UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended December 31, 2011
Or
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
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SECURITIES EXCHANGE ACT OF 1934
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For the transition period from _________ to _________
Commission File Number: 333-125121
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VESTIN REALTY MORTGAGE II, INC.
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(Exact name of registrant as specified in its charter)
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MARYLAND
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61-1502451
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(State or Other Jurisdiction of
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(I.R.S. Employer
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Incorporation or Organization)
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Identification No.)
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8880 W. SUNSET ROAD, SUITE 200, LAS VEGAS, NEVADA 89148
(Address of Principal Executive Offices) (Zip Code)
Registrant’s telephone number, including area code 702.227.0965
Securities registered pursuant to Section 12(b) of the Act:
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Common Stock, $0.0001 Par Value
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Nasdaq Global Select Market
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(Title of each class)
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(Name of each exchange on which registered)
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Securities registered pursuant to Section 12(g) of the Act:
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None
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(Title of class)
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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Sec. 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Sec. 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,”“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer [ ]
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Accelerated filer [ ]
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Non-accelerated filer [ ]
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Smaller reporting company [X]
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [X]
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter.
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Class
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Market Value as of
June 30, 2011
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Common Stock, $0.0001 Par Value
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$
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18,263,923
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Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.
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Class
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Number of Shares Outstanding
As of March 16, 2012
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Common Stock, $0.0001 Par Value
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12,531,405
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TABLE OF CONTENTS
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Page
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PART I
Note Regarding Forward-Looking Statements
This report and other written reports and oral statements made from time to time by us may contain forward-looking statements. Such forward-looking statements may be identified by the use of such words as “expects,” “plans,” “estimates,” “intend,” “might,” “may,” “could,” “will,” “feel,” “forecasts,” “projects,” “anticipates,” “believes” and words of similar expression. Forward-looking statements are likely to address such matters as our business strategy, future operating results, future sources of funding for real estate loans brokered by us, future economic conditions and pending litigation involving us. Some of the factors which could affect future results are set forth in the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Factors Affecting Our Operating Results.”
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ITEM 1.
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BUSINESS
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General
Vestin Fund II, LLC (“Fund II”) was organized in December 2000 as a Nevada limited liability company for the purpose of investing in commercial real estate loans (hereafter referred to as “real estate loans”). Vestin Realty Mortgage II, Inc. (“VRM II”) was organized in January 2006 as a Maryland corporation for the sole purpose of effecting a merger with Fund II. On March 31, 2006, Fund II merged into VRM II and the members of Fund II received one share of VRM II’s common stock for each membership unit of Fund II. References in this report to the “Company,”“we,”“us,” or “our” refer to Fund II with respect to the period prior to April 1, 2006 and to VRM II with respect to the period commencing on April 1, 2006. Because we were a limited liability company (“LLC”) during the prior periods reflected in this report, we make reference to Fund II’s “members” rather than “stockholders” in reporting our financial results.
We invest in loans secured by real estate through deeds of trust or mortgages (hereafter referred to collectively as “deeds of trust” and as defined in our management agreement (“Management Agreement”) as “Mortgage Assets”). We commenced operations in June 2001.
At our annual meeting held on December 15, 2011, a majority of the shareholders voted to amend our Bylaws to expand our investment policy to include investments in and acquisition, management and sale of real property or the acquisition of entities involved in the ownership or management of real property. A majority of the shareholders also voted to amend our charter to change the terms of our existence from its expiration date of December 31, 2020 to perpetual existence. As a result, we will begin to acquire, manage, renovate, reposition, sell or otherwise invest in real property or acquire entities involved in the ownership or management of real property.
As of December 31, 2011, we operated as a real estate investment trust (“REIT”). We are not a mutual fund or an investment company within the meaning of the Investment Company Act of 1940. As a REIT, we are required to have a December 31 fiscal year end. Our Board of Directors has been exploring releasing our status as a REIT. We expect a resolution will be made by March 30, 2012 to terminate our REIT status based on legal advice to be received by this date. As such, the Company will not be taxed as a REIT for the year ending December 31, 2012. The required filings to make this resolution effective have been prepared and submitted to the Internal Revenue Service as of the date of this filing.
Vestin Group, Inc. (“Vestin Group”), a Delaware corporation, owns a significant majority of Vestin Mortgage, LLC, a Nevada limited liability company, who is our manager (the “manager” or “Vestin Mortgage”). On January 7, 2011, Vestin Mortgage converted from a corporation to a limited liability company. Michael Shustek, the CEO and managing member of our manager and CEO, President and a director of us, wholly owns Vestin Group, which is engaged in asset management, real estate lending and other financial services through its subsidiaries. Our manager, prior to June 30, 2006, also operated as a licensed Nevada mortgage broker and was generally engaged in the business of brokerage, placement and servicing of commercial loans secured by real property. On July 1, 2006, a mortgage broker license was issued to an affiliated company, Vestin Originations, Inc. (“Vestin Originations”), which is majority-owned by Vestin Group. Vestin Originations continued the business of brokerage, placement and servicing of real estate loans. Effective February 14, 2011, the business of brokerage and placement of real estate loans will be performed by affiliated or non-affiliated mortgage brokers, including Vestin Originations and Advant Mortgage, LLC (“Advant”), both licensed Nevada mortgage brokers, which are indirectly majority by Mr. Shustek.
Pursuant to a management agreement, our manager is responsible for managing our operations and implementing our business strategies on a day-to-day basis. Consequently, our operating results are dependent to a significant extent upon our manager’s ability and performance in managing our operations and servicing our assets.
Vestin Mortgage is also the manager of Vestin Realty Mortgage I, Inc. (“VRM I”), as the successor by merger to Vestin Fund I, LLC (“Fund I”), and Vestin Fund III, LLC (“Fund III”). These entities were formed to invest in real estate loans. VRM I has investment objectives similar to ours, and Fund III is in the process of an orderly liquidation of its assets.
The consolidated financial statements include the accounts of us, our wholly owned taxable REIT subsidiary, TRS II, Inc. (“TRS II”), and Hawaii Funeral Services, LLC (“HFS”) and related trusts from July 1, 2010 to December 1, 2011 (see Note A – Organization of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Report Form 10-K). All significant inter-company transactions and balances have been eliminated in consolidation.
During April 2009, we entered into an accounting services agreement with Strategix Solutions, LLC (“Strategix Solutions”), a Nevada limited liability company, for the provision of accounting and financial reporting services. Strategix Solutions also provides accounting and financial reporting services to VRM I and Fund III. Our CFO and other members of our accounting staff are employees of Strategix Solutions. Strategix Solutions is managed by LL Bradford and Company, LLC ("LL Bradford"), a certified public accounting firm that has provided non-audit accounting services to us. The principal manager of LL Bradford was a former officer of our manager from April 1999 through January 1, 2005. Strategix Solutions is owned by certain partners of LL Bradford, none of whom are currently or were previously officers of our manager. As used herein, “management” means our manager, its manager, its executive officers and the individuals at Strategix Solutions who perform accounting and financial reporting services on our behalf. On January 21, 2011, Eric Bullinger was appointed as our new CFO by the Board of Directors, pursuant to the terms of our agreement with Strategix Solutions, who was responsible for designating, subject to the approval of our Board of Directors, a new CFO for the Company. From May 21, 2010, until January 21, 2011, our current CEO, Michael Shustek, was acting as our interim CFO.
Segments
We are currently authorized to operate two reportable segments, investments in real estate loans and investments in real property. As of December 31, 2011, we had not commenced investing in real property.
Our objective is to invest approximately 97% of our assets in real estate loans and real estate investments, while maintaining approximately 3% as a working capital cash reserve. Current market conditions have impaired our ability to be fully invested in real estate loans. As of December 31, 2011, approximately 60% of our assets, net of allowance for loan losses, are classified as investments in real estate loans.
Real Estate Loan Objectives
As of December 31, 2011, our loans were in the following states: Arizona, California, Colorado, Nevada, Ohio, Oregon and Texas. The loans we invest in are selected for us by our manager from among loans originated by affiliated or non-affiliated mortgage brokers. When a mortgage broker originates a loan for us, that entity identifies the borrower, processes the loan application, brokers and sells, assigns, transfers or conveys the loan to us. We believe that our loans are attractive to borrowers because of the expediency of our manager’s loan approval process, which takes about ten to twenty days.
As a commercial real estate lender willing to invest in loans to borrowers who may not meet the credit standards of other financial institutional lenders, the default rate on our loans has been higher than those generally experienced in the mortgage lending industry. Because of our willingness to fund riskier loans, borrowers are generally willing to pay us an interest rate that is above the rates generally charged by other commercial lenders. We invest a significant amount of our funds in loans in which the real property, held as collateral, is not generating any income to the borrower. The loans in which we invest are generally riskier because the borrower’s repayment depends on their ability to refinance the loan or develop the property so they can refinance the loan.
Our principal investment objectives are to maintain and grow stockholder value by:
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Producing revenues from the interest income on our real estate loans;
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Providing cash dividends from the net income generated by our real estate loans; and
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Reinvesting, to the extent permissible, payments of principal and net proceeds from sales of foreclosed properties.
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Acquisition and Investment Policies
Generally, the collateral on our real estate loans is the real property that the borrower is purchasing or developing, together with a guarantee from the principal owners of the borrower. We sometimes refer to these real properties as the security properties. While we may invest in other types of loans, most of the loans in which we invest have been made to real estate developers.
Our real estate investments are not insured or guaranteed by any governmental agency.
Our manager continuously evaluates prospective investments, selects the loans in which we invest and makes all investment decisions on our behalf. In evaluating prospective real estate loan investments, our manager considers such factors as the following:
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The ratio of the amount of the investment to the value of the property by which it is secured, or the loan-to-value ratio;
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The potential for capital appreciation or depreciation of the property securing the investment;
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Expected levels of rental and occupancy rates, if applicable;
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Potential for rental increases, if applicable;
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Current and projected revenues from the property, if applicable;
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The status and condition of the record title of the property securing the investment;
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Geographic location of the property securing the investment; and
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The financial condition of the borrowers and their principals, if any, who guarantee the loan.
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Our manager may obtain our loans from affiliated or non-affiliated mortgage brokers. We may purchase existing loans that were originated by third party lenders or brokered by affiliates to facilitate our purchase of the loans. Our manager or any affiliated mortgage broker will sell, assign, transfer or convey the loans to us without a premium, but may include its service fees and compensation.
When selecting real estate loans for us, our manager generally adheres to the following guidelines, which are intended to control the quality of the collateral given for our loans:
1. Priority of Loans. Our policy is to secure most of our loans by first deeds of trust. First deeds of trust are loans secured by a full or divided interest in a first deed of trust secured by the property. We will not invest in any loan that is junior to more than one loan.
2. Loan-to-Value Ratio. The amount of our loan combined with the outstanding debt secured by a senior loan on a security property generally does not exceed the following percentage of the appraised value of the security property at origination:
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Type of Secured Property
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Loan-to-Value Ratio
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Residential
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75%
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Unimproved Land
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60% (of anticipated as-if developed value)
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Acquisition and Development
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60% (of anticipated as-if developed value)
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Commercial Property
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75% (of anticipated as-if developed value)
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Construction
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75% (of anticipated post- developed value)
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Leasehold Interest
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75% (of value of leasehold interest)
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We may deviate from these guidelines under certain circumstances. For example, our manager, in its discretion, may increase any of the above loan-to-value ratios if it believes a given loan is supported by credit adequate to justify a higher loan-to-value ratio, including personal guarantees. Occasionally, our collateral may include personal property attached to the real property as well as real property. We do not have specific requirements with respect to the projected income or occupancy levels of a property securing our investment in a particular loan. These loan-to-value ratios will not apply to financing offered to the purchaser of any real estate acquired through foreclosure or to refinance an existing loan that is in default. In those cases, our manager, in its sole discretion, may accept financing terms that it believes are reasonable and in our best interest.
Loan-to-value ratios are initially based on appraisals obtained at the time of loan origination. Such appraisals, which may have been commissioned by the borrower and may precede the placement of the loan with us, are generally dated no greater than 12 months prior to the date of loan origination. Current loan-to-value ratios are generally based on the most recent appraisals and include allowances for loan losses. Recognition of allowance for loan losses will result in a maximum loan-to-value ratio of 100% per loan.
Appraisals may not reflect subsequent changes in value and may be for the current estimate of the “as-if developed” value of the property, which approximates the post-construction value of the collateralized property assuming that such property is developed. “As-if developed” values on raw land loans or acquisition and development loans often dramatically exceed the immediate sales value. Realization of the “as-if-developed” value depends upon anticipated zoning changes and successful development efforts by the borrower. Completion of such development efforts may in turn depend upon the availability of additional financing. As most of the appraisals will be prepared on an “as-if developed” basis, if a loan goes into default prior to development of a project, the market value of the property may be substantially less than the appraised value. As a result, there may be less security than anticipated at the time the loan was originally made. If there is less security and a default occurs, we may not recover the outstanding balance of the loan.
We, or the borrower, retain appraisers who are state certified or licensed appraisers and/or hold designations from one or more of the following organizations: the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, the National Association of Review Appraisers, the Appraisal Institute, the National Society of Real Estate Appraisers, American Society of Real Estate Appraisers, or from other appraisers with other qualifications acceptable to our manager. However, appraisals are only estimates of value and cannot be relied on as measures of realizable value. An employee or agent of our manager will review each appraisal report and will generally conduct a physical inspection for each property. A physical inspection includes an assessment of the subject property, the adjacent properties and the neighborhood, but generally does not include entering any structures on the property.
3. Terms of Real Estate Loans. Our loans as of December 31, 2011, had original terms of 2 months to 120 months, excluding extensions. Most of our loans are for an initial term of 12 months. Generally, our original loan agreements permit extensions to the term of the loan by mutual consent. Such extensions are generally provided on loans where the original term was 12 months or less and where a borrower requires additional time to complete a construction project or negotiate take-out financing. Our manager generally grants extensions when a borrower is in compliance with the material terms of the loan, including, but not limited to the borrower’s obligation to make interest payments on the loan. In addition, if circumstances warrant, our manager may extend a loan that is in default as part of a work out plan to collect interest and/or principal. The weighted average term of outstanding loans, including extensions, at December 31, 2011, was 14 months.
As of December 31, 2011 and 2010, most of our loans provided for payments of interest only, some of which have accrued interest, with a “balloon” payment of principal payable in full at the end of the term. In addition, we may invest in real estate loans that require borrowers to maintain interest reserves funded from the principal amount of the loan for a period of time. At December 31, 2011 and 2010, we had no investments in real estate loans that had interest reserves.
4. Escrow Conditions. Our loans will often be funded by us through an escrow account held by a title insurance company, subject to the following conditions:
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Borrowers will obtain title insurance coverage for all loans, providing title insurance in an amount at least equal to the principal amount of the loan. Title insurance insures only the validity and priority of our deed of trust, and does not insure us against loss by other causes, such as diminution in the value of the security property.
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Borrowers will obtain liability insurance coverage for all loans.
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Borrowers will obtain fire and casualty insurance for all loans secured by improved real property, covering us in an amount sufficient to cover the replacement cost of improvements.
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All insurance policies, notes, deeds of trust or loans, escrow agreements, and any other loan documents for a particular transaction will cover us as a beneficiary.
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5. Purchase of Real Estate Investments from Affiliates. We may acquire real estate loans from our affiliates, including our manager, that are accounted for at the principal balance and no gain or loss is recognized by us or any affiliate. These purchases may include allowable fees and expenses, but no other compensation for the loans. Excluding the compensation paid to our manager, all income generated and expense associated with the loans so acquired shall be treated as belonging to us.
6. Note Hypothecation. We may also acquire real estate loans secured by assignments of secured promissory notes. These real estate loans must satisfy our stated investment standards, including our loan-to-value ratios, and may not exceed 80% of the principal amount of the assigned note upon acquisition. For example, if the property securing a note we acquire is a commercial property, the total amount of outstanding debts secured by the property generally must not exceed 75% of the appraised value of the property, and the real estate loan generally will not exceed 80% of the principal amount of the assigned note. For real estate loans secured by promissory notes, we will rely on the appraised value of the underlying property, as determined by an independent written appraisal that was conducted within the then-preceding twelve months. If an appraisal was not conducted within that period, then we will arrange for a new appraisal to be prepared for the property prior to acquisition of the loan.
7. Participation. We participate in loans with other lenders by providing funds for or purchasing an undivided interest in a loan meeting our investment guidelines described above. We participate in loans with our affiliates, subject to our voluntary compliance with the applicable guidelines of the North American Securities Administrators Association (“NASAA Guidelines”). The independent directors on our Board may authorize a departure from such NASAA Guidelines. Typically, we participate in loans if:
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We did not have sufficient funds to invest in an entire loan;
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We are seeking to increase the diversification of our loan portfolio; or
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A loan fits within our investment guidelines, however it would constitute more than 20% of our capital or otherwise be disproportionately large given our then existing portfolio.
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Loans in which unaffiliated investors have participated through inter-creditor agreements (“Inter-creditor Agreements”) are accounted for as secured borrowings. The Inter-creditor Agreements provide us additional funding sources for real estate loans whereby an unaffiliated investor (the “Investor”) may participate on a non-paripassu basis in certain real estate loans with us and/or VRM (collectively, the “Lead Lenders”). In the event of borrower non-performance, the Inter-creditor Agreements generally provide that the Lead Lenders must repay the Investor’s loan amount either by (i) continuing to remit to the Investor the interest due on the participated loan amount; (ii) substituting an alternative loan acceptable to the Investor; or (iii) repurchasing the participation from the Investor for the outstanding balance plus accrued interest.
Additionally, an Investor may participate in certain loans with the Lead Lenders through Participation Agreements. In the event of borrower non-performance, the Participation Agreement may allow the Investor to be repaid up to the amount of the Investor’s investment prior to the Lead Lender being repaid. Real estate loan financing under the Participation Agreements are also accounted for as a secured borrowing. We do not receive any revenues for entering into secured borrowings arrangements.
As of December 31, 2011, 75% of our loans were loans in which we participated with other lenders, most of whom are our affiliates.
8. Diversification. We voluntarily comply with applicable NASAA Guidelines, unless otherwise approved by the independent members of our board of directors, which provide that we neither invest in or make real estate loans on any one property, which would exceed, in the aggregate, an amount equal to 20% of our stockholders’ equity, nor may we invest in or make real estate loans to or from any one borrower, which would exceed, in the aggregate, an amount greater than 20% of our stockholders’ equity. As of December 31, 2011, our single largest investment in real estate loans, the Spectrum Town Center Property, LLC loan, accounted for approximately 25% of our stockholders’ equity. When funded during April 2008, this loan constituted less than 20% of our stockholders’ equity. However, our loan portfolio has declined in size primarily due to sales, foreclosures and modifications. The loan’s interest rate was at 15% per annum and as of December 31, 2011, our portion of the outstanding balance of the loan was approximately $12.6 million. During May 2009, this loan was deemed non-performing. For additional information regarding the above non-performing loan, see “Non-Performing Loans” in Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Report Form 10-K.
As of December 31, 2011, we had loans with common guarantors. For additional information regarding loans with common guarantors see Note C – Financial Instruments and Concentrations of Credit Risk of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Report Form 10-K.
9. Reserve Fund. We have established contingency working capital reserves of approximately 3% of our stockholders’ equity to cover our unexpected cash needs.
10. Credit Evaluations. When reviewing a loan proposal, our manager determines whether a borrower has sufficient equity in the security property. Our manager may also consider the income level and creditworthiness of a borrower to determine its ability to repay the real estate loan.
11. Sale of Real Estate Loan Investments. Our manager may sell our real estate loans or interest in our loans to either affiliates or non-affiliated parties when our manager believes that it is advantageous for us to do so. However, we do not expect that our loans will be generally marketable or that a secondary market will develop for them.
Real Estate Loans to Affiliates
We will not invest in real estate loans made to our manager, Vestin Group or any of our affiliates. However, we may acquire an investment in a real estate loan payable by our manager when our manager has assumed the obligations of the borrower under that loan through a foreclosure on the property.
Investment of Loans From our Manager and Its Affiliates
In addition to those loans our manager selects for us, we invest in loans that were originated by affiliates as long as the loan(s) otherwise satisfies all of our lending criteria. However, we will not acquire a loan from or sell a loan to a real estate program in which our manager or an affiliate has an interest except in compliance with applicable NASAA Guidelines or as otherwise approved by the independent members of our board of directors.
Types of Loans We Invest In
We primarily invest in loans that are secured by first or second trust deeds on real property. Such loans fall into the following categories: raw and unimproved land, acquisition and development, construction, commercial property and residential loans. The following discussion sets forth certain guidelines our manager generally intends to follow in allocating our investments among the various types of loans. Our manager, however, may change these guidelines at its discretion, subject to review by our board of directors. Actual investments will be determined by our manager pursuant to the terms of the Management Agreement. The actual percentages invested among the various loan categories may vary as a result of changes in the size of our loan portfolio.
Raw and Unimproved Land Loans
Generally, 15% to 25% of the loans invested in by us may be loans made for the purchase or development of raw, unimproved land. Generally, we determine whether to invest in these loans based upon the appraised value of the property and the borrower’s actual capital investment in the property. We will generally invest in loans for up to 60% of the initial as-if developed appraised value of the property and we generally require that the borrower has invested in the property actual capital expenditures of at least 25% of the property’s value. As-if developed values on raw and unimproved land loans often dramatically exceed the immediate sales value and may include anticipated zoning changes, and successful development by the purchaser, upon which development is dependent on availability of financing.
Acquisition and Development Loans
Generally, 10% to 25% of the loans invested in by us may be acquisition and development loans. Such loans enable borrowers to acquire and/or complete the basic infrastructure and development of their property prior to the construction of buildings or structures. Such development may include installing utilities, sewers, water pipes, and/or streets, together with the costs associated with obtaining entitlements, including zoning, mapping and other required governmental approvals. We will generally invest in loans with an initial face value of up to 60% of the appraised value of the property. Loan-to-value ratios on acquisition and development loans are calculated using as-if developed appraisals. Such appraisals have the same valuation limitations as raw and unimproved land loans, described above.
Construction Loans
Generally, 10% to 70% of our loans may be construction loans. Such loans provide funds for the construction of one or more structures on developed land. Funds under this type of loan will generally not be forwarded to the borrower until work in the previous phase of the project has been completed and an independent inspector has verified certain aspects of the construction and its costs. We will typically require material and labor lien releases by the borrower per completed phase of the project. We will review the appraisal of the value of the property and proposed improvements, and will generally finance up to 75% of the initial appraised value of the property and proposed improvements. Such appraisals have the same valuation limitations as raw and unimproved land loans, described above.
Commercial Property Loans
Generally, 20% to 50% of the loans we invest in may be commercial property loans. Such loans provide funds to allow borrowers to acquire income-producing property or to make improvements or renovations to the property in order to increase the net operating income of the property so that it may qualify for institutional refinancing. Generally, we review the initial property appraisal and generally invest in loans for up to 75% of such appraised value of the property.
Residential Loans
A small percentage of the loans invested in by us may be residential loans. Such loans facilitate the purchase or refinance of one to four family residential property units provided the borrower uses one of the units on the property as such borrower’s principal residence. We will generally invest in loans for up to 75% of the initial value of the property.
Collateral
Each loan is secured by a lien on either a fee simple or leasehold interest in real property as evidenced by a first deed of trust or a second deed of trust.
First Deed of Trust
Historically, most of our loans were secured by first deeds of trust. Thus as a lender, we would have rights as a first priority lender of the collateralized property. As of December 31, 2011, approximately 49% of our loans were secured by first deeds of trust. When funded, such loans constituted more than 85% of our loans. The percentage of our loans secured by first deeds of trust has decreased primarily due to the decrease in loans secured by first deeds of trust through sales, foreclosures and modifications.
Second Deed of Trust
Prior to September 2008, our objective has been that not more than 10% of our loan portfolio would be secured by second deeds of trust; unless our board of directors approves a higher percentage. During September 2008, the board authorized us to allow loans secured by second deeds of trust to constitute up to 15% of our loans, due to loan restructuring and business opportunities. In a second priority loan, the rights of the lender (such as the right to receive payment on foreclosure) will be subject to the rights of the first priority lender. In a wraparound loan, the lender’s rights will be comparably subject to the rights of a first priority lender, but the aggregate indebtedness evidenced by the loan documentation will be the first priority loan plus the new funds the lender invests. The lender would receive all payments from the borrower and forward to the senior lender its portion of the payments the lender receives. As of December 31, 2011, approximately 51% of our loans were secured by a second deed of trust. When funded, such loans constituted less than 15% of our loans. The percentage of our loans in second deeds of trust has increased primarily due to the decrease in loans secured by first deeds of trust through sales, foreclosures and modifications.
Prepayment Penalties and Exit Fees
Generally, the loans we invest in will not contain prepayment penalties but may contain exit fees payable when the loan is paid in full, by the borrower, to our manager or its affiliates as part of their compensation. If interest rates decline, the amount we can charge as interest on our loans will also likely decline. Moreover, if a borrower should prepay obligations that have a higher interest rate from an earlier period, we will likely not be able to reinvest the funds in real estate loans earning that higher rate of interest. In the absence of a prepayment fee, we will receive neither the anticipated revenue stream at the higher rate nor any compensation for its loss. As of December 31, 2011, none of our loans had a prepayment penalty, although eight of our loans, totaling approximately $37.4 million, had an exit fee. Out of the eight loans with an exit fee, four loans, totaling approximately $26.6 million, were considered non-performing as of December 31, 2011. Depending upon the amount by which lower interest rates are available to borrowers, the amount of the exit fees may not be significant in relation to the potential savings borrowers may realize as a result of prepaying their loans.
Extensions to Term of Loan
Our original loan agreements generally permit extensions to the term of the loan by mutual consent. Such extensions are generally provided on loans where the original term was 12 months or less and where a borrower requires additional time to complete a construction project or negotiate take-out financing. Our manager generally grants extensions when a borrower is in compliance with the material terms of the loan, including, but not limited to the borrower’s obligation to make interest payments on the loan. In addition, if circumstances warrant, our manager may extend a loan that is in default as part of a work out plan to collect interest and/or principal.
Interest Reserves
We may invest in loans that include a commitment for an interest reserve, which is usually established at loan closing. The interest reserve may be advanced by us or other lenders with the amount of the borrower’s indebtedness increased by the amount of such advances.
Balloon Payment
As of December 31, 2011, most of our loans provided for payments of interest only with a “balloon” payment of principal payable in full at the end of the term. There are no specific criteria used in evaluating the credit quality of borrowers for real estate loans requiring balloon payments. Furthermore, a substantial period of time may elapse between the review of the financial statements of the borrower and the date when the balloon payment is due. As a result, there is no assurance that a borrower will have sufficient resources to make a balloon payment when due. To the extent that a borrower has an obligation to pay real estate loan principal in a large lump sum payment, its ability to repay the loan may be dependent upon its ability to sell the property, obtain suitable refinancing or otherwise raise a substantial amount of cash. As a result, these loans can involve a higher risk of default than loans where the principal is paid at the same time as the interest payments.
Repayment of Loans on Sale of Properties
We may require a borrower to repay a real estate loan upon the sale of the property rather than allow the buyer to assume the existing loan. We will generally require repayment if we determine that repayment appears to be advantageous to us based upon then-current interest rates, the length of time that the loan has been held by us, the creditworthiness of the buyer and our objectives.
Variable Rate Loans
Occasionally we may acquire variable rate loans. Variable rate loans may use as indices the one and five year Treasury Constant Maturity Index, the Prime Rate Index and the Monthly Weighted Average Cost of Funds Index for Eleventh District Savings Institutions (Federal Home Loan Bank Board
It is possible that the interest rate index used in a variable rate loan will rise (or fall) more slowly than the interest rate of other loan investments available to us. If we make variable rate loans, our manager, in conjunction with a mortgage broker we may use, will attempt to minimize this interest rate differential by tying variable rate loans to indices that are sensitive to fluctuations in market rates. Additionally, variable rate loans may contain an interest rate floor.
Variable rate loans generally have interest rate caps. For these loans, there is the risk that the market rate may exceed the interest cap rate.
Real Estate Investment Objectives
As of December 31, 2011, we had not purchased any real estate properties. Investments in commercial properties will be primarily in Nevada, Arizona, California, Oregon and Texas or in other areas of the Southwestern and Western part of the United States. Properties acquired may include, but are not limited to, office buildings, shopping centers, business and industrial parks, manufacturing facilities, multifamily properties, warehouses and distribution facilities, motel and hotel properties and recreation and leisure properties. We will not invest in unimproved land or construction or development of properties. We intend to lease properties owned by us and to hold properties until such time as we believe it is the optimal time to capitalize on the capital appreciation of our properties.
We intend to invest principally in properties that generate current income. Potential gain on sale of appreciated properties will be a secondary objective.
Acquisition and Investment Strategies
Capitalizing on Availability of Properties
We believe that excellent opportunities exist in our target markets in the Southwestern United States to acquire quality properties at significant discounts. Some of these properties should exhibit stable cash flow, but are currently underperforming. We intend to generate value by improving cash flows through aggressive leasing, asset management and repositioning of the property. We will acquire these properties directly from owners, through the foreclosure process, or from financial institutions holding foreclosed real estate.
Maximizing Value of Acquired Properties
We will seek to reposition properties that we acquire through strategic renovation and re-tenanting such properties. Repositioning of properties may be accomplished by (1) stabilizing occupancy; (2) upgrading and renovating existing structures; and (3) investing significant efforts in recruiting tenants whose goods and services meet the needs of the surrounding neighborhood. We currently do not intend to engage in significant development or redevelopment of properties as the costs of development and redevelopment may exceed the cost of properties that we acquire.
Southwestern and Western United States Focus
Our acquisition efforts will occur in the Southwestern and Western United States, primarily in Nevada, California and Arizona. These regions have recently experienced severe economic distress, which has in turn led to significant declines in real estate values. We believe such factors have created a significant pipeline of acquisition opportunities. Despite the recent downturn, we believe these regions have fundamentally diverse and dynamic economies that hold the potential to recover significantly as the overall economy in the United States improves and that such recovery will in turn improve the real estate markets in these regions.
Focus on Strong Property and Submarket Fundamentals
We will seek to acquire properties that present strong characteristics that we believe are essential for a successful real estate investment. These include:
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an attractive location in established markets;
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desirable physical attributes such as a contemporary design and function, adequate parking, flexible and efficient floor plans and environmentally friendly design; and
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a strong multi-tenant base with limited exposure to significant tenant concentrations.
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Apply a Disciplined Underwriting Process
We intend to utilize a disciplined underwriting process in our evaluation of potential property acquisitions. In evaluating a property’s cash flow potential, we intend to use conservative assumptions regarding future cash flow, taking into account not only current rents but future rents that may be negotiated at a discount during the current market downturn, the credit worthiness of tenants and other factors that may affect cash flow, which we believe our management team is well positioned to understand. We also intend to utilize assumptions regarding the timing and level of a market recovery that we believe to be conservative. We intend to acquire properties that are able to provide returns, regardless of when a market recovery occurs, with potential for cash flow improvement and capital appreciation.
Leasing
The terms and conditions of any lease we enter into with our tenants may vary substantially. However, we expect that our leases will conform with the standard market practices in the geographic area where the property is located. We expect to execute new tenant leases and tenant lease renewals, expansions and extensions with terms that are dictated by the current market conditions. If it is economically practical, we may verify the creditworthiness of each tenant. If we verify the creditworthiness of each tenant, we may use industry credit rating services for any guarantors of each potential tenant. We may also obtain relevant financial data from potential tenants and guarantors, such as income statements, balance sheets and cash flow statements. We may require personal guarantees from shareholders of our corporate tenants. However, there can be no guarantee that the tenants selected will not default on their leases or that we can successfully enforce any guarantees.
Financing Sources
We will seek financing from a variety of sources to fund our potential acquisitions. Such sources may include cash on hand, cash flow from operating activities and cash proceeds from any public offering or private placement of equity or debt securities. We may also seek to obtain a revolving credit facility and other secured or unsecured loans to fund acquisitions. We cannot provide any assurance that we will be successful in obtaining any financing for all or any of our potential acquisitions.
Borrowing
We may incur indebtedness to:
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Declare dividends to enable us to comply with REIT distribution requirements;
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Finance our investments in real estate loans;
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Prevent a default under real estate loans that are senior to our real estate loans;
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Discharge senior real estate loans if this becomes necessary to protect our investment in real estate loans; or
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Operate or develop a property that we acquired under a defaulted loan.
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Our indebtedness should not exceed 70% of the fair market value of our real estate loans. This indebtedness may be with recourse to our assets.
In addition, we may enter into structured arrangements with other lenders in order to provide them with a senior position in real estate loans that we might jointly fund. For example, we might establish a wholly owned special purpose corporation that would borrow funds from an institutional lender under an arrangement where the resulting real estate loans would be assigned to a trust, and the trust would issue a senior certificate to the institutional lender and a junior certificate to the special purpose corporation. This would assure the institutional lender of repayment in full prior to our receipt of any repayment on the jointly funded real estate loans.
Competition
Generally, real estate developers depend upon the timely completion of a project to obtain a competitive advantage when selling their properties. We have sought to attract real estate developers by offering expedited loan processing, which generally provides quick approval and funding of a loan. As a result, we have established a market niche as a non-conventional real estate lender.
We consider our direct competitors to be the providers of real estate loans who offer short-term, equity-based loans on an expedited basis for higher fees and rates than those charged by other financial institutional lenders such as commercial banks. Many of the companies against which we compete have substantially greater financial, technical and other resources than either our company or our manager that may allow them to enjoy significant competitive advantages. Competition in our market niche depends upon a number of factors, including terms and interest rates of a loan, the price of a property, speed of loan processing and closing escrow on properties, cost of capital, reliability, quality of service and support services.
Regulation
We are managed by Vestin Mortgage, subject to the oversight of our board of directors, pursuant to the terms and conditions of our Management Agreement. Vestin Originations and Advant, affiliates of Vestin Mortgage, operate as a mortgage brokers and are subject to extensive regulation by federal, state and local laws and governmental authorities. Mortgage brokers we may use conduct their real estate loan businesses under a license issued by the State of Nevada Mortgage Lending Division. Under applicable Nevada law, the division has broad discretionary authority over the mortgage brokers’ activities, including the authority to conduct periodic regulatory audits of all aspects of their operations.
We, our manager, and certain affiliates are also subject to the Equal Credit Opportunity Act of 1974, which prohibits creditors from discriminating against loan applicants on the basis of race, color, sex, age or marital status, and the Fair Credit Reporting Act of 1970, which requires lenders to supply applicants with the name and address of the reporting agency if the applicant is denied credit. We are also subject to various other federal and state securities laws regulating our activities. In addition, our manager is subject to the Employee Retirement Income Security Act of 1974.
The NASAA Guidelines have been adopted by various state agencies charged with protecting the interests of investors. Administrative fees, loan fees, and other compensation paid to our manager and its affiliates would be generally limited by the NASAA Guidelines. These Guidelines also include certain investment procedures and criteria, which are required for new loan investments. We are not required to comply with NASAA Guidelines; however, we voluntarily comply with applicable NASAA Guidelines unless a majority of our unaffiliated directors determines that it is in our best interest to diverge from such NASAA Guidelines.
Because our business is regulated, the laws, rules and regulations applicable to us are subject to modification and change. There can be no assurance that laws, rules or regulations will not be adopted in the future that could make compliance much more difficult or expensive, restrict our ability to invest in or service loans, further limit or restrict the amount of commissions, interest and other charges earned on loans, or otherwise adversely affect our business or prospects.
Employees
We have no employees. Our manager has provided and will continue to provide most of the employees necessary for our operations, except as described below regarding Strategix Solutions, LLC. As of December 31, 2011, the Vestin entities had a total of 12 full-time and no part-time employees. Except as hereinafter noted, all employees are at-will employees and none are covered by collective bargaining agreements. John Alderfer, our former CFO, is a party to an employment, non-competition, confidentiality and consulting contract with Vestin Group, Inc., the parent company of our manager, through December 31, 2016.
During April 2009, we entered into an accounting services agreement with Strategix Solutions, LLC (“Strategix Solutions”), a Nevada limited liability company, for the provision of accounting and financial reporting services. Strategix Solutions also provides accounting and financial reporting services to VRM I and Fund III. Our CFO and other members of our accounting staff are employees of Strategix Solutions. Strategix Solutions is managed by LL Bradford and Company, LLC ("LL Bradford"), a certified public accounting firm that has provided non-audit accounting services to us. The principal manager of LL Bradford was a former officer of our manager from April 1999 through January 1, 2005. Strategix Solutions is owned by certain partners of LL Bradford, none of whom are currently or were previously officers of our manager. As of December 31, 2011, Strategix Solutions dedicates to us a total of three employees.
Available Information
Our Internet website address is www.vestinrealtymortgage2.com. We make available free of charge through http://phx.corporate-ir.net/phoenix.zhtml?c=193758&p=irol-sec our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports as soon as reasonably practical after such material is electronically filed with or furnished, pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, to the United States Securities and Exchange Commission (“SEC”). Further, a copy of this annual report on Form 10-K is located at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operations of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov. Information contained on our website does not constitute a part of this Report on Form 10-K.
ITEM 1A. RISK FACTORS
Risks Related to Our Business
Real Estate Loan
Current economic conditions have increased the risk of defaults on our loans. Defaults on our real estate loans have reduced our revenues and may continue to do so in the future.
We are in the business of investing in real estate loans and, as such, we are subject to risk of defaults by borrowers. Our performance has been and will continue to be directly impacted by any defaults on the loans in our portfolio. As a commercial real estate lender willing to invest in loans to borrowers who may not meet the credit standards of other financial institutional lenders, the rate of default on our loans has been higher than those generally experienced in the real estate lending industry. A sustained period of increased defaults over the past several years has adversely affected our business, financial condition, liquidity and the results of our operations and may continue to do so in the future.
Our exposure to the negative developments in the credit markets and general economy has likely been increased by our business strategy, which entails more lenient underwriting standards and expedited loan approval procedures. At this time, we are not able to predict how long such difficult economic conditions will continue. As a result, we may not be able to recover the full amount of our loans if the borrower defaults. Moreover, any failure of a borrower to pay interest on loans will reduce our revenues, impair our ability to pay dividends to stockholders and, most likely, the value of our stock. Similarly, any failure of a borrower to repay loans when due may reduce the capital we have available to make new loans, thereby adversely affecting our operating results.
The recent recession and constraints in the credit markets adversely affected our operating results and financial condition.
As a commercial real estate lender willing to invest in riskier loans, rates of delinquencies, foreclosures and losses on our loans have been higher than those generally experienced in the commercial mortgage lending industry during periods of economic slowdown or recession. The recent recession adversely affected the general economy and the availability of funds for commercial real estate developers. We believe this lack of available funds led to an increase in defaults on our loans. Furthermore, problems experienced in the U.S. credit markets starting in the summer of 2007 have reduced the availability of credit for many prospective borrowers. These problems persist in the markets we are serving, making it more difficult for our borrowers to obtain the anticipated re-financing necessary in many cases to pay back our loans. Thus, an extended period of illiquidity in the credit markets has resulted in a material increase in the number of our loans that are not paid back on time. A continuation of increased delinquencies, defaults or foreclosures will have an adverse affect upon our ability to originate, purchase and securitize loans, which could significantly harm our business, financial condition, liquidity and results of operations. The recovery of the general economy has not yet resulted in a material improvement of the real estate markets in many of our principal markets. In addition, the recession slowed economic activity, resulting in a decline in new lending. Continuation of depressed conditions in the principal markets we serve may result in our continuing to fund fewer loans, thereby reducing our opportunities to generate interest income.
Our underwriting standards and procedures are more lenient than many institutional lenders, which has resulted and may continue to result in a higher level of non-performing assets and less amounts available for distribution.
Our underwriting standards and procedures are more lenient than many institutional lenders in that we will invest in loans to borrowers who may not be required to meet the credit standards of other financial institutional real estate lenders. As a result, we have experienced and may continue to experience a higher rate of defaults by our borrowers and an increase in non-performing assets in our loan portfolio. We approve real estate loans more quickly than other lenders. We rely heavily on third-party reports and information such as appraisals and environmental reports. Because of our accelerated due diligence process, we may accept documentation that was not specifically prepared for us or commissioned by us. This creates a greater risk of the information contained therein being out of date or incorrect. Generally, we will not spend more than 20 days assessing the character and credit history of our borrowers. Due to the nature of loan approvals, there is a risk that the credit inquiry we perform will not reveal all material facts pertaining to the borrower and the security.
We depend upon our real estate security to secure our real estate loans, and we may suffer a loss if the value of the underlying property declines. We are currently experiencing a trend of declining real estate values, which has reduced the value of our collateral and resulted in losses on defaulted loans.
We depend upon our real estate security to protect us on the loans that we make. We depend upon the skill of independent appraisers to value the security underlying our loans. However, notwithstanding the experience of the appraisers, they may make mistakes, or the value of the real estate may decrease due to subsequent events. Our appraisals are generally dated within 12 months of the date of loan origination and may have been commissioned by the borrower. Therefore, the appraisals may not reflect a decrease in the value of the real estate due to events subsequent to the date of the appraisals. Since the summer of 2007, there has been a significant decline in real estate values in many of the markets where we operate, resulting in a decline in the estimated value of the real estate securing our loans. Such decline may continue in several of the principal markets in which we operate.
In addition, most of the construction and acquisition and development loan appraisals are prepared on an as-if developed basis, which approximates the post-construction value of the collateralized property assuming such property is developed. As-if developed values on raw land loans or acquisition and development loans often dramatically exceed the immediate sales value. Realization of the as-if-developed values may depend upon anticipated zoning changes, successful development by the borrower and the availability of additional financing. As most of the appraisals will be prepared on an as-if developed basis, if the loan goes into default prior to completion of the project, the market value of the property may be substantially less than the appraised value. As a result, there may be less security than anticipated at the time the loan was originally made. If there is less security and a default occurs, we may not recover the full amount of our loan, thus reducing the amount of funds available to distribute.
Our loan portfolio is concentrated in the Western states, several of which have not recovered from in the recent recession. Lack of geographical diversification increases our vulnerability to market downturns.
Commercial real estate markets in the states related to our loan portfolio have suffered significantly during the recent recession, with declining real estate values and high rates of default on real estate loans. Our loan concentration in these states has increased our vulnerability to the troubled real estate markets. Real estate markets vary greatly from location to location and our manager has limited experience outside of the Western and Southwestern United States. Any effort to expand into new geographical regions could be complicated by our manager’s lack of experience in such regions.
We typically make “balloon payment” loans, which are riskier than loans with payments of principal over an extended period of time.
The loans we invest in or purchase generally require the borrower to make a “balloon payment” on the principal amount upon maturity of the loan. A balloon payment is a large principal balance that is payable after a period of time during which the borrower has repaid none or only a small portion of the principal balance. Loans with balloon payments are riskier than loans with payments of principal over an extended time period such as 15 or 30 years because the borrower’s repayment depends on its ability to sell the property, obtain suitable refinancing or otherwise raise a substantial amount of cash when the loan comes due. The borrower’s ability to achieve a successful sale or refinancing of the property may be adversely impacted by deteriorating economic conditions or illiquidity in the credit markets. There are no specific criteria used in evaluating the credit quality of borrowers for loans requiring balloon payments. Furthermore, a substantial period of time may elapse between the review of the financial statements of the borrower and the date when the balloon payment is due. As a result, there is no assurance that a borrower will have sufficient resources to make a balloon payment when due.
An increased percentage of our loan portfolio consists of second deeds of trust, which generally entail a higher degree of risk than first deeds of trust.
We invest in second deeds of trust and, in rare instances, wraparound, or all-inclusive, real estate loans. Our board is required to approve our investing more than 10% of our assets in second deeds of trust. During September 2008, the board authorized us to allow loans secured by second deeds of trust to constitute up to 15% of our loans, due to loan restructuring and business opportunities. However, as a result of sales, foreclosures and modifications of loans secured by first deeds of trust, our loans secured by second deeds of trust have exceeded these percentages. In a second deed of trust, our rights as a lender, including our rights to receive payment on foreclosure, will be subject to the rights of the first deed of trust. In a wraparound real estate loan, our rights will be similarly subject to the rights of a first deed of trust, but the aggregate indebtedness evidenced by our loan documentation will be the first deed of trust plus the new funds we invest. We would receive all payments from the borrower and forward to the senior lender its portion of the payments we receive. Because both of these types of loans are subject to the first deed of trust’s right to payment on foreclosure, we incur a greater risk when we invest in each of these types of loans that we will not be able to collect the full amount of our loan and may provide an allowance for the full amount of the loan. If we are unable to collect the amounts secured by second deeds of trust, our operating results will suffer and we will have less funds available to distribute to shareholders.
Our loans are not guaranteed by any governmental agency.
Our loans are not insured or guaranteed by a federally owned or guaranteed mortgage agency. Consequently, our recourse, if there is a default, may be to foreclose upon the real property securing a loan and/or pursuing the borrower’s guarantee of the principal. The value of the foreclosed property may have decreased and may not be equal to the amount outstanding under the corresponding loan, resulting in a decrease of the amount available to distribute.
Our real estate loans are not readily marketable, and we expect no secondary market to develop.
Our real estate loans are not readily marketable, and we do not expect a secondary market to develop for them. As a result, we will generally bear all the risk of our investment until the loans mature. This will limit our ability to hedge our risk in changing real estate markets and may result in reduced returns to our investors.
The terms of any indebtedness we incur may increase our operating risk and may reduce the amount we have available to distribute to stockholders.
We may borrow up to 70% of the fair market value of our outstanding real estate loans at any time. The terms of any additional indebtedness we incur may vary. However, some lenders may require as a condition of making a loan to us that the lender will receive a priority on loan repayments received by us. As a result, if we do not collect 100% on our investments, the first dollars may go to our lenders and we may incur a loss that will result in a decrease of the amount available for distribution. In addition, we may enter into securitization arrangements in order to raise additional funds. Such arrangements could increase our leverage and adversely affect our cash flow and our ability to declare dividends.
There is a substantial risk that we would be unable to raise additional funding if needed to meet our obligations or expand our loan portfolio.
Our ability to borrow funds to meet obligations or expand our loan portfolio is doubtful in light of current market conditions. In addition, our ability to raise funds through an equity financing would be hindered by the current price of our stock. As a result, our ability to grow is constrained and we must depend upon our internal resources to meet our obligations. If we raise capital through an equity offering, this may result in substantial dilution to our current stockholders. Any debt financing may be expensive and might include restrictive covenants that would constrain our ability to declare dividends to our shareholders. We may not be able to raise capital on reasonable terms, if at all, in the current market environment.
We have and may continue to have difficulty protecting our rights as a secured lender.
We believe that our loan documents will enable us to enforce our commercial arrangements with borrowers. However, the rights of borrowers and other secured lenders may limit our practical realization of those benefits. For example:
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Judicial foreclosure is subject to the delays of protracted litigation. Although we expect non-judicial foreclosure to be quicker, our collateral may deteriorate and decrease in value during any delay in foreclosing on it;
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The borrower’s right of redemption during foreclosure proceedings can deter the sale of our collateral and can for practical purposes require us to manage the property;
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Unforeseen environmental hazards may subject us to unexpected liability and procedural delays in exercising our rights;
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The rights of senior or junior secured parties in the same property can create procedural hurdles for us when we foreclose on collateral;
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Required licensing and regulatory approvals may complicate our ability to foreclose or to sell a foreclosed property where our collateral includes an operating business;
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State and federal bankruptcy laws can prevent us from pursuing any actions, regardless of the progress in any of these suits or proceedings.
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By becoming the owner of property, we have and may continue to incur additional obligations, which may reduce the amount of funds available for distribution.
We intend to own real property. Acquiring a property at a foreclosure sale may involve significant costs. If we foreclose on the security property, we expect to obtain the services of a real estate broker and pay the broker’s commission in connection with the sale of the property. We may incur substantial legal fees and court costs in acquiring a property through contested foreclosure and/or bankruptcy proceedings. In addition, significant expenditures, including property taxes, maintenance costs, mortgage payments, insurance costs and related charges, must be made on any property we own regardless of whether the property is producing any income.
Under applicable environmental laws, any owner of real property may be fully liable for the costs involved in cleaning up any contamination by materials hazardous to the environment. Even though we might be entitled to indemnification from the person that caused the contamination, there is no assurance that the responsible person would be able to indemnify us to the full extent of our liability. Furthermore, we would still have court and administrative expenses for which we may not be entitled to indemnification.
Our results are subject to fluctuations in interest rates and other economic conditions.
Our results of operations will vary with changes in interest rates and with the performance of the relevant real estate markets. If the economy is healthy, we expect that more people will be borrowing money to acquire, develop or renovate real property. However, if the economy grows too fast, interest rates may increase too much and the cost of borrowing may become too expensive. Alternatively, if the economy enters a recession as we currently have experienced, real estate development may continue to slow. The slowdown in real estate lending may mean we will have fewer loans to acquire, thus reducing our revenues and dividends to stockholders. As a result of the current economic recession, our revenues and dividends have been reduced.
Interest rate fluctuations may affect our operating results as follows:
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If interest rates rise, borrowers under loans with monthly or quarterly principal payments may be compelled to extend their loans to decrease the principal paid with each payment because the interest component has increased. If this happens, we are likely to be at a greater risk of the borrower defaulting on the extended loan, and the increase in the interest rate on our loan may not be adequate compensation for the increased risk. Additionally, any fees paid to extend the loan are paid to our manager or affiliated mortgage brokers, not to us. Our revenues and dividends will decline if we are unable to reinvest at higher rates or if an increasing number of borrowers default on their loans; and
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If interest rates decline, the amount we can charge as interest on our loans will also likely decline. Moreover, if a borrower should prepay obligations that have a higher interest rate from an earlier period, we will likely not be able to reinvest the funds in real estate loans earning that higher rate of interest. In the absence of a prepayment fee, we will receive neither the anticipated revenue stream at the higher rate nor any compensation for its loss. However, depending upon the amount by which interest rates decline, the amount of the exit fees is generally not significant in relation to the potential savings borrowers may realize as a result of prepaying their loans.
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We may have a lack of control over participations.
We will consider investing in or purchasing loans jointly with other lenders and purchasers, some of whom might be affiliates of Vestin Mortgage. We will initially have, and will maintain a controlling interest as lead lender in participations with non-affiliates. Although it is not our intention to lose control, there is a risk that we will be unable to remain as the lead lender in the loans in which we participate in the future. In the event of participation with a publicly registered affiliate, the investment objectives of the participants shall be substantially identical. There shall be no duplicate fees. The compensation to the sponsors must be substantially identical, and the investment of each participant must be on substantially the same terms and conditions.
Each participant shall have a right of first refusal to buy the other's interest if the co-participant decides to sell its interest. We will not participate in joint ventures or partnerships with affiliates that are not publicly registered except as permitted by applicable NASAA Guidelines or otherwise approved by the independent members of our board of directors. If our co-participant affiliate determines to sell its interest in the loan, there is no guarantee that we will have the resources to purchase such interest and we will have no control over a sale to a third party purchaser.
Bankruptcy of a Borrower
If a borrower becomes a debtor under bankruptcy law, either voluntarily or involuntarily, an automatic stay of all proceedings against the borrower's property will be in effect. This stay will prevent us, or our related entities, from foreclosing on the property until relief from the stay can be obtained from the bankruptcy court. No guarantee can be given that the bankruptcy court will lift the stay, and significant legal fees and costs may be incurred in attempting to obtain such relief. Further, in certain bankruptcy reorganization plans, the bankruptcy court may modify the terms of the loan as part of a reorganization plan of the debtor. In the event a loan is unsecured, the Bankruptcy Court may wipe out the debt owing to us altogether.
Risk of Legal Claims
Lawsuits may damage our ability to meet our obligations to you. We are exposed to legal claims in the ordinary course of our business. Claims by borrowers in default or disappointed investors or others may require the time and attention of our management and could result in adverse judgments which would damage our financial condition and impair our ability to make principal and interest payments on the Notes.
Real Estate Investments
Unsettled market conditions may persist, which could result in significant losses on any properties we acquire, thereby adversely affect our financial condition and results of operations.
The economy remains unsettled, with growth prospects uncertain because of high unemployment and depressed conditions in several of the real estate markets where we intend to acquire properties, primarily in the Southwestern and Western parts of the United States. Should real estate markets in the areas we purchase in continue to struggle, there is a significant risk that any real estate investments we make may prove unprofitable. An economic slowdown may result in decreased demand for space in the properties we acquire, forcing us to lower rents or provide tenant improvements at our expense or provide other concessions or additional services to attract tenants in any of our properties that have excess supply. Further deterioration in the real estate market after we acquire properties may result in a decline in the market value of our properties or cause us to experience other losses related to our assets, which may adversely affect our results of operations.
Our Manager’s experience is primarily in real estate secured lending, not acquiring real estate.
Our Manager is primarily engaged in the business of making real estate secured loans. It has relatively limited experience operating a business that invests in real estate. Most of this experience relates to its management of Vestin Fund III, LLC (“Fund III”), a company which was engaged both in lending and acquiring real estate. While our Manager has gained experience in managing and repositioning properties acquired through foreclosure, its limited experience running a business that seeks to identify suitable properties for investment may result in our acquiring properties that prove to be bad investments.
Our relatively small size may result in a portfolio of investments which lacks diversification.
Because of our relatively small size compared to many of our competitors, the aggregate number of properties we are able to acquire at any given time will be limited. In addition, we may not be successful in obtaining financing to fund our acquisitions. Accordingly, our portfolio of acquired properties may lack diversification. If our portfolio is not diversified, any loss experienced on one or more properties can be expected to have a material adverse effect on our stockholders’ equity and our results of operations.
We may incur debt to acquire properties and our cash flow may not be sufficient to make required payments on any such debt or repay such debt as it matures.
We may rely on debt financing for a portion of the purchase price of properties we acquire. Depending on the level of debt that we incur, we may be required to dedicate a substantial portion of our funds from operations to servicing our debt, and our cash flow may be insufficient to meet required payments of principal and interest. If a property is mortgaged to secure payment of debt and we are unable to meet mortgage payments, the mortgagee could foreclose upon that property, appoint a receiver and receive an assignment of rents and leases or pursue other remedies. In addition, if principal payments due at maturity cannot be refinanced, extended or paid with proceeds of other capital transactions, our cash flow may not be sufficient to repay maturing debt. We do not anticipate that any debt we may incur will require significant principal payments prior to maturity. However, we may need to raise additional equity capital, obtain secured or unsecured debt financing, issue private or public debt, or sell some of our assets to either refinance or repay our debt as it matures. We cannot assure you that these sources of financing or refinancing will be available to us at reasonable terms or at all. Our inability to obtain financing or refinancing to repay our maturing debt, and our inability to refinance existing debt on reasonable terms, may require us to make higher interest and principal payments, issue additional equity securities, or sell some of our assets on disadvantageous terms, all or any of which may result in foreclosure of properties, partial or complete loss on our investment and otherwise adversely affect our financial conditions and results of operations.
We will face significant competition in our efforts to acquire properties.
Our acquisition strategy is focused on commercial real estate, and we will face significant competition from other investors, REITs, hedge funds, private equity funds and other private real estate investors with greater financial resources and access to capital than available to us. A number of funds have recently been formed for the specific purpose of investing in commercial real estate. We may not be able to compete successfully for investments with larger, better capitalized firms or with companies that have extensive contacts in the real estate industry. In addition, the number of entities and the amount of purchasers competing for suitable investments may increase, all of which could result in competition for accretive acquisition opportunities and adversely affect our acquisition plans. Significant competition for distressed properties could also have the effect of driving up the prices of such properties, thereby making it more difficult to acquire properties at a deep discount to intrinsic value.
The properties we acquire will be subject to property taxes that may increase in the future, which could adversely affect our cash flow.
The properties we acquire will be subject to property taxes that may increase as property tax rates change and as the properties are assessed or reassessed by taxing authorities. As the owner of the properties, we are ultimately responsible for payment of the taxes to the government. If property taxes increase, our tenants may be unable to make the required tax payments, ultimately requiring us to pay the taxes.
Compliance or failure to comply with laws requiring access to our properties by disabled persons could result in substantial cost.
The Americans with Disabilities Act, or ADA, and other federal, state and local laws generally require public accommodations be made accessible to disabled persons. Noncompliance could result in the imposition of fines by the government or the award of damages to private litigants. These laws may require us to modify the properties we acquire. Legislation or regulations adopted in the future may impose further burdens or restrictions on us with respect to improved access by disabled persons. We may incur unanticipated expenses that may be material to our financial condition or results of operations to comply with ADA and other laws, or in connection with lawsuits brought by private litigants.
We may face intense competition for tenants at the properties we acquire.
We may face competition from developers, owners and operators of commercial real estate who may own properties similar to ours in the same markets where we acquire properties. If our competitors offer space at rental rates below current market rates, or below the rental rates we currently charge our tenants, we may lose existing or potential tenants and we may be pressured to reduce our rental rates below those we expect to charge or to offer more substantial rent abatements, tenant improvements, early termination rights or below-market renewal options in order to retain tenants when our tenants’ leases expire. This competitive environment could have a material adverse effect on our ability to lease our properties or any newly developed or acquired property, as well as on the rents charged.
The properties we acquire may expose us to unknown liabilities, which could harm our growth and future operations.
We may acquire properties subject to liabilities and without any recourse, or with only limited recourse, against the prior owners or other third parties with respect to unknown liabilities. As a result, if a liability were asserted against us based upon ownership of those properties, we might have to pay substantial sums to settle or contest it, which could adversely affect our results of operations and cash flow. Unknown liabilities with respect to acquired properties might include liabilities for clean-up of undisclosed environmental contamination, claims by tenants, vendors or other persons against the former owners of the properties, liabilities incurred in the ordinary course of business and claims for indemnification by general partners, directors, officers and others indemnified by the former owners of the properties.
We may be required to make significant capital expenditures to improve our properties in order to retain and attract tenants, causing a decline in operating revenues and reducing cash available for debt service and distributions to stockholders.
To the extent adverse economic conditions continue in the real estate market and demand for commercial space remains low, we may be required to make rent or other concessions to tenants, accommodate requests for renovations, build-to-suit remodeling and other improvements or provide additional services to our tenants. As a result, we may have to make significant capital or other expenditures in order to retain tenants whose leases expire and to attract new tenants in sufficient numbers. Additionally, we may need to raise capital to make such expenditures. If we are unable to do so or capital is otherwise unavailable, we may be unable to make the required expenditures. This could result in non-renewals by tenants upon expiration of their leases, which would result in declines in revenues from operations and reduce cash available for debt service and distributions to stockholders.
We may face potential difficulties or delays renewing leases or re-leasing space to tenants, which could adversely affect our cash flow and revenues.
We will depend upon rents received from our tenants to generate income from our acquired properties. If a tenant experiences a downturn in its business or other types of financial distress, it may be unable to make timely rental payments. As a result, our cash flow could decrease and our ability to make distributions to our stockholders could be adversely affected.
Properties that have significant vacancies could be difficult to sell, which could diminish our return on investment.
A property may incur vacancies either by the continued default of tenants under their leases or the expiration of tenant leases. If vacancies continue for a long period of time, we may suffer reduced revenues. In addition, the resale value of the property could be diminished because the market value of a particular property may depend principally upon the value of the leases of such property.
The illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties and harm our financial condition.
Real estate investments, especially commercial properties, are relatively illiquid and may become even more illiquid during periods of economic downturn. As a result, we may not be able to sell a property or properties quickly or on favorable terms, or otherwise promptly change our portfolio, in response to changing economic, financial and investment conditions when it otherwise may be prudent to do so. This inability to respond quickly to changes in the performance of our properties and sell an unprofitable property could adversely affect our cash flows and results of operations, thereby limiting our ability to make distributions to our stockholders.
Rising energy costs may have an adverse effect on our operations and revenue.
Electricity and natural gas, the most common sources of energy used by commercial buildings, are subject to significant price volatility. In recent years, energy costs, including energy generated by natural gas and electricity, have fluctuated significantly. Some of our properties may be subject to leases that require our tenants to pay all utility costs while other leases may provide that tenants will reimburse us for utility costs in excess of a base year amount. It is possible that some or all of our tenants will not fulfill their lease obligations and reimburse us for their share of any significant energy rate increases and that we will not be able to retain or replace our tenants if energy price fluctuations continue. Also, to the extent under a lease we agree to pay for such costs, rising energy prices will have a negative effect on our results of operations, cash flows and ability to make distributions to our stockholders.
Uninsured losses or losses in excess of our insurance coverage could adversely affect our financial condition and our cash flows.
We plan to maintain comprehensive liability, fire, flood, earthquake, wind (as deemed necessary or as required by lenders), extended coverage and rental loss insurance with respect to our acquired properties. Certain types of losses, however, may be either uninsurable or not economically insurable, such as losses due to earthquakes, riots, acts of war or terrorism. Should an uninsured loss occur, we could lose both our investment in and anticipated profits and cash flows from a property. If any such loss is insured, we may be required to pay a significant deductible on any claim for recovery of the loss prior to our insurer being obligated to reimburse us for the loss, or the amount of the loss may exceed our coverage for the loss. In addition, we may determine not to insure some or all of our properties at levels considered customary in our industry and which would expose us to an increased risk of loss. As a result, our business, financial condition and results of operations, our ability to make distributions to our stockholders and the value of our common stock may be adversely affected.
Environmental liabilities are possible and can be costly.
Federal law imposes liability on a landowner for the presence of improperly disposed hazardous substances on the landowner’s property. This liability is without regard to fault for or knowledge of the presence of such substances and may be imposed jointly and severally upon all succeeding landowners from the date of the first improper disposal. The laws of the states and localities in which we may acquire properties may have similar or additional requirements. We cannot assure that hazardous substances or wastes, contaminants, pollutants or sources thereof (as defined by present or future state and federal laws and regulations) will not be discovered on properties during our ownership or after sale to a third party. If such hazardous materials are discovered on a property, we may be required to remove those substances or sources and clean up such affected property. We may incur full recourse liability for the entire cost of any such removal and cleanup. We cannot assure you that the cost of any such removal and cleanup would not exceed the value of the property or that we could recoup any such costs from any third party. We may also be liable to tenants and other users of the affected property and to owners, tenants or users of neighboring properties, and it may find it difficult or impossible to sell the affected property prior to or following any such cleanup.
We intend to rely on the knowledge of our management team in making investment decisions.
We are relying on the ability of our management, including our Manager and its management, our executive officers, and the Board. All aspects of the management of the Company are entrusted to the Manager, our executive officers, and the Board. We intend to rely on the knowledge of our management team concerning our target markets in the Southwestern and Western parts of the United States. We may determine whether or not to invest in specific properties based entirely on our executives’ knowledge of a given real estate market. In the event that we lose one or more of our executive officers or terminate the relationship with our Manager, it could have a material adverse impact on our business and our results of operations.
We may participate in joint venture investments, which have additional risk.
We may participate in joint ventures with non-affiliated persons. Our investment in joint ventures which own properties, instead of investing directly in the properties itself, may involve additional risks including, but not limited to:
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the possibility that our partner might become bankrupt;
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the possibility that our partner may at any time have economic or business interests or goals which are inconsistent or compete with the business interests or goals of the Company; or
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the possibility that our partner may be in a position to take action contrary to our instructions, requests, policies or objectives.
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Among other things, actions by such a partner might have the result of subjecting property owned by the joint venture to liabilities in excess of those contemplated by the terms of the joint venture agreement, might expose us to liabilities of the joint venture in excess of our proportionate share of such liabilities or might have other adverse consequences for the Company. There is an additional risk that joint venturers may not be able to agree on matters relating to the property they own, and that unresolved disputes may delay the joint venture’s ability to act and result in substantial costs to the joint venturers.
We may also from time to time participate jointly with investment programs or other entities sponsored by the Manager or one of its affiliates. The risks of such joint ownership may be similar to those mentioned above. However, the Company or the Manager may also experience difficulty in enforcing the Company’s rights in the joint venture due to the obligations that the Manager or our directors or officers may owe to the other partner in such a joint venture.
Increasing numbers of loan defaults may negatively impact our business.
The regions in which we intend to operate have experienced a marked increase in the number of loans that are in default or are at risk of default. If levels of defaults remain high or rise further, our business may be negatively affected in a number of ways. As a holder of loans, we may experience significant losses due to defaults by borrowers. Defaults may also make obtaining financing more difficult. This may hinder our ability to acquire properties with financing and may also make it difficult for us to resell properties we acquire. Potential buyers may be unable to obtain financing on acceptable terms, with the result that the demand for our properties may be reduced and resale prices may be depressed. Additionally, sales of properties at reduced prices will lower the value of comparable properties. As defaults rise, foreclosures may negatively impact the value of the properties in which we invest. We may lose some or all of our investment in these properties as a result.
Conflicts of Interest Risks
Our manager and its affiliates face conflicts of interest arising from fees received from our real estate assets.
Affiliated or non-affiliated mortgage brokers receive substantial fees from borrowers on real estate loans that we invest in that would otherwise increase our returns. Many of these fees are paid on an up-front basis. In some cases, the mortgage brokers or our manager may be entitled to additional fees for loan extensions or modifications and loan assumptions, reconveyances and exit fees. The mortgage brokers’ compensation is based on the volume and size of the real estate loans selected for us, regardless of their performance, which could create an incentive to make or extend riskier loans. Our interests may diverge from those of our manager, affiliated or non-affiliated mortgage brokers and Mr. Shustek when our manager decides whether we should charge the borrower higher interest rates or our manager’s affiliates should receive higher fees from borrowers and to the extent that the mortgage brokers benefit from up-front fees that are not shared with us.
Our manager and/or its affiliates may receive substantial fees from us for their services in connection with the acquisition, disposition and management of commercial real estate properties. These fees could influence our manager and the recommendations that it makes in investing in a particular property or may result in paying a higher purchase price for the property than it would otherwise recommend if it did not receive fees. The fees may also influence our manager to recommend transactions with respect to the sale of a property or properties that may not be in our best interest at the time. These fees are payable regardless as to the quality of the underlying real estate or property management services and our manager has considerable discretion with respect to the acquisition, disposition and leasing of our real estate properties.
We rely on our manager to manage our day-to-day operations and select our real estate assets for investment.
Our ability to achieve our investment objectives and to pay dividends to our shareholders depends upon our manager’s and its affiliate’s performance in obtaining, processing, making and brokering loans and the selection of commercial real estate properties for us to invest in and determining the financing arrangements for borrowers and the acquisition of commercial properties. Stockholders have no opportunity to evaluate information on properties that we acquire or the financial status and creditworthiness of borrowers, the terms of mortgages, the real property that is our collateral or other economic or financial data concerning our loans and commercial properties. We pay our manager an annual management fee of up to 0.25% of our aggregate capital received by us from the sale of shares or membership units. This fee is payable regardless of the performance of our loan portfolio or commercial properties. Our manager’s duties to our stockholders are generally governed by the terms of the Management Agreement, rather than by common law principles of fiduciary duty. Moreover, our manager is not required to devote its employees’ full time to our business and may devote time to business interests competitive to our business.
Our success depends on certain key personnel, the loss of whom could adversely affect our operating results, and on our manager’s ability to attract and retain qualified personnel.
Our success depends in part upon the continued contributions of Michael V. Shustek (Chief Executive Officer and President). Mr. Shustek has extensive experience in our line of business, extensive market contacts and familiarity with our company. If Mr. Shustek were to cease his employment with our manager, he might be difficult to replace and our operating results could suffer. None of the key personnel of our manager is subject to an employment, non-competition or confidentiality agreement with our manager, or us and we do not maintain “key man” life insurance policies on any of them. Our future success also depends upon our manager’s ability to hire and retain additional highly skilled managerial, operational and marketing personnel. Our manager may require additional operations and marketing people who are experienced in obtaining, processing, making and brokering loans and in the acquisition, disposition and management of real properties, the selection of tenants for our real properties and the determination of any financing arrangements and who also have contacts in the relevant markets. Competition for personnel is intense, and we cannot be assured that we will be successful in attracting and retaining skilled personnel. If our manager were unable to attract and retain key personnel, the ability of our manager to make prudent investment decisions on our behalf may be impaired.
Vestin Mortgage serves as our manager pursuant to a long-term Management Agreement that may be difficult to terminate and does not reflect arm’s length negotiations.
We have entered into a long-term Management Agreement with Vestin Mortgage to act as our manager. The term of the Management Agreement is for the duration of our existence. The Management Agreement may only be terminated upon the affirmative vote of a majority in interest of stockholders entitled to vote on the matter or by our board of directors for cause upon 90 days’ written notice of termination. Consequently, it may be difficult to terminate our Management Agreement and replace our manager in the event that our performance does not meet expectations or for other reasons unless the conditions for termination of the Management Agreement are satisfied. The Management Agreement was negotiated by related parties and may not reflect terms as favorable as those subject to arm’s length bargaining.
Our manager faces conflicts of interest concerning the allocation of its personnel’s time.
Our manager is also the manager of VRM I and Fund III. VRM I is a company with investment objectives similar to ours and Fund III has commenced an orderly liquidation of its assets. Our manager and Mr. Shustek, who indirectly owns a majority of our manager, anticipate that they may also sponsor other real estate programs having investment objectives similar to ours. As a result, our manager and Mr. Shustek may have conflicts of interest in allocating their time and resources between our business and other activities. During times of intense activity in other programs and ventures, our manager and its key people will likely devote less time and resources to our business than they ordinarily would. Our Management Agreement with our manager does not specify a minimum amount of time and attention that our manager and its key people are required to devote to our company. Thus, our manager may not spend sufficient time managing our operations, which could result in our not meeting our investment objectives.
Our manager faces conflicts of interest relating to other investments in real estate loans.
We expect to invest in real estate assets consisting of loans and, commercial properties when one or more other companies managed by our manager are also investing in real estate loans and commercial properties. There is a risk that our manager may select for us a real estate asset investment that provides lower returns than an investment purchased by another program or entity managed by our manager. Our manager is also the manager of VRM I and Fund III. VRM I is a company with investment objectives similar to ours and Fund III is in the process of an orderly liquidation of its assets. There are no restrictions or guidelines on how our manager will determine which real estate assets are appropriate for us and which are appropriate for VRM I or another company that our manager manages. Moreover, our manager has no obligation to provide us with any particular opportunities or even a pro rata share of opportunities afforded to other companies it manages.
Our manager may face conflicts of interest in considering a possible combination of the Company with VRM I.
VRM I is a company that engages in making mortgage loans similar to the loans that we make and is managed by our manager. There may be cost savings and operating synergies that could be achieved by our combination with VRM I. Our management has evaluated issues relevant to a proposed combination; however at this time, no decision has been made with respect to whether the proposed combination will take place. Since our manager owes a duty to the investors in each of these entities, it could face a conflict of interest in considering such a combination. Any decision with respect to the proposed combination with VRM I will be subject to the approval of the independent directors and stockholders of VRM I as well as the approval of our Board of Directors and stockholders.
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ITEM 2.
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PROPERTIES
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Our manager shares office facilities through a sublease, in Las Vegas, Nevada, with its parent corporation, Vestin Group. In March 2010, Vestin Group entered into a ten–year lease agreement for office facilities in Las Vegas, Nevada.
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ITEM 3.
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LEGAL PROCEEDINGS
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Please refer to Note N - Legal Matters Involving The Manager and Note O - Legal Matters Involving The Company in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K for information regarding legal proceedings, which discussion is incorporated herein by reference.
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ITEM 4.
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MINE SAFETY DISCLOSURES
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None.
PART II
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ITEM 5.
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MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
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Market Information
Our common stock is traded on the Nasdaq Global Select Market under the symbol VRTB and began trading on May 1, 2006. The price per share of common stock presented below represents the highest and lowest sales price for our common stock on the Nasdaq Global Select Market.
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2011
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High
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Low
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First Quarter
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$ | 1.64 | $ | 1.01 | ||||
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Second Quarter
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$ | 1.52 | $ | 1.02 | ||||
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Third Quarter
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$ | 1.65 | $ | 1.10 | ||||
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Fourth Quarter
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$ | 1.40 | $ | 1.08 | ||||
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2010
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High
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Low
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First Quarter
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$ | 2.55 | $ | 1.64 | ||||
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Second Quarter
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$ | 1.99 | $ | 1.35 | ||||
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Third Quarter
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$ | 1.89 | $ | 1.21 | ||||
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Fourth Quarter
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$ | 1.72 | $ | 1.36 | ||||
Holders
As of March 16, 2012, there were approximately 2,610 holders of record of 12,720,783 shares of our common stock.
Dividend Policy
In order to maintain its qualification as a REIT under the Code, we are required to distribute (within a certain period after the end of each year) at least 90% of our REIT taxable income for such year (determined without regard to the dividends made deduction and by excluding net capital gain). In August 2006, our board of directors voted to authorize a Dividend Declaration Policy that allows, at the Company’s discretion, for dividends to be declared monthly instead of quarterly. During June 2008, our Board of Directors decided to suspend the payment of dividends. No dividends were declared during the years ended December 31, 2010and December 31, 2011. In light of our accumulated loss, we do not expect to pay dividends in the foreseeable future.
Recent Sales of Unregistered Securities
None
Equity Compensation Plan Information
None
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
On March 21, 2007, our board of directors authorized the repurchase of up to $10 million worth of our common stock. Depending upon market conditions, shares may be repurchased from time to time at prevailing market prices through open market or privately negotiated transactions. We are not obligated to purchase any shares. Subject to applicable securities laws, repurchases may be made at such times and in such amounts, as our manager deems appropriate. As of December 31, 2011 we had a total of 2,276,580 shares of treasury stock of which 189,378 were received as a part of a settlement in the amount of approximately $0.2 million. On this date we retired 2,087,202 shares leaving a balance of 189,378 at a cost of approximately $0.2 million. As of December 31, 2010 we had a total of 1,857,850 shares of treasury stock carried on our books at cost totaling approximately $6.9 million.
The following is a summary of our stock acquisitions during the three months ended December 31, 2011, as required by Regulation S-K, Item 703.
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Period
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(a) Total Number of Shares Purchased
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(b) Average Price Paid per Share
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(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
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(d) Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs
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October 1 – October 31, 2011
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-- | $ | -- | -- | $ | 2,685,269 | ||||||||||
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November 1 – November 30, 2011
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-- | -- | -- | 2,685,269 | ||||||||||||
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December 1 – December 31, 2011
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189,378 | 1.18 | -- | 2,461,802 | ||||||||||||
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Total
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189,378 | $ | 1.18 | -- | $ | 2,461,802 | ||||||||||
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ITEM 7.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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The following is a financial review and analysis of our financial condition and results of operations for the years ended December 31, 2011 and 2010. This discussion should be read in conjunction with our financial statements and accompanying notes and other detailed information regarding us appearing elsewhere in this report on Form 10-K and our reports on Form 10-Q, Part I, Item 2 Management’s Discussion and Analysis of Financial Conditions and Results of Operations for the quarters ended March 31, 2011, June 30, 2011 and September 30, 2011.
FORWARD-LOOKING STATEMENTS
Certain statements in this report, including, without limitation, matters discussed under this Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations, should be read in conjunction with the consolidated financial statements, related notes, and other detailed information included elsewhere in this report on Form 10-K. We are including this cautionary statement to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Statements that are not historical fact are forward-looking statements. Certain of these forward-looking statements can be identified by the use of words such as “believes,” “anticipates,” “expects,” “intends,” “plans,” “projects,” “estimates,” “assumes,”“may,” “should,” “will,” or other similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors, which could cause actual results, performance or achievements to differ materially from future results, performance or achievements. These forward-looking statements are based on our current beliefs, intentions and expectations. These statements are not guarantees or indicative of future performance. Important assumptions and other important factors that could cause actual results to differ materially from those forward-looking statements include, but are not limited to, those factors, risks and uncertainties of this Annual Report on Form 10-K and in our other securities filings with the Securities and Exchange Commission (“SEC”). Our future financial condition and results of operations, as well as any forward-looking statements, are subject to change and involve inherent risks and uncertainties. Our estimates of the value of collateral securing our loans may change, or the value of the underlying property could decline subsequent to the date of our evaluation. As a result, such estimates are not guarantees of the future value of the collateral. The forward-looking statements contained in this report are made only as of the date hereof. We undertake no obligation to update or revise information contained herein to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
RESULTS OF OPERATIONS
OVERVIEW
Our primary business objective is to generate income while preserving principal by investing in real estate loans. We believe there is a significant market opportunity to make real estate loans to owners and developers of real property whose financing needs are not met by other real estate lenders. The loan underwriting standards utilized by our manager and the mortgage brokers we utilize are less strict than those used by many institutional real estate lenders. In addition, one of our competitive advantages is our ability to approve loan applications more quickly than many institutional lenders. As a result, in certain cases, we may make real estate loans that are riskier than real estate loans made by many institutional lenders such as commercial banks. However, in return, we seek a higher interest rate and our manager takes steps to mitigate the lending risks such as imposing a lower loan-to-value ratio. While we may assume more risk than many institutional real estate lenders, in return, we seek to generate higher yields from our real estate loans.
Our operating results are affected primarily by: (i) the amount of capital we have to invest in real estate loans, (ii) the level of real estate lending activity in the markets we service, (iii) our ability to identify and work with suitable borrowers, (iv) the interest rates we are able to charge on our loans and (v) the level of non-performing assets, foreclosures and related loan losses which we may experience.
Our recent operating results have been adversely affected by increases in allowances for loan losses and increases in non-performing assets. This negative trend accelerated sharply during the year ended December 31, 2008 and continues to affect our operations. As of December 31, 2011, we had five loans considered non-performing (i.e., based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due). These loans are currently carried on our books at a value of approximately $10.0 million, net of allowance for loan losses of approximately $19.6 million. These loans have been placed on non-accrual of interest status and may be the subject of pending foreclosure proceedings.
Non-performing assets, net of allowance for loan losses, totaled approximately $20.3 million or 39% of our total assets as of December 31, 2011, as compared to approximately $73.9 million or 66% of our total assets as of December 31, 2010. See Note F – Real Estate Held for Sale and Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.
We believe that the significant level of our non-performing assets is a direct result of the deterioration of the economy and credit markets during the past several years. As the economy weakened and credit became more difficult to obtain, many of our borrowers who develop and sell commercial real estate projects were unable to complete their projects, obtain takeout financing or were otherwise adversely impacted. While the general economy has improved, the commercial real estate markets in many of the areas where we make loans continue to suffer from depressed conditions. Our exposure to the negative developments in the credit markets and general economy has likely been increased by our business strategy, which entails more lenient underwriting standards and expedited loan approval procedures. Moreover, declining real estate values in the principal markets in which we operate has in many cases eroded the current value of the security underlying our loans.
Continued weakness in the commercial real estate markets and the weakness in lending may continue to have an adverse impact upon our markets. This may result in further defaults on our loans, and we might be required to record additional reserves based on decreases in market values, or we may be required to restructure additional loans. This increase in loan defaults has materially affected our operating results and led to the suspension of dividends to our stockholders. For additional information regarding our non-performing loans see “Non-Performing Loans” in Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.
As of December 31, 2011, our loan-to-value ratio was 68%, net of allowances for loan losses, on a weighted average basis generally using updated appraisals. Additional increases in loan defaults accompanied by additional declines in real estate values, as evidenced by updated appraisals generally prepared on an “as-is-basis,” will have a material adverse effect on our financial condition and operating results. The current loan-to-value ratio is primarily a result of declining real estate values, which have eroded the market value of our collateral.
As of December 31, 2011, we have provided a specific reserve allowance for five non-performing loans and five performing loans based on updated appraisals of the underlying collateral and our evaluation of the borrower for these loans, obtained by our manager. For further information regarding allowance for loan losses, refer to Note D – Investments in Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Our capital, subject to a 3% reserve, will constitute the bulk of the funds we have available for investment in real estate loans.
As of December 31, 2011, our loans were in the following states: Arizona, California, Colorado, Nevada, Ohio, Oregon and Texas.
At our annual meeting held on December 15, 2011, a majority of the shareholders voted to amend our Bylaws to expand our investment policy to include investments in and acquisition, management and sale of real property or the acquisition of entities involved in the ownership or management of real property. A majority of the shareholders also voted to amend our charter to change the terms of our existence from its expiration date of December 31, 2020 to perpetual existence. As a result, we will begin to acquire, manage, renovate, reposition, sell or otherwise invest in real property or acquire entities involved in the ownership or management of real property.
We are currently exploring the possibility of a stock for stock merger with VRM I. A special committee of our board of directors, consisting solely of independent directors, has been appointed to evaluate and negotiate the potential merger. The special committee has engaged independent financial and legal advisors to assist in this process. Any such proposed merger would be subject to the approval of our shareholders as well as the shareholders of VRM I.
SUMMARY OF FINANCIAL RESULTS
The Year Ended December 31, 2011
|
Total Revenue:
|
2011
|
2010
|
$ Change
|
% Change
|
||||||||||||
|
Interest income from investment in real estate loans
|
$ | 1,244,000 | $ | 1,829,000 | $ | (585,000 | ) | (32 | %) | |||||||
|
Gain related to pay off of real estate loan, including recovery of allowance for loan loss
|
249,000 | 124,000 | 125,000 | 101 | % | |||||||||||
|
Gain related to pay off of notes receivable, including recovery of allowance for notes receivable
|
505,000 | 142,000 | 363,000 | 256 | % | |||||||||||
|
Other Income
|
89,000 | -- | 89,000 | 100 | % | |||||||||||
|
Total
|
$ | 2,087,000 | $ | 2,095,000 | $ | (8,000 | ) | (0.3 | %) | |||||||
Our revenue from interest income is dependent upon the balance of our investment in real estate loans and the interest earned on these loans. Interest income has been adversely affected by the level of modified loans and the reduction in new lending activity during the first three quarters of 2011. We experienced an increase in new lending activity in the second half of 2011. We anticipate that the activity in our loan portfolio will produce an increase in interest income for 2012. It is premature at this time to predict whether or not the increase in lending activity in the second half of 2011 will be sustained in the future. Scheduled payments on fully allowed for notes receivable and loans resulted in an increase in gain related to payoff of real estate loan and other income.
For additional information see Note D – Investments in Real Estate Loans and Note I - Notes Receivable of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.
|
Total Operating Expenses:
|
2011
|
2010
|
$ Change
|
% Change
|
||||||||||||
|
Management fees – related party
|
$ | 1,098,000 | $ | 1,098,000 | $ | -- | -- | |||||||||
|
Provision for loan loss
|
1,028,000 | 8,300,000 | (7,272,000 | ) | (88 | %) | ||||||||||
|
Interest expense
|
206,000 | 965,000 | (759,000 | ) | (79 | %) | ||||||||||
|
Professional fees
|
1,419,000 | 4,750,000 | (3,331,000 | ) | (70 | %) | ||||||||||
|
Provision for doubtful accounts related to receivable
|
-- | 133,000 | (133,000 | ) | (100 | %) | ||||||||||
|
Loan fees
|
-- | 3,000 | (3,000 | ) | (100 | %) | ||||||||||
|
Consulting fees
|
217,000 | 105,000 | 112,000 | 107 | % | |||||||||||
|
Insurance
|
304,000 | 316,000 | (12,000 | ) | (4 | %) | ||||||||||
|
Other
|
310,000 | 687,000 | (377,000 | ) | (55 | %) | ||||||||||
|
Total
|
$ | 4,571,000 | $ | 16,357,000 | $ | (11,786,000 | ) | (70 | %) | |||||||
Operating expenses were 70% lower in 2011 largely as a result of a significant decrease in the provision for loan losses in 2011 compared to 2010. The decrease in provision for loan losses follows intensive efforts of the past several years to resolve the troubled loans which accumulated in the wake of the recession and real estate crash. Interest expense decreased in 2011 due to the decreased balance of secured borrowings compared to 2010. Professional fees have decreased due to a significant decrease in pending litigation.
See “Specific Loan Allowance” in Note D – Investments in Real Estate Loans, Note J – Secured Borrowings and Note O – Legal Matters Involving The Company of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.
|
Non-operating income (loss):
|
2011
|
2010
|
$ Change
|
% Change
|
||||||||||||
|
Interest income from banking institutions
|
$ | 7,000 | $ | 1,000 | $ | 6,000 | 600 | % | ||||||||
|
Discounted professional fees
|
1,580,000 | -- | 1,580,000 | 100 | % | |||||||||||
|
Impairment of marketable securities – related party
|
-- | (628,000 | ) | 628,000 | (100 | %) | ||||||||||
|
Settlement expense
|
-- | (2,239,000 | ) | 2,239,000 | (100 | %) | ||||||||||
|
Total
|
$ | 1,587,000 | $ | (2,866,000 | ) | $ | 4,453,000 | (155 | %) | |||||||
During 2011 we recorded discounts received related to past legal bills of approximately $1.6 million. There was no comparable discount during 2010. During 2010 we recognized an impairment of our marketable securities – related party of approximately $0.6 million and a settlement expense of approximately $2.2 million related to the Nevada Lawsuit. There were no such comparable expenses in 2011.
See Note E — Investment In Marketable Securities – Related Party and Note O – Legal Matters Involving The Company of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.
|
Discontinued operations, net of income taxes:
|
2011
|
2010
|
$ Change
|
% Change
|
||||||||||||
|
Net gain on sale of real estate held for sale
|
$ | 1,258,000 | $ | 285,000 | $ | 973,000 | 341 | % | ||||||||
|
Income from guarantors related to real estate held for sale
|
-- | 2,000 | (2,000 | ) | (100 | %) | ||||||||||
|
Expenses related to real estate held for sale
|
(867,000 | ) | (1,138,000 | ) | 271,000 | (24 | %) | |||||||||
|
Gain related to HFS settlement
|
430,000 | -- | 430,000 | 100 | % | |||||||||||
|
Income from Hawaiian cemeteries and mortuaries, net of income taxes
|
1,889,000 | 159,000 | 1,730,000 | 1088 | % | |||||||||||
|
Write-downs on real estate held for sale
|
(1,951,000 | ) | (3,686,000 | ) | 1,735,000 | (47 | %) | |||||||||
|
Total
|
$ | 759,000 | $ | (4,378,000 | ) | $ | 5,137,000 | (117 | %) | |||||||
During 2011 we recorded net gains on sale of real estate held for sale for properties sold in prior periods due to payments on settlement agreements. In addition, decreased expenses and write-downs on real estate held for sale, along with income received from Hawaiian cemeteries and mortuaries acquired, resulted in revenue generated from our discontinued operations. The decrease in write-downs on real estate held for sale is due to current appraisals reflecting a current value closer to the recorded value of asset.
See Note F — Real Estate Held For Sale and Note G – Asset Held For Sale and Discontinued Operations of the Notes to the Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.
CAPITAL AND LIQUIDITY
Liquidity is a measure of a company’s ability to meet potential cash requirements, including ongoing commitments to fund lending activities and general operating purposes. Subject to a 3% reserve, we generally seek to use all of our available funds to invest in real estate assets. Distributable cash flow generated from such loans is paid out to our stockholders, in the form of a dividend. We do not anticipate the need for hiring any employees, acquiring fixed assets such as office equipment or furniture, or incurring material office expenses during the next twelve months. We may pay our manager an annual management fee of up to 0.25% of the aggregate capital received by Fund II and us from the sale of shares or membership units.
During the year ended December 31, 2011, net cash flows used in operating activities were approximately $0.7 million. Operating cash flows were adversely impacted by the payment of prior accounts payable and accrued liabilities balances of approximately $2.1 million which mainly consisted of payment of legal bills and reversal of prior accrued liabilities. This increase in cash flow was offset by an overall decrease in our operating expenses, during the year ended December 31, 2011, as compared to 2010. Cash flows related to investing activities consisted of cash used by loan investments in new real estate loans of approximately $14.3 million, cash provided by loan payoffs and sale of investments in real estate loans to related and third parties of approximately $9.7 million, the sale of real estate and assets held for sale of approximately $9.4 million and proceeds from notes receivable of approximately $0.5 million. Cash flows from financing activities consisted of cash used for payments on notes payable of approximately $1.5 million, repurchase on secured borrowings of approximately $1.1 million, purchase of treasury stock of approximately $0.8 million and distributions to non-controlling interest related to the assets held for sale of approximately $0.4 million.
At December 31, 2011, we had approximately $9.2 million in cash, $0.6 million in marketable securities – related party and approximately $52.6 million in total assets. We intend to meet short-term working capital needs through a combination of proceeds from loan payoffs, loan sales, sales of real estate held for sale and/or borrowings. We believe we have sufficient working capital to meet our operating needs during the next 12 months.
We have no current plans to sell any new shares. Although a small percentage of our shareholders have elected to reinvest their dividends, we suspended payment of dividends in June 2008 and at this time are not able to predict when dividend payments will resume. Accordingly, we do not expect to issue any new shares through our dividend reinvestment program in the foreseeable future.
When economic conditions permit, we may seek to expand our capital resources through borrowings from institutional lenders or through securitization of our loan portfolio or similar arrangements. No assurance can be given that, if we should seek to borrow additional funds or to securitize our assets, we would be able to do so on commercially attractive terms. Our ability to expand our capital resources in this manner is subject to many factors, some of which are beyond our control, including the state of the economy, the state of the capital markets and the perceived quality of our loan portfolio.
We are considering various other options to enhance the Company’s capital resources. We are seeking to raise funds through the private placement of various classes of promissory notes, some of which would be secured by certain of our real estate owned properties. Our ability to raise any significant funds through such private placements in unknown.
On March 21, 2007, our Board of Directors authorized the repurchase of up to $10 million worth of our common stock. Depending upon market conditions, shares may be repurchased from time to time at prevailing market prices through open market or privately negotiated transactions. We are not obligated to purchase any shares. Subject to applicable securities laws, repurchases may be made at such times and in such amounts, as our manager deems appropriate. As of December 31, 2011 we had a total of 2,276,580 shares of treasury stock. On this date we retired 2,087,202 shares leaving a balance of 189,378 at a cost of approximately $0.2 million. As of December 31, 2010 we had a total of 1,857,850 shares of treasury stock carried on our books at cost totaling approximately $6.9 million.
We maintain working capital reserves of approximately 3% in cash and cash equivalents, certificates of deposits and short-term investments or liquid marketable securities. This reserve is available to pay expenses in excess of revenues, satisfy obligations of underlying properties, expend money to satisfy our unforeseen obligations and for other permitted uses of working capital. As of March 16, 2012, we have met our 3% reserve requirement.
Investments in Real Estate Loans Secured by Real Estate Portfolio
We offer five real estate loan products consisting of commercial property, construction, acquisition and development, land, and residential loans. The effective interest rates on all product categories range from 0% to 15%. Revenue by product will fluctuate based upon relative balances during the period. We had investments in 24 real estate loans, as of December 31, 2011, with a balance of approximately $58.0 million as compared to investments in 18 real estate loans as of December 31, 2010, with a balance of approximately $60.2 million.
For additional information on our investments in real estate loans, refer to Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.
Asset Quality and Loan Reserves
As a commercial real estate lender willing to invest in riskier loans, rates of delinquencies, foreclosures or losses on our loans could be higher than those generally experienced in the commercial mortgage lending industry during this period of economic slowdown and recession. Problems in the sub-prime residential mortgage market have adversely affected the general economy and the availability of funds for commercial real estate developers. We believe this lack of available funds has led to an increase in defaults on our loans. Furthermore, problems experienced in U.S. credit markets from 2007 through 2009 reduced the availability of credit for many prospective borrowers. While credit markets have generally improved, the commercial real estate markets in our principal areas of operation have not recovered, thereby resulting in continuing constraints on the availability of credit in these markets. These problems have made it more difficult for our borrowers to obtain the anticipated re-financing necessary in many cases to pay back our loans. Thus, we have had to work with some of our borrowers to either modify, restructure and/or extend their loans in order to keep or restore the loans to performing status. Our manager will continue to evaluate our loan portfolio in order to minimize risk associated with current market conditions.
OFF-BALANCE SHEET ARRANGEMENTS
As of December 31, 2011 and 2010, we do not have any interests in off-balance sheet special purpose entities nor do we have any interests in non-exchange traded commodity contracts.
RELATED PARTY TRANSACTIONS
From time to time, we may acquire or sell investments in real estate loans from/to our manager or other related parties pursuant to the terms of our Management Agreement without a premium. No gain or loss is recorded on these transactions, as it is not our intent to make a profit on the purchase or sale of such investments. The purpose is generally to diversify our portfolio by syndicating loans, thereby providing us with additional capital to make additional loans. For further information regarding related party transactions, refer to Note H – Related Party Transactions in the Notes to our Consolidated Financial Statements in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.
CRITICAL ACCOUNTING ESTIMATES
Revenue Recognition
Interest income on loans is accrued by the effective interest method. We do not accrue interest income from loans once they are determined to be non-performing. A loan is considered non-performing when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due.
The following table presents a sensitivity analysis, averaging the balance of our loan portfolio at the end of the last six quarters, to show the impact on our financial condition at December 31, 2011, from fluctuations in weighted average interest rate charged on loans as a percentage of the loan portfolio:
|
Changed Assumption
|
Increase (Decrease) in Interest Income
|
|||
|
Weighted average interest rate assumption increased by 1.0% or 100 basis points
|
$ | 572,000 | ||
|
Weighted average interest rate assumption increased by 5.0% or 500 basis points
|
$ | 2,858,000 | ||
|
Weighted average interest rate assumption increased by 10.0% or 1,000 basis points
|
$ | 5,715,000 | ||
|
Weighted average interest rate assumption decreased by 1.0% or 100 basis points
|
$ | (572,000 | ) | |
|
Weighted average interest rate assumption decreased by 5.0% or 500 basis points
|
$ | (2,858,000 | ) | |
|
Weighted average interest rate assumption decreased by 10.0% or 1,000 basis points
|
$ | (5,715,000 | ) | |
The purpose of this analysis is to provide an indication of the impact that the weighted average interest rate fluctuations would have on our financial results. It is not intended to imply our expectation of future revenues or to estimate earnings. We believe that the assumptions used above are appropriate to illustrate the possible material impact on the consolidated financial statements.
Allowance for Loan Losses
We maintain an allowance for loan losses on our investments in real estate loans for estimated credit impairment in our investment in real estate loans portfolio. Our manager’s estimate of losses is based on a number of factors including the types and dollar amounts of loans in the portfolio, adverse situations that may affect the borrower’s ability to repay, prevailing economic conditions and the underlying collateral securing the loan. Additions to the allowance are provided through a charge to earnings and are based on an assessment of certain factors, which may indicate estimated losses on the loans. Actual losses on loans are recorded as a charge-off or a reduction to the allowance for loan losses. Subsequent recoveries of amounts previously charged off are added back to the allowance or included as income.
The following table presents a sensitivity analysis to show the impact on our financial condition at December 31, 2011, from increases and decreases to our allowance for loan losses as a percentage of the loan portfolio:
|
Changed Assumption
|
Increase (Decrease) in Allowance for Loan Losses
|
|||
|
Allowance for loan losses assumption increased by 1.0% of loan portfolio
|
$ | 580,000 | ||
|
Allowance for loan losses assumption increased by 5.0% of loan portfolio
|
$ | 2,901,000 | ||
|
Allowance for loan losses assumption increased by 10.0% of loan portfolio
|
$ | 5,802,000 | ||
|
Allowance for loan losses assumption decreased by 1.0% of loan portfolio
|
$ | (580,000 | ) | |
|
Allowance for loan losses assumption decreased by 5.0% of loan portfolio
|
$ | (2,901,000 | ) | |
|
Allowance for loan losses assumption decreased by 10.0% of loan portfolio
|
$ | (5,802,000 | ) | |
Estimating allowances for loan losses requires significant judgment about the underlying collateral, including liquidation value, condition of the collateral, competency and cooperation of the related borrower and specific legal issues that affect loan collections or taking possession of the property. As a commercial real estate lender willing to invest in loans to borrowers who may not meet the credit standards of other financial institutional lenders, the default rate on our loans could be higher than those generally experienced in the mortgage lending industry. We and our manager generally approve loans more quickly than other real estate lenders and, due to our expedited underwriting process, there is a risk that the credit inquiry we perform will not reveal all material facts pertaining to a borrower and the security.
We may discover additional facts and circumstances as we continue our efforts in the collection and foreclosure processes. This additional information often causes management to reassess its estimates. In recent years, we have revised estimates of our allowance for loan losses. Circumstances that may cause significant changes in our estimated allowance include, but are not limited to:
|
|
·
|
Declines in real estate market conditions that can cause a decrease in expected market value;
|
|
|
·
|
Discovery of undisclosed liens for community improvement bonds, easements and delinquent property taxes;
|
|
|
·
|
Lack of progress on real estate developments after we advance funds. We customarily utilize disbursement agents to monitor the progress of real estate developments and approve loan advances. After further inspection of the related property, progress on construction occasionally does not substantiate an increase in value to support the related loan advances;
|
|
|
·
|
Unanticipated legal or business issues that may arise subsequent to loan origination or upon the sale of foreclosed upon property; and
|
|
|
·
|
Appraisals, which are only opinions of value at the time of the appraisal, may not accurately reflect the value of the property.
|
Real Estate Held for Sale
Real estate held for sale includes real estate acquired through foreclosure and will be carried at the lower of the recorded amount, inclusive of any senior indebtedness, or the property's estimated fair value, less estimated costs to sell, with fair value based on appraisals and knowledge of local market conditions. The carrying values of real estate held for sale are assessed on a regular basis from updated appraisals, comparable sales values or purchase offers.
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2011, FASB issued ASU 2011-04 “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” The amendments in this update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the Board does not intend for the amendments in this update to result in a change in the application of the requirements in Topic 820. Some of the amendments clarify the Board’s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. For public entities, the new guideline is effective for interim and annual periods beginning after December 15, 2011 and should be applied prospectively. The Company does not expect that the guidance effective in future periods will have a material impact on its consolidated financial statements.
In May 2011, the FASB issued ASC Update No. 2011-05, Comprehensive Income (Topic 820): Presentation of Comprehensive Income. Update No. 2011-05 requires that net income, items of other comprehensive income and total comprehensive income be presented in one continuous statement or two separate consecutive statements. The amendments in this Update also require that reclassifications from other comprehensive income to net income be presented on the face of the financial statements. We are required to adopt Update No. 2011-05 for our first quarter ending March 31, 2012, with the exception of the presentation of reclassifications on the face of the financial statements, which has been deferred by the FASB under ASC Update No. 2011-12, Comprehensive Income (Topic 820): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income. Our adoption of Update No. 2011-05 will not impact our future results of operations or financial position.
In December 2011, the Financial Accounting Standards Board (“FASB”) released Accounting Standards Update No. 2011-10 (“ASU 2011-10”), Property, Plant and Equipment (Topic 360): Derecognition of in Substance Real Estate—a Scope Clarification (a consensus of the FASB Emerging Issues Task Force). ASU 2011-10 clarifies when a parent (reporting entity) ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt, the reporting entity should apply the guidance for Real Estate Sale (Subtopic 360-20). The provisions of ASU 2011-10 are effective for public companies for fiscal years and interim periods within those years, beginning on or after June 15, 2012. When adopted, ASU 2011-10 is not expected to materially impact our consolidated financial statements.
|
ITEM 8.
|
FINANCIAL STATEMENTS
|
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
|
Page
|
|
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Vestin Realty Mortgage II, Inc.
We have audited the accompanying consolidated balance sheets of Vestin Realty Mortgage II, Inc. (the “Company”) as of December 31, 2011 and 2010 and the related consolidated statements of operations, equity and other comprehensive loss, and cash flows for each of the two years in the period ended December 31, 2011. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vestin Realty Mortgage II, Inc. as of December 31, 2011 and 2010, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America.
/s/ JLK Partners, LLP
Irvine, California
March 16, 2012
FINANCIAL STATEMENTS
|
VESTIN REALTY MORTGAGE II, INC.
|
||||||||
|
CONSOLIDATED BALANCE SHEETS
|
||||||||
|
ASSETS
|
||||||||
|
December 31, 2011
|
December 31, 2010
|
|||||||
|
Assets
|
||||||||
|
Cash
|
$ | 9,226,000 | $ | 7,884,000 | ||||
|
Investment in marketable securities - related party
|
592,000 | 539,000 | ||||||
|
Interest and other receivables, net of allowance of $5,468,000 at December 31, 2011 and $3,952,000 at December 31, 2010
|
14,000 | 2,119,000 | ||||||
|
Notes receivable, net of allowance of $17,250,000 at December 31, 2011 and $14,131,000 at December 31, 2010
|
-- | -- | ||||||
|
Real estate held for sale
|
10,767,000 | 12,808,000 | ||||||
|
Investment in real estate loans, net of allowance for loan losses of $26,247,000 at December 31, 2011 and $33,557,000 at December 31, 2010
|
31,777,000 | 26,719,000 | ||||||
|
Due from related parties
|
110,000 | 712,000 | ||||||
|
Assets under secured borrowings
|
-- | 1,320,000 | ||||||
|
Other assets
|
149,000 | 150,000 | ||||||
|
Assets held for sale
|
-- | 59,416,000 | ||||||
|
Total assets
|
$ | 52,635,000 | $ | 111,667,000 | ||||
|
LIABILITIES AND EQUITY
|
||||||||
|
Liabilities
|
||||||||
|
Accounts payable and accrued liabilities
|
$ | 753,000 | $ | 5,325,000 | ||||
|
Secured borrowings
|
-- | 1,088,000 | ||||||
|
Notes payable
|
25,000 | 1,324,000 | ||||||
|
Unearned revenue
|
-- | 26,000 | ||||||
|
Deferred gain on sale of HFS
|
102,000 | -- | ||||||
|
Liabilities related to assets held for sale
|
-- | 45,769,000 | ||||||
|
Total liabilities
|
880,000 | 53,532,000 | ||||||
|
Commitments and contingencies
|
||||||||
|
Equity
|
||||||||
| Stockholders' equity | ||||||||
|
Preferred stock, $0.0001 par value; 1,000,000 shares authorized; none issued
|
-- | -- | ||||||
|
Treasury stock, at cost, 189,378 shares at December 31, 2011 and 1,857,850 at December 31, 2010
|
(190,000 | ) | (6,907,000 | ) | ||||
|
Common stock, $0.0001 par value; 100,000,000 shares authorized; 12,720,783 shares issued and 12,531,405 outstanding at December 31, 2011, and 14,997,363 shares issued and 13,139,513 outstanding at December 31, 2010
|
1,000 | 1,000 | ||||||
|
Additional paid-in capital
|
271,005,000 | 278,550,000 | ||||||
|
Accumulated deficit
|
(219,070,000 | ) | (218,203,000 | ) | ||||
|
Common shares held by trusts related to assets held for sale
|
-- | (648,000 | ) | |||||
|
Accumulated other comprehensive income (loss)
|
9,000 | (37,000 | ) | |||||
|
Total stockholders’ equity before non-controlling interest – related party
|
51,755,000 | 52,756,000 | ||||||
|
Noncontrolling interest – related party
|
-- | 5,379,000 | ||||||
|
Total equity
|
51,755,000 | 58,135,000 | ||||||
|
Total liabilities and equity
|
$ | 52,635,000 | $ | 111,667,000 | ||||
The accompanying notes are an integral part of these consolidated statements.
-36-
|
VESTIN REALTY MORTGAGE II, INC.
|
||||||||
|
CONSOLIDATED STATEMENTS OF OPERATIONS
|
||||||||
| For the Year Ended | ||||||||
|
12/31/2011
|
12/31/2010
|
|||||||
|
Revenues
|
||||||||
|
Interest income from investment in real estate loans
|
$ | 1,244,000 | $ | 1,829,000 | ||||
|
Gain related to pay off of real estate loan, including recovery of allowance for loan loss
|
249,000 | 124,000 | ||||||
|
Gain related to pay off of notes receivable, including recovery of allowance for notes receivable
|
505,000 | 142,000 | ||||||
|
Other income
|
89,000 | -- | ||||||
|
Total revenues
|
2,087,000 | 2,095,000 | ||||||
|
Operating expenses
|
||||||||
|
Management fees - related party
|
1,098,000 | 1,098,000 | ||||||
|
Provision for loan loss
|
1,028,000 | 8,300,000 | ||||||
|
Interest expense
|
206,000 | 965,000 | ||||||
|
Professional fees
|
1,419,000 | 4,750,000 | ||||||
|
Provision for doubtful accounts related to receivable
|
-- | 133,000 | ||||||
|
Loan fees
|
-- | 3,000 | ||||||
|
Consulting fees
|
217,000 | 105,000 | ||||||
|
Insurance
|
304,000 | 316,000 | ||||||
|
Other
|
310,000 | 687,000 | ||||||
|
Total operating expenses
|
4,582,000 | 16,357,000 | ||||||
|
Loss from operations
|
(2,495,000 | ) | (14,262,000 | ) | ||||
|
Non-operating income (loss)
|
||||||||
|
Interest income from banking institutions
|
7,000 | 1,000 | ||||||
|
Impairment of marketable securities - related party
|
-- | (628,000 | ) | |||||
|
Discounted professional fees
|
1,580,000 | -- | ||||||
|
Settlement expense
|
-- | (2,239,000 | ) | |||||
|
Total other non-operating income (loss), net
|
1,587,000 | (2,866,000 | ) | |||||
|
Provision for income taxes
|
-- | -- | ||||||
|
Loss from continuing operations
|
(908,000 | ) | (17,128,000 | ) | ||||
|
Discontinued operations, net of income taxes
|
||||||||
|
Income from guarantors related to real estate held for sale
|
-- | 2,000 | ||||||
|
Net gain on sale of real estate held for sale
|
1,258,000 | 285,000 | ||||||
|
Expenses related to real estate held for sale
|
(867,000 | ) | (1,138,000 | ) | ||||
|
Write-downs on real estate held for sale
|
(1,951,000 | ) | (3,686,000 | ) | ||||
|
Gain related to HFS settlement
|
430,000 | -- | ||||||
|
Income from Hawaiian cemeteries and mortuaries, net of income taxes
|
1,889,000 | 159,000 | ||||||
|
Total income (loss) from discontinued operations
|
759,000 | (4,378,000 | ) | |||||
|
Net loss
|
(149,000 | ) | (21,506,000 | ) | ||||
|
Allocation to non-controlling interest – related party
|
(718,000 | ) | (60,000 | ) | ||||
|
Net loss attributable to common stockholders
|
$ | (867,000 | ) | $ | (21,566,000 | ) | ||
|
Basic and diluted income (loss) per weighted average common share
|
||||||||
|
Continuing operations
|
$ | (0.08 | ) | $ | (1.27 | ) | ||
|
Discontinued operations
|
$ | 0.01 | $ | (0.33 | ) | |||
|
Total basic and diluted loss per weighted average common share
|
$ | (0.07 | ) | $ | (1.60 | ) | ||
|
Dividends declared per common share
|
$ | -- | $ | -- | ||||
|
Weighted average common shares outstanding
|
12,991,208 | 13,464,092 | ||||||
The accompanying notes are an integral part of these consolidated statements.
-37-
VESTIN REALTY MORTGAGE II, INC.
CONSOLIDATED STATEMENTS OF EQUITY AND OTHER COMPREHENSIVE LOSS
|
Treasury Stock
|
Common Stock
|
||||||||||||||||||||||||||
|
Shares
|
Amount
|
Shares
|
Amount
|
Additional
Paid-in-
Capital
|
Accumulated Deficit
|
Accumulated
Other Comprehensive
Loss
|
Common shares held by trusts related to assets held for sale
|
Noncontrolling Interest – Related Party
|
Total
|
||||||||||||||||||
|
Stockholders' Equity at
December 31, 2009
|
1,381,137
|
$
|
(6,152,000)
|
13,616,226
|
$
|
1,000
|
$
|
278,550,000
|
$
|
(196,637,000)
|
$
|
(552,000)
|
$
|
-
|
$
|
-
|
$
|
75,210,000
|
|||||||||
|
Net Loss
|
(21,566,000)
|
60,000
|
(21,506,000)
|
||||||||||||||||||||||||
|
Recognition of Unrealized Loss on Marketable Securities – Related Party
|
628,000
|
628,000
|
|||||||||||||||||||||||||
|
Unrealized Loss on Marketable Securities - Related Party
|
(113,000)
|
(113,000)
|
|||||||||||||||||||||||||
|
Comprehensive Loss
|
(20,991,000)
|
||||||||||||||||||||||||||
|
Noncontrolling Interest – Related Party
|
5,319,000
|
5,319,000
|
|||||||||||||||||||||||||
|
Purchase of Treasury Stock
|
476,713
|
(755,000)
|
(476,713)
|
(648,000)
|
(1,403,000)
|
||||||||||||||||||||||
|
Stockholders' Equity at
December 31, 2010
|
1,857,850
|
$
|
(6,907,000)
|
13,139,513
|
$
|
1,000
|
$
|
278,550,000
|
$
|
(218,203,000)
|
$
|
(37,000)
|
$
|
(648,000)
|
$
|
5,379,000
|
$
|
58,135,000
|
|||||||||
|
Net Loss
|
(867,000)
|
718,000
|
(149,000)
|
||||||||||||||||||||||||
|
Unrealized Gain on Marketable Securities - Related Party
|
46,000
|
46,000
|
|||||||||||||||||||||||||
|
(103,000)
|
|||||||||||||||||||||||||||
|
Distributions – Related Party
|
(440,000)
|
(440,000)
|
|||||||||||||||||||||||||
|
Disposition of Assets Held for Sale
|
648,000
|
(5,657,000)
|
(5,009,000)
|
||||||||||||||||||||||||
|
Retire Treasury Stock
|
(2,087,202)
|
7,545,000
|
--
|
(7,545,000)
|
--
|
||||||||||||||||||||||
|
Purchase of Treasury Stock
|
418,730
|
(828,000)
|
(418,730)
|
(828,000)
|
|||||||||||||||||||||||
|
Stockholders' Equity at
December 31, 2011
|
189,378
|
$
|
(190,000)
|
12,720,783
|
$
|
1,000
|
$
|
271,005,000
|
$
|
(219,070,000)
|
$
|
9,000
|
$
|
--
|
$
|
--
|
$
|
51,755,000
|
|||||||||
The accompanying notes are an integral part of these consolidated statements.
-38-
|
VESTIN REALTY MORTGAGE II, INC.
|
||||||||
|
CONSOLIDATED STATEMENTS OF CASH FLOWS
|
||||||||
|
For the Year Ended
|
||||||||
|
12/31/2011
|
12/31/2010
|
|||||||
|
Cash flows from operating activities:
|
||||||||
|
Net loss
|
$ | (149,000 | ) | $ | (21,506,000 | ) | ||
|
Adjustments to reconcile net loss to net cash used in operating activities:
|
||||||||
|
Provision for doubtful accounts related to receivable
|
-- | 134,000 | ||||||
|
Impairment of marketable securities - related party
|
-- | 628,000 | ||||||
|
Write-downs on real estate held for sale
|
1,951,000 | 3,686,000 | ||||||
|
Gain on sale of real estate held for sale
|
(1,258,000 | ) | (454,000 | ) | ||||
|
Loss on sale of real estate held for sale
|
-- | 169,000 | ||||||
|
Recovery of allowance for doubtful notes receivable included in other income
|
(505,000 | ) | (124,000 | ) | ||||
|
Gain related to recovery of allowance for loan loss
|
(249,000 | ) | -- | |||||
|
Provision for loan loss
|
1,028,000 | 8,300,000 | ||||||
|
Prepaid interest income – unearned income
|
-- | 62,000 | ||||||
|
Amortized interest income
|
(26,000 | ) | (36,000 | ) | ||||
|
Amortized financing costs, included in interest expense
|
-- | 175,000 | ||||||
|
Change in operating assets and liabilities:
|
||||||||
|
Interest and other receivables
|
2,105,000 | (155,000 | ) | |||||
|
Assets held for sale, net of liabilities
|
(590,000 | ) | (159,000 | ) | ||||
|
Due to/from related parties, net
|
601,000 | (395,000 | ) | |||||
|
Other assets
|
220,000 | 193,000 | ||||||
|
Accounts payable and accrued liabilities
|
(3,860,000 | ) | 1,013,000 | |||||
|
Net cash used in operating activities
|
$ | (732,000 | ) | $ | (8,469,000 | ) | ||
|
Cash flows from investing activities:
|
||||||||
|
Investments in real estate loans
|
$ | (14,337,000 | ) | $ | (3,795,000 | ) | ||
|
Purchase of investments in real estate loans from:
|
||||||||
|
VRM I
|
-- | (1,033,000 | ) | |||||
|
Fund III
|
-- | (200,000 | ) | |||||
|
Third parties
|
-- | (6,822,000 | ) | |||||
|
Proceeds from loan payoffs
|
6,416,000 | 12,870,000 | ||||||
|
Sale of investments in real estate loans to:
|
||||||||
|
VRM I
|
-- | 2,000,000 | ||||||
|
Other related parties
|
500,000 | -- | ||||||
|
Third parties
|
2,743,000 | 375,000 | ||||||
|
Proceeds related to real estate held for sale
|
479,000 | 11,418,000 | ||||||
|
Purchases of assets held for sale
|
-- | (325,000 | ) | |||||
|
Proceeds on nonrefundable extension fees on real estate held for sale
|
89,000 | -- | ||||||
|
Proceeds from sale of asset held for sale
|
9,369,000 | -- | ||||||
|
Proceeds from note receivable
|
505,000 | 161,000 | ||||||
|
Notes receivable
|
-- | (37,000 | ) | |||||
|
Purchase of marketable securities – related party
|
(6,000 | ) | -- | |||||
|
Net cash provided by investing activities
|
$ | 5,758,000 | $ | 14,612,000 | ||||
The accompanying notes are an integral part of these consolidated statements.
-39-
|
VESTIN REALTY MORTGAGE II, INC.
|
||||||||
|
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
|
||||||||
|
For the Year Ended
|
||||||||
|
12/31/2011
|
12/31/2010
|
|||||||
|
Cash flows from financing activities:
|
||||||||
|
Principal payments on notes payable
|
$ | (1,518,000 | ) | $ | (244,000 | ) | ||
|
Proceeds from issuance of notes payable
|
-- | 1,296,000 | ||||||
|
Distributions to holder of noncontrolling interest – related party
|
(440,000 | ) | -- | |||||
|
Cash used for pay down on secured borrowings
|
(1,088,000 | ) | -- | |||||
|
Purchase of treasury stock at cost
|
(638,000 | ) | (755,000 | ) | ||||
|
Net cash provided by (used in) financing activities
|
$ | (3,684,000 | ) | $ | 297,000 | |||
|
NET CHANGE IN CASH
|
1,342,000 | 6,440,000 | ||||||
|
Cash, beginning of period
|
7,884,000 | 1,444,000 | ||||||
|
Cash, end of period
|
$ | 9,226,000 | $ | 7,884,000 | ||||
|
Supplemental disclosures of cash flows information:
|
||||||||
|
Interest paid
|
$ | 206,000 | $ | 747,000 | ||||
|
Non-cash investing and financing activities:
|
||||||||
|
Retirement of treasury stock
|
$ | 7,545,000 | $ | -- | ||||
|
Treasury stock acquired through settlement
|
$ | (190,000 | ) | $ | -- | |||
|
Payoff of loans funded through secured borrowings
|
$ | -- | $ | 6,822,000 | ||||
|
Write-off of notes receivable and related allowance
|
$ | 8,090,000 | $ | -- | ||||
|
Note payable relating to prepaid D & O insurance
|
$ | 219,000 | $ | 244,000 | ||||
|
Real estate held for sale acquired through foreclosure, net of prior allowance
|
$ | 160,000 | $ | 9,033,000 | ||||
|
Assets held for sale acquired, net of related liabilities and noncontrolling interest –related party
|
$ | -- | 8,494,000 | |||||
|
Deferred gain on asset held for sale
|
$ | 102,000 | $ | -- | ||||
|
Investment in real estate loans by purchase of secured borrowings
|
$ | 1,320,000 | $ | -- | ||||
|
Accrued liabilities related to sale of asset held for sale
|
$ | 38,000 | $ | -- | ||||
|
Write-off of interest receivable and related allowance
|
$ | 160,000 | $ | 658,000 | ||||
|
Seller-financed real estate held for sale reclassification
|
$ | -- | $ | 3,500,000 | ||||
|
Decrease in deposit liability related to pay off of real estate held for sale - seller financed
|
$ | -- | $ | 260,000 | ||||
|
Adjustment to note receivable and related allowance for charge offs
|
$ | 3,580,000 | $ | -- | ||||
|
Conversion of secured loans to unsecured notes receivable
|
$ | -- | $ | 4,957,000 | ||||
|
Reclassification of loan, net of allowance for loan losses, to accounts receivable
|
$ | -- | $ | 1,956,000 | ||||
|
Recognition of unrealized loss on marketable securities – related party
|
$ | -- | $ | 628,000 | ||||
|
Unrealized gain (loss) on marketable securities - related party
|
$ | 46,000 | $ | (113,000 | ) | |||
The accompanying notes are an integral part of these consolidated statements.
-40-
VESTIN REALTY MORTGAGE II, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2011
NOTE A — ORGANIZATION
Vestin Realty Mortgage II, Inc. (“VRM II”) formerly Vestin Fund II, LLC (“Fund II”) invests in loans secured by real estate through deeds of trust or mortgages (hereafter referred to collectively as “deeds of trust” and as defined in our management agreement (“Management Agreement”) as “Mortgage Assets”). References in this report to the “Company,”“we,”“us,” or “our” refer to Fund II with respect to the period prior to April 1, 2006 and to VRM II with respect to the period commencing on April 1, 2006. Because we were a limited liability company (“LLC”) during the prior periods reflected in this report, we make reference to Fund II’s “members” rather than “stockholders” in reporting our financial results.
We operate as a real estate investment trust (“REIT”). We are not a mutual fund or an investment company within the meaning of the Investment Company Act of 1940, nor are we subject to any regulation thereunder. As a REIT, we are required to have a December 31 fiscal year end. Our Board of Directors has been exploring releasing our status as a REIT. We expect a resolution will be made by March 30, 2012 to terminate our REIT status based on legal advice to be received by this date. As such, the Company will not be taxed as a REIT for the year ending December 31, 2012. The required filings to make this resolution effective have been prepared and submitted to the Internal Revenue Service as of the date of this filing.
Vestin Group, Inc. (“Vestin Group”), a Delaware corporation, owns a significant majority of Vestin Mortgage, LLC, a Nevada limited liability company, who is our manager (the “manager” or “Vestin Mortgage”). On January 7, 2011, Vestin Mortgage converted from a corporation to a limited liability company. Michael Shustek, the CEO and managing member of our manager and CEO, President and a director of us, wholly owns Vestin Group, which is engaged in asset management, real estate lending and other financial services through its subsidiaries. Our manager, prior to June 30, 2006, also operated as a licensed Nevada mortgage broker and was generally engaged in the business of brokerage, placement and servicing of commercial loans secured by real property. On July 1, 2006, a mortgage broker license was issued to an affiliated company, Vestin Originations, Inc. (“Vestin Originations”), which is majority-owned by Vestin Group. Vestin Originations continued the business of brokerage, placement and servicing of real estate loans. Effective February 14, 2011, the business of brokerage and placement of real estate loans will be performed by affiliated or non-affiliated mortgage brokers, including Vestin Originations and Advant Mortgage, LLC (“Advant”), both licensed Nevada mortgage brokers, which are indirectly majority by Mr. Shustek.
As discussed in Part I, Item 1, Business of this Annual Report on Form 10-K, we are managed by Vestin Mortgage pursuant to a management agreement. Vestin Mortgage is also the manager of Vestin Realty Mortgage I, Inc. (“VRM I”), as the successor by merger to Vestin Fund I, LLC (“Fund I”) and Vestin Fund III, LLC (“Fund III”). These entities were formed to invest in real estate loans. VRM I has investment objectives similar to ours, and Fund III is in the process of an orderly liquidation of its assets.
The consolidated financial statements include the accounts of us, our wholly owned taxable REIT subsidiary, Vestin TRS II, Inc (“TRS II”), Hawaii Funeral Services, LLC (“HFS”) and related trusts (see Note G). All significant inter-company transactions and balances have been eliminated in consolidation.
During April 2009, we entered into an accounting services agreement with Strategix Solutions, LLC (“Strategix Solutions”), a Nevada limited liability company, for the provision of accounting and financial reporting services. Strategix Solutions also provides accounting and financial reporting services to VRM I and Fund III. Our CFO and other members of our accounting staff are employees of Strategix Solutions. Strategix Solutions is managed by LL Bradford and Company, LLC ("LL Bradford"), a certified public accounting firm that has provided non-audit accounting services to us. The principal manager of LL Bradford was a former officer of our manager from April 1999 through January 1, 2005. Strategix Solutions is owned by certain partners of LL Bradford, none of whom are currently or were previously officers of our manager. As used herein, “management” means our manager, its manager, its executive officers and the individuals at Strategix Solutions who perform accounting and financial reporting services on our behalf.
On January 21, 2011, Eric Bullinger was appointed as our new CFO by the Board of Directors, pursuant to the terms of our agreement with Strategix Solutions, who was responsible for designating, subject to the approval of our Board of Directors, a new CFO for the Company. From May 21, 2010, until January 21, 2011, our current CEO, Michael Shustek, was acting as our interim CFO.
NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The financial statements of the Company have been prepared in accordance with the accounting principles generally accepted in the United States of America (“GAAP”). Management has included all normal recurring adjustments considered necessary to give a fair presentation of operating results for the periods presented.
Management Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include interest-bearing and non-interest-bearing bank deposits, money market accounts, short-term certificates of deposit with original maturities of three months or less, and short-term instruments with a liquidation provision of one month or less.
Revenue Recognition
Interest is recognized as revenue on performing loans when earned according to the terms of the loans, using the effective interest method. We do not accrue interest income on loans once they are determined to be non-performing. A loan is non-performing when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due. Cash receipts will be allocated to interest income, except when such payments are specifically designated by the terms of the loan as principal reduction. Interest is fully allowed for on impaired loans and is recognized on a cash basis method.
Investments in Real Estate Loans
We may, from time to time, acquire or sell investments in real estate loans from or to our manager or other related parties pursuant to the terms of our Management Agreement without a premium. The primary purpose is to either free up capital to provide liquidity for various reasons, such as loan diversification, or place excess capital in investments to maximize the use of our capital. Selling or buying loans allows us to diversify our loan portfolio within these parameters. Due to the short-term nature of the loans we make and the similarity of interest rates in loans we normally would invest in, the fair value of a loan typically approximates its carrying value. Accordingly, discounts or premiums typically do not apply upon sales of loans and therefore, generally no gain or loss is recorded on these transactions, regardless of whether to a related or unrelated party.
Investments in real estate loans are secured by deeds of trust or mortgages. Generally, our real estate loans require interest only payments with a balloon payment of the principal at maturity. We have both the intent and ability to hold real estate loans until maturity and therefore, real estate loans are classified and accounted for as held for investment and are carried at amortized cost. Loans sold to or purchased from affiliates are accounted for at the principal balance and no gain or loss is recognized by us or any affiliate. Loan-to-value ratios are initially based on appraisals obtained at the time of loan origination and are updated, when new appraisals are received or when management’s assessment of the value has changed, to reflect subsequent changes in value estimates. Such appraisals are generally dated within 12 months of the date of loan origination and may be commissioned by the borrower.
The Company considers a loan to be impaired when, based upon current information and events, it believes it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Company’s impaired loans include troubled debt restructuring, and performing and non-performing loans in which full payment of principal or interest is not expected. The Company calculates an allowance required for impaired loans based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or at the loan’s observable market price or the fair value of its collateral.
Loans that have been modified from their original terms are evaluated to determine if the loan meets the definition of a Troubled Debt Restructuring (“TDR”) as defined by ASC 310-40. When the Company modifies the terms of an existing loan that is considered a TDR, it is considered performing as long as it is in compliance with the modified terms of the loan agreement. If the modification calls for deferred interest, it is recorded as interest income as cash is collected.
Allowance for Loan Losses
We maintain an allowance for loan losses on our investments in real estate loans for estimated credit impairment. Our manager’s estimate of losses is based on a number of factors including the types and dollar amounts of loans in the portfolio, adverse situations that may affect the borrower’s ability to repay, prevailing economic conditions and the underlying collateral securing the loan. Additions to the allowance are provided through a charge to earnings and are based on an assessment of certain factors, which may indicate estimated losses on the loans. Actual losses on loans are recorded first as a reduction to the allowance for loan losses. Generally, subsequent recoveries of amounts previously charged off are recognized as income.
Estimating allowances for loan losses requires significant judgment about the underlying collateral, including liquidation value, condition of the collateral, competency and cooperation of the related borrower and specific legal issues that affect loan collections or taking possession of the property. As a commercial real estate lender willing to invest in loans to borrowers who may not meet the credit standards of other financial institutional lenders, the default rate on our loans could be higher than those generally experienced in the real estate lending industry. We and our manager generally approve loans more quickly than other real estate lenders and, due to our expedited underwriting process; there is a risk that the credit inquiry we perform will not reveal all material facts pertaining to a borrower and the security.
Additional facts and circumstances may be discovered as we continue our efforts in the collection and foreclosure processes. This additional information often causes management to reassess its estimates. In recent years, we have revised estimates of our allowance for loan losses. Circumstances that have and may continue to cause significant changes in our estimated allowance include, but are not limited to:
|
|
·
|
Declines in real estate market conditions, which can cause a decrease in expected market value;
|
|
|
·
|
Discovery of undisclosed liens for community improvement bonds, easements and delinquent property taxes;
|
|
|
·
|
Lack of progress on real estate developments after we advance funds. We customarily utilize disbursement agents to monitor the progress of real estate developments and approve loan advances. After further inspection of the related property, progress on construction occasionally does not substantiate an increase in value to support the related loan advances;
|
|
|
·
|
Unanticipated legal or business issues that may arise subsequent to loan origination or upon the sale of foreclosed property; and
|
|
|
·
|
Appraisals, which are only opinions of value at the time of the appraisal, may not accurately reflect the value of the property.
|
Discontinued Operations
We have reclassified for all periods presented in the accompanying consolidated statements of operations, the amounts related to discontinued operations and real estate held for sale, in accordance with the applicable accounting criteria. In addition, the assets and liabilities related to the discontinued operations are reported separately in the accompanying consolidated balance sheets as real estate held for sale, assets held for sale, and liabilities related to assets held for sale.
Real Estate Held for Sale
Real estate held for sale (“REO”) includes real estate acquired through foreclosure and will be carried at the lower of the recorded amount, inclusive of any senior indebtedness, or the property's estimated fair value, less estimated costs to sell, with fair value based on appraisals and knowledge of local market conditions. While pursuing foreclosure actions, we seek to identify potential purchasers of such property. It is not our intent to invest in or to own real estate as a long-term investment. We generally seek to sell properties acquired through foreclosure as quickly as circumstances permit, taking into account current economic conditions. The carrying values of REO are assessed on a regular basis from updated appraisals, comparable sales values or purchase offers.
Management classifies real estate as REO when the following criteria are met:
|
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Management commits to a plan to sell the properties;
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The property is available for immediate sale in its present condition subject only to terms that are usual and customary;
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An active program to locate a buyer and other actions required to complete a sale have been initiated;
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The sale of the property is probable;
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The property is being actively marketed for sale at a reasonable price; and
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Withdrawal or significant modification of the sale is not likely.
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Real Estate Held For Sale – Seller-Financed
We occasionally finance sales of foreclosed properties (“seller-financed REO”) to third parties. In order to record a sale of real estate when we provide financing, the buyer of the real estate is required to make minimum initial and continuing investments. Minimum initial investments range from 10% to 25% based on the type of real estate sold. In addition, there are limits on commitments and contingent obligations incurred by a seller in order to record a sale.
Because we occasionally foreclose on loans with raw land or developments in progress, available financing for such properties is often limited and we frequently provide financing up to 100% of the selling price on these properties. In addition, we may make additional loans to the buyer to continue development of a property. Although sale agreements are consummated at closing, they lack adequate initial investment by the buyer to qualify as a sale transaction. These sale agreements are not recorded as a sale until the minimum requirements are met.
These sale agreements are recorded under the deposit method or cost recovery method. Under the deposit method, no profit is recognized and any cash received from the buyer is reported as a deposit liability on the balance sheet. Under the cost recovery method, no profit is recognized until payments by the buyer exceed the carrying basis of the property sold. Principal payments received will reduce the related receivable, and interest collections will be recorded as unrecognized gross profit on the balance sheet. The carrying values of these properties would be included in real estate held for sale – seller financed on the consolidated balance sheets, when applicable.
In cases where the investment by the buyer is significant (generally 20% or more) and the buyer has an adequate continuing investment, the purchase money debt is not subject to future subordination, and a full transfer of risks and rewards has occurred, we will use the full accrual method. Under the full accrual method, a sale is recorded and the balance remaining to be paid is recorded as a normal note. Interest is recorded as income when received.
Secured Borrowings
Secured borrowings provide an additional source of capital for our lending activity. Secured borrowings allow us to increase the diversification of our loan portfolio and to invest in loans that we might not otherwise invest in. We do not receive any fees for entering into secured borrowing arrangements; however, we may receive revenue for any differential of the interest spread, if applicable. Loans in which unaffiliated investors have participated through inter-creditor agreements (“Inter-creditor Agreements”) are accounted for as secured borrowings.
The Inter-creditor Agreements provide us additional funding sources for real estate loans whereby an unaffiliated investor (the “Investor”) may participate on a non-paripassu basis in certain real estate loans with us and/or VRM I (collectively, the “Lead Lenders”). In the event of borrower non-performance, the Inter-creditor Agreements generally provide that the Lead Lenders must repay the Investor’s loan amount either by (i) continuing to remit to the Investor the interest due on the participated loan amount; (ii) substituting an alternative loan acceptable to the Investor; or (iii) repurchasing the participation from the Investor for the outstanding balance plus accrued interest.
Additionally, an Investor may participate in certain loans with the Lead Lenders through Participation Agreements. In the event of borrower non-performance, the Participation Agreement may allow the Investor to be repaid up to the amount of the Investor’s investment prior to the Lead Lender being repaid. Real estate loan financing under the Participation Agreements are also accounted for as a secured borrowing. We do not receive any revenues for entering into secured borrowing arrangements.
Investment in Marketable Securities – Related Party
Investment in marketable securities – related party consists of stock in VRM I. The securities are stated at fair value as determined by the closing market prices as of December 31, 2011 and 2010. All securities are classified as available-for-sale.
We are required to evaluate our available-for-sale investment for other-than-temporary impairment charges. We will determine when an investment is considered impaired (i.e., decline in fair value below its amortized cost), and evaluate whether the impairment is other than temporary (i.e., investment value will not be recovered over its remaining life). If the impairment is considered other than temporary, we will recognize an impairment loss equal to the difference between the investment’s cost and its fair value.
According to the SEC Staff Accounting Bulletin, Topic 5: Miscellaneous Accounting, M - Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities, there are numerous factors to be considered in such an evaluation and their relative significance will vary from case to case. The following are a few examples of the factors that individually or in combination, indicate that a decline is other than temporary and that a write-down of the carrying value is required:
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The length of the time and the extent to which the market value has been less than cost;
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The financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology that may impair the earnings potential of the investment or the discontinuance of a segment of the business that may affect the future earnings potential; or
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The intent and ability of the holder to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value.
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Fair Value Disclosures
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e. “the exit price”) in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various valuation approaches, including quoted market prices and discounted cash flows. The established hierarchy for inputs used, in measuring fair value, maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from independent sources. Unobservable inputs are inputs that reflect a company’s judgment concerning the assumptions that market participants would use in pricing the asset or liability developed based on the best information available under the circumstances. The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:
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Level 1 – Valuations based on quoted prices in active markets for identical instruments that the Company is able to access. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.
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Level 2 – Valuations based on quoted prices in active markets for instruments that are similar, or quoted prices in markets that are not active for identical or similar instruments, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
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Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement, which utilize the Company’s estimates and assumptions.
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If the volume and level of activity for an asset or liability have significantly decreased, we will still evaluate our fair value estimate as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. In addition, since we are a publicly traded company, we are required to make our fair value disclosures for interim reporting periods.
Basic and Diluted Earnings Per Common Share
Basic earnings per share (“EPS”) is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding. Diluted EPS is similar to basic EPS except that the weighted average number of common shares outstanding is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been exercised. We had no outstanding common share equivalents during the years ended December 31, 2011 and 2010.
Common Stock Dividends
During June 2008, our Board of Directors decided to suspend the payment of dividends. We will continue to comply with the REIT requirements and will distribute at least ninety percent (90%) of our REIT taxable income. Our Board of Directors will closely monitor our operating results in order to determine when dividends should be reinstated; however, we do not expect them to be reinstating dividends in the foreseeable future.
Treasury Stock
On March 21, 2007, our board of directors authorized the repurchase of up to $10 million worth of our common stock. Depending upon market conditions, shares may be repurchased from time to time at prevailing market prices through open market or privately negotiated transactions. We are not obligated to purchase any shares. Subject to applicable securities laws, repurchases may be made at such times and in such amounts, as our manager deems appropriate. As of December 31, 2011 we had a total of 2,276,580 shares of treasury stock of which 189,378 were received as a part of a settlement in the amount of approximately 0.2 million. On this date we retired 2,087,202 shares leaving a balance of 189,378 at a cost of approximately $0.2 million. As of December 31, 2010 we had a total of 1,857,850 shares of treasury stock carried on our books at cost totaling approximately $6.9 million.
Segments
We are currently authorized to operate two reportable segments, investments in real estate loans and investments in real property. As of December 31, 2011, we had not commenced investing in real property.
Our objective is to invest approximately 97% of our assets in real estate loans and real estate investments, while maintaining approximately 3% as a working capital cash reserve. Current market conditions have impaired our ability to be fully invested in real estate loans. As of December 31, 2011, approximately 60% of our assets, net of allowance for loan losses, are classified as investments in real estate loans.
Reclassifications
Certain amounts in the December 31, 2010 consolidated financial statements have been reclassified to conform to the December 31, 2011 presentation.
Principles of Consolidation
Our consolidated financial statements include the accounts of VRM II, TRS II, our wholly owned subsidiary, and Hawaii Funeral Services, LLC (“HFS”), in which we had a controlling interest through December 1, 2011. Our consolidated financial statements also included the accounts of the funeral merchandise and service trusts, cemetery merchandise and service trusts, and cemetery perpetual care trusts (“Trusts”) in which we had a variable interest and were the primary beneficiary. Intercompany balances and transactions have been eliminated in consolidation.
The Trusts are variable interest entities of HFS, as defined in ASC Topic 810. In accordance with this guidance, we have determined that we were the primary beneficiary of these trusts, as we absorbed a majority of the losses and returns associated with these trusts. We consolidated our Trust investments with a corresponding amount recorded as Care trusts’ corpus.
Noncontrolling Interests
The FASB issued authoritative guidance for noncontrolling interests in December 2007, which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The guidance clarifies that a noncontrolling interest in a subsidiary, which is sometimes referred to as an unconsolidated investment, is an ownership interest in the consolidated entity that should be reported as a component of equity in the consolidated financial statements. Among other requirements, the guidance requires consolidated net income to be reported at amounts attributable to both the parent and the noncontrolling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest.
Income Taxes
As of December 31, 2011 we were organized and conducted our operations to qualify as a REIT under Sections 856 to 860 of the Internal Revenue Code of 1986, as amended (the “Code”) and to comply with the provisions of the Internal Revenue Code with respect thereto. A REIT is generally not subject to federal income tax on that portion of its REIT taxable income (“Taxable Income”) which is distributed to its stockholders, provided that at least 90% of Taxable Income is distributed and provided that certain other requirements are met. Our Taxable Income may substantially exceed or be less than our net income as determined based on GAAP, because, differences in GAAP and taxable net income consist primarily of allowances for loan losses or doubtful account, write-downs on real estate held for sale, amortization of deferred financing cost, capital gains and losses, and deferred income. Certain assets of ours are held in a taxable REIT subsidiary (“TRS”). The income of a TRS is subject to federal and state income taxes. For more information please refer to Note P – Subsequent Events
A tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation process, based on the technical merits. Based on our evaluation, we have concluded that there are no significant uncertain tax positions requiring recognition on our consolidated financial statements. The net income tax provision for the years ended December 31, 2011and 2010 were approximately zero.
NOTE C — FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
Financial instruments consist of cash, interest and other receivables, notes receivable, accounts payable and accrued liabilities, due to/from related parties and notes payable. The carrying values of these instruments approximate their fair values due to their short-term nature. Marketable securities – related party and investment in real estate loans are further described in Note L – Fair Value.
Financial instruments with concentration of credit and market risk include cash, interest and other receivables, marketable securities - related party, notes receivable, accounts payable, accrued liabilities and secured borrowings, due to/from related parties, notes payable, and loans secured by deeds of trust.
We maintain cash deposit accounts and certificates of deposit which, at times, may exceed federally-insured limits. To date, we have not experienced any losses. As of December 31, 2011 and 2010, we had approximately $0 and $6.3 million, respectively, in excess of the federally-insured limits.
As of December 31, 2011, 36%, 28% 19% and 15% of our loans were in Nevada, Arizona, Texas and California, respectively, compared to 39%, 24% 21% and 16%, at December 31, 2010, respectively. As a result of this geographical concentration of our real estate loans, the downturn in the local real estate markets in these states has had a material adverse effect on us.
At December 31, 2011, the aggregate amount of loans to our three largest borrowers represented approximately 53% of our total investment in real estate loans. These real estate loans consisted of commercial and land loans, located in Arizona, Texas and California, with a first lien position on the California loan and second lien positions on the Arizona and Texas loans. Their interest rates are between 8% and 15%, and the aggregate outstanding balance is approximately $30.7 million. As of December31, 2011, our largest loan, totaling $12.6 million, is located in Arizona and has an interest rate of 15%, was considered non-performing and has been fully reserved. The loan located in Texas, considered non-performing with an interest rate of 8%, is a result of troubled debt restructuring whereby the total interest is being fully deferred and was payable December 31, 2011. Foreclosure proceedings have begun due to no payment being received. The loan located in California, a performing loan with an interest rate of 11%, is a result of troubled debt restructuring. Through March 25, 2011, interest was being paid monthly at 6% and deferred at 5%. Effective March 25, 2011, the total interest is being fully deferred until February 2012, at which time 6% interest will, once again, be payable monthly and 5% will be deferred and due upon maturity. See “Troubled Debt Restructuring” in Note D – Investments in Real Estate Loans. At December 31, 2010, the aggregate amount of loans to our three largest borrowers represented approximately 51% of our total investment in real estate loans. These real estate loans consisted of commercial and land loans, located in Arizona, Texas and California, with a first lien position on the California loan and second lien positions on the Arizona and Texas loans. Their interest rates range between 8% and 15%, and the aggregate outstanding balance is approximately $30.7 million.
We have a significant concentration of credit risk with our largest borrowers. During the year ended December 31, 2011, four of our performing loans totaling approximately $17.9 million, of which our portion was approximately $9.9 million, accounted for approximately 58% of our interest income. Three of these loans were paid in full as of December 31, 2011. During the year ended December 31, 2010, two of our performing loans totaling approximately $19.6 million, of which our portion was approximately $9.6 million, accounted for approximately 39% of our interest income. One of these loans was paid in full as of December 31, 2010. Any additional defaults in our loan portfolio will have a material adverse effect on us.
The success of a borrower’s ability to repay its real estate loan obligation in a large lump-sum payment may be dependent upon the borrower’s ability to refinance the obligation or otherwise raise a substantial amount of cash. With the weakened economy, credit continues to be difficult to obtain and as such, many of our borrowers who develop and sell commercial real estate projects have been unable to complete their projects, obtain takeout financing or have been otherwise adversely impacted. In addition, an increase in interest rates over the loan rate applicable at origination of the loan may have an adverse effect on our borrower’s ability to refinance.
Common Guarantors
As of December 31, 2011 and December 31, 2010, two and four loans, respectively totaling approximately $15.9 million and $19.8 million, respectively, representing approximately 27.3% and 32.8% of our portfolio’s total value, respectively, along with two unsecured notes receivable totaling approximately $3.9 million, had a common guarantor. As of December 31, 2011 and December 31, 2010, both loans were fully reserved and were considered non-performing. As of December 31, 2010, the two unsecured notes receivable were fully reserved; however, the guarantor of these notes had stopped making payments, and, as a result, the notes were fully charged off as of December 31, 2011.
As of December 31, 2011 and 2010, four loans totaling approximately $11.0 and $9.9 million, respectively, had a common guarantor. These loans represented approximately 19.0% and 16.4%, respectively, of our portfolio’s total value as of December 31, 2011 and 2010. One loan at December 31, 2010 was related to our secured borrowings of approximately $1.3 million including approximately $0.2 million in interest reserves. As of December 31, 2011 we repurchased the secured borrowings portion of the loan. Another loan at December 31, 2011 and 2010 is secured by a second deed of trust and had a balance of approximately $0.9 million and $1.0 million, respectively. All four loans were considered performing as of December 31, 2011 and 2010.
As of December 31 2011 and 2010, nine and three loans totaling approximately $6.2 million and $3.1 million, respectively, representing approximately 10.7% and 5.2%, respectively, of our portfolio’s total value, had a common guarantor. At December 31, 2011 and 2010, all loans were considered performing.
For additional information regarding the above non-performing loans, see “Non-Performing Loans” in Note D – Investments In Real Estate Loans.
NOTE D — INVESTMENTS IN REAL ESTATE LOANS
As of December 31, 2011 and 2010, most of our loans provided for payments of interest only with a “balloon” payment of principal payable in full at the end of the term.
In addition, we may invest in real estate loans that require borrowers to maintain interest reserves funded from the principal amount of the loan for a period of time. At December 31, 2011 and 2010, we had no investments in real estate loans that had interest reserves.
Loan Portfolio
As of December 31, 2011, we had five available real estate loan products consisting of commercial, construction, acquisition and development (“A/D”), land and residential. The effective interest rates on all product categories range from 0% to 15%. Revenue by product will fluctuate based upon relative balances during the period.
During the second quarter ended June 30, 2010, the Trustee in a Bankruptcy case, involving one of our non-performing commercial loans in California, sold the assets of the Borrower to an unrelated third party for an aggregate amount of $4.1 million. The proceeds, net of all court costs, closing costs, trustee’s fees, real estate taxes and security guard services, totaled approximately $3.4 million. An unaffiliated lender was successful in claiming an interest in the proceeds of the bankruptcy sale, purportedly based on loans of approximately $0.9 million, secured by some of the equipment located at the property. A motion to determine the allocation of the sale proceeds was filed with the Bankruptcy Court. A settlement was reached with the unaffiliated lender, and, as a result, we, VRM I and Fund III received $2.7 million, of which our portion equals $2.0 million, on May 11, 2011.
Investments in real estate loans as of December 31, 2011, were as follows:
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Loan Type
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Number of Loans
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Balance *
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Weighted Average Interest Rate
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Portfolio Percentage
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Current Weighted Average Loan-To-Value, Net of Allowance for Loan Losses
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Residential
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1 | $ | 385,000 | 8.00 | % | 0.66 | % | 61.41 | % | |||||||||||
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Commercial
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19 | 40,050,000 | 10.97 | % | 69.02 | % | 71.43 | % | ||||||||||||
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Construction
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1 | 6,656,000 | 8.00 | % | 11.47 | % | 89.49 | % | ||||||||||||
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Land
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3 | 10,933,000 | 10.75 | % | 18.85 | % | 64.15 | % | ||||||||||||
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Total
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24 | $ | 58,024,000 | 10.57 | % | 100.00 | % | 71.10 | % | |||||||||||
Investments in real estate loans as of December 31, 2010, were as follows:
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Loan Type
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Number of Loans
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Balance *
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Weighted Average Interest Rate
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Portfolio Percentage
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Current Weighted Average Loan-To-Value, Net of Allowance for Loan Losses
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Residential
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-- | $ | -- | -- | % | -- | % | -- | % | |||||||||||
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Commercial
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13 | 41,111,000 | 11.13 | % | 68.20 | % | 65.19 | % | ||||||||||||
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Construction
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2 | 8,231,000 | 8.54 | % | 13.66 | % | 86.69 | % | ||||||||||||
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Land
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3 | 10,934,000 | 10.75 | % | 18.14 | % | 76.15 | % | ||||||||||||
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Total
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18 | $ | 60,276,000 | 10.71 | % | 100.00 | % | 74.10 | % | |||||||||||
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*
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Please see Balance Sheet Reconciliation below.
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The “Weighted Average Interest Rate” as shown above is based on the contractual terms of the loans for the entire portfolio including non-performing loans. The weighted average interest rate on performing loans only, as of December 31, 2011 and 2010, was 6.79% and 8.49%, respectively. Please see “Non-Performing Loans” and “Asset Quality and Loan Reserves” below for further information regarding performing and non-performing loans.
Loan-to-value ratios are generally based on the most recent appraisals and may not reflect subsequent changes in value and include allowances for loan losses. Recognition of allowance for loan losses will result in a maximum loan-to-value ratio of 100% per loan.
The following is a schedule of priority of real estate loans as of December 31, 2011 and 2010:
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Loan Type
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Number of Loans
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December 31, 2011Balance*
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Portfolio
Percentage
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Number of Loans
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December 31, 2010Balance*
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Portfolio
Percentage
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First deeds of trust
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18 | $ | 28,684,000 | 49.43 | % | 10 | $ | 25,334,000 | 42.03 | % | ||||||||||||||
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Second deeds of trust
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6 | 29,340,000 | 50.57 | % | 8 | 34,942,000 | 57.97 | % | ||||||||||||||||
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Total
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24 | $ | 58,024,000 | 100.00 | % | 18 | $ | 60,276,000 | 100.00 | % | ||||||||||||||
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*
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Please see Balance Sheet Reconciliation below.
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The following is a schedule of contractual maturities of investments in real estate loans as of December 31, 2011:
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Non-performing and past due loans (a)
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$ | 29,564,000 | ||
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January 2012 – March 2012(b)
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20,227,000 | |||
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April 2012 – June 2012(b)
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2,315,000 | |||
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July 2012 – September 2012(b)
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2,802,000 | |||
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October 2012 – December 2012(b)
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1,238,000 | |||
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Thereafter
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1,878,000 | |||
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Total
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$ | 58,024,000 |
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(a)
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Amounts include the balance of non-performing loans.
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(b)
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Amounts include loans that have been or are in the process of being extended subsequent to March 16, 2012.
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The following is a schedule by geographic location of investments in real estate loans as of December 31, 2011 and 2010:
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December 31, 2011 Balance *
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Portfolio Percentage
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December 31, 2010 Balance *
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Portfolio Percentage
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Arizona
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$ | 16,108,000 | 27.76 | % | $ | 14,678,000 | 24.35 | % | ||||||||
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California
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8,564,000 | 14.76 | % | 9,633,000 | 15.98 | % | ||||||||||
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Colorado
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895,000 | 1.54 | % | -- | -- | |||||||||||
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Nevada
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21,114,000 | 36.39 | % | 23,350,000 | 38.74 | % | ||||||||||
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Ohio
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323,000 | 0.56 | % | -- | -- | |||||||||||
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Oregon
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46,000 | 0.08 | % | 46,000 | 0.08 | % | ||||||||||
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Texas
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10,974,000 | 18.91 | % | 12,569,000 | 20.85 | % | ||||||||||
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Total
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$ | 58,024,000 | 100.00 | % | $ | 60,276,000 | 100.00 | % | ||||||||
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*
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Please see Balance Sheet Reconciliation below.
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Balance Sheet Reconciliation
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The following table reconciles the balance of the loan portfolio to the amount shown on the accompanying Consolidated Balance Sheets.
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December 31, 2011 Balance (a)
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December 31, 2010 Balance (a)
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Balance per loan portfolio
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$ | 58,024,000 | $ | 60,276,000 | ||||
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Less:
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Allowance for loan losses (a)
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(26,247,000 | ) | (33,557,000 | ) | ||||
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Balance per consolidated balance sheet
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$ | 31,777,000 | $ | 26,719,000 | ||||
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(a)
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Please refer to Specific Reserve Allowance below.
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Non-Performing Loans
As of December 31, 2011, we had five loans considered non-performing (i.e., based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due). These loans are currently carried on our books at a value of approximately $10.0 million, net of allowance for loan losses of approximately $19.6 million, which does not include the allowances of approximately $6.7 million relating to performing loans as of December 31, 2011. Except as otherwise provided below, these loans have been placed on non-accrual of interest status and may be the subject of pending foreclosure proceedings.
At December 31, 2011, the following loans were non-performing:
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Loan Type
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Number Of Non-Performing Loans
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Balance at
December 31, 2011
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Allowance for Loan Losses
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Net Balance at
December 31, 2011
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Commercial
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5 | $ | 29,564,000 | $ | (19,570,000 | ) | $ | 9,994,000 | ||||||||
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Total
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5 | $ | 29,564,000 | $ | (19,570,000 | ) | $ | 9,994,000 | ||||||||
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Commercial – As of December 31, 2011, five of our 19 commercial loans were considered non-performing. The outstanding balance on the five non-performing loans was approximately $39.1 million, of which our portion was approximately $29.6 million. As of December 31, 2011, these loans have been non-performing from 0 months to 43 months. Our manager has commenced foreclosure proceedings on a majority of these loans, and has proceeded with legal action to enforce the personal guarantees if necessary. As of December 31, 2011, based on our manager’s evaluations and updated appraisals, our manager has provided a specific allowance to these commercial loans of approximately $24.0 million, of which our portion is approximately $19.6 million.
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At December 31, 2010, the following loans were non-performing:
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Loan Type
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Number Of Non-Performing Loans
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Balance at
December 31, 2010
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Allowance for Loan Losses
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Net Balance at
December 31, 2010
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Commercial
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5 | $ | 21,079,000 | $ | (19,541,000 | ) | $ | 1,538,000 | ||||||||
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Construction
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1 | 2,896,000 | (2,736,000 | ) | 160,000 | |||||||||||
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Total
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6 | $ | 23,975,000 | $ | (22,277,000 | ) | $ | 1,698,000 | ||||||||
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·
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Commercial – As of December 31, 2010, five of our 13 commercial loans were considered non-performing. The outstanding balance on the five non-performing loans was approximately $31.0 million, of which our portion was approximately $21.1 million. As of December 31, 2010, these loans have been non-performing from 16 months to 31 months. Our manager has commenced foreclosure proceedings on a majority of these loans, and has proceeded with legal action to enforce the personal guarantees if necessary. As of December 31, 2010, based on our manager’s evaluations and updated appraisals, our manager has provided a specific allowance to these commercial loans of approximately $24.5 million, of which our portion is approximately $19.5 million.
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·
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Construction – As of December 31, 2010, one of our two construction loans was considered non-performing. The outstanding balance on the loan is $2.9 million, of which our portion is approximately $2.9 million. As of December 31, 2010, this loan has been considered non-performing for the last 4 months. As of December 31, 2010, based on our manager’s evaluation and an updated appraisal obtained by our manager during the year ended December 31, 2010, our manager has provided a specific allowance of approximately $2.7 million, of which our portion is approximately $2.7 million.
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Asset Quality and Loan Reserves
Losses may occur from investing in real estate loans. The amount of losses will vary as the loan portfolio is affected by changing economic conditions and the financial condition of borrowers.
The conclusion that a real estate loan is uncollectible or that collectability is doubtful is a matter of judgment. On a quarterly basis, our manager evaluates our real estate loan portfolio for impairment. The fact that a loan is temporarily past due does not necessarily mean that the loan is non-performing. Rather, all relevant circumstances are considered by our manager to determine impairment and the need for specific reserves. Such evaluation, which includes a review of all loans on which full collectability may not be reasonably assured, considers among other matters:
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Prevailing economic conditions;
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Historical experience;
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The nature and volume of the loan portfolio;
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|
·
|
The borrowers’ financial condition and adverse situations that may affect the borrowers’ ability to pay;
|
|
|
·
|
Evaluation of industry trends; and
|
|
|
·
|
Estimated net realizable value of any underlying collateral in relation to the loan amount.
|
Based upon this evaluation, a determination is made as to whether the allowance for loan losses is adequate to cover any potential losses on an individual loan basis; we do not have a general allowance for loan losses. Additions to the allowance for loan losses are made by charges to the provision for loan loss. As of December 31, 2011, our ratio of total allowance for loan losses to total loans with an allowance for loan loss is approximately 64%. The following is a breakdown of allowance for loan losses related to performing and non-performing loans as of December 31, 2011 and 2010:
|
As of December 31, 2011
|
||||||||||||
|
Balance
|
Allowance for loan losses **
|
Balance, net of allowance
|
||||||||||
|
Non-performing loans – no related allowance
|
$ | -- | $ | -- | $ | -- | ||||||
|
Non-performing loans – related allowance
|
29,564,000 | (19,570,000 | ) | 9,994,000 | ||||||||
|
Subtotal non-performing loans
|
29,564,000 | (19,570,000 | ) | 9,994,000 | ||||||||
|
Performing loans – no related allowance
|
17,064,000 | -- | 17,064,000 | |||||||||
|
Performing loans – related allowance
|
11,396,000 | (6,677,000 | ) | 4,719,000 | ||||||||
|
Subtotal performing loans
|
28,460,000 | (6,677,000 | ) | 21,783,000 | ||||||||
|
Total
|
$ | 58,024,000 | $ | (26,247,000 | ) | $ | 31,777,000 | |||||
|
As of December 31, 2010
|
||||||||||||
|
Balance
|
Allowance for loan losses**
|
Balance, net of allowance
|
||||||||||
|
Non-performing loans – no related allowance
|
$ | -- | $ | -- | $ | -- | ||||||
|
Non-performing loans – related allowance
|
23,975,000 | (22,277,000 | ) | 1,698,000 | ||||||||
|
Subtotal non-performing loans
|
23,975,000 | (22,277,000 | ) | 1,698,000 | ||||||||
|
Performing loans – no related allowance
|
14,056,000 | -- | 14,056,000 | |||||||||
|
Performing loans – related allowance
|
22,245,000 | (11,280,000 | ) | 10,965,000 | ||||||||
|
Subtotal performing loans
|
36,301,000 | (11,280,000 | ) | 25,021,000 | ||||||||
|
Total
|
$ | 60,276,000 | $ | (33,557,000 | ) | $ | 26,719,000 | |||||
|
**
|
Please refer to Specific Reserve Allowances below.
|
Our manager evaluated our loans and, based on current estimates with respect to the value of the underlying collateral, believes that such collateral is sufficient to protect us against further losses of principal or interest. However, such estimates could change or the value of the underlying real estate could decline. Our manager will continue to evaluate our loans in order to determine if any other allowance for loan losses should be recorded.
|
|
Specific Reserve Allowances
|
As of December 31, 2011, we have provided a specific reserve allowance for five non-performing loans and five performing loans based on updated appraisals of the underlying collateral and/or our evaluation of the borrower.
The following table is a roll-forward of the allowance for loan losses for the years ended December 31, 2011 and 2010 by loan type.
|
Loan Type
|
Balance at
12/31/10
|
Specific Reserve Allocation
|
Reduction in Specific Reserve Allocation
|
Loan Pay Downs
|
Transfers to REO and Notes Receivables
|
Balance at
12/31/11
|
||||||||||||||||||||
|
Commercial
|
$ | 27,486,000 | $ | 507,000 | $ | (1,413,000 | ) | $ | (248,000 | ) | $ | (3,940,000 | ) | $ | 22,392,000 | |||||||||||
|
Construction
|
5,647,000 | 61,000 | -- | -- | (2,737,000 | ) | 2,971,000 | |||||||||||||||||||
|
Land
|
424,000 | 460,000 | -- | -- | -- | 884,000 | ||||||||||||||||||||
|
Total
|
$ | 33,557,000 | $ | 1,028,000 | $ | (1,413,000 | ) | $ | (248,000 | ) | $ | (6,677,000 | ) | $ | 26,247,000 | |||||||||||
|
|
·
|
Commercial – As of December 31, 2011, eight of our 19 commercial loans had a specific reserve allowance totaling approximately $28.7 million, of which our portion is approximately $22.4 million. The outstanding balance on these eight loans was approximately $44.3 million, of which our portion was approximately $32.4 million.
|
|
|
·
|
Construction – As of December 31, 2011, our one construction loan had a specific reserve allowance totaling approximately $3.2 million, of which our portion was approximately $3.0 million. The outstanding balance on this loan was approximately $7.2 million, of which our portion is $6.7 million.
|
|
|
·
|
Land – As of December 31, 2011, one of our three land loans had a specific reserve allowance totaling approximately $884,000. The outstanding balance on this loan was approximately $2.5 million.
|
|
Loan Type
|
Balance at
12/31/09
|
Specific Reserve Allocation
|
Sales
|
Loan Pay Downs
|
Transfers to REO and Assets Held for Sale
|
Balance at
12/31/10
|
||||||||||||||||||||
|
Commercial
|
$ | 45,362,000 | $ | 3,134,000 | $ | (9,642,000 | ) | $ | (1,611,000 | ) | $ | (9,757,000 | ) | $ | 27,486,000 | |||||||||||
|
Construction
|
8,361,000 | 4,742,000 | -- | (3,347,000 | ) | (4,109,000 | ) | 5,647,000 | ||||||||||||||||||
|
Land
|
5,193,000 | 424,000 | -- | -- | (5,193,000 | ) | 424,000 | |||||||||||||||||||
|
Total
|
$ | 58,916,000 | $ | 8,300,000 | $ | (9,642,000 | ) | $ | (4,958,000 | ) | $ | (19,059,000 | ) | $ | 33,557,000 | |||||||||||
·
|
|
·
|
Commercial – As of December 31, 2010, 10 of our 13 commercial loans had a specific reserve allowance totaling approximately $34.0 million, of which our portion is approximately $27.5 million. The outstanding balance on these 10 loans was approximately $50.4 million, of which our portion was approximately $38.0 million.
|
|
|
·
|
Construction – As of December 31, 2010, our two construction loans had a specific reserve allowance totaling approximately $5.9 million, of which our portion was approximately $5.6 million. The outstanding balance on these two loans was approximately $10.1 million, of which our portion is $8.2 million.
|
|
|
·
|
Land – As of December 31, 2010, one of our three land loans had a specific reserve allowance totaling approximately $424,000. The outstanding balance on this loan was approximately $2.4 million.
|
Troubled Debt Restructuring
As of December 31, 2011 and 2010, we had seven and five loans, totaling approximately $30.8 million and $28.0 million, respectively, that met the definition of a Troubled Debt Restructuring or TDR. When the Company modifies the terms of an existing loan that is considered TDR, it is considered performing as long as it is in compliance with the modified terms of the loan agreement. If the modification calls for deferred interest, it is recorded as interest income as cash is collected. Impairment on these loans is generally determined by the lesser of the value of the underlying collateral or the present value of expected future cash flows. During the previous 12 months there have been four loans that became TDR loans and all remain performing. The following is a breakdown of our TDR loans that were considered performing and non-performing as of December 31, 2011 and2010:
|
As of December 31, 2011
|
||||||||||||||||||||||||
|
Total
|
Performing
|
Non-Performing
|
||||||||||||||||||||||
|
Loan Type
|
Number of Loans
|
Fund Balance
|
Number of Loans
|
Fund Balance
|
Number of Loans
|
Fund Balance
|
||||||||||||||||||
|
Commercial
|
5 | $ | 16,740,000 | 3 | $ | 2,821,000 | 2 | $ | 13,919,000 | |||||||||||||||
|
Construction
|
1 | 6,655,000 | 1 | 6,655,000 | -- | -- | ||||||||||||||||||
|
Land
|
1 | 7,450,000 | 1 | 7,450,000 | -- | -- | ||||||||||||||||||
|
Total
|
7 | $ | 30,845,000 | 5 | $ | 16,926,000 | 2 | $ | 13,919,000 | |||||||||||||||
|
As of December 31, 2010
|
||||||||||||||||||||||||
|
Total
|
Performing
|
Non-Performing
|
||||||||||||||||||||||
|
Loan Type
|
Number of Loans
|
Fund Balance
|
Number of Loans
|
Fund Balance
|
Number of Loans
|
Fund Balance
|
||||||||||||||||||
|
Commercial
|
3 | $ | 15,186,000 | 2 | $ | 11,936,000 | 1 | $ | 3,250,000 | |||||||||||||||
|
Construction
|
1 | 5,335,000 | 1 | 5,335,000 | -- | -- | ||||||||||||||||||
|
Land
|
1 | 7,450,000 | 1 | 7,450,000 | -- | -- | ||||||||||||||||||
|
Total
|
5 | $ | 27,971,000 | 4 | $ | 24,721,000 | 1 | $ | 3,250,000 | |||||||||||||||
|
|
·
|
Commercial – As of December 31, 2011 and 2010, we had 19 and 13 commercial loans, respectively, five and three of them, respectively, were modified pursuant to TDR. As of December 31, 2011, five of the loans were secured by second deeds of trust and two of the five loans were considered performing prior to their restructuring. As of December 31, 2010, all of the loans were secured by second deeds of trust and two of the three loans were considered performing prior to their restructuring. On January 1, 2011, the principal amount of one of the non-performing loans was reduced by approximately $0.8 million. Interest only payments were due monthly from September 2010 until August 2011, at which point payments of interest and principal started and will continue until September 2013. The interest rate was adjusted from 12% to 4.5%. As of December 31, 2011 this loan was considered performing. During January 2012, one of the loans became non-performing and on February 7, 2012, we, VRMI and VFIII entered into a Deed in Lieu Agreement with a borrower for a second deed of trust loan that matured on December 31, 2011 with a balance of approximately $11.8 million, of which our portion was approximately $10.7 million.. For additional information, see “Non-Performing” of this Note D – Investments in Real Estate Loans and Note P – Subsequent Events
|
|
|
·
|
Construction – As of December 31, 2011 and 2010, we had one construction loan modified pursuant to TDR. As of December 31, 2011, the loan continues to perform as required by the loan modifications. On September 20, 2011 we repurchased the secured borrowings portion of this loan for approximately $1.1 million. For additional information, see Note J – Secured Borrowings. During January 2012, additional restructuring of this loan occurred. For additional information, see Note P – Subsequent Events.
|
|
|
·
|
Land – As of December 31, 2011 and2010, we had one land loan modified pursuant to TDR. As of March 16, 2012, the loan continues to perform as required by the loan modifications.
|
Extensions
As of December 31, 2011, our manager had granted extensions on nine loans totaling approximately $41.4 million of which our portion was approximately $36.5 million, pursuant to the terms of the original loan agreements, which permit extensions by mutual consent, or as part of a TDR. Such extensions are generally provided on loans where the original term was 12 months or less and where a borrower requires additional time to complete a construction project or negotiate take-out financing. Our manager generally grants extensions when a borrower is in compliance with the material terms of the loan, including, but not limited to the borrower’s obligation to make interest payments on the loan. In addition, if circumstances warrant, our manager may extend a loan that is in default as part of a work out plan to collect interest and/or principal. Subsequent to their extension, three of the 11 loans had become non-performing. The loans, which became non-performing after their extension, had a total principal amount at December 31, 2011, of $19.1 million, of which our portion is $16.9 million.
As of December 31, 2010, our manager had granted extensions on 11 loans totaling approximately $50.4 million of which our portion was approximately $38.9 million, pursuant to the terms of the original loan agreements, which permit extensions by mutual consent, or as part of a TDR. Such extensions are generally provided on loans where the original term was 12 months or less and where a borrower requires additional time to complete a construction project or negotiate take-out financing. Our manager generally grants extensions when a borrower is in compliance with the material terms of the loan, including, but not limited to the borrower’s obligation to make interest payments on the loan. In addition, if circumstances warrant, our manager may extend a loan that is in default as part of a work out plan to collect interest and/or principal. Subsequent to their extension, three of the 11 loans had become non-performing. The loans, which became non-performing after their extension, had a total principal amount at December 31, 2010, of $11.9 million, of which our portion is $9.1 million. Our manager extended one non-performing loan secured by a second trust deed, during the year ended December 31, 2010, to postpone our foreclosure of the property to determine our exposure in relation to the first trust deed.
NOTE E — INVESTMENT IN MARKETABLE SECURITIES – RELATED PARTY
As of December 31, 2011 and 2010, we owned 538,178 and 533,675 shares, respectively, of VRM I’s common stock, representing approximately 8.50% and 8.35%, respectively, of their total outstanding common stock. The closing price of VRM I’s common stock on December 31, 2011 and 2010 was $1.10 and $1.01, respectively, per share.
At September 30, 2010, our manager evaluated the near-term prospects of VRM I in relation to the severity and duration of the unrealized loss. Based on that evaluation and current market conditions, we have determined there was an other-than-temporary impairment on our investment in VRM I as of September 30, 2010. We reversed our unrealized other comprehensive losses and realized a loss on our investment to its fair value of $1.08 per share as of September 30, 2010, totaling approximately $0.6 million and recognizing an impairment of approximately $0.6 million.
As of December 31, 2011, our manager evaluated the near-term prospects of VRM I in relation to the severity and duration of the unrealized loss since October 1, 2010. Based on that evaluation and our ability and intent to hold this investment for a reasonable period of time sufficient for a forecasted recovery of fair value, we do not consider our investment in VRM I to be other-than-temporarily impaired at December 31, 2011. During the year ended December 31, 2011, the trading price for VRM I’s common stock ranged from $1.08 to $1.40 per share. We will continue to evaluate our investment in marketable securities on a quarterly basis.
NOTE F — REAL ESTATE HELD FOR SALE
At December 31, 2011, we held five properties with a total carrying value of approximately $10.8 million, which were acquired through foreclosure and recorded as investments in real estate held for sale (“REO”). Our REO are accounted for at the lower of cost or fair value less costs to sell with fair value based on appraisals and knowledge of local market conditions. We seek to sell properties acquired through foreclosure as quickly as circumstances permit taking into account current economic conditions. Set forth below is a roll-forward of REO during the year ended December 31, 2011:
|
Description
|
Balance at
12/31/10
|
Acquisitions Through Foreclosure
|
Write Downs
|
Additions/
(Cash Reductions)
|
Seller Financed / New Loan
|
Net Cash Proceeds on Sales
|
Net Gain (Loss) on Sale of Real Estate
|
Balance at
12/31/11
|
||||||||||||||||||||||||
|
Land
|
$ | 12,808,000 | $ | -- | $ | (1,951,000 | ) | $ | (90,000 | ) | $ | -- | $ | -- | $ | -- | $ | 10,767,000 | ||||||||||||||
|
Residential Building
|
-- | 160,000 | -- | -- | -- | (427,000 | ) | 267,000 | -- | |||||||||||||||||||||||
|
Total
|
$ | 12,808,000 | $ | 160,000 | $ | (1,951,000 | ) | $ | (90,000 | ) | $ | -- | $ | (427,000 | ) | $ | 267,000 | $ | 10,767,000 | |||||||||||||
Land
As of December 31, 2011, we held five REO properties classified as Land, totaling approximately $10.8 million. These properties were acquired between December 2006 and October 2010 and consist of commercial land and residential land. During the year ended December 31, 2011, our manager continually evaluated the carrying value of these properties and based on its estimates and updated appraisals, these properties were written down approximately $2.0 million. Our manager is currently working with prospective buyers to sell these properties; however, no assurance can be given that these sales will take place.
In August, 2011, VREO XVIII, LLC, an entity owned by us, VRM I and VF III entered into a purchase and sale agreement to sell one of the REO assets. The terms of the sale provided for an all cash transaction in the amount of $2 Million, with a closing to occur within 60 days. The date of closing was extended several times, but ultimately, the transaction cancelled, as the purchaser was unable to obtain financing. Non-refundable extension fees in the amount of $110,000 were collected, of which our portion was approximately $90,000.
Residential Building
As of December 31, 2011, we held no REO properties classified as Residential Building. On February 11, 2011, we completed our foreclosure of a property secured by a non-performing construction loan in Nevada and classified it as residential apartment/condo REO totaling approximately $0.2 million, net of prior allowance for loan loss. On July 25, 2011 we sold the residential apartment/condo REO for gain of approximately $64,000.On December 19, 2011 we received a settlement from a guarantor on two REO properties held by a common guarantor, one sold in 2011 and the other in a prior period. The settlement was part cash of $0.3 million and 189,378 shares of VRM II stock which we now hold as treasury stock valued at approximately $0.2 million. As a result, we recorded an additional gain on both properties in 2011 totaling approximately $0.5 million.
|
Description
|
Balance at
12/31/09
|
Acquisitions Through Foreclosure
|
Write Downs
|
Additions/
(Cash Reductions)
|
Seller Financed / New Loan
|
Net Cash Proceeds on Sales
|
Net Gain (Loss) on Sale of Real Estate
|
Balance at
12/31/10
|
||||||||||||||||||||||||
|
Land
|
$ | 19,959,000 | $ | 7,342,000 | $ | (3,686,000 | ) | $ | (9,000 | ) | $ | (3,500,000 | ) | $ | (7,627,000 | ) | $ | 329,000 | $ | 12,808,000 | ||||||||||||
|
Residential Building
|
2,135,000 | 1,691,000 | -- | -- | -- | (3,782,000 | ) | (44,000 | ) | -- | ||||||||||||||||||||||
|
Total
|
$ | 22,094,000 | $ | 9,033,000 | $ | (3,686,000 | ) | $ | (9,000 | ) | $ | (3,500,000 | ) | $ | (11,409,000 | ) | $ | 285,000 | $ | 12,808,000 | ||||||||||||
Land
As of December 31, 2010, we held seven REO properties classified as Land, totaling approximately $12.8 million. These properties were acquired between December 2006 and October 2010 and consist of commercial land and residential land. During the year ended December 31, 2010, our manager continually evaluated the carrying value of these properties and based on its estimates and updated appraisals these properties were written down approximately $3.7 million. Our manager is currently working with prospective buyers to sell these properties; however, no assurance can be given that these sales will take place.
|
|
·
|
Golf Course – A partially completed golf course located in Texas was foreclosed upon by us in August 2004. On February 12, 2010, this property was sold to an unrelated third party for its book value of approximately $0.6 million. No gain or loss was associated with this transaction.
|
|
|
·
|
Commercial Land – On February 12, 2010, we sold commercial land REO in Nevada for approximately $4.0 million, to an unrelated third party. As part of this transaction, we paid our manager and Vestin Originations a total of $160,000 in administrative fees. On April 27, 2010, we, VRM I and Fund III sold our commercial land REO property located in Texas to an unrelated third party for approximately $0.6 million, of which our portion was approximately $0.3 million. No gain or loss was associated with this transaction. During the year ended December 31, 2010, our manager continually evaluated the carrying value of our commercial land REO and based on its estimates and updated appraisals on these properties, one was written down approximately $1.5 million. As of December 31, 2010, we held three properties, classified as commercial land REO, located in Arizona and Nevada totaling approximately $4.4 million.
|
|
|
·
|
Residential Land – On January 15, 2010, four properties located in Nevada were sold to an unrelated third party for their approximate book value of a combined $2.1 million, of which our portion was approximately $1.7 million. No gain or loss was associated with these transactions. During April 2010, we acquired through foreclosure two properties located in Nevada with a net book value of approximately $5.2 million. During July 2010, one property located in Nevada was sold to an unrelated third party for approximately $3.7 million, resulting in a gain of $73,000. The other property was sold to an unrelated third party for approximately $1.1 million, resulting in a loss of $8,000. During the year ended December 31, 2010, our manager continually evaluated the carrying value of our residential land REO and based on its estimates and updated appraisals three of these properties were written down a total of approximately $1.6 million. As of December 31, 2010, we held four properties, classified as residential land REO, located in Arizona and California totaling approximately $8.4 million.
|
Residential Building
As of December 31, 2010, we had no REO properties classified as a Residential Building. During the year ended December 31, 2010, our manager continually evaluated the carrying value of the Residential Building REO properties we held, and based on its estimates and updated appraisals, no write-downs were deemed necessary.
|
|
·
|
Single Family Residential Properties – During the three months ended March 31, 2010, we and VRM I sold all the units on our Washington property for a total of approximately $1.0 million, of which our portion was approximately $0.8 million. These transactions resulted in a net gain for us of $96,000. During April and May 2010, we, VRM I and Fund III sold the two remaining units on our REO property located in California to an unrelated third party for a total of $325,000, of which our portion was $278,000. These transactions resulted in a net gain for us of $21,000. As of December 31, 2010, we had no single family residential properties.
|
|
|
·
|
Residential Apartment/Condo – On April 23, 2010, we, VRM I and Fund III sold the remaining unit on one REO property located in Nevada to an unrelated third party for its approximate book value of $81,000, of which our portion was $78,000. There was no gain or loss associated with this transaction. On August 25, 2010, we, VRM I and Fund III sold a REO property located in Nevada to an unrelated third party for approximately $1.3 million, of which our portion was $1.0 million. This transaction resulted in a net loss for us of $41,000. On August 5, 2010, we and VRM I completed our foreclosure of a property secured by a non-performing construction loan in Nevada and classified it as residential apartment/condo REO totaling approximately $1.7 million, of which our portion was approximately $1.6 million, net of prior allowance for loan loss. During September 2010, we and VRM I sold this property to an unrelated third party for approximately $1.6 million, of which our portion was approximately $1.5 million. This transaction resulted in a net loss for us of $120,000. As of December 31, 2010, we had no residential apartment/condo properties.
|
NOTE G — ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS
As discussed in Note O – Legal Matters Involving the Company, during July 2010, we, VRM I and Vestin Mortgage acquired through foreclosure the RightStar property, which includes 4 cemeteries and 8 mortuaries in Hawaii. Subsequent to our foreclosure of this property, we and VRM I acquired our manager’s interest in this property for $500,000, of which our portion was $375,000. Our manager recorded no gain or loss as a result of this transaction. At the time of foreclosure, the RightStar assets were moved into Hawaii Funeral Services, LLC (“HFS”) of which we held 62% and VRM I held 38%.
Effective January 1, 2009, we adopted FASB's accounting standard related to business combination which required acquisition method of accounting to be used for all business combinations and for an acquirer to be identified for each business combination. This accounting standard requires an acquirer to recognize the assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. It also requires the acquirer in a business combination achieved in stages (sometimes referred to as a step acquisition) to recognize the identifiable assets and liabilities, as well as the non-controlling interest in the acquiree, at the full amounts of their fair values (or other amounts determined in accordance with the standard).
Our acquisition of HFS was accounted for in accordance with this standard and the Company has allocated the purchase price of HFS based upon the estimated fair value of the net assets acquired and liabilities assumed and the fair value of the noncontrolling interest measured at the acquisition date. The estimated fair value of HFS at the time of the acquisition totaled $14.1 million.
We performed an allocation as of the foreclosure date as follows:
|
Cash
|
$ | 1,032,000 | ||
|
Preneed receivables
|
4,063,000 | |||
|
Other receivable
|
1,037,000 | |||
|
Inventory
|
22,000 | |||
|
Property and equipment
|
8,390,000 | |||
|
Other assets
|
523,000 | |||
|
Accounts payable and accrued liabilities
|
(842,000 | ) | ||
|
Deferred preneed revenues
|
(72,000 | ) | ||
|
Net assets
|
$ | 14,153,000 |
In addition, we estimated the fair value of the non-controlling interest at $5.4 million.
Immediately upon foreclosure, we committed to a plan to sell all interests in HFS, at which point we began classifying the related assets of HFS as assets held for sale, and the related liabilities as liabilities related to assets held for sale. Additionally, we have classified HFS’s results as discontinued operations.
Assets and groups of assets and liabilities which comprise disposal groups are classified as “held for sale” when all of the following criteria are met: a decision has been made to sell, the assets are available for sale immediately, the assets are being actively marketed at a reasonable price in relation to the current fair value, a sale has been or is expected to be concluded within twelve months of the balance sheet date, and significant changes to the plan to sell are not expected. Assets held for sale are not depreciated.
Additionally, the operating results and cash flows related to these assets and liabilities are included in discontinued operations in the consolidated statements of operations and consolidated statements of cash flows for the year ended December 31, 2011.
The following is summary of net assets held for sale through November 30, 2011:
|
November 30, 2011
|
||||
|
Assets:
|
||||
|
Current Assets
|
$ | 3,772,000 | ||
|
Preneed cemetery receivables, net
|
3,324,000 | |||
|
Cemetery property, at cost
|
3,140,000 | |||
|
Property and equipment
|
5,335,000 | |||
|
Deferred charges and other assets
|
1,066,000 | |||
|
Cemetery trust investments
|
44,210,000 | |||
|
Total assets
|
$ | 60,847,000 | ||
|
Liabilities:
|
||||
|
Accounts payable and accrued liabilities
|
$ | 1,120,000 | ||
|
Deferred preneed cemetery revenues
|
1,752,000 | |||
|
Trusts’ corpus
|
46,228,000 | |||
|
Total liabilities
|
49,100,000 | |||
|
Net assets held for sale
|
$ | 11,747,000 | ||
On December 1, 2011, we and VRM I closed the sale of its membership interests in HFS, including the variable interest entities of HFS, to NorthStar Hawaii, LLC (“NorthStar”). The sale was effected pursuant to a Membership Interest Purchase Agreement dated October 3, 2011. We received the entire purchase price at the closing resulting in net proceeds of $8,866,000. In addition to the net proceeds, we retained approximately $806,000 of the cash balance held by HFS and assumed accounts payables of approximately $38,000. Pursuant to terms of the agreement, we have an option to repurchase HFS under certain conditions from NorthStar in consideration of the full amount of the sales price for a period of 15 months following the closing of the transaction. As a result of this option, our net gain of approximately $102,000 has been recognized as “Deferred gain on sale of HFS” on the balance sheet. The gain will be recognized upon the expiration of this option.
As discussed in Note O – Legal Matters Involving the Company, in April 2006, the lenders of the loans made to RightStar, Inc. (“RightStar”) filed suit against the State of Hawaii listing 26 causes of action, including allegations that the State of Hawaii has illegally blocked the lender’s right to foreclose and take title to its collateral by inappropriately attaching conditions to the granting of licenses needed to operate the business, the pre-need trust funds and the perpetual care trust funds and that the State of Hawaii has attempted to force the lenders to accept liability for any statutory trust fund deficits while no such lender liability exists under the laws of the State of Hawaii. The State of Hawaii responded by filing allegations against Vestin Mortgage and us alleging that these Vestin entities improperly influenced the former RightStar trustees to transfer trust funds to us.
On May 9, 2007, we, VRM I, Vestin Mortgage, the State of Hawaii and Comerica Incorporated (“Comerica”) announced that an arrangement had been reached to auction the RightStar assets. The auction was not successful. On June 12, 2007, the court approved the resolution agreement, which provides that the proceeds of the foreclosure sale would be allocated in part to VRM I, Vestin Mortgage and us and in part to fund the trust’s statutory minimum balances. We, VRM I, Vestin Mortgage, the State of Hawaii and Comerica have pledged to cooperate to recover additional amounts owed to the trusts and the creditors from others. Should the recovery meet or exceed $9 million, all parties have agreed that no further litigation between the state of Hawaii and Vestin will be reinstituted related to the trust’s statutory minimum balances. The Vestin entities and the State of Hawaii signed a new agreement that would permit the foreclosure to proceed. On October 12, 2009, the State Court approved the agreement permitting the foreclosure to proceed. On January 25, 2010, the Circuit Court of the First Circuit for the State of Hawaii confirmed the right of us, VRM I and Vestin Mortgage, to acquire through foreclosure the RightStar assets.
An alleged trust deficiency ranging from $24.4 million to $32.7 million may have existed prior to our acquiring the RightStar properties through foreclosure. Under state law, such deficiencies are generally required to be funded. However, due to the agreement with the state of Hawaii and certain actuarial information obtained from third parties, no accrual has been recorded as of December 31, 2011.
We, VRM I., and our manager (collectively, “Vestin”) entered into a settlement agreement with Alternative Debt Portfolios, L.P. and Alternative Debt Portfolios, LLC (collectively, “ADP”). On September 22, 2008 a judgment was entered by the Hawaii Circuit Court in favor of Vestin against ADP in the amount of $1,119,000 plus interest. ADP filed an appeal with the Intermediate Court of Appeals for the State of Hawaii and put up a cash bond of $1,972,000. Both Vestin and ADP agreed to settle the appeal and on November 28, 2011 a Settlement and Mutual Release Agreement was agreed to whereby ADP received $800,000 from the cash bond. Vestin received the remainder of the cash bond, less fees pertaining to the settlement, in the amount of approximately $0.1 million. The parties agreed to a full release as part of the settlement.
NOTE H — RELATED PARTY TRANSACTIONS
From time to time, we may acquire or sell investments in real estate loans from/to our manager or other related parties. Pursuant to the terms of our Management Agreement, such acquisitions and sales are made without any mark up or mark down. No gain or loss is recorded on these transactions, as it is not our intent to make a profit on the purchase or sale of such investments. The purpose is generally to diversify our portfolio by syndicating loans, thereby providing us with additional capital to make additional loans.
Transactions with the Manager
Our manager is entitled to receive from us an annual management fee of up to 0.25% of our aggregate capital contributions received by us and Fund II from the sale of shares or membership units, paid monthly. The amount of management fees paid to our manager for the years ended December 31, 2011 and 2010, were $1.1 million, during each period.
As of December 31, 2011 and 2010, our manager owned 92,699 of our common shares, representing approximately 0.73% and 0.71%, respectively, of our total outstanding common stock. For the years ended December 31, 2011 and 2010, we declared $0 in dividends payable to our manager based on the number of shares our manager held on the dividend record dates.
On February 12, 2010, we sold commercial land held for sale in Nevada for approximately $4.0 million, to an unrelated third party. As part of this transaction, we paid our manager and Vestin Originations a total of $160,000 in administrative fees.
On April 1, 2010, we funded a borrower’s extension fee of approximately $0.5 million, which was paid to our manager. The amount was added to the loan balance, which was paid in full during June 2010.
During July 2010, we, VRM I and Vestin Mortgage acquired through foreclosure the RightStar property, which includes 4 cemeteries and 8 mortuaries in Hawaii, with a net book value of approximately $14.1 million, of which our portion was approximately $8.5 million. Subsequent to our foreclosure of this property, we and VRM I, acquired our manager’s interest in this property for $500,000, of which our portion was $375,000. Our manager recorded no gain or loss as a result of this transaction.
During the years ended December 31, 2010, our manager received administrative fees of approximately $0.5 million, related to the sale of VRM I, Fund III and our REO properties. Our pro-rata share of these fees totaled approximately $0.3 million. There were no similar transactions in 2011. There were also no similar fees paid to Vestin Originations during the years ended December 31, 2011and 2010. See Note F – Real Estate Held for Sale.
As of December 31, 2011, we had receivables from our manager of approximately $19,000. As of December 31, 2010, we had receivables from our manager of approximately $5,000.
Transactions with Other Related Parties
As of December 31, 2011 and, 2010, we owned 538,178 and 533,675, respectively, common shares of VRM I, representing approximately 8.5% and 8.4%, respectively, of their total outstanding common stock. For the years ended December 31, 2011 and 2010, we recognized no dividend income from VRM I based on the number of shares we held on the dividend record dates.
As of December 31, 2011 and 2010, VRM I owned 537,078 and 225,134, respectively, of our common shares, representing approximately 4.2% and 1.7%, respectively, of our total outstanding common stock. For the years ended December 31, 2011 and 2010, we declared no dividends payable to VRM I based on the number of shares VRM I held on the dividend record dates.
During the year ended December 31, 2010, we sold approximately $2.0 million in real estate loans to VRM I. We had no similar transactions in 2011. No gain or loss resulted from the 2010 transactions.
As of December 31, 2011, we had receivables from VRM I of approximately $0.1 million, primarily related to legal fees. As of December 31, 2010, we had receivables from VRM I of approximately $0.7 million, primarily related to legal fees.
As of December 31, 2011 and 2010, Fund III owned 114,117 of our common shares, representing approximately 0.9% of our total outstanding common stock. For the years ended December 31, 2011 and 2010, we declared $0, in dividends payable to Fund III based on the number of shares Fund III held on the dividend record dates.
During the year ended December 31, 2010, we purchased approximately $0.2 million in real estate loans from Fund III. We had no similar transactions in 2011. No gain or loss resulted from the 2010 transactions.
As of December 31, 2011, we had a payable to Fund III of $13,000. As of December 31, 2010, we had a payable to Fund III of $37,000.
During December 2011, we, and VRM I completed the sale of our membership interests in HFS to NorthStar. We, paid Advant Mortgage a commission fee of $489,000, shared pro-rata among us and VRM I.
During the year ended December 31, 2011, we sold $500,000 of performing loans to a trust in which a director is one of the trustees. No gain or loss resulted from these transactions. No such transaction occurred during the year December 31, 2010.
NOTE I — NOTES RECEIVABLE
During December 2006, we and VRM I entered into a settlement agreement in the amount of $1.5 million with the guarantors of a loan collateralized by a 126 unit (207 bed) assisted living facility in Phoenix, AZ, which we had foreclosed on. Our portion was approximately $1.3 million. The promissory note is payable in seven annual installments of $100,000 with an accruing interest rate of 7%, with the remaining note balance due in April 2013. During 2011, we had received $88,000 in regularly scheduled principal payments. Also during 2011, an agreement which would accept approximately $0.4 million as a final payment for the note was approved, of which approximately $0.3 million was received. The balance of this agreement of approximately $68,000 was fully reserved as of December 31, 2011. Payments will be recognized as income when received.
During July 2009, we, VRM I, and Fund III entered into a promissory note, totaling approximately $1.4 million, of which our portion is approximately $1.3 million, with the borrowers of a construction loan, as part of the repayment terms of the loan. In addition, we received a principal pay off on the loan of approximately $3.9 million, which reflected our book value of the loan, net of allowance for loan loss of approximately $2.4 million. The promissory note accrues interest over a 60-month period with an interest rate of 7%, with the first monthly payment due on the 37th month. The remaining note balance and accrued interest will be due at maturity. Payments will be recognized as income when received. The balance of approximately $1.3 million was fully reserved as of December 31, 2011.
During July 2009, we, VRM I, and Fund III entered into a promissory note, totaling approximately $1.3 million, of which our portion is approximately $1.2 million, with the borrowers of a construction loan, as part of the repayment terms of the loan. In addition, we received a principal pay off on the loan of approximately $1.6 million, which reflected our book value of the loan, net of allowance for loan loss of approximately $2.8 million. The promissory note accrues interest over a 60-month period with an interest rate of 7%, with the first monthly payment due on the 37th month. The remaining note balance and accrued interest will be due at maturity. Payments will be recognized as income when received. The balance of approximately $1.2 million was fully reserved as of December 31, 2011.
During December 2009, we and VRM I entered into a promissory note with the borrowers of a land loan, totaling approximately $6.1 million, of which our portion is approximately $5.6 million, as part of the sale of the land collateralizing the loan. In addition, we and VRM I received a principal payoff of $2.0 million, of which our portion was approximately $1.8 million, on the land loan. The remaining balance of approximately $1.2 million, of which our portion is approximately $1.1 million, was refinanced as a loan to the new owners of property. The promissory note is for a 60-month period, with an interest rate of 6.0%, with the first monthly payment due on December 10, 2014. Payments will be recognized as income when they are received. The balance of approximately $5.6 million was fully reserved as of December 31, 2011.
During July 2010, we entered into a promissory note, totaling $48,000 with the guarantor of a previous land loan. The remaining note balance of $2,500 as of December 31, 2011 will be paid in monthly installments of $500 each through May 2012.
As of November 30, 2010, we had five loans totaling approximately $19.0 million, of which our portion is approximately $1.1 million, before allowances totaling approximately $4.2 million, of which our portion is approximately $0.2 million, and were guaranteed by common guarantors. Pursuant to agreements entered into on March 16, 2009 and July 2, 2009, which modified these loans, three of these loans continued to be secured by real property and two became unsecured due to the permanent financing being obtained for less than the outstanding balance on the loans. On November 30, 2010, we entered into additional agreements to modify the terms related to these five loans in order to further enhance our investment. Pursuant to these additional agreements, we obtained an additional guarantor, interest in operating profits and any aggregate sales proceeds of $10.4 million less operating profits previously received related to these properties. The new guarantor is the managing member of the borrowing entities who is also the principal manager of L.L. Bradford and was a former officer of our manager from April 1999 through January 2005.In the event the total proceeds from the operating profits and sales proceeds do not equal $10.4 million, each borrower will execute a promissory note to pay us the deficiency, which shall be guaranteed by the guarantors, including the new guarantor. In addition, we agreed to release our deeds of trust on two of the three loans secured by real estate totaling $9.0 million, of which our portion is $0.5 million. As a result of releasing our deeds of trust we classified these loans as unsecured notes receivable for the same amount and recognized a full allowance on this balance.
During 2011, it was determined we lost our collateral related to investments in two second deeds of trust due to foreclosures by the holders of the first deeds of trust. At the time of this determination, the net balances of these investments were fully reserved. The guarantor on these investments had stopped making payments and, as a result, the balances totaling approximately $3.9 million were fully charged off as of December 31, 2011.
During March 2011, we were awarded a deficiency judgment totaling $5.0 million related to a REO sold in a prior period. The balance accrues interest at the rate of 9% until paid in full. Provided all payments of approximately $3.0 million as outlined in the judgment are received, the remaining balance of judgment shall be forgiven. The balance of approximately $2.9 million was fully reserved as of December 31, 2011.
During March 2011, we were awarded a deficiency judgment totaling $2.8 million related to a REO sold in a prior period. The balance accrues interest at the rate of 9% until paid in full. Provided all payments of approximately $1.2 million as outlined in the judgment are received, the remaining balance of judgment shall be forgiven. The balance of approximately $1.2 million was fully reserved as of December 31, 2011.
NOTE J— SECURED BORROWINGS
Secured borrowings provide an additional source of capital for our lending activity. Secured borrowings allow us to increase the diversification of our loan portfolio and to invest in loans that we might not otherwise invest in. We do not receive any fees for entering into secured borrowing arrangements; however, we may receive revenue in any differential of the interest spread, if applicable. Loans in which unaffiliated investors have participated through inter-creditor agreements (“Inter-creditor Agreements”) are accounted for as secured borrowings. The Inter-creditor Agreements provide us additional funding sources for real estate loans whereby an unaffiliated investor (the “Investor”) may participate on a non-paripassu basis in certain real estate loans with us and/or VRM I (collectively, the “Lead Lenders”). In the event of borrower non-performance, the Inter-creditor Agreements generally provide that the Lead Lenders must repay the Investor’s loan amount either by (i) continuing to remit to the Investor the interest due on the participated loan amount; (ii) substituting an alternative loan acceptable to the Investor; or (iii) repurchasing the participation from the Investor for the outstanding balance plus accrued interest.
Additionally, an Investor may participate in certain loans with the Lead Lenders through Participation Agreements. In the event of borrower non-performance, the Participation Agreement may allow the Investor to be repaid up to the amount of the Investor’s investment prior to the Lead Lender being repaid. Real estate loan financing under the Participation Agreements are also accounted for as a secured borrowing. We do not receive any revenues for entering into secured borrowings arrangements.
During June 2008, we, our manager, and Vestin Originations entered into an intercreditor agreement with an unrelated third party related to the funding of six real estate loans. (See exhibit 10.5 Intercreditor Agreement under the Exhibit Index included in Part IV, Item 15 of this Report Form 10-K). The participation interest is at 11% on the outstanding balance. We incurred approximately $0.9 million in finance costs related to the secured borrowings; these costs were being amortized to interest expense over the term of the agreements. As of December 31, 2011, and 2010, we had approximately $0.0 million and $1.3 million, respectively, in funds, including approximately $0.0 million and $0.2 million, respectively in interest reserves, used under Inter-creditor agreements.
On September 20, 2011 we repurchased the secured borrowings for approximately $1.1 million. Interest expense for the year ended December 31, 2011 and 2010 amounted to approximately $88,000 and $0.6 million, respectively.
NOTE K — NOTES PAYABLE
In April 2011, we financed a 12-month insurance policy for Directors and Officers liability, with an annual interest rate of 3.2%. The agreement required a down payment of $82,000 and nine monthly payments of $28,000 beginning on May 27, 2011. As of December 31, 2011, the outstanding balance of the note was $25,000. During January 2012, the outstanding balance of the note was paid in full.
On December 3, 2010, we and VRM I mortgaged a mixed-use land held for sale property for $1.6 million, of which our portion was approximately $1.3 million. The note has an interest rate of 9%, payable monthly and a maturity date of December 2, 2011. As of December 31, 2011 this note had been paid in full. Interest expense for the year ended December 31, 2011 amounted to approximately $107,000.
NOTE L — FAIR VALUE
As of December 31, 2011 and 2010, financial assets and liabilities utilizing Level 1 inputs included investment in marketable securities - related party. We had no assets or liabilities utilizing Level 2 inputs, and assets and liabilities utilizing Level 3 inputs included investments in real estate loans and secured borrowings.
To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, our degree of judgment exercised in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an asset or liability will be classified in its entirety based on the lowest level of input that is significant to the measurement of fair value.
Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, our own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. We use prices and inputs that are current as of the measurement date, including during periods of market dislocation, such as the recent illiquidity in the auction rate securities market. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition may cause our financial instruments to be reclassified from Level 1 to Level 2 or Level 3 and/or vice versa.
Our valuation techniques will be consistent with at least one of the three possible approaches: the market approach, income approach and/or cost approach. Our Level 1 inputs are based on the market approach and consist primarily of quoted prices for identical items on active securities exchanges. Our Level 2 inputs are primarily based on the market approach of quoted prices in active markets or current transactions in inactive markets for the same or similar collateral that do not require significant adjustment based on unobservable inputs. Our Level 3 inputs are primarily based on the income and cost approaches, specifically, discounted cash flow analyses, which utilize significant inputs based on our estimates and assumptions.
The following table presents the valuation of our financial assets and liabilities as of December 31, 2011, measured at fair value on a recurring basis by input levels:
|
Fair Value Measurements at Reporting Date Using
|
||||||||||||||||||||
|
Quoted Prices in Active Markets For Identical Assets (Level 1)
|
Significant Other Observable Inputs (Level 2)
|
Significant Unobservable Inputs (Level 3)
|
Balance at 12/31/2011
|
Carrying Value on Balance Sheet at 12/31/2011
|
||||||||||||||||
|
Assets
|
||||||||||||||||||||
|
Investment in marketable securities - related party
|
$ | 592,000 | $ | -- | $ | -- | $ | 592,000 | $ | 592,000 | ||||||||||
|
Investment in real estate loans
|
$ | -- | $ | -- | $ | 30,646,000 | $ | 30,646,000 | $ | 31,777,000 | ||||||||||
The following table presents the changes in our financial assets and liabilities that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) from January 1, 2011 to December 31, 2011:
|
Assets
|
||||||||
|
Investment in
real estate loans
|
Assets under secured borrowings
|
|||||||
|
Balance on January 1, 2011
|
$ | 26,624,000 | $ | 1,320,000 | ||||
|
Change in temporary valuation adjustment included in net loss
|
||||||||
|
Increase in allowance for loan losses
|
(1,028,000 | ) | -- | |||||
|
Purchase and additions of assets
|
||||||||
|
Transfer of allowance on real estate loans to real estate held for sale
|
2,736,000 | -- | ||||||
|
Reduction of allowance on real estate loans due to loan payment
|
249,000 | -- | ||||||
|
New mortgage loans and mortgage loans acquired
|
13,723,000 | -- | ||||||
|
Transfer of allowance on real estate loans converted to unsecured notes receivable
|
3,940,000 | -- | ||||||
|
Sales, pay downs and reduction of assets
|
||||||||
|
Collections and settlements of principal and sales of investment in real estate loans
|
(9,046,000 | ) | -- | |||||
|
Conversion of real estate loans to unsecured notes receivable
|
(3,940,000 | ) | -- | |||||
|
Transfer of real estate loans to real estate held for sale
|
(2,896,000 | ) | -- | |||||
|
Payments on assets under secured borrowings
|
(1,320,000 | ) | ||||||
|
Temporary change in estimated fair value based on future cash flows
|
284,000 | -- | ||||||
|
Transfer to Level 1
|
-- | -- | ||||||
|
Transfer to Level 2
|
-- | -- | ||||||
|
Balance on December 31, 2011, net of temporary valuation adjustment
|
$ | 30,646,000 | $ | -- | ||||
|
Liabilities
|
||||
|
Secured borrowings
|
||||
|
Balance on January 1, 2011
|
$ | 1,088,000 | ||
|
Payment on secured borrowings
|
(1,088,000 | ) | ||
|
Balance on December 31, 2011, net of temporary valuation adjustment
|
$ | -- | ||
The following table presents the valuation of our financial assets and liabilities as of December 31, 2010, measured at fair value on a recurring basis by input levels:
|
Fair Value Measurements at Reporting Date Using
|
||||||||||||||||||||
|
Quoted Prices in Active Markets For Identical Assets (Level 1)
|
Significant Other Observable Inputs (Level 2)
|
Significant Unobservable Inputs (Level 3)
|
Balance at 12/31/2010
|
Carrying Value on Balance Sheet at 12/31/2010
|
||||||||||||||||
|
Assets
|
||||||||||||||||||||
|
Investment in marketable securities - related party
|
$ | 539,000 | $ | -- | $ | -- | $ | 539,000 | $ | 539,000 | ||||||||||
|
Investment in real estate loans
|
$ | -- | $ | -- | $ | 26,624,000 | $ | 26,624,000 | $ | 26,719,000 | ||||||||||
|
Assets under secured borrowings
|
$ | -- | $ | -- | $ | 1,320,000 | $ | 1,320,000 | $ | 1,320,000 | ||||||||||
|
Liabilities
|
||||||||||||||||||||
|
Secured borrowings
|
$ | -- | $ | -- | $ | 1,088,000 | $ | 1,088,000 | $ | 1,088,000 | ||||||||||
The following table presents the changes in our financial assets and liabilities that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) from January 1, 2010 to December 31, 2010:
|
Assets
|
||||||||
|
Investment in
real estate loans
|
Assets under secured borrowings
|
|||||||
|
Balance on January 1, 2010
|
$ | 52,460,000 | $ | 8,370,000 | ||||
|
Change in temporary valuation adjustment included in net loss
|
||||||||
|
Increase in allowance for loan losses
|
(8,300,000 | ) | -- | |||||
|
Purchase and additions of assets
|
||||||||
|
Transfer of real estate loans to real estate held for sale
|
(18,333,000 | ) | -- | |||||
|
Transfer of allowance on real estate loans to real estate held for sale
|
9,302,000 | -- | ||||||
|
New mortgage loans and mortgage loans bought
|
8,528,000 | -- | ||||||
|
Transfer of real estate loan to assets held for sale
|
(17,290,000 | ) | -- | |||||
|
Transfer of allowance on real estate loan to assets held for sale
|
9,756,000 | -- | ||||||
|
Assets under secured borrowings
|
6,822,000 | -- | ||||||
|
Sales, pay downs and reduction of assets
|
||||||||
|
Collections of principal and sales of investment in real estate loans
|
(31,575,000 | ) | -- | |||||
|
Reduction of allowance for loan losses related to sales and payments of investment in real estate loans
|
14,600,000 | -- | ||||||
|
Payments on assets under secured borrowings
|
-- | (7,050,000 | ) | |||||
|
Temporary change in estimated fair value based on future cash flows
|
654,000 | -- | ||||||
|
Transfer to Level 1
|
-- | -- | ||||||
|
Transfer to Level 2
|
-- | -- | ||||||
|
Balance on December 31, 2010, net of temporary valuation adjustment
|
$ | 26,624,000 | $ | 1,320,000 | ||||
|
Liabilities
|
||||
|
Secured borrowings
|
||||
|
Balance on January 1, 2010
|
$ | 7,910,000 | ||
|
Payment on secured borrowings
|
(6,822,000 | ) | ||
|
Balance on December 31, 2010, net of temporary valuation adjustment
|
$ | 1,088,000 | ||
NOTE M - RECENT ACCOUNTING PRONOUNCEMENTS
In May 2011, FASB issued ASU 2011-04 “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” The amendments in this update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the Board does not intend for the amendments in this update to result in a change in the application of the requirements in Topic 820. Some of the amendments clarify the Board’s intent about the application of existing fair value measurement requirements. Other amendments change a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. For public entities, the new guideline is effective for interim and annual periods beginning after December 15, 2011 and should be applied prospectively. The Company does not expect that the guidance effective in future periods will have a material impact on its consolidated financial statements.
In May 2011, the FASB issued ASC Update No. 2011-05, Comprehensive Income (Topic 820): Presentation of Comprehensive Income. Update No. 2011-05 requires that net income, items of other comprehensive income and total comprehensive income be presented in one continuous statement or two separate consecutive statements. The amendments in this Update also require that reclassifications from other comprehensive income to net income be presented on the face of the financial statements. We are required to adopt Update No. 2011-05 for our first quarter ending March 31, 2012, with the exception of the presentation of reclassifications on the face of the financial statements, which has been deferred by the FASB under ASC Update No. 2011-12, Comprehensive Income (Topic 820): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income. Our adoption of Update No. 2011-05 will not impact our future results of operations or financial position.
In December 2011, the Financial Accounting Standards Board (“FASB”) released Accounting Standards Update No. 2011-10 (“ASU 2011-10”), Property, Plant and Equipment (Topic 360): Derecognition of in Substance Real Estate—a Scope Clarification (a consensus of the FASB Emerging Issues Task Force). ASU 2011-10 clarifies when a parent (reporting entity) ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt, the reporting entity should apply the guidance for Real Estate Sale (Subtopic 360-20). The provisions of ASU 2011-10 are effective for public companies for fiscal years and interim periods within those years, beginning on or after June 15, 2012. When adopted, ASU 2011-10 is not expected to materially impact our consolidated financial statements.
NOTE N — LEGAL MATTERS INVOLVING THE MANAGER
The United States Securities and Exchange Commission (the “Commission”), conducted an investigation of certain matters related to us, our manager, Vestin Capital, VRM I, and Fund III. We fully cooperated during the course of the investigation. On September 27, 2006, the investigation was resolved through the entry of an Administrative Order by the Commission (the “Order”). Our manager, Vestin Mortgage and its Chief Executive Officer, Michael Shustek, as well as Vestin Capital (collectively, the “Respondents”), consented to the entry of the Order without admitting or denying the findings therein.
In the Order, the Commission found that the Respondents violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 through the use of certain slide presentations in connection with the sale of units in Fund III and in our predecessor, Vestin Fund II, LLC. The Respondents consented to the entry of a cease and desist order, the payment by Mr. Shustek of a fine of $100,000 and Mr. Shustek’s suspension from association with any broker or dealer for a period of six months, which expired in March 2007. In addition, the Respondents agreed to implement certain undertakings with respect to future sales of securities. We are not a party to the Order.
The Manager and Fund III were defendants in a civil action filed by Birkeland Family, LLC III and Birkeland Family, LLC V (“Plaintiffs”) in District Court for Clark County, Nevada. The Plaintiffs alleged as causes of action against the Manager and Fund III: Breach of contract and breach of the implied covenant of good faith and fair dealing regarding the sale of the office building commonly described as 8379 W. Sunset Road, Las Vegas, Nevada. The action sought monetary, punitive and exemplary damages. On January 18, 2011, summary judgment was granted in favor of Fund III, with the Court finding that Fund III was not part of the lease and, therefore, could not be held liable for damages. The Manager is still involved in this civil action. Fund III is attempting to recover legal fees associated with this matter. Any fees not recovered will be reimbursed by the Manager.
For additional information, see Note O – Legal Matters Involving the Company
In addition to the matters described above, our manager is involved in a number of other legal proceedings concerning matters arising in connection with the conduct of its business activities. Our manager believes it has meritorious defenses to each of these actions and intends to defend them vigorously. Other than the matters described above, our manager believes that it is not a party to any pending legal or arbitration proceedings that would have a material adverse effect on our manager’s financial condition or results of operations or cash flows, although it is possible that the outcome of any such proceedings could have a material impact on our manager’s net income in any particular period.
NOTE O — LEGAL MATTERS INVOLVING THE COMPANY
We, VRM I and Vestin Mortgage (“Defendants”) were defendants in a breach of contract class action filed in San Diego Superior Court by certain plaintiffs who alleged, among other things, that they were wrongfully denied roll-up rights in connection with the merger of Fund I into VRM I and Fund II into VRM II. The court certified a class of all former Fund I unit holders and Fund II unit holders who voted against the mergers of Fund I into VRM I and Fund II into VRM II. The trial began in December 2009 and concluded in January 2010. On February 11, 2010, the Defendants were notified of a Tentative Statement of Decision, in their favor issued by the Superior Court for the State of California in San Diego following a trial. In the Tentative Statement, the Court found that there was no roll-up and therefore no breach of contract. The Court entered final judgment for the Defendants on March 18, 2010. Defendants and Plaintiffs agreed to a post-judgment settlement by which Plaintiffs agreed not to appeal the judgment in consideration of a waiver by the Defendants of any claim to recover actual court costs from the Plaintiffs. The Court granted final approval of this settlement of post-judgment rights on July 9, 2010.
We, Vestin Mortgage and Michael V. Shustek (“Defendants”) were defendants in a civil action filed by 88 sets of plaintiffs representing approximately 138 individuals (“Plaintiffs”), in District Court for Clark County, Nevada (the “Nevada Lawsuit”). The Plaintiffs alleged, among other things, that Defendants: breached certain alleged contractual obligations owed to Plaintiffs; breached fiduciary duties supposedly owed to Plaintiffs; and misrepresented or omitted material facts regarding the conversion of Fund II into VRM II. The action sought monetary and punitive damages. The court dismissed the claim for punitive damages. On September 8, 2010, the parties agreed to settle the case. The Settlement Agreement provides for the settlement and complete release of all claims against the Defendants. The settlement was made without admission of liability by Defendants.
In addition to the matters described above, we are involved in a number of other legal proceedings concerning matters arising in the ordinary course of our business activities. We believe we have meritorious defenses to each of these actions and intend to defend them vigorously. Other than the matters described above, we believe that we are not a party to any pending legal or arbitration proceedings that would have a material adverse effect on our financial condition or results of operations or cash flows, although it is possible that the outcome of any such proceedings could have a material impact on our operations in any particular period.
NOTE P— SUBSEQUENT EVENTS
The following subsequent events have been evaluated through the date of this filing with the SEC.
During January 2012 we, VRM I and VF III modified one of our existing loans. The interest rate of this loan was changed from 3% paying monthly with 5% accruing to 7% paid monthly. The interest currently accrued on the existing loan, which was fully allowed for, of approximately $1.0 million will be moved to notes receivable with the balance remaining fully allowed for.
During January 2012, we paid our manager approximately $550,000 of management fees for services to be performed from January through June 2012. A discount of 7% will be applied to the July 2012 payment.
On February 7, 2012, we, VRMI and VFIII entered into a Deed in Lieu Agreement with a borrower for a second deed of trust loan that matured on December 31, 2011 with a balance of approximately $11.8 million, of which our portion was approximately $10.7 million. These assets are subject to a first trust deed of approximately $39 million. The property includes a 430 unit full service hotel located in Ft. Worth, Texas. The hotel includes operations which will be consolidated into our financial statements from the date of this agreement. The property will be held for sale and pursuant to the terms of the agreement the net proceeds from the sale shall be distributed as follows through July 31, 2012: (i) satisfy all amounts due on the first deed of trust, (ii) $11 million to us, VRMI and VFIII, (iii) $3 million to the former borrower and (iv) all remaining amounts will be divided with 50% going to us, VRMI and VFIII and 50% going to the former borrower. Following July 31, 2012, the net proceeds from the sale will be distributed similar to other real estate sale transactions.
During January 2012, we purchased 60,000 shares of Annaly Capital Management Inc. This company is a publicly traded REIT and the shares were deemed to be part of our 3% working capital reserve. During February 2012, we sold all of our shares for a gain of approximately $21,000.
Our Board of Directors has been exploring releasing our status as a REIT. We expect a resolution will be made by March 30, 2012 to terminate our REIT status based on legal advice to be received by this date. As such, the Company will not be taxed as a REIT for the year ending December 31, 2012. The required filings to make this resolution effective have been prepared and submitted to the Internal Revenue Service as of the date of this filing
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
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ITEM 9A.
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CONTROLS AND PROCEDURES
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Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required financial disclosure. In connection with the preparation of this Report on Form 10-K, our manager carried out an evaluation, under the supervision and with the participation of our CEO and CFO, as of December 31, 2011, of the effectiveness of the design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-15(e) under the Exchange Act. Based upon our evaluation, our CEO and CFO concluded that, as of December 31, 2011, our disclosure controls and procedures were not effective to provide reasonable assurance that information we are required to disclose in our reports under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our CFO and CEO, as appropriate to allow timely decisions regarding required disclosure due to the material weakness in our internal control over financial reporting as described below.
Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within our company have been or will be detected. Even effective internal control over financial reporting can only provide reasonable assurance with respect to financial statement preparation. Furthermore, because of changes in conditions, the effectiveness of internal control over financial reporting may vary over time. Our manager, CEO and CFO do not expect that our controls and procedures will prevent all errors.
The certifications of our CEO and CFO required under Section 302 of the Sarbanes-Oxley Act have been filed as Exhibits 31.1 and 31.2 to this report.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for our Company, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes those policies and procedures that: pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of our Company; provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of our Company are being made only in accordance with authorizations of management and directors of our Company; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our Company's assets that could have a material effect on our financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management has conducted an assessment, including testing, of the effectiveness of our internal control over financial reporting as of December 31, 2011. In making its assessment of internal control over financial reporting, management used the criteria in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this assessment, management, with the participation of the Chief Executive and Chief Financial Officers, believes that, as of December 31, 2011, we did not maintain effective internal control over financial reporting due to the material weakness described below.
A material weakness is a deficiency, or 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. We identified the following material weakness in our assessment of the effectiveness of internal control over financial reporting:
We did not design and implement adequate controls related to the accounting of foreclosure transactions, specifically in this instance, applying consolidation guidance to determine whether and how to consolidate another entity as it relates to investments held by us and VRM I. This material weakness has resulted in the required restatement of previously issued consolidated financial statements for the quarter ended September 30, 2010.
Plan of Remediation
During the second fiscal quarter of 2011, we changed our controls to determine, verify and review the accounting of foreclosure transactions to specifically address whether these transactions are subject to consolidation accounting. We will continue to evaluate these changes to determine the material weakness described above has been remediated.
Changes in Internal Control Over Financial Reporting
As required by Rule 13a-15(d) under the Exchange Act, our management, including our CEO and our CFO, has evaluated our internal control over financial reporting to determine whether any changes occurred during the third fiscal quarter of 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. During the third quarter of 2011, management was able to amend the Form 10-Q which included a restatement of previously issued consolidated financial statements for the quarter ended September 30, 2010. Additionally, management has established additional internal controls to further evaluate foreclosure transactions to assist in determining whether the accounting for the transaction should be reported on a consolidated basis. Management will continue to evaluate these additional internal controls to determine whether the material weakness discussed above has been remediated.
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ITEM 9B.
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OTHER INFORMATION
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None.
PART III
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ITEM 10.
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DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
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We are managed on a day-to-day basis by Vestin Mortgage, a majority-owned subsidiary of Vestin Group.
Directors and Executive Officers
The following table sets forth the names, ages as of March 16, 2012 and positions of the individuals who serve as our directors and executive officers as of March 16, 2012.
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Name
|
Age
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Title
|
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Michael V. Shustek
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53
|
President, Chief Executive Officer and Director
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|
Eric Bullinger(4)
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41
|
Chief Financial Officer
|
|
Robert J. Aalberts(1)(2)(3)
|
60
|
Director
|
|
John E. Dawson
|
54
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Director
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|
Roland M. Sansone(1)(2)(3)
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57
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Director
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|
Fredrick J. Zaffarese Leavitt(1)(2)(3)
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41
|
Director
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|
|
(1)
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Member of the audit committee.
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|
|
(2)
|
Member of the nominating committee.
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|
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(3)
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Member of the compensation committee.
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|
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(4)
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During April 2009, we entered into an accounting services agreement with Strategix Solutions, LLC (“Strategix Solutions”), a Nevada limited liability company, for the provision of accounting and financial reporting services. Strategix Solutions also provides accounting and financial reporting services to VRM I and Fund III. Our CFO and other members of our accounting staff are employees of Strategix Solutions. Strategix Solutions is managed by LL Bradford and Company, LLC ("LL Bradford"), a certified public accounting firm that has provided non-audit accounting services to us. The principal manager of LL Bradford was a former officer of our manager from April 1999 through January 1, 2005. Strategix Solutions is owned by certain partners of LL Bradford, none of whom are currently or were previously officers of our manager. As of December 31, 2011, Strategix Solutions dedicates to us a total of three employees, including Eric Bullinger, who is our CFO.
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The following table sets forth the names, ages as of March 16, 2012 and positions of the individuals who serve as directors, executive officers and certain significant employees of Vestin Mortgage (our manager) or our affiliates:
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Name
|
Age
|
Title
|
|
Michael V. Shustek
|
53
|
President, Chief Executive Officer and Chairman
|
|
Eric Bullinger
|
41
|
Chief Financial Officer
|
|
Michael J. Whiteaker
|
62
|
Vice President of Regulatory Affairs
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Directors, Executive Officers and certain significant employees of Vestin Realty Mortgage II, Vestin Mortgage (our manager), Vestin Group, Vestin Originations or our affiliates.
Michael V. Shustek has been a director of our manager and Chairman of the board of directors, Chief Executive Officer and a director of Vestin Group since April 1999 and a Director and CEO of us and Vestin Realty Mortgage I, Inc. (“VRM I”) since January 2006. In February 2004, Mr. Shustek became the President of Vestin Group. Mr. Shustek also serves on the loan committee of our manager and its affiliates. In 2003, Mr. Shustek became the Chief Executive Officer of our manager. In 1995, Mr. Shustek founded Del Mar Mortgage, and has been involved in various aspects of the real estate industry in Nevada since 1990. In 1993, he founded Foreclosures of Nevada, Inc., a company specializing in non-judicial foreclosures. In 1993, Mr. Shustek also started Shustek Investments, a company that originally specialized in property valuations for third-party lenders or investors.
In 1997, Mr. Shustek was involved in the initial founding of Nevada First Bank, with the largest initial capital base of any new state charter in Nevada’s history. Mr. Shustek has co-authored two books, entitled “Trust Deed Investments,” on the topic of private mortgage lending, and “If I Can Do It, So Can You.” Mr. Shustek is a guest lecturer at the University of Nevada, Las Vegas, where he also has taught a course in Real Estate Law and Ethics. Mr. Shustek received a Bachelor of Science degree in Finance at the University of Nevada, Las Vegas. As our founder and CEO, Mr. Shustek is highly knowledgeable with regard to our business operations and loan portfolio. In addition, his participation on the Board of Directors is essential to ensure efficient communication between the Board and management. See Note N - Legal Matters Involving The Manager in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K for information regarding legal matters involving our manager and Mr. Shustek.
Eric Bullinger was appointed as our Chief Financial Officer (CFO) on January 21, 2011. In addition, Mr. Bullinger was appointed as the Chief Financial Officer of Vestin Realty Mortgage I, Inc. (“VRM I”) and the equivalent of the Chief Financial Officer of Vestin Fund III, LLC. Mr. Bullinger’s services are furnished to us pursuant to an accounting services agreement entered into by our manager and Strategix Solutions. Strategix Solutions is managed by LL Bradford, a certified public accounting firm, and provides accounting and financial reporting services on our behalf. Mr. Bullinger is a Certified Public Accountant and has worked for LL Bradford for approximately 12years. Mr. Bullinger has overseen various audit engagements of public and private companies. He received a Bachelor of Business Administration degree in Accounting from the University of Wyoming.
Michael J. Whiteaker has been Vice President of Regulatory Affairs since May 1999. Mr. Whiteaker is experienced in the banking and finance regulatory fields, having served with the State of Nevada, Financial Institution Division from 1982 to 1999 as its Supervisory Examiner, responsible for the financial and regulatory compliance audits of all financial institutions in Nevada. Mr. Whiteaker has worked extensively on matters pertaining to both state and federal statutes, examination procedures, policy determination and credit administration for commercial and real estate loans. From 1973 to 1982, Mr. Whiteaker was Assistant Vice President of Nevada National Bank, responsible for a variety of matters including loan review. Mr. Whiteaker has previously served on the Nevada Association of Mortgage Brokers, Legislative Committee and is a past member of the State of Nevada, Mortgage Advisory Council.
Independent Directors of Vestin Realty Mortgage II
Robert J. Aalberts was a director of Vestin Group from April 1999 to December 2005. He has been a member of our board of directors since January 2006 and was a director for VRM I from January 2006 until he resigned in January 2008. In March 2009, Mr. Aalberts was appointed to replace Mr. Micone, who resigned from VRM I’s Board. Since 1991, Professor Aalberts has held the Ernst Lied Professor of Legal Studies professorship in the College of Business at the University of Nevada, Las Vegas. From 1984 to 1991, Professor Aalberts was an Associate Professor of Business Law at Louisiana State University in Shreveport, Louisiana. From 1982 through 1984, he served as an attorney for Gulf Oil Company. Professor Aalberts has co-authored a book relating to the regulatory environment, law and business of real estate; including Real Estate Law (7th Ed. (2009) 6th Ed. (2006)) published by the Thomson/West Company. He is also the author of numerous legal articles, dealing with various aspects of real estate, business and the practice of law. Since 1992, Professor Aalberts has been the Editor-in-chief of the Real Estate Law Journal. Professor Aalberts received his Juris Doctor degree from Loyola University, in New Orleans, Louisiana, a Masters of Arts from the University of Missouri, Columbia, and received a Bachelor of Arts degree in Social Sciences, Geography from the Bemidji State University in Bemidji, Minnesota. He was admitted to the State Bar of Louisiana in 1982 (currently inactive status). Mr. Aalberts’ extensive knowledge of business and real estate law is a valuable resource for our Board of Directors.
John E. Dawson was previously a director of Vestin Group from March 2000 to December 2005. He has been a member of our board of directors since March 2007 and was a director for VRM I from March 2007 until he resigned in January 2008. Since 2005 Mr. Dawson has been a partner of the Las Vegas law firm of Lionel Sawyer & Collins. Previous to that, from 1995 to 2005, Mr. Dawson was a partner at the law firm of Marquis &Aurbach. Mr. Dawson received his Bachelor’s Degree from Weber State and his Juris Doctor from Brigham Young University. Mr. Dawson received his Masters of Law (L.L.M.) in Taxation from the University of San Diego in 1993. Mr. Dawson was admitted to the Nevada Bar in 1988 and the Utah Bar in 1989. Mr. Dawson’s legal knowledge, and his familiarity with the business and legal communities in Las Vegas, provide an important perspective as the Board addresses issues related to the management of our loan portfolio and REO.
Roland M. Sansone was a director for Vestin Group from December 2004 to December 2005. He has been a member of our board of directors since January 2006 and was a director for VRM I from January 2006 until he resigned in January 2008. In addition, he has served as President of Sansone Development, Inc. since 2002. Sansone Development, Inc. is a real estate development company. Mr. Sansone has been self-employed as a Manager and developer of real estate since 1980. Mr. Sansone is currently the president of several companies that develop, own and manage commercial and residential property. Mr. Sansone attended Mt. San Antonio College. Mr. Sansone has extensive experience and familiarity with real estate markets that is invaluable to our Board’s oversight of our lending operations.
Fredrick J. Zaffarese Leavitt was a director for Vestin Group from November 2004 to December 2005. He has been a member of our board of directors since January 2006 and was a director for VRM I from January 2006 until he resigned in January 2008. Since August of 1993 Mr. Zaffarese Leavitt has been an accountant for the United States Department of the Interior where his responsibilities include the review and audit of various states, local and municipality governments for compliance with federal laws and regulations as well as preparation of financial statements for Executive Branch and Congressional review. Additionally, Mr. Zaffarese Leavitt sits on various audit committees involving the utility industry. Mr. Zaffarese Leavitt is a CPA and a graduate of University of Nevada Las Vegas. The Board also determined that Mr. Zaffarese-Leavitt meets the audit committee financial expert requirements of NASDAQ Marketplace Rule 4350(d)(2)(A). Mr. Zaffarese Leavitt’s experience as an accountant provides the Board with an important perspective on financial reporting and internal controls.
CORPORATE GOVERNANCE
Board Composition
Our board of directors is authorized to have up to 15 directors. Our board of directors is currently comprised of five directors. In accordance with our articles of charter and bylaws, our board of directors is divided into three classes, class I, class II and class III, with each class serving staggered three-year terms. The members of the classes are divided as follows:
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·
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The class I director is Mr. Zaffarese Leavitt, and his term will expire at the 2013 annual meeting of stockholders;
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|
|
·
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The class II directors are Messrs. Dawson and Sansone, and their terms will expire at the 2014 annual meeting of stockholders; and
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|
|
·
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The class III directors are Messrs. Aalberts and Shustek, and their terms will expire at the 2012 annual meeting of stockholders.
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The authorized number of directors may be changed only by resolution of the board of directors. Any additional directors resulting from an increase in the number of directors will be distributed between the three classes so that, as nearly as possible, each class will consist of one third of the directors. This classification of our board of directors may have the effect of delaying or preventing changes in our control or management. Our directors will hold office until their successors have been elected and qualified or until their earlier death, resignation, disqualification or removal for cause by the affirmative vote of the holders of at least a majority of our outstanding stock entitled to vote on election of directors.
Board Leadership
Michael V. Shustek serves as our CEO and as the Chairman of our Board of Directors. Mr. Shustek was the founder of our Company and has served as its CEO since inception. Our Board of Directors believes that Mr. Shustek is best situated to serve as Chairman of the Board because he is the director most familiar with our business and loan portfolio and is therefore best positioned to lead Board discussions relating to strategic priorities and opportunities. In this regard, the Board noted Mr. Shustek’s extensive experience in secured real estate lending and his familiarity with our assets and operations. The Board of Directors believes that under these circumstances, the combined role of CEO and Chairman promotes effective strategy development and execution.
We have not appointed a lead independent director, viewing this position as unnecessary given the small size of our Board of Directors. However, Mr. Zaffarese Leavitt generally chairs executive sessions of our independent directors.
Board Committees
Our board of directors has appointed an audit committee, a nominating committee and a compensation committee. There are no family relationships among any of our directors or executive officers.
Audit Committee
Fredrick J. Zaffarese Leavitt (Chairman)
Robert J. Aalberts
Roland M. Sansone
Compensation Committee
Robert J. Aalberts (Chairman)
Roland M. Sansone
Fredrick J. Zaffarese Leavitt
Nominating Committee
Roland M. Sansone (Chairman)
Robert J. Aalberts
Fredrick J. Zaffarese Leavitt
Special Committee
Fredrick J. Zaffarese Leavitt (Chairman)
Roland Sansone
John Dawson
Audit committee – The Audit Committee is responsible for the appointment, compensation, retention and oversight of the Company’s independent accountants. In addition, the Audit Committee reviews with the Company’s management and its independent accountants financial information that will be provided to stockholders and others, the systems of internal controls which management and our board of directors have established and our audit and financial reporting processes. The Audit Committee operates under a written Audit Committee Charter adopted by our board of directors, which is available at http://www.vestinrealtymortgage2.com/VRT_About/CommitteeCharters.aspx. Our Audit Committee, consisting of Mr. Zaffarese Leavitt (chair), Mr. Aalberts and Mr. Sansone, met in February 2012 in connection with the audit of our 2011 financial statements, and held a total of nine meetings in fiscal 2011.Our Audit Committee oversees our accounting and financial reporting processes, internal systems of control, independent auditor relationships and the audits of our financial statements. This committee’s responsibilities include, among other things:
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|
·
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Selecting and hiring our independent auditors;
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|
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·
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Evaluating the qualifications, independence and performance of our independent auditors;
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|
|
·
|
Approving the audit and non-audit services to be performed by our independent auditors;
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|
|
·
|
Reviewing the design, implementation, adequacy and effectiveness of our internal controls and our critical accounting policies;
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|
|
·
|
Overseeing and monitoring the integrity of our financial statements and our compliance with legal and regulatory requirements as they relate to financial statements or accounting matters; and
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|
|
·
|
Reviewing with management and our auditors any earnings announcements and other public announcements regarding our results of operations.
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Our independent auditors and internal financial personnel regularly meet privately with our audit committee and have unrestricted access to this committee. Our Audit Committee currently consists of Mr. Zaffarese Leavitt, Mr. Aalberts and Mr. Sansone. Our board of directors has determined that each of these directors meet the independence standards for audit committee members and that Mr. Zaffarese Leavitt meets the financial expertise requirements set forth in Section 407 of the Sarbanes Oxley Act of 2002.
Nominating Committee – Our Nominating Committee was formed to assist our board of directors by identifying individuals qualified to become directors. During fiscal 2011, the Nominating Committee, consisting of Mr. Sansone (chair), Mr. Zaffarese Leavitt and Mr. Aalberts, held one meeting. Our nominating committee currently consists of Mr. Sansone, Mr. Zaffarese Leavitt and Mr. Aalberts.
The Nominating Committee operates under a charter adopted by our board of directors, which is available at http://www.vestinrealtymortgage2.com/VRT_About/CommitteeCharters.aspx. Responsibilities of the Nominating Committee include, among other things:
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|
·
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Evaluating the composition, size, operations and governance of our board of directors and making recommendations regarding future planning and the appointment of directors;
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|
|
·
|
Evaluating the independence of our directors and candidates for election to the Board; and
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|
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·
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Evaluating and recommending candidates for election to our board of directors.
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Compensation Committee – Our Compensation Committee operates under a charter adopted by our board of directors, which is available at http://www.vestinrealtymortgage2.com/VRT_About/CommitteeCharters.aspx. It was established to assist our board of directors relating to compensation of the Company’s directors and its sole manager Vestin Mortgage and to produce as may be required an annual report on executive officer compensation. Subject to applicable provisions of our bylaws and the Management Agreement with our manager, the compensation committee is responsible for reviewing and approving compensation paid by us to our manager. During fiscal 2011 the Compensation Committee, consisting of Mr. Aalberts, Mr. Zaffarese Leavitt and Mr. Sansone, held one meeting. On April 13, 2011, the compensation committee met and reaffirmed the directors’ fees of $500 per meeting and the Manager’s fee. Our compensation committee currently consists of Mr. Aalberts (chair), Mr. Zaffarese Leavitt and Mr. Sansone. No member of the Compensation Committee had a relationship that requires disclosure as a compensation committee interlock.
Special Committee - The Board of Directors of the Company has appointed a special committee to evaluate and negotiate a potential stock for stock merger with Vestin Realty Mortgage I, Inc. The special committee held 10 meetings in 2011. The compensation that is being paid to the special committee is $60,000 plus $750 per meeting to the Chairman of the committee and $22,500 plus $750 per meeting to the remaining members.
Our board of directors may establish other committees to facilitate the management of our business.
Criteria for Selecting Directors
In evaluating candidates, the Nominating Committee will consider an individual’s business and professional experience, the potential contributions they could make to our Board and their familiarity with our business. The Nominating Committee will consider candidates recommended by our directors, members of our management team and third parties. The Nominating Committee will also consider candidates suggested by our stockholders. We do not have a formal process established for this purpose.
We do not have a formal diversity policy with respect to the composition of our Board of Directors. However, the Nominating Committee seeks to ensure that the Board of Directors is composed of directors whose diverse backgrounds, experience and expertise will provide the Board with a range of perspectives on matters coming before the Board.
Stockholders are encouraged to contact the Chair of the Nominating Committee if they wish the Committee to consider a proposed candidate. Stockholders should submit the names of any candidates in writing, together with background information about the candidate, and send the materials to the attention of Mr. Roland Sansone at the following address: 8880 W. Sunset Road, Suite 200, Las Vegas, NV 89148. Stockholders wishing to directly nominate candidates for election to the Board must provide timely notice in accordance with the requirements of our Bylaws, between the 150th and 120th days prior to the anniversary of the date of mailing of the notice for the preceding year’s annual meeting of stockholders.
Code of Ethics
Our board of directors has adopted a Code of Business Conduct and Ethics that applies to all of our directors, officers and employees of our manager. The Code of Business Conduct and Ethics may be found on our web site at http://www.vestinrealtymortgage2.com/VRT_About/GovernanceDocuments.aspx.
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ITEM 11.
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EXECUTIVE COMPENSATION
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We do not pay any compensation to our executive officers. We pay our manager a management (acquisition and advisory) fee of up to 0.25% of the amounts raised by us and Fund II through the sale of shares or units. Payment of the management fee is reviewed by and subject to approval of our Compensation Committee. For the year ended December 31, 2011, we paid our manager approximately $1.1 million for its management services, which represented approximately 56% of the revenues received by our manager and its affiliates in 2011.
Pursuant to our management agreement, we pay our manager a fee which is calculated as a percentage of our original capital contributions. In addition, we may pay our manager or its affiliates for services rendered in selling properties acquired through foreclosure. We also pay a fee to Strategix Solutions which is based upon the wages of the employees providing the services. We have evaluated the risks entailed in these fee arrangements and we do not believe that such risks are reasonably likely to have a material adverse effect upon the Company.
Our manager and our affiliates also receives various fees from borrowers. Such fees may include origination fees as well as charges for servicing, extending or modifying their loans. We are not a party to such fee arrangements and have no control over them. As discussed under Risk Factors, many of these fees are paid on an up-front basis and, as a result, could create an incentive for our manager and our affiliates to make or extend riskier loans. Funding risky loans could have a material adverse effect upon our operating results and financial condition.
Except as specified about, our independent directors receive $500 for each board meeting and committee meeting they attend, whether in person or by phone, and are reimbursed for travel expenses and other out-of-pocket costs of attending board and committee meetings.
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ITEM 12.
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
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Shown below is certain information as of March 16, 2012, with respect to beneficial ownership, as that term is defined in Rule 13d-3 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), of shares of common stock by the only persons or entities known to us to be a beneficial owner of more than 5% of the outstanding shares of common stock. Unless otherwise noted, the percentage ownership is calculated based on 12,720,783shares of our common stock as of March 16, 2012.
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Name and Address of
Beneficial Owner
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Amount and Nature of
Beneficial Ownership
|
Percent of Class
|
||
|
Michael V. Shustek
8880 West Sunset Rd Ste 200
Las Vegas, NV 89148
|
Sole voting and investment power of 1,735,214 shares and shared voting and investment power of 75,097shares
|
14.2%
|
The following table sets forth the total number and percentage of our common stock beneficially owned as of March 16, 2012,by:
|
|
·
|
Each director;
|
|
|
·
|
Our chief executive officer, chief financial officer and the officers of our manager who function as the equivalent of our executive officers; and
|
|
|
·
|
All executive officers and directors as a group.
|
Unless otherwise noted, the percentage ownership is calculated based on 12,531,405shares of our total outstanding common stock as of March 16, 2012.
|
Common Shares Beneficially Owned
|
||||||
|
Beneficial Owner
|
Address
|
Number
|
Percent
|
|||
|
Michael V. Shustek(1)
|
8880 West Sunset Rd. Ste 200
Las Vegas, NV 89118
|
1,810,311
|
14.2%
|
|||
|
John Dawson (2)
|
1321 Imperia
Henderson, NV 89052
|
25,487
|
**
|
|||
|
Robert J. Aalberts (2)
|
311 Vallarte Dr.
Henderson, NV 89014
|
189
|
**
|
|||
|
Frederick J. Zaffarese Leavitt
|
P.O. Box 91683
Henderson, NV 89009
|
--
|
--
|
|||
|
Roland M. Sansone
|
2310 E. Sunset Rd #8015
Las Vegas, NV 89119
|
--
|
--
|
|||
|
All directors and executive officers as a group (5 persons)
|
1,835,987
|
14.2%
|
||||
** Less than one percent of our total outstanding common stock.
|
(1)
|
Mr. Shustek is the Chairman, President and Chief Executive Officer of Vestin Mortgage and indirectly owns a significant majority of the capital stock of our manager through Vestin Group. Mr. Shustek is the beneficial owner of 1,810,311 shares of our common stock, representing approximately 14.2% of our outstanding common stock (based upon 12,531,405shares of common stock outstanding at March 16, 2012). Mr. Shustek, directly owns 1,528,398 shares of our common stock (totaling 12.0%) and indirectly owns and has economic benefit of 92,699 shares of our common stock (totaling 0.73%) through his ownership of Vestin Mortgage. Mr. Shustek has economic benefit of and shares voting and dispositive power of 75,097 shares of our common stock (totaling 0.59%) owned by his spouse, of which 25,309 shares were acquired by her prior to their marriage. In addition, through his management powers, Mr. Shustek has sole voting and dispositive power with respect to 114,117 (0.90%) shares owned by Fund III. Mr. Shustek owns an approximate 14.5% interest in Fund III and is the Chairman, President and Chief Executive Officer of Vestin Mortgage, the manager of Fund III. Mr. Shustek’s pecuniary interest in our shares owned by Fund III is 16,547 shares.
|
Mr. Shustek has sole voting and dispositive power with respect to shares owned directly by himself and with respect to shares owned by Vestin Mortgage and Fund III. .
|
(2)
|
Except as otherwise indicated, and subject to applicable community property and similar laws, the persons listed as beneficial owners of the shares have sole voting and investment power with respect to such shares.
|
|
ITEM 13.
|
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
|
From time to time, we may acquire or sell investments in real estate loans from/to our manager or other related parties pursuant to the terms of our Management Agreement without a premium. No gain or loss is recorded on these transactions, as it is not our intent to make a profit on the purchase or sale of such investments. The purpose is generally to diversify our portfolio by syndicating loans, thereby providing us with additional capital to make additional loans.
Please refer to Note H – Related Party Transactions in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K, for information regarding our related party transactions, which are incorporated herein by reference.
Director Independence. The Board of Directors has determined that each of the current non-employee Directors (i.e., Messrs. Dawson, Aalberts, Zaffarese-Leavitt, and Sansone) are “independent,” as that term is defined in Rule 4200(a)(15) of The Nasdaq Stock Market, Inc.’s listing requirements. In making these determinations, the Board of Directors did not rely on any exemptions to The Nasdaq Stock Market, Inc.’s requirements.
|
ITEM 14.
|
PRINCIPAL ACCOUNTING FEES AND SERVICES
|
During the year ended December 31, 2011 and 2010, JLK Partners, LLP (“JLK”) services to us as follows:
|
December 31, 2011
|
December 31, 2010
|
|||||||
|
Audit Fees
|
$ | 233,000 | $ | 190,000 | ||||
|
Audit Related Fees
|
$ | -- | $ | -- | ||||
|
Tax Fees
|
$ | -- | $ | -- | ||||
|
All Other Fees
|
$ | -- | $ | -- | ||||
JLK did not perform any non-audit services for us in the years ended December 31, 2011 and 2010.
The Audit Committee has direct responsibility to review and approve the engagement of the independent auditors to perform audit services or any permissible non-audit services. All audit and non-audit services to be provided by the independent auditors must be approved in advance by the Audit Committee. The Audit Committee may not engage the independent auditors to perform specific non-audit services proscribed by law or regulation. All services performed by our independent auditors under engagements entered into from May 6, 2003 to April 1, 2006, were approved by the Audit Committee of Vestin Group, all services performed after April 1, 2006, were approved by our Audit Committee, pursuant to our pre-approval policy, and none was approved pursuant to the de minimis exception to the rules and regulations of the Securities Exchange Act of 1934, Section 10A(i)(1)(B), on pre-approval.
|
ITEM 15.
|
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
|
The following are filed as part of this Report:
(a) 1. Financial Statements
The list of the financial statements contained herein are contained in Part II, Item 8 Financial Statements on this Annual Report on Form 10-K, which is hereby incorporated by reference.
|
|
(a)
|
3. Exhibits
|
EXHIBIT INDEX
|
Exhibit No.
|
Description of Exhibits
|
|
|
2.1 (2)
|
Agreement and Plan of Merger between Vestin Fund II, LLC and the Registrant
|
|
|
2.2(12)
|
Membership Interest Purchase Agreement between VRM I, VRM II and NorthStar Hawaii, LLC
|
|
|
3.1 (1)
|
Articles of Incorporation of the Registrant
|
|
|
3.2 (1)
|
Bylaws of the Registrant
|
|
|
3.3 (1)
|
Form of Articles Supplementary of the Registrant
|
|
|
3.4 (5)
|
Amendment to Vestin Realty Mortgage II’s Articles of Incorporation, effective December 31, 2007.
|
|
|
3.6 (6)
|
Amended Articles of Incorporation of the Registrant
|
|
|
4.1 (1)
|
Reference is made to Exhibits 3.1, 3.2 and 3.3
|
|
|
4.2 (2)
|
Specimen Common Stock Certificate
|
|
|
4.3 (1)
|
Form of Rights Certificate
|
|
|
4.4 (4)
|
Junior Subordinated Indenture
|
|
|
4.5 (8)
|
Letter Agreement dated November 7, 2008 pertaining to Junior Subordinated Indenture
|
|
|
4.6 (9)
|
First Supplemental Indenture dated of February 3, 2009 pertaining to Junior Subordinated Indenture
|
|
|
4.7 (9)
|
Letter Agreement dated March 25, 2009 pertaining to Junior Subordinated Indenture
|
|
|
10.1 (1)
|
Form of Management Agreement between Vestin Mortgage, LLC and the Registrant
|
|
|
10.2 (1)
|
Form of Rights Agreement between the Registrant and the rights agent
|
|
|
10.3 (4)
|
Form of Purchase Agreement
|
|
|
10.4 (4)
|
Amended and Restated Trust Agreement
|
|
|
10.5 (7)
|
Intercreditor Agreement, dated June 16, 2008, by and between Vestin Originations, Inc., Vestin Mortgage, LLC, Vestin Realty Mortgage II, Inc., and Owens Mortgage Investment Fund
|
|
|
10.6 (10)
|
Agreement between Strategix Solutions, LLC and Vestin Realty Mortgage II, Inc. for accounting services.
|
|
|
10.7 (11)
|
Second Supplemental Indenture, dated as of May 27, 2009 pertaining to Junior Subordinated Indenture
|
|
|
10.8 (11)
|
First Amendment to Amended and Restated Trust Agreement, dated as of May 27, 2009
|
|
| 10.9 | Deed in Lieu | |
|
21.1 (2)
|
List of subsidiaries of the Registrant
|
|
|
31.1
|
Section 302 Certification of Michael V. Shustek
|
|
|
31.2
|
Section 302 Certification of Eric Bullinger
|
|
|
32
|
Certification Pursuant to 18 U.S.C. Sec. 1350
|
|
|
99.2R (3)
|
Vestin Realty Mortgage II, Inc. Code of Business Conduct and Ethics
|
|
(1)
|
Incorporated herein by reference to Post-Effective Amendment No. 6 to our Form S-4 Registration Statement filed on January 4, 2006 (File No. 333-125121)
|
|
|
(2)
|
Incorporated herein by reference to Post-Effective Amendment No. 7 to our Form S-4 Registration Statement filed on January 13, 2006 (File No. 333-125121)
|
|
|
(3)
|
Incorporated herein by reference to the Transition Report on Form 10-K for the nine month transition period ended March 31, 2006 filed on September 7, 2006 (File No. 000-51892)
|
|
|
(4)
|
Incorporated herein by reference to the Current Report on Form 8-K filed on June 27, 2007 (File No. 000-51892)
|
|
|
(5)
|
Incorporated herein by reference to the Current Report on Form 8-K filed on January 4, 2008 (File No. 000-51892)
|
|
|
(6)
|
Incorporated herein by reference to the Annual Report on Form 10-K filed on March 14, 2008 (File No. 000-51892)
|
|
|
(7)
|
Incorporated herein by reference to the Quarterly Report on Form 10-Q filed on August 11, 2008 (File No. 000-51892)
|
|
|
(8)
|
Incorporated herein by reference to the Quarterly Report on Form 10-Q filed on November 10, 2008 (File No. 000-51892)
|
|
|
(9)
|
Incorporated herein by reference to the Annual Report on Form 10-K filed on March 26, 2009 (File No. 000-51892)
|
|
|
(10)
|
Incorporated herein by reference to the Quarterly Report on Form 10-Q filed on May 8, 2009 (File No. 000-51892)
|
|
|
(11)
|
Incorporated herein by reference to the Current Report on Form 8-K filed on June 10, 2009 (File No. 000-51892)
|
|
|
(12)
|
Incorporated herein by reference to the Current Report on Form 8-K/A filed on November 14, 2011 (File No. 000-51892)
|
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
|
Vestin Realty Mortgage II, Inc.
|
||
|
By:
|
/s/ Michael V. Shustek
|
|
|
Michael V. Shustek
|
||
|
President and Chief Executive Officer
|
||
|
Date:
|
March 16, 2012
|
|
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
|
Signature
|
Capacity
|
Date
|
||
|
/s/ Michael V. Shustek
|
President and Chief Executive Officer and Director
|
March 16, 2012
|
||
|
Michael V. Shustek
|
(Principal Executive Officer)
|
|||
|
/s/ Eric Bullinger
|
Chief Financial Officer
|
March 16, 2012
|
||
|
Eric Bullinger
|
(Principal Financial and Accounting Officer)
|
|||
|
/s/ John E. Dawson
|
Director
|
March 16, 2012
|
||
|
John E. Dawson
|
||||
|
/s/ Robert J. Aalberts
|
Director
|
March 16, 2012
|
||
|
Robert J. Aalberts
|
||||
|
/s/ Fredrick J. Zaffarese Leavitt
|
Director
|
March 16, 2012
|
||
|
Fredrick J. Zaffarese Leavitt
|
||||
|
/s/ Roland M. Sansone
|
Director
|
March 16, 2012
|
||
|
Roland M. Sansone
|
Exhibit 31.1
CERTIFICATIONS
I, Michael V. Shustek, certify that:
1. I have reviewed this Form 10-K of Vestin Realty Mortgage II, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a–15(e) and 15d–15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a–15(f) and 15d–15(f)) for the registrant and have:
|
|
(a)
|
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
|
|
|
(b)
|
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
|
|
|
(c)
|
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
|
|
|
(d)
|
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
|
5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
|
|
(a)
|
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
|
|
|
(b)
|
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
|
Date: March 16, 2012
|
/s/ Michael V. Shustek
|
|
Michael V. Shustek
|
|
Chief Executive Officer
|
|
Vestin Realty Mortgage II, Inc.
|
Exhibit 31.2
CERTIFICATIONS
I, Eric Bullinger, certify that:
1. I have reviewed this Form 10-K of Vestin Realty Mortgage II, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a–15(e) and 15d–15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a–15(f) and 15d–15(f)) for the registrant and have:
|
|
(a)
|
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
|
|
|
(b)
|
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
|
|
|
(c)
|
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
|
|
|
(d)
|
Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and
|
5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
|
|
(a)
|
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and
|
|
|
(b)
|
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.
|
Date: March 16, 2012
|
/s/ Eric Bullinger
|
|
Eric Bullinger
|
|
Chief Financial Officer
|
|
Vestin Realty Mortgage II, Inc.
|
Exhibit 32
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
Michael V. Shustek, as Chief Executive Officer of Vestin Realty Mortgage II, Inc. (the “Registrant”), and Eric Bullinger, as Chief Financial Officer of the Registrant, hereby certify, pursuant to 18 U.S.C. Sec. 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
|
|
(1)
|
The Registrant’s Report on Form 10-K for the year ended December 31, 2011, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
|
|
|
(2)
|
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.
|
Date: March 16, 2012
|
/s/ Michael V. Shustek
|
|
Michael V. Shustek
|
|
Chief Executive Officer
|
|
Vestin Realty Mortgage II, Inc.
|
Date: March 16, 2012
|
/s/ Eric Bullinger
|
|
Eric Bullinger
|
|
Chief Financial Officer
|
|
Vestin Realty Mortgage II, Inc.
|