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, 2008
OR
(_) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 333-11625
CAPITAL ALLIANCE INCOME TRUST LTD., A REAL ESTATE INVESTMENT TRUST
------------------------------------------------------------------
(Exact name of Registrant)
Delaware 94-3240473
------------------------------ -----------------
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification Number)
100 Pine Street
Suite 560
San Francisco, California 94111
- --------------------------------------- ----------
(Address of principal executive office) (zip code)
(415) 693-9500
--------------
(Registrant's telephone number)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered Common Stock
$0.01 par value American Stock Exchange
Check whether the registrant (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act during the past 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 [_]
Smaller Reporting Company Yes [X] No [_]
As of August 4, 2008, the issuer's common shares closed at $4.39 and the
aggregate market value of the issuer's shares of Common Stock, $.01 par value,
held by non-affiliates of the issuer was approximately $1,229,200. At that date
approximately 381,000 common shares were outstanding of which 280,000 common
shares were held by non-affiliates.
CAPITAL ALLIANCE INCOME TRUST, LTD
A REAL ESTATE INVESTMENT TRUST
Notes to Consolidated Financial Statements
(unaudited)
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION (UNAUDITED)
ITEM 1 CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets 3
Consolidated Statements of Operations 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6-11
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 12-15
AND RESULTS OF OPERATIONS
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT RISK 15-16
ITEM 4 CONTROLS AND PROCEDURES 16
PART II - OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS 17
ITEM 1A RISK FACTORS 17-20
SIGNATURES 22
CERTIFICATIONS
All other items called for by the instructions to Form 10-Q have been omitted
because the items are not applicable or the relevant information is not
material.
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
Consolidated Balance Sheets
June 30, December 31,
2008 2007
------------ ------------
ASSETS (unaudited)
------------
Cash and cash equivalents $ 2,304,199 $ 962,190
Marketable securities 24,621 133,459
Accounts receivable 896,274 1,189,339
Allowance for doubtful accounts (609,750) (910,000)
------------ ------------
Net accounts receivable 286,524 279,339
Notes receivable:
Mortgage notes receivable 7,622,178 11,144,365
Allowance for loan losses (556,703) (2,155,000)
------------ ------------
Net notes receivable 7,065,475 8,989,365
Real estate owned 3,378,714 1,804,826
Other assets 1,738 --
------------ ------------
Total assets $ 13,061,271 $ 12,169,179
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Bank loans payable $ 2,008,877 $ 3,641,828
Senior liens 2,636,110 --
Other liabilities 181,304 313,336
------------ ------------
Total liabilities 4,826,291 3,955,164
Stockholders' equity
Preferred stock, $.01 par value;1,600,000 shares authorized; 2,138 2,138
213,820 shares issued and outstanding at June 30, 2008
and December 31, 2007
Additional paid in capital - preferred stock 5,509,728 5,509,728
Less treasury stock: 16,919 and 16,919 preferred shares at
June 30, 2008 and December 31, 2007 at cost (229,179) (229,179)
Common stock, $.01 par value; 2,000,000 shares authorized; 5,000 5,000
500,032 shares issued and outstanding at June 30, 2008
and December 31, 2007
Additional paid in capital - common stock 9,404,372 9,394,577
Less treasury stock: 119,500 and 119,500 common shares at
June 30, 2008 and December 31, 2007 at cost (1,699,771) (1,699,771)
Accumulated other comprehensive income (582) (385)
Accumulated deficit (4,756,726) (4,768,093)
------------ ------------
Total stockholders' equity 8,234,980 8,214,015
------------ ------------
Total liabilities and stockholders' equity $ 13,061,271 $ 12,169,179
============ ============
See accompanying notes to consolidated financial statements.
3
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
Consolidated Statements of Operations
(unaudited)
Three Months Ended Six Months Ended
June 30 June 30
2008 2007 2008 2007
--------- --------- --------- ---------
REVENUES
Interest income $ 123,091 $ 304,901 $ 359,701 $ 643,683
Other income 1,957 4,344 6,353 6,598
--------- --------- --------- ---------
Total revenues 125,048 309,245 366,054 650,281
EXPENSES
Loan servicing fees to related parties -- 8,350 -- 15,500
Interest expense on loans 32,871 73,286 81,086 184,968
Commission expenses 14,713 1,011 36,918 1,011
Provision (recovery) for loan losses (81,509) 118,000 (56,509) 221,649
Provision (recovery) of doubtful accounts 6,954 -- (40,046) --
Wages and salaries 90,504 105,113 194,831 204,759
Taxes 5,148 9,978 19,998 19,153
Loan origination costs -- 36,962 -- 62,465
General and administrative 51,179 82,853 161,286 200,898
--------- --------- --------- ---------
Total expenses 119,860 435,553 397,564 910,403
--------- --------- --------- ---------
LOSS FROM OPERATIONS 5,188 (126,308) (31,510) (260,122)
Operating expenses of real estate owned 10,348 -- 7,379 --
Gain (loss) on real estate owned (793) -- 56,370 (3,182)
(Loss) on securities transactions (12,645) (9,656) (20,873) (9,656)
--------- --------- --------- ---------
Total gain (loss) from other items (3,090) (9,656) 42,876 (12,838)
--------- --------- --------- ---------
NET INCOME (LOSS) $ 2,098 $(135,964) $ 11,366 $(272,960)
========= ========= ========= =========
PREFERRED DIVIDENDS -- -- -- --
--------- --------- --------- ---------
NET INCOME (LOSS) $ 2,098 $(135,964) $ 11,366 $(272,960)
========= ========= ========= =========
BASIC EARNINGS PER COMMON SHARE $ 0.01 $ (0.36) $ 0.03 $ (0.72)
========= ========= ========= =========
DILUTED EARNINGS PER COMMON SHARE $ 0.01 $ (0.36) $ 0.03 $ (0.72)
========= ========= ========= =========
DIVIDENDS PAID PER PREFERRED SHARE $ -- $ -- $ -- $ --
========= ========= ========= =========
DIVIDENDS PAID PER COMMON SHARE $ -- $ -- $ -- $ --
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
4
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
Consolidated Statements of Cash Flows
(unaudited)
Six Months Ended
June 30
2008 2007
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income (loss) $ 11,366 $ (272,960)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Provision for (recovery of) loan losses (56,509) 221,649
Unrealized gain on marketable securities 36,839 --
Recovery of doubtful accounts (40,046) --
Stock-based compensation expense 9,795 --
Change in accounts receivable (25,748) (211,681)
Change in other assets, net 1,739 --
Change in other liabilities (144,983) (48,874)
----------- -----------
Net cash used in operating activities (207,547) (311,866)
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds (loss) from sale of marketable securities 71,999 (89,000)
Proceeds from origination costs -- 62,464
Change in real estate owned, net 1,769,825 234,868
Proceeds from mortgage notes receivable 1,327,732 2,900,928
----------- -----------
Net cash provided by investing activities 3,169,556 3,109,260
CASH FLOWS FROM FINANCING ACTIVITIES
Payments for bank loans, net (1,620,000) (2,837,753)
Purchase of treasury stock -- --
Preferred dividends paid -- --
Common dividends paid -- --
----------- -----------
Net cash used in financing activities (1,620,000) (2,837,753)
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,342,009 (40,359)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 962,190 599,943
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,304,199 $ 559,584
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest $ 93,570 $ 200,721
=========== ===========
Cash paid for taxes $ 50 $ 159
=========== ===========
NON-CASH INVESTING AND FINANCING ACTIVITIES
Foreclosures, net of reserves and senior liens $ 707,603 $ 1,849,220
=========== ===========
See accompanying notes to consolidated financial statements.
5
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
1. Organization
------------
References to the "Company" refer to Capital Alliance Income Trust Ltd.
(the "Trust") - a Real Estate Investment Trust ("REIT") - and WrenCap
Funding Corporation ("WCFC"), collectively. The Trust was incorporated in
Delaware on December 12, 1995. On April 15, 1997 the Trust formed, a
taxable REIT subsidiary, Capital Alliance Funding Corporation ("CAFC"). On
April 20, 2007, the subsidiary's name was changed to WrenCap Funding
Corporation. Both the Trust and WCFC are incorporated in Delaware. The
Trust owns all of WCFC's common and preferred shares and the Trust and WCFC
are consolidated in the Company's financial statements.
Prior to December 29, 2006, the Company was externally advised by Capital
Alliance Advisors, Inc. (the "Former Manager", "CAAI"). On December 29,
2006, the Former Manager was terminated and the Company became self
advised.
2. Summary of significant accounting policies
------------------------------------------
These financial statements should be read in conjunction with the audited
financial statements and notes thereto for the year ended December 31, 2007
as reported in the Company's Form 10-KSB filed pursuant to 15d-2 with the
Securities and Exchange Commission.
Basis of presentation. The accompanying unaudited consolidated financial
statements as of June 30, 2008 and 2007 have been prepared in accordance
with accounting principles generally accepted in the United States of
America for interim financial statements and pursuant to the instructions
on the Form 10-Q and Article 10 of Regulation S-X of the Securities and
Exchange Commission. The financial information herein reflects all
adjustments (consisting of normal, recurring adjustments) which are, in the
opinion of management, necessary for a fair statement of results for the
interim period. The results of operations for the three and six months
ended June 30, 2008, are not necessarily indicative of the results to be
expected for the full year. These financial statements should be read in
conjunction with the Company's audited financial statements and the notes
thereto included in the Company's Form 10-KSB filed for the year ended
December 31, 2007.
Use of estimates. The preparation of consolidated financial statements in
conformity with accounting principles generally accepted in the United
States of America 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.
Taxes. The Trust has elected to be taxed as a REIT under the Internal
Revenue Code of 1986, as amended (the "Code"). Under the Code, REIT's are
generally not required to pay federal income taxes if they distribute at
least 90% of their taxable income and meet certain income, asset and
shareholder tests. If the Company fails to qualify as a REIT in any taxable
year, the Company will be subject to federal income taxes at regular
corporate rates (including any alternative minimum tax) and may not be able
to qualify as a REIT for the four subsequent taxable years.
Even as a REIT, the Company may be subject to certain state and local taxes
on its income and property, and to federal income and excise taxes on its
undistributable taxable income.
Revenue recognition. Interest income is recorded on the accrual basis of
accounting in accordance with the terms of the loans. Management reviews
the likelihood that a loan will be repaid when the payment of principal or
interest is 90 or more days past due. For these delinquent loans,
Management may continue to record interest income or establish a loan loss
reserve to protect against losses in the loan portfolio including
previously accrued interest. However, if the mortgage's collateral is
considered insufficient to satisfy the outstanding balance, after estimated
foreclosure and selling costs, additional interest is not accrued. Loan
origination income and extension fees are deferred and recognized over the
remaining life of the loan as interest income.
6
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
2. Summary of significant accounting policies (continued)
------------------------------------------------------
Cash and cash equivalents. Cash and cash equivalents include cash and
highly liquid investments with maturities of three months or less when
purchased. The Company deposits cash in financial institutions insured by
the Federal Deposit Insurance Corporation. At times, the Company's account
balances may exceed the insured limits. The Company has not experienced
losses on these accounts and management believes the Company is not exposed
to significant risks on such accounts.
Marketable securities. Marketable securities are classified as either
trading, or available-for-sale. Management has not acquired any securities
classified as trading securities. Trading securities, if acquired, would be
reported at fair value, with unrealized gains and losses reported in the
statement of operations. Available-for-sale securities are reported at fair
value with unrealized gains and losses excluded from earnings and reported
in accumulated other comprehensive income. Realized gains and losses on
sales of both trading and available-for-sale securities are determined on
an average cost basis and are reported in the statement of operations.
Concentration of credit risk. The Company holds numerous mortgage notes
receivable. These notes are secured by deeds of trust on residential
properties located primarily in California, which results in a
concentration of credit risk. The value of the loan portfolio may be
affected by changes in the economy or other conditions of the geographical
area. Three loans representing approximately 7% of the loan portfolio are
deeds of trust on residential properties not in California.
Stock-based compensation. During the six months ended June 30, 2007 no
option awards were issued. During the six months ended June 30, 2008,
84,655 options were re-issued. As the options were re-issued, no further
disclosure is required pursuant to FASB Statement No. 123 (revised 2004)
("FAS 123(R)"), "Share-Based Payment," which is a revision of FASB
Statement No. 123 ("FAS 123"), "Accounting for Stock-Based Compensation."
Fair value of financial instruments. For cash and cash equivalents, the
carrying amount is a reasonable estimate of fair value. For mortgage notes
receivable, fair value is estimated by comparing the mortgage note
receivable interest rate to current interest rates at which similar loans
would be made to borrowers with similar credit ratings and for the same
remaining maturities. For loans payable, fair value is estimated by
comparing the current applicable interest rates to the current applicable
borrowing rates. As of June 30, 2008 and December 31, 2007, the fair value
of the Company's assets and liabilities approximate the carrying amounts
reflected in the consolidated financial statements.
Reclassifications. Certain 2007 amounts have been reclassified to conform
to the 2008 presentation. Such reclassifications had no effect on reported
net income or earnings per share.
Earnings Per Share. In accordance with SFAS No. 128 "Earnings Per Share,"
the Company presents both basic and diluted earnings per share. Basic
earnings per share excludes dilution and is computed by dividing net income
available to common stockholders by the weighted average number of shares
outstanding for the period. Diluted earnings per share reflects the
potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock, where
such exercise or conversion would result in a lower earnings per share
amount. At June 30, 2008, options to purchase 88,940 shares of common stock
are not considered in the diluted earnings per share calculation due to
anti-dilution. This is disclosed in Note 7.
Recent accounting pronouncements. In June 2006, the FASB issued
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - An
Interpretation of FASB Statement No. 109", (FIN 48). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise's
financial statements in accordance with FASB Statement No. 109, "Accounting
for Income Taxes". This interpretation is effective for fiscal years
beginning after December 15, 2006. The Company's adoption of FIN 48 did not
have a material impact on the consolidated financial statements.
7
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
2. Summary of significant accounting policies (continued)
------------------------------------------------------
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities" (SFAS 159). SFAS 159 permits
entities to chose to measure many financial instruments and certain other
items at fair value that are not currently required to be measured at fair
value. SFAS 159 also establishes presentation and disclosure requirements
designed to facilitate comparison between entities that choose different
measurement attributes for similar types of assets and liabilities. SFAS
159 is effective for the Company's year ending December 31, 2009. The
company is currently evaluating the impact of SFAS 159 on the Company's
consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (R), "Business Combinations"
("SFAS 141 (R)") which replaces SFAS No. 141, "Business Combinations" and
requires a company to recognize the assets acquired, the liabilities
assumed, and any noncontrolling interest in the acquired entity to be
measured at their fair values as of the acquisition date. SFAS 141 (R) also
requires acquisition costs to be expensed as incurred and does not permit
certain restructuring activities previously allowed under Emerging Issues
Task Force Issue No. 95-3 to be recorded as a component of purchase
accounting. SFAS 141 (R) applies prospectively to business combinations for
which the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008. The Company is
currently evaluating the effect the adoption of SFAS 141 (R) may have on
the Company's consolidated Financial Statements.
3. Mortgage notes receivable
-------------------------
Reconciliation of the mortgage notes receivable balances follows:
June 30, December 31,
2008 2007
------------ ------------
Balance, beginning of period $ 11,144,365 $ 17,121,939
Additions during period:
Originations -- --
Deductions during period:
Collections of principal (25,938) (162,099)
Repayments (1,301,794) (3,750,290)
Write off of uncollectible loans -- (91,447)
Foreclosures, net of reserve (2,194,455) (1,973,738)
------------ ------------
Balance, end of period $ 7,622,178 $ 11,144,365
============ ============
Mortgage notes receivable are stated at the principal outstanding. Interest
on the mortgages is due monthly and principal is usually due as a balloon
payment at loan maturity.
As of June 30, 2008, the Company's loan portfolio included 23 loans
totaling $7,622,178 of which 8 loans totaling $3,808,267 representing 50%
of the loan portfolio were delinquent over two payments. In assessing the
collectability of these delinquent mortgage loans, management has
established a loan loss reserve of $556,703, if it is necessary to
foreclose upon the mortgage loans.
As of December 31, 2007, the Company's loan portfolio included 31 loans
totaling $11,144,365 of which 10 loans totaling $4,182,117 representing 37%
of the loan portfolio were delinquent over two payments. In assessing the
collectability of these delinquent mortgage loans, management has
established a loan loss reserve of $2,155,000, if it is necessary to
foreclose upon the mortgage loans.
In assessing the delinquent mortgage loans, management estimates a net gain
will be recognized, if it is necessary to foreclose on the delinquent
mortgage loans. Estimates are based on an anticipated sales price of the
foreclosed property that includes a discount from the latest appraised
value of the property, less the sum of pre-existing liens, costs of
disposition, the face amount of the mortgage loan and accrued interest
receivable.
8
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
4. Allowance for loan losses
-------------------------
The allowance for loan losses is based on the risk value of the subject
collateral and non-collateral based metrics. Management believes a $556,703
and $2,155,000 allowance for loan losses is adequate to protect against
potential losses inherent in all mortgage notes receivable as of June 30,
2008 and December 31, 2007, respectively. Actual losses may differ from the
estimate.
A reconciliation of the allowance for loan losses follows:
June 30, December 31,
2008 2007
----------- -----------
Provision for loan losses as reported
on consolidated statements of operations ($ 56,509) $ 1,852,194
Adjustment for prior accruals 68,509 --
Write-off of uncollectible loans (net) (1,610,297) (479,503)
----------- -----------
Total adjustments to allowance (1,598,297) 1,372,691
Balance, beginning of period 2,155,000 782,309
----------- -----------
Balance, end of period $ 556,703 $ 2,155,000
=========== ===========
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
5. Real estate owned
-----------------
As of December 31, 2007, the Company owned three properties. During the six
months ended June 30, 2008, the Company foreclosed on four properties and
sold one property. Two of these properties included senior liens of
$1,998,377 and $511,939. As of June 30, 2008, the Company owned six
properties.
A reconciliation of the real estate owned account shows its cash and
non-cash activities follows:
June 30, December 31,
2008 2007
----------- -----------
Balance, beginning of period $ 1,804,826 $ 245,000
Add: Foreclosed mortgage notes, net of reserve (non-cash) 4,735,810 1,973,738
Less: Write-downs of property (non-cash) (1,273,649) (108,864)
Less: Deferred carrying costs (118,448) --
Add: Gain (loss) on sale (non-cash) -- (63,229)
Less: Proceeds from sale of real estate owned
(net of closing costs) (1,769,825) (241,819)
----------- -----------
Balance, end of period $ 3,378,714 $ 1,804,826
=========== ===========
6. Bank Loans Payable
------------------
The Company has a line of credit with a lender in which the Company pledges
qualified mortgage notes and receives advances of up to 80% of the value of
the note. Interest is payable monthly at the daily one month LIBOR rate and
a spread of 2.00%. During the six months ended June 30, 2008, the Company
reduced its institutional borrowings from $3,641,828 to $2,000,000. As of
June 30, 2008, the Company had an accrued interest payable of $8,877. The
Company does not anticipate the renewal of this line of credit which is
scheduled to mature on November 14, 2008.
9
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
7. Earnings per share
------------------
The following table represents a reconciliation of the numerators and
denominators of the basic and diluted earnings per common share for the six
months ended June 30, 2008 and 2007:
2008 2007
--------- ---------
Numerator:
Net income (loss) $ 11,366 $(272,960)
Preferred dividends -- --
--------- ---------
Numerator for basic and diluted earnings per share income
(loss) available to common stockholders $ 11,366 $(272,960)
========= =========
Denominator:
Basic weighted average shares 380,532 380,532
Dilutive effect of options 1,476 --
--------- ---------
Diluted weighted average shares 382,008 380,532
========= =========
Basic earnings per common share $ 0.03 $ (0.72)
========= =========
Diluted earnings per common share $ 0.03 $ (0.72)
========= =========
8. Related party transactions
--------------------------
On January 1, 2007, to facilitate the transition to self-management, the
Trust engaged the Former Manager to continue servicing its mortgage loans
and REO until alternate servicing was arranged. CAAI was paid $50 per month
per loan file for loan servicing and $500 per month per REO. Effective June
30, 2007, the Former Manager's loan servicing responsibilities was
terminated. The Trust paid $5,650 in loan servicing fees and $1,500 in REO
coordination fees for the three months ended June 30, 2007. Within the 2007
financial statements loan servicing and REO coordination fees are included
in loan servicing fees to related parties.
On January 1, 2007, the Trust entered into a sub-lease agreement with the
Former Manager. As of June 30, 2008 and 2007, the Trust paid rent of
$20,483 and $19,588, respectively, to the Former Manager. The Trust was
given notice by the Former that the lease would be terminated July 4, 2008
and the Trust has relocated and entered into a new lease with an
independent third party.
On March 8, 2008, Thomas B. Swartz, a Non-Independent Director, resigned
from the Trust's Board of Directors. Mr. Swartz received $21,100 in cash
and his stock options were allowed to continue until their scheduled
maturity or June 3, 2009, whichever date occurs earlier.
9. Preferred, common and treasury stock
------------------------------------
The Preferred Share dividend preference is non-cumulative The Preferred
Shares are entitled to a dividend in an amount equal to an annualized
return on the adjusted net capital contribution of Preferred Shares at each
dividend record date during each year. If the Directors do not set a record
date, the record date is the first day of the month. The annualized return
is the lesser of: (a) 10.25%, (b) 1.50 % over the Prime Rate (determined on
a not less than quarterly basis) or (c) the rate set by the Board of
Directors.
After declaring dividends for a given year to the Preferred Shareholders in
the amount of the dividend preference, no further dividends may be declared
on the Preferred Shares for the subject year, until the dividends declared
on each Common Share for that year equals the dividend preference for each
Preferred Share for such year. Any additional dividends generally will be
allocated such that the amounts of dividends per share to the Preferred
Shareholders and Common Shareholders for the subject year are equal. Any
additional Preferred Share dividends are non-cumulative.
10
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
9. Preferred, common and treasury stock (continued)
------------------------------------
Preferred Shareholders are entitled to receive all liquidating
distributions until they have received an amount equal to their aggregate
adjusted net capital contribution. Thereafter, Common Shareholders are
entitled to all liquidation distributions until the aggregate adjusted net
capital contributions of all Common Shares has been reduced to zero. Any
subsequent liquidating distributions will be allocated among Common
Shareholders and Preferred Shareholders pro rata.
The Preferred Shares are redeemable by a shareholder, subject to the
consent of the Board of Directors, annually on June 30 ("Redemption Date")
for written redemption requests received by May 15 of such year. Preferred
Shares requesting redemption shall cease to be entitled to distribution,
voting rights and other benefits as of May 30 prior to the Redemption Date.
However, if the Board of Directors postpones or delays action on Preferred
Shares redemption request beyond June 30, the date for the suspension of
such shareholders rights and benefits shall be delayed proportionately. The
Board of Directors may in its sole discretion deny, delay, postpone or
consent to any or all requests for redemption. The redemption amount to be
paid for redemption of such Preferred Shares is the adjusted net capital
contribution plus unpaid declared and accrued dividends, divided by the
aggregate net capital contributions plus declared and accrued but unpaid
dividends attributable to all Preferred Shares outstanding, multiplied by
the net asset value of the Trust attributable to the Preferred Shares which
shall be that percentage of the Trust's net asset value that the aggregate
adjusted net capital contributions of all Preferred Shares bears to the
adjusted net capital contributions of all Shares outstanding.
The Trust has the power to redeem or prohibit the transfer of a sufficient
number of Common and/or Preferred Shares or the exercise of warrants and/or
options and to prohibit the transfer of shares to persons that would result
in a violation of the Trust's shareholding requirements. Only with the
explicit approval of the Trust's Board of Directors may a shareholder own
more than 9.8% of the total outstanding shares.
10. Fair Value Measurements
-----------------------
Effective January 1, 2008, the Company adopted SFAS No. 157, "Fair Value
Measurement", for its financial assets and liabilities that are re-measured
and reported at fair value at each reporting period and non-financial
assets and liabilities that are re-measured and reported at fair value at
least annually. In accordance with the provisions of FAS 157-2, "Effective
Date of FASB Statement No. 157", the Company has elected to defer adoption
of SFAS 157 as it relates to its non-financial assets and non-financial
liabilities that are recognized and disclosed at fair value in the
financial statements on a nonrecurring basis until January 1, 2009. The
Company is evaluating the impact, if any, this standard will have on its
non-financial assets and liabilities.
The adoption of SFAS 157 to the Company's financial assets and liabilities
that are re-measured and reported at fair value at least annually did not
have an impact on the Company's financial results.
The following table presents information about the Company's assets and
liabilities that are measured at fair value on a recurring basis as of June
30, 2008 and indicates the fair value hierarchy of the valuation techniques
the Company utilized to determine such fair value. In general, fair values
determined by Level 1 inputs utilize quoted prices (unadjusted) in active
markets for identical assets or liabilities. Fair values determined by
Level 2 inputs utilize data points that are observable such as quoted
prices, interest rates and yield curves. Fair values determined by Level 3
inputs are unobservable data points for the asset or liability and includes
situations where there is little, if any, market activity for the asset or
liability.
June 30,
2008 Level 1 Level 2 Level 3
---------- ---------- ------- -------
Asset:
Cash and cash equivalents $2,304,199 $2,304,199 $ -- $ --
Marketable securities 24,621 24,621
---------- ---------- ------- -------
Total $2,328,820 $2,328,820 $ -- $ --
========== ========== ======= =======
The fair values of the Company's cash and cash equivalents and marketable
securities are determined through market observable and corroborated
sources. The carrying amounts reflected in the balance sheets for other
current assets and accrued expenses approximate fair value due to their
short-term maturities.
11
PART I - ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Certain statements contained herein are not based on historical information and
certain statements contained in future filings by the Company with the SEC, in
the Company's press releases or in the Company's public and stockholder
communications may not be based on historical facts and are "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Forward-looking statements may be identified by reference to a future
period or periods, or by the use of forward-looking terms such as "may", "will",
"expect", "anticipate", or similar terms. Actual results could materially differ
from those in the forward-looking statements due to a variety of factors.
Preparation of the Company's consolidated financial statements is based upon the
operating results of the Trust and WCFC. Management's discussion and analysis of
the results of operations for the three and six months ended June 30, 2008 and
2007 follows:
OVERVIEW
In May of 1997, the Trust registered its common shares with the Securities and
Exchange Commission under the Securities Act of 1933. On September 30, 1998, the
initial public offering of Common Shares was completed. Since October 1, 1998,
the common shares have been listed on the American Stock Exchange ("AMEX").
During the fourth quarter of 2006, the Company's shareholders voted to terminate
the outside manager ("Former Manager" or "CAAI") and initiate internal
management. On December 29, 2006, the Former Manager's management and advisory
contracts were terminated and the Company commenced self-management. On July 2,
2008, the shareholder approved a new corporate name, Eastern Light Capital,
Incorporated. The new name will become official in the third quarter of 2008 and
the common shares will continue to trade on the AMEX with a new ticker symbol.
Since the onset of 2007, the mortgage industry has experienced and is continuing
to experience tumultuous change. Many industry participants have announced
significant workforce reductions, delayed earnings reports and experienced
precipitous drops in their share price. The most unfortunate companies have
sought bankruptcy protection or have been forced into regulatory supervised
mergers with better capitalized companies. The trends which precipitated these
changes include the absence of credit, increasing residential mortgage
delinquencies, loan foreclosures and the protracted withdrawal of investor
interest in mortgage securities and whole loans.
The Company's residential loan portfolio continues to harbor unacceptable levels
of non-performing assets. The portfolio's delinquencies will also reduce current
revenues until the non-performing loans are monetized and their proceeds
re-invested. During 2007, significant loan loss reserves were taken to recognize
the embedded losses in non-performing loans and the general decline in
residential mortgage loan values. In response to these problems and to maximize
shareholder value, Management has continued to focus on efficient asset
management as the strategic alternative to selling loans at depressed
valuations. As mortgage loans are monetized, the Company's investment focus will
expand to provide a source of future profitability and increased shareholder
value. Foreclosed loans, also known as Other Real Estate Owned or "REO"
typically require additional time to monetize. However, Management does not
expect to report additional writedowns on its current REO balance.
The Trust is a real estate investment trust ("REIT") and REIT's are generally
required to distribute at least 90% of their annual taxable income as dividend
payments. During 2005, 2006 and 2007, the Trust incurred taxable losses. On
account of these losses, dividend payments were curtailed during 2005. These
taxable losses, also known as Net Operating Losses ("NOL"), allow the Trust to
retain future taxable income equal to the cumulative amount of its NOL balance.
The Internal Revenue Code waives mandatory dividend payments until prior years
taxable losses are recovered.
When the Trust produces pre-NOL taxable income, the Trust's Board of Directors
will need to reconcile the competing opportunities of strengthening the
Company's balance sheet and the priority of restoring dividend payments. This
issue will require additional review and analysis by the Board of Directors.
12
CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies of the Company are in accordance with
accounting principles generally accepted in the United States of America. The
Company's significant accounting policies are described in the notes to the
consolidated financial statements. Certain accounting policies require
management to make significant estimates and assumptions, which have a material
impact on the carrying value of certain assets and liabilities, and the Company
considers these to be critical accounting policies. The estimates and
assumptions used are based on historical experience and other factors, which
management believes to be reasonable under the circumstances. Actual results
could differ significantly from these estimates and assumptions, which could
have a material impact on the carrying value of assets and liabilities at the
balance sheet dates and results of operations for the reporting periods.
The following are critical accounting policies that require the most significant
estimates and assumptions that are particularly susceptible to a significant
change in the preparation of the financial statements and are not presented in
their relative order of importance.
Revenue recognition. Interest income accrues as it is earned. Loans are placed
on a nonaccrual status when any portion of the principal or interest is four
scheduled payments past due or earlier when concern exists as to the ultimate
collectability of principal or interest. Nonaccrual status loans are returned to
an accrual status when principal and interest become current and are anticipated
to be fully collectible.
Allowance for Loan Losses. A provision for loan losses is based on management's
evaluation of an amount that is adequate to absorb losses inherent in the
existing loan portfolio. The evaluation, which includes a review of all loans on
which full collection may not be reasonably assumed, considers among other
matters, general economic conditions, the fair market value or the estimated net
realizable value of the underlying collateral, past loan loss experience, trends
in loan delinquency and other factors that warrant recognition in providing for
an adequate loan loss allowance.
Allowance for Doubtful Accounts. An allowance for accounts receivable claims is
based on management's evaluation of the likelihood of collection. The evaluation
is based on the payee's ability and willingness to pay the claim in full as well
as the costs associated with possible legal action.
Real estate owned. Real estate owned represents property acquired in
foreclosure of mortgage notes receivable. The real estate is carried at the
lower of the value of the mortgage note receivable less selling costs on the
real estate or fair market value. Certain estimates and assumptions are required
in determining the cost to sell or in estimating the fair market value of the
real estate.
Stock options. Stock options granted prior to December 15, 2005 were issued
with exercise prices no less than the market price of the Trust's common stock
on the dates of grant. Because the exercise price is fixed at or above market
price and other key terms are fixed, use of the intrinsic-value method was
utilized and the Trust did not recognize an expense for these options. If the
terms of these options were changed, variable accounting might need to be used,
and the Trust might then need to begin recognizing compensation expense for the
options. Options granted after December 15, 2005 are issued with exercise prices
not less than 110% of the market price of the Trust's common stock on the award
dates and are subject to a mandatory expense calculation at the award dates and
recognized upon vesting.
The Audit Committee of the Trust's Board of Directors has discussed and approved
the critical accounting policies and the development, selection and disclosure
of the estimates and alternatives prior to filing this report with the
Securities and Exchange Commission.
Operating Strategy.
- -------------------
Mortgage investment loans are reported as mortgage notes receivable and are held
until prepayment, maturity or foreclosure. The Company owns non-conforming
mortgage loans on one-to-four unit residential properties secured by first and
second deeds of trust. These loans are primarily secured by California real
estate. Historically, the Trust limited its mortgage investments to a cumulative
loan to value ratio ("CLTV") that did not exceed 75% of the underlying
collateral at the time of investment. The Company seeks to maximize the value of
its loan portfolio through active asset management. The Company is reviewing its
current investment policies to include other REIT permissible assets in addition
to residential mortgage loans.
13
Loan Origination. During 2007 and the six months ended June 30, 2008, the
Company did not make or acquire any new loans. Prospectively, portfolio loans
may be internally originated or acquired from unaffiliated third parties.
Asset Management. Asset management is mortgage loan servicing and real estate
owned ("REO") dispositions. Loan servicing consists of collecting payments from
borrowers making required advances, accounting for principal and interest
payments, holding borrowed proceeds in escrow until fulfillment of mortgage loan
requirements, contacting delinquent borrowers, and in the event of unremedied
defaults performing other administrative duties including supervising
foreclosures. In assessing a delinquent mortgage loan, management reviews the
likelihood that a net gain will be recognized from foreclosing on the delinquent
mortgage loan. Estimates are based on an anticipated sales price of the
foreclosed property that includes a discount from the latest appraised value of
the property, less the sum of pre-existing liens, costs of disposition, the face
amount of the mortgage loan and accrued interest receivable.
Only mortgage loans owned by the Company are serviced. The Company does not
acquire loan servicing rights or maintain a loan's servicing rights at
disposition. REO dispositions include all of the supervisory and administrative
processes of preparing a foreclosed asset for sale.
Commitments and Contingencies. The Company only issues loan commitments on a
conditional basis and generally funds such loans promptly upon removal of any
conditions. The Trust did not have any commitments to fund loans as of June 30,
2008 and 2007. On December 14, 2005, the Trust unconditionally guaranteed CAFC's
sale of mortgage loans to Lehman Brothers Bank. During 2005, no loans were sold
to Lehman Brothers Bank pursuant to this guarantee. During the first quarter of
2006, two loans for $2,500,000 were sold to Lehman Bothers Bank pursuant to this
guarantee. Since the first quarter of 2006, the Company has not sold any loans
to Lehman Brothers Bank or its affiliates.
As of June 30, 2008, the Company owned six properties. Two of these properties
included Senior liens of $1,998,377 and $511,939.
As of June 30, 2008, the following table summarizes the Company's outstanding
repayment obligations:
Maximum Other
Commercial Commitments (a) Total Amounts
as of June 30, 2008 Committed Amount of Commitment Expiration Per Period
- ---------------------------------------- -------------- -------------- -------------- --------------- --------------
Less than 1 - 3 years 4 - 5 After 5
1 year years years
Lines of Credit (b) $2,008,877 $2,008,877 0 0 0
Standby Repurchase Obligations 0 0 0 0 0
Total Commercial Commitments $2,008,877 $2,008,877 0 0 0
(a) Commercial commitments are funding commitments that could potentially
require registrant performance in the event of demands by third parties or
contingent events, such as under lines of credit extended or under
guarantees of debt.
(b) Outstanding obligations as of June 30, 2008 due in less than 1 year were
$2,008,877.
RESULTS OF OPERATIONS
The historical information presented herein is not necessarily indicative of
future operations.
Three months ended June 30, 2008 and 2007. Revenues for the second quarter
decreased to $125,048 as compared to $309,245 for the same period in the prior
year. The decrease in revenue, during the second quarter of 2008 was due to
decreases in interest income of $181,810. Interest income declines on account of
a reduction in the mortgage notes receivable balance.
Expenses for the second quarter of 2008 decreased to $119,860 as compared to
$435,553 for the same period in the prior year. The decrease in expenses during
the second quarter of 2008 was primarily due to the decreases in the provision
for loan losses of $199,509, in interest expenses of $40,415, in loan
origination costs of $36,962 and general and administrative of $31,674.
14
Six months ended June 30, 2008 and 2007. Revenues for the six months of 2008
decreased to $366,054 as compared to $650,281 for the same period in the prior
year. The decrease in revenue, during the first six months of 2008 was due to
decreases in interest income of $283,982. Interest income declines on account of
a reduction in the mortgage notes receivable balance.
Expenses for the six months ended June 30, 2008 decreased to $397,564 as
compared to $910,403 for the same period in the prior year. The decrease in
expenses during the first six months of 2008 was primarily due to the decreases
in the provision for loan losses of $278,158, in interest expenses of $103,882
and loan origination costs of $62,465.
LIQUIDITY AND CAPITAL RESOURCES
The Trust's $7,000,000 term facility is scheduled to mature November 14, 2008.
Due to the general curtailment of mortgage credit facilities, Management does
not believe that this facility will be renewed or extended. The Company's cash
and near cash investments are sufficient to retire the facility's outstanding
balance of approximately $2,000,000. Management believes that the cash flows
from operations, mortgage principal payments and the sales proceeds of REO will
be sufficient to meet the liquidity needs of the company's businesses for the
next twelve months.
Six months ended June 30, 2008 and 2007. As of January 1, 2008 and 2007, the
Trust had $962,190 and $599,943 of cash and cash equivalents, respectively.
During the six month period ended June 30, 2008, cash and cash equivalents
increased by $1,342,009. During the six month period ended June 30, 2007, cash
and cash equivalents decreased by $40,359. After taking into effect the various
transactions discussed below, cash and cash equivalents at June 30, 2008 and
2007 were $2,304,199 and $559,584.
The following summarizes the changes in net cash provided by operating
activities, net cash used for investing activities, and net cash provided by
financing activities.
Net cash used in operating activities during the six months ended June 30, 2008
and 2007 was $207,547 and $311,866, respectively. During the first six months of
2008, net income provided $11,366, a change in other liabilities used $144,983,
and the provision for loan losses used $56,509. During the first six months of
2007, net loss used $272,960, an increase in accounts receivable used $211,681
and the provision for loan losses provided $221,649.
Net cash provided by investing activities for the six months ended June 30, 2008
and 2007 was $3,169,556 and $3,109,260, respectively. During the first six
months of 2008, proceeds from mortgage notes receivable provided $1,327,732, and
the acquisition and sale of REO provided $1,769,825. During the first six months
of 2007, a net decrease in mortgage notes receivable provided $2,900,928.
Net cash used in financing activities during the six months ended June 30, 2008
and 2007 was $1,620,000 and $2,837,753, respectively. During the first six
months of 2008, net payments of bank loans used cash of $1,620,000. During the
first six months of 2007, net payments of bank loans used cash of $2,837,753.
PART I - ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Market risk. Market risk is the exposure to loss resulting from changes in
interest rates, credit spreads, foreign exchange rates, commodity prices, and
equity prices. The primary market risks to which the Company is exposed are
interest rate risk and credit risk.
Interest rate risk. Interest rate risk is highly sensitive to many factors,
including governmental, monetary and tax policies, domestic and international
economic and political considerations and other factors beyond the control of
the Company. Changes in the general level of the U.S. Treasury yield curve can
have significant effects on the market value of the Company's portfolio. The
majority of the Company's assets are fixed-rate loans with a spread to U.S.
Treasuries. The Trust's loans are valued on the June 30, 2008 and December 31,
2007 balance sheet at the lower of cost or market.
As U.S. Treasury securities are priced to a lower yield and/or the spread to
U.S. Treasuries used to price the Company's assets are decreased, the market
value of the Company's portfolio may increase. Conversely, as U.S. Treasury
securities are priced to a higher yield and/or the spread to U.S. Treasuries
used to price the Company's assets is increased, the market value of the
Company's portfolio may decline. Changes in the level of the U.S. Treasury yield
curve can also affect, among other things, the prepayment assumptions used to
value certain of the Trust's loans. In addition, changes in the general level of
the United States Prime Rate or one month LIBOR can affect the Trust's net
interest income. The Company's borrowings are floating rate based on a spread
over the daily one month LIBOR. As these rates increases or decreases, the
Company's interest expense will move in the same direction.
15
On account of the relatively short adjusted weighted average maturity of the
Company's portfolio loans (24 months), a variety of financial instruments
available to limit the effects of interest rate fluctuations on its operations
have not been utilized. The use of these types of derivatives (such as interest
rate swaps, caps, floors and other interest rate exchange contracts) to hedge
interest-earnings assets and/or interest-bearing liabilities carry risks,
including the risk that the net losses on a hedge position may exceed the amount
invested in such instruments. As the level of variable rate mortgage financing
of the portfolio increases or the weighted average maturity of the portfolio
increases, the Trust may utilize a variety of financial instruments to limit the
effects of interest rate fluctuations.
Credit risk. Credit risk is the exposure to loss from loan defaults and
foreclosures. Default and foreclosure rates are subject to a wide variety of
factors, including, but not limited to, property values, supply/demand factors,
construction trends, consumer behavior, regional economics, interest rates, the
strength of the American economy and other factors beyond the control of the
Company.
All loans are subject to a certain probability of default and foreclosure. An
increase in default rates will reduce the book value of the Company's assets and
the Company's earnings and cash flow available to fund operations and pay
dividends.
The Company manages credit risk through the underwriting process, limiting loans
at the time of funding to 75% of the collateral's appraised value, establishing
loss assumptions and carefully monitoring loan performance. Nevertheless, the
Company assumes that a certain portion of its loans will default and adjusts the
allowance for loan losses based on that assumption.
Asset and liability management. Asset and liability management is concerned
with the timing and magnitude of the maturity of assets and liabilities. In
general, management's strategy is to approximately match the term of the Trust's
liabilities to the portfolio's adjusted weighted average maturity (24 months).
The majority of the Company's assets pay a fixed coupon and the income from such
assets are relatively unaffected by interest rate changes. The Company's
borrowings are currently under a variable rate line of credit that resets daily.
Given this relationship between assets and liabilities, the Company's interest
rate sensitivity gap is highly negative. This implies that a period of falling
short term interest rates will tend to increase the Company's net interest
income, while a period of rising short term rates will tend to reduce the
Trust's net interest income.
PART I - ITEM 4
CONTROLS AND PROCEDURES
(A) Evaluation of Disclosure Controls and Procedures. The Chief Executive
Officer and the Principal Accounting Officer of the Trust have, based on their
evaluation of the Company's disclosure controls and procedures within 90 days of
the filing date of this report, evaluated the effectiveness of such controls and
procedures. Based on such evaluations, they have concluded that the Trust's
disclosure controls and procedures have effectively operated to ensure that all
material information relating to the Company and its operations and financial
condition has been made known to them by other officers and employees within the
Company and its Manager on a timely basis.
(B) Changes in Internal Controls. There have been no significant changes in
the Company's internal controls or in other factors that could significantly
affect those controls subsequent to the date of their evaluation. Accordingly,
no corrective actions with regard to such controls or procedures have been
required.
16
PART II
OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
The Trust is involved in five legal proceedings as of June 30, 2008.
CAFC was named as defendant in a case filed on December 7, 2004. Plaintiff
alleged that CAFC made a fraudulent loan to him by cross collateralizing two
separate properties. The cross collateralization was necessary to grant the
borrower the desired loan, since there was insufficient equity in the primary
property used as collateral for the loan. Two amended complaints have been filed
in addition to the initial one. The Plaintiff initially represented himself.
After CAFC was allowed by the court to foreclose on the primary collateral and
the borrowing was paid in full. Plaintiff, upon the Court's insistence, obtained
counsel and has filed an amended complaint. The Plaintiff was deposed in May of
2006 and in June of 2008, the case was dismissed.
On April 14, 2006, CAIT and CAFC were served a summons alleging that the Company
was involved with misleading a former mortgage holder. Upon the satisfaction of
their mortgage claim from the proceeds of a Company provided mortgage, the
former mortgage holder released their escrow settlement to the new purchaser
without re-recording their subordinate mortgage claim. On July 14, 2006, the
property was sold at a Trustee sale and the Company's loan was paid in full. The
former mortgage holder's unrecorded claim was not satisfied at the
aforementioned Trustee sale. The Company believes the former mortgage holder's
action is without merit and is seeking dismissal.
On November 1, 2007, CAFC was served a summons dated September 5, 2007 from a
former borrower alleging that the Company assisted the replacement lender to
unlawfully and illegally foreclose on the former borrower's property. The
Company believes the former mortgage holder's action is without merit and is
seeking dismissal.
On November 9, 2007, CAIT and CAFC were each served a summons dated October 9,
2007 alleging that the Company defrauded another mortgage company's investors.
The other mortgage company, a former lender to a CAFC borrower, received the
payoff proceeds of a CAFC provided loan from escrow. The other mortgage
investment company allegedly failed to distribute the payoff proceeds of the
repaid mortgage to the mortgage note's owners/participants and an
owner/participant of the repaid note alleges that the Company assisted in the
fraud. The Company was dismissed from the case in July of 2008.
In March 2008, CAIT was named as a defendant in a complaint alleging breach of
contract, fraud and negligence relating to two foreclosed properties. The
Company believes the former mortgage holder's action is without merit and is
seeking dismissal.
ITEM 1A RISK FACTORS
The Company routinely encounters and addresses risks, some of which will cause
its future results to fluctuate. The Company's present view of certain important
strategic risks is presented below and these risk factors set forth below are
not the only risks that the Company may face or that could adversely affect
operating performance and value. If any of the risks discussed in this Form 10-Q
actually occur, the business, financial condition and results of operations
could be materially adversely affected. If this were to occur, the trading price
of the Company's securities could decline significantly and an investor may lose
all or part of their investment.
The following discussion of risk factors contains "forward-looking statements",
which may be important to understanding any statement in this Form 10-Q or
elsewhere. The following information should be read in conjunction with Part I,
Item 1 - Management's Discussion and Analysis of Financial Condition and Results
of Operations on Form 10-KSB for 2007.
Increased borrowing costs related to funding agreements would adversely affect
operating profitability.
The Company's borrowing costs under funding agreements correspond to LIBOR
plus a margin. The LIBOR rate may vary and increased borrowing costs would
adversely affect operating profitability.
17
Higher interest rates may harm the Company's book value and cause the price of
its securities to decline.
Increases in interest rates may harm the market value of the Company's
mortgage assets. Fixed rate mortgages are generally harmed by an increase in the
general rate of interest. In accordance with GAAP, the Company may be required
to reduce its book value by the amount of any decrease in the market value of
its mortgage-related assets.
Failure to procure replacement funding on favorable terms, or at all, may
adversely affect the Company's results and may, in turn, negatively affect the
Company's share price.
The current situation in the sub-prime mortgage sector and the current
weakness in the broader mortgage market have adversely affected the Company's
lender and the current lender is unwilling or unable to provide the Company with
financing. This will reduce liquidity. Also, if one or more major market
participants fail, it could negatively impact the marketability of all
securities and this could negatively impact the value of the mortgages in the
Company's portfolio, thus reducing its net book value.
Possible market developments could cause the Company's lender to require the
Company pledge additional assets as collateral.
If these assets are insufficient to meet the collateral requirements, then
the Company may be compelled to liquidate particular assets at an inopportune
time. Possible market developments, including a sharp rise in interest rates, a
change in prepayment rates or increasing market concern about the value or
liquidity of one or more asset categories in which the Company invests may
reduce the market value of the Company's investments and cause the Company to
encumber additional collateral. This requirement for additional collateral may
compel the Company to liquidate its assets at a disadvantageous time, thus
harming operating results and net profitability.
The Company's funding agreements to borrow funds may give its lender greater
rights in the event that either the Company or the lender files for bankruptcy.
The Company's borrowings under repurchase agreements may qualify for
special treatment under the bankruptcy code, giving the Company's lender the
ability to avoid the automatic stay provisions of the bankruptcy code and to
take possession of and liquidate the Company's collateral under the repurchase
agreements without delay in the event that the Company files for bankruptcy.
Furthermore, the special treatment of repurchase agreements under the bankruptcy
code may make it difficult for the Company to recover its pledged assets in the
event that a lender files for bankruptcy. Thus, the use of repurchase agreements
exposes the Company's pledged assets to risk in the event of a bankruptcy filing
by either the Company or its lender.
Competition may prevent the Company from acquiring mortgage-related assets at
favorable yields and that would negatively impact the Company's profitability.
Future marginal GAAP net income largely depends on the Company's ability to
acquire mortgage-related assets at favorable spreads over its borrowing costs.
In acquiring mortgage assets, the Company competes with other REITs, investment
banking firms, savings and loan associations, banks, insurance companies, mutual
funds, other lenders and other entities that purchase mortgage-related assets,
many of which have greater financial resources. As a result, the Company may not
in the future be able to acquire sufficient mortgage assets at favorable spreads
over its borrowing costs. If that occurs, future marginal profitability will be
harmed.
Mortgages are subject to delinquency, foreclosure and loss, which could result
in losses.
Residential mortgage loans are secured by single-family residential
property and are subject to risks of loss, delinquency and foreclosure. The
ability of a borrower to repay a loan secured by a residential property is
dependent upon the income or assets of the borrower. A number of factors,
including a general economic downturn, acts of nature, terrorism, social unrest
and civil disturbances, may impair borrower's abilities to repay their loans.
Accordingly, the Company is subject to all of the risks of the underlying
mortgage loans. In the event of a mortgage default, the Company may not realize
its anticipated return on its investment and may incur a loss.
Changes to the nature, extent or regulation of the business activities of Fannie
Mae or Freddie Mac or declines in the U.S. real estate or credit markets might
adversely affect their credit ratings and the market prices of their securities,
including mortgage assets owned by the Company.
Fannie Mae and Freddie Mac are shareholder-owned publicly traded
corporations created by charters of the U.S. Congress. They are commonly
referred to as government-sponsored enterprises ("GSEs") because of their
special relationship with the U.S. government, although their obligations are
not guaranteed by the U.S. government. Fannie Mae and Freddie Mac purchase
mortgage loans from mortgage originators and either hold those mortgages in
their portfolios or pool them into MBS, which they guarantee for full and timely
payment of principal and interest, regardless of whether the mortgagors actually
make the payments. Fannie Mae's and Freddie Mac's obligations in respect of
their respective guarantees rank equally with their respective senior unsecured
debt securities, which are currently rated AAA by Standard and Poor's, Moody's
and Fitch.
18
There can be no assurance that Fannie Mae or Freddie Mac will continue to
maintain their special relationship with the U.S. government or that the current
regulatory structure of Fannie Mae and Freddie Mac will be maintained.
Furthermore, the recent conditions in the U.S. subprime mortgage market have
exposed Fannie Mae and Freddie Mac to substantial losses, and they could face
more losses if the U.S. real estate and credit markets continue to decline.
Elimination or modification of the special relationship or a change in their
current regulatory structure, or further declines in the U.S. real estate or
credit markets, could require or cause Fannie Mae or Freddie Mac to change the
nature and extent of their business activities, could adversely affect their
activities, financial condition and overall risk profile, and could adversely
affect their credit ratings and the market prices of residential whole loans and
the shareholder's equity in the Company.
The Company's Board of Directors may change the Company's operating policies and
strategies without prior notice or stockholder approval and such changes could
harm the Company's business, results of operation and stock price.
The Company's Board of Directors can modify or significantly waive the
current operating policies and strategies without prior notice and without
stockholder approval. The Company cannot predict the effect any change to its
current operating policies and strategies may have on its business, operating
results and stock price; however, the effects may be adverse.
The Company depends on key personnel and the loss of any of its key personnel
could harm its operations.
The Company depends on the diligence, experience and skill of its officers
and other employees. Key officers include: Richard J. Wrensen, Chairman,
President, Chief Executive Officer and Chief Financial Officer; Andrea Barney,
Principal Accounting Officer and Controller; and Gregory Bronshvag, Vice
President Operations and Secretary. The Company's dependence on its key
personnel is heightened by the fact that it has a relatively small number of
employees and the loss of any key person could harm the entire business,
financial condition, cash flow and results of operations. In particular, the
loss of the services of Richard J. Wrensen could seriously harm its business.
The Company may forego attractive opportunities in lieu of complying with REIT
requirements.
In order to qualify as a REIT for federal income tax purposes, the Company
must continually satisfy test concerning, among other things, its sources of
income, the nature and diversification of the Company's mortgage portfolio and
other assets, the amount it distributes to its stockholders and the ownership of
its stock. The Company may also be required to make distributions to
stockholders at disadvantageous times or when it does not have funds readily
available for distribution. Thus, compliance with REIT requirements may hinder
the Company's ability to operate solely on the basis of maximizing profits.
Failure to maintain an exemption from the Investment Company Act would harm the
Company's results of operations.
The Company believes that it conducts its business in a manner that allows
it to avoid being regulated as an investment company under the Investment
Company Act of 1940, as amended. If the Company failed to continue to qualify
for an exemption from registration as an investment company, it ability to use
leverage would be substantially reduced and the Company would be unable to
conduct its business as planned. The Investment Company Act exempts entities
that are primarily engaged in the business of purchasing or otherwise acquiring
"mortgages and other liens on and interest in real estate". Under the SEC's
current interpretation, qualification for this exemption generally requires the
Company to maintain at least 55% of its assets directly in qualifying real
estate interests. In meeting the 55% requirement under the Investment Company
Act, the Company currently may treat residential mortgages as qualifying
interest. If the SEC or its staff adopts a contrary interpretation, the Company
could be required to sell a substantial amount of its residential whole loans
under potentially adverse market conditions. Further, in order to maintain its
exemption from registration as an investment company, the Company may be
precluded from acquiring other investments whose yield is somewhat higher than
the yield on whole mortgage loans or MBS.
The Company has not established a minimum dividend payment level for its common
stockholders and there are no assurances of the Company's ability to pay
dividends in the future.
After fully utilizing its Net Operating Loss Carry-forward, the Company
intends to pay quarterly dividends and to make distributions to its stockholders
in amounts such that all or substantially all of its taxable income in each
year, subject to certain adjustments, is distributed. This, along with other
factors, should enable the Company to qualify for the tax benefits accorded to a
REIT under the Code. The Company has not established a minimum dividend payment
level for stockholders and its ability to pay dividends may be harmed by the
risk factors described in this report on Form 10-Q. All distributions to the
Company's stockholders will be made at the discretion of its Board of Directors
and will depend on its earnings, its financial condition, maintenance of its
REIT status and such other factors as its Board of Directors may deem relevant
from time to time. There are no assurances of the Company's ability to pay
dividends in the future. If the Company were to raise additional capital, its
earnings per share and dividends per share may decline as a result of not being
able to invest all of the new capital during the quarter in which additional
shares are sold and possibly the entire following calendar quarter.
19
The Company's charter does not permit ownership of over 9.8% of its common or
preferred stock and attempts to acquire the common or preferred stock in excess
of the 9.8% limit are void without prior approval from the Board of Directors.
For the purpose of preserving the REIT qualification and for other reasons,
the Company's charter prohibits direct or constructive ownership by any person
of more than 9.8% of the lesser of the total number or value of the outstanding
shares of its common stock or more than 9.8% of the outstanding shares of its
preferred stock. The charter's constructive ownership rules are complex and may
cause the outstanding stock owned by a group of related individuals or entities
to be deemed to be constructively owned by one individual or entity. As a
result, the acquisition of less than 9.8% of the outstanding stock by an
individual or entity could cause that individual or entity to own constructively
in excess of 9.8% of the outstanding stock and thus by subject to the Company
charter's ownership limit. Any attempt to own or transfer shares of the common
or preferred stock in excess of the ownership limit without the consent of the
Board of Directors shall be void and will result in the shares being transferred
by operation of law to a charitable trust. The Board of Directors has granted
one exemption from the 9.8% ownership limitation.
Future offering of debt securities, which would be senior to all classes of
stock and equity securities, may harm the market price of the Company's common
and preferred stock.
In the future, the Company may attempt to increase its capital resources by
making additional offerings of debt or equity securities, including commercial
paper, medium-term notes, senior or subordinated notes and classes of preferred
stock or common stock. Upon liquidation, holders of the Company's debt
securities and share of preferred stock and lenders with respect to other
borrowings will receive a distribution of the Company's available assets prior
to the common stockholders. The preferred stockholders may have a preference on
dividend payments that could limit the Company's ability to make a dividend
distribution to the common stockholders. Because the decision to issue
securities in any future offering will depend on market conditions and other
factors beyond the Company's control, the Company cannot predict or estimate the
amount, timing or nature of its future offerings. Thus, the common stockholders
bear the risk of any future offerings reducing the market price of the Company's
common stock.
The Company may fail to qualify for continued listing on the American Stock
Exchange ("AMEX").
Due to changes in the ownership and profitability of the Company and the
evolving listing requirements of exchange traded companies, the Company's common
stock may not continue to qualify for AMEX listing. Without listing on the AMEX
or another national exchange, the Company's common share price may incur reduced
liquidity and a reduced transaction price.
ITEM 1B UNRESOLVED STAFF COMMENTS
None
ITEM 2 CHANGES IN SECURITIES
No common shares and preferred shares were purchased for treasury stock during
the six month period ended June 30, 2008.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
None
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ITEM 4 SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
The 2008 Annual Shareholder meeting was held on July 2, 2008 as the previously
scheduled meeting date of June 25, 2008 was adjourned to allow additional
shareholders to participate in the shareholder vote. The following table
summarizes the results of the vote by proposal.
Proposal One: Election of Directors
- -----------------------------------
Results for Mr. Wrensen FOR: 409,189 WITHHOLD: 33,616
Results for Mr. Grainer FOR: 390,513 WITHHOLD: 48,828
Proposal Two: Corporate Name Change
- -----------------------------------
Preferred Shareholders FOR: 112,522 AGAINST: 2,307 ABSTAIN: 2,509
Common Shareholders FOR: 283,915 AGAINST: 41,950 ABSTAIN: 9,366
Messrs. Wrensen and Grainer were re-elected as Directors and the name change was
approved.
ITEM 5 OTHER INFORMATION
None
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
--------
Exhibit No.
3.1 Certificate of Incorporation and Amendment No. 1 (1)
3.2 Bylaws of the Registrant (1)
3.3 Certificate of Amendment of Certificate of Incorporation (3)
4.1 Form of Stock Certificate of Common Shares of the Registrant (2)
10.2 Form of Indemnity Agreement between the Registrant and its
Directors and Officers (1)
24.7 Power of Attorney of Richard J. Wrensen (4)
31.1 Sarbanes Certification of Richard J. Wrensen
31.2 Sarbanes Certification of Andrea Barney
32.1 Sarbanes Certification
(1) These exhibits were previously contained in Registrant's Registration
Statement filed on Form S-11 with the Commission on September 9, 1996, and
are incorporated by reference herein.
(2) These exhibits were previously contained in Amendment No. 1 to the
Registrant's Registration Statement filed on Form S-11 with the Commission
on January 15, 1997, and are incorporated by reference herein.
(3) These exhibits were previously contained in Form 10-Q for the period ending
June 30, 1997 filed with the Commission on August 14, 1997, and are
incorporated by reference herein.
(4) This exhibit was previously contained in Form 10-K for the period ending
December 31, 1998 filed with the Commission on April 10, 1999, and is
incorporated by reference herein.
(b) Reports on Form 8-K.
--------------------
Form 8-K was filed on:
o April 28, 2008 due to the press release of April 25, 2008 announcing
the 2008 Annual Meeting date.
o May 16, 2008 due to the press release of May 16, 2008 announcing
2008's first quarter Earnings.
o July 7, 2008 due to the press release of July 2, 2008 announcing the
results of the 2008 Annual Meeting.
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SIGNATURES
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 hereunto duly authorized.
CAPITAL ALLIANCE INCOME TRUST LTD.,
A Real Estate Investment Trust
Dated: August 13, 2008
/s/ Richard J. Wrensen
-----------------------
Richard J. Wrensen
President, Chief Executive Officer
and Chief Financial Officer
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