2008, the FASB issued FASB Staff Position FAS 140-4 and FIN 46(R)-8 – Disclosures about Transfers of Financial Assets and Interests in Variable Interest Entities (“FSP 140-4 and 46(R)-8”). This FSP requires additional disclosures by public entities with continuing involvement in transfers of financial assets to special purpose entities and with variable interests in VIEs, including sponsors that have a variable interest in a VIE. Additionally, this FSP requires certain disclosures to be provided by a public entity that is (1) a sponsor of a qualifying special-purpose entity (“SPE”) that holds a variable interest in the qualifying SPE but was not the transferor (non-transferor) of financial assets to the qualifying SPE, and (2) a servicer of a qualifying SPE that holds a significant variable interest in the qualifying SPE but was not the transferor (non-transferor) of financial assets to the qualifying SPE. This FSP is effective for the first reporting period (interim or annual) that ends after December 15, 2008. The adoption of this standard did not have a material impact on our financial position or results of operations.
NOTE N — 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 found 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 expired 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.
On November 21, 2005, Desert Land filed a complaint in the state District Court of Nevada against Vestin Group, Vestin Mortgage and Del Mar Mortgage, Inc. which complaint is substantially similar to a complaint previously filed by Desert Land in the United States District Court, which complaint was dismissed by the United States Court of Appeals for the Ninth Circuit, which dismissal was upheld when the United States Supreme Court denied Desert Land’s Writ of Certiorari. 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 Fund II. 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 void 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. In December 2008, this lawsuit was settled. The settlement has no effect on us.
VRM I and Vestin Mortgage, Inc. (“Defendants”) are defendants in a breach of contract class 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 court certified a class of all former Fund I unit holders who voted against the merger of Fund I into Vestin Realty Mortgage I, Inc. The trial is currently scheduled to begin on June 19, 2009. 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 VRM I’s management agreement and Fund I’s Operating Agreement contain indemnity provisions whereby Vestin Mortgage and Michael V. Shustek may be eligible for indemnification by VRM I with respect to the above actions.
VRM I, Vestin Mortgage, Inc. and Michael V. Shustek (“Defendants”) are defendants in a civil action filed by approximately 25 separate plaintiffs (“Plaintiffs”) in District 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 I into VRM I. The action seeks monetary damages, punitive damages, and rescission . The trial is currently scheduled to begin on April 19, 2010. 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 VRM I’s management agreement and Fund I’s operating agreement contain indemnity provisions whereby Vestin Mortgage and Michael V. Shustek may be eligible for indemnification by VRM I with respect to the above actions.
In addition to the matters described above, our manager is involved in a number of other 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 O — 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 and us alleging that these Vestin entities improperly influenced the former RightStar trustees to transfer trust funds to us.
On May 9, 2007, we, VRM I, Vestin Mortgage, the State of Hawaii and Comerica Incorporated announced that an arrangement had been reached to auction the RightStar assets. On June 12, 2007, the court approved the resolution agreement, which provides that the proceeds of the foreclosure sale will be allocated in part to VRM I, Vestin Mortgage and us and in part to fund the trust’s statutory minimum balances. We, VRM I, Vestin Mortgage, the State of Hawaii and Comerica have pledged to cooperate to recover additional amounts owed to the trusts and the creditors from others, while mutually releasing each other and RightStar from all claims. We, VRM I, Vestin Mortgage and the State of Hawaii have received offers and are currently requesting, entertaining, and reviewing bids on the RightStar properties. The outcome of this auction cannot be determined at this time.
We and Vestin Mortgage, Inc. (“Defendants”) are defendants in a breach of contract class 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 court certified a class of all former Fund II unit holders who voted against the merger of Fund II into Vestin Realty Mortgage II, Inc., and a subclass of all class members who were over the age of 60 and Nevada residents at the time of the merger. The trial is currently scheduled to begin on June 19, 2009. 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 us with respect to the above actions.
We, Vestin Mortgage, Inc. and Michael V. Shustek (“Defendants”) are defendants in a civil action filed by 88 sets of plaintiffs representing approximately 138 individuals (“Plaintiffs”), in District 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, punitive damages and rescission . The trial is currently scheduled to begin on April 19, 2010. 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 us with respect to the above actions. We, Vestin Mortgage, Inc. and Michael Shustek have entered into confidential settlement agreements with individual plaintiffs who collectively held approximately 10% of the total shares at issue in the action. In addition, four individual plaintiffs have voluntarily withdrawn their claims against us, Vestin Mortgage, Inc. and Michael Shustek with prejudice.
In addition to the matters described above, we are involved in a number of other legal proceedings concerning matters arising in the ordinary course 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 P — DIVIDEND REQUIREMENT
To maintain our status as a REIT, we are required to declare dividends, 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 dividends 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.
Our Board of Directors decided to suspend the payment of dividends during June 2008. We will continue to comply with the REIT requirements and will distribute at least ninety percent (90%) of our annual taxable income. Our Board of Directors will closely monitor our operating results in order to determine when dividends should be reinstated.
NOTE Q — SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following schedule is a selected quarterly financial data for the year ended December 31, 2008 and December 31, 2007:
| | | For the Year Ended December 31, 2008 | |
| | | 1st Quarter | | | 2nd Quarter | | | 3rd Quarter | | | 4th Quarter | | | Year | |
| | | | | | | | | | | | | | | | |
| Total revenues | | $ | 7,156,000 | | | $ | 5,916,000 | | | $ | 3,687,000 | | | $ | 2,548,000 | | | $ | 19,307,000 | |
| Total operating expenses | | | 2,103,000 | | | | 24,867,000 | | | | 23,924,000 | | | | 46,758,000 | | | | 97,652,000 | |
| Total non-operating income (loss) | | | 185,000 | | | | 1,639,000 | | | | (2,102,000 | ) | | | (2,692,000 | ) | | | (2,970,000 | ) |
| Total income (loss) from real estate held for sale | | | (1,965,000 | ) | | | (11,291,000 | ) | | | (17,807,000 | ) | | | (17,791,000 | ) | | | (48,854,000 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Income (loss) before provision for income taxes | | | 3,273,000 | | | | (28,603,000 | ) | | | (40,146,000 | ) | | | (64,693,000 | ) | | | (130,169,000 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Provision for income taxes | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | |
| | | | | | | | | | | | | | | | | | | | | |
| NET INCOME (LOSS) | | $ | 3,273,000 | | | $ | (28,603,000 | ) | | $ | (40,146,000 | ) | | $ | (64,693,000 | ) | | $ | (130,169,000 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Basic and diluted earnings per weighted average common share | | $ | 0.22 | | | $ | (1.92 | ) | | $ | (2.72 | ) | | $ | (4.54 | ) | | $ | (8.86 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Dividends declared per common share | | $ | 0.32 | | | $ | 0.17 | | | $ | -- | | | $ | -- | | | $ | 0.49 | |
| | | | | | | | | | | | | | | | | | | | | |
| Weighted average common shares | | | 14,872,330 | | | | 14,881,563 | | | | 14,772,583 | | | | 14,250,794 | | | | 14,695,756 | |
| | | | | | | | | | | | | | | | | | | | | |
| Weighted average term of outstanding loans, including extensions | | 19 months | | | 17 months | | | 20 months | | | 20 months | | | 20 months | |
| | | For the Year Ended December 31, 2007 | |
| | | 1st Quarter | | | 2nd Quarter | | | 3rd Quarter | | | 4th Quarter | | | Year | |
| | | | | | | | | | | | | | | | |
| Total revenues | | $ | 6,653,000 | | | $ | 8,269,000 | | | $ | 6,939,000 | | | $ | 7,149,000 | | | $ | 29,010,000 | |
| Total operating expenses | | | 1,158,000 | | | | 1,461,000 | | | | 5,162,000 | | | | 4,098,000 | | | | 11,879,000 | |
| Total non-operating income | | | 182,000 | | | | 313,000 | | | | 793,000 | | | | 555,000 | | | | 1,843,000 | |
| Total income (loss) from real estate held for sale | | | 706,000 | | | | (2,729,000 | ) | | | (1,029,000 | ) | | | 1,006,000 | | | | (2,046,000 | ) |
| | | | | | | | | | | | | | | | | | | | | |
| Income before provision for income taxes | | | 6,383,000 | | | | 4,392,000 | | | | 1,541,000 | | | | 4,612,000 | | | | 16,928,000 | |
| | | | | | | | | | | | | | | | | | | | | |
| Provision for income taxes | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | |
| | | | | | | | | | | | | | | | | | | | | |
| NET INCOME | | $ | 6,383,000 | | | $ | 4,392,000 | | | $ | 1,541,000 | | | $ | 4,612,000 | | | $ | 16,928,000 | |
| | | | | | | | | | | | | | | | | | | | | |
| Basic and diluted earnings per weighted average common share | | $ | 0.43 | | | $ | 0.29 | | | $ | 0.10 | | | $ | 0.31 | | | $ | 1.14 | |
| | | | | | | | | | | | | | | | | | | | | |
| Dividends declared per common share | | $ | 0.39 | | | $ | 0.41 | | | $ | 0.38 | | | $ | 0.33 | | | $ | 1.50 | |
| | | | | | | | | | | | | | | | | | | | | |
| Weighted average common shares | | | 14,943,760 | | | | 14,940,865 | | | | 14,894,003 | | | | 14,861,056 | | | | 14,909,651 | |
| | | | | | | | | | | | | | | | | | | | | |
| Weighted average term of outstanding loans, including extensions | | 20 months | | | 17 months | | | 18 months | | | 19 months | | | 19 months | |
NOTE R — SUBSEQUENT EVENTS
On January 7, 2009, we sold the Preston Hollow Assisted Living, L.P. loan to an unaffiliated third party for approximately $1.1 million, which approximated our book value of the loan, net of allowances. No gain or loss was recognized.
On January 16, 2009, we, VRM I, and Fund III foreclosed upon Redwood Place, LLC and classified the property as real estate held for sale. During February 2009, our manager received a sales agreement to purchase the property for approximately $8.7 million, of which our portion would be approximately $6.7 million.
On January 26, 2009, we and VRM I, settled with a plaintiff, involved in the breach of contract class action filed in San Diego, whereby we and VRM I, repurchased the plaintiff���s stock and classified it as treasury stock.
During January and February 2009, we, Vestin Mortgage, Inc. and Michael Shustek have entered into confidential settlement agreements with individual plaintiffs who collectively held approximately 10% of the total shares at issue in the action. In addition, four individual plaintiffs have voluntarily withdrawn their claims against us, Vestin Mortgage, Inc. and Michael Shustek with prejudice.
On February 11, 2009, we sold the Trinity Theo, LLC loan to an unaffiliated third party for approximately $1.6 million, no gain or loss was recognized.
As of March 4, 2009, one performing loan, totaling $12.6 million, subsequently became delinquent in interest payments. Our manager has commenced foreclosure proceedings, and is proceeding with legal action to enforce the personal guarantees. However, no assurance can be given at this time that full payment will be received on this newly delinquent loan.
On March 6, 2009, we and, VRM I foreclosed upon Bright Haven Builders, LLC and classified the property as real estate held for sale.
During January 2009, our manager received a sales agreement to purchase the Cliff Shadows Properties, LLC property for approximately $9.6 million, of which our portion would be approximately $9.1 million. On March 6, 2009, we, VRM I, and Fund III completed the sale of 98 units, with the remaining units pending final escrow.
On March 23, 2008, we, VRM I and Fund III, sold the Peoria 180, LLC loan to an unrelated third party for $3.0 million. The sale resulted in no gain or loss.
On December 31, 2008, we were not in compliance with the revised tangible net worth covenant and the debt to tangible net worth covenant in the First Supplemental Indenture. On March 25, 2009, we entered into a letter agreement with Taberna providing for a waiver of all financial covenants effective December 31, 2008 through June 30, 2009. In addition, pursuant to the letter agreement we will exchange $20 million of the junior subordinated notes for certain replacement securities, which we expect to acquire for approximately $10 million of cash. This will reduce our obligation on the junior subordinated notes to approximately $36.3 million, which should facilitate future compliance with financial covenants set forth in the First Supplemental Indenture. This transaction would result in a net gain of approximately $9 million including transaction cost. The replacement securities will be acquired with funds consisting of $5 million from our operating funds and $5 million from the $5 million letter of credit referred to in Note I Junior Subordinated Notes. The funds shall be deposited on or before April 2, 2009. In addition, we are to pay additional interest equal to $250,000 per year, payable quarterly on the same payment dates as the current terms of the Junior Subordinated Notes. We agreed to make a nonrefundable payment of $200,000 to Taberna to cover its costs related to the waiver and exchange arrangement.
On March 25, 2009, we entered into an unsecured promissory note for $3 million payable on or before May 8, 2009, with an exit fee of $0.6 million due on or before May 26, 2009. We intend to use these funds to purchase a portion of the junior subordinated notes referred to above. Per the terms of the loan, all subsequent proceeds from loan repayments and sales of property will be used to pay down the note. We are currently anticipating receipt of proceeds from the sale of properties, which will meet our on-going obligations. No assurance can be made that these sales will be completed.
On March 23, 2009, our board of directors authorized us to enter into a consulting agreement with the previous COO of the Manager to assist us in the repurchase of the Junior Subordinated Notes. The consulting fees paid will be up to three and half percent of the discounted amount of the repurchase
| |
| VESTIN REALTY MORTGAGE II, INC. | |
| REAL ESTATE LOANS ON REAL ESTATE * | |
| REAL ESTATE LOAN ROLL FORWARD | |
| | | | |
| | | | |
| 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 | |
| | | | | |
| Additions during the period | | | | |
| New real estate loans and additions | | | 146,245,000 | |
| Real estate loans bought | | | 14,760,000 | |
| Deductions during the period | | | | |
| Collections of principal and reductions | | | 103,430,000 | |
| Foreclosed loans (Real estate held for sale) | | | -- | |
| Real estate loans sold | | | 8,907,000 | |
| | | | | |
| Net Change in 2007 | | | 48,668,000 | |
| | | | | |
| Balance, December 31, 2007 | | $ | 291,063,000 | |
| | | | | |
| Additions during the period | | | | |
| New real estate loans and additions | | | 90,794,000 | |
| Real estate loans bought | | | 12,506,000 | |
| Deductions during the period | | | | |
| Collections of principal and reductions | | | 50,900,000 | |
| Foreclosed loans (Real estate held for sale) | | | 48,907,000 | |
| Real estate loans sold | | | 69,514,000 | |
| | | | | |
| Net Change in 2008 | | | (66,021,000 | ) |
| | | | | |
| Balance, December 31, 2008 | | $ | 225,042,000 | |
* Includes loans related to real estate held for sale – seller financed.
| |
| VESTIN REALTY MORTGAGE II, INC. | |
| REAL ESTATE LOANS ON REAL ESTATE * | |
| REAL ESTATE LOANS BY TYPE OF PROPERTY | |
| | |
| | |
| As of December 31, 2008: | | | | | | | | | | | | | | | |
| Type of Property | | Interest Rate | | | Face Amount of Loan | | | Carrying Amount of Loan | | | Maturity Date | | | Amount Subject to Delinquency | |
| | | | | | | | | | | | | | | | |
| Acquisition and Development | | | 13% | | | $ | 13,000,000 | | | $ | 13,000,000 | | | | 06/08 | | | $ | 13,000,000 | |
| Commercial | | | 6%-15% | | | $ | 164,567,000 | | | $ | 107,456,000 | | | 04/04-04/10 | | | $ | 67,538,000 | |
| Construction | | | 9.53%-12.5% | | | $ | 44,105,000 | | | $ | 27,612,000 | | | 03/08-12/10 | | | $ | 7,601,000 | |
| Land | | | 11%-13% | | | $ | 96,255,000 | | | $ | 76,974,000 | | | 05/08-12/09 | | | $ | 56,722,000 | |
| Total | | | | | | | 317,927,000 | | | | 225,042,000 | | | | | | | | 144,861,000 | |
| | | | | | | | | | | | | | | | | | | | | |
| As of December 31, 2007: | | | | | | | | | | | | | | | | | | | | |
| Type of Property | | Interest Rate | | | Face Amount of Loan | | | Carrying Amount of Loan | | | Maturity Date | | | Amount Subject to Delinquency | |
| | | | | | | | | | | | | | | | | | | | | |
| Acquisition and Development | | | 12%-13.75% | | | $ | 24,270,000 | | | $ | 18,338,000 | | | 07/07-06/08 | | | $ | 5,338,000 | |
| Commercial | | | 8.65%-15% | | | $ | 202,690,000 | | | $ | 131,257,000 | | | 03/04-12/08 | | | $ | 19,446,000 | |
| Construction | | | 9.53%-12.5% | | | $ | 73,841,000 | | | $ | 45,883,000 | | | 10/06-12/08 | | | $ | 1,681,000 | |
| Land | | | 10%-14% | | | $ | 132,250,000 | | | $ | 95,585,000 | | | 06/07-12/09 | | | $ | 4,100,000 | |
| Total | | | | | | $ | 433,051,000 | | | $ | 291,063,000 | | | | | | | $ | 30,565,000 | |
| |
| VESTIN REALTY MORTGAGE II, INC. | |
| REAL ESTATE LOANS ON REAL ESTATE * | |
| REAL ESTATE LOANS BY LIEN POSITION | |
| | |
| | |
| As of December 31, 2008: | | | | | | | | | | | | | |
| Lien Position | | Face Amount of Loan | | | Interest Rate | | | Carrying Amount of Loan | | Maturity Date | | Amount Subject to Delinquency | |
| | | | | | | | | | | | | | |
1st | | $ | 260,503,000 | | | | 6%-15% | | | $ | 188,219,000 | | 03/04-12/10 | | $ | 139,368,000 | |
2nd | | $ | 57,423,000 | | | | 10.5%-15% | | | $ | 36,823,000 | | 06/08-04/10 | | $ | 5,493,000 | |
| Total | | $ | 317,926,000 | | | | | | | $ | 225,042,000 | | | | $ | 144,861,000 | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| As of December 31, 2007: | | | | | | | | | | | | | | | | | |
| Lien Position | | Face Amount of Loan | | | Interest Rate | | | Carrying Amount of Loan | | Maturity Date | | Amount Subject to Delinquency | |
| | | | | | | | | | | | | | | | | | |
1st | | $ | 432,051,000 | | | | 8.65%-15% | | | $ | 288,665,000 | | 03/04-12/09 | | $ | 30,565,000 | |
2nd | | $ | 1,000,000 | | | | 10.5%-12% | | | $ | 2,398,000 | | 06/08 | | $ | -- | |
| Total | | $ | 433,051,000 | | | | | | | $ | 291,063,000 | | | | $ | 30,565,000 | |
* Includes loans related to real estate held for sale – seller financed.
| |
| 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, 2008: | |
| | |
| Description of Loan | | Interest Rate | | Final Maturity Date | Periodic Payment Terms | Lien Position | | Face Amount of Loan | | | Carrying Amount of Loan | | | Amount Subject to Delinquency | |
| | | | | | | | | | | | | | | | |
| | | 13.00% | | 06/29/08 | Fixed Interest only, Balloon Payment $13,000,000 | 1st | | $ | 13,000,000 | | | $ | 13,000,000 | | | $ | 13,000,000 | |
| Commercial | | | 12.00% | | 02/12/09 | Fixed Interest only, Balloon Payment $16,002,000 | 1st | | $ | 19,453,000 | | | $ | 16,002,000 | | | $ | 16,002,000 | |
| Commercial | | | 10.00% | | 10/29/08 | Fixed Interest only, Balloon Payment $11,600,000 | 1st | | $ | 16,000,000 | | | $ | 11,600,000 | | | $ | 11,600,000 | |
| Commercial | | | 15.00% | | 04/30/10 | Fixed Interest only, Balloon Payment 10,163,000 | 2nd | | $ | 23,610,000 | | | $ | 10,163,000 | | | $ | -- | |
| Commercial | | | 11.50% | | 04/05/08 | Fixed Interest only, Balloon Payment $11,350,000 | 1st | | $ | 14,977,000 | | | $ | 11,350,000 | | | $ | 11,350,000 | |
| Commercial | | | 14.00% | | 03/31/04 | Fixed Interest only, Balloon Payment $17,291,000 | 1st | | $ | 26,598,000 | | | $ | 17,291,000 | | | $ | 17,291,000 | |
| Commercial | | | 15.00% | | 04/30/09 | Fixed Interest only, Balloon Payment $12,600,000 | 2nd | | $ | 14,000,000 | | | $ | 12,600,000 | | | $ | -- | |
| Land | | | 12.00% | | 06/17/08 | Fixed Interest only, Balloon Payment $7,707,000 | 1st | | $ | 9,500,000 | | | $ | 7,707,000 | | | $ | 7,707,000 | |
| Land | | | 11.00% | | 06/30/08 | Variable Interest only, Balloon Payment $14,806,000 | 1st | | $ | 18,000,000 | | | $ | 14,806,000 | | | $ | 14,806,000 | |
| Land | | | 11.00% | | 03/14/09 | Fixed Interest only, Balloon Payment $6,981,000 | 1st | | $ | 7,000,000 | | | $ | 6,981,000 | | | $ | -- | |
| Land | | | 11.50% | | 09/26/08 | Fixed Interest only, Balloon Payment $7,725,000 | 1st | | $ | 8,425,000 | | | $ | 7,218,000 | | | $ | 7,218,000 | |
| Land | | | 11.50% | | 12/11/09 | Fixed Interest only, Balloon Payment $15,555,000 | 1st | | $ | 22,300,000 | | | $ | 15,555,000 | | | $ | 15,555,000 | |
| Total | | | | | | | | | | 192,863,000 | | | | 144,273,000 | | | | 114,529,000 | |
| As of December 31, 2007: | |
| | |
| Description of Loan | | Interest Rate | | Final Maturity Date | Periodic Payment Terms | Lien Position | | Face Amount of Loan | | | Carrying Amount of Loan | | | Amount Subject to Delinquency | |
| | | | | | | | | | | | | | | | |
| | | 13.00% | | 06/29/08 | Fixed Interest only, Balloon Payment $13,000,000 | 1st | | $ | 13,000,000 | | | $ | 13,000,000 | | | $ | -- | |
| Commercial | | | 14.00% | | 03/31/04 | Fixed Interest only, Balloon Payment $17,290,000 | 1st | | $ | 34,000,000 | | | $ | 17,291,000 | | | $ | 17,290,644 | |
| Commercial | | | 12.00% | | 09/30/06 | Fixed Interest only, Balloon Payment $16,981,000 | 1st | | $ | 24,500,000 | | | $ | 16,981,000 | | | $ | -- | |
| Commercial | | | 11.50% | | 10/05/07 | Fixed Interest only, Balloon Payment $11,387,000 | 1st | | $ | 18,000,000 | | | $ | 11,388,000 | | | $ | -- | |
| Commercial | | | 10.00% | | 06/30/07 | Fixed Interest only, Balloon Payment $11,600,000 | 1st | | $ | 16,000,000 | | | $ | 11,600,000 | | | $ | -- | |
| Commercial | | | 10.50% | | 07/12/07 | Fixed Interest only, Balloon Payment $20,869,000 | 1st | | $ | 25,588,000 | | | $ | 20,870,000 | | | $ | -- | |
| Commercial | | | 14.00% | | 06/28/07 | Fixed Interest only, Balloon Payment $25,703,000 | 1st | | $ | 26,800,000 | | | $ | 25,704,000 | | | $ | -- | |
| Construction | | | 12.00% | | 07/16/07 | Fixed Interest only, Balloon Payment $16,117,000 | 1st | | $ | 31,250,000 | | | $ | 16,117,000 | | | $ | -- | |
| Land | | | 11.00% | | 12/30/07 | Variable Interest only, Balloon Payment $14,797,000 | 1st | | $ | 18,000,000 | | | $ | 14,798,000 | | | $ | -- | |
| Land | | | 14.00% | | 01/27/08 | Fixed Interest only, Balloon Payment $12,037,000 | 1st | | $ | 17,000,000 | | | $ | 12,038,000 | | | $ | -- | |
| Land | | | 11.50% | | 12/11/09 | Fixed Interest only, Balloon Payment $14,171,000 | 1st | | $ | 22,300,000 | | | $ | 14,171,000 | | | $ | -- | |
| Total | | | | | | | | | $ | 246,438,000 | | | $ | 173,958,000 | | | $ | 17,290,644 | |
* Includes loans related to real estate held for sale – seller financed.
| 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 our management, including the CEO and CFO, as of December 31, 2008, 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 our evaluation, our CEO and CFO concluded that, as of December 31, 2008, our disclosure controls and procedures are designed at a reasonable assurance level and are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.
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.
The certifications of the our CEO and CFO 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, 2008. 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, 2008, the Company’s internal control over financial reporting is effective based on those criteria.
Our internal control over financial reporting as of December 31, 2008 have 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
As required by Rule 13a-15(d) under the Exchange Act, our management, including our CEO and our CFO, has evaluated our internal control over financial reporting to determine whether any changes occurred during the fourth fiscal quarter of 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, there has been no such change during the fourth fiscal quarter of 2008.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Vestin Realty Mortgage II, Inc.
We have audited Vestin Realty Mortgage II, Inc’s., (“the Company”) internal control over financial reporting as of December 31, 2008, 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, included in the accompanying “Management’s Report on Internal Control over Financial Reporting”. Our responsibility is to express an opinion on 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, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, 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 of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. 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, the Company maintained in all material respects, effective internal control over financial reporting as of December 31, 2008 based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Vestin Realty Mortgage II, Inc., as of December 31, 2008 and 2007 and the related consolidated statements of operations, equity and other comprehensive income (loss) and cash flows for the years ended December 31, 2008, 2007 and for the twelve months ended December 31, 2006 and our report dated March 26, 2009 expressed an unqualified opinion on those consolidated financial statements.
/s/ Moore Stephens Wurth Frazer and Torbet, LLP
Orange, California
March 26, 2009
Not applicable.
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, 2008 and positions of the individuals who serve as our directors and executive officers as of December 31, 2008:
| Name | Age | Title |
| | | |
| Michael V. Shustek | 50 | President, Chief Executive Officer and Director |
| Rocio Revollo | 47 | Chief Financial Officer |
| John E. Dawson | 51 | Director |
| Robert J. Aalberts(1)(2)(3) | 57 | Director |
| Fredrick J. Zaffarese Leavitt(1)(2)(3) | 38 | Director |
| Roland M. Sansone(1)(2)(3) | 53 | 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, 2009 and positions of the individuals who serve as directors, executive officers and certain significant employees of Vestin Mortgage (our manager), Vestin Group, Vestin Originations or our affiliates:
| Name | Age | Title |
| | | |
| Michael V. Shustek | 50 | President, Chief Executive Officer and Chairman |
| Rocio Revollo | 47 | Chief Financial Officer |
| Michael J. Whiteaker | 59 | Vice President of Regulatory Affairs of Vestin Group |
| Daniel B. Stubbs | 47 | Senior Vice President of Vestin Group |
| Edwin H. Bentzen IV | 32 | Corporate Controller of Vestin Group |
Directors, Executive Officers and certain significant employees of Vestin Realty Mortgage II, Vestin Mortgage (our manager), Vestin Group, Vestin Originations or our affiliates
Michael V. Shustek 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 and a Director and CEO of us and Vestin Realty Mortgage I, Inc. (“VRM I”) 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.
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 Note N Legal Matters Involving The Manager in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K for information regarding legal matters involving our manager and Mr. Shustek.
Rocio Revollo was appointed as our Chief Financial Officer on March 21, 2007. In addition, Ms. Revollo was appointed the CFO of VRM I and Vestin Group on March 21, 2007. Prior to being appointed as the CFO of us, VRM I and Vestin Group, Ms. Revollo served as the 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.
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 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. Mr. Whiteaker has previously served on the Nevada Association of Mortgage Brokers, Legislative Committee and is a past member of the State of Nevada, Mortgage Advisory Council. He currently is a director of the Private Lenders Group, an organization devoted to creating and maintaining the highest professional standards possible among licensed Nevada Mortgage brokers.
Daniel B. Stubbs has been the Senior Vice President of Underwriting and Secretary of our manager since January 2000. Mr. Stubbs heads the loan department for our manager and its 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.
Edwin H. Bentzen IV has been the Corporate Controller of Vestin Group since April 2007. Prior to being Corporate Controller of Vestin Group, Mr. Bentzen served as a Financial Reporting Analyst for Vestin Group since January 2006. Mr. Bentzen served at Ameristar Casinos Inc. as Senior Internal Auditor from June 2005 through January 2006 and an Internal Auditor from June 2003 to June 2005. Prior to June 2003, Mr. Bentzen was engaged in public tax accounting at a local firm in Las Vegas. Mr. Bentzen is a Certified Internal Auditor and received a Masters of Science in Accountancy and a Bachelor of Science degree in Hotel Administration, with an emphasis in gaming, 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 member of our boar of directors since January 2006 and was a director for VRM I from January 2006 until he resigned in January 2008. In March 2009, Mr. Aalberts was appointed to replace Mr. Micone, who resigned from VRM I’s Board. 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 (7th Ed. (2009) 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 member of our boar of directors since January 2006 and was a director for VRM I from January 2006 until he resigned in January 2008. 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 member of our boar of directors since January 2006 and was a director for VRM I from January 2006 until he resigned in January 2008. In additions, 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.
John E. Dawson was previously a director of Vestin Group from March 2000 to December 2005. He has been a member of our boar of directors since March 2007 and was a director for VRM I from March 2007 until he resigned in January 2008. Since 2005 Mr. Dawson has been a partner of the Las Vegas law firm of Lionel Sawyer & Collins. Previous to that, from 1995 to 2005, Mr. Dawson was a partner at the law firm of Marquis & Aurbach. Mr. Dawson received his Bachelor’s Degree from Weber State and his Juris Doctor from Brigham Young University. Mr. Dawson received his Masters of Law (L.L.M.) in Taxation from the University of San Diego in 1993. Mr. Dawson was admitted to the Nevada Bar in 1988 and the Utah Bar in 1989.
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 Leavitt, and his term will expire at the 2010 annual meeting of stockholders; |
| | · | The class II directors are Messrs, Dawson and Sansone, and their terms will expire at the 2011 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.
During the year ended December 31, 2008, the Board held seven meetings, the Audit Committee held five meeting and the Nominating Committee held one meeting. Four out of five directors, as of December 31, 2008, attended 100% of the aggregate of all Board and applicable standing committee meetings. The remaining director, Roland M. Sanson, attended 100% of the Audit Committee and Nominating Committees meetings and three of the seven Board meeting. Directors are encouraged to attend annual meetings of our stockholders. At the last annual meeting of stockholders, all of the five then-current directors attended.
Board Committees
Our board of directors has appointed 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 is responsible for the appointment, compensation, retention and oversight of the Company’s independent accountants. In addition, the Audit Committee reviews with the Company’s management and its independent accountants financial information that will be provided to stockholders and others, the systems of internal controls which management and our board of directors have established and our audit and financial reporting processes. The Audit Committee operates under a written Audit Committee Charter adopted by our board of directors, which is available at http://www.vestinrealtymortgage2.com/VRT_About/CommitteeCharters.aspx. Our Audit Committee, consisting of Mr. Zaffarese Leavitt (chair), Mr. Aalberts and Mr. Sansone, met in March 2009 in connection with the audit of our 2008 financial statements, and held a total of four meetings in fiscal 2008. 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 non-audit 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. Our Audit Committee currently consists of Mr. Zaffarese Leavitt, Mr. Aalberts and Mr. Sansone. Our board of directors has determined that each of these directors meet the independence standards for audit committee members and that Mr. Zaffarese Leavitt meets the financial expertise requirements set forth in Section 407 of the Sarbanes Oxley Act of 2002.
Nominating Committee – Our Nominating Committee’s was formed to assist our board of directors by identifying individuals qualified to become directors. During fiscal 2008, the Nominating Committee, consisting of Mr. Sansone (chair), Mr. Zaffarese Leavitt and Mr. Aalberts, held no meetings. Our nominating committee currently consists of Mr. Sansone, Mr. Zaffarese Leavitt and Mr. Aalberts.
The Nominating Committee operates under a charter adopted by our board of directors, which is available at http://www.vestinrealtymortgage2.com/VRT_About/CommitteeCharters.aspx. Responsibilities of the Nominating Committee include, among other things:
| | · | Evaluating the composition, size, operations and governance of our board of directors and making recommendations regarding future planning and the appointment of directors; |
| | · | Evaluating the independence of our directors and candidates for election to the Board; and |
| | · | Evaluating and recommending candidates for election to our board of directors. |
In evaluating candidates, the Nominating Committee will consider an individual’s business and professional experience, the potential contributions they could make to our Board and their familiarity with our business. The Nominating Committee will consider candidates recommended by our directors, members of our management team and third parties. The Nominating Committee will also consider candidates suggested by our stockholders. We do not have a formal process established for this purpose. Stockholders are encouraged to contact the Chair of the Nominating Committee if they wish the Committee to consider a proposed candidate. Stockholders should submit the names of any candidates in writing, together with background information about the candidate, and send the materials to the attention of Mr. Ronald Sansone at the following address: 6149 South Rainbow Boulevard, Las Vegas, NV 89118. Stockholders wishing to directly nominate candidates for election to the Board must provide timely notice in accordance with the requirements of our Bylaws, between the 150th and 120th days prior to the anniversary of the date of mailing of the notice for the preceding year’s annual meeting of stockholders.
Compensation Committee – Our Compensation Committee operates under a charter adopted by our board of directors, which is available at http://www.vestinrealtymortgage2.com/VRT_About/CommitteeCharters.aspx. It was established to assist our board of directors relating to compensation of the Company’s directors 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. During fiscal 2007 the Compensation Committee, consisting of Mr. Aalberts, Mr. Zaffarese Leavitt and Mr. Sansone, held one meeting. Our compensation committee currently consists of Mr. Aalberts (chair), Mr. Zaffarese Leavitt and Mr. Sansone. No member of the Compensation Committee had a relationship that requires disclosure as a compensation committee interlock.
Our board of directors may establish other committees to facilitate the management of our business.
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 http://www.vestinrealtymortgage2.com/VRT_About/GovernanceDocuments.aspx.
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 year ended December 31, 2008, 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 2008.
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 January 31, 2009, 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 13,785,040 shares of our common stock as of January 31, 2009.
Name and Address of Beneficial Owner | | Amount and Nature of Beneficial Ownership | | Percent of Class |
| | | | | |
Michael V. Shustek 6149 South Rainbow Boulevard Las Vegas, NV 89118 | | Sole voting and investment power of 1,155,042 shares and shared voting and investment power of 225,134 shares | | 10.01% |
The following table sets forth the total number and percentage of our common stock beneficially owned as of January 31, 2009, by:
| | · | Our chief executive officer, chief financial officer and the officers of our manager who function as the equivalent of our executive officers; and |
| | · | All executive officers and directors as a group. |
Unless otherwise noted, the percentage ownership is calculated based on 13,785,040 shares of our total outstanding common stock as of January 31, 2009.
| | | | Common Shares Beneficially Owned | |
| Beneficial Owner | Address | | Number | | | Percent | |
| | | | | | | | |
| Michael V. Shustek(1) | 6149 S. Rainbow Blvd. Las Vegas, NV 89118 | | | 1,380,176 | | | | 10.01% | |
| Rocio Revollo (3) | 6149 S. Rainbow Blvd. Las Vegas, NV 89118 | | | 384 | | | | ** | |
| John Dawson (2) (3) | 3052 Sabine Hill Ave. Henderson, NV 89052 | | | 5,894 | | | | ** | |
| Robert J. Aalberts (2) (3) | 2901 El Camino Ave. Las Vegas, NV 89102 | | | 189 | | | | ** | |
| Frederick J. Zaffarese Leavitt | P.O. Box 91683 Henderson, NV 89009 | | | -- | | | | -- | |
| Roland M. Sansone | 2310 E. Sunset Rd #8015 Las Vegas, NV 89119 | | | -- | | | | -- | |
| All directors and executive officers as a group (7 persons) | | | | 1,386,643 | | | | 10.06% | |
** Less than one percent of our total outstanding common stock.
| (1) | 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 is the beneficial owner of 1,380,176 shares of Common Stock of the Issuer. Mr. Shustek, directly owns 948,226 shares of the Issuer’s common stock and indirectly owns and has economic benefit of 92,699 shares of the Issuer’s common stock through his ownership of Vestin Mortgage. In addition, through his management powers with respect to VRM I, Mr. Shustek has shared voting and dispositive power over 225,134 shares, owned by VRM I and sole voting and dispositive power with respect to 114,117 shares owned by Fund III. Mr. Shustek owns an approximate 4.3% interest in VRM I and is an executive officer and director of VRM I. Mr. Shustek’s pecuniary interest in the Issuer’s shares owned by VRM I is 9,768 shares. Mr. Shustek owns an approximate 11.1% interest in Fund III and is the Chairman, President and Chief Executive Officer of Vestin Mortgage, Inc., the manager of Fund III. Mr. Shustek’s pecuniary interest in the Issuer’s shares owned by Fund III is 12,716 shares. Mr. Shustek has sole voting and dispositive power with respect to shares owned directly by himself and, with respect to shares owned by Vestin Mortgage and Fund III. He has shared voting and dispositive power with respect to shares owned by VRM I. Voting and dispositive power with respect to shares owned by VRM I is shared with the members of VRM I’s Board of Directors.
In May 2008, Mr. Shustek amended the 10b5-1 trading plan (the “Plan”), announced on April 30, 2007, pursuant to Rule 10b5-1 promulgated under the Securities Exchange Act of 1934. Pursuant to the First Amended and Restated Plan, Mr. Shustek may spend up to an additional $2.6 million to acquire shares of the Company’s common stock at prevailing market prices over the course of the next 13 months. All purchases have been and will continue to be executed by independent broker-dealers on specified dates in accordance with the requirements of Rule 10b5-1. The First Amended and Restated Plan become effective on July 2, 2008 and expires on June 24, 2009. As of January 31, 2009, Mr. Shustek had purchased 455,855 shares under this plan for a total of approximately $1.7 million. |
| (2) | Includes 5,416 shares held by the 12557 Limited Partnership, which Mr. Dawson is the controlling general partner. |
| (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 without a premium. 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.
Please refer to Note G – Related Party Transactions in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K, for information regarding our related party transactions, which are incorporated herein by reference.
During the years ended December 31, 2008 and 2007, Moore Stephens Wurth Frazer and Torbet, LLP (“Moore Stephens”) provided various audit, audit related and non-audit services to us as follows:
| | | December 31, 2008 | | | December 31, 2007 | |
| Audit Fees | | $ | 296,000 | | | $ | 335,000 | |
| 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 from May 6, 2003 to April 1, 2006, were approved by the Audit Committee of Vestin Group, all services performed after April 1, 2006, were approved by our Audit Committee, 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.
The following are filed as part of this Report:
(a) 1. Financial Statements
The list of the financial statements contained herein are contained in Part II, Item 8 Financial Statements and Supplementary Data on this Annual Report on Form 10-K, which is hereby incorporated by reference.
(a) 2. Financial Statement Schedules
The list of the financial statements schedules contained herein are contained in Part II, Item 8 Financial Statements and Supplementary Data on this Annual Report on Form 10-K, which is hereby incorporated by reference.
(a) 3. Exhibits
| Exhibit No. | | Description of Exhibits |
| 2.1 (2) | | Agreement and Plan of Merger between Vestin Fund II, LLC and the Registrant |
| 3.1 (1) | | Articles of Incorporation of the Registrant |
| 3.2 (1) | | Bylaws of the Registrant |
| 3.3 (1) | | Form of Articles Supplementary of the Registrant |
| 3.4 (5) | | Amendment to Vestin Realty Mortgage II’s Articles of Incorporation, effective December 31, 2007. |
| 3.5 (5) | | Amendment to Vestin Realty Mortgage II’s Articles of Incorporation, effective December 31, 2007. |
| 3.6 (6) | | Amended Articles of Incorporation of the Registrant |
| 4.1 (1) | | Reference is made to Exhibits 3.1, 3.2 and 3.3 |
| 4.2 (2) | | Specimen Common Stock Certificate |
| 4.3 (1) | | Form of Rights Certificate |
| 4.4 (4) | | Junior Subordinated Indenture |
| 4.5 (8) | | Letter Agreement dated November 7, 2008 pertaining to Junior Subordinated Indenture |
| | |
| | |
| 10.1 (1) | | Form of Management Agreement between Vestin Mortgage, Inc. and the Registrant |
| 10.2 (1) | | Form of Rights Agreement between the Registrant and the rights agent |
| 10.9 (4) | | Form of Purchase Agreement |
| 10.10 (4) | | Amended and Restated Trust Agreement |
| 10.11 (7) | | Intercreditor Agreement, dated June 16, 2008, by and between Vestin Originations, Inc., Vestin Mortgage, Inc., Vestin Realty Mortgage II, Inc., and Owens Mortgage Investment Fund |
| 21.1 (2) | | List of subsidiaries of the Registrant |
| | |
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| 99.2R (3) | | Vestin Realty Mortgage II, Inc. Code of Business Conduct and Ethics |
| (1) | | 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). |
| (2) | | 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). |
| (3) | | 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) |
| (4) | | Incorporated herein by reference to the Current Report on Form 8-K filed on June 27, 2007 (File No. 000-51892) |
| (5) | | Incorporated herein by reference to the Current Report on Form 8-K filed on January 4, 2008 (File No. 000-51892) |
| (6) | | Incorporated herein by reference to the Annual Report on Form 10-K filed on March 14, 2008 (File No. 000-51892) |
| (7) | | Incorporated herein by reference to the Quarterly Report on Form 10-Q filed on August 11, 2008 (File No. 000-51892) |
| (8) | | Incorporated herein by reference to the Quarterly Report on Form 10-Q filed on November 10, 2008 (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. |
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| | By: | /s/ Michael V. Shustek |
| | | Michael V. Shustek |
| | | President and Chief Executive Officer |
| | Date: | March 26, 2009 |
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 26, 2009 |
| Michael V. Shustek | | (Principal Executive Officer) | | |
| | | | | |
| /s/ Rocio Revollo | | Chief Financial Officer and Director | | March 26, 2009 |
| Rocio Revollo | | (Principal Financial and Accounting Officer) | | |
| | | | | |
| /s/ John E. Dawson | | Director | | March 26, 2009 |
| John E. Dawson | | | | |
| | | | | |
| /s/ Robert J. Aalberts | | Director | | March 26, 2009 |
| Robert J. Aalberts | | | | |
| | | | | |
| /s/ Fredrick J. Zaffarese Leavitt | | Director | | March 26, 2009 |
| Fredrick J. Zaffarese Leavitt | | | | |
| | | | | |
| /s/ Roland M. Sansone | | Director | | March 26, 2009 |
| Roland M. Sansone | | | | |
