UNITED STATES
SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period endedSeptember 30, 2018
or
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
| For the transition period from | to | ||
Commission File Number:000-1695962
KORTH DIRECT MORTGAGE LLC
(Exact name of registrant as specified in its charter)
| Florida | 27-0644172 | |
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
2937 SW 27th Avenue, Suite 307, Miami FL 33133 |
| (Address of principal executive offices) |
| (305) 668-8485 |
| (Registrant’s telephone number, including area code) |
| (Former name, former address and formal fiscal year, if changed since last report) |
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.
ý Yeso No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
ýYesoNo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or, an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company”, in Rule 12b-2 of the Exchange Act.
| Large accelerated filer☐ | Accelerated filer☐ | |
| Non-accelerated filer☐ | Smaller reporting company ☑ | |
| Emerging growth company ☑ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☑
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APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
The registrant is a limited liability company, all of the common equity of which is held by affiliates. There is no market for the membership shares of Korth Direct Mortgage LLC. As of September 30, 2018, there were 1,000,000 shares of Korth Direct Mortgage LLC outstanding.
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PART I – FINANCIAL INFORMATION
| Item 1. | Financial Statements | 4 |
| Unaudited Statements of Financial Condition | 4 | |
| Unaudited Statements of Operations | 5 | |
| Unaudited Statements of Cash Flows | 6 | |
| Notes to Financial Statements | 7 | |
| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 11 |
| Item 3. | Quantitative and Qualitative Disclosures about Market Risk | 13 |
| Item 4. | Controls and Procedures | 13 |
| PART II – OTHER INFORMATION | ||
| Item 1. | Legal Proceedings | 13 |
| Item 1A. | Risk Factors | 13 |
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 13 |
| Item 3. | Defaults Upon Senior Securities | 14 |
| Item 4. | Mine Safety Disclosures | 14 |
| Item 5. | Other Information | 14 |
| Item 6. | Exhibits | 15 |
| SIGNATURES | 15 | |
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PART I—FINANCIAL INFORMATION
UNAUDITED STATEMENTS OF FINANCIAL CONDITION
| September 30, 2018 | December 31, 2017 | |||||||
| (Unaudited) | ||||||||
| ASSETS | ||||||||
| Cash and Cash Equivalents | $ | 26,687 | $ | 19,844 | ||||
| Restricted Cash | 139,678 | 55,487 | ||||||
| Mortgages Owned | 13,178,351 | 1,999,132 | ||||||
| Mortgage Servicing Rights, at Fair Value | 423,038 | - | ||||||
| Prepaid Expenses | 10,584 | 11,332 | ||||||
| TOTAL ASSETS | $ | 13,778,338 | $ | 2,085,795 | ||||
| LIABILITIES AND MEMBERS’ DEFICIT | ||||||||
| LIABILITIES | ||||||||
| Due to Parent | $ | 548,832 | $ | 334,324 | ||||
| Escrow Payable | 139,678 | 46,579 | ||||||
| Due to Investors | - | 8,908 | ||||||
| Accrued Expenses | 9,750 | 15,000 | ||||||
| Mortgage Secured Notes Payable | 13,178,351 | 1,999,132 | ||||||
| Total Liabilities | 13,876,611 | 2,403,943 | ||||||
| MEMBERS’ DEFICIT | ||||||||
| Accumulated Deficit | (101,795 | ) | (321,670 | ) | ||||
| Capital | 3,522 | 3,522 | ||||||
| Total Members’ Deficit | (98,273 | ) | (318,148 | ) | ||||
| TOTAL LIABILITIES AND MEMBERS’ DEFICIT | $ | 13,778,338 | $ | 2,085,795 | ||||
See accompanying notes to the unaudited financial statements.
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UNAUDITED STATEMENTS OF OPERATIONS
FOR THE PERIOD FROM JANUARY 1 THROUGH SEPTEMBER 30
| For the Nine Months Ended | For the Nine Months Ended | |||||||
| September 30, 2018 | September 30, 2017 | |||||||
| REVENUES | ||||||||
| Origination Revenue, Net | $ | 174,866 | $ | 21,180 | ||||
| Servicing Revenue | 37,685 | 1,195 | ||||||
| Processing Revenue | 4,150 | 1,500 | ||||||
| Interest Income | 87 | - | ||||||
| Total Revenues | 216,788 | 23,875 | ||||||
| COST OF REVENUES | ||||||||
| Broker Underwriting Expense | 101,160 | - | ||||||
| Bank Fees | 2,344 | 260 | ||||||
| Appraisal Costs | 5,555 | 950 | ||||||
| Marketing | 23,743 | 4,235 | ||||||
| License and Registration | 13,498 | 4,623 | ||||||
| Ratings | 30,000 | 10,000 | ||||||
| Technology Fees | 5,030 | 3,067 | ||||||
| Total Cost of Revenues | 181,330 | 23,135 | ||||||
| GROSS PROFIT (LOSS) | 35,458 | 740 | ||||||
| OPERATING EXPENSES | ||||||||
| Office Supplies | 1,818 | 1,207 | ||||||
| Accounting | 29,480 | - | ||||||
| Salaries | 107,881 | 95,517 | ||||||
| Payroll Taxes | 7,116 | 6,659 | ||||||
| Professional & Legal | 89,450 | 46,980 | ||||||
| SEC Filing Expense | 989 | - | ||||||
| Travel & Entertainment | 1,286 | 729 | ||||||
| Business Development | 599 | - | ||||||
| Total Expenses | 238,619 | 151,092 | ||||||
| Other Income | ||||||||
| Unrealized Gain on Mortgages Owned | 423,038 | - | ||||||
| Net Profit/(Loss) From Operations | 219,877 | (150,352 | ) | |||||
| NET PROFIT/(LOSS) | $ | 219,877 | $ | (150,352 | ) | |||
See accompanying notes to the unaudited financial statements.
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UNAUDITED STATEMENTS OF CASH FLOWS
| For the Nine Months Ended | For the Nine Months Ended | |||||||
| September 30, 2018 | September 30, 2017 | |||||||
| CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
| Net Profit/(Loss) | $ | 219,877 | $ | (150,352 | ) | |||
| Adjustments to Reconcile Net Profit/(Loss) to | ||||||||
| Net Cash Provided by/(Used in) Operating Activities: | ||||||||
| Unrealized Gain on Motgages Owned | (423,038 | ) | - | |||||
| Changes in Operating Assets and Liabilities: | ||||||||
| Restricted Cash | (84,191 | ) | (37,264 | ) | ||||
| Mortgage Secured Notes Issued | 11,179,219 | 1,052,873 | ||||||
| Prepaid Expenses | 748 | - | ||||||
| Due to Parent | 214,506 | 152,290 | ||||||
| Taxes Payable | - | (8,213 | ) | |||||
| Escrow Payable | 93,099 | 34,913 | ||||||
| Due to Investors | (8,908 | ) | 2,351 | |||||
| Accrued Expenses | (5,250 | ) | - | |||||
| New Mortgage Lending | (11,179,219 | ) | (1,052,873 | ) | ||||
| Total Adjustments | (213,034 | ) | 144,077 | |||||
| NET CASH PROVIDED BY/(USED IN) OPERATING ACTIVITIES | 6,843 | (6,275 | ) | |||||
| NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS | 6,843 | (6,275 | ) | |||||
| CASH AND CASH EQUIVALENTS – Beginning of Period | 19,844 | 7,290 | ||||||
| CASH AND CASH EQUIVALENTS – End of Period | $ | 26,687 | $ | 1,015 | ||||
See accompanying notes to the unaudited financial statements.
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NOTES TO UNAUDITED FINANCIAL STATEMENTS
NOTE 1 - NATURE OF BUSINESS
Korth Direct Mortgage LLC (the “Company”) is a limited liability company formed in the State of Florida. The Company is a wholly owned subsidiary of J. W. Korth & Company, L.P. (“J. W. Korth”), an SEC and FINRA registered broker dealer. The Company was created to sell Notes secured by mortgage loans.
The Company and J. W. Korth & Company executed a support agreement that provides financial, managerial, and office support to the Company until it is fully operational and a going concern. Pursuant to this agreement, for any moneys owed by the Company to J. W Korth, J. W. Korth may not seek reimbursement from the Company until the Company shall maintain a liquid net worth of at least $1,000,000 for a minimum period of 90 days.
Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with US generally accepted accounting principles (“GAAP”) have been condensed or omitted. These unaudited financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s 2017 Annual Report on Form 10-K filed with the Securities and Exchange Commission.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying financial statements are solely for the Company. The financial statements of the parent company, J. W. Korth, have these accounts consolidated within them.
BASIS OF ACCOUNTING
The accompanying financial statements have been prepared on the accrual basis of accounting, in accordance with GAAP.
CASH AND CASH EQUIVALENTS
For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.
MORTGAGE VALUATION
Mortgages that are current are carried at the principal value owed by the borrower, as of the date of the financial statements, according to the amortization schedule for the loan. All mortgages owned as of the date of these financial statements are current. The net present value of the servicing revenue is recorded as mortgage servicing rights, at fair value on the Unaudited Statements of Financial Condition, and is recognized on the Unaudited Statement of Operations as an unrealized gain on mortgages owned.
MORTGAGE SECURED NOTES
The Company funds the mortgage loans that it makes by issuing Mortgage Secured Notes (“MSNs”), which are secured by those same mortgages. As of the date of these financial statements, the Company has funded loans totaling $13,200,250, and it issued MSNs secured by those loans, also in the amount of $13,200,250. The deals have been funded in multiple ways, including private placements, SEC registered deals, and 144a offerings.
REVENUE RECOGNITION
The Company has three primary sources of revenue: origination fees, servicing fees, and processing fees.
Origination Fees
Loan origination fees represent revenue earned from originating mortgage loans, net of any credits given to the borrower. The net includes a $27,369 closing credit that was given to the borrower in the quarter ending June 30, 2018. Loan origination fees generally represent flat, per-loan fee amounts and are recognized as revenue at the time the loans are funded.
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Servicing Fees
Loan servicing fees represent revenue earned for servicing loans for various investors. Loan servicing fees are a percentage of the outstanding unpaid principal balance and represent the difference between the Corresponding Mortgage Loan (“CM Loan”) interest received and the MSN interest payable. Servicing Fees are recognized as revenue as the related mortgage payments are received; similarly, loan servicing expenses are charged to operations as incurred.
Processing Fees
Processing fees are collected from the borrower at the time the commitment letter is signed and cover a variety of expenses during the underwriting process. If the Company cancels the transaction, then unused fees are refunded. If the transaction is unable to proceed for any reason not the fault of the Company, then the Company keeps the full processing fee. Revenues from processing fees are recognized at closing or at the time a transaction is canceled.
Unrealized Gain on Mortgages Owned
The net present value of the servicing income is recognized at the time the mortgage is initiated. This value uses several inputs that are highly subjective including: discount rate, prepayment rate, the current interest rate environment, and default rate assumptions. Since the Company has limited operating history and a small amount of loans outstanding, we have a limited basis to predict prepayment rates and default rates.
ESTIMATES
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
DUE TO PARENT AND PAYABLES
Items due to parent are operating expenses due to the parent company, J. W. Korth, pursuant to the support agreement. The date such payments are due has not yet been determined. A repayment plan for operating expenses will be created a future date.
INCOME TAXES
The Company is a limited liability company which is treated as a partnership for federal and state income tax. Accordingly, no provision for federal income taxes is required since the members report their proportionate share of company taxable income or loss on their respective income tax returns. Such income or losses are proportionately allocated to the members based upon their ownership interests.
In accordance with Financial Accounting Standards Board Accounting Standards Codification (“ASC”) 740 –Income Taxes, management has evaluated uncertain tax positions taken or expected to be taken in the Company’s tax returns. In order for a benefit to be recognized, a tax position must be more-likely-than-not to be sustained when challenged or examined by the applicable taxing authority. For the nine months ended September 30, 2018, the Company has no material uncertain tax positions to be accounted for in the financial statements.
NOTE 3 - RESTRICTED CASH
The Company maintains two segregated accounts in trust for borrowers and investors. The value of these accounts is carried under the asset “Restricted Cash.”
The “In Trust for 1” account holds the monthly tax and insurance payments collected from borrowers and distributes payments annually, on behalf of borrowers, to the appropriate tax authority and insurance companies. This account corresponds to the Escrow Payable liability. As of September 30, 2018, this account has a liability of $139,678.
The “In Trust for 2” account receives payments from borrowers and distributes payments to investors, and pays the servicing fee to the Company. This account corresponds to the Due to Investors liability. As of September 30, 2018, this account has a zero balance.
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NOTE 4 - COMMITMENTS
The Company relies entirely on its parent, J. W. Korth, to provide office space, internet connectivity, phone service, and incidentals through the end of 2018.
NOTE 5 - INDEMNIFICATIONS
The Company provides representations and warranties to counterparties in connection with a variety of commercial transactions and occasionally indemnifies them against potential losses caused by the breach of those representations and warranties. These indemnifications generally are standard contractual terms and are entered into in the normal course of business. The maximum potential amount of future payments that the Company could be required to make under these indemnifications cannot be estimated. However, the Company believes that it is unlikely it will have to make material payments under these arrangements and has not recorded any contingent liability in the financial statements for these indemnifications.
NOTE 6 - CUSTOMERS
As of September 30, 2018, the Company has seven customers. The Company defines customers as borrowers that have an active loan with the Company, or are in the midst of the underwriting process and have a commitment fee on deposit with the Company. Currently, 68% of loans, by unpaid balance, are geographically concentrated in the state of Ohio.
NOTE 7 - RELATED PARTY TRANSACTIONS
The Company is currently supported by its parent company, J. W. Korth. This support is expected to be repaid once the Company is cash flow positive. The Company records this value as a liability on its balance sheet. The Company owed J. W. Korth $548,832 and $334,324 as of September 30, 2018 and December 31, 2017, respectively. Pursuant to the Support Agreement between the Company and J. W. Korth, J. W. Korth may not seek reimbursement from the Company until the Company shall maintain a liquid net worth of at least $1,000,000 for a minimum of 90 days.
NOTE 8 - FAIR VALUE
GAAP establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring financial assets and liabilities at fair value. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy are described below:
Level I—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.
Level II—Inputs (other than quoted prices included in Level I) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.
Level III—Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.
Valuation Process
Cash and cash equivalents:
The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2.
Mortgages Owned and Mortgage Secured Notes Payable:
All of the loans on the balance sheet as of September 30, 2018, were either underwritten or securitized within the last 10 months. Due to the recency of issue and the securitization and sale of these loans, all priced at par, the Company has determined that the fair values were determined by the market at the time of sale and should be classified as Level II of the fair value hierarchy. The carrying amounts for these items approximate the fair value. For amortizing loans, the Company discounts those to remaining principal value.
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Due to the fact that the Company issues notes secured directly by underlying loans, our assets and liabilities in this category have identical values and assets have offsetting balances.
Mortgage Servicing
The net present value of the servicing income is recognized at the time the mortgage is initiated as an unrealized gain, beginning in 2018. This value uses several inputs that are highly subjective including: discount rate, constant prepayment rate, the current interest rate environment, and default rate assumptions. Since the Company has limited operating history and a small amount of loans outstanding, we have a limited basis to predict prepayment rates and default rates, but have engaged a third party to assist us in our valuation of this asset, beginning in the three months ended June 30, 2018. For the prior quarter, the servicing rights were combined under the caption “Mortgages Owned, at Fair Value” on the Unaudited Statement of Financial Condition; however, beginning this period and for those going forward the servicing has been separated to its own line item as “Mortgage Servicing Rights, at Fair Value”
Fair Value Disclosure
The following tables display the Company’s assets and liabilities measured at fair value on a recurring basis:
| December 31, 2017 | ||||||||||||||||
| Total | Level I | Level II | Level III | |||||||||||||
| Financial Assets | ||||||||||||||||
| Mortgages Owned | $ | 1,999,132 | $ | - | $ | 1,999,132 | $ | - | ||||||||
| Financial Liabilities | ||||||||||||||||
| Mortgage Secured Notes Payable | $ | 1,999,132 | $ | - | $ | 1,999,132 | $ | - | ||||||||
| September 30, 2018 | ||||||||||||||||
| Financial Assets | ||||||||||||||||
| Mortgages Owned | $ | 13,178,351 | $ | - | $ | 13,178,351 | $ | - | ||||||||
| Mortgage Servicing | 423,038 | - | - | 423,038 | ||||||||||||
| Total Financial Assets | $ | 13,601,389 | $ | - | $ | 13,178,351 | $ | 423,038 | ||||||||
| Financial Liabilities | ||||||||||||||||
| Mortgage Secured Notes Payable | $ | 13,178,351 | $ | - | $ | 13,178,351 | $ | - | ||||||||
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Fair Value Measurements
Changes in Fair Value Measurements for the quarter ended September 30, 2018
The Company has engaged MIAC Analytics to assist in the valuation of the mortgage servicing component of its business. This lead to significant changes in underlying assumptions within the valuation model, which are detailed below.
The following table presents a reconciliation of changes in Level 3 assets and liabilities reported in the Statements of Financial Condition for the quarter ended September 30, 2018:
| Changes in assets: | ||||
| Quarter ended September 30, 2018 | Mortgage Servicing Value | |||
| Beginning balance at June 30, 2018 | $ | 307,668 | ||
| Purchases | - | |||
| Sales | - | |||
| Issues | - | |||
| Settlements | - | |||
| Net realized gain/loss | - | |||
| Unrealized Gain from newly issued mortgages | 122,243 | |||
| Fair Value adjustment | (6,873 | ) | ||
| Transfers into Level 3 | - | |||
| Transfers out of Level 3 | - | |||
| Ending balance at September 30, 2018 | $ | 423,038 | ||
The Company’s policy for recording transfers between levels of the fair value hierarchy is to recognize as of the financial statement date. For the quarter ended September 30, 2018, there were no transfers between levels.
The Company has established valuation processes and policies for its Level 3 investments to ensure that the methods used are fair and consistent in accordance with ASC 820 –Fair Value Measurements and Disclosures. The Company’s valuation committee performs reviews of the Level 3 investments’ valuations, which include reviewing any significant price changes reported from the prior period. When a Level 3 investment has a significant price change, the valuation committee reviews relevant market data to substantiate the price change.
The following table presents quantitative information regarding the significant unobservable inputs the Company uses to determine the fair value of Level 3 investments held as of September 30, 2018:
| Investment type | Fair Value | Valuation technique | Unobservable input | Value |
| Mortgage servicing | $423,038 | Net Present Value | Prepayment Discount | 5.62% |
| Discount rate | 15.00% |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following is a discussion of our historical consolidated financial condition and results of operations, and should be read in conjunction with (i) our historical consolidated financial statements and accompanying notes thereto included elsewhere in this Quarterly Report on Form 10-Q; (ii) our Annual Report on Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission (the “SEC”) on April 2, 2018, as amended; and (iii) our management’s discussion and analysis of financial condition and results of operations included in our 2017 Form 10-K. This discussion includes forward-looking statements that are subject to risk and uncertainties. Actual results may differ substantially from the statements we make in this section due to a number of factors that are discussed in “Forward-Looking Statements” herein and “Part I – Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2017.
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Overview
Korth Direct Mortgage LLC (“KDM,” the “Company”, “we,” or “us”) was organized in Florida on July 24, 2009, under the name HCMK Consulting LLC. We changed our name to J. W. Korth & Company LLC, in November 2010, and then to Korth Direct Mortgage LLC, on August 24, 2016. Our principal executive offices are located at 2937 SW 27th Avenue Suite 307, Miami, Florida 33133, and our telephone number is (305) 668-8485. Our website address is www.korthdirect.com.
Korth Direct Mortgage LLC, began its formal operations in October of 2016 when we engaged our Chief Lending Officer. KDM is a licensed Mortgage Lender Servicer with the State of Florida. Our NMLS License Number is 1579547. Our operating history is limited. We are primarily supported by our parent company, J. W. Korth & Company, L.P. (“J.W. Korth & Company”), a FINRA and SEC registered broker-dealer founded in 1982. We believe we will continue to be supported by our parent company through mid-2019. Over this period, we believe that we will achieve adequate revenue and cash-flow through making and servicing our mortgage loans to make us self-sufficient. Although we do not anticipate the need to raise any funds to finance our operating expenses during this period, we believe that we could do so quickly by selling our mortgage servicing rights. During this period, we expect no research and development expenses and no expenses for plant and equipment, and that office space will continued to be shared with our parent company. We anticipate renting office space and adding staff as necessary as our lending and servicing grow; these expenses would be paid for by ordinary revenues.
The total support we have received from J. W. Korth & Company through September 30, 2018, is $548,832. The Support Agreement provides support that is at the discretion of J. W. Korth & Company, and could be ended at any time for any reason. However, J. W. Korth & Company expects to continue to provide approximately another $200,000 to support KDM, after which the Company is expected to be self-supporting.
Results of Operations for the Nine Months ended September 30, 2018
The Company had net income of $219,877 for the nine months ended September 30, 2018; 81% of our revenue for that nine-month period was attributable to origination revenue, and for the period we had servicing and processing revenue of $37,685 and $4,150, respectively. Costs were dominated by the brokerage underwriting expense of $101,160, which accounted for approximately 58% of direct costs. Our servicing revenue has begun to become significant and, after the transaction that we closed in September, creates approximately $12,000 revenue monthly going forward. Gross profit accelerated in Q3, with the most recent quarter accounting for $25,064 of the total $35,458 year to date. Operating expenses increased by 58% over the same period in 2017 ($238,619 vs $151,092) due to operations coming online and actual deals getting funded and closed, with associated professional and legal expenses increasing.
Higher expenses and costs were offset by the unrealized gain on mortgages owned, which was $423,038 at September 30, 2018, an increase of $115,370 over the prior quarter due to new lending. A discussion of the assumptions underlying the valuation can be found in Note 8 of the Notes to our Unaudited Financial Statements.
We are optimistic about our future. We believe that we can proceed with regularity and great responsiveness by transitioning, as we have, from registered offerings of our MSNs to offerings exempt from registration under Securities and Exchange Commission Rule 144A. The time we spent becoming a public reporting company has positioned us to be able to execute successfully in this market. We have seen our time to close on an MSN offering go from 6 months to approximately 4 weeks. This has resulted in a dramatic change to our ability to fund mortgages quickly and efficiently. We believe that we are now positioned to take advantage of our market and grow at a steadily increasing pace.
Financial Condition for the Nine Months Ended September 30, 2018
As of September 30, 2018, we had six loans on our balance sheet for a total of $13,178,351 at fair value. The original loan amounts totaled $13,200,250; however, two loans are amortizing and are carried at their remaining principal balances. We have recognized an unrealized gain of $423,038, which is the net present value of the future servicing income we receive from the loans made to date. We did not include this category of income on our 2017 year-end financial statements, but first did so in 2018-Q1. This value is highly subjective and includes such variables as constant prepayment rate (CPR), discount rate, and market pricing data; this value will be recalculated quarterly. The current value was provided by a third-party consulting firm and uses 15.0% for the discount rate and includes a 5.62% constant prepayment rate (“CPR”), along with other assumptions customary to the industry.
We expect to close an additional $10 to $15 million of loans by year end. We do not expect to increase staff by a material amount until we have sufficient pipeline and servicing to warrant additional outlay. Should we need additional liquidity in the short term, we will either securitize or sell all or some of our mortgage servicing rights.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We have no instruments subject to market risk.
Item 4. Controls and Procedures.
We are responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined by Securities Exchange Act Rule 13a-15(f). Our internal controls are designed to provide reasonable assurance as to the reliability of our financial statements for external purposes in accordance with accounting principles generally accepted in the United States.
Internal control over financial reporting has inherent limitations and may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable, not absolute, assurance with respect to financial statement preparation and presentation. Further, because of changes in conditions, the effectiveness of internal control over financial reporting may vary over time.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.
Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our internal control over financial reporting as of September 30, 2018, as required by Securities Exchange Act Rule 13a-15(c). In making our assessment, we have utilized the criteria set forth by the 2013 Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We concluded that based on our evaluation our internal control over financial reporting was effective as of September 30, 2018.
Changes in internal control over financial reporting
In the quarter ended March 31, 2018, we made changes to our internal control procedures with respect to financial reporting to further tighten our internal processes. Our financial reports are now reviewed on a periodic basis to ensure proper disclosure of report elements and classification of expenses.
Changes in disclosure controls and procedures
Commencing in the quarter ended June 30, 2018, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, our Chief Executive and Chief Financial Officers concluded that our disclosure controls and procedures with respect to the borrower-provided financial statements presented in our registration statements effective December 12, 2017, and April 26, 2018, were not effective to prevent errors in our presentation. Our controls and procedures have been amended to prevent errors in any future reports which may include borrower-provided financial statements for the properties that we have financed.
PART II—OTHER INFORMATION
The Company is not subject to any material legal proceeding. The Company is a defendant in a suit regarding a mortgage brokerage fee dispute. The Company is fully indemnified for the suit by the borrower in the transaction which is the subject of the suit. We do not believe that the proceeding is material under Item 103 of SEC Regulation S-K.
There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017, as amended. Please refer to the “Risks Factors” section in our Annual Report for a discussion of risks to which our business, financial condition, results of operations and cash flows are subject.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
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Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not Applicable.
None.
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*Filed here with.
Pursuant to the requirements 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.
KORTH DIRECT MORTGAGE LLC
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| Dated: November 13, 2018 | By: | /s/ James W. Korth | |
| James W. Korth, Chief Executive Officer and Manager | |||
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