UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2007
Or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
SECURITIES EXCHANGE ACT OF 1934 |
Transition Period From _______ To ________
COMMISSION FILE NUMBER 333-125347
VESTIN REALTY MORTGAGE I, INC. |
| (Exact name of registrant as specified in its charter) |
| MARYLAND | 20-4028839 | |
| (State or Other Jurisdiction of | (I.R.S. Employer | |
| Incorporation or Organization) | Identification No.) |
8379 WEST SUNSET ROAD, LAS VEGAS, NEVADA 89113
(Address of Principal Executive Offices) (Zip Code)
Registrant’s Telephone Number: 702.227.0965
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 whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
| Large accelerated filer [ ] | Accelerated filer [X] | Non-accelerated filer [ ] |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act).
Yes [ ] No [X]
As of August 6, 2007, there were 6,872,114 shares of the Company’s Common Stock outstanding.
TABLE OF CONTENTS
Page | ||
PART I - FINANCIAL INFORMATION
ITEM 1. | CONSOLIDATED FINANCIAL STATEMENTS |
VESTIN REALTY MORTGAGE I, INC. | ||||||||
CONSOLIDATED BALANCE SHEETS | ||||||||
ASSETS | ||||||||
June 30, 2007 | December 31, 2006 | |||||||
(Unaudited) | ||||||||
| Assets | ||||||||
| Cash | $ | 1,869,000 | $ | 1,523,000 | ||||
| Certificates of deposit | -- | 150,000 | ||||||
| Investment in marketable securities - related party | 3,129,000 | 1,953,000 | ||||||
| Interest and other receivables | 896,000 | 938,000 | ||||||
| Notes receivable, net of allowance of $621,000 at June 30, 2007 and $885,000 at December 31, 2006 | 94,000 | 102,000 | ||||||
| Real estate held for sale | 3,316,000 | 3,689,000 | ||||||
| Real estate held for sale - seller financed | 7,911,000 | 7,911,000 | ||||||
| Investment in real estate loans, net of allowance for loan losses of $4,396,000 at June 30, 2007 and $4,534,000 at December 31, 2006 | 47,247,000 | 48,631,000 | ||||||
| Assets under secured borrowings | -- | 310,000 | ||||||
| Due from related parties | -- | 1,000 | ||||||
| Other assets | 198,000 | 124,000 | ||||||
| Total assets | $ | 64,660,000 | $ | 65,332,000 | ||||
LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||
| Liabilities | ||||||||
| Accounts payable and accrued liabilities | $ | 233,000 | $ | 307,000 | ||||
| Due to related parties | 35,000 | -- | ||||||
| Secured borrowings | -- | 310,000 | ||||||
| Notes payable | 148,000 | 22,000 | ||||||
| Deposit liability | 1,533,000 | 1,255,000 | ||||||
| Unearned revenue | -- | 69,000 | ||||||
| Dividend payable | 323,000 | 1,030,000 | ||||||
| Total liabilities | 2,272,000 | 2,993,000 | ||||||
| Commitments and Contingencies | ||||||||
| Stockholders' equity | ||||||||
| Preferred stock, $0.0001 par value; 1,000,000 shares authorized; none issued | -- | -- | ||||||
| Common stock, $0.0001 par value; 25,000,000 shares authorized; 6,871,883 share issued and outstanding at June 30, 2007 and 6,869,790 shares issued and outstanding at December 31, 2006 | 1,000 | 1,000 | ||||||
| Additional paid in capital | 62,247,000 | 62,235,000 | ||||||
| Retained earnings | (182,000 | ) | (7,000 | ) | ||||
| Accumulated other comprehensive income | 322,000 | 110,000 | ||||||
| Total stockholders' equity | 62,388,000 | 62,339,000 | ||||||
| Total liabilities and stockholders' equity | $ | 64,660,000 | $ | 65,332,000 | ||||
See review report of Independent Registered Public Accounting Firm.
The accompanying notes are an integral part of these consolidated statements.
- 1 -
CONSOLIDATED STATEMENTS OF OPERATIONS | ||||||||||||||||
(UNAUDITED) | ||||||||||||||||
For The Three Months Ended | For The Three Months Ended | For The Six Months Ended | For The Six Months Ended | |||||||||||||
June 30, 2007 | June 30, 2006 | June 30, 2007 | June 30, 2006 | |||||||||||||
Revenues | ||||||||||||||||
| Interest income from investment in real estate loans | $ | 1,154,000 | $ | 981,000 | $ | 2,331,000 | $ | 2,087,000 | ||||||||
| Dividend income - related party | 68,000 | -- | 105,000 | -- | ||||||||||||
| Recovery of allowance for doubtful notes receivable | 160,000 | -- | 258,000 | -- | ||||||||||||
| Other income | 186,000 | 116,000 | 212,000 | 174,000 | ||||||||||||
| Total revenues | 1,568,000 | 1,097,000 | 2,906,000 | 2,261,000 | ||||||||||||
Operating expenses | ||||||||||||||||
| Management fees-related party | 69,000 | 69,000 | 138,000 | 138,000 | ||||||||||||
| Provision for loan loss | -- | -- | -- | 3,000,000 | ||||||||||||
| Interest expense | 7,000 | 10,000 | 13,000 | 71,000 | ||||||||||||
| Professional fees | 216,000 | 120,000 | 344,000 | 316,000 | ||||||||||||
| Professional fees - related party | 10,000 | 15,000 | 19,000 | 26,000 | ||||||||||||
| Other | 128,000 | 65,000 | 247,000 | 168,000 | ||||||||||||
| Total operating expenses | 430,000 | 279,000 | 761,000 | 3,719,000 | ||||||||||||
Income (loss) from operations | 1,138,000 | 818,000 | 2,145,000 | (1,458,000 | ) | |||||||||||
Income from real estate held for sale | ||||||||||||||||
| Net gain on sale of real estate held for sale | -- | 2,000 | -- | 2,000 | ||||||||||||
| Write down on real estate held for sale | (373,000 | ) | -- | (373,000 | ) | -- | ||||||||||
| Income (expenses) related to real estate held for sale | (31,000 | ) | (3,000 | ) | 4,000 | (19,000 | ) | |||||||||
| Total income (loss) from real estate held for sale | (404,000 | ) | (1,000 | ) | (369,000 | ) | (17,000 | ) | ||||||||
| Income (loss) before provision for income taxes | 734,000 | 817,000 | 1,776,000 | (1,475,000 | ) | |||||||||||
| Provision for income taxes | -- | -- | -- | -- | ||||||||||||
NET INCOME (LOSS) | $ | 734,000 | $ | 817,000 | $ | 1,776,000 | $ | (1,475,000 | ) | |||||||
| Basic and diluted earnings (loss) per weighted average common share / membership unit | $ | 0.11 | $ | 0.12 | $ | 0.26 | $ | (0.21 | ) | |||||||
| Dividends declared per common share / cash distribution to members per membership unit | $ | 0.14 | $ | 0.10 | $ | 0.28 | $ | 0.16 | ||||||||
| Weighted average common shares / membership units | 6,871,260 | 6,867,957 | 6,870,813 | 6,896,712 | ||||||||||||
See review report of Independent Registered Public Accounting Firm.
The accompanying notes are an integral part of these consolidated statements.
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VESTIN REALTY MORTGAGE I, INC. | ||||||||||||||||||||||||
CONSOLIDATED STATEMENTS OF EQUITY AND OTHER COMPREHENSIVE INCOME | ||||||||||||||||||||||||
FOR THE SIX MONTHS ENDED JUNE 30, 2007 | ||||||||||||||||||||||||
(UNAUDITED) | ||||||||||||||||||||||||
Common Stock | ||||||||||||||||||||||||
Number of Shares | Amount | Additional Paid-in-Capital | Retained Earnings | Accumulated Other Comprehensive Income | Total | |||||||||||||||||||
| Stockholders' Equity at December 31, 2006 | 6,869,790 | $ | 1,000 | $ | 62,235,000 | $ | (7,000 | ) | $ | 110,000 | $ | 62,339,000 | ||||||||||||
| Comprehensive Income: | ||||||||||||||||||||||||
| Net Income | 1,776,000 | 1,776,000 | ||||||||||||||||||||||
| Unrealized Gain on Marketable Securities - Related Party | 212,000 | 212,000 | ||||||||||||||||||||||
| Comprehensive Income | 1,988,000 | |||||||||||||||||||||||
| Dividends Declared to Stockholders | (1,951,000 | ) | (1,951,000 | ) | ||||||||||||||||||||
| Reinvestment of Dividends | 2,093 | -- | 12,000 | 12,000 | ||||||||||||||||||||
Stockholders' Equity at June 30, 2007 (Unaudited) | 6,871,883 | $ | 1,000 | $ | 62,247,000 | $ | (182,000 | ) | $ | 322,000 | $ | 62,388,000 | ||||||||||||
See review report of Independent Registered Public Accounting Firm.
The accompanying notes are an integral part of these consolidated statements.
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VESTIN REALTY MORTGAGE I, INC. | ||||||||
CONSOLIDATED STATEMENTS OF CASH FLOWS | ||||||||
(UNADUITED) | ||||||||
For The Six Months Ended | For The Six Months Ended | |||||||
June 30, 2007 | June 30, 2006 | |||||||
Cash flows from operating activities: | ||||||||
| Net income (loss) | $ | 1,776,000 | $ | (1,475,000 | ) | |||
| Adjustments to reconcile net income (loss) to net cash provided by operating activities: | -- | |||||||
| Write down of real estate held for sale | 373,000 | -- | ||||||
| Recovery of allowance for doubtful notes receivable | (258,000 | ) | -- | |||||
| Provision for loan loss | -- | 3,000,000 | ||||||
| Gain on sale of marketable securities | -- | (1,000 | ) | |||||
| Amortized interest income | (69,000 | ) | -- | |||||
| Change in operating assets and liabilities: | -- | |||||||
| Interest and other receivables | 42,000 | 163,000 | ||||||
| Due to/from Manager | 36,000 | 248,000 | ||||||
| Due to VRM II | -- | 4,000 | ||||||
| Other assets | 112,000 | (9,000 | ) | |||||
| Accounts payable and accrued liabilities | (74,000 | ) | 127,000 | |||||
| Net cash provided by operating activities | 1,938,000 | 2,057,000 | ||||||
Cash flows from investing activities: | ||||||||
| Investments in real estate loans | (5,816,000 | ) | (21,055,000 | ) | ||||
| Purchase of investments in real estate loans from: | -- | |||||||
| VRM II | -- | (500,000 | ) | |||||
| Third parties | -- | (75,000 | ) | |||||
| Proceeds from loan payoffs | 7,338,000 | 24,470,000 | ||||||
| Sale of investments in real estate loans to: | -- | |||||||
| VRM II | -- | 1,200,000 | ||||||
| Third parties | -- | 125,000 | ||||||
| Proceeds from sale of investment in real estate held for sale | -- | 25,000 | ||||||
| Legal expenses paid and applied against loan allowance | (138,000 | ) | (126,000 | ) | ||||
| Proceeds from note receivable | 266,000 | 9,000 | ||||||
| Purchase of marketable securities - related party | (964,000 | ) | -- | |||||
| Proceeds from sale of marketable securities | -- | 1,717,000 | ||||||
| Purchase of certificates of deposit | -- | (2,532,000 | ) | |||||
| Proceeds from maturities of certificates of deposit | 150,000 | -- | ||||||
| Proceeds from unearned revenue | -- | 100,000 | ||||||
| Deposit liability | 278,000 | 331,000 | ||||||
| Net cash provided by investing activities | $ | 1,114,000 | $ | 3,689,000 | ||||
See review report of Independent Registered Public Accounting Firm.
The accompanying notes are an integral part of these consolidated statements.
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VESTIN REALTY MORTGAGE I, INC. | ||||||||
CONSOLIDATED STATEMENTS OF CASH FLOWS | ||||||||
(UNAUDITED) | ||||||||
For The Six Months Ended | For The Six Months Ended | |||||||
June 30, 2007 | June 30, 2006 | |||||||
Cash flows from financing activities: | ||||||||
| Principal payments on notes payable | $ | (60,000 | ) | $ | (923,000 | ) | ||
| Dividends paid to stockholders, net of reinvestments | (2,570,000 | ) | -- | |||||
| Dividends paid to stockholders, net of reinvestments - related party | (76,000 | ) | -- | |||||
| Members' distributions, net of reinvestments | -- | (1,668,000 | ) | |||||
| Members' distributions - related party | -- | (25,000 | ) | |||||
| Members' redemptions | -- | (6,377,000 | ) | |||||
| Net cash used in financing activities | (2,706,000 | ) | (8,993,000 | ) | ||||
NET CHANGE IN CASH | 346,000 | (3,247,000 | ) | |||||
Cash, beginning of period | 1,523,000 | 7,884,000 | ||||||
Cash, end of period | $ | 1,869,000 | $ | 4,637,000 | ||||
Supplemental disclosures of cash flows information: | ||||||||
| Interest paid | $ | 7,000 | $ | 71,000 | ||||
| Non-cash investing and financing activities: | ||||||||
| Dividend payable | $ | 323,000 | $ | -- | ||||
| Adjustment to note receivable and related allowance | $ | 6,000 | $ | -- | ||||
| Payoffs of loans funded through secured borrowings | $ | 310,000 | $ | 2,719,000 | ||||
| Loan rewritten with same or similar collateral | $ | 300,000 | $ | -- | ||||
| Unearned revenue from loans rewritten with same or similar property as collateral | $ | 69,000 | $ | 225,000 | ||||
| Reinvestment of dividends | $ | 12,000 | $ | -- | ||||
| Unrealized gain on marketable securities - related party | $ | 212,000 | $ | -- | ||||
See review report of Independent Registered Public Accounting Firm.
The accompanying notes are an integral part of these consolidated statements.
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VESTIN REALTY MORTGAGE I, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2007
(UNAUDITED)
NOTE A — ORGANIZATION
Vestin Fund I, LLC (“Fund I”) was organized in December 1999 as a Nevada limited liability company for the purpose of investing in real estate loans. Vestin Realty Mortgage I, Inc. (“VRM I”) was organized in January 2006 as a Maryland corporation for the sole purpose of effecting a merger with Fund I. On May 1, 2006, Fund I merged into VRM I and the members of Fund I received one share of VRM I’s common stock for each membership unit of Fund I. References in this report to the “Company”, “we”, “us” or “our” refer to Fund I with respect to the period prior to May 1, 2006 and to VRM I with respect to the period commencing on May 1, 2006. Because we were a limited liability company (“LLC”) during the prior periods reflected in this report, we make reference to Fund I’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 August 2000.
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, Inc., which is engaged in asset management, real estate lending and other financial services though its subsidiaries. Our manager, prior to June 30, 2006, also operated as a licensed Nevada mortgage broker and was engaged in the business of brokerage, placement and servicing of commercial loans secured by real property. On July 1, 2006, the mortgage broker license was issued to an affiliated company, Vestin Originations, Inc. that has continued the business of brokerage, placement and servicing of commercial real estate loans. Vestin Originations, Inc. is a wholly owned subsidiary of Vestin Group.
Pursuant to our management agreement, our manager implements our business strategies on a day-to-day basis, manages and provides services to us, and provides similar services to any of 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 under the particular circumstances. Consequently, our operating results are dependent upon our manager’s ability and performance in managing our operations and servicing our assets.
Vestin Mortgage, Inc. is also the manager of Vestin Realty Mortgage II, Inc., as the successor by merger to Vestin Fund II, LLC (“Fund II”), referred to as (“VRM II”), Vestin Fund III, LLC (“Fund III”) and inVestin Nevada, Inc., a company wholly owned by our manager’s CEO. These entities also invest in real estate loans.
The consolidated financial statements include the accounts of us and our wholly owned taxable REIT subsidiary, TRS I, Inc. All significant inter-company transactions and balances have been eliminated in consolidation.
NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Management Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the 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.
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 provided the price does not exceed the par value of the loan. The primary purpose is to either free up capital to provide liquidity for various reasons, such as loan diversification, or place excess capital in investments to maximize the use of our capital. Selling or buying loans allows us to diversify our loan portfolio within these parameters. Due to the short-term nature of the loans we make and the similarity of interest rates in loans we normally would invest in, the fair value of a loan typically approximates its carrying value. Accordingly, discounts or premiums typically do not apply upon sales of loans and therefore, generally no gain or loss is recorded on these transactions, regardless of whether to a related or unrelated party.
Investments in real estate loans are secured by deeds of trust or mortgages. Generally, our real estate loans require interest only payments with a balloon payment of the principal at maturity. We have both the intent and ability to hold real estate loans until maturity and therefore, real estate loans are classified and accounted for as held for investment and are carried at amortized cost. Loans sold to or purchased from affiliates are accounted for at the principal balance and no gain or loss is recognized by us or any affiliate. Loan to value ratios are based on appraisals obtained at the time of loan origination and may not reflect subsequent changes in value estimates. Such appraisals are generally dated within 12 months of the date of loan origination and may be commissioned by the borrower. The appraisals may be for the current estimate of the “as-if developed” value of the property, which approximates the post-construction value of the collateralized property assuming that such property is developed. As-if developed values on raw land loans or acquisition and development loans often dramatically exceed the immediate sales value and may include anticipated zoning changes and timely successful development by the purchaser. As most of the appraisals will be prepared on an as-if developed basis, if a loan goes into default prior to any development of a project, the market value of the property may be substantially less than the appraised value. As a result, there may be less security than anticipated at the time the loan was originally funded. If there is less security and a default occurs, we may not recover the full amount of the loan.
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. Subsequent recoveries of amounts previously charged off are added back to the allowance or included as income.
Estimating allowances for loan losses requires significant judgment about the underlying collateral, including liquidation value, condition of the collateral, competency and cooperation of the related borrower and specific legal issues that affect loan collections or taking possession of the property. As a 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 approves loans more quickly than other real estate lenders and, due to our expedited underwriting process, there is a risk that the credit inquiry we perform will not reveal all material facts pertaining to a borrower and the security.
Additional facts and circumstances are discovered as we continue our efforts in the collection and foreclosure processes. This additional information often causes management to reassess its estimates. In recent years, we have revised estimates of our allowance for loan losses. Circumstances that may cause significant changes in our estimated allowance include, but are not limited to:
| · | Declines in real estate market conditions, which can cause a decrease in expected market value; |
| · | Discovery of undisclosed liens for community improvement bonds, easements and delinquent property taxes; |
| · | Lack of progress on real estate developments after we advance funds. We customarily utilize disbursement agents to monitor the progress of real estate developments and approve loan advances. After further inspection of the related property, progress on construction occasionally does not substantiate an increase in value to support the related loan advances; |
| · | Unanticipated legal or business issues that may arise subsequent to loan origination or upon the sale of foreclosed upon property; and |
| · | Appraisals, which are only opinions of value at the time of the appraisal, may not accurately reflect the value of the property. |
Real Estate Held For Sale
Real estate held for sale includes real estate acquired through foreclosure and will be carried at the lower of the recorded amount, inclusive of any senior indebtedness, or the property's estimated fair value, less estimated costs to sell, with fair value based on appraisals and knowledge of local market conditions. While pursuing foreclosure actions, 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 occasionally foreclose on loans with raw land or developments in progress, available financing for such properties is often limited and we frequently provide financing up to 100% of the selling price on these properties. In addition, we may make additional loans to the buyer to continue development of a property. Although sale agreements are consummated at closing, they lack adequate initial investment by the buyer to qualify as a sales transaction as defined in FAS 66. These sale agreements are not recorded as a sale until the requirements of FAS 66 are met.
These sale agreements are recorded under the deposit method or cost recovery method as defined in FAS 66. Under the deposit method, no profit is recognized and any cash received from the buyer is reported as a deposit liability on the balance sheet. Under the cost recovery method, no profit is recognized until payments by the buyer exceed the carrying basis of the property sold. Principal payments received will reduce the related receivable, and interest collections will be recorded as unrecognized gross profit on the balance sheet. The carrying values of these properties are included in real estate held for sale on the accompanying consolidated balance sheets.
In cases where the investment by the buyer is significant (generally 20% or more) and the buyer has an adequate continuing investment, the purchase money debt is not subject to future subordination, and a full transfer of risks and rewards has occurred, we will use the full accrual method. Under the full accrual method, a sale is recorded and the balance remaining to be paid is recorded as a normal note. Interest is recorded as income when received.
Classification of Operating Results from Real Estate Held for Sale
FAS 144 – Accounting for the Impairment or Disposal of Long-Lived Assets ("FAS 144'') generally requires operating results from long lived assets held for sale to be classified as discontinued operations as a separately stated component of net income. 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 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 II 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 II. The securities are stated at fair value as determined by the market price as of June 30, 2007. All securities are classified as available-for-sale under the provisions of FAS 115 – Accounting for Certain Investments in Debt and Equity Securities.
Fair Value of Financial Instruments
FAS 107 – Disclosures about Fair Value of Financial Instruments (“FAS 107”) requires the determination of fair value of our financial assets. The following methods and assumptions were used to estimate the fair value of financial instruments included in the following categories:
| (a) | Certificate of Deposits and Short-Term Investments: The carrying amounts of these instruments are at amortized cost, which approximates fair value. |
| (b) | Investment in Real Estate Loans: The carrying value of these instruments, net of the allowance for loan losses, approximates the fair value due to their short-term maturities. Fair values for loans, which are delinquent and/or in foreclosure are determined by underlying collateral securing the loans. |
| (c) | Assets under Secured Borrowing: The carrying amount of these instruments approximate fair value. The fair value is estimated based upon projected cash flows discounted at the estimated current interest rates at which similar loans would be made. |
At June 30, 2007 and December 31, 2006, the estimated fair values of the real estate loans, including seller financed loans, were approximately $52.5 million and $54.2 million, respectively. These estimates were based upon the present value of expected cash flows discounted at rates currently available for similar loans. Fair value estimates are made at a specific point in time; based on relevant market information; are subjective in nature; and involve uncertainties and matters of significant judgment. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that would be collected upon maturity or disposition of the loans.
Basic and Diluted Earnings Per Common Share
Basic earnings per share (“EPS”) is computed, in accordance with FAS 128 – Earnings per Share (“FAS 128”), by dividing net income available to common stockholders by the weighted average number of common shares outstanding. Diluted EPS is similar to basic EPS except that the weighted average number of common shares outstanding is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been exercised. We had no outstanding common share equivalents during the six months ended June 30, 2007. The following is a computation of the EPS data for the six months ended June 30, 2007:
For the Three Months Ended June 30, 2007 | For the Six Months Ended June 30, 2007 | |||||||
| Net income available to common stockholders | $ | 734,000 | $ | 1,776,000 | ||||
| Weighted average number of common shares outstanding during the period | 6,871,260 | 6,870,813 | ||||||
| Basic and diluted earnings per common share | $ | 0.11 | $ | 0.26 | ||||
Net Income Allocated to Members Per Weighted Average Membership Unit
Fund I 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. The following is a computation of the net income per weighted average membership unit for the four months ended April 30, 2006, basic earnings per share for the two months ended June 30, 2007 and total earnings per weighted average share/membership unit for the six months ended June 30, 2007:
For the Four Months Ended April 30, 2006 | For the Two Months Ended June 30, 2006 | For the Six Months Ended June 30, 2006 | ||||||||||
| Net income (loss) available to common stockholders / members | $ | (2,016,000 | ) | $ | 541,000 | $ | (1,475,000 | ) | ||||
| Weighted average number of common shares / units outstanding during the period | 6,910,950 | 6,868,740 | 6,896,712 | |||||||||
| Basic and diluted earnings (loss) per common share / membership unit | $ | (0.29 | ) | $ | 0.08 | $ | (0.21 | ) | ||||
Common Stock Dividends
Cash dividends declared during the six months ended June 30, 2007, were $0.28 per common share.
On July 23, 2007, the Board of Directors declared a monthly cash dividend of $0.047 per share for the month of July 2007, that will be paid on August 30, 2007, to the stockholders of record as of August 9, 2007.
Segments
We operate as one business segment.
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.
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 after net loss carry forward for the six months ended June 30, 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 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. As of June 30, 2007 and December 31, 2006, we had approximately $1.3 million and $1.5 million, respectively, in excess of the federally insured limits.
As of June 30, 2007, 44%, 16%, 9% and 9% of our loans were in Nevada, Hawaii, Arizona and Oregon, respectively, compared to 35%, 15%, 9% and 9%, at December 31, 2006, respectively. As a result of this geographical concentration of our real estate loans, a downturn in the local real estate markets in these states could have a material adverse effect on us.
At June 30, 2007, the aggregate amount of loans to our four largest borrowers represented 34.13% of our total investment in real estate loans, including loans related to seller financed real estate held for sale. These real estate loans consisted of commercial and land loans, located in Nevada and Hawaii with a first lien position, interest rates between 5% and 14%, with an aggregate outstanding balance of approximately $20.2 million and maturing through September 2007. At December 31, 2006, the aggregate amount of loans to our four largest borrowers represented 33.37% of our total investment in real estate loans including loans related to seller financed real estate held for sale. These real estate loans consisted of commercial and land located in Hawaii and Nevada, with a first lien position, interest rates between 5% and 14%, with an aggregate outstanding balance of approximately $20.3 million. The loans in Hawaii described above referred to the RighStar loans discussed in Note D – Investments in Real Estate Loans. We have a significant concentration of credit risk with our four largest borrowers, a default by any of such borrowers 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. An increase in interest rates over the loan rate applicable at origination of the loan may have an adverse effect on the borrower’s ability to refinance.
NOTE D — INVESTMENTS IN REAL ESTATE LOANS
As of June 30, 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, with the exception of one of our loans that had both principal and interest payments along with a “balloon” payment at the end of the term. As of June 30, 2007, this loan had a balance of approximately $7.5 million and had an original term of thirty-six months, maturing in the next three months.
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 June 30, 2007, we had approximately $4.9 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 $56.2 million. These loans had interest reserves of approximately $1.8 million, of which our portion was approximately $0.2 million. At December 31, 2006, we had approximately $17.1 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 $120.3 million. These loans had interest reserves of approximately $5.6 million, of which our portion was approximately $0.7 million.
As of June 30, 2007, 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 5% to 14%. Revenue by product will fluctuate based upon relative balances during the period.
Investments in real estate loans including loans related to seller financed real estate held for sale, as of June 30, 2007, were as follows:
Loan Type | Number Of Loans | Balance (2) | Weighted Average Interest Rate | Portfolio Percentage | Weighted Average Loan To Value (1) | |||||||||||||||
| Acquisition and development | 4 | $ | 3,450,000 | 12.41% | 5.84% | 65.96% | ||||||||||||||
| Commercial | 16 | 38,108,000 | 10.46% | 64.50% | 80.95% | |||||||||||||||
| Construction | 6 | 3,327,000 | 11.48% | 5.63% | 70.64% | |||||||||||||||
| Land | 6 | 13,200,000 | 12.43% | 22.34% | 58.90% | |||||||||||||||
| Residential | 1 | 1,000,000 | 12.00% | 1.69% | 80.00% | |||||||||||||||
| 33 | $ | 59,085,000 | 11.10% | 100.00% | 74.55% | |||||||||||||||
Investments in real estate loans including loans related to seller financed real estate held for sale, as of December 31, 2006 were as follows:
Loan Type | Number Of Loans | Balance (2) | Weighted Average Interest Rate | Portfolio Percentage | Weighted Average Loan To Value (1) | |||||||||||||||
| Acquisition and development | 4 | $ | 2,788,000 | 12.01% | 4.60% | 64.20% | ||||||||||||||
| Commercial | 14 | 36,072,000 | 9.99% | 59.43% | 81.44% | |||||||||||||||
| Construction | 6 | 5,994,000 | 11.68% | 9.87% | 64.66% | |||||||||||||||
| Land | 9 | 15,843,000 | 12.31% | 26.10% | 52.16% | |||||||||||||||
| 33 | $ | 60,697,000 | 10.85% | 100.00% | 71.35% | |||||||||||||||
| (1) | Loan to value ratios are based on the most recent appraisals and may not reflect subsequent changes in value. Such appraisals, which may be commissioned by the borrower, are generally dated no greater than 12 months prior to the date of loan origination. The appraisals may be for the current estimate of the “as-if developed” value of the property, which approximates the post-construction value of the collateralized property assuming that such property is developed. “As-if developed” values on raw land loans or acquisition and development loans often dramatically exceed the immediate sales value and may include anticipated zoning changes, and successful development by the purchaser; upon which development is dependent on availability of financing. As most of the appraisals will be prepared on an “as-if developed” basis, if a loan goes into default prior to completion of the development of the project, the market value of the property may be substantially less than the appraised value. As a result, there may be less security than anticipated at the time the loan was originally made. If there is less security and a default occurs, we may not recover the full amount of the loan. |
| (2) | The following table reconciles the balance of the loan portfolio to the amount shown on the accompanying Consolidated Balance Sheets. The contra accounts represent the amount of real estate held for sale sold to third parties where we provided financing. GAAP requires the borrower to have a certain percentage of equity ownership (ranging from 10% to 25%) to allow us to record the sale of a property. In addition, the borrower must maintain a minimum commitment in the property on a continuing basis. Therefore, until the borrower meets this requirement, the investment in the new loan is reduced by the amount originally invested in the real estate held for sale. |
June 30, 2007 Balance | December 31, 2006 Balance | |||||||
| Balance per loan portfolio | $ | 59,085,000 | $ | 60,697,000 | ||||
| Less: | ||||||||
| Seller financed loans included in real estate held for sale | (7,911,000 | ) | (7,911,000 | ) | ||||
| Proceeds of principal on seller financed loans included in deposit liability | 469,000 | 379,000 | ||||||
| Allowance for loan losses | (4,396,000 | ) | (4,534,000 | ) | ||||
| Balance per consolidated balance sheet | $ | 47,247,000 | $ | 48,631,000 | ||||
The following is a schedule of priority of real estate loans, including loans related to seller financed real estate held for sale as of June 30, 2007 and December 31, 2006:
Loan Type | Number of Loans | June 30, 2007 Balance* | Portfolio Percentage | Number of Loans | December 31, 2006 Balance* | Portfolio Percentage | ||||||||||||||||||
| First deeds of trust | 31 | $ | 58,069,000 | 98.28% | 31 | $ | 60,359,000 | 99.44% | ||||||||||||||||
| Second deeds of trust | 2 | 1,016,000 | 1.72% | 2 | 338,000 | 0.56% | ||||||||||||||||||
| 33 | $ | 59,085,000 | 100.00% | 33 | $ | 60,697,000 | 100.00% | |||||||||||||||||
* Please see (2) above
The following is a schedule of contractual maturities of investments in real estate loans, including loans related to seller financed real estate held for sale, as of June 30, 2007:
| July 2007 – September 2007 | $ | 38,400,000 | ||
| October 2007 – December 2007 | 10,750,000 | |||
| January 2008 – March 2008 | 6,219,000 | |||
| April 2008 – June 2008 | 716,000 | |||
| July 2008 – September 2008 | 3,000,000 | |||
| Thereafter | -- | |||
| Total | $ | 59,085,000 |
The following is a schedule by geographic location of investments in real estate loans, including loans related to seller financed real estate held for sale, as of June 30, 2007 and December 31, 2006:
June 30, 2007 Balance* | Portfolio Percentage | December 31, 2006 Balance* | Portfolio Percentage | |||||||||||||
| Arizona | $ | 5,500,000 | 9.31% | $ | 5,509,000 | 9.08% | ||||||||||
| California | 3,750,000 | 6.35% | 6,988,000 | 11.51% | ||||||||||||
| Hawaii | 9,307,000 | 15.75% | 9,307,000 | 15.33% | ||||||||||||
| Nevada | 26,005,000 | 44.01% | 21,310,000 | 35.11% | ||||||||||||
| New York | 2,819,000 | 4.77% | 3,246,000 | 5.35% | ||||||||||||
| Oklahoma | 1,937,000 | 3.28% | 1,937,000 | 3.19% | ||||||||||||
| Oregon | 5,200,000 | 8.80% | 5,200,000 | 8.57% | ||||||||||||
| Texas | 4,167,000 | 7.05% | 4,168,000 | 6.87% | ||||||||||||
| Washington | 400,000 | 0.68% | 3,032,000 | 4.99% | ||||||||||||
| Total | $ | 59,085,000 | 100.00% | $ | 60,697,000 | 100.00% | ||||||||||
* Please see (2) above
At June 30, 2007, the following loans were non-performing (based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due); RightStar (Part I & Part II), Monterrey Associates LP, Forest Development LLC and Pirates Lake, LTD. These loans are currently carried on our books at a value of approximately $9.8 million, net of allowance for loan losses of approximately $4.4 million for the RightStar loans. These loans have been placed on non-accrual of interest status and are the subject of pending foreclosure proceedings.
| · | RightStar (Part I & Part II) are loans secured by a lien on the business and virtually all of the property of RightStar, which includes 4 cemeteries and 8 mortuaries in Hawaii with an outstanding balance of approximately $32.3 million of which our portion is approximately $9.3 million ($4.4 million for Part I and $4.9 million for Part II). The lenders have commenced a judicial foreclosure on the loans, Part I and Part II. |
| · | Monterrey Associates, L.P., is a loan secured by a 248 Unit apartment complex in Oklahoma City, OK, along with other real estate collateral, with an outstanding balance of approximately $4.4 million of which our portion is approximately $1.2 million. The loan is ten months in arrears in payments of interest. Our manager has commenced foreclosure proceedings and is filing litigation to enforce the personal guarantee on the loan. Our manager has evaluated this loan and concluded that the value of the underlying collateral is sufficient to protect us from loss of principal. No specific allowance was deemed necessary. In addition, our manager completed foreclosure proceedings on a second mortgage on a 233 unit apartment complex during the three months ended March 31, 2007. We obtained title to the property subject to a non-recourse first mortgage, which was held by an unrelated third party. During the three months ended March 31, 2007, we sold this property to an unrelated third party who is subject to the non-recourse first mortgage. This transaction did not result in any gain or loss. |
| · | Forest Development, LLC, is a loan secured by two 4,000 square foot single family residences, together with the four remaining lots in a subdivision, located on Mt. Charleston, NV with an outstanding balance of approximately $2.6 million of which our portion is approximately $0.6 million. The loan is eight months in arrears in payment of interest. Our manager has commenced foreclosure proceedings and has filed litigation to enforce the personal guarantee on the loan. Forest Development subsequently counterclaimed and also filed a separate lawsuit against us, VRM II, Fund I, Fund II, Fund III, Vestin Mortgage, Inc. and Vestin Originations, Inc (the “Defendants”) alleging that the Defendants breached the construction loan agreement and thus jeopardized the completion of the project alleging actions for fraud, breach of fiduciary duty, breach of Construction Loan Agreement, negligence, intentional interference with contractual relations, bad faith breach of contract, conversion, undue and improper control and interference over borrower’s business, joint venture or de facto partnership, and injunctive relief. The lawsuit seeks monetary damages, punitive damages, and seeks an injunction to stop the foreclosure. The Defendants believe that the allegations are without merit and that they have adequate defenses. The Defendants intend to undertake a vigorous defense. In April 2007, the borrower filed for protection under Chapter 11 of the United State Bankruptcy Code. Our manager has evaluated this loan and concluded that the value of the underlying collateral is sufficient to protect us from loss of principal. No specific allowance was deemed necessary. |
| · | Pirates Lake, LTD., is a loan to provide bridge financing for approximately 46.75 acres of land in Galveston, TX, with an outstanding balance of approximately $8.5 million of which our portion is approximately $3.0 million. The loan is secured by a first lien on the property and guaranteed by the borrower. Additionally, the loan is secured by a second position lien on approximately 0.5 acres of land located in Houston, Texas. The loan is two months in arrears in payments of interest. Our manager has commenced foreclosure proceedings. On August 7, 2007, we, VRM II and Fund III entered into a settlement agreement with the borrower whereby the foreclosure was postponed. Principal, accrued interest and $75,000 for expenses incurred by us, VRM II and Fund III relating to the loan is now due on October 1, 2007. Our manager has evaluated this loan and concluded that the value of the underlying collateral is sufficient to protect us from loss of principal. No specific allowance was deemed necessary. |
The following schedule summarizes the non-performing loans as of June 30, 2007:
Description of Collateral | Balance at June 30, 2007 | Maturity Date | Number of Months Non-Performing | Percentage of Total Loan Balance | |||||||||
| 4 cemeteries and 8 mortuaries in Hawaii Part I** | $ | 4,415,000 | 3/31/2004 | 39 | 24% of Part I | ||||||||
| 4 cemeteries and 8 mortuaries in Hawaii Part II** | 4,892,000 | 3/31/2004 | 39 | 35% of Part II | |||||||||
| 248-unit apartment complex in Oklahoma City, OK | 1,237,000 | 9/1/2006 | 10 | 28% | |||||||||
| 2 single family residences and 4 lots in Mt. Charleston, NV | 631,000 | 10/27/2006 | 8 | 24% | |||||||||
| 46.75 acres of land located in Galveston, TX | 3,000,000 | 6/30/2007 | 2 | 35% | |||||||||
| $ | 14,175,000 | ||||||||||||
** Please refer to (3) Specific Reserve Allowance below.
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 June 30, 2007, we have provided a specific reserve related to the two loans secured by 4 cemeteries and 8 mortuaries in Hawaii (“RightStar loans”), of approximately $4.4 million. Our manager evaluated the loans and concluded that the remaining underlying collateral was sufficient to protect us against further losses of principal. Our manager will continue to evaluate these loans in order to determine if any other allowance for loan losses should be recorded.
Because any decision regarding the allowance for loan losses reflects a judgment about the probability of future events, there is an inherent risk that such judgments will prove incorrect. In such event, actual losses may exceed (or be less than) the amount of any reserve. To the extent that we experience losses greater than the amount of our reserves, we may incur a charge to our earnings that will adversely affect our operating results and the amount of any distributions payable to our stockholders.
The following is a roll-forward of the allowance for loan losses for the six months ended June 30, 2007
Description | Balance at December 31, 2006 | Specific Reserve Allocation | RightStar Legal Reserve | Balance at June 30, 2007 | ||||||||||||
| Specific allowance (3) | $ | 4,534,000 | $ | -- | $ | (138,000 | ) | 4,396,000 | ||||||||
| Total | $ | 4,534,000 | $ | -- | $ | (138,000 | ) | $ | 4,396,000 | |||||||
(3) | Specific Reserve Allowance |
RightStar Loan Allowance -RightStar, Inc. (“RightStar”) defaulted on our loans in the fall of 2004. The lenders commenced a judicial foreclosure on the loans, part I and part II, which is secured by a lien on the business and virtually all of the property of RightStar, which includes 4 cemeteries and 8 mortuaries in Hawaii. The aggregate principal balance of the loan is approximately $32.3 million. The loans, part I and part II, are owned as follows:
Senior Principal Amount (Part II) | Junior Principal Amount (Part I) | Total | ||||||||||
| VRM I | $ | 4,892,000 | $ | 4,415,000 | $ | 9,307,000 | ||||||
| VRM II | 9,108,000 | 8,183,000 | 17,291,000 | |||||||||
| 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 II acquired the senior portion of the loan on July 14, 2005 for approximately $15.5 million of which our portion was approximately $5.4 million (including accrued interest of approximately $0.5 million). We and VRM II 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, Inc. purchased the junior principal amount owned by the unrelated third party for $500,000. Vestin Mortgage, Inc. has agreed that any monies it receives as a result of payment of the notes or proceeds from a foreclosure sale are limited to its $500,000 investment in the notes plus expenses.
RightStar is currently being operated by a court appointed receiver.
Foreclosure proceedings are being delayed by the State of Hawaii, which has refused to issue licenses to potential buyers or the lenders to: (1) operate the facility, (2) operate a pre-need program and (3) operate a perpetual care program. During the three months ended March 31, 2006, the State of Hawaii notified the lenders of a potential statutory trust fund deficiency, estimated to be between $20 million and $30 million and claimed that this balance has priority over all lenders. The lenders dispute the amount and priority of this deficit.
In April 2006, the lenders filed suit against the State of Hawaii listing 26 causes of action, including allegations that the State of Hawaii has illegally blocked the lender’s right to foreclose and take title to its collateral by inappropriately attaching conditions to the granting of licenses needed to operate the business, the pre-need trust funds and the perpetual care trust funds and that the State of Hawaii has attempted to force the lenders to accept liability for any statutory trust fund deficits while no such lender liability exists under the laws of the State of Hawaii. The State of Hawaii responded by filing allegations against Vestin Mortgage, Inc. and us alleging that these Vestin entities improperly influenced the former RightStar trustees to transfer trust funds to us.
On May 9, 2007, The State of Hawaii, VRM I, VRM II, Vestin Mortgage and Comerica Incorporated announced that an arrangement has 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 to fund the trusts statutory minimum balances, and to VRM I, VRM II and Vestin Mortgage. The State of Hawaii, VRM I, VRM II, Vestin Mortgage 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. The outcome of this auction cannot be determined at this time.
We have evaluated the estimated value of the underlying collateral, the potential trust fund deficit, and the expected cost and length of litigation. Based on this estimate we increased our total specific reserve allowance for loss by approximately $3.0 million during the twelve months ended December 31, 2006 and specifically allocated our general allowance of approximately $0.4 million to the RightStar loans. The increase in the reserve allowance included approximately $0.5 million for estimated litigation fees and expenses, which we have incurred in enforcing our rights against the underlying collateral. We will continue to evaluate our position in the RightStar loan as the situation progresses. As of June 30, 2007, our specific reserve allowance on the RightStar loans totaled approximately $4.4 million.
In addition, our manager granted extensions on 12 loans pursuant to the terms of the original loan agreements, which permit extensions by mutual consent. Such extensions are generally provided on loans where the original term was 12 months or less and where a borrower requires additional time to complete a construction project or negotiate take-out financing. However, our manager only grants extensions when a borrower is in full compliance with the terms of the loan, including, but not limited to the borrower’s obligation to make interest payments on the loan. Included in the 12 extended loans was the Mid-State Raceway loan, which was extended from March 31, 2007 to March 31, 2008. As part of the extension agreement, the borrower made a principal payment of approximately $3.0 million, of which our portion was approximately $0.4 million, and the loan interest rate increased from 9% to 12%. The aggregate amount due to us from borrowers whose loans had been extended as of June 30, 2007 was approximately $17.9 million. Our manager concluded that no allowance for loan loss was necessary with respect to these loans as of June 30, 2007.
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; |
| · | Historical experience; |
| · | The nature and volume of the loan portfolio; |
| · | The borrowers’ financial condition and adverse situations that may affect the borrowers’ ability to pay; |
| · | Evaluation of industry trends; and |
| · | Estimated net realizable value of any underlying collateral in relation to the loan amount. |
Based upon this evaluation, a determination is made as to whether the allowance for loan losses is adequate to cover any potential losses. Additions to the allowance for loan losses are made by charges to the provision for loan losses. As of June 30, 2007 and December 31, 2006 approximately $4.9 million and $3.4 million, respectively, in non-performing loans had no specific allowance for loan losses. As of June 30, 2007 and December 31, 2006, approximately $9.3 million, in non-performing loans had a specific allowance for loan losses of approximately $4.4 million and $4.5 million, respectively. At June 30, 2007, the following loans were non-performing (based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due); RightStar (Part I & Part II), Monterrey Associates LP, Forest Development LLC and Pirates Lake, LTD. These loans have been placed on non-accrual of interest status and are the subject of pending foreclosure proceedings. Our manager evaluated the loans and concluded that the underlying collateral was sufficient to protect us against further losses of principal or interest. Our manager will continue to evaluate these loans in order to determine if any other allowance for loan losses should be recorded.
NOTE E — INVESTMENT IN MARKETABLE SECURITIES – RELATED PARTY
As of June 30, 2007, we owned 542,349 shares of VRM II’s common stock, representing approximately 1.40% of their total outstanding common stock.
NOTE F — REAL ESTATE HELD FOR SALE
At June 30, 2007, we held one property with a total carrying value of approximately $3.3 million, which was acquired through foreclosure and recorded as investments in real estate held for sale. The summary below includes our percentage ownership in the property. 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. The following is a roll-forward of investments in real estate held for sale during the six months ended June 30, 2007:
Description | Date Acquired | Percentage of Ownership | Balance at December 31, 2006 | Acquisitions (Reductions) | Seller Financed Sales | Proceeds from Sales | Gain on Sale of Real Estate | Balance at June 30, 2007 | |||||||||||||||||||||
480 residential building lots & 2 family dwellings in Cathedral City, CA (1) | 12/21/2006 | 12% | $ | 3,689,000 | $ | (373,000 | ) | $ | -- | $ | -- | $ | -- | $ | 3,316,000 | ||||||||||||||
Total | $ | 3,689,000 | $ | (373,000 | ) | $ | -- | $ | -- | $ | -- | $ | 3,316,000 | ||||||||||||||||
| (1) | During November 2006, we, VRM II 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. As of June 30, 2007, our manager evaluated the carrying value of the acquired property and based on its estimate, our manager has written down the value of the property $3,000,000, of which our portion was $373,000. |
NOTE G — REAL ESTATE HELD FOR SALE – SELLER FINANCED
At June 30, 2007, we held an interest in one property with a total carrying value of approximately $7.9 million, which had been sold in a transaction where we provided the financing to the purchaser. GAAP requires us to include these properties in real estate held for sale until the borrower has met and maintained certain requirements. We may share ownership of such properties with VRM II, Fund III, our manager, or other related and/or unrelated parties. The summary below includes our percentage of ownership in the property held during the six months ended June 30, 2007. These investments in real estate held for sale are accounted for at the lower of cost or fair value less costs to sell with fair value based on appraisals and knowledge of local market conditions. The following is a roll-forward of seller financed real estate held for sale for the six months ended June 30, 2007:
Description | Date Acquired | Percentage of Ownership | Balance at December 31, 2006 | Acquisitions | Sales | Gain (Loss) on Sale | Balance at June 30, 2007 | ||||||||||||||||||
Assisted living facility in Las Vegas, Nevada (1) | 9/23/2004 | 52% | $ | 7,911,000 | $ | -- | $ | -- | $ | -- | $ | 7,911,000 | |||||||||||||
| $ | 7,911,000 | $ | -- | $ | -- | $ | -- | $ | 7,911,000 | ||||||||||||||||
(1) | During September 2004, we and VRM II sold an assisted living facility in Las Vegas, NV and financed 100% of the purchase price of approximately $15.3 million maturing in September 2007. The transaction resulted in no gain or loss. As of June 30, 2007, we had received approximately $1.5 million in payments from the borrower. These principal and interest payments are recorded as a deposit liability. Interest payments will be recognized as income once the equity requirement has been met or the loan is paid in full. |
Until borrowers have met the minimum equity ownership requirement to allow us to record a sale, we will record payments received under the deposit method or the cost recovery method, which ever is applicable in accordance with FAS 66.
NOTE H — RELATED PARTY TRANSACTIONS
From time to time, we may acquire or sell investments in real estate loans from/to our manager or other related parties pursuant to the terms of our Management Agreement provided the price does not exceed the par value of the loan. No gain or loss is recorded on these transactions, as it is not our intent to make a profit on the purchase or sale of such investments. The purpose is generally to diversify our portfolio by syndicating loans, thereby providing us with additional capital to make additional loans.
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 I from the sale of shares or membership units, paid monthly. The amount of management fees paid to our manager for the three and six months ended June 30, 2007 and 2006 was $69,000 and $138,000, respectively for each period.
As of June 30, 2007, our manager owned 100,000 of our common shares. For the three and six months ended June 30, 2007, we declared approximately $14,000 and $28,000, respectively, in dividends payable to our manager based on the number of shares our manager held on the dividend record dates. During the four months ended April 30, 2006, we recorded pro-rata distributions owed to our manager of $25,000 and no dividends were declared during the two months ended June 30, 2006.
Transactions with Other Related Parties
As of June 30, 2007, we owned 542,349 common shares of VRM II, representing approximately 1.40% of their total outstanding common stock. For the three and six months ended June 30, 2007, we recognized $68,000 and $105,000, respectively, in dividend income from VRM II based on the number of shares we held on the dividend record dates.
As of June 30, 2007, VRM II owned 511,025 of our common shares, representing approximately 7.44% of our total outstanding common stock. For the three and six months ended June 30, 2007, we declared approximately $66,000 and $126,000, respectively, in dividends payable to VRM II based on the number of shares VRM II held on the dividend record dates.
During the six months ended June 30, 2006, we sold $1.2 million in real estate loans to VRM II and bought $0.5 million in real estate loans from VRM II. No gain or loss resulted from these transactions.
As of June 30, 2007, we owed to related parties, under common management, $35,000 and as of December 31, 2006, we had receivables from a related party, under common management, of $1,000.
During the three and six months ended June 30, 2007, we incurred $10,000 and $19,000, 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. During the three and six months ended June 30, 2006, we incurred $15,000 and $26,000, respectively, for legal fees to the law firm of Levine, Garfinkel & Katz.
NOTE I — NOTES RECEIVABLE
During October 2004, we and VRM II sold the Castaways Hotel/Casino in Las Vegas, Nevada of which our portion of the net cash proceeds was $2,118,000. We originally sold this property under a 100% seller financing arrangement. The borrowers then sold the property to an unrelated third party that resulted in a payoff of the note and also allowed us to record the sale and remove the asset from seller financed real estate held for sale. In addition, during September 2004, we received a promissory note from the guarantors of the loan in the amount of $160,000 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 $119,000, which is based on a discount rate of 8% as of that date. As of June 30, 2007, we have received $25,000 in principal payments. The outstanding balance as of June 30, 2007, was $102,000, net of allowance of $41,000.
During March 2005, we and VRM II sold the 126 unit hotel in Mesquite, Nevada for $5,473,000 of which our share of the proceeds were approximately $1.8 million, which resulted in a loss of $389,000. In addition, during June 2005, we and VRM II entered into a settlement agreement with the guarantors of the loan in the amount of $2,000,000 in exchange for a release of their personal guarantees of which our share was $640,000. The balance is secured by a second deed of trust and is payable in a first installment of $100,000 due in July 2005 and monthly interest only payments of 5% on $1,100,000 from July 2005 through July 2008, at which time the entire balance is due. As of June 30, 2007, we have received $288,000 in principal payments. Payments will be recognized as income when received. The balance of $352,000 is fully reserved as of June 30, 2007.
During November 2004, we and VRM II sold the 140 Unit/224 beds senior facility in Mesa, Arizona of which our portion of the consideration received totaled $1,009,000. We and VRM II received a promissory note from the original guarantor in the amount of $478,000 of which our portion was $67,000. 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. Beginning June 25, 2006 through May 25, 2009, payments are to increase to $20,000 monthly. Due to the uncertainty of collectibility, we have provided a valuation allowance for the entire remaining balance of the promissory note. Income will be recognized when payments are received. As of June 30, 2007, we received $28,000 in principal payments. The balance of $31,000 is fully reserved as of June 30, 2007.
During December 2005, we and VRM II sold the 460 acre residential subdivision in Lake Travis, TX for approximately $5.5 million, of which our portion was approximately $1.8 million. The purchase price included cash proceeds of $5 million and a $500,000 note receivable with an imputed interest rate of 8% in July 2006. A net gain of $71,000 resulted in this transaction, of which our portion was $24,000. The purchaser has defaulted on the note and our manager pursued litigation. During the six months ended June 30, 2007, we and VRM II entered into a settlement agreement, which reduced the note to $175,000, of which our portion is $60,000. The balance of $60,000 is fully reserved as of June 30, 2007.
During 2006, we and VRM II entered into a settlement agreement in the amount of $1.5 million with the guarantors of a loan that we foreclosed on. Our portion was approximately $137,000. The promissory noted 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. The balance of approximately $137,000 is fully reserved as of June 30, 2007.
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 II 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 October 2006, we, our manager, Vestin Origination, Inc., VRM II and Fund III entered into an intercreditor agreement with an unrelated third party related to the funding of a construction real estate loan. (See exhibit 10.8 Intercreditor Agreement under the Exhibit Index included in Part II – Other Information, Item 6 Exhibits of this Report Form 10-Q). The secured borrowing was recognized pro rata between us, VRM II and Fund III for the amount each entity has funded for the loan. During May 2007, the secured borrowings were paid in full. As of June 30, 2007, we did not have any funds used under Inter-creditor Agreements as compared to approximately $310,000 used under Inter-creditor Agreements as of December 31, 2006.
NOTE K — NOTE PAYABLE
In May 2007, we financed a 12-month insurance policy for Directors and Officers liability, with an annual interest rate of 7.25%. The agreement required a down payment of $34,000 and nine monthly payments of $21,000 beginning on May 27, 2007. As of June 30, 2007, the outstanding balance of the note was approximately $145,000.
In addition, as of June 30, 2007, we had borrowings from a margin account collateralized by securities held at a brokerage firm totaling approximately $3,000.
NOTE L — RECENT ACCOUNTING PRONOUNCEMENTS
In February 2007, the Financial Accounting Standards Board (FASB) issued FAS 159, The Fair Value Option for Financial Assets and Financial Liabilities. FAS 159 permits entities to choose to measure financial assets and liabilities (except for those that are specifically scoped out of the Statement) at fair value. The election to measure a financial asset or liability at fair value can be made on an instrument-by-instrument basis and is irrevocable. The difference between carrying value and fair value at the election date is recorded as a transition adjustment to opening retained earnings. Subsequent changes in fair value are recognized in earnings. The effective date for FAS 159 is as of the beginning of an entity's first fiscal year that begins after November 15, 2007. We are evaluating FAS 159 and have not yet determined the impact the adoption will have on our consolidated financial statements, but it is not expected to be significant.
NOTE M — LEGAL MATTERS INVOLVING THE MANAGER
The United States Securities and Exchange Commission (the “Commission”), conducted an investigation of certain matters related to us, our manager, Vestin Capital, VRM II and Fund III. We fully cooperated during the course of the investigation. On September 27, 2006, the investigation was resolved through the entry of an Administrative Order by the Commission (the “Order”). Our manager, Vestin Mortgage and its Chief Executive Officer, Michael Shustek, as well as Vestin Capital (collectively, the “Respondents”), consented to the entry of the Order without admitting or denying the findings therein. In the Order, the Commission finds that the Respondents violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 through the use of certain slide presentations in connection with the sale of units in Fund III and in Fund II, the predecessor to VRM II. 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 and we do not expect that the sanctions imposed upon the Respondents will have any material affect upon our operations.
VRM II and Vestin Mortgage, Inc. (“Defendants”) are defendants in a breach of contract action filed in San Diego Superior Court by certain plaintiffs who allege, among other things, that they were wrongfully denied appraisal rights in connection with the merger of Fund II into Vestin Realty Mortgage II, Inc. The action is being brought as a purported class action on behalf of all members of Vestin Fund II who did not vote in favor of the merger. The Defendants believe that the allegations are without merit and that they have adequate defenses. The Defendants intend to undertake a vigorous defense. The terms of our management agreement and Fund II’s Operating Agreement contain indemnity provisions whereby, Vestin Mortgage and Michael V. Shustek may be eligible for indemnification by VRM II with respect to the above actions.
VRM II, Vestin Mortgage, Inc. and Michael V. Shustek (“Defendants”) are defendants in a civil action filed by 88 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 II into VRM II. The action seeks monetary damages and a rescission of the REIT conversion. The Defendants believe that the allegations are without merit and that they have adequate defenses. The Defendants intend to undertake a vigorous defense. The terms of VRM II’s management agreement and Fund II’s operating agreement contain indemnity provisions whereby, Vestin Mortgage and Michael V. Shustek may be eligible for indemnification by VRM II 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 pending state court litigation involving Desert Land as further described below and the matters described in Note N – Legal Matters Involving the Company below, 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 the manager’s net income in any particular period.
NOTE N — LEGAL MATTERS INVOLVING THE COMPANY
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 Ninth Circuit United Court of Appeals, 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. On March 6, 2006, Desert Land amended the state court complaint to name us. Desert Land alleges that one or more of the defendants have transferred assets to other entities without receiving reasonable value therefore; alleges plaintiffs are informed and believe that defendants have made such transfers with the actual intent to hinder, delay or defraud Desert Land; that such transfers made the transferor insolvent and that sometime between February 27 and April 1, 2003, Vestin Group transferred $1.6 million to VRM I for that purpose. The state court complaint further alleges that Desert Land is entitled to avoid such transfers and that pursuant to NRS 112.20, Desert Land is entitled to an injunction to enjoin defendants from further disposition of assets. Additionally, Del Mar Mortgage, Inc. has indemnified Vestin Group and Vestin Mortgage for any losses and expenses in connection with the action, and Mr. Shustek has guaranteed the indemnification. The Defendants believe that the allegations are without merit and that they have adequate defenses. The Defendants intend to undertake a vigorous defense.
In April 2006, the lenders filed suit against the State of Hawaii listing 26 causes of action, including allegations that the State of Hawaii has illegally blocked the lender’s right to foreclose and take title to its collateral by inappropriately attaching conditions to the granting of licenses needed to operate the business, the pre-need trust funds and the perpetual care trust funds and that the State of Hawaii has attempted to force the lenders to accept liability for any statutory trust fund deficits while no such lender liability exists under the laws of the State of Hawaii. The State of Hawaii responded by filing allegations against Vestin Mortgage, Inc. and VRM II alleging that these Vestin entities improperly influenced the former RightStar trustees to transfer trust funds to VRM II.
On May 9, 2007, The State of Hawaii, VRM I, VRM II, Vestin Mortgage and Comerica Incorporated announced that an arrangement has 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 to fund the trusts statutory minimum balances, and to VRM I, VRM II and Vestin Mortgage. The State of Hawaii, VRM I, VRM II, Vestin Mortgage 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. The outcome of this auction cannot be determined at this time.
We and Vestin Mortgage, Inc. (“Defendants”) are defendants in a breach of contract action filed in San Diego Superior Court by certain plaintiffs who allege, among other things, that they were wrongfully denied appraisal rights in connection with the merger of Fund I into Vestin Realty Mortgage I, Inc. The action is being brought as a purported class action on behalf of all members of Vestin Fund I who did not vote in favor of the merger. The Defendants believe that the allegations are without merit and that they have adequate defenses. The Defendants intend to undertake a vigorous defense. The terms of our management agreement and Fund I’s Operating Agreement contain indemnity provisions whereby, Vestin Mortgage and Michael V. Shustek may be eligible for indemnification by us with respect to the above actions.
We, Vestin Mortgage, Inc. and Michael V. Shustek (“Defendants”) are defendants in a civil action filed by 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 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, we are involved in a number of other legal proceedings concerning matters arising in connection with the conduct of our business activities. We believe we have meritorious defenses to each of these actions and intend to defend them vigorously. Other than the matters described above, we believe that we are not a party to any pending legal or arbitration proceedings that would have a material adverse effect on our financial condition or results of operations or cash flows, although it is possible that the outcome of any such proceedings could have a material impact on our net income in any particular period.
NOTE O — DIVIDEND REQUIREMENT
To maintain our status as a REIT, we are required to make dividend distributions, other than capital gain dividends, to our stockholders each year in an amount at least equal to (1) the sum of (a) 90% of our taxable income, computed without regards to the dividends paid deduction and our net capital gain, and (b) 90% of the net income, after tax, from foreclosure property, minus (2) the sum of certain specified items of non-cash income over 5% of our REIT taxable income. All dividend distributions will be made at the discretion of our Board of Directors and will depend on our earnings, both tax and GAAP, financial condition, maintenance of REIT status and such other factors as the Board of Directors deems relevant.
NOTE P — SUBSEQUENT EVENTS
On July 23, 2007, the Board of Directors declared a monthly cash dividend of $0.047 per share for the month of July 2007, that will be paid on August 30, 2007, to the stockholders of record as of August 9, 2007.
On August 7, 2007, we, VRM II and Fund III entered into a settlement agreement with the borrower of Pirates Lake, LTD. whereby the foreclosure was postponed. Principal, accrued interest and $75,000 for expenses incurred by us, VRM II and Fund III relating to the loan is now due on October 1, 2007.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Vestin Realty Mortgage I, Inc.:
We have reviewed the accompanying consolidated balance sheet of Vestin Realty Mortgage I, Inc. and its subsidiary as of June 30, 2007, the related consolidated statements of operations for the three-month and six-month periods ended June 30, 2007 and 2006, the related consolidated statement of equity and other comprehensive income for the six-month period ended June 30, 2007 and the related consolidated statements of cash flows for the six-month periods ended June 30, 2007 and 2006. All information included in these consolidated financial statements is the representation of the management of Vestin Realty Mortgage I, Inc.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the consolidated financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the accompanying consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Vestin Realty Mortgage I, Inc. as of December 31, 2006 and the related consolidated statements of operations, equity and other comprehensive income and cash flows for the twelve months ended December 31, 2006, management’s assessment of the effectiveness of the internal control over financial reporting as of December 31, 2006 and the effectiveness of the internal control over financial reporting as of December 31, 2006, and in our report dated March 12, 2007, we expressed an unqualified opinion on those consolidated financial statements; an unqualified opinion on management’s assessment of, and an unqualified opinion on the effective operation of internal control over financial reporting. The consolidated financial statements and management’s assessment of the effectiveness of internal control over financial reporting referred to above are not presented herein. In our opinion, the information set forth in the accompanying consolidated balance sheet as of December 31, 2006, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/Moore Stephens Wurth Frazer and Torbet, LLP
Orange, California
August 6, 2007
ITEM 2. | 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 three and six months ended June 30, 2007 and 2006. This discussion should be read in conjunction with our consolidated financial statements and accompanying notes and other detailed information regarding us appearing elsewhere in this report on Form 10-Q.
FORWARD LOOKING STATEMENTS
Certain statements in this report, including, without limitation, matters discussed under this Item 2, “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-Q. We are including this cautionary statement to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Statements that are not historical fact are forward-looking statements. Certain of these forward-looking statements can be identified by the use of words such as “believes,” “anticipates,” “expects,” “intends,” “plans,” “projects,” “estimates,” “assumes,” “may,” “should,” “will,” or other similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors, which could cause actual results, performance or achievements to differ materially from future results, performance or achievements. These forward-looking statements are based on our current beliefs, intentions and expectations. These statements are not guarantees or indicative of future performance. Important assumptions and other important factors that could cause actual results to differ materially from those forward-looking statements include, but are not limited to, those factors, risks and uncertainties described in Item 1A of this report on Form 10-Q for the six months ended June 30, 2007 and in our other securities filings with the Securities and Exchange Commission. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to change and involve inherent risks and uncertainties. The forward-looking statements contained in this report are made only as of the date hereof. We undertake no obligation to update or revise information contained herein to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
RESULTS OF OPERATIONS
OVERVIEW
Our primary business objective is to generate income by investing in real estate loans. We believe there is a significant market opportunity to make real estate loans to owners and developers of real property whose financing needs are not met by other financial institutional real estate lenders. The loan underwriting standards utilized by our manager and Vestin Originations are less strict than other financial institutional real estate lenders. In addition, one of our competitive advantages is our ability to approve loan applications more quickly than other financial institutional lenders. As a result, in certain cases, we may make real estate loans that are riskier than real estate loans made by other financial 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 other financial 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 capital, subject to a 3% reserve, will constitute the bulk of the funds we have available for investment in real estate loans. We do not have any arrangements in place to materially increase the funds we will have available to invest from any other sources. See discussion under – “Capital and Liquidity.”
Our operating results during the past several years have been adversely affected by allowances for non-performing loans. At June 30, 2007, the following loans were non-performing (based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due); RightStar (Part I & Part II), Monterrey Associates LP, Forest Development LLC and Pirates Lake, LTD. These loans are currently carried on our books at a value of approximately $9.8 million, net of allowance for loan losses of approximately $4.4 million for the RightStar loans. These loans have been placed on non-accrual of interest status and are the subject of pending foreclosure proceedings. On August 7, 2007, we, VRM II and Fund III entered into a settlement agreement with the borrower of Pirates Lake, LTD. whereby the foreclosure was postponed. Principal, accrued interest and $75,000 for expenses incurred by us, VRM II and Fund III relating to the loan is now due on October 1, 2007. For additional information, see “Specific Loan Allowance” in Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Item 1 Consolidated Financial Statements of this report Form 10-Q. Non-performing assets, net of allowance for loan losses, totaled approximately $13.1 million or 20% of our total assets as of June 30, 2007, as compared to approximately $11.8 million or 18% of our total assets as of December 31, 2006. At June 30, 2007, non-performing assets consisted of approximately $3.3 million of real estate held for sale not sold through seller financing and approximately $9.8 million of non-performing loans, net of allowance for loan losses. In addition, during the six months ended June 30, 2007, our manager evaluated the carrying value of the acquired properties located in Cathedral City, CA and based on its estimate, our manager has written down the value of the property by $3,000,000, of which our portion was $373,000.
The level of non-performing assets may reflect the continuing weakness in certain sectors of the economy and the risk inherent in our business strategy that entails more lenient underwriting standards and expedited loan approval procedures. If the economy weakens and our borrowers who develop and sell commercial real estate projects are unable to complete their projects or obtain takeout financing or are otherwise adversely impacted, we may experience an increase in loan defaults, which may reduce the amount of funds we have to pay dividends to our stockholders. Such conditions may also require us to restructure loans. The weighted average term of our outstanding loans, including extensions and loans related to seller financed real estate held for sale, as of June 30, 2007 and December 31, 2006 was 20 and 19 months, respectively.
Uncertain economic conditions during the next year could have a material impact on the collectibility of our loans. A downturn in the real estate markets where we conduct business might increase defaults on our loans and might require us to record additional reserves with respect to non-performing loans. To date, the problems experienced by some lenders in the sub-prime residential mortgage market have not had any material adverse affect upon the commercial mortgage markets in which we operate. Nonetheless, we are aware that weakness in residential lending could at some point have an adverse impact upon our markets. Recognizing the risk, we seek to maintain an adequate loan-to-value ratio, including loans related to seller financed real estate held for sale, which, as of June 30, 2007, was 74.55% on a weighted average basis, generally using appraisals prepared on an “as-if developed basis” in connection with the loan origination. The increase in the weighted average loan to value ratio from 71.35%, as of December 31, 2006, to 74.55%, as of June 30, 2007, is primarily due to five loans that were funded during the six months ended June 30, 2007, totaling $4.1 million, with loan to value ratios ranging from 71.79% to 80.00%. The majority of these loans were to repeat borrowers with a history of good standing with us. In addition, the original terms of these loans were 12 months or less. We hope to retain sufficient cushion in the underlying equity position to protect the value of our loans in the event of a default. Nevertheless, no assurances can be given that a marked increase in loan defaults accompanied by a rapid decline in real estate values will not have a material adverse effect upon our financial condition and operating results.
From time to time, we may acquire or sell investments in real estate loans from/to our manager or other related parties pursuant to the terms of our Management Agreement provided the price does not exceed the par value of the loan. No gain or loss is recorded on these transactions, as it is not our intent to make a profit on the purchase or sale of such investments. The purpose is generally to diversify our portfolio by syndicating loans, thereby providing us with additional capital to make additional loans. For further information regarding related party transactions, refer to Note H – Related Party Transactions in the notes to our consolidated financials statements in Item 1 Consolidated Financial Statements in Part I of this report Form 10-Q.
As of June 30, 2007, our loans were in the following states: Arizona, California, Hawaii, Nevada, New York, Oklahoma, Oregon, Texas and Washington.
Comparison of Operating Results for the three and six months ended June 30, 2007 to the three and six months ended June 30, 2006.
For the Three Months Ended June 30, | For the Six Months Ended June 30, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
| Revenues | $ | 1,568,000 | $ | 1,097,000 | $ | 2,906,000 | $ | 2,261,000 | ||||||||
| Operating expenses | 430,000 | 279,000 | 761,000 | 3,719,000 | ||||||||||||
| Income (loss) from real estate held for sale | (404,000 | ) | (1,000 | ) | (369,000 | ) | (17,000 | ) | ||||||||
| Income (loss)before provision for income taxes | 734,000 | 817,000 | 1,776,000 | (1,475,000 | ) | |||||||||||
| Provision for income taxes | -- | -- | -- | -- | ||||||||||||
| Net income (loss) | $ | 734,000 | $ | 817,000 | $ | 1,776,000 | $ | (1,475,000 | ) | |||||||
| Basic and diluted earnings per common share | $ | 0.11 | $ | 0.08 | 0.26 | $ | 0.08 | |||||||||
| Net income (loss) allocated to members per weighted average membership units | $ | 0.04 | $ | (0.29 | ) | |||||||||||
| Dividends declared per common share / cash distributions per membership unit | $ | 0.14 | $ | 0.10 | 0.29 | $ | 0.26 | |||||||||
| Weighted average common shares / membership units | 6,871,260 | 6,867,957 | 6,870,813 | 6,896,712 | ||||||||||||
| Weighted average term of outstanding loans, including extensions | 20 months | 20 months | 20 months | 20 months | ||||||||||||
Comparison of Operating Results for the three months ended June 30, 2007 to the three months ended June 30, 2006.
Total Revenues: For the three months ended June 30, 2007 total revenues increased by approximately $471,000 or 42.9% compared to the same period in 2006 due in significant part to the following factors:
| · | Interest income from investments in real estate loans increased approximately $173,000 during the three months ended June 30, 2007 compared to the same period in 2006, largely as a result of higher interest rates. Our revenue is dependent upon the balance of our investment in real estate loans and the interest earned on these loans. As of June 30, 2007, our investment in real estate loans, including loans related to seller financed real estate held for sale, was approximately $59.1 million with a weighted average interest rate of 11.10%. As of June 30, 2006, our investment in real estate loans, including loans related to seller financed real estate held for sale, was approximately $57.8 million with a weighted average interest rate of 9.8%. |
| · | During the three months ended June 30, 2007, we earned approximately $159,000 in other income from principal payments on notes receivable that were fully reserved and approximately $141,000 as the result of a legal settlement. |
Total Operating Expenses: For the three months ended June 30, 2007, total operating expenses were $430,000 compared to approximately $279,000 during the three months ended June 30, 2006, an increase of approximately $151,000 or 54.1%. Expenses were primarily affected by the following factors:
| · | Professional fees increased approximately $91,000 primarily due to an increase in legal fees relating to several legal actions filed with respect to the REIT conversion. See Note N – Legal Matters Involving The Company of the Consolidated Financial Statements included in Part I, Item 1 Consolidated Financial Statements of this Interim Report Form 10-Q. |
| · | During the three months ended June 30, 2007, we incurred an increase of approximately $30,000 in expenses related to the annual stockholders meeting and public filing expenses, including nasdaq fees, compared to the same period in 2006. |
Total Income(Loss) from Real Estate Held for Sale: For the three months ended June 30, 2007, total loss from real estate held for sale was $404,000 compared to a loss of $1,000 during the same period in 2006. During the three months ended June 30, 2007, our manager evaluated the carrying value of the acquired property located in Cathedral City, CA and based on its estimate, our manager has written down the value of the property by $3,000,000, of which our portion was $373,000. See Note F – Real Estate Held for Sale in the notes of Part I, Item 1 - Consolidated Financial Statements to this interim report Form 10-Q.
Comparison of Operating Results for the six months ended June 30, 2007 to the six months ended June 30, 2006
Total Revenues:
For the six months ended June 30, 2007 total revenues increased by approximately $645,000 or 28.5% compared to the same period in 2006 due in significant part to the following factors:
| · | Interest income from investments in real estate loans increased approximately $244,000 during the six months ended June 30, 2007 compared to the same period in 2006, largely as a result of the higher interest rates referred to above. |
| · | During the six months ended June 30, 2007, we recognized approximately $105,000 in dividend income from investment in a related party. We had no comparable income during the same period in 2006. |
| · | During the six months ended June 30, 2007, we earned approximately $258,000 in other income from principal payments on notes receivable that were fully reserved, in addition to the legal settlement referred to above. During the same period 2006, we recognized approximately $13,000 of revenues from comparable sources. |
Total Operating Expenses: For the six months ended June 30, 2007, total operating expenses were $761,000 compared to approximately $3.7 million during the six months ended June 30, 2006, a decrease of approximately $3.0 million or 79.5%. Expenses were primarily affected by the following factor:
| · | During the 2006 period, we recognized a provision for loan loss of $3 million related to the loans secured by 4 cemeteries and 8 mortuaries in Hawaii. See “Specific Loan Allowance” in Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part I, Item 1 Consolidated Financial Statements of this Interim Report Form 10-Q. There was no comparable loan loss provision in the six months ended June 30, 2007. |
Total Income(Loss) from Real Estate Held for Sale: For the six months ended June 30, 2007, total income from real estate held for sale was $369,000 compared to a loss of $17,000 during the same period in 2006. During the three months ended June 30, 2007, our manager evaluated the carrying value of the acquired property located in Cathedral City, CA and based on its estimate, our manager has written down the value of the property by $3,000,000, of which our portion was $373,000. See Note F – Real Estate Held for Sale in the notes of Part I, Item 1 - Consolidated Financial Statements to this interim report Form 10-Q.
Dividends: To maintain our status as a REIT, we are required to make distributions, other than capital gain dividends, to our stockholders each year in an amount at least equal to (1) the sum of (a) 90% of our taxable income, computed without regards to the dividends paid deduction and our net capital gain, and (b) 90% of the net income, after tax, from foreclosure property, minus (2) the sum of certain specified items of non-cash income over 5% of our REIT taxable income. From January 1, 2007 through June 30, 2007, we declared dividends to our shareholders of approximately $2.6 million.
Distributions to Members: During the four months ended April 30, 2006, we distributed approximately $1.7 million to Fund I’s members.
CAPITAL AND LIQUIDITY
Liquidity is a measure of a company’s ability to meet potential cash requirements, including ongoing commitments to fund lending activities and general operating purposes. Subject to a 3% reserve, we generally use all of our available funds to invest in real estate loans. Distributable cash flow generated from such loans is paid out to our stockholders, in the form of a dividend. We do not anticipate the need for hiring any employees, acquiring fixed assets such as office equipment or furniture, or incurring material office expenses during the next twelve months because our manager will manage our affairs. We may pay our manager an annual management fee of up to 0.25% of our aggregate capital received by us and Fund II from the sale of shares or membership units.
During the six months ended June 30, 2007, cash flows provided by operating activities approximated $1.9 million. Investing activities consisted of cash provided by loan payoffs of approximately $7.3 million. Cash used for new investments and purchases of real estate loans totaled approximately $5.8 million. Financing activities mainly consisted of dividends to stockholders, net of reinvestment, of approximately $2.6 million.
At June 30, 2007, we had approximately $1.9 million in cash, $3.1 million in marketable securities – related party and approximately $65.0 million in total assets. We intend to meet short-term working capital needs through a combination of proceeds from loan payoffs, loan sales and/or borrowings. We believe we have sufficient working capital to meet our operating needs in the near term.
Since we distribute most or all of our distributable cash generated by operations, our sources of liquidity include repayments of outstanding loans, dividend reinvestments by our stockholders, arrangements with third parties to participate in our loans and proceeds from issuance of note payable and secured borrowings.
We have no current plans to sell any new shares except through our dividend reinvestment program. As of July 31, 2007, approximately 3% of our shareholders owning less than 1% our outstanding shares have elected to reinvest their dividends. The level of dividend reinvestment in the future will depend upon our performance, as well as the number of our stockholders who prefer to reinvest rather than receive current dividends.
We rely primarily upon repayment of outstanding loans to provide capital for investment in new loans. Any significant level of defaults on outstanding loans could reduce the funds we have available for investment in new loans. Resulting foreclosure proceedings may not generate full repayment of our loans and may result in significant delays in the return of invested funds. This would diminish our capital resources and would impair our ability to invest in new loans. Non-performing assets included loans in non-accrual status, net of allowance for loan losses, and real estate held for sale not sold through seller financing totaling approximately $9.8 million and $3.7 million, respectively, as of June 30, 2007, compared to approximately $8.1 million and $3.7 million, respectively, as of December 31, 2006. It is possible that no earnings will be recognized from these assets until they are disposed of, or that no earnings will be recognized at all, and the time it will take to dispose of these assets cannot be predicted. Our manager believes that these non-performing assets are a result of factors unique to specific borrowers and properties. Because of the estimated value of the underlying properties, we do not currently believe that any losses beyond those already recognized will be incurred from these assets upon final disposition. However, it is possible that we will not be able to realize the full estimated carrying values upon disposition.
To maintain our status as a REIT, we will be required to make distributions, other than capital gain dividends, to our stockholders each year in an amount at least equal to (1) the sum of (a) 90% of our taxable income, computed without regards to the dividends paid deduction and our net capital gain, and (b) 90% of the net income, after tax, from foreclosure property, minus (2) the sum of certain specified items of noncash income over 5% of our REIT taxable income.
Loans in which unaffiliated investors have participated through inter-creditor agreements (“Inter-creditor Agreements”) are accounted for as secured borrowings in accordance with Statement of Financial Accounting Standards (“FAS”) 140 – Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“FAS 140”). The Inter-creditor Agreements provide us additional funding sources for real estate loans whereby an unaffiliated investor (the “Investor”) may participate on a non-pari passu basis in certain real estate loans with us and/or VRM II and/or Fund III (collectively, the “Lead Lenders”).
In the event of borrower non- performance, the Inter-creditor Agreements generally provide that the Lead Lenders must repay the Investor’s loan amount either by (i) continuing to remit to the Investor the interest due on the participated loan amount; (ii) substituting an alternative loan acceptable to the Investor; or (iii) repurchasing the participation from the Investor for the outstanding balance plus accrued interest.
During October 2006, we, our manager, Vestin Origination, Inc., VRM II and Fund III entered into an intercreditor agreement with an unrelated third party related to the funding of a construction real estate loan. (See exhibit 10.8 Intercreditor Agreement under the Exhibit Index included in Part II – Other Information, Item 6 Exhibits of this Report Form 10-Q). The secured borrowing was recognized pro rata between us, VRM II and Fund III for the amount each entity has funded for the loan. During May 2007, the secured borrowings were paid in full. As of June 30, 2007, we did not have any funds used under Inter-creditor Agreements as compared to approximately $310,000 used under Inter-creditor Agreements as of December 31, 2006.
We maintain working capital reserves of approximately 3% in cash and cash equivalents, certificates of deposits and short-term investments or liquid marketable securities. This reserve is available to pay expenses in excess of revenues, satisfy obligations of underlying properties, expend money to satisfy our unforeseen obligations and for other permitted uses of working capital.
Investments in Real Estate Loans Secured by Real Estate Portfolio
We offer five real estate loan products consisting of commercial, construction, acquisition and development, land, and residential loans. The effective interest rates on all product categories range from 5% to 14%. Revenue by product will fluctuate based upon relative balances during the period. We had investments in 33 real estate loans, including loans related to seller financed real estate held for sale, as of June 30, 2007, with a balance of approximately $59.1 million as compared to investments in 33 real estate loans, including loans related to seller financed real estate held for sale, as of December 31, 2006, with a balance of approximately $60.7 million.
At June 30, 2007, the following loans were non-performing (based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due); RightStar (Part I & Part II), Monterrey Associates LP, Forest Development LLC and Pirates Lake, LTD. These loans are currently carried on our books at a value of approximately $9.8 million, net of allowance for loan losses of approximately $4.4 million for the RightStar loans. These loans have been placed on non-accrual of interest status and are the subject of pending foreclosure proceedings. On August 7, 2007, we, VRM II and Fund III entered into a settlement agreement with the borrower of Pirates Lake, LTD. whereby the foreclosure was postponed. Principal, accrued interest and $75,000 for expenses incurred by us, VRM II and Fund III relating to the loan is now due on October 1, 2007.
During March 2007, our manager extended the Mid-State Raceway loan from March 31, 2007 to March 31, 2008. As part of the extension agreement, the borrower made a principal payment of approximately $3.0 million, of which our portion was approximately $0.4 million, and the loan interest rate increased from 9% to 12%.
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 June 30, 2007, we have provided a specific reserve related to the 4 cemeteries and 8 mortuaries in Hawaii, of which our portion of the specific reserve is approximately $4.4 million. Our manager evaluated the loans and concluded that the remaining underlying collateral was sufficient to protect us against further losses of principal or interest. Our manager will continue to evaluate these loans in order to determine if any other allowance for loan losses should be recorded. For additional information on our investments in real estate loans, refer to Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part I, Item 1 Consolidated Financial Statements of this Interim Report Form 10-Q.
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 periodic 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; |
| · | Historical experience; |
| · | 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 six months ended June 30, 2007, refer to Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part I, Item 1 Consolidated Financial Statements of this Interim Report Form 10-Q.
Investments in Real Estate Held for Sale
At June 30, 2007, we held one property with a total carrying value of approximately $3.3 million, which was acquired through foreclosure and recorded as investments in real estate held for sale. Our investments in real estate held for sale are accounted for at the lower of cost or fair value less costs to sell with fair value based on appraisals and knowledge of local market conditions. It is not our intent to invest in or own real estate as a long-term investment. We seek to sell properties acquired through foreclosure as quickly as circumstances permit. During the six months ended June 30, 2007, our manager evaluated the carrying value of the acquired properties located in Cathedral City, CA and based on its estimate, our manager has written down the value of the property by $3,000,000 of which our portion was $373,000.
For additional information on our investments in real estate held for sale, refer to Note F –Real Estate Held for Saleof the Notes to the Consolidated Financial Statements included in Part I, Item 1 Consolidated Financial Statements of this Interim Report Form 10-Q.
Investments in Real Estate Held for Sale — Seller Financed
At June 30, 2007, we held an interest in one property with a total carrying value of approximately $7.9 million, which was sold in a transaction where we provided the financing to the purchaser. GAAP requires us to include these properties in real estate held for sale until the borrower has met and maintained certain requirements. We may share ownership of such properties with VRM II, Fund III, our manager, or other related and/or unrelated parties. These investments in real estate held for sale are accounted for at the lower of cost or fair value less costs to sell with fair value based on appraisals and knowledge of local market conditions. For additional information on our investments in real estate loans, refer to Note G –Real Estate Held for Sale-Seller Financed of the Notes to the Consolidated Financial Statements included in Part I, Item 1 Consolidated Financial Statements of this Interim Report Form 10-Q.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any interests in off-balance sheet special purpose entities nor do we have any interests in non-exchange traded commodity contracts.
CONTRACTUAL OBLIGATIONS
The following summarizes our contractual obligations at June 30, 2007:
Contractual Obligation | Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More Than 5 Years | |||||||||||||||
Notes payable (1) | $ | 148,000 | $ | 148,000 | $ | -- | $ | -- | $ | -- | ||||||||||
| Total | $ | 148,000 | $ | 148,000 | $ | -- | $ | -- | $ | -- | ||||||||||
(1) | See Note K – Notes Payable of the Notes to the Consolidated Financial Statements included in Part I, Item 1 Consolidated Financial Statements of this Interim Report Form 10-Q. |
CRITICAL ACCOUNTING ESTIMATES
Revenue Recognition
Interest income on loans is accrued by the effective interest method. We do not accrue interest income from loans once they are determined to be impaired. A loan is impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due.
The following table presents a sensitivity analysis to show the impact on our financial condition at June 30, 2007, 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 | $ | 606,000 | ||
| Weighted average interest rate assumption increased by 5.0% or 500 basis points | $ | 3,028,000 | ||
| Weighted average interest rate assumption decreased by 1.0% or 100 basis points | $ | (606,000 | ) | |
| Weighted average interest rate assumption decreased by 5.0% or 500 basis points | $ | (3,028,000 | ) | |
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 June 30, 2007, 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 | $ | 591,000 | ||
| Allowance for loan losses assumption increased by 5.0% of loan portfolio | $ | 2,954,000 | ||
| Allowance for loan losses assumption decreased by 1.0% of loan portfolio | $ | (591,000 | ) | |
| Allowance for loan losses assumption decreased by 5.0% of loan portfolio | $ | (2,954,000 | ) | |
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 approves loans more quickly than other real estate lenders and, due to our expedited underwriting process, there is a risk that the credit inquiry we perform will not reveal all material facts pertaining to a borrower and the security.
We may discover additional facts and circumstances as we continue our efforts in the collection and foreclosure processes. This additional information often causes management to reassess its estimates. In recent years, we have revised estimates of our allowance for loan losses. Circumstances that may cause significant changes in our estimated allowance include, but not limited to:
| · | Declines in real estate market conditions that can cause a decrease in expected market value; |
| · | Discovery of undisclosed liens for community improvement bonds, easements and delinquent property taxes; |
| · | Lack of progress on real estate developments after we advance funds. We customarily utilize disbursement agents to monitor the progress of real estate developments and approve loan advances. After further inspection of the related property, progress on construction occasionally does not substantiate an increase in value to support the related loan advances; |
| · | Unanticipated legal or business issues that may arise subsequent to loan origination or upon the sale of foreclosed upon property; and |
| · | Appraisals, which are only opinions of value at the time of the appraisal, may not accurately reflect the value of the property. |
Real Estate Held For Sale
Real estate held for sale includes real estate acquired through foreclosure and will be carried at the lower of the recorded amount, inclusive of any senior indebtedness, or the property's estimated fair value, less estimated costs to sell, with fair value based on appraisals and knowledge of local market conditions. While pursuing foreclosure actions, 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 and initial continuing investments. Minimum initial investments as defined by FAS 66 range from 10% to 25% based on the type of real estate sold. In addition, FAS 66 limits commitments and contingent obligations incurred by a seller in order to record a sale.
Because we occasionally foreclose on loans with raw land or developments in progress, available financing for such properties is often limited and we frequently provide financing up to 100% of the selling price on these properties. In addition, we may make additional loans to the buyer to continue development of a property. Although sale agreements are consummated at closing, they lack adequate initial investment by the buyer to qualify as a sales transaction as defined in FAS 66. These sale agreements are not recorded as a sale until the requirements of FAS 66 are met.
These sales agreements are recorded under the deposit method or cost recovery method as defined in FAS 66. Under the deposit method, no profit is recognized and any cash received from the buyer is reported as a deposit liability on the balance sheet. Under the cost recovery method, no profit is recognized until payments by the buyer exceed the carrying basis of the property sold. Principal payments received will reduce the related receivable, and interest collections will be recorded as unrecognized gross profit on the balance sheet. The carrying values of these properties are included in real estate held for sale on the accompanying consolidated balance sheets.
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
We are exposed to market risk, primarily from changes in interest rates. We do not deal in any foreign currencies and do not own any options, futures or other derivative instruments. We do not have a significant amount of debt.
Most of our assets consisted of investments in real estate loans, which from time to time include those that are financed under Inter-creditor Agreements. At June 30, 2007, our aggregate investment in real estate loans was approximately $47.2 million, net of allowance, with a weighted average effective interest rate of 11.10%. Most of the real estate loans had an initial term of 12 months. The weighted average term of outstanding loans, including extensions and loans related to seller financed real estate held for sale, at June 30, 2007, was 20 months. All but two of the outstanding real estate loans at June 30, 2007, were fixed rate loans. All of the real estate loans are held for investment purposes; none are held for sale. We intend to hold such real estate loans to maturity. None of the real estate loans had prepayment penalties and 14 had an exit fee.
Market fluctuations in interest rates generally do not affect the carrying value of our investment in real estate loans. However, significant and sustained changes in interest rates could affect our operating results. If interest rates decline significantly, some of the borrowers could prepay their loans with the proceeds of a refinancing at lower interest rates. This would reduce our earnings and funds available for dividend distribution to stockholders. On the other hand, a significant increase in interest rates could result in a slowdown in real estate development activity that would reduce the demand for commercial real estate loans. As a result, we might encounter greater difficulty in identifying appropriate borrowers. We are not in a position to quantify the potential impact on our operating results from a material change in interest rates.
The following table contains information about the investment in real estate loans, including loans related to seller financed real estate held for sale, in our portfolio as of June 30, 2007. The presentation aggregates the investment in real estate loans by their maturity dates for maturities occurring in each of the years 2007 through 2010 and thereafter and separately aggregates the information for all maturities arising after 2010. The carrying values of these assets approximate their fair value as of June 30, 2007.
Interest Earning Assets Aggregated by Maturity at June 30, 2007 | ||||||||||||||||||||||||
Interest Earning Assets | 2007 | 2008 | 2009 | 2010 | Thereafter | Total | ||||||||||||||||||
| Investments in real estate loans | $ | 49,150,000 | $ | 9,935,000 | $ | -- | $ | -- | $ | -- | $ | 59,085,000 | ||||||||||||
| Weighted average interest rates | 11.11% | 11.03% | --% | --% | --% | 11.10% | ||||||||||||||||||
At June 30, 2007, we also had approximately $5.0 million invested in cash and marketable securities – related party (VRM II). 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.
ITEM 4. | CONTROLS AND PROCEDURES |
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-Q, our management carried out an evaluation, under the supervision and with the participation of the our management, including the CEO and CFO, as of June 30, 2007, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) under the Exchange Act. Based upon this evaluation, our CEO and CFO believe that these controls and procedures are adequate to ensure we are able to collect, process and disclose within the required time periods the information we are required to disclose in the reports we file with the SEC.
The certifications of the our Chief Executive Officer and Chief Financial Officer required under Section 302 of the Sarbanes-Oxley Act have been filed as Exhibits 31.1 and 31.2 to this report.
Changes in Internal Control Over Financial Reporting
Our management has identified the following change in our internal controls over financial reporting during the Quarter ended June 30, 2007. During April 2007, our manager appointed a Corporate Controller with the requisite experience to assist and work directly with our Chief Financial Officer.
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.
ITEM 4T. | CONTROLS AND PROCEDURES |
Not applicable
PART II – OTHER INFORMATION
ITEM 1. | LEGAL PROCEEDINGS |
Please refer to Note M Legal Matters Involving the Manager and Note N Legal Matters Involving the Company in Part I Item 1 Financial Statements of this Form 10-Q for information regarding our legal proceedings, which are incorporated herein by reference.
ITEM 1A. | RISK FACTORS |
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 distributions.
We are in the business of investing in real estate loans and, as such, we are subject to risk of defaults by borrowers. Our performance will be directly impacted by any defaults on the loans in our portfolio. As a 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. We seek to mitigate the risk by estimating the value of the underlying collateral and insisting on adequate loan-to-value ratios. However, we cannot be assured that these efforts will fully protect us against losses on defaulted loans. Any subsequent decline in real estate values on defaulted loans could result in less security than anticipated at the time the loan was originally made, which may result in our not recovering the full amount of the loan. Any failure of a borrower to repay loans or interest on loans will reduce our revenues and distributions and the value of common stock. Our weighted average loan-to-value ratio, including loans related to seller financed real estate held for sale, as of June 30, 2007 was 74.55% as compared to 71.35% as of December 31, 2006. Our appraisals are generally dated within 12 months of the date of loan origination and may not reflect a decrease in the value of the real estate due to events subsequent to the date of the appraisals.
As of June 30, 2007, we had in our portfolio approximately $9.8 million in delinquent loans, net of allowance for loan losses, and approximately $3.3 million of real estate held for sale not sold through seller financing for a total of approximately $13.1 million in non-performing assets, which represented approximately 21% of our stockholders’ equity. As of June 30, 2007, we also had approximately $7.9 million of seller financed real estate held for sale and had received approximately $1.5 million in payments from borrowers on the loans associated with these properties. We do not believe that a rising interest rate environment will increase or accelerate our delinquency rate because all of our loans are short term.
Our underwriting standards and procedures are more lenient than other financial institutional lenders, which may result in a higher level of non-performing assets and less amounts available for distribution.
Our underwriting standards and procedures are more lenient than other financial 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, which 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. There may be a greater risk of default by our borrowers, which may impair our ability to make timely distributions and which may reduce the amount we have available to distribute.
We depend upon our real estate security to secure our real estate loans, and we may suffer a loss if the value of the underlying property declines.
We depend upon our real estate security to protect us on the loans that we make. We depend upon the skill of independent appraisers to value the security underlying our loans. However, notwithstanding the experience of the appraisers, they may make mistakes, or the value of the real estate may decrease due to subsequent events. Our appraisals are generally dated within 12 months of the date of loan origination and may have been commissioned by the borrower. Therefore, the appraisals may not reflect a decrease in the value of the real estate due to events subsequent to the date of the appraisals. In addition, most of the appraisals are prepared on an as-if developed basis, which approximates the post-construction value of the collateralized property assuming such property is developed. As-if developed values on raw land loans or acquisition and development loans often dramatically exceed the immediate sales value and may include anticipated zoning changes and successful development by the purchaser upon which development is dependent on availability of financing. As most of the appraisals will be prepared on an as-if developed basis, if the loan goes into default prior to completion of the project, the market value of the property may be substantially less than the appraised value. As a result, there may be less security than anticipated at the time the loan was originally made. If there is less security and a default occurs, we may not recover the full amount of our loan, thus reducing the amount of funds available to distribute.
We typically make “balloon payment” loans, which are riskier than loans with payments of principal over an extended period of time.
The loans we invest in or purchase generally require the borrower to make a “balloon payment” on the principal amount upon maturity of the loan. A balloon payment is a large principal balance that is payable after a period of time during which the borrower has repaid none or only a small portion of the principal balance. As of June 30, 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, with the exception of one of our loans that has both principal and interest payments along with a “balloon” payment at the end of the term. Loans with balloon payments are riskier than loans with even payments of principal over an extended time period such as 15 or 30 years because the borrower’s repayment depends on its ability to sell the property profitably, obtain suitable refinancing or otherwise raise a substantial amount of cash when the loan comes due. There are no specific criteria used in evaluating the credit quality of borrowers for loans requiring balloon payments. Furthermore, a substantial period of time may elapse between the review of the financial statements of the borrower and the date when the balloon payment is due. As a result, there is no assurance that a borrower will have sufficient resources to make a balloon payment when due.
Our loans are not guaranteed by any governmental agency.
Our loans are not insured or guaranteed by a federally owned or guaranteed mortgage agency. Consequently, our recourse, if there is a default, may be to foreclose upon the real property securing a loan and/or pursuing the borrower’s guarantee of the principal. The value of the foreclosed property may have decreased and may not be equal to the amount outstanding under the corresponding loan, resulting in a decrease of the amount available to distribute.
Our real estate loans may not be marketable, and we expect no secondary market to develop.
We do not expect our real estate loans to be marketable, and we do not expect a secondary market to develop for them. As a result, we will generally bear all the risk of our investment until the loans mature. This will limit our ability to hedge our risk in changing real estate markets and may result in reduced returns to our investors.
Any borrowing by us will increase risk and may reduce the amount we have available to distribute to stockholders.
We may borrow funds to expand our capacity to invest in real estate loans. We may borrow up to 70% of the fair market value of our outstanding real estate loans at any time. Any such borrowings will require us to carefully manage our cost of funds. No assurance can be given that we will be successful in this effort. Should we be unable to repay the indebtedness and make the interest payments on the loans, the lender will likely declare us in default and require that we repay all amounts owing under the loan facility. Even if we are repaying the indebtedness in a timely manner, interest payments owing on the borrowed funds may reduce our income and the distributions. As of June 30, 2007 and December 31, 2006, we had total indebtedness of $0 and $310,000, respectively.
We may borrow funds from several sources, and the terms of any indebtedness we incur may vary. However, some lenders may require as a condition of making a loan to us that the lender will receive a priority on loan repayments received by us. As a result, if we do not collect 100% on our investments, the first dollars may go to our lenders and we may incur a loss that will result in a decrease of the amount available for distribution. In addition, we may enter into securitization arrangements in order to raise additional funds. Such arrangements could increase our leverage and adversely affect our cash flow and our ability to make distributions. During October 2006, we, our manager, Vestin Origination, Inc., VRM II and Fund III entered into an intercreditor agreement with an unrelated third party related to the funding of a construction real estate loan. he secured borrowing was recognized pro rata between us, VRM II and Fund III for the amount each entity has funded for the loan. During May 2007, the secured borrowings were paid in full.
We may need cash to meet our minimum REIT distribution requirements and limit U.S. federal income taxation. Because we are required to distribute annually to our stockholders at least 90% of our REIT taxable income (determined without regard to the dividends paid deduction and by excluding net capital gains) to qualify as a REIT and because we intend to distribute substantially all of our REIT taxable income and net capital gain, our ability to expand our loan portfolio will depend in large part on external sources of capital. In addition, if our minimum distribution requirements to maintain our REIT status and minimize U.S. federal income taxation become large relative to our cash flow as a result of our taxable income exceeding our cash flow from operations, then we may be required to borrow funds or raise capital by selling assets to meet those distribution requirements. Any equity financing may result in substantial dilution to our stockholders, and any debt financing may include restrictive covenants. We may not be able to raise capital on reasonable terms, if at all.
We may have difficulty protecting our rights as a secured lender.
We believe that our loan documents will enable us to enforce our commercial arrangements with borrowers. However, the rights of borrowers and other secured lenders may limit our practical realization of those benefits. For example:
| · | Judicial foreclosure is subject to the delays of protracted litigation. Although we expect non-judicial foreclosure to be quicker, our collateral may deteriorate and decrease in value during any delay in foreclosing on it; |
| · | The borrower’s right of redemption during foreclosure proceedings can deter the sale of our collateral and can for practical purposes require us to manage the property; |
| · | Unforeseen environmental hazards may subject us to unexpected liability and procedural delays in exercising our rights; |
| · | The rights of senior or junior secured parties in the same property can create procedural hurdles for us when we foreclose on collateral; |
| · | Required licensing and regulatory approvals may complicate our ability to foreclose or to sell a foreclosed property where our collateral includes an operating business. We have recently experienced difficulties in foreclosing on the RightStar loans discussed in Note N – Legal Matters Involving The Company in the notes to the consolidated financial statement under Part I, Item I. Consolidated Financial Statements to this Interim Report Form 10-Q, because of the need to obtain a license from the State of Hawaii to operate funeral homes and cemeteries; |
| · | We may not be able to pursue deficiency judgments after we foreclose on collateral; and |
| · | State and federal bankruptcy laws can prevent us from pursuing any actions, regardless of the progress in any of these suits or proceedings. |
By becoming the owner of property, we may incur additional obligations, which may reduce the amount of funds available for distribution.
We intend to own real property only if we foreclose on a defaulted loan and purchase the property at the foreclosure sale. Acquiring a property at a foreclosure sale may involve significant costs. If we foreclose on the security property, we expect to obtain the services of a real estate broker and pay the broker’s commission in connection with the sale of the property. We may incur substantial legal fees and court costs in acquiring a property through contested foreclosure and/or bankruptcy proceedings. In addition, significant expenditures, including property taxes, maintenance costs, mortgage payments, insurance costs and related charges, must be made on any property we own regardless of whether the property is producing any income.
Under applicable environmental laws, any owner of real property may be fully liable for the costs involved in cleaning up any contamination by materials hazardous to the environment. Even though we might be entitled to indemnification from the person that caused the contamination, there is no assurance that the responsible person would be able to indemnify us to the full extent of our liability. Furthermore, we would still have court and administrative expenses for which we may not be entitled to indemnification.
A prolonged economic slowdown, lengthy or severe recession or significant increase in interest rates could harm our business.
The risks associated with our business are more acute during periods of economic slowdown or recession because these periods can be accompanied by decreased demand for consumer credit and declining real estate values. As a 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 could adversely affect the general economy or the availability of funds for commercial real estate developers. This in turn could lead to an increase in defaults on our loans. Furthermore, if interest rates were to increase significantly, the costs of borrowing may become too expensive, which may negatively impact the refinance market by reducing demand for real estate lending. For the six months ended June 30, 2007, loan originations accounted for all but one loan funded during that period as there was one loan refinanced during the period. Any sustained period of increased delinquencies, foreclosures or losses or a significant increase in interest rates could adversely affect our ability to originate, purchase and securitize loans, which could significantly harm our business, financial condition, liquidity and results of operations.
As of June 30, 2007, none of our loans had a prepayment penalty and 14 loans had an exit fee. Based on our manager’s historical experience, we expect that our loans will include exit fees. Should interest rates decrease, our borrowers may prepay their outstanding loans with us in order to receive a more favorable rate. This may reduce the amount of funds we have available to distribute.
Our results 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 the distributions.
One of the results of interest rate fluctuations is that borrowers may seek to extend their low-interest-rate loans after market interest rates have increased. This creates two risks for us:
| · | If interest rates rise, borrowers under loans with monthly or quarterly principal payments may be compelled to extend their loans to decrease the principal paid with each payment because the interest component has increased. If this happens, we are likely to be at a greater risk of the borrower defaulting on the extended loan, and the increase in the interest rate on our loan may not be adequate compensation for the increased risk. Additionally, any fees paid to extend the loan are paid to Vestin Originations, not to us. Our revenues and distributions will decline if we are unable to reinvest at higher rates or if an increasing number of borrowers default on their loans; and |
| · | If, at a time of relatively low interest rates, a borrower should prepay obligations that have a higher interest rate from an earlier period, we will likely not be able to reinvest the funds in real estate loans earning that higher rate of interest. In the absence of a prepayment fee, we will receive neither the anticipated revenue stream at the higher rate nor any compensation for its loss. This is a risk if the loans we invest in do not have prepayment penalties or exit fees. |
Our results will also reflect other economic conditions, such as a particular industry migrating to or from one of the states into which we make loans.
Legal actions seeking damages and appraisal rights could harm our operating results and financial condition.
We have recently been named in several legal actions seeking damages and appraisal rights in connection with the REIT conversion. See Note M – Legal Matters Involving The Manager and Note N – Legal Matters Involving The Company in the notes to the consolidated financial statement under Part I, Item I. Consolidated Financial Statements to this Interim Report Form 10-Q. While we believe these actions are without merit, the defense of such actions could materially increase our legal costs and may require the substantial attention of our management. This in turn might adversely impact our operating results. Moreover, any adverse outcome in such actions could result in our having to pay substantial damages that would reduce our cash resources and harm our financial condition.
We face competition for real estate loans that may reduce available yields and fees available.
We consider our direct competitors to be the providers of real estate loans 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. If our competition decreases interest rates on their loans or makes funds more easily accessible, yields on our loans could decrease and the costs associated with making loans could increase, both of which would reduce our revenues and the distributions.
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 make distributions depends upon our manager’s and its affiliate’s performance in obtaining, processing, making and brokering loans for us to invest in and determining the financing arrangements for borrowers. Stockholders have no opportunity to evaluate the financial information or creditworthiness of borrowers, the terms of mortgages, the real property that is our collateral or other economic or financial data concerning our loans. We pay our manager an annual management fee of up to 0.25% of our aggregate capital received by us and Fund I from the sale of shares or membership units. This fee is payable regardless of the performance of our loan portfolio. Our manager has no fiduciary obligations to our stockholders, is not required to devote its employees’ full time to our business and may devote time to business interests competitive to our business.
Our manager’s lack of experience with certain real estate markets could impact its ability to make prudent investments on our behalf.
As of June 30, 2007, our loans were in the following states: Arizona, California, Hawaii, Nevada, New York, Oklahoma, Oregon, Texas and Washington. Depending on the market and on our company’s performance, we plan to expand our investments throughout the United States. However, our manager has limited experience outside of the Western and Southern United States. Real estate markets vary greatly from location to location and the rights of secured real estate lenders vary considerably from state to state. Our manager’s limited experience in most U.S. real estate markets may impact its ability to make prudent investment decisions on our behalf. Accordingly, where our manager deems it necessary, it plans to utilize independent real estate advisors and local legal counsel located in markets where it lacks experience for consultation prior to making investment decisions. Stockholders will not have an opportunity to evaluate the qualifications of such advisors and no assurance can be given that they will render prudent advice to our manager.
Our success depends on key personnel of our manager, the loss of whom could adversely affect our operating results, and on our manager’s ability to attract and retain qualified personnel.
Our success depends in part upon the continued contributions of certain key personnel of our manager, including; Michael V. Shustek (Chief Executive Officer and President), Rocio Revollo (Chief Financial Officer), James M. Townsend (Chief Operating 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 key employees were to cease employment, our operating results could suffer. None of the key personnel of our manager are 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 II, Fund III and inVestin Nevada, companies with investment objectives similar to ours. Our manager and Mr. Shustek, who indirectly owns 100% of our manager, anticipate that they may also sponsor other real estate programs having investment objectives similar to ours. As a result, our manager and Mr. Shustek may have conflicts of interest in allocating their time and resources between our business and other activities. During times of intense activity in other programs and ventures, our manager and its key people will likely devote less time and resources to our business than they ordinarily would. Our management agreement with our manager does not specify a minimum amount of time and attention that our manager and its key people are required to devote to our company. Thus, our manager may not spend sufficient time managing our operations, which could result in our not meeting our investment objectives.
Our manager and its affiliates will face conflicts of interest arising from our fee structure.
Vestin Originations, an affiliate of our manager, will receive substantial fees from borrowers for transactions involving real estate loans. Many of these fees are paid on an up-front basis. In some cases, Vestin Originations is entitled to additional fees for loan extensions or modifications and loan assumptions and reconveyances. These and other fees are quantified and described in greater detail under “Management Agreement — Compensation.” Vestin Originations’ compensation is based on the volume and size of the real estate loans selected for us, regardless of their performance, which could create an incentive to make or extend riskier loans. Our interests may diverge from those of our manager, Vestin Originations and Mr. Shustek to the extent that Vestin Originations benefits from up-front fees that are not shared with us.
Vestin Originations will be receiving fees from borrowers that would otherwise increase our returns. Because Vestin Originations receives all of these fees, our interests will diverge from those of our manager, Vestin Originations and Mr. Shustek when our manager decides whether we should charge the borrower higher interest rates or our manager’ affiliates should receive higher fees from borrowers.
We paid our manager a management fee of approximately $138,000 for the six months ended June 30, 2007. In addition, Vestin Mortgage and Vestin Originations received a total of $72,000 and approximately $5.7 million, respectively in fees directly from borrowers for the six months ended June 30, 2007. 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 II, Fund III and inVestin Nevada. Our assets represented approximately 14% of the assets managed by Vestin Mortgage as of June 30, 2007.
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 II, Fund III and inVestin Nevada, 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 II, Fund III, inVestin Nevada or another company that our manager manages. Moreover, our manager has no obligation to provide us with any particular opportunities or even a pro rata share of opportunities afforded to other companies it manages.
UNITED STATES FEDERAL INCOME TAX RISKS RELATING TO OUR REIT QUALIFICATION
Our failure to qualify as a REIT would subject us to U.S. federal income tax, which would reduce amounts available for distribution to our stockholders.
We have elected to be taxed as a REIT under the Code. Our qualification as a REIT requires us to satisfy numerous requirements (some on an annual and quarterly basis) established under highly technical and complex Code provisions for which there are only limited judicial or administrative interpretations, and involves the determination of various factual matters and circumstances not entirely within our control. We intend that our organization and method of operation will enable us to qualify as a REIT, but we may not so qualify or we may not be able to remain so qualified in the future. Future legislation, new regulations, administrative interpretations or court decisions could adversely affect our ability to qualify as a REIT or adversely affect our stockholders.
If we fail to qualify as a REIT in any taxable year, we would be subject to U.S. federal income tax (including any applicable alternative minimum tax) on our taxable income at corporate rates, and we would not be allowed to deduct distributions made to our stockholders in computing our taxable income. We may also be disqualified from treatment as a REIT for the four taxable years following the year in which we failed to qualify. The additional tax liability would reduce our net earnings available for investment or distribution to stockholders. In addition, we would no longer be required to make distributions to our stockholders. Even if we continue to qualify as a REIT, we will continue to be subject to certain U.S. federal, state and local taxes on our income and property.
Distributions from a REIT are currently taxed at a higher rate than corporate distributions.
Under the Tax Relief and Reconciliation Act of 2003, the maximum U.S. federal income tax rate on both distributions from certain domestic and foreign corporations and net long-term capital gain for individuals was reduced to 15% until 2008. The Tax Increase Prevention and Reconciliation Act of 2005, which signed into law on May 17, 2006, extended the 15% long-term net capital gain rate to 2010. However, this reduced rate of tax on distributions generally will not apply to our distributions (except those distributions identified by the company as “capital gain dividends” which are taxable as long-term capital gain) and therefore such distributions generally will be taxed as ordinary income. Ordinary income generally is subject to U.S. federal income tax rate at a rate of up to 35% for individuals. The higher tax rate on our distributions may cause the market to devalue our common stock relative to stock of those corporations whose distributions qualify for the lower rate of taxation. Please note that, as a general matter, distributions from a REIT will be taxed at the same rate as stockholders’ share of Vestin Realty Mortgage I’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 I 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 June 30, 2007, we held one property with a total carrying value of approximately $3.3 million recorded as investments in real estate held for sale. As of June 30, 2007, we also held interests in one property with a total carrying value of approximately $7.9 million, which was sold in a transaction in which we or an affiliate provided the financing and recorded as seller financed real estate held for sale. United States generally accepted accounting principals (“GAAP”) requires us to include this property in real estate held for sale until the borrower has met and maintained certain requirements. The real estate held for sale and the seller financed real estate held for sale collectively constituted approximately 17.4% of our assets as of June 30, 2007. In addition, our seller financed real estate held for sale property is an assisted living facility, which cannot be operated by a taxable REIT subsidiary.
Taxable REIT subsidiaries are subject to corporate-level tax, which may devalue our common stock relative to other companies.
Taxable REIT subsidiaries are corporations subject to corporate-level tax. Our use of taxable REIT subsidiaries may cause the market to value its common stock lower than the stock of other publicly traded REITs which may not use taxable REIT subsidiaries and lower than the equity of mortgage pools taxable as non-publicly traded partnerships such as Fund I’s intended qualification prior to the REIT conversion, which generally are not subject to any U.S. federal income taxation on their income and gain.
Our use of taxable REIT subsidiaries may have adverse U.S. federal income tax consequences.
We must comply with various tests to continue to qualify as a REIT for U.S. federal income tax purposes, and our income from and investments in taxable REIT subsidiaries generally do not constitute permissible income and investments for purposes of the REIT qualification tests. While we will attempt to ensure that our dealings with our taxable REIT subsidiaries will not adversely affect our REIT qualification, we cannot be assured that we will successfully achieve that result. Furthermore, we may be subject to a 100% penalty tax, or our taxable REIT subsidiaries may be denied deductions, to the extent our dealings with our taxable REIT subsidiaries are not deemed to be arm’s length in nature.
We may endanger our REIT status if the distributions we receive from our taxable REIT subsidiaries exceed applicable REIT gross income tests.
The annual gross income tests that must be satisfied to ensure REIT qualification may limit the amount of distributions that we can receive from our taxable REIT subsidiaries and still maintain our REIT status. Generally, not more than 25% of our gross income can be derived from non-real estate related sources, such as distributions from a taxable REIT subsidiary. If, for any taxable year, the distributions we received from our taxable REIT subsidiaries, when added to our other items of non-real estate related income, represent more than 25% of our total gross income for the year, we could be denied REIT status, unless we were able to demonstrate, among other things, that our failure of the gross income test was due to reasonable cause and not willful neglect.
We may lose our REIT status if we issue shares under our stockholders’ rights plan.
Under Section 562(c) of the Code, a REIT generally cannot make a distribution unless the distribution is pro rata, with no preference to any share of stock as compared to other shares of the same class of stock. A REIT that is not in compliance with this requirement may lose its REIT status. Under our stockholders’ rights plan, upon certain events, some holders of our common stock and not others will have the right to acquire shares of Series A preferred stock. When effective, this right could be treated as a deemed distribution to those holders of our common stock entitled to the right with no distribution to other such holders. Thus, this right, when effective, could be treated as a distribution that is not consistent with the requirements of Section 562(c) of the Code, which could result in the loss of our REIT qualification.
RISK OF OWNERSHIP OF OUR COMMON STOCK
The market price and trading volume of our common stock may be volatile.
The market price of our common stock since trading commenced on June 1, 2006 to June 30, 2007, has ranged from $1.01 to $7.48. We believe the price of our stock has been affected by, among other things, selling pressure from stockholders seeking immediate liquidity and the level of non-performing assets, which we own. Our stock price may be highly volatile and subject to wide fluctuations. In addition, the trading volume in our common stock may fluctuate and cause significant price variations to occur. Our Company will be dissolved on December 31, 2019 unless the holders of a majority of our common stock determine otherwise. As we move closer to the dissolution date, we expect to stop making new loans and we expect that our stock price will approach our book value per share.
We cannot be assured that the market price of our common stock will not fluctuate or decline significantly in the future. Some of the factors, many of which are beyond our control, that could negatively affect our stock price or result in fluctuations in the price or trading volume of our common stock include:
| · | increases in loans defaulting or becoming non-performing or being written off; |
| · | actual or anticipated variations in our quarterly operating results or distributions; |
| · | publication of research reports about us or the real estate industry; |
| · | changes in market valuations of similar companies; |
| · | changes in tax laws affecting REITs; |
| · | litigation; |
| · | adverse market reaction to any increased indebtedness we incur in the future; and |
| · | general market and economic conditions. |
Market interest rates could have an adverse effect on our stock price.
One of the factors that will influence the price of our common stock will be the dividend yield on our common stock (as a percentage of the price of our common stock) relative to market interest rates. Thus, an increase in market interest rates may lead prospective purchasers of our common stock to expect a higher dividend yield, a lack of which could adversely affect the market price of our common stock.
We are the subject of shareholder litigation which may depress the price of our stock.
A number of lawsuits have been filed against us by shareholders who claim, among other things, that they were improperly denied dissenter’s rights in connection with the conversion of Fund I into a REIT. We believe the suits are without merit and we intend to vigorously defend against such claims. Nonetheless, the outcome of the lawsuits cannot be predicted at this time, nor can a meaningful evaluation be made of the potential impact upon us if the plaintiffs were to prevail in their claims. The resulting uncertainty may depress the price of our stock. Moreover, concerns about the potential diversion of our manager’s time to deal with these lawsuits may have an adverse effect upon the price of our stock.
Our charter documents and Maryland law contain provisions that may delay, defer or prevent a change of control transaction.
Our charter and bylaws and Maryland corporate law contain a number of provisions (as further described in exhibit 3.2 Bylaws of the Registrant under the Exhibit Index included in Part IV, Item 15 Exhibits and Financial Statement Schedules of this Report Form 10-K) that could delay, defer or prevent a transaction or a change in control of us that might involve a premium price for holders of our common stock or otherwise be in their best interests, including:
| · | Ownership Limit. Our articles of incorporation, subject to certain exceptions, authorizes our board of directors to take such actions as are necessary and desirable to preserve our qualification as a REIT and to limit any person to actual or constructive ownership of no more than a 9.8% of the number or value, whichever is more restrictive, of the outstanding shares of our stock, unless our board of directors waives this ownership limit. However, our board of directors may not grant a waiver of the ownership limit that would permit a person to acquire more than 15% of our stock without exception. The ownership limit may have the effect of precluding a change in control of us by a third party, even if such change in control would be in the interest of the our stockholders (and even if such change in control would not reasonably jeopardize our REIT status). |
| · | Staggered Board. Our board of directors is divided into three classes, with each class serving staggered three-year terms. This classification of our board of directors may have the effect of delaying or preventing changes in our control or management. |
| · | Removal of Directors. Directors may be removed only for cause and only by the affirmative vote of stockholders holding at least a majority of the shares then outstanding and entitled to be cast for the election of directors. |
| · | Stockholders’ Rights Plan. We have a stockholders’ rights plan that enables our board of directors to deter coercive or unfair takeover tactics and to prevent a person or a group from gaining control of us without offering a fair price to all stockholders. Unless our board of directors approves the person’s or group’s purchase, after that person gains control of us, all other stockholders will have the right to purchase securities from us at a price that is less than their then fair market value. Purchases by other stockholders would substantially reduce the value and influence of the shares of our common stock owned by the acquiring person or group. Our board of directors, however, can prevent the stockholders’ rights plan from operating in this manner. This gives our board of directors’ significant discretion to approve or disapprove a person’s or group’s efforts to acquire a large interest in us. |
| · | Duties of Directors with Respect to Unsolicited Takeovers. Under Maryland law, a director is required to perform his or her duties (a) in good faith, (b) in a manner he or she believes to be in the best interests of the corporation and (c) with the care that an ordinarily prudent person in a like position would use under similar circumstances. Maryland law provides protection for Maryland corporations against unsolicited takeovers by, among other things, retaining the same standard of care in the performance of the duties of directors in unsolicited takeover situations. The duties of directors of Maryland corporations do not require them to (a) accept, recommend or respond to any proposal by a person seeking to acquire control of the corporation, (b) authorize the corporation to redeem any rights under, or modify or render inapplicable, any stockholders rights plan, (c) make a determination under Maryland Business Combination Act or Maryland Control Share Acquisition Act or (d) act or fail to act solely because of the effect of the act or failure to act may have on an acquisition or potential acquisition of control of the corporation or the amount or type of consideration that may be offered or paid to the stockholders in an acquisition. Moreover, under Maryland law the act of the directors of a Maryland corporation relating to or affecting an acquisition or potential acquisition of control is not subject to any higher duty or greater scrutiny than is applied to any other act of a director. Maryland law also contains a statutory presumption that an act of a director of a Maryland corporation satisfies the applicable standards of conduct for directors under Maryland law. |
| · | Maryland General Corporation Law. Certain provisions of the MGCL may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change of control under circumstances that otherwise could provide the holders of shares of our common stock with the opportunity to realize a premium over the then-prevailing market price of such shares, including: |
| · | “business combination” provisions that, subject to limitations, prohibit certain business combinations between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of the voting power of our shares or an affiliate or associate of ours who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of our then outstanding voting shares) or an affiliate thereof for five years after the most recent date on which the stockholder becomes an interested stockholder, and thereafter imposes special appraisal rights and special stockholder voting requirements on these combinations; and |
| · | “control share” provisions that provide that “control shares” of our company (defined as shares which, when aggregated with other shares controlled by the stockholder, entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding all interested shares. |
| · | We have opted out of the control share provisions of the MGCL pursuant to a provision in our bylaws. However, our board of directors may by amendment to our bylaws opt in to the control share provisions of the MGCL in the future. |
| · | Advance Notice of Director Nominations and Stockholder Proposals. Our bylaws impose certain advance notice requirements that must be met for nominations of persons for election to the board of directors and the proposal of business to be considered by stockholders. |
Our rights and the rights of our stockholders to take action against our directors and officers are limited.
Maryland law provides that a director has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. Our charter limits the liability of our directors and officers to us and our stockholders for money damages, except for liability resulting from:
| · | actual receipt of an improper benefit or profit in money, property or services; or |
| · | a final judgment based upon a finding of active and deliberate dishonesty by the director or officer that was material to the cause of action adjudicated. |
In addition, our articles of incorporation authorize us to obligate our company, and our bylaws require us, to indemnify our directors and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist under common law. Accordingly, in the event that actions taken in good faith by any of our directors or officers impede the performance of our company, stockholders’ ability to recover damages from such director or officer will be limited.
ITEM 2. | UNREGISTERED SALES OF EQUITY AND USE OF PROCEEDS |
None.
ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
None.
ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
None.
ITEM 5. | OTHER INFORMATION |
None.
ITEM 6. |
EXHIBIT INDEX
| (1) | Incorporated herein by reference to our Form S-4 Registration Statement filed on May 27, 2005 (File No. 333-125347). | ||
| (2) | Incorporated herein by reference to Post-Effective Amendment No. 3 to our Form S-4 Registration Statement filed on January 4, 2006 (File No. 333-125347). | ||
| (3) | Incorporated herein by reference to Post-Effective Amendment No. 4 to our Form S-4 Registration Statement filed on January 31, 2006 (File No. 333-125347). | ||
| (4) | Incorporated herein by reference to the Transition Report on Form 10-K for the ten month transition period ended April 30, 2006 filed on June 28, 2006 (File No. 000-51964) | ||
| (5) | Incorporated herein by reference to the Quarterly Report on Form 10-Q for the three months ended September 30, 2006 filed on October 26, 2006 (File No. 000-51964) |
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 I, Inc. | ||
| By: | /s/ Michael V. Shustek | |
| Michael V. Shustek | ||
| President and Chief Executive Officer | ||
| Date: | August 7, 2007 | |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature | Capacity | Date | ||
/s/ Michael V. Shustek | President and Chief Executive Officer and Director | August 7, 2007 | ||
| Michael V. Shustek | (Principal Executive Officer) | |||
/s/ Rocio Revollo | Chief Financial Officer | August 7, 2007 | ||
| Rocio Revollo | (Principal Financial and Accounting Officer) | |||
/s/ John E. Dawson | Director | August 7, 2007 | ||
| John E. Dawson | ||||
/s/ Robert J. Aalberts | Director | August 7, 2007 | ||
| Robert J. Aalberts | ||||
/s/ Fredrick J. Zaffarese Leavitt | Director | August 7, 2007 | ||
| Fredrick J. Zaffarese Leavitt | ||||
/s/ Roland M. Sansone | Director | August 7, 2007 | ||
| Roland M. Sansone |