Washington, D.C. 20549
FORM 10-KSB
[X] Annual Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 (fee required) for the Fiscal Year
Ended December 31, 1997.
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the Transition Period from
____________ to _____________.
Commission File Number 333-10109
UNITED MORTGAGE TRUST
(Name of small business issuer in its charter)
MARYLAND 75-6496585
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1701 N. Greenville, Suite 403, Richardson, Texas 75081
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code:
(972) 705-9805
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Exchange on which Registered
None
Securities registered pursuant to Section 12(g) of the Act:
None
Check whether the Registrant (1) 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
Check if no disclosure of delinquent filers in response to
Item 405 of Regulation S-B is contained herein, and will not be
contained, to the best of the Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part
III of this Form 10-KSB or any amendment to this Form 10-KSB [X]
The Registrant's revenues for the year ended December 31, 1997
were $199,600.
As of March 27, 1998, 327,694 shares of the Registrant's Common
Stock were outstanding. However, there is currently no trading
market for the Shares.
DOCUMENTS INCORPORATED BY REFERENCE
None
Transitional Small Business Disclosure Format Yes [ ] No [X]
TABLE OF CONTENTS
Page
PART I
Item 1. Description of Business............
Item 2. Description of Property............
Item 3. Legal Proceedings..................
Item 4. Submission of Matters to a Vote
of Security Holders................
PART II
Item 5. Market for Common Equity and
Related Stockholder Matters........
Item 6. Management's Discussion and
Analysis or Plan of Operations......
Item 7. Financial Statements...............
Item 8. Changes in and Disagreements
with Accountants on Accounting
and Financial Disclosure...........
PART III
Item 9. Directors, Executive Officers,
Promoters and Control Persons;
Compliance With Section 16(a) of
the Exchange Act....................
Item 10. Executive Compensation............
Item 11. Security Ownership of Certain
Beneficial Owners and Management...
Item 12. Certain Relationships and
Related Transactions...............
Item 13. Exhibits and Reports on
Form 8-K...........................
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
GENERAL
United Mortgage Trust (the "Company") is a Maryland real estate
investment trust formed on July 12, 1996 which operates as a real
estate investment trust (a "REIT") under the Internal Revenue Code
of 1986, as amended (the "Code"). The Company had the initial
closing of the sale of shares of its initial public offering on
August 8, 1997. The principal executive offices of the Company are
located at 1701 N. Greenville, Suite 403, Richardson, Texas 75081,
telephone number (972) 705-9805.
Statements in this report regarding the Company's business
which are not historical facts are "forward-looking
statements" as contemplated in the Private Securities
Litigation Reform Act of 1995. Such statements should be read
in light of the risks and uncertainties attendant to the
business of the Company, including, without limitation,
increased risks of default on loans made to borrowers who do
not satisfy the underwriting requirements for traditional
mortgage financing, various conflicts of interest arising out
of the Company's relationship with its officers, the Advisor
and their Affiliates, including the payment of fees, the
purchase of mortgages from an Affiliate and other related
party transactions, limited diversity in the Company's
portfolio of Mortgage Investments, risk of decrease in net
interest income due to interest rate fluctuations, prepayment
risks of Mortgage Investments, risk of loss due to default on
Mortgage Investments and risk of failure to maintain REIT
status and being subject to tax as a regular corporation. For
a description of these and other risks associated with the
business of the Company, see "Risk Factors" commencing on page
__.
Reference is made to the Glossary commencing on page __ of
this report for definitions of capitalized terms used in the
following description of the Company's business and elsewhere in
this report.
The Company invests exclusively in first lien, fixed rate
mortgages secured by single family residential property throughout
the United States. Such loans will be originated by others to the
Company's specifications or to specifications approved by the
Company. Most, if not all, of such loans are not insured or
guaranteed by a federally owned or guaranteed mortgage agency and
will be made to borrowers who do not satisfy the income ratios,
credit record criteria, loan-to-value ratios, employment history
and liquidity requirements of traditional mortgage financing.
The Company produces net interest income on its mortgage
portfolio while maintaining strict cost controls in order to
generate net income for monthly distribution to its shareholders.
The Company operates in a manner that will permit it to qualify as
a REIT for federal income tax purposes. As a result of REIT
status, the Company would be permitted to deduct dividend
distributions it pays to its shareholders, thereby effectively
eliminating the "double taxation" that generally results when a
corporation earns income and distributes that income to
stockholders in the form of dividends.
The Company is self-administered with the Company's President
acting as Administrator. The Administrator manages the day-to-day
operations of the Company, subject to the supervision of the
Company's Board of Trustees. The Advisor to the Company is
Mortgage Trust Advisors, Inc. (the "Advisor".) The Advisor has
been retained to use its best efforts to seek out and present to
the Company, whether through its own efforts or those of third
parties retained by it, suitable and a sufficient number of
investment opportunities which are consistent with the investment
policies and objectives of the Company and consistent with such
investment programs as the Trustees may adopt from time to time in
conformity with the Company's Declaration of Trust.
The Company intends to acquire its Mortgage Investments from
several sources, including South Central Mortgage, Inc. ("SCMI"),
an Affiliate of the Advisor. The amount of Mortgage Investments to
be acquired from SCMI cannot be determined at this time and will
depend upon the Mortgage Investments that are available from SCMI
or other sources at the time the Company has funds to invest. At
this time, SCMI is the only Affiliate that is expected to sell any
Mortgage Investment to the Company. SCMI is a Texas corporation
that is in the business of purchasing, selling and servicing
mortgages. All Mortgage Investments purchased from SCMI or other
Affiliates of the Advisor have been and will be at prices no higher
than those that would be paid to unaffiliated third parties for
mortgages with comparable terms, rates, credit risks and seasoning.
The Company utilizes the services of SCMI and nonaffiliated
third parties to service the Mortgages acquired by the Company.
The servicing of the Mortgages includes the collection of monthly
payments from the borrower, the distribution of all principal and
interest to the Company, the payment of all real estate taxes and
insurance to be paid out of escrow, regular distribution of
information regarding the application of all funds received and
enforcement of collection for all delinquent accounts, including
foreclosure of such account when and as necessary.
PROCEEDS FROM PUBLIC OFFERING OF SHARES
On March 5, 1997, the Company commenced a public offering of
a maximum of 2,500,000 Shares of Beneficial Interest, par value
$.01 per share (the "Shares"). The public offering is continuing
with the Shares being distributed on a "best efforts" basis by
First Financial United Investments Ltd., L.L.P. (the "Selling Group
Manager") and other broker-dealer firms that are members of the
National Association of Securities Dealers, Inc. ("NASD") and
selected by the Selling Group Manager.
Pursuant to the prospectus for that public offering, the
subscription payments by investors were held in an escrow account
at Texas Commerce Bank National Association (the "Escrow Agent" and
now known as Chase Bank) until the sale of at least 125,000 Shares
to a minimum of 100 investors independent of the Company and of
each other. On August 8, 1997, those requirements were satisfied
and the Company closed the initial sale of 126,863 Shares. After
the first closing in August, 1997, additional closings have
occurred on the first day of each subsequent month and will
continue on a monthly (or more frequent) basis in the future until
the termination of the offering of the Shares. The subscription
proceeds that are received from investors are held in escrow until
the next closing and interest earned on those subscription proceeds
pending that closing will be distributed to each subscriber, pro
rata, calculated based upon the number of days each such
subscriber's funds are held in escrow, subject to any applicable
withholding provisions of the Code.
During the year ended December 31, 1997, the any applicable
withholding provisions of the Code. Company sold a total of 192,508
Shares in its public offering for Gross Offering Proceeds of
$3,850,160. Of those Gross Offering Proceeds, the Company paid
$405,162 in commissions and other offering expenses and received
Net Offering Proceeds of $3,444,998.
The Company uses its best efforts to invest or commit for
investment the full amount of Net Offering Proceeds within 60 days
of their receipt. Any Net Offering Proceeds not immediately
invested in Mortgage Investments will be temporarily invested by
the Company in Interim Mortgage Loans and in certain other short
term investments appropriate for a trust account or investments
which yield "qualified temporary investment income" within the
meaning of Section 856c(6)(D) of the Code or other investments
which invest directly or indirectly in any of the foregoing (such
as repurchase agreements collateralized by any of the foregoing
types of securities) and/or such investments necessary for the
Company to maintain its REIT qualification or in short term highly
liquid investments such as in investments with banks having assets
of at least $50,000,000, savings accounts, bank money market
accounts, certificates of deposit, bankers' acceptances or
commercial paper rated A-1 or better by Moody's Investors Service,
Inc., or securities issued, insured or guaranteed by the United
States government or government agencies, or in money market funds
having assets in excess of $50,000,000 which invest directly or
indirectly in any of the foregoing.
INVESTMENT OBJECTIVES AND POLICIES
Investment Policy
The primary investment policy of the Company is to purchase
first lien mortgage notes secured by single family homes. A
significant portion of the home buying public is unable to qualify
for government insured or guaranteed or conventional mortgage
financing. Strict income ratios, credit record criteria, loan-to-
value ratios, employment history and liquidity requirements serve
to eliminate traditional financing alternatives for many working
class home buyers. A large market of what are referred to as "B",
"C", "D", and "DD" grade mortgage notes has been generated through
utilization of non-conforming underwriting criteria for those
borrowers who do not satisfy the underwriting requirements for
government insured or guaranteed or conventional mortgage
financing. Although there is no industry standard for the grading
of those non-conforming loans, the grade is primarily based on the
credit worthiness of the borrower. The Company acquires what it
considers to be "B", "C" and "D" grade mortgage loans. Typically
non-conforming notes bear interest at above market rates consistent
with the perceived increased risk of default. In practice, non-
conforming notes experience their highest percentage of default in
the initial 12 months of the loan. The Company attempts to reduce
the rate and expense of early payment defaults through the
adherence to investment policies that require the seller of a note
to the Company with a payment history of less than 12 months to
replace or repurchase any non-performing note and reimburse the
Company for any interest, escrows, foreclosure, eviction, and
property maintenance costs.
Underwriting Criteria
The underwriting criteria for purchase of Mortgages by the Company
are as follows:
1. Priority of Lien. All notes purchased must be secured by a
first lien that is insured by a title insurance company. The
Company will not purchase second liens or other subordinate or
junior liens. Purchase of "wrap notes" will be permitted subject
to loan to value ratios specified below. A "wrap note" is a
secured lien note that "wraps" around an existing first lien and on
which the holder has the right to service the first lien
indebtedness.
2. Rate. The Advisor will seek to acquire Mortgage
Investments that will provide a satisfactory net yield to the
Company. Net yield is determined by the yield realized after
payment of the note servicing fee (1/2 of 1% of note balance,
annually) and administrative costs (estimated to be 1/2 of 1% of the
Company's average invested capital). See "Other Restrictions in
Declaration of Trust - Limitation on Total Operating Expenses".
The servicing and administrative cost burden is estimated to
approximate 1% of the interest income. All rates are fixed rates
because the Company does not acquire adjustable rate loans. Some
notes are bought at a discount to increase their yield above the
contractual rate. No notes are purchased at a premium above the
outstanding principal balance. This investment policy allows for
acquisition of notes at various rates.
3. Term and Amortization. There is no minimum term for the
notes acquired. Maximum term may not exceed 360 months.
Amortization will vary from 0 (interest only on loans 12 months and
less) to 360 months. Interim Mortgage Loans may not exceed 12
months in term. Balloon notes are allowed, amortization need not
match term. No amortization may exceed 360 months.
4. Loan-to-Value Ratio. Except as set forth below, any loan
purchased may not exceed a 85% loan-to-value ratio ("LTV").
Exceptions will be made for: (i) loans with LTV's in excess of 85%
which may be purchased if discounted sufficiently to bring the cost
to value ratio to 85% or less (the LTV's will be established by
appraisal on unseasoned loans, and by broker price opinion (BPO) or
appraisals not more than 12 months old on seasoned notes) and (ii)
Interim Mortgage Loans (loans to real estate investors for purchase
of homes for resale) may be purchased if they will not exceed a 50%
LTV and will have a maturity of one year or less.
5. Seasoning. Loans must have a minimum of 12 months payment
history or will be required to have seller recourse through the
twelfth payment. Those Seller recourse agreements will require the
seller of a note to the Company to replace or repurchase any non-
performing note and reimburse the Company for any interest,
escrows, foreclosure, eviction, and property maintenance costs. A
note will be considered non performing if any portion of the
principal, interest or escrow payment is 30 days past due.
6. Borrower, Loan and Property Information. A completed
Uniform Residential Loan Application (FNMC form 1003, FDMC form
65), or other form acceptable to the Company must accompany each
loan acquired. The Form must include property address, year built,
square footage, type of construction, purchase price of the
property, date of purchase, down payment and original loan amount,
rate, term and amortization, borrower and co-borrower name,
address, home and work telephone numbers, prior residence, prior
mortgagee or landlord, current employer and, if employed less than
one year at current employer, previous employer, monthly income and
expense information, listing of assets and liabilities and a
listing of three references, with phone numbers and addresses,
including next of kin. In addition, each loan file should include
a Verification of Employment (completed) and a Verification of Rent
(completed), if applicable.
7. Appraisals and BPO's. Each unseasoned loan must have an
appraisal demonstrating a loan to value ratio of not more than 85%.
The appraisals may be limited in scope (not requiring interior
inspection) but must be performed by appraisers approved by the
Company's Advisor. Each seasoned note must be accompanied by a
Broker Price Opinion (not more than 12 months old), demonstrating a
loan to value ratio not in excess of 85%, and photographs of the
property securing the loan.
8. Credit. Payment histories reflecting no late payments (30
days +) for twelve consecutive months will be deemed a sufficient
demonstration of creditworthiness of the borrower for seasoned
notes. For unseasoned notes, the borrower must have the following:
a. Current credit report with acceptable explanations for any
adverse ratings, no active bankruptcies, no prior foreclosures.
b. Employment, verified, with current employer, or no lapse in
employment for the last 12 months.
c. Income ratio, verified, indicating income at least 2.5
times the monthly payment inclusive of escrows.
d. Prior mortgage payment or rental history demonstrating 12
consecutive months pay history with no late pays (30 days past
due).
9. Escrow Requirement. All loans must have adequately funded
tax and insurance escrow accounts and a continuing obligation to
fund 1/12th of the annual insurance and tax amounts each month.
10. Estoppel Letters. Each loan purchased must be accompanied
with both a maker's and a payee's estoppel letter attesting to loan
balances, payment amount, rate, term, security, escrow balance,
current status of account, and next payment date. Estoppel letters
must be no more than 30 days old at time of loan acquisition.
11. Hazard Insurance. Each loan purchased must have, in
effect, a prepaid hazard insurance policy with a mortgagee's
endorsement for the benefit of the Company in an amount not less
than the outstanding principal balance on the loan. The Company
reserves the right to review the credit rating of the insurance
issuer and, if deemed unsatisfactory, request replacement of the
policy by an acceptable issuer.
12. Geographical Boundaries. The Company may purchase loans
in any of the 48 contiguous United States. However, in states
which provide redemption rights after foreclosure, the maximum loan
to value ratio will be 80%, or alternatively the loan must provide
mortgage insurance.
13. Mortgagees' Title Insurance. Each loan purchase must have
a valid mortgagees' title insurance policy insuring a first lien
position in an amount not less than the outstanding principal
balance of the loan.
14. Guarantees, Recourse Agreements, and Mortgage Insurance.
Loans with loan-to-value ratios in excess of 85% and/or less than
12 months seasoning will not be purchased without one or more of
the following: government guarantees, seller recourse agreement,
mortgage insurance or similar guarantees or insurances approved by
the Board of Trustees, including a majority of the Independent
Trustees.
15. Pricing. Mortgages will be purchased at no minimum
percentage of the principal balance, but in no event in excess of
the outstanding principal balance. Prices paid for notes will vary
with seasoning, interest rate, credit, loan-to-value ratios, pay
histories, guarantees or recourse agreements, and average yield of
the Company's loan portfolio among other factors. The Company's
objectives will be accomplished through purchase of high rate
loans, prepayment of notes purchased at a discount, reinvestment of
principal payments, interim home purchase loans and other short
term investment of cash reserves and, if utilized, leverage of
capital to purchase additional loans.
Restriction on Investments
The Declaration of Trust prohibits investments in (i) any
foreign currency, bullion, commodities or commodities future
contracts (this limitation is not intended to apply to interest
rate futures, when used solely for hedging purposes); (ii) short
sales; and (iii) any security in any entity holding investments or
engaging in activities prohibited by the Company's Declaration of
Trust.
In addition to other investment restrictions imposed by the
Trustees from time to time consistent with the Company's objective
to qualify as a REIT, the Company will observe the following
restrictions on its investments set forth in its Declaration of
Trust:
(a) The Company may not invest in real estate contracts of
sale unless such contracts of sale are recordable in the chain
of title and unless such investment is made in conjunction
with the acquisition or sale of real property or when held as
security for Mortgages made or acquired by the Company.
(b)Not more than 10% of the Company's total assets will be
invested in unimproved real property or mortgage loans on
unimproved real property. For purposes of this paragraph,
"unimproved real properties" does not include properties under
construction, under the contract for development or plan for
development within one year.
(c) The Company may not invest in equity securities unless a
majority of Trustees, including a majority of Independent
Trustees, not otherwise interested in such transaction approve
the transaction as being fair, competitive and commercially
reasonable.
(d) The Company may not make or invest in any mortgage loans
that are subordinate to any mortgage or equity interest of the
Advisor, a Trustee or Affiliates thereof.
(e) To the extent the Company invests in real property, a
majority of the Trustees shall determine the consideration
paid for such real property, based on the fair market value of
the property. If a majority of the Independent Trustees
determine, or if the real property is acquired from the
Advisor, as Trustee or Affiliates thereof, such fair market
value shall be determined by a qualified independent real
estate appraiser selected by the Independent Trustees.
(f) The Company will not invest in indebtedness (herein called
"junior debt") secured by a mortgage on real property which is
subordinate to the lien of other indebtedness (herein called
"senior debt"), except where the amount of such junior debt,
plus the outstanding amount of the senior debt, does not
exceed 85% of the appraised value of such property, if after
giving effect thereto, the value of all such investments of
the Company (as shown on the books of the Company in
accordance with generally accepted accounting principles after
all reasonable reserves but before provision for depreciation)
would not then exceed 25% of the Company's tangible assets.
(g) The Company will not commingle the Company's funds with
those of any other person or entity, except that the use of a
zero balance or clearing account shall not constitute a
commingling of trust funds and that funds of the Company and
funds of other entities sponsored by a Sponsor or its
Affiliates may be held in an account or accounts established
and maintained for the purpose of making computerized
disbursements and/or short-term investments provided the
Company's funds are protected from claims of such other
entities and creditors of such other entities.
(h) The Company may not invest in interest only strip
securities, principal only strip securities, CMO residual
interest or similar securities or securities derivatives that
are highly volatile or that are highly sensitive to prepayment
rates and other market factors. The Company may not purchase
CMO securities at a significant premium.
(i) The Company may not use or apply land for farming,
horticulture or similar purposes.
(j) The Company will not engage in trading, as compared with
investment activities.
(k) The Company will not engage in underwriting or the agency
distribution of securities issued by others.
Other Policies
Although the Company does not intend to invest in real
property, to the extent it does, a majority of the Trustees shall
determine the consideration paid for such real property, based on
the fair market value of the property. If a majority of the
Independent Trustees determine, or if the real property is acquired
from the Advisor, as Trustee or Affiliates thereof, such fair
market value shall be determined by a qualified independent real
estate appraiser selected by the Independent Trustees.
The Company will use its best efforts to conduct its
operations so as not to be required to register as an investment
company under the Investment Company Act of 1940 and so as not to
be deemed a "dealer" in mortgages for federal income tax purposes.
The Company will not engage in any transaction which would
result in the receipt by the Advisor or its Affiliates of any
undisclosed "rebate" or "give-up" or in any reciprocal business
arrangement which results in the circumvention of the restrictions
contained in the Declaration of Trust and in applicable state
securities laws and regulations upon dealings between the Company
and the Advisor and its Affiliates.
Changes in Investment Objectives and Policies
The investment restrictions contained in the Declaration of
Trust may only be changed by amending the Declaration of Trust with
the approval of the Shareholders. However, subject to those
investment restrictions, the methods for implementing the Company's
investment policies may vary as new investment techniques are
developed.
OTHER RESTRICTIONS IN DECLARATION OF TRUST
Limitation on Total Operating Expenses
The Company's goal is to limit its annual Total Operating
Expenses (exclusive of loan servicing fees) to 0.5% of the Average
Invested Assets. But, if less than all of the Shares are sold, it
is unlikely that the Company will be able fully to achieve that
goal, at least in the initial years of operation. In any event,
however, the Declaration of Trust provides that the annual Total
Operating Expenses of the Company shall not exceed in any fiscal
year the greater of 2% of the Average Invested Assets of the
Company or 25% of the Company's Net Income. In the event the Total
Operating Expenses exceed the limitations described above then
within 60 days after the end of the Company's fiscal year, the
Advisor shall reimburse the Company the amount by which the
aggregate annual Total Operating Expenses paid or incurred by the
Company exceed the limitation.
Limitation on Acquisition Expenses and Fees
The total of Acquisition Fees and Acquisition Expenses shall
be reasonable, and shall not exceed an amount equal to 6% of the
purchase price of any Mortgage Investment. Notwithstanding the
above, a majority of the Trustees (including a majority of the
Independent Trustees) not otherwise interested in the transaction
may approve fees in excess of these limits if they determine the
transaction to be commercially competitive, fair and reasonable to
the Company. However, notwithstanding the foregoing, the
Acquisition Fees to be paid to the Advisor or its Affiliates for
sourcing, evaluating, structuring and negotiating the acquisition
terms of Mortgage Investments shall not exceed 3.0% of the
principal amount of each Mortgage Investment.
Restrictions on Transactions with Affiliates
The Company's Declaration of Trust imposes certain
restrictions upon dealings between the Company and the Advisor, any
Trustee or Affiliates thereof. In particular, the Declaration of
Trust provides that The Company shall not engage in transactions
with any Sponsor, the Advisor, a Trustee or Affiliates thereof,
except to the extent that each such transaction has, after
disclosure of such affiliation, been approved or ratified by the
affirmative vote of a majority of the Independent Trustees, not
otherwise interested in such transaction, who have determined that
(a) the transaction is fair and reasonable to the Company and its
shareholders; (b) the terms of such transaction are at least as
favorable as the terms of any comparable transactions made on arms
length basis and known to the Trustees; and (c) the total
consideration is not in excess of the appraised value of the
property being acquired, if an acquisition is involved. As a
result of the foregoing, a majority of the Independent Trustees,
not otherwise interested in the transaction, will be required to
approve the purchase of each Mortgage Investment that is purchased
from a Sponsor, the Advisor or an Affiliate thereof, after
determining that those purchases are made on terms and conditions
that are no less favorable than those that could be obtained from
independent third parties for mortgages with comparable terms,
rates, credit risks and seasoning. The Advisor Agreement with the
Advisor and the use of SCMI, an affiliate of the Advisor, to
service the mortgage notes acquired by the Company for an annual
service fee equal to 0.5% of the outstanding principal balance of
each note that it services for the Company have been approved by
the Trustees.
Payments to the Advisor, the Trustees and their Affiliates for
services rendered in a capacity other than that as the Advisor or
Trustees may only be made upon a determination of a majority of the
Independent Trustees, not otherwise interested in such transaction
that: (1) the compensation is not in excess of their compensation
paid for any comparable services; and (2) the compensation is not
greater than the charges for comparable services available from
others who are competent and not affiliated with any of the parties
involved.
Restrictions on Borrowing
The Company may borrow funds to make Distributions to its
Shareholders or to acquire additional Mortgage Investments.
However, the ability of the Company to borrow funds is subject to
the limitations set forth in the Declaration of Trust which
provides that the Company may not incur indebtedness unless: (i)
such indebtedness is not in excess of 50% of the Net Asset Value of
the Company; or (ii) a majority of the Independent Trustees have
determined that such indebtedness is otherwise necessary to satisfy
the requirement that the Company distribute at least 95% of its
REIT Taxable Income or is advisable to assure that the Company
maintains its qualification as a REIT for federal income tax
purposes.
In addition, the aggregate borrowings of the Company, secured
and unsecured, shall be reasonable in relation to the Net Assets of
the Company and shall be reviewed by the Trustees at least
quarterly. The maximum amount of such borrowings in relation to
the Net Assets shall, in the absence of satisfactory showing that a
higher level of borrowing is appropriate, not exceed 50%. Any
excess over such 50% level shall be approved by a majority of
Independent Trustees and disclosed to Shareholders in the next
quarterly report of the Company, along with justification for such
excess.
COMPETITION
The Company believes that its principal competition in the
business of acquiring and holding Mortgage Investments are
financial institutions such as banks, savings and loans, life
insurance companies, institutional investors such as mutual funds
and pension funds, and certain other mortgage REITs. While most of
these entities have significantly greater resources than the
Company, the Company anticipates that it will be able to compete
effectively and generate relatively attractive rates of return for
stockholders due to its relatively low level of operating costs,
its relationships with its sources of Mortgage Investments and the
tax advantages of its REIT status. The existence of these
competitive entities, as well as the possibility of additional
entities forming in the future, may increase the competition for
the acquisition of Mortgage Investments, resulting in higher prices
and lower yields on such Mortgage Investments.
EMPLOYEES
As of March 27, 1998, the Company had one employee.
CERTAIN LEGAL ASPECTS OF MORTGAGE LOANS
The following discussion contains summaries of certain legal
aspects of mortgage loans which are general in nature. Because
many of the legal aspects of mortgage loans are governed by
applicable state laws (which may vary substantially), the following
summaries do not purport to be complete, to reflect the laws of any
particular state, to reflect all the laws applicable to any
particular mortgage loan or to encompass the laws of all states in
which the properties securing mortgage loans in which the Company
might invest are situated. The summaries are qualified in their
entirety by reference to the applicable federal and state laws
governing mortgage loans.
Mortgages and Deeds of Trust Generally
Mortgage loans are secured by either mortgages or deeds of
trust or other similar security instruments, depending upon the
prevailing practice in the state in which the related mortgaged
property is located. There are two parties to a mortgage, the
mortgagor, who is the borrower and owner of the mortgaged property,
and the mortgagee, who is the lender. In a mortgage transaction,
the mortgagor delivers to the mortgagee a note, bond or other
written evidence of indebtedness and a mortgage. A mortgage
creates a lien upon the real property encumbered by the mortgage as
security for the obligation evidenced by the note bond or other
evidence of indebtedness. Although a deed of trust is similar to a
mortgage, a deed of trust has three parties, the borrower-property
owner called the trustor (similar to a mortgagor), a lender called
the beneficiary (similar to a mortgagee), and a third-party grantee
called the trustee. Under a deed of trust, the borrower grants the
property, until the debt is paid, in trust for the benefit of the
beneficiary to the trustee to secure payment of the obligation
generally with a power of sale. The trustee's authority under a
deed of trust and the mortgagee's authority under a mortgage are
governed by applicable law, the express provisions of the deed of
trust or mortgage, and, in some cases, the direction of the
beneficiary.
The real property covered by a mortgage is most often the fee
estate in land and improvements. However, a mortgage may encumber
other interests in real property such as a tenant's interest in a
lease of land and improvements and the leasehold estate created by
such lease. A mortgage covering an interest in real property other
than the fee estate requires special provisions in the instrument
creating such interest or in the mortgage to protect the mortgagee
against termination of such interest before the mortgage is paid.
Priority of liens on mortgaged property created by mortgages
and deeds of trust depends on their terms and, generally, on the
order of filing with a state, county or municipal office, although
such priority may in some states be altered by the mortgagee's or
beneficiary's knowledge of unrecorded liens against the mortgaged
property. However, filing or recording does not establish priority
over governmental claims for real estate taxes and assessments. In
addition, the Internal Revenue Code of 1986, as amended, provides
priority to certain tax liens over the lien of the mortgage.
Foreclosure
Foreclosure of a mortgage is generally accomplished by
judicial actions initiated by the service of legal pleadings upon
all necessary parties having an interest in the real property.
Delays in completion of foreclosure may occasionally result from
difficulties in locating necessary parties defendant. When the
mortgagee's right to foreclose is contested, the legal proceedings
necessary to resolve the issue can be time-consuming. A judicial
foreclosure may be subject to most of the delays and expenses of
other litigation, sometimes requiring up to several years to
complete. At the completion of the judicial foreclosure
proceedings, if the mortgagee prevails, the court ordinarily issues
a judgment of foreclosure and appoints a referee or other
designated official to conduct the sale of the property. Such
sales are made in accordance with procedures which vary from state
to state. The purchaser at such sale acquires the estate or
interest in real property covered by the mortgage.
Foreclosure of a deed of trust is generally accomplished by a
non-judicial trustee's sale under a specific provision in the deed
of trust and/or applicable statutory requirements which authorizes
the trustee, generally following a request from the
beneficiary/lender, to sell the property to a third party upon any
default by the borrower under the terms of the note or deed of
trust. A number of states may also require that a lender provide
notice of acceleration of a note to the borrower. Notice
requirements under a trustee' sale vary from state to state. In
some states, the trustee must record a notice of default and send a
copy to the borrower-trustor and to any person who has recorded a
request for a copy of a notice of default and notice of sale. In
addition, the trustee must provide notice in some states to any
other individual having an interest in the real property, including
any junior lienholders. In some states, the borrower, or any other
person having a junior encumbrance on the real estate, may, during
a reinstatement period, cure the default by paying the entire
amount in arrears plus the costs and expense incurred in enforcing
the obligations. Generally, state law controls the amount of
foreclosure expenses and costs, including attorneys' fees, which
may be covered by a lender. If the deed of trust is not
reinstated, a notice of sale must be posted in a public place and,
in most states, published for a specific period of time in one or
more newspapers. In addition, some state laws require that a copy
of the notice of sale be posted on the property and sent to all
parties having an interest in the real property.
In case of foreclosure under either a mortgage or deed of
trust, the sale by the referee or other designated official or by
the trustee is often a public sale. However, because of the
difficulty a potential buyer at the sale might have in determining
the exact status of title to the property subject to the lien of
the mortgage or deed of trust and the redemption rights that may
exist (see "Statutory Rights of Redemption" below), and because the
physical condition of the property may have deteriorated during the
foreclosure proceedings and/or for a variety of other reasons
(including exposure to potential fraudulent transfer allegations),
a third party may be unwilling to purchase the property at the
foreclosure sale. For these and other reasons, it is common for
the lender to purchase the property from the trustee, referee or
other designated official for an amount equal to the outstanding
principal amount of the indebtedness secured by the mortgage or
deed of trust, together with accrued, and unpaid interest and the
expenses of foreclosure, in which event, if the amount bid by the
lender equals the full amount of such debt, interest and expenses,
the mortgagee's debt will be extinguished. Thereafter, the lender
will assume the burdens of ownership, including paying operating
expenses and real estate taxes and making repairs. The lender is
then obligated as an owner until it can arrange a sale of the
property to a third party. The lender will commonly obtain the
services of a real estate broker and pay the broker's commission in
connection with the sale of the property. Depending upon market
conditions, the ultimate proceeds of the sale of the property may
not equal the lender's investment in the property. Moreover, a
lender commonly incurs substantial legal fees and court costs in
acquiring a mortgaged property through contested foreclosure and/or
bankruptcy proceedings. Furthermore, an increasing number of
states require that any environmental hazards be eliminated before
a property may be resold. In addition, a lender may be responsible
under federal or state law for the cost of cleaning up a mortgaged
property that is environmentally contaminated. See "Environmental
Risks" below. As a result, a lender could realize an overall loss
on a mortgage loan even if the related mortgaged property is sold
at foreclosure or resold after it is acquired through foreclosure
for an amount equal to the full outstanding principal amount of the
mortgage loan, plus accrued interest.
In foreclosure proceedings, some courts have applied general
equitable principles. These equitable principles are generally
designed to relieve the borrower from the legal effects of his
defaults under the loan documents. Examples of judicial remedies
that have been fashioned include judicial requirements that the
lender undertake affirmative and expensive actions to determine the
causes of the borrower's default and the likelihood that the
borrower will be able to reinstate the loan. In some cases, courts
have substituted their judgment for the lender's judgment and have
required that lenders reinstate loans or recast payment schedules
in order to accommodate borrowers who are suffering from temporary
financial disability. In other cases, courts have limited the
right of the lender to foreclose if the default under the mortgage
instrument is not monetary, such as the borrower's failing to
maintain adequately the property or the borrower's executing a
second mortgage or deed of trust affecting the property. Finally,
some courts have been faced with the issue of whether or not
federal or state constitutional provisions reflecting due process
concerns for adequate notice require that borrowers under mortgages
receive notices in addition to the statutorily-prescribed minimum.
For the most part, these cases have upheld the notice provisions
as being reasonable or have found that the sale under a deed of
trust, or under a mortgage having a power of sale, does not involve
sufficient state action to afford constitutional protection to the
borrower.
Environmental Risks
Real property pledged as security to a lender may be subject
to potential environmental risks. Of particular concern may be
those mortgaged properties which are, or have been, the site of
manufacturing, industrial or disposal activity. Such environmental
risks may give rise to a diminution in value of property securing
any mortgage loan or, as more fully described below, liability for
clean-up costs or other remedial actions, which liability could
exceed the value of such property or the principal balance of the
related mortgage loan. In certain circumstances, a lender may
choose not to foreclose on contaminated property rather than risk
incurring liability for remedial actions.
Under the laws of certain states, the owner's failure to
perform remedial actions required under environmental laws may in
certain circumstances give rise to a lien on mortgaged property to
ensure the reimbursement of remedial costs incurred by the same.
In some states such lien law priority over the lien of an existing
mortgage against such property. Because the costs of remedial
action could be substantial, the value of a mortgaged property as
collateral for a mortgage loan could be adversely affected by the
existence of an environmental condition giving rise to a lien.
The state of law is currently unclear as to whether and under
what circumstances clean-up costs, or the obligation to take
remedial actions, can be imposed on a secured lender. Under the
laws of some states and under the federal Comprehensive
Environmental Response, Compensation, and Liability Act of 1980, as
amended ("CERCLA"), current ownership or operation of a property
provides a sufficient basis for imposing liability for the costs of
addressing releases or threatened releases of hazardous substances
on that property. Under such laws, a secured lender who holds
indicia of ownership primarily to protect its interest in a
property could under certain circumstances fall within the liberal
terms of the definition of "owner or operator", consequently, such
laws often specifically exclude such a secured lender, provided
that the lender does not participate in the facility's management
of environmental matters.
In 1992, the United States Environmental Protection Agency
(the "EPA") issued a rule interpreting and delineating CERCLA's
secured creditor exemption. This rule defined and specified the
range of permissible actions that may be undertaken by a lender who
holds a contaminate facility as collateral without exceeding the
bounds of the secured creditor exemption. In February 1994,
however, the United States Court of Appeals for the D.C. Circuit
struck down the EPA's lender liability rule on the grounds that it
exceeded EPA's rule making authority under CERCLA. A petition for
writ of certiorari to the United States Supreme Court appealing the
D.C. Circuit's decision was denied in January 1995. At the present
time, the future status of the rule and similar legislation now
pending in Congress is unclear, although the EPA has stated that it
will continue to adhere to the rule as a matter of policy and is in
the process of preparing guidance to this effect. Certain courts
that have addressed the issue of lender liability under CERCLA
have, in some cases without relying on any EPA rule or policy,
nonetheless interpreted the secured creditor exemption consistent
with the EPA rule. In any event, the EPA rule does not or would
not necessarily affect the potential for liability under state law
or federal laws other than CERCLA. Furthermore, it is not clear at
the present time whether any such lender protections would be
binding in actions brought by a party other than the federal
government.
The Company expects that at the time most, if not all,
mortgage loans are purchased no environmental assessment or a very
limited environmental assessment of the mortgaged properties will
have been conducted.
"Hazardous substances" are generally defined as any dangerous,
toxic or hazardous pollutants, chemicals, wastes or substances,
including, without limitation, those so identified pursuant to
CERCLA or any other environmental laws now existing, and
specifically including, without limitation, asbestos and asbestos
containing materials, polychlorinated biphenyls, radon gas,
petroleum and petroleum products, and urea formaldehyde.
If a lender is or becomes liable for clean up costs, it may
bring an action for contribution against the current owners or
operators, the owners or operators at the time of on-site disposal
activity or any other party who contributed to the environmental
hazard, but such persons or entities may be bankrupt or otherwise
judgment proof. Furthermore, such action against the borrower may
be adversely affected by the limitations on recourse in the loan
documents. Similarly, in some states anti-deficiency legislation
and other statutes requiring the lender to exhaust its security
before bringing a personal action against the borrower (see "Anti-
Deficiency Legislation" below) may curtail the lender's ability to
recover from its borrower the environmental clean up and other
related costs and liabilities incurred by the lender.
Junior Mortgage and Deeds of Trust; Rights of Senior Mortgages or
Beneficiaries
Priority of liens on mortgaged property created by mortgages
or deeds of trust depends on their terms and, generally, on the
order of filing with a state, county or municipal office, although
such priority may in some states be altered by the mortgagee's or
beneficiary's knowledge of unrecorded liens, leases or encumbrances
against the mortgaged property. However, filing or recording does
not establish priority over governmental claims for real estate
taxes and assessments or, in some states, for reimbursement of
remediation costs of certain environmental conditions. See
"Environmental Risks". In addition, the Code provides priority to
certain tax liens over the lien of a mortgage.
The Company does not presently intend to acquire junior
mortgages or deeds of trust which are subordinate to senior
mortgages or deeds of trust held by the other lenders. The rights
of the Company as mortgagee or beneficiary under a junior mortgage
or deed of trust will be subordinate to those of the mortgagee as
beneficiary under the senior mortgage or deeds of trust, including
the prior rights of the senior mortgagee as beneficiary to receive
rents, hazard insurance and condemnation proceeds and to cause the
property securing the mortgage loan to be sold upon default of the
mortgagor, thereby extinguishing the junior mortgagee's or
beneficiary's lien unless the Company asserts its subordinate
interest in foreclosure litigation or satisfies the defaulted
senior loan. As discussed more fully below, in many states a
junior mortgagee may satisfy a defaulted senior loan in full, or
may cure such default, and bring the senior loan current, in either
event adding the amounts expended to the balance due on the junior
loan. Absent a provision in the senior mortgage, no notice of
default is required to be given to the junior mortgagee or
beneficiary.
The form of mortgage or deed of trust used by many
institutional lenders confers on the mortgagee or beneficiary the
right both to receive proceeds collected under any hazard insurance
policy and awards made in connection with any condemnation
proceedings, and to apply such proceeds and awards to any
indebtedness secured by the mortgage or deed of trust, in such
order as the mortgagee may determine. Thus, in the event
improvements on the property are damaged or destroyed by fire or
other casualty, or in the event the property is taken by
condemnation, the mortgagee or beneficiary under the senior
mortgage or deed of trust will have the prior right to collect any
insurance proceeds payable under a hazard insurance policy and any
award of damages in connection with the condemnation and to apply
the same to the indebtedness secured by the senior mortgage or deed
of trust. Proceeds in excess of the amount of senior indebtedness
will, in most cases, be applied to the indebtedness secured by a
junior mortgage or deed of trust. The laws of certain states may
limit the ability of mortgagees or beneficiaries to apply the
proceeds of hazard insurance and partial condemnation awards to the
secured indebtedness. In such states, the mortgagor or trustor
must be allowed to use the proceeds of hazard insurance to repair
the damage unless the security of the mortgagee or beneficiary has
been impaired. Similarly, in certain states, the mortgagee or
beneficiary is entitled to the award for a partial condemnation of
the real property security only to the extent that its security is
impaired.
The form of mortgage or deed of trust used by many
institutional lenders typically contains a "future advance" clause,
which provides that additional amounts advanced to or on behalf of
the mortgagor or trustor by the mortgagee or beneficiary are to be
secured by the mortgage or deed of trust While such a clause is
valid under the laws of most states, the priority of any advance
made under the clause depends, in some states, on whether the
advance was an "obligatory" or "optional" advance. If the
mortgagee or beneficiaries obligated to advance the additional
amounts, the advance may be entitled to receive the same priority
as amounts initially made under the mortgage or deed of trust,
notwithstanding that there may be intervening junior mortgages or
deeds of trust and other liens between the date of recording of the
mortgage or deed of trust and the date of the future advance, and
notwithstanding that the mortgagee or beneficiary had actual
knowledge of such intervening junior mortgages or deeds of trust
and other liens at the time of the advance. Where the mortgagee or
beneficiary is not obligated to advance the additional amounts and
has actual knowledge of the intervening junior mortgages or deeds
of trust and other liens, the advance may be subordinate to such
intervening junior mortgages or deeds of trust and other liens.
Priority of advances under a "future advance" clause rests, in
other states, on state law giving priority to advances made under
the loan agreement up to a "credit limit" amount stated in the
recorded mortgage or deed of trust.
Another provision typically found in the forms of mortgage and
deed of trust used by many institutional lenders obligates the
mortgagor or trustor to pay before delinquency all taxes and
assessments on the property and, when due, all encumbrances,
charges and liens on the property which appear prior to the
mortgage, to provide and maintain fire insurance on the property,
to maintain and repair the property and not to commit or permit any
waste thereof, and to appear in and defend any action or proceeding
purporting to affect the property or the rights of the mortgagee
under the mortgage. Upon a failure of the mortgagor or trustor to
perform any of these obligations, the mortgagee or beneficiary is
given the right under the mortgage or deed of trust to perform the
obligation itself, at its election, with the mortgagor or trustor
agreeing to reimburse the mortgagee or beneficiary for any sums
expended by the mortgagee or beneficiary on behalf of the mortgagor
or trustor. All sums so expended by the mortgagee or beneficiary
become part of the indebtedness secured by the mortgage.
Statutory Rights of Redemption
In some states, after a foreclosure sale pursuant to a
mortgage or deed of trust, the borrower and certain foreclosed
junior lienors are given a statutory period in which to redeem the
property from the foreclosure sale. In some states, redemption may
occur only upon payment of the entire principal balance of the
loan, accrued interest and expenses of foreclosure. In other
states, redemption may be authorized if the borrower pays only a
portion of the sums due. The effect of a statutory right of
redemption is to diminish the ability of the lender to sell the
foreclosed property. The right of redemption may defeat the title
of any purchaser as a foreclosure sale or any purchaser from the
lender subsequent to a foreclosure sale. Certain states permit a
lender to avoid a post-sale redemption by waiving its right to a
deficiency judgment. Consequently, the practical effect of the
redemption right is often to force the lender to retain the
property and pay the expenses of ownership until the redemption
period has run.
Anti-Deficiency Legislation
The Company may acquire interests in mortgage loans which are
nonrecourse loans as to which, in the event of default by a
borrower, recourse may be had only against the specific property
pledged to secure the related mortgage loan and not against the
borrower's other assets. Even if recourse is available pursuant to
the terms of the mortgage loan against the borrower's assets in
addition to the mortgaged property, certain states have imposed
statutory prohibitions which impose prohibitions against or
limitations on such recourse. Some state statutes limit the right
of the mortgagee or beneficiary to obtain a deficiency judgment
against the borrower following foreclosure. A deficiency judgment
is a personal judgment against the former borrower equal in most
cases to the difference between the net amount realized upon the
public sale of the security and the amount due to the lender.
Other statutes require the mortgagee or beneficiary to exhaust the
security afforded under a mortgage by foreclosure in an attempt to
satisfy the full debt before bringing a personal action against the
borrower. In certain states, the lender has the option of bringing
a personal action against the borrower on the debt without first
exhausting such security; however, in some of these states, the
lender, following judgment on such personal action, may be deemed
to have elected a remedy and may be precluded from exercising
remedies with respect to the security. The practical effect of
such an election requirement is that lenders will usually proceed
first against the security rather than bringing personal action
against the borrower. Other statutory provisions limit any
deficiency judgment against the former borrower following a
judicial sale to the access of the outstanding debt over the fair
market value of the property at the time of the public sale. The
purpose of these statutes is generally to prevent a mortgagee form
obtaining a large deficiency judgment against the borrower as a
result of low bids or the absence of bids at the judicial sale.
Bankruptcy Laws
Statutory provisions, including the Bankruptcy Code and state
laws affording relief to debtors, may interfere with and delay the
ability of the secured mortgage lender to obtain payment of the
loan, to realize upon collateral and/or to enforce a deficiency
judgment. Under the Bankruptcy Code, virtually all actions
(including foreclosure actions and deficiency judgment proceeding)
are automatically stayed upon the filing of the bankruptcy
petition, and, often, no interest or principal payments are made
during the course of the bankruptcy proceeding. The delay and
consequences thereof caused by such automatic stay can be
significant. Also, under the Bankruptcy Code, the filing of a
petition in bankruptcy by or on behalf of a junior lienor,
including, without limitation, any junior mortgagee, may stay the
senior lender from taking action to foreclose out such junior lien.
Under the Bankruptcy Code, provided certain substantive and
procedural safeguards for the lender are met, the amount and terms
of a mortgage secured by property of the debtor may be modified
under certain circumstances. The outstanding amount of the loan
secured by the real property may be reduced to the then current
value of the property (with a corresponding partial reduction of
the amount of the lender's security interest) pursuant to a
confirmed plan or lien avoidance proceeding, thus leaving the
lender a general unsecured creditor for the differences between
such value and the outstanding balance of the loan. Other
modifications may include the reduction in the amount of each
monthly payment, which reduction may result from a reduction in the
rate of interest and/or the alteration of the repayment schedule
(with or without affecting the unpaid principal balance of the
loan), and/or an extension (or reduction) of the final maturity
date. Some courts with federal bankruptcy jurisdiction have
approved plans, based on the particular facts of the reorganization
case, that effected the curing of a mortgage loan default by paying
arrearage over a number of years. Also, under the Bankruptcy Code,
a bankruptcy court may permit a debtor through its rehabilitative
plan to de-accelerate a secured loan and to reinstate the loan even
though the lender accelerated the mortgage loan and final judgment
of foreclosure had been entered in state court (provided no sale of
the property had yet occurred) prior to the filing of the debtor's
petition. This may be done even if the full amount due under the
original loan is never repaid. Other types of significant
modifications to the terms of the mortgage or deed of trust may be
acceptable to the bankruptcy court, often depending on the
particular facts and circumstances of the specific case.
In a bankruptcy or similar proceeding action may be taken
seeking the recovery as a preferential transfer of any payments
made by the mortgagor under the related mortgage loan to the
lender. Payments on long-term debt may be protected from recovery
as preferences if they are payments in the ordinary course of
business made on debts incurred in the ordinary course of business.
Whether any particular payment would be protected depends upon the
facts specific to a particular transaction.
Enforceability of Certain Provisions
Prepayment Provisions
In the absence of state statutory provisions prohibiting
prepayment fees (e.g., in the case of single-family residential
loans) courts generally enforce claims requiring prepayment fees
unless enforcement would be unconscionable. However, the laws of
certain states may render prepayment fees unenforceable for certain
residential loans or after a mortgage loan has been outstanding for
a certain number of years, or may limit the amount of any
prepayment fee to a specified percentage of the original principal
amount of the mortgage loan, to a specified percentage of the
outstanding principal balance of a mortgage loan, or to a fixed
number of month's interest on the prepaid amount. In certain
states, prepayment fees payable on default or other involuntary
acceleration of a mortgage loan may not be enforceable against the
mortgagor or trustor. Some state statutory provisions may also
treat certain prepayment fees as usurious if in excess of statutory
limits. See "Certain Laws and Regulations - Applicability of Usury
Laws". The Company may invest in mortgage loans that do not
require the payment of specified fees as a condition to prepayment
or the requirements of which have expired, and to the extent
mortgage loans do require such fees, such fees generally may not be
a material deterrent to the prepayment of mortgage loans by the
borrowers.
Due-On-Sale Provisions
The enforceability of due-on-sale clauses has been the subject
of legislation or litigation in many states, and in some cases,
typically involving single family residential mortgage
transactions, their enforceability has been limited or denied. The
Garn-St. Germain Depository Institutions Act of 1982 (the "Garn-St.
Germain Act") preempts state constitutional, statutory and case law
that prohibits the enforcement of due-on-sale clauses and permits
lenders to enforce these claims in accordance with their terms,
subject to certain exceptions. As a result, due-on-sale clauses
have become generally enforceable except in those states whose
legislatures exercised their authority to regulate the
enforceability of such clauses with respect to certain mortgage
loans. The Garn-St. Germain Act does "encourage" lenders to permit
assumption of loans at the original rate of interest or at some
other rate less than the average of the original rate and the
market rates.
Under federal bankruptcy law, due-on-sale clauses may not be
enforceable in bankruptcy proceedings and may, under certain
circumstances, be eliminated in any modified mortgage resulting
from such bankruptcy proceeding.
Acceleration on Default
The Company may invest in mortgage loans which contain a
"debt-acceleration" clause, which permits the lender to accelerate
the full debt upon a monetary or nonmonetary default of the
borrower. The courts of most states will enforce clauses providing
for acceleration in the event of a material payment default after
giving effect to any appropriate notices. The equity courts of any
state, however, may refuse to foreclose a mortgage or deed of trust
when an acceleration of the indebtedness would be inequitable or
unjust or the circumstances would render the acceleration
unconscionable. Furthermore, in some states, the borrower may
avoid foreclosure and reinstate an accelerated loan by paying only
the defaulted amounts and the costs and attorneys' fees incurred by
the lender in collecting such defaulted payments.
State courts also are known to apply various legal and
equitable principles to avoid enforcement of the forfeiture
provisions of installment contracts. For example, a lender's
practice of accepting late payments from the borrower may be deemed
a waiver of the forfeiture clause. State courts also may impose
equitable grace periods for payment of arrearage or otherwise
permit reinstatement of the contract following a default. Not
infrequently, if a borrower under an installment contract has
significant equity in the property, equitable principles will be
applied to reform or reinstate the contract or to permit the
borrower to share the proceeds upon a foreclosure sale of the
property if the sale price exceeds the debt.
Secondary Financing: Due-on-Encumbrance Provisions
Some mortgage loans may have no restrictions on secondary
financing, thereby permitting the borrower to use the mortgaged
property as security for one or more additional loans. Some
mortgage loans may preclude secondary financing (often by
permitting the first lender to accelerate the maturity of its loan
if the borrower further encumbers the mortgaged property) or may
require the consent of the senior lender to any junior or
substitute financing; however, such provisions may be unenforceable
in certain jurisdictions under certain circumstances.
Where the borrower encumbers the mortgaged property with one
or more junior liens, the senior lender is subjected to additional
risk. First, the borrower may have difficulty servicing and
repaying multiple loans. Second, acts of the senior lender which
prejudice the junior lender or impair the junior lender's security
may create a superior equity in favor of the junior lender. Third,
if the borrower defaults on the senior loan and/or any junior loan
or loans, the existence of junior loans and actions taken by junior
lenders can impair the security available to the senior lender and
can interfere with, delay and in certain circumstances even prevent
the taking of action by the senior lender. Fourth, the bankruptcy
of a junior lender may operate to stay foreclosure or similar
proceedings by the senior lender.
Applicability of Usury Laws
State and federal usury laws limit the interest that lenders
are entitled to receive on a mortgage loan. In determining whether
a given transaction is usurious, courts may include charges in the
form of "points" and "fees" as "Interest", but may exclude payments
in the form of "reimbursement of foreclosure expenses" or other
charges found to be distinct from "interest". If, however, the
amount charged for the use of the money loaned is found to exceed a
statutorily established maximum rate, the form employed and the
degree of overcharge are both immaterial. Statutes differ in their
provision as to the consequences of a usurious loan. One group of
statues requires the lender to forfeit the interest above the
applicable limit or imposes a specified penalty. Under this
statutory scheme, the borrower may have the recorded mortgage or
deed of trust canceled upon paying its debt with lawful interest,
or the lender may foreclose, but only for the debt plus lawful
interest. Under a second, more severe type of statute, a violation
of the usury law results in the invalidation of the transaction,
thereby permitting the borrower to have the recorded mortgage or
deed of trust canceled without any payment and prohibiting the
lender from foreclosing.
RISK FACTORS
The purchase of the Shares offered hereby involves a high
degree of risk and is suitable only for persons with the financial
capability of making and holding long-term investments that are not
readily reducible to cash. Prospective investors must, therefore,
have adequate means of providing for their current needs and
personal contingencies. Prospective investors should also consider
the following factors:
A. Investment and Business Risks
1. Lack of Liquidity. There is currently no established
trading market for the Shares and the Company has no plans to
liquidate and distribute the proceeds to its Shareholders.
Although the Company intends to seek to have the Shares listed on
NASDAQ or an exchange after the sale of all of the Shares offered
in its initial public offering, there can be no assurance that
those efforts will be successful or that an established trading
market for the Shares will develop. Accordingly, Shareholders may
not be able to sell their Shares or use them as collateral for a
loan. Furthermore, even if a market for the sale of Shares
develops, a Shareholder may experience a substantial loss on the
sale of those Shares. Consequently, the purchase of Shares should
be considered only as a long-term investment.
2. Increased Risk of Default in Non-Conforming Loans. The
Company is in the business of lending money and, as such, takes the
risk of defaults by borrower. Most, if not all, of such loans will
not be insured or guaranteed by a federally owned or guaranteed
mortgage agency and will be made to borrowers who do not satisfy
the income ratios, credit record criteria, loan-to-value ratios,
employment history and liquidity requirements of traditional
mortgage financing. See "Investment Objectives and Policies -
Investment Policy". Accordingly, the risk of default by the
borrower in those "non-conforming loans" is higher than the risk of
default in loans made to persons who qualify for traditional
mortgage financing. If the borrower defaults, the Company may be
forced to purchase the property at a foreclosure sale. If the
Company cannot quickly sell or refinance such property, and the
property does not produce any significant income, the Company's
profitability will be adversely affected. See "Risk Factors - Risk
of Loss on Non-Insured, Non-Guaranteed Mortgage Loans" and "Risk
Factors - Bankruptcy of Borrowers May Delay or Prevent Recovery".
3. Fees Payable to the Advisor and Affiliates. The Advisor
and its Affiliates will receive substantial compensation from the
proceeds of the Company's initial public offering and the
operations of the Company, including: (1) commissions, due
diligence fees and Shares payable to the Selling Group Manager; (2)
Acquisition Fees payable to the Advisor equal to 3% of the
principal amount of each Mortgage Investment acquired by the
Company; (3) loan servicing fees payable to SCMI; (4) real estate
brokerage commissions; and (5) a Subordinated Incentive Fee payable
to the Advisor. These fees, other than the Subordinated Incentive
Fee, will be payable even if the Company is not profitable. See
"Management Compensation" for a discussion of the fees payable to
the Advisor and its Affiliates. The structure of those fees may
cause conflicts of interest between the Company, the Advisor and
its Affiliates. In addressing these conflicts of interest, the
Trustees, the Administrator and the Advisor will be required to
abide by their fiduciary duties to the Company and the
Shareholders.
4. Purchase of Mortgage Notes from Affiliate. The Company
intends to acquire its Mortgage Investments from several sources,
including SCMI, an Affiliate of the Advisor. The amount of Mortgage
Investments to be acquired from SCMI cannot be determined at this
time and will depend upon the Mortgage Investments that are
available from SCMI or other sources at the time the Company has
funds to invest. At this time, SCMI is the only Affiliate that is
expected to sell any Mortgage Investment to the Company. Due to
the affiliation between the Advisor and SCMI and the fact that SCMI
may make a profit on the sale of Mortgage Investments to the
Company, the Advisor will have a conflict of interest in
determining if Mortgage Investments should be purchased from SCMI
or unaffiliated third parties. However, all Mortgage Investments
purchased from SCMI or other Affiliates will be at prices no higher
than those that would be paid to unaffiliated third parties for
mortgages with comparable terms, rates, credit risks and seasoning.
5. Non-Arm's-Length Agreements. The agreements and
arrangements relating to compensation between the Company and the
Advisor or its Affiliates are not the result of arm's-length
negotiations. However, the majority of the Trustees are
Independent Trustees and all of the Trustees may be removed, with
or without cause, by the holders of a majority of the outstanding
Shares. The Advisor may be removed for cause by a majority of such
Independent Trustees without ratification by the Shareholders.
6. Competition for the Time and Services of Common Officers
and Trustees. The Company will rely on the Advisor and its
Affiliates for supervision of the management of the operations of
the Company. In the performance of their duties, the officers,
directors and employees of the Advisor and its Affiliates may, for
their own account or that of others, originate mortgages and
acquire investments similar to those made or acquired by the
Company. The Trustees also may act as trustees, directors or
officers, or engage in other capacities, in other REITs or limited
partnerships, and may acquire and originate similar Mortgage
Investments for their own account or that of others. Accordingly,
conflicts of interest may arise in operating more than one entity
with respect to allocating time between such entities. The
Trustees, the Administrator and the Advisor will devote such time
to the affairs of the Company and to the other entities in which
they are involved, as they determine in their sole discretion,
exercised in good faith and in compliance with their fiduciary
obligations to the Company, to be necessary for the benefit of the
Company and such other entities.
7. Competition by the Company with Affiliates for the Purchase
and Sale of Mortgage Investments. Various REITs, partnerships or
other entities may in the future be formed by the Advisor or its
Affiliates to engage in businesses which may be competitive with
the Company and which may have the same management as the Company.
To the extent that such other REITs, partnerships or entities with
similar investment objectives (or programs with dissimilar
objectives for which a particular Mortgage Investments may
nevertheless be suitable) (collectively "Affiliated Programs") have
funds available for investment at the same time as the Company and
a potentially suitable investment has been offered to the Company
or an Affiliated Program, conflicts of interest will arise as to
which entity should acquire the investment.
If any conflict arises between the Company and any of the
other Affiliated Programs, the Advisor will initially review the
investment portfolios of the Company and of each of such Affiliated
Programs and will determine whether or not such mortgage loan or
other investment should be made by the Company or such other
Affiliated Programs based upon such factors as the amount of funds
available for investment, yield, portfolio diversification, type
and location of the property on which the mortgage loan will be
made, and proposed loan terms. The Trustees (including the
Independent Trustees) will be responsible for monitoring this
allocation method (and that described below with respect to new
Affiliated Programs established in the future) to be sure that each
is applied fairly to the Company.
If the Advisor or its Affiliates establish new Affiliated
Programs after the commencement of the Company's initial public
offering and the making of a Mortgage Investment appears equally
appropriate for the Company and one or more of such subsequently
formed Affiliated Programs, the Mortgage Investment will be
allocated to one program on a basis of rotation with the initial
order of priority determined by the dates of formation of the
programs.
Further, the Trustees and the officers, directors and
employees of the Advisor and its Affiliates may for their own
account or that of others originate and acquire Mortgages and
Mortgage Investments similar to those made or acquired by the
Company. The Trustees and the Advisor are, however, subject to a
fiduciary duty to the Company and the Shareholders. Each Trustee,
on his own behalf, and the Advisor, on behalf of itself, the
officers and directors of the Advisor, and all Persons controlled
by the Advisor and its officers and directors, has agreed to first
present suitable investments to the Company before recommending or
presenting such opportunities to others or taking advantage of such
opportunities on their own behalf, except as otherwise described
with respect to Affiliated Programs or the business of SCMI. See
"Management - Summary of the Advisory Agreement". Except as
described above, and subject to their fiduciary duty to the Company
and the Shareholders, neither the Trustees, the Advisor nor its
Affiliates will be obligated to present to the Company any
particular investment opportunity which comes to their attention,
even if such opportunity is of a character which might be suitable
for investment by the Company.
There may be conflicts of interest on the part of the Advisor
between the Company and any other Affiliates of the Advisor which
have the same investment objectives at such time as the Company
attempts to sell Mortgage Investments, as well as in other
circumstances.
8. Additional Conflicts with Affiliates. Although the Company
does not presently expect to do so, it is permitted to invest in
mortgage loans on properties owned by Affiliates. However, it may
only do so if those transactions are approved by a majority of the
Trustees not otherwise interested in the transactions as being fair
and reasonable to the Company and on terms and conditions not less
favorable to the Company than those available from third parties.
See "Other Restrictions in Declaration of Trust - Restrictions on
Transactions with Affiliates".
9. Lack of Diversification. Although the Company's initial
public offering is for a maximum of 2,500,000 Shares ($50,000,000),
as of December 31, 1997, the Company had only sold 202,508 Shares
for Gross Offering Proceeds of $4,050,160. The Company is entitled
to terminate the offering at any time in its sole discretion for
any reason whatsoever. Because the Company has not sold all of the
Shares, the investment portfolio of the Company consists of fewer
investments. As a result, the Company has an increased risk of
loss in connection with a smaller number of investments.
Furthermore, subject to the limits on expenses set forth in the
Declaration of Trust, the returns on Shares sold will be reduced as
a result of allocating all Company expenses among such Shares.
10. Shareholders Must Rely on Management. The Trustees will
be responsible for the management and control of the Company, but
will employ the Administrator to manage the Company's day to day
affairs. The Trustees will retain the Advisor to use its best
efforts to seek out and present to the Company, whether through its
own efforts or those of third parties retained by it, suitable and
a sufficient number of investment opportunities which are
consistent with the investment policies and objectives of the
Company and consistent with such investment programs as the
Trustees may adopt from time to time in conformity with the
Declaration of Trust. The Trustees have initially delegated to the
Advisor, subject to the supervision and review of the Trustees and
consistent with the provisions of the Company's Declaration of
Trust, the power and duty to: (i) develop underwriting criteria and
a model for the Company's investment portfolio; (ii) acquire,
retain or sell Mortgage Investments; (iii) seek out, present and
recommend investment opportunities consistent with the Company's
investment policies and objectives, and negotiate on behalf of the
Company with respect to potential investments or the disposition
thereof; (iv) pay the debts and fulfill the obligations of the
Company, and handle, prosecute and settle any claims of the
Company, including foreclosing and otherwise enforcing mortgages
and other liens securing investments; (v) obtain for the Company
such services as may be required for mortgage brokerage and
servicing and other activities relating to the investment portfolio
of the Company; (vi) evaluate, structure and negotiate prepayments
or sales of Mortgage Investments; (vii) from time to time, or as
requested by the Trustees, make reports to the Company as to its
performance of the foregoing services and (viii) to supervise other
aspects of the business of the Company. The success of the Company
will, to a large extent, depend on the quality of the management
provided by the Advisor, particularly as it relates to evaluating
the merits of proposed investments. Although the Shareholders
elect the Trustees annually, Shareholders have no right or power
otherwise to take part in the management of the Company, except to
the extent permitted by the Declaration of Trust. Accordingly, no
person should purchase any of the Shares offered hereby unless he
is willing to entrust all aspects of the management and control of
the business of the Company to the Trustees, the Administrator and
the Advisor.
11. Limited Ability to Meet Fixed Expenses. Operating
expenses of the Company, including certain compensation to the
Administrator, servicing and administration expenses payable to an
Affiliate and unaffiliated mortgage servicers and the Independent
Trustees, must be met regardless of the Company's profitability.
The Company is also obligated to distribute 95% of its REIT Taxable
Income (which may under certain circumstances exceed its Cash Flow)
in order to continue to qualify as a REIT for federal income tax
purposes. See "Federal Income Tax Considerations - Qualification
as a REIT". Accordingly, it is possible that the Company may be
required to borrow funds or liquidate a portion of its investments
in order to pay its expenses or to make the required cash
distributions to Shareholders. Although the Company generally may
borrow funds, there can be no assurance that such funds will be
available to the extent, and at the time, required by the Company.
See "Other Restrictions in Declaration of Trust - Restrictions on
Borrowing".
12. Investment Company Regulatory Considerations. The Company
is not a mutual fund or any other type of investment company
subject to the registration and regulatory provisions of the
Investment Company Act of 1940 (the "Investment Company Act"). The
Trustees will attempt to monitor the proportion of the Company's
portfolio which is placed in various investments so that the
Company does not come within the definition of an investment
company under the Investment Company Act. As a result, the Company
may have to forego certain investments which would produce a more
favorable return to the Company.
13. Anti-Takeover Considerations and Restrictions on Share
Accumulation. Provisions of the Maryland corporation law
applicable to the Company make business combinations with the
Company more difficult and place restrictions on persons acquiring
more than 10% of the Company's outstanding shares. Further, in
order for the Company to qualify as a REIT, no more than 50% of the
outstanding Shares may be owned, directly or indirectly, by five or
fewer individuals at any time during the last half of the Company's
taxable year. To ensure that the Company will not fail to qualify
as a REIT under this test, the Company's Declaration of Trust
grants the Trustees the power to place restrictions on the
accumulation of Shares and provides that Shares held by one
shareholder in excess of 9.8% of the total Shares outstanding no
longer entitle the shareholder to vote or receive Distributions.
While these restrictions are designed to prevent any five
individuals from owning more than 50% of the Shares, they would
also discourage a change of control of the Company. The
restrictions and provisions under law and these adopted by the
Company may also (i) deter individuals and entities from making
tender offers for Shares, which offers may be attractive to
Shareholders or (ii) limit the opportunity for Shareholders to
receive a premium for their Shares in the event an investor is
making purchases of Shares in order to acquire a block of Shares.
14. Limited Liability Of Trustees And Officers. The Company's
Declaration of Trust provides that the Trustees and officers of the
Company shall have the fullest limitation on liability permitted by
the laws of the State of Maryland. Pursuant to the Maryland
statute under which the Company was formed, a Trustee of the
Company is not personally liable for the obligations of the Company
except, if a Trustee otherwise would be liable, that provision does
not relieve the Trustee from any liability to the Company or its
Shareholders for any act that constitutes: (1) bad faith; (2)
willful misfeasance; (3) gross negligence; or (4) reckless
disregard of the Trustee's duties. However, as permitted by the
Maryland statute, the Company's Declaration of Trust further limits
the liability of the Company's Trustees and officers by providing
that the Trustees and the officers shall be liable to the Company
or the Shareholders only (i) to the extent the Trustee or officer
actually received an improper benefit or profit in money, property
or services, in which case any such liability shall not exceed the
amount of the benefit or profit in money, property or services
actually received; or (ii) to the extent that a judgment or other
final adjudication adverse to such Trustee or officer is entered in
a proceeding based on a finding in the proceeding that such
Trustee's or officer's action or failure to act was the result of
active and deliberate dishonesty and was material to the cause of
action adjudicated in the proceeding. In all situations in which
the limitations of liability contained therein apply, the remedies
available to the Company or its Shareholders shall be limited to
equitable remedies, such as injunctive relief or recision, and
shall not include the right to recover money damages. As a result
of that limitation on liability, the Company and its Shareholders
may be limited in their ability to recover from the Trustees and
officers of the Company for any damages caused by a breach of the
duties those persons owe to the Company.
15. Risk of Potential Future Offerings. The Company may in
the future increase its capital resources by making additional
offerings of Shares on terms deemed advisable by the Company's
Trustees. Depending upon the terms upon which any additional
Shares might be offered, the effect of additional equity offerings
may be the dilution of the equity of stockholders of the Company or
the reduction of the price of the Company's Shares, or both. The
Company is unable to estimate the amount, timing or nature of
additional offerings as they will depend upon market conditions and
other factors.
B. Operations Risks
16. Economic Risks. The results of the Company's operations
are affected by various factors, many of which are beyond the
control of the Company. The results of the Company's operations
depend on, among other things, the level of net interest income
generated by the Company's Mortgage Investments, the market value
of such Mortgage Investments and the supply of and demand for such
Mortgage Investments. The Company's net interest income varies
primarily as a result of changes in short-term interest rates,
borrowing costs and prepayment rates, the behavior of which involve
various risks and uncertainties as set forth below. Interest
rates, borrowing costs and credit losses depend upon the nature and
terms of the Mortgage Investments, the geographic location of the
properties securing the Mortgage Investments, conditions in
financial markets, the fiscal and monetary policies of the United
States government and the Board of Governors of the Federal Reserve
System, international economic and financial conditions,
competition and other factors, none of which can be predicted with
any certainty. Because changes in interest rates may significantly
affect the Company's activities, the operating results of the
Company depend, in large part, upon the ability of the Company
effectively to manage its interest rate risks while maintaining its
status as a REIT. See "Risk Factors - Fluctuations in Interest
Rates May Affect Return on Investment".
17. Risk of Loss on Non-Insured, Non-Guaranteed Mortgage
Loans. The Company generally does not intend to obtain credit
enhancements for its single-family mortgage loans, because the
majority, if not all, of such mortgage loans will be "non-
conforming" in that they will not meet all of the underwriting
criteria required for the sale of the mortgage loan to a federally
owned or guaranteed mortgage agency. Accordingly, during the time
it holds such mortgage loans for which third party insurance is not
obtained, the Company will be subject to the general risks of
borrower defaults and bankruptcies and special hazard losses that
are not covered by standard hazard insurance (such as those
occurring from earthquakes or floods). In the event of a default
on any single-family mortgage loan held by the Company, including,
without limitation, resulting from higher default levels as a
result of declining property values and worsening economic
conditions, among other factors, the Company would bear the risk of
loss of principal to the extent of any deficiency between the value
of the related mortgage property, and the amount owing on the
mortgage loan. Defaulted mortgage loans would also cease to be
eligible collateral for borrowings and would have to be financed by
the Company out of other funds until ultimately liquidated,
resulting in increased financing costs and reduced net income or a
net loss. See "Certain Legal Aspects of Mortgage Loans".
18. Bankruptcy Of Borrowers May Delay Or Prevent Recovery.
The recovery of sums advanced by the Company in making Mortgage
Investments and protecting its security may be delayed or impaired
by the operation of the federal bankruptcy laws. Any borrower has
the ability to delay a foreclosure sale by the Company for a period
ranging from several months to several years or more by filing a
petition in bankruptcy, which automatically stays any actions to
enforce the terms of the loan. The length of this delay and the
costs associated therewith will generally have an adverse impact on
the Company's profitability. See "Certain Legal Aspects of
Mortgage Loans".
19. Ability to Acquire Mortgage Investments; Competition and
Supply. In acquiring Mortgage Investments, the Company will
compete with other REITs, investment banking firms, savings and
loan associations, banks, mortgage bankers, insurance companies,
mutual funds, other lenders, Ginnie Mae, Fannie Mae, Freddie Mac
and other entities purchasing Mortgage Investments, most of which
will have greater financial resources than the Company. In
addition, there are several mortgage REITs similar to the Company,
and others may be organized in the future. Some of these entities
can be expected to have substantially greater experience in
originating or acquiring Mortgage Investments than the Advisor and
the Company. The effect of the existence of additional potential
purchasers of Mortgage Investments may be to increase competition
for the available supply of Mortgage Investments suitable for
purchase by the Company.
20. Environmental Liabilities. In the event that the Company
is forced to foreclose on a defaulted mortgage loan to recover its
investment in such mortgage loan, the Company may be subject to
environmental liabilities in connection with such real property as
a result of which liabilities the value of the real property may be
diminished. While the Company intends to exercise due diligence to
discover potential environmental liabilities prior to the
acquisition of any property through foreclosure, hazardous
substances or wastes, contaminants, pollutants or sources thereof
(as defined by state and federal laws and regulations) may be
discovered on properties during the Company's ownership or after a
sale thereof to a third party. If such hazardous substances are
discovered on a property, the Company may be required to remove
those substances or sources and clean up the property. There can
be no assurances that the Company would not incur full recourse
liability for the entire cost of any removal and clean up, that the
cost of such removal and clean up would not exceed the value of the
property or that the Company could recoup any of such costs form
any third party. The Company may also be liable to tenants and
other users of neighboring properties. In addition, the Company
may find it difficult or impossible to sell the property prior to
or following any such clean up. See "Certain Legal Aspects of
Mortgage Loans - Environmental Risks".
21. Risk of Leverage. Subject to certain restrictions
described in "Other Restrictions in Declaration of Trust -
Restrictions on Borrowing", including the affirmative vote of the
Independent Trustees, the Company would be allowed to incur
financing with respect to the acquisition of Mortgage Investments
in an aggregate amount not to exceed 50% of the Net Assets of the
Company. The effect of leveraging is to increase the risk of loss.
The higher the rate of interest on the financing, the more
difficult it would be for the Company to meet its obligations and
the greater the chance of default. Such financing may be secured
by liens on the Company's interest in Mortgage Investments.
Accordingly, the Company could lose its investment in Mortgage
Investments if the Company defaults on the indebtedness. To the
extent possible, such debt will be of non-recourse type, meaning
that neither the Shareholders nor the Company will be liable for
any deficiency between the proceeds of a sale or other disposition
of the Mortgage Investments and the amount of the debt.
22.Reliance On Appraisals Which May Not Be Accurate Or Which
May Be Affected By Subsequent Events. Since the Company is an
"asset" rather than a "credit" lender, the Company is relying
primarily on the real property securing the Mortgage Investments to
protect its investment. Thus, the Company will rely on appraisals
and Broker Price Opinions ("BPO's"), to determine the fair market
value of real property used to secure Mortgage Investments made by
the Company. See "Investment Objectives and Policies -
Underwriting Criteria". No assurance can be given that such
appraisals or BPO's will, in any or all cases, be accurate.
Moreover, since an appraisal or BPO is given with respect to the
value of real property at a given point in time, subsequent events
could adversely affect the value of real property used to secure a
loan. Such subsequent events may include general or local economic
conditions, neighborhood values, interest rates and new
construction. Moreover, subsequent changes in applicable
governmental laws and regulations may have the effect of severely
limiting the permitted uses of the property, thereby drastically
reducing its value. Accordingly, if an appraisal is not accurate
or subsequent events adversely effect the value of the property,
the Mortgage Investment would not be as secure as anticipated, and,
in the event of foreclosure, the Company may not be able to recover
its entire investment.
23. Fluctuations In Interest Rates May Affect Return On
Investment. Recent years have demonstrated that mortgage interest
rates are subject to abrupt and substantial fluctuations. If
prevailing interest rates rise above the average interest rate
being earned by the Company's Mortgage Investments, investors may
be unable to quickly liquidate their investment in order to take
advantage of higher returns available from other investments. See
"Risk Factors - Lack of Liquidity". Furthermore, interest rate
fluctuations may have a particularly adverse effect on the Company
if it used money borrowed at variable rates to fund fixed rate
Mortgage Investments. In that event, if prevailing interest rates
rise, the Company's cost of money could exceed the income earned
from that money, thus reducing the Company's profitability or
causing losses through liquidation of Mortgage Investments in order
to repay the debt on the borrowed money or default if the Company
cannot cover the debt on the borrowed money.
24. Mortgages May Be Considered Usurious. Most, if not all,
of the Mortgages the Company will purchase will not be exempt from
state usury laws and thus there exists some uncertainty with
respect to mortgage loans in states with restrictive usury laws.
However, the Company anticipates that it will only purchase
mortgage loans if the mortgage agreements provide that the amount
of such interest charge therein will be reduced if, and to the
extent that, the interest or other charges would otherwise be
usurious. See "Certain Legal Aspects of Mortgage Loans -
Applicability of Usury Laws".
25. Risks of Bankruptcy of Mortgage Servicer. The Company's
Mortgages will be serviced by SCMI or by other entities. Although
the Company intends to obtain fidelity bonds and directors and
officers indemnity insurance to lower risks of liability from the
actions of such entities, there may be additional risks in the
event of the bankruptcy or insolvency of any such entities or in
the event of claims by their creditors, which would not be present
if the Company were qualified in all instances to service its
Mortgage Investments directly. For example, such entities will,
from time to time, receive on the Company's behalf, payments of
principal, interest, prepayment premiums and sales proceeds. In
the event of bankruptcy or insolvency of the entity in possession
of the Company's assets, its creditors could seek to attach such
assets in satisfaction of their claims which could delay
remittances to the Company. If such entities hold these payments
in segregated accounts as they are contractually obligated to do,
then the Advisor believes any such claim should be resolved in
favor of the Company as the beneficial owner.
C. Tax Risks
26. Material Tax Risks Associated With Investment In Shares.
An investment in Shares involves material tax risks. Each
prospective purchaser of Shares is urged to consult his own tax
adviser with respect to the federal (as well as state and local)
income tax consequences of such an investment. For a more detailed
description of the tax consequences of an investment in Shares.
See "Federal Income Tax Considerations".
27. Risk of Inability to Qualify as a REIT. The Company has
and intends to continue to conduct its operations to enable it to
qualify as a REIT under the Internal Revenue Code (the "Code"). To
qualify as a REIT, and thereby avoid the imposition of federal
income tax on any income it distributes to the Shareholders, the
Company must continually satisfy three income tests, two asset
tests and one distribution test. See "Federal Income Tax
Considerations - Qualification as a REIT". The Company has
received an opinion of its legal counsel that it is more likely
than not that the Company will qualify as a REIT. See "Risk
Factors - Limitations on Opinion of Counsel as to Tax Matters" and
"Federal Income Tax Considerations - General".
Because at least 75% of the Company's assets must be
qualifying real estate assets at the end of each calendar quarter,
the time at which the Company would be entitled to elect to be
taxed as a REIT may be delayed until the Company acquires
qualifying real estate assets such as Mortgages (including certain
temporary investments) which constitute 75% of the Company's total
assets.
If, in any taxable year, the Company should fail to distribute
at least 95% of its taxable income, it would be taxed as a
corporation and distributions to its Shareholders would not be
deductible in computing its taxable income for federal income tax
purposes. Because of the possible receipt of income without
corresponding cash receipts due to timing differences that may
arise between the realization of taxable income and net cash flow
(e.g. by reason of the original issue discount rules) or the
payment by the Company of amounts which do not give rise to a
current deduction (such as principal payments on indebtedness) it
is possible that the Company may not have sufficient cash or liquid
assets at a particular time to distribute 95% of its taxable
income. In such event, the Company could declare a consent
dividend or the Company could be required to borrow funds or
liquidate a portion of its investments in order to pay its
expenses, make the required Distributions to Shareholders, or
satisfy its tax liabilities, including the possible imposition of a
4 percent excise tax. There can be no assurance that such funds
will be available to the extent, and at the time, required by the
Company. In the event of any adjustment of deductions of gross
income by the IRS the Company could declare a deficiency dividend.
See "Federal Income Tax Considerations - Qualification as a REIT -
Distributions to Shareholders".
If the Company is taxed as a corporation, the payment of tax
by the Company would substantially reduce the funds available for
distribution to Shareholders or for reinvestment and, to the extent
that Distributions had been made in anticipation of the Company's
qualification as a REIT, the Company might be required to borrow
additional funds or to liquidate certain of its investments in
order to pay the applicable tax. Moreover, should the Company's
election to be taxed as a REIT be terminated or voluntarily
revoked, the Company may not be able to elect to be treated as a
REIT for the following four year period. See "Federal Income Tax
Considerations - Qualification as a REIT".
28. Restrictions on Maximum Share Ownership. In order for the
Company to qualify as a REIT, no more than 50% of the outstanding
Shares may be owned, directly or indirectly, by five or fewer
individuals at any time during the last half of the Company's
taxable year. To ensure that the Company will not fail to qualify
as a REIT under this test, the Company's Declaration of Trust
grants the Trustees the power to place restrictions on the
accumulation of Shares. These restrictions may (i) discourage a
change of control of the Company, (ii) deter individuals and
entities from making tender offers for Shares, which offers may be
attractive to Shareholders or (iii) limit the opportunity for
Shareholders to receive a premium for their Shares in the event an
investor is making purchases of Shares in order to acquire a block
of Shares. See "Summary of Declaration of Trust - Restriction on
Transfer of Shares" and "Risk Factors - Anti-Takeover
Considerations and Restrictions on Share Accumulation".
29. Limitations on Opinion of Counsel as to Tax Matters. As
set forth more fully in "Federal Income Tax Considerations -
General", Counsel to the Company has expressed its opinion based on
the facts described in the Prospectus for the Company's initial
public offering, on the Declaration of Trust, and on certain
representations by the Company and the Advisor, that it is more
likely than not (a) that the Company will qualify as a REIT; and
(b) that Distributions to a Shareholder which is a Tax-Exempt
Entity will not constitute unrelated business taxable income
("UBTI"), provided that such Shareholder has not financed the
acquisition of its Shares with "acquisition indebtedness" within
the meaning of the Code; Counsel has not expressed its opinion as
to certain other issues because of the factual nature of such
issues or the lack of clear authority in the law. Accordingly,
there may be a risk that the Company's treatment of certain tax
items could be challenged by the IRS and that the Company or
Shareholders could be adversely affected as a result. It should be
noted, in any event, that Counsel's opinions are based on existing
laws, judicial decisions and administrative regulations, rulings
and practice, all of which are subject to change, which may be
retroactive, and, further, are not in all cases binding on the IRS.
D. ERISA Risks
30. Risks Of Investment By Tax-exempt Investors. In
considering an investment in the Company of a portion of the assets
of a trust of a pension or profit-sharing plan qualified under
Section 401(a) of the Code and exempt from tax under Section
501(a), the plan fiduciary should consider (i) whether the
investment satisfies the diversification requirements of Section
404(a)(3) of the Employee Retirement Income Security Act of 1974
("ERISA"); (ii) whether the investment is prudent, since Shares are
not freely transferable and there may not be a market created in
which he can sell or otherwise dispose of the Shares; (iii) whether
interests in the Company or the underlying assets owned by the
Company constitute "plan assets" for purposes of Section 4975 of
the Code and (iv) whether the "prohibited transaction" rules of
ERISA would apply and prohibit certain of the contemplated
transactions between the Company and the Advisor or its Affiliates.
ERISA requires that the assets of a plan be valued at their fair
market value as of the close of the plan year, and it may not be
possible to adequately value the Shares from year to year, since
there will not be a market for those Shares and the appreciation of
any property may not be shown in the value of the Shares until the
Company sells or otherwise disposes of its investments See "ERISA
Considerations".
FEDERAL INCOME TAX CONSIDERATIONS
The following discussion summarizes material Federal income
tax considerations to the Company and the purchasers of the Shares.
This discussion is based on existing Federal income tax law, which
is subject to change, possibly retroactively. This discussion does
not discuss all aspects of Federal income taxation which may be
relevant to a particular investor in light of its personal
investment circumstances or to certain types of investors subject
to special treatment under the Federal income tax laws (including
financial institutions, insurance companies, broker dealers and,
except to the extent discussed below, tax exempt entities and
foreign taxpayers) and it does not discuss any aspects of state,
local or foreign tax law. This discussion assumes that investors
will hold their Shares as "capital assets" (generally, property
held for investment) under the Code. Prospective investors are
advised to consult their tax advisors as to the specific tax
consequences of purchasing, holding and disposing of the Shares,
including the application and effect of Federal, state, local and
foreign income and other tax laws.
General
The Company has and intends to continue to operate in a manner
that will permit the Company to qualify a REIT for the taxable year
ending December 31, 1997, and in each taxable year thereafter.
This treatment will permit the Company to deduct dividend
distributions to its stockholders for Federal income tax purposes,
thus effectively eliminating the "double taxation" that generally
results when a corporation earns income and distributes that income
to its stockholders in the form of dividends.
In connection with its initial public offering, the Company
obtained an opinion of Berry Moorman P.C. ("Counsel") concerning
the likely outcome on the merits of the material federal income tax
issues. In particular, it is Counsel's opinion that it is more
likely than not that (i) the Company has been organized in
conformity with the requirements for qualification as a REIT, and
its method of operation described in the Prospectus for its initial
public offering and in the Declaration of Trust will meet the
requirements for taxation as a REIT under the Code for any taxable
year with respect to which the Company makes the necessary
election; and (ii) Distributions to a Shareholder which is a Tax-
Exempt Entity will not constitute UBTI, provided such Shareholder
has not financed the acquisition of its Shares with "acquisition
indebtedness" within the meaning of the Code. In rendering this
opinion, Counsel assumed that the share ownership requirements
(discussed below in "Qualification as a REIT") will be met after
the first taxable year of the Company and has also based its
opinion upon information and undertakings supplied by the Company
and the Advisor, and the facts contained in the Prospectus
concerning the organization and proposed operation of the Company.
Any alteration of the foregoing may adversely affect the validity
of the opinions rendered.
Each prospective investor should note that the opinions
described herein represent only Counsel's best legal judgment as to
the most likely outcome of an issue if the matter were litigated.
Opinions of counsel have no binding effect or official status of
any kind, and in the absence of a ruling from the IRS, there can be
no assurance that the IRS will not challenge the conclusion or
propriety of any of Counsel's opinions. The Company does not
intend to apply for a ruling from the IRS that it qualifies as a
REIT.
Qualification as a REIT
Under the Code, a trust, corporation or unincorporated
association meeting certain requirements (set forth below) may
elect to be treated as a REIT for purposes of federal income
taxation. If a valid election is made, then, subject to certain
conditions, the Company's income which is distributed to its
Shareholders will be taxed to such Shareholders without being
subject to tax at the Company level. The Company will be taxed on
any of its income that is not distributed to the Shareholders. Once
made, the REIT election continues in effect until voluntarily
revoked or automatically terminated by the Company's failure to
qualify as a REIT for a taxable year. If the Company's election to
be treated as a REIT is terminated automatically, the Company will
not be eligible to elect REIT status until the fifth taxable year
after the year for which the Company's election was terminated.
However, this prohibition on a subsequent election to be taxed as a
REIT is not applicable if (i) the Company did not willfully fail to
file a timely return with respect to the termination taxable year,
(ii) inclusion of incorrect information in such return was not due
to fraud with intent to evade tax, and (iii) the Company
establishes that failure to meet the requirements was due to
reasonable cause and not to willful neglect. While the Company has
no intention of voluntarily revoking its REIT election, if it does
so, it will be prohibited from electing REIT status for the year to
which such revocation relates and for the next four taxable years.
There can be no assurance, however, that the Company will
continue to qualify as a REIT in any particular taxable year, given
the highly complex nature of the rules governing REITs, the ongoing
importance of factual determinations and the possibility of future
changes in the circumstances of the Company. If the Company were
not to qualify as a REIT in any particular year, it would be
subject to Federal income tax as a regular, domestic corporation,
and its stockholders would be subject to tax in the same manner as
stockholders of such corporation. In this event, the Company could
be subject to potentially substantial income tax liability in
respect of each taxable year that it fails to qualify as a REIT,
and the amount of earnings and cash available for distribution to
its stockholders could be significantly reduced or eliminated.
The following is brief summary of certain technical
requirements that the Company must meet on an ongoing basis in
order to qualify, and remain qualified, as a REIT under the Code.
Share Ownership Tests The Shares of the Company (i) must be
transferable, (ii) must be held by 100 or more persons during at
least 335 days of a taxable year of 12 months (or during a
proportionate part of a taxable year of less than 12 months), and
(iii) no more than 50% of the outstanding Shares may be owned,
directly or indirectly, by five or fewer individuals at any time
during the last half of the Company's taxable year. The
requirements of (ii) and (iii) are not applicable to the first
taxable year for which an election to be treated as a REIT is made.
In addition, the Declaration of Trust permits a restriction on
transfers of Shares that would result in violation of the rule in
(iii) above. Applicable Treasury Regulations state that such a
restriction will not cause the shares to be nontransferable as
required by (i).
Asset Tests The Company must generally meet the following
asset tests (the "REIT Asset Tests") at the close of each quarter
of each taxable year.
(a) at least 75% of the value of the Company's total assets
must consist of Qualified REIT Real Estate Assets, Government
securities, cash, and cash items (the "75% Asset Test"); and
(b) the value of securities held by the Company but not taken
into account for purposes of the 75% Asset Test must not
exceed (i) 5% of the value of the Company's total assets in
the case of securities of any one non-government issuer, or
(ii) 10% of the outstanding voting securities of any such
issuer.
Gross Income Tests The Company must generally meet the
following gross income tests (the "REIT Gross Income Tests") for
each taxable year.
(a) at least 75% of the Company's gross income must be derived
from certain specified real estate sources including interest
income and gain from the disposition of Qualified REIT Real
Estate Assets or "qualified temporary investment income"
(i.e., income derived form "new capital" within one year of
the receipt of such capital) (the "75% Gross Income Test");
(b) at least 95% of the Company's gross income for each
taxable year must be derived from sources of income qualifying
for the 75% Gross Income Test, dividends, interest, and gains
from the sale of stock or other securities not held for sale
in the ordinary course of business (the "95% Gross Income
Test"); and
(c) less than 30% of the Company's gross income must be
derived from the sale of Qualified REIT Real Estate Assets
held for less than four years, stock or securities held for
less than one year (including certain interest rate swap and
cap agreements entered into to hedge variable rate debt
incurred to acquire Qualified Real Estate Assets) and certain
"dealer" property (the "30% Gross Income Test").
The Company intends to maintain its REIT status by carefully
monitoring its income, to comply with the REIT Gross Income Tests.
See "Taxation of the Company" for a discussion of the tax
consequences of failure to comply with the REIT provisions of the
Code.
Distributions to Shareholders Each year, the Company must
distribute to its Shareholders an amount equal to (a) 95% of the
sum of (i) its REIT Taxable Income (defined below) before deduction
of dividends paid and excluding any net capital gain and (ii) the
excess of net income from "foreclosure property" (described above
in "Sources of Income") over the tax on such income, minus (b) any
"excess noncash income" (income attributable to leveled stepped
rents, original issue discount on purchase money debt, or a like
kind exchange that is later determined to be taxable) (the "95%
Distribution Test").
REIT Taxable Income is the taxable income of a REIT, computed
as if the REIT were an ordinary corporation, but with an allowance
for a deduction for dividends paid, an exclusion for net income
from foreclosure property, a deduction for the 100% tax on the
greater of the amount by which the REIT fails the 75% or the 95%
income test, and an exclusion for an amount equal to any net income
derived from prohibited transactions.
Dividends that are either (i) paid during the taxable year or
(ii) declared before the Company's tax return for the taxable year
must be filed (including extensions) and paid within 12 months of
the end of such taxable year and no later than the Company's next
regular distribution payment, are considered distributions for
purposes of the 95% Distribution Test. Such dividends are taxable
to the Shareholders (other than Tax-Exempt Entities) in the years
in which they are paid, even though they reduce the Company's REIT
Taxable Income for the year in which declared. However, see
"Taxation of the Company" for discussion of an excise tax provision
which could require the Company to distribute its fourth quarter
dividend in each year on or before January 31st of the following
year.
The Trustees intend to make Distributions to the Shareholders
on a monthly basis sufficient to meet the 95% Distribution Test.
Because of the possible receipt of income from certain sources
without corresponding cash receipts, because of timing differences
that may arise between the realization of taxable income and net
cash flow (e.g. as a result of the original issue discount rules),
and because of possible adjustments by the IRS to deductions and
gross income reported by the Company, it is possible that the
Company may not have sufficient cash or liquid assets at a
particular time to distribute 95% of its REIT Taxable Income. In
such event, the Company may attempt to declare a consent dividend,
which is a hypothetical distribution to Shareholders out of the
earnings and profits of the Company. The effect of such a consent
dividend, to those Shareholders who agree to such treatment, and as
long as such consent dividend is not preferential, would be that
such Shareholders would be treated for federal income tax purposes
as if such amount had been paid to them in cash and they had then
immediately contributed such amount back to the Company as
additional paid-in capital. This would result in taxable income
distribution but would also increase their tax basis in their
Shares by the amount of the taxable income recognized.
If the Company fails to meet the 95% Distribution Test due to
an adjustment to the Company's income by reason of a judicial
decision or by agreement with the IRS, the Company may pay a
"deficiency dividend" to Shareholders in the taxable year of the
adjustment, which would relate back to the year being adjusted. In
such case, the Company would also be required to pay interest plus
a penalty to the IRS. However, a deficiency dividend cannot be
used to meet the 95% Distribution Test if the failure to meet such
test was not due to a later adjustment to the Company's income but
rather was attributable to the Company's failure to distribute
sufficient amounts to the Shareholders. If the Company cannot
declare a consent dividend or if it lacks sufficient cash to
distribute 95% of its REIT Taxable Income or to pay a "deficiency
dividend" in appropriate circumstances, the Company could be
required to borrow funds or liquidate a portion of its investments
in order to pay its expenses, make the required cash distributions
to Shareholders, or satisfy its tax liabilities. There can be no
assurance that such funds will be available to the extent, and at
the time, required by the Company.
In addition, if the IRS successfully challenged the Company's
deduction of all or a portion of the fees it pays to the Advisor,
such payments could be recharacterized as dividend distributions to
the Advisor in its capacity as Shareholder. If such distributions
were viewed as preferential distributions they would not count
toward the 95% Distribution Test. Because of the factual nature of
the inquiry, Counsel is unable to opine as to the deductibility of
such fees. See "Taxation of the Company - Fees paid by the
Company", below.
Termination of the Company
In any year in which the Company qualifies as a REIT, the
Company will generally not be subject to Federal income tax on that
portion of its REIT taxable income or capital gain which is
distributed to its stockholders. The Company will, however, be
subject to Federal income tax at normal corporate income tax rates
upon any undistributed taxable income or capital gain.
Notwithstanding its qualification as a REIT, the Company may
also be subject to tax in certain other circumstances. If the
Company fails to satisfy either the 75% or the 95% Gross Income
Test, but nonetheless maintains its qualification as a REIT because
certain other requirements are met, it will generally be subject to
a 100% tax on the greater of the amount by which the Company fails
either the 75% or the 95% Gross Income Test. The Company will also
be subject to a tax of 100% on net income derived from any
"prohibited transaction", and if the Company has (i) net income
from the sale or other disposition of "foreclosure property' which
is held primarily for sale to customers in the ordinary course of
business or (ii) other non-qualifying income from foreclosure
property, it will be subject to Federal income tax on such income
at the highest corporate income tax rate. In addition, if the
Company fails to distribute during each calendar year at least the
sum of (i) 85% of its REIT ordinary income for such year and (ii)
95% of its REIT capital gain net income for such year, the Company
would be subject to a 4% Federal excise tax on the excess of such
required distribution over the amounts actually distributed during
the taxable year, plus any undistributed amount of ordinary and
capital gain net income from the preceding taxable year. The
Company may also be subject to the corporate alternative minimum
tax, as well as other taxes in certain situations not presently
contemplated.
Taxation of Taxable Shareholders
Dividend Income. Distributions from the Company will be
taxable to Shareholders who are not Tax-Exempt Entities as ordinary
income to the extent of the current or accumulated earnings and
profits of the Company. Distributions from the Company which are
designated as capital gains dividends by the Company will be taxed
as long-term capital gains to taxable Shareholders to the extent
that they do not exceed the Company's actual net capital gain for
the taxable year. Shareholders that are corporations may be
required to treat up to 20% of any such capital gains dividends as
ordinary income. Such distributions, whether characterized as
ordinary income or as capital gain, are not eligible for the 70%
dividends received deduction for corporations.
Distributions from the Company to Shareholders which are not
designated as capital gains dividends and which are in excess of
the Company's current or accumulated earnings and profits are
treated as a return of capital to the Shareholders and reduce the
tax basis of a Shareholder's Shares (but not below zero). Any such
distribution in excess of the tax basis is taxable to any such
Shareholder that is not a Tax-Exempt Entity as a gain realized from
the sale of the Shares.
The declaration by the Company of the consent dividend would
result in taxable income to consenting Shareholders other than Tax-
Exempt Entities) without any corresponding cash distributions. See
"Qualification as a REIT - Distributions to Shareholders", above.
Portfolio Income. Dividends paid to Shareholders will be
treated as portfolio income with respect to Shareholders who are
subject to the passive activity loss rules. Such income therefore
will not be subject to reduction by losses from passive activities
(i.e. any interest in a rental activity or in a trade or business
in which the Shareholder does not materially participate, such as
an interest held as a limited partner) of such Shareholder. Such
Distributions will, however, be considered investment income which
may be offset by certain investment expense deductions.
No Flow Through of Losses. Shareholders should note that they
are not permitted to deduct any net losses of the Company.
Sale of Shares. Shareholders who sell their Shares will
recognize taxable gain or loss equal to the difference between the
amount realized on such sale and their basis in such Shares. Gain
or loss recognized by a Shareholder who is not a dealer in
securities and whose Shares have been held for more than one year
will generally be taxable as long-term capital gain or loss.
Back-up Withholding. Distributions from the Company will
ordinarily not be subject to withholding of federal income taxes.
Withholding of such tax at a rate of 31% may be required, however,
by reason of a failure of a Shareholder to supply the Company or
its agent with the Shareholder's Taxpayer Identification Number.
Such "Backup" withholding may also apply to a Shareholder who is
otherwise exempt from backup withholding if such shareholder fails
properly to document his status as an exempt recipient of
distributions. Each Shareholder will therefore be asked to provide
and certify his correct Taxpayer Identification Number or to
certify that he is an exempt recipient.
Taxation of Tax-Exempt Entities
In general, a Shareholder which is a Tax-Exempt Entity will
not be subject to tax on distributions from the Company. The IRS
has ruled that amounts distributed as dividends by a qualified REIT
do not constitute unrelated business taxable income ("UBTI") when
received by a Tax-Exempt Entity. Thus, Distributions paid to a
Shareholder which is a Tax-Exempt entity and gain on the sale of
Shares by a Tax-Exempt Entity (other than those Tax-Exempt Entities
described below) will not be treated as UBTI, even if the Company
incurs indebtedness in connection with the acquisition of real
property or the acquisition or making of a Mortgage, provided that
the Tax-Exempt Entity has not financed the acquisition of its
Shares of the Company.
For Tax-Exempt Entities which are social clubs, voluntary
employee benefit associations, supplemental unemployment benefit
trusts, and qualified group legal services plans exempt from
federal income taxation under Code sections 501(c)(7), (c)(9),
(c)(17) and (c)(20), respectively, income from an investment in the
Company will constitute UBTI unless the organization is able
properly to deduct amounts set aside or placed in reserve for
certain purposes so as to offset the UBTI generated by its
investment in the Company. Such prospective investors should
consult their own tax advisors concerning these "set aside" and
reserve requirements.
In the case of a "qualified trust" (generally, a pension or
profit sharing trust) holding stock in a REIT, the Revenue
Reconciliation Act of 1993 treats the beneficiaries of such a trust
as holding stock in the REIT in proportion to their actuarial
interests in the qualified trust, instead of the prior law
treatment of a qualified trust as a single individual. The Revenue
Reconciliation Act of 1993 also requires a qualified trust that
holds more than 10% of the shares of a REIT to treat a percentage
of REIT dividends as UBTI if the REIT incurs debt to acquire or
improve real property. This new rule applies to taxable years
beginning in 1994 only if (i) the qualification of the REIT depends
upon the application of the "look through" exception (described
above) to the restriction on REIT shareholdings by five or fewer
individuals, including qualified trusts, and (ii) the REIT is
"predominantly held" by qualified trusts. A REIT is "predominantly
held" by qualified trusts if either (A) a single qualified trust
holds more than 25% by value each owning more than 10% by value,
hold in the aggregate more than 50% of the interests in the REIT.
The percentage of any dividend paid (or treated as paid) to such a
qualified trust that is treated as UBTI is equal to the amount of
modified gross income (gross income less directly connected
expenses) from the unrelated trade or business of the REIT
(treating the REIT as if it were a qualified trust), divided by the
total modified gross income of the REIT. A de minimis exception
applies where the percentage is less than 5%. Because (i) the
Company expects the Shares to be widely held, and (ii) the
Declaration of Trust prohibits any Shareholder from owning more
than 9.8 percent of the Shares entitled to vote, this new provision
should not result in UBTI to any Tax-Exempt Entity.
Statement of Stock Ownership
The Company is required to demand annual written statements
from the record holders of designated percentages of its Shares
disclosing the actual owners of the Shares. The Company must also
maintain, within the Internal Revenue District in which it is
required to file its federal income tax return, permanent records
showing the information it has received as to the actual ownership
of such Shares and a list of those persons failing or refusing to
comply with such demands.
State and Local Taxes
The tax treatment of the Company and its Shareholders in
states having taxing jurisdiction over them may differ from the
federal income tax treatment. Accordingly, no discussion of state
taxation of the Company, the Shares or the Shareholders is provided
herein nor is any representation made as to the tax status of the
Company, the Shares or Shareholders in such states. Each
Shareholder should consult his own tax advisor as to the status of
the Shares under the respective state tax laws applicable to him.
ERISA CONSIDERATIONS
In considering whether to purchase Shares with the assets of a
Qualified Plan, the plan fiduciary should consider (i) whether the
investment is in accordance with the documents and instruments
governing the Qualified Plan; (ii) whether such an investment,
alone and in conjunction with any other plan investment, satisfies
the diversification, prudence and liquidity requirements of ERISA,
to the extent applicable; (iii) the need to value the assets of the
Qualified Plan annually; and (iv) the effect if the assets of the
Company are treated as "plan assets" following such investment.
The plan fiduciary should also recognize that ERISA generally
requires that the assets of an employee benefit plan be held in
trust and that the trustee, or a duly authorized investment manager
(within the meaning of Section 3(38) of ERISA), has exclusive
authority and discretion to manage and control the assets of the
plan. As discussed below, the Company has received an opinion of
Berry, Moorman, King & Hudson, P.C. ("Counsel") that, under current
law (and subject to certain reservations and requirements set forth
therein), it is more likely than not that the assets of the Company
will not be deemed to be "plan assets" if Qualified Plans invest in
Shares. In the event that the assets of the Company are
nevertheless deemed to be plan assets under ERISA despite such
opinion of Counsel, the Trustees and the Advisor would be deemed
fiduciaries to each Qualified Plan which purchased Shares. As
such, they would be held to the fiduciary standards of ERISA in all
Company investments, and the person or persons who have investment
discretion over the assets of Qualified Plans subject to ERISA who
authorized the investment could be liable under ERISA for
investments made by the Company which do not conform to such
standards.
If the Trustees and the Advisors are considered fiduciaries
under ERISA and the Code, they will also be "parties in interest"
under ERISA (and "disqualified persons" under the Code) with
respect to an investing Qualified Plan and one or more of their
Affiliates could also be so characterized. ERISA and the Code
absolutely prohibit certain transactions between a Qualified Plan
and a "party in interest" (or "disqualified person"). Under these
rules, certain of the contemplated transactions between the
Trustees and the Advisor or any of their Affiliates and the Company
could constitute "prohibited transactions" under ERISA and the
Code. In such event, certain of the parties involved in the
transaction could be required to take any or all of the following
actions: (i) undo the transaction, (ii) restore to the Qualified
Plan any profit realized on the transaction, (iii) make good to the
Qualified Plan any loss suffered by it as a result of such
transaction, and (iv) pay an excise tax. If an IRA engages in a
prohibited transaction, it could lose its tax-exempt status, but,
in that case, the other penalties for prohibited transactions would
not apply.
A fiduciary of a Qualified Plan is prohibited from taking
certain actions with respect to the assets of such plan, including
investing the assets with respect to which it is a fiduciary in an
entity from which the fiduciary could derive a benefit. To prevent
a violation of these rules, the Company will not permit the
purchase of Shares with assets of any Qualified Plan (including an
IRA) if the Company, the Sponsor, the Advisor or any of their
Affiliates (i) has investment discretion with respect to the assets
of the Qualified Plan to be invested, (ii) regularly gives
individualized investment advice which serves as the primary basis
for the investment decisions made with respect to such assets, or
(iii) is otherwise a fiduciary with respect to the assets for
purposes of the prohibited transaction provisions of ERISA or the
Code.
Plan Assets Regulation
On November 13, 1986, the Department of Labor promulgated a
final regulation defining the term "plan assets" for purposes of
ERISA and the prohibited transaction rules of the Code (the "Final
Regulation"). Under the Final Regulation, when a plan makes an
equity investment in another entity, the underlying assets of that
entity generally will not be considered plan assets if (1) the
equity interest is a "publicly offered security" (as such term is
used in the Final Regulation) or a security issued by an investment
company registered under the Investment Company Act of 1940, (2)
the entity is a "real estate operating company" (as such term is
used in the Final Regulation), or (3) equity participation by
benefit plan investors is "not significant" (as such term is used
in the Final Regulation).
The Final Regulation provides that a "publicly offered
security" is a security that is (i) freely transferable, (ii) part
of a class of securities that is owned by 100 or more investors
independent of the issuer and of one another, and (iii) sold to the
plan as part of an offering of securities to the public pursuant to
an effective registration statement under the Securities Act of
1933 and the class of securities of which such security is a part
is registered under the Securities Exchange Act of 1934 within 120
days (or such later time as may be allowed by the Securities and
Exchange Commission) after the end of the fiscal year of the issuer
during which the offering of such securities to the public
occurred.
The underlying assets of the Company will not be considered to
be plan assets so long as the Shares remain "freely transferable"
under the Final Regulation. The Final Regulation provides that a
determination as to whether a security is freely transferable is
inherently factual in nature and must be made on the basis of all
relevant facts and circumstances. The Final Regulation also
provides that if a security is part of an offering in which the
minimum investment is $10,000 or less (as the case with the
Shares), certain enumerated restrictions on transfer and assignment
ordinarily will not, along or in combination, affect a finding that
such securities are freely transferable. The preamble to the Final
Regulation (which is not considered primary legal authority) goes
one step further providing that if the minimum investment
requirement is satisfied and there are no transfer restrictions
other than those enumerated, the security in effect will be
presumed to be freely transferable. A security that is not
entitled to the presumption may still qualify as freely
transferable if the facts and circumstances so indicate.
The Company has represented that no restrictions on
transferability of the Shares exist other than those set forth in
the Declaration of Trust. Accordingly, the Shares should qualify
as "freely transferable" under the Final Regulation, and Counsel
has rendered an opinion that, if the Shares are "widely held" and
properly registered for securities purposes under the requirements
described above, it is more likely than not that the Shares will be
"publicly offered securities" and that the underlying assets of the
Company will not be considered to be plan assets under the Final
Regulation.
Annual Valuation
A fiduciary of a Qualified Plan subject to ERISA is required
to determine annually the fair market value of the assets of such
Qualified Plan as of the end of such Plan's fiscal year and to file
annual reports reflecting such value. In addition, a trustee of an
IRA must provide an IRA participant with a statement of the value
of the IRA each year.
Because the Shares are not expected to be listed for quotation
and a public market is unlikely to develop until the sale of all of
the Shares, it is likely that no determination of the fair market
value of a Share will be readily available. In these
circumstances, the Declaration of Trust provides that the Company
may, but need not, make available to fiduciaries of Qualified Plans
an annual good faith estimate of the value of the Company's
portfolio of investments, on the basis of their value if then
liquidated, and the amount attributable to each Share. There can
be no assurance that, if the Company does provide this estimate,
(i) such value could or will actually be realized by the Company or
by Shareholders upon liquidation (in part because appraisals or
estimates of value do not necessarily indicate the price at which
assets could be sold and because no attempt will be made to
estimate the expenses of selling any asset of the Company), (ii)
Shareholders could realize such value if they were to attempt to
sell their Shares, or (iii) such value would comply with the ERISA
or IRA requirements described above.
GLOSSARY
The definitions of certain terms used in this Annual Report
are set forth below.
"Acquisition Expenses" shall mean expenses related to the
Company's selection of, and investment in, Mortgage Investments,
whether or not acquired or made, including but not limited to legal
fees and expenses, travel and communications expenses, costs of
appraisals, accounting fees and expenses, title insurance and
miscellaneous other expenses.
"Acquisition Fees" shall mean the total of all fees and
commissions, however designated, paid by any party in connection
with the origination or acquisition of Mortgages and other Mortgage
Investments by the Company. Included in the computation of such
fees or commissions shall be any real estate commission, selection
fee, development fee, nonrecurring management fee, loan fees or
points or any fee of a similar nature, however designated.
"Adjusted Contributions" shall mean (i) the product of $20
times the number of outstanding Shares, reduced by (ii) the total
of cash distributed to Shareholders with respect to the Shares from
Disposition Proceeds and the return (if any) of uninvested Net
Offering Proceeds.
"Administrator" shall mean the Company's President who shall
be an officer and director of the Company and who, subject to the
Trustees, will manage the day-to-day operations of the Company.
"Advisor" shall mean the person(s) or entity retained by the
Trustees that will be responsible for providing advice with respect
to developing a model for the Company's portfolio, developing
underwriting criteria and monitoring yields and performing other
duties as described in the Advisory Agreement, including a person
or entity to which an Advisor subcontracts substantially all such
functions. Initially the Advisor shall be Mortgage Trust Advisors,
Inc., or anyone which succeeds it in such capacity.
"Advisory Agreement" shall mean the agreement between the
Company and the Advisor pursuant to which the Advisor will act as
the investment advisor and administrator of the Company.
"Affiliate" shall mean (i) any Person directly or indirectly
controlling, controlled by or under common control with another
Person, (ii) any Person owning or controlling 10% or more of the
outstanding voting securities or beneficial interests of such other
Person, (iii) any executive officer, director, trustee, general
partner of such Person, and (iv) if such other Person is an
executive officer, director, trustee or partner of another entity,
then the entity for which that Person acts in any such capacity.
"Average Invested Assets" shall mean the average of the
aggregate book value of the assets of the Company for any period
invested, directly or indirectly, in Mortgage Investments before
reserves for depreciation or bad debts or other similar non-cash
reserves, computed by taking the average of such values at the end
of each month during such period.
"Capital Distributions" shall mean Distributions of: (i) non-
reinvested principal payments and (ii) Proceeds of Mortgage
Prepayments, Sales and Insurance.
"Code" shall mean the Internal Revenue Code of 1986, as
amended, or corresponding provisions of subsequent revenue laws.
"Declaration of Trust" shall mean the Declaration of Trust of
the Company, as amended and/or amended and restated from time to
time.
"Disposition Proceeds" shall mean: (1) Proceeds of Mortgage
Prepayments, Sales or Insurance and (2) payments of principal when
due which are paid to the Company with respect to Mortgage
Investments and other Mortgages.
"Distributions" shall mean any cash distributed to
Shareholders arising from their interest in the Company.
"Independent Trustees" shall mean the Trustees who (i) are not
affiliated, directly or indirectly, with the Advisor, a Sponsor or
any of their Affiliates, whether by ownership of, ownership
interest in, employment by, any material business or professional
relationship with, or service as an officer or director of the
Advisor, a Sponsor or any of their Affiliates, (ii) do not serve as
a director or Trustee of more than two other REITs organized by a
Sponsor or advised by the Advisor and (iii) perform no other
services for the Company, except as Trustees. For this purpose, an
indirect relationship shall include circumstances in which a member
of the immediate family of a Trustee has one of the foregoing
relationships with the Advisor, a Sponsor or the Company.
"Interim Mortgage Loans" shall mean loans of 12 months or less
in term, made to investors for the purchase, renovation and sale of
single family homes. Interim Mortgage Loans are "Mortgages" but
are not "Mortgage Investments" as that term is defined herein.
"Mortgage Investments" shall mean the Company's permanent
investments in Mortgages. There may be a delay between the time
investors purchase Shares and the time the investment proceeds are
invested in Mortgage Investments. Until the Company's funds are
invested in Mortgage Investments, the Company will invest its funds
in short-term investments, including investments with various
financial institutions (meeting certain asset or net worth
requirements) which may not be insured or guaranteed by a
government or government-sponsored entity and in Interim Mortgage
Loans.
"Mortgage Prepayments, Sales or Insurance" shall mean any
Company transaction (other than the receipt of base interest,
principal payments when due on a Mortgage and the issuance of
Shares) including without limitation prepayments, sales, exchanges,
foreclosures, or other dispositions of Mortgage Investments and
other Mortgages held by the Company or the receipt of insurance
proceeds or of guarantee proceeds from any insurer or recoursing
party or otherwise, or any other disposition of Company assets.
"Mortgages" shall mean, in a broad sense, beneficial interests
or participation interests in whole mortgages, mortgage
certificates, mortgage-backed securities, participation
certificates backed by either a single mortgage or a pool of
mortgages or interests in pass-through entities which, under the
REIT provisions of the Internal Revenue Code, would be considered
to be qualifying real estate assets for purposes of the Company's
qualification as a REIT (e.g. regular interests in real estate
mortgage investment conduits ("REMICs")).
"Net Assets" or "Net Asset Value" shall mean the total assets
of the Company (other than intangibles) at cost before deducting
depreciation or other non-cash reserves less total liabilities of
the Company, calculated at least quarterly on a basis consistently
applied.
"Net Income" shall mean, for any period, total revenues
applicable to such period, less the expenses applicable to such
period other than additions to allowances or reserves for
depreciation, amortization or bad debts or other similar non-cash
reserves; provided, however, that Net Income shall not include any
gain from the sale or other disposition of the Company's Mortgage
Investments or other assets.
"Person" shall mean and include individuals, corporations,
limited liability companies, limited partnerships, general
partnerships, joint stock companies or associations, joint
ventures, companies, trusts, banks, trust companies, land trusts,
business trusts or other entities and governments and agencies and
political subdivisions thereof.
"Proceeds of Mortgage Prepayments, Sales and Insurance" shall
mean receipts from Mortgage Prepayments, Sales or Insurance less
the following:
(i) the amount paid or to be paid in connection with or as an
expense of such Mortgage Prepayments, Sales or Insurance; and
(ii) the amount necessary for the payment of all debts and
obligations of the Company including but not limited to fees
to the Advisor or Affiliates and amounts, if any, required to
be paid to, arising from or otherwise related to the
particular Mortgage Prepayments, Sales or Insurance.
"REIT" shall mean a corporation or trust which qualifies as a
real estate investment trust described in sections 856 through 860
of the Code (the "REIT Provisions").
"REIT Taxable Income" shall mean the taxable income as
computed for a corporation which is not a REIT, (ii) without the
deductions allowed by sections 241 through 247, 249 and 250 of the
Code (relating generally to the deduction for dividends received);
(ii) excluding amounts equal to (a) the net income from foreclosure
property, and (b) the net income derived form prohibited
transactions; (iii) deducting amounts equal to (x) any net loss
derived from prohibited transactions, and (y) the tax imposed by
section 857(b)(5) of the Code upon a failure to meet the 95% and/or
the 75% gross income tests; and (iv) disregarding the dividends
paid, computed without regard to the amount of the net income from
foreclosure property which is excluded from REIT Taxable Income.
"Shareholders" shall mean holders of the Shares.
"Shares" shall mean the shares of beneficial interest, par
value $.01 per share, of the Company.
"Sponsor" shall mean any person directly or indirectly
instrumental in organizing, wholly or in part, the Company or any
Person who will control, manage or participate in the management of
the Company and any Affiliate of such Person, but does not include
(i) any person whose only relationship with the Company is that of
an independent asset manager whose only compensation from the
Company is as such, and (ii) wholly-independent third parties such
as attorneys, accountants, and underwriters whose only compensation
from the Company is for professional services. A Person may also
be deemed a Sponsor of the Company by: (i) taking the initiative,
directly or indirectly, in founding or organizing the business or
enterprise of the Company, either alone or in conjunction with one
or more other Persons; (ii) receiving a material participation in
the Company in connection with the founding or organizing of the
business of the Company, in consideration of the services or
property, or both services and property; (iii) having a substantial
number of relationships and contacts with the Company; (iv)
possessing significant rights to control Company properties; (v)
receiving fees for providing services to the Company which are paid
on a basis that is not customary in the industry; or (vi) providing
goods or services to the Company on a basis which was not
negotiated at arms length with the Company.
"Subordinated Incentive Fee" shall mean the fee paid to the
Advisor pursuant to the Advisory Agreement. The Subordinated
Incentive Fee shall be equal to 25% of the amount by which the
Company's Net Income for a year exceeds a 10% per annum non-
compounded cumulative return on its Adjusted Contributions. For
each year which it receives a Subordinated Incentive Fee, the
Advisor shall also receive 5-year options to purchase 10,000 Shares
at the initial offering price of $20 per share. See "Management -
Summary of Advisory Agreement".
"Total Operating Expenses" shall mean all operating, general,
and administrative expenses of the Company as determined by
generally accepted accounting principles, exclusive of the expenses
of raising capital, interest payments, taxes, non-cash expenditures
(i.e. depreciation, amortization, bad debt reserve), Acquisition
Fees and other costs related directly to a specific Mortgage by the
Company, such as expenses for originating, acquiring, servicing or
disposing of a Mortgage.
ITEM 2. DESCRIPTION OF PROPERTY.
Office Lease
The Company's offices are located inside SCMI's offices.
Pursuant to an oral lease, the Company pays SCMI a monthly rent of
$385 for those offices.
Mortgage Investments
The primary investment policy of the Company is to purchase
first lien mortgage notes secured by single family homes. A
significant portion of the home buying public is unable to qualify
for government insured or guaranteed or conventional mortgage
financing. Strict income ratios, credit record criteria, loan-to-
value ratios, employment history and liquidity requirements serve
to eliminate traditional financing alternatives for many working
class home buyers. A large market of what are referred to as "B",
"C", "D", and "DD" grade mortgage notes has been generated through
utilization of non-conforming underwriting criteria for those
borrowers who do not satisfy the underwriting requirements for
government insured or guaranteed or conventional mortgage
financing. Although there is no industry standard for the grading
of those non-conforming loans, the grade is primarily based on the
credit worthiness of the borrower. The Company acquires what it
considers to be "B", "C" and "D" grade mortgage loans. Typically
non-conforming notes bear interest at above market rates consistent
with the perceived increased risk of default. In practice, non-
conforming notes experience their highest percentage of default in
the initial 12 months of the loan. The Company attempts to reduce
the rate and expense of early payment defaults through the
adherence to investment policies that require the seller of a note
to the Company with a payment history of less than 12 months to
replace or repurchase any non-performing note and reimburse the
Company for any interest, escrows, foreclosure, eviction, and
property maintenance costs. In addition to investing in first lien
mortgage notes, the Company will also temporarily invest funds in
Interim Mortgage Loans which are loans of 12 months or less in term
that are made to investors for the purchase, renovation and sale of
single family homes. For more information regarding the Company's
investment policies, see "Investment Objectives and Policies"
contained in Item 1 of this Form 10-KSB.
As of December 31, 1997, the Company owned 72 first lien
mortgage notes with an aggregate unpaid principal balance of
$2,823,840. The average first lien mortgage note owned by the
Company had an annual interest rate of 11.39%, an unpaid principal
balance of $39,220, a term remaining of 308 months, a current
annual yield of approximately 12.20%, and loan-to-investment ratio
of 83.49%. The notes were acquired for approximately 93.33% of the
outstanding unpaid principal balance.
The Company's investment in 30 Interim Mortgage Loans at
December 31, 1997 was $877,275. The Interim Mortgage Loans are
secured by first lien mortgage notes which bear interest at 16.75%,
paid monthly, have terms of 6 months, and have loan-to-value of no
greater than 50%.
All of the properties that are the security for the Mortgage
Investments and Interim Mortgage Loans are located in Texas. Each
of the properties is adequately covered by a mortgagee's title
insurance policy and hazard insurance.
ITEM 3. LEGAL PROCEEDINGS.
No information is required pursuant to this Item.
ITEM 4. SUBMISSION OF MATTERS TO THE VOTE OF SECURITY HOLDERS.
No items were submitted to a vote of the Company's
shareholders during the fourth fiscal quarter.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
There is currently no established trading market for the
Shares. Although the Company intends to seek to have the Shares
listed on NASDAQ or an exchange after the sale of all of the Shares
offered in its public offering, there can be no assurance that
those efforts will be successful or that an established trading
market for the Shares will develop.
As of December 31, 1997, the Company had 202,508 Shares
outstanding, held by 172 shareholders of record.
The Company intends to continue to reinvest its Disposition
Proceeds except to the extent they represent capital gains on loans
purchased at a discount. The Company intends to distribute
substantially all of its taxable income with respect to each year
(which does not ordinarily equal net income as calculated in
accordance with GAAP) to its shareholders so as to comply with the
REIT provisions of the Code. To the extent the Company has funds
available, the Company will declare regular monthly dividends
(unless the Trustees determine that monthly dividends are not
feasible, in which case dividends would be paid quarterly). Any
taxable income remaining after the distribution of the final
regular monthly dividend each year will be distributed together
with the first regular monthly dividend payment of the following
taxable year or in a special dividend distributed prior thereto.
The dividend policy is subject to revision at the discretion of the
Board of Trustees. All Distributions will be made by the Company
at the discretion of the Board of Trustees and will depend on the
taxable earnings of the Company, the financial condition of the
Company, maintenance of REIT status and such other factors as the
Board of Trustees deems relevant.
Distributions to Shareholders will generally be subject to tax
as ordinary income, although a portion of such Distributions may be
designated by the Company as capital gain or may constitute a tax-
free return of capital. The Company does not intend to declare
dividends that would result in a return of capital. Any
Distribution to Shareholders of income or capital assets of the
Company will be accompanied by a written statement disclosing the
source of the funds distributed. If, at the time of distribution,
this information is not available, a written explanation of the
relevant circumstances will accompany the Distribution and the
written statement disclosing the source of the funds distributed
will be sent to the Shareholders not later than 60 days after the
close of the fiscal year in which the Distribution was made. In
addition, the Company will annually furnish to each of its
stockholders a statement setting forth Distributions paid during
the preceding year and their characterization as ordinary income,
capital gains, or return of capital.
During the year ended December 31, 1997, the Company paid
total dividends of $0.85 per Share.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
Results of Operations
United Mortgage Trust was formed on July 12, 1996, however
operations commenced in March, 1997 when approval was given by the
Securities and Exchange Commission for the Company's initial public
offering of its Shares. Therefore this report does not contain
comparisons of liquidity and results of operations between the year
ended December 31, 1996 and December 31, 1997.
During 1997, the Company purchased 71 first lien mortgage
notes with a total unpaid principal balance of $2,793,868. The
average first lien mortgage note had an annual interest rate of
11.38%, an unpaid principal balance of $39,350, a term remaining of
303 months, a current annual yield of approximately 12.20%, and
loan-to-investment ratio of 83.53%. The notes were acquired for
approximately 93.33% of the outstanding unpaid principal balance.
One note acquired as of December 31, 1996 had an annual interest
rate of 11.5%, an unpaid principal balance of $29,990, a term
remaining of 356 months, a current annual yield of approximately
12.34%, and loan-to-investment ratio of 83.34%. The note was
acquired for approximately 92.81% of the outstanding unpaid
principal balance.
The total portfolio of Mortgage Investments at December 31,
1997 contained 72 notes, with an annual interest rate of 11.39%, an
unpaid principal balance of $39,220, a term remaining of 308
months, a current yield of 12.20%, and a loan-to-investment ration
of 83.49%. The notes were acquired for an average of 93.33% of the
outstanding unpaid principal balance.
The Company's investment in 30 Interim Mortgage Loans at
December 31, 1997 was $877,275. The Interim Mortgage Loans are
secured by first lien mortgage notes which bear interest at 16.75%,
paid monthly, have terms of 6 months, and have loan-to-value of
50%. There were no interim mortgage investment at year end December
31, 1996.
All of the properties that are security for the Mortgage
Investments and Interim Mortgage Loans are located in Texas. Each
of the properties is adequately covered by a mortgagees title
insurance policy and hazard insurance.
The Company's Mortgage Investments and Interim Mortgage Loans
generated $172,027 of interest income in 1997. Expenses of
$122,556 were offset by reimbursement from the Advisor to the
Company, of $105,212 for 1997, and an additional $44,917
reimbursing a portion of the 1996 overhead expenses. The Funding
Agreement (see Exhibit 2 attached hereto) between Mortgage Trust
Advisors, Inc. and the Company, dated December 15, 1997 but
effective January 1, 1997 states that the Advisor will fund all of
the Company's general and administrative expenses and in turn the
Company will contribute to the Advisor as a contribution to the
Advisor's overhead costs, on a monthly basis, and amount equal to
one-half of 1% of the Company's Average Invested Assets for the
immediately preceding month. Total contributions to the Advisor
from the Company shall not exceed the lesser of (a) the total of
general and administrative expenses funds by the Advisor, or (b) an
amount equal to the maximum allowable Total Operating Expenses
under the Declaration of Trust. The result was net income of
$199,600 for the year ended December 21, 1997. Earnings per share
were $2.66.
Capital Resources and Liquidity
The Company was initially capitalized with $200,000 from the
sale of 10,000 Shares to the Advisor in 1996, and is dependent upon
proceeds received from the public offering of shares to carry on
its proposed business. Initial capital raised was used to organize
the Company and fund overhead before operations commenced. The
Company intends to utilize the Net Offering Proceeds primarily to
invest in mortgages. The Company's shares are registered for sale
in Arizona, California, Colorado, Florida, Georgia, Illinois,
Indiana, Michigan, Ohio, Pennsylvania, Texas, and subsequent to
December 31, 1997, Utah. Sales of shares commenced March 5, 1997
and will continue until all registered shares have been sold or
until March 4, 1999.
On August 8, 1997, the Company had the initial closing of its
public offering and $2,537,260 in subscription proceeds were
released from escrow. These funds represented 126,863 shares of
beneficial interest and 130 investors independent of the Company
and each other. As of December 31, 1997, the outstanding shares of
the Company were 202,508 owned by 172 separate shareholders. Gross
Offering Proceeds from the sale of shares as of December 31, 1997
were $4,050,150. Gross Offering Proceeds of $3,850,150 raised in
the year ended December 31, 1997 were allocated as follows: $19,250
to the Selling Group Manager representing 0.5% of the Gross
Offering Proceeds for due diligence fees; $385,017 to the Selling
Group Manager representing 10% of the Gross Offering Proceeds for
Selling Commissions; $895 to the escrow agent representing $5 per
shareholder pursuant to the Escrow Agreement as compensation for
distributing interest accrued to subscribers; and, $3,644,998 to
the Company.
During the year ended December 31, 1997, the Company had used
Net Offering Proceeds to acquire 71 first lien mortgage notes, for
$2,607,692 or approximately 93.33% of the outstanding unpaid
principal balance of $2,793,868. Sixty-two of the notes acquired
were from SCMI, an affiliate of the Advisor. The remaining 9 notes
were acquired from private individuals. At December 31, 1997 the
Company had used Net Offering Proceeds to pay acquisition fees in
the amount of $82,771 to the Advisor, which represents
approximately 3% of the unpaid principal balance of the first lien
notes acquired. the Company's used $877,275 of Net Offering
Proceeds to purchase 30 interim mortgage loans at December 31,
1997.
The Company began distributions to shareholders on September
29, 1997. Monthly distributions have continued each month
thereafter. Annualized distributions for the year ended December
31, 1997 resulted in a 10.7% rate of return. The Company expects to
continue to purchase mortgage investments and interim mortgage
loans at sufficient discounts and rates to allow for continuing
monthly distribution to shareholders equating to a 10% annual rate
of return.
The Company has expanded the selling group to eight
broker/dealers, including the Selling Group Manager, First
Financial United Investments Ltd., L.L.P.. The Company will
continue to expand the selling group and to register the shares in
additional states as deemed appropriate by management.
The Company intends to continue to invest Net Offering
Proceeds from the ongoing sale of shares on a twice a month basis
throughout 1998. The Net Offering Proceeds will be invested in
mortgage investments and interim mortgage loans similar in nature
to those previously acquired by the Company.
The Company does not anticipate seeking the listing of its
shares on a nationally recognized market until the earlier of all
2,500,000 shares registered in the initial public offering have
been sold or the expiration of offering period March 4, 1999.
On March 20, 1997 the Company entered into a Revolving Loan
Agreement (the "Agreement") with Abrams Centre National Bank (the
"Bank"), wherein The Company can borrow up to $150,000 on a
revolving basis for a term of one year from the date of the
Agreement. Interest on the outstanding principal balance of the
loan is paid monthly at a varying rate per annum which is one (1%)
in excess of the bank's prime rate of interest. The borrowing base
in the Agreement is the lesser of (a) one hundred (100%) percent of
the sum of all amounts paid by The Company for all of its first
lien mortgage notes or (b) eighty (80%) percent of the unpaid
principal balances of all first lien mortgage notes owned by the
Company. Collateral for the Agreement is property in which a
security interest is held by the Company. As security for the
prompt satisfaction of all obligations of the Agreement, the
Company agreed to assign, transfer and set over to the Bank all of
its right, title and interest in and to the Collateral. As of
December 31, 1997, the drawn down balance of the Revolving Line of
Credit was $138,000. The Company is currently negotiating with the
lending bank to increase its line of credit to $500,000 with the
same terms stated above. (See Exhibit 1 attached hereto.)
The Company is producing, and plans to continue producing, net
interest income on its mortgage portfolio while maintaining strict
cost controls in order to generate net income for monthly
distribution to its shareholders.
The Company operates, and plans to continue to operate, in a
manner that will permit it to qualify as a REIT for federal income
tax purposes. As a result of REIT status, the Company is permitted
to deduct distributions to shareholders, thereby effectively
eliminating the "double taxation" that generally results when a
corporation earns income and distributes that income to
stockholders in the form of dividends.
ITEM 7. FINANCIAL STATEMENTS.
UNITED MORTGAGE TRUST
Page
Independent Auditors' Report
Balance Sheets as of December 31, 1997 and 1996
Statements of Operations
Year Ended December 31, 1997 and the Period
from July 12, 1996 (Date of Inception)
to December 31, 1996
Statements of Changes in Shareholders' Equity
Year Ended December 31, 1997 and the
Period from July 12, 1996
(Date of Inception) to December 31, 1996
Statements of Cash Flows
Year Ended December 31, 1997 and the
Period from July 12, 1996
(Date of Inception) to December 31, 1996
Notes to Financial Statements
INDEPENDENT AUDITORS' REPORT
Board of Trustees
United Mortgage Trust
We have audited the accompanying balance sheets of United Mortgage
Trust as of December 31, 1997 and 1996, and the related statements
of operations, changes in shareholders' equity and cash flows for
the year ended December 31, 1997 and the period from July 12, 1996
(date of inception) to December 31, 1996. These financial
statements are the responsibility of the Trust's management. Our
responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also
includes 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 financial statements referred to above present
fairly, in all material respects, the financial position of United
Mortgage Trust as of December 31, 1997 and 1996, and the results of
its operations and its cash flows for the year ended December 31,
1997 and the period from July 12, 1996 (date of inception) to
December 31, 1996, in conformity with generally accepted accounting
principles.
Jackson & Rhodes P.C.
Dallas, Texas
February 18, 1998 (Except as to Note 1, which
is as of March 16, 1998)
UNITED MORTGAGE TRUST
BALANCE SHEETS
December 31, 1997 and 1996
ASSETS
1997
1996
Cash
$ 248
$ 13,051
Investment in first lien mortgage notes
2,722,036
27,834
Interim mortgage notes
877,275
-
Deferred offering costs
-
126,563
Accrued interest receivable
38,746
137
Receivable from affiliate (Note 5)
12,116
-
Equipment, less accumulated
depreciation of $736 and $216
1,850
2,370
Other assets
2,337
917
$ 3,654,608
$ 170,872
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Note payable (Note 3)
$ 138,000
$ -
Dividend payable
33,799
-
Accounts payable and accrued
liabilities
883
17,876
172,682
17,876
Commitments and contingencies (Note 6)
-
-
Shareholders' equity:
Shares of beneficial interest; $.01 par
value; 100,000,000 shares authorized;
202,508 & 10,000 shares outstanding
2,025
100
Additional paid-in capital
3,467,964
199,900
Retained earnings (deficit)
11,937
(47,004)
Total shareholders' equity
3,481,926
152,996
$ 3,654,608
$ 170,872
See accompanying notes to financial
statements.
UNITED MORTGAGE TRUST
STATEMENTS OF OPERATIONS
Year Ended December 31, 1997
and the Period From
July 12, 1996 (Date of Inception)
to December 31, 1996
1997
1996
Revenues:
Interest income
$ 172,027
$ 859
Expenses:
Salaries and wages
62,198
37,977
General and administrative
52,554
9,886
Interest expense
7,804
-
Expense reimbursement from
affiliate (Note 5)
(150,129)
-
(27,573)
47,863
Net income (loss)
$ 199,600
$
(47,004)
Net income (loss) per share
of beneficial interest
$ 2.66
$
(4.70)
Weighted average shares outstanding
75,089
10,000
See accompanying notes to financial
statements.
UNITED MORTGAGE TRUST
STATEMENTS OF CHANGES IN
SHAREHOLDERS' EQUITY
Year Ended December 31,
1997
and the Period From July 12, 1996 (Date of
Inception)
to December 31, 1996
Shares of
Beneficia
l
Additional
Retained
Interest
Paid-in
Earnings
Shares
Amount
Capital
(Deficit)
Total
Sale of Shares of
beneficial interest
10,000
$ 100
$ 199,900
$ -
$ 200,000
Net loss
- -
- -
-
(47,004)
(47,004)
Balance, December 31, 1996
10,000
100
199,900
(47,004)
152,996
Proceeds from shares
issued
192,508
1,925
3,443,064
-
3,444,989
Offering costs
-
-
(175,000)
-
(175,000)
Dividends ($.85 per share)
-
-
-
(140,659)
(140,659)
Net income
-
-
-
199,600
199,600
Balance, December 31, 1997
202,508
$ 2,025
$3,467,964
$11,937
$3,481,926
See accompanying notes to financial
statements.
UNITED MORTGAGE TRUST
STATEMENT OF CASH FLOWS
Year Ended December 31, 1997
and the Period from
July 12, 1996 (Date of Inception)
to December 31, 1996
1997
1996
Cash flows from operating activities:
Net income (loss)
$ 199,600
$
(47,004)
Adjustments to reconcile net
income (loss) to net cash provided
by (used in) operating activities:
Depreciation and amortization
700
299
Amortization of discount on mortgage
notes
(10,277)
-
Accrued interest receivable
(38,609)
(137)
Other assets
(1,600)
(1,000)
Accounts payable and accrued liabilities
16,806
17,876
Net cash provided by (used in)
operating activities
166,620
(29,966)
Cash flows from investing activities:
Investment in first lien mortgage notes
(2,607,692)
(27,834)
Principal receipts on first
lien mortgage notes
6,538
-
Investment in interim mortgage notes
(877,275)
-
Loan acquisition cost
(82,771)
-
Purchase of equipment
-
(2,586)
Net cash used in investing activities
(3,561,200)
(30,420)
Cash flows from financing activities:
Proceeds from issuance of shares
of beneficial interest
3,444,989
200,000
Offering costs
(48,437)
(126,563)
Net borrowings on note payable
138,000
-
Receivable from affiliate
(12,116)
-
Dividends
(140,659)
-
Net cash provided by financing activities
3,381,777
73,437
Net increase (decrease) in cash
(12,803)
13,051
Cash at beginning of year
13,051
-
Cash at end of year
$ 248
$ 13,051
Interest paid
$ 7,804
$ -
See accompanying notes to financial
statements.
NOTES TO FINANCIAL STATEMENTS
For the Years Ended December 31, 1997 and 1996
1. Description of Business
The Company
United Mortgage Trust (the "Company") is a Maryland real estate
investment trust which intends to qualify as a real estate
investment trust (a "REIT") under federal income tax laws. The
Advisor to the Company is a shareholder, Mortgage Trust
Advisors, Inc., (the "Advisors") a Texas corporation. The
Company will invest exclusively in first lien, fixed rate
mortgages secured by single family residential property
throughout the United States. Such loans will be originated by
others to the Company's specifications or to specifications
approved by the Company. Most, if not all, of such loans will
not be insured or guaranteed by a federally owned or guaranteed
mortgage agency.
The Company is currently offering up to 2,500,000 shares in a
public offering at an offering price of $20 per share. During
1998 (as of March 16, 1998), the Company had sold an additional
125,186 shares aggregating Net Offering Proceeds of $2,240,484.
2. Summary of Significant Accounting Policies
Use of Estimates and Assumptions
The preparation of financial statements in conformity with
generally accepted accounting principles 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 financial statements and
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents
include cash and certificates of deposit with original
maturities of less than three months.
Investment in First Lien Mortgage Notes
First lien mortgage notes are carried at the lower of aggregate
cost or market net of loan acquisition fees and discounts on
notes.
First Lien Mortgage Notes and Interim Mortgage Notes
First lien mortgage notes and interim mortgage notes are
recorded at the lower of cost or estimated net realizable value,
net of discounts and including loan acquisition costs. The
mortgage notes and liens are collateralized by real property
owned by the borrowers. Loan acquisition fees are incurred when
the Company purchases the first lien mortgages. Approximately
$82,771 was paid to the Advisors in connection with these fees.
The loan acquisition fee and the discount on the notes are
amortized using the interest method over the estimated life of
the mortgages (5-1/2 years). Unamortized discount and loan
acquisition costs amounted to $178,057 at December 31, 1997.
Offering Costs
Costs incurred related to the Company's proposed public offering
were deferred and offset against the proceeds in 1997.
Office Equipment
Office equipment is recorded at cost and depreciated by the
straight-line method over the five-year expected useful lives of
the assets. Expenditures for normal maintenance and repairs are
charged to income, and significant improvements are capitalized.
Income Taxes
The Company intends to qualify as a REIT under the Internal
Revenue Code of 1986 as amended (the "Code"). 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 shareholders provided that at least 95% of Taxable Income
is distributed. No provision for taxes will be made in the
financial statements, as the Company believes it is in compliance
with the Code.
Earnings Per Share
Earnings per share is computed by dividing net income (loss) by
the weighted average number of shares of beneficial interest
outstanding during each period.
3. Note Payable
The Company has an 11% note payable maturing on March 20, 1998,
collateralized with the assignment of certain first lien
mortgage notes.
4. Employment Contract/Stock Options
The Company has entered into an employment agreement with its
Chairperson which provides for a salary plus a bonus equal to
25% multiplied by the amount which the Company's administrative
expenses fall below the approved administrative budget. The
Chairperson has received options to purchase 2,500 shares of
Trust stock at $20 per share. The Chairperson also will
receive, at the end of each year of service for five years,
additional options to purchase 2,500 shares of Trust stock at
$20 per share.
For each year in which they serve, each Trustee of the Company
also receives 5-year options to purchase 2,500 shares of the
Company stock at $20 per share. Options aggregating 7,500
shares had been issued to the Trustees as of December 31, 1997.
5. Related Party Transactions
The Company leases its office space from an affiliate under
terms of a month-to-month lease at $385 per month. Rent expense
amounted to $3,540 for the year ended December 31, 1997 and
$2,660 for the period ended December 31, 1996.
The Company purchased first lien mortgage notes from South
Central Mortgage, Inc., a related party, for $2,607,692 for the
year ended December 31, 1997. The Company has also entered into
a Mortgage Servicing Agreement with South Central Mortgage,
Inc., incurring service fees of $3,834 during 1997. The Company
also paid acquisition fees of $82,771 to the Advisor during
1997.
In 1997, the Company entered into a Funding Agreement with the
Advisors whereby the Advisors agreed to fund the Company's
general and administrative expenses. In consideration of the
agreement, the Company will contribute to the Advisor, as a
contribution to the Advisor's overhead on a monthly basis, an
amount equal to .5% (one-half of one percent) of the Company's
average invested assets for the immediately preceding month. A
similar agreement applies to the 1996 period and $44,917 of the
expense reimbursement for 1997 relates to 1996 expenses.
6. Commitments and Contingencies
Concentration of Credit Risk
Financial instruments which potentially expose the Company to
concentrations of credit risk are primarily temporary cash
investments and mortgage notes receivable. The Company places
its temporary cash investments with major financial institutions
and, by policy, limits the amount of credit exposure to any one
financial institution. The majority of all first lien mortgage
notes receivable are "Sub-Prime, B and C Grade" notes secured by
single family homes, principally in the Dallas/Fort Worth
Metropolitan area.
Fair Value of Financial Instruments
The following disclosure of the estimated fair value of financial
instruments is made in accordance with the requirements of SFAS
No. 107, "Disclosures about Fair Value of Financial Instruments."
The estimated fair value amounts have been determined by the
Company, using available market information and appropriate
valuation methodologies.
The fair value of financial instruments classified as current
assets or liabilities including cash and cash equivalents,
receivables and accounts payable approximate carrying value due
to the short-term maturity of the instruments. The fair value of
first lien mortgage notes approximates carrying value based on
their effective interest rates compared to current market rates.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.
The Company has not had any changes in its accountants or any
disagreements with its accountants that are required to be
disclosed pursuant to this item.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL
PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
The Trustees are responsible for the overall management and
control of the affairs of the Company. The Trustees employ the
Company's President to act as Administrator to manage the day-to-
day operations of the Company and have retained the Advisor to use
its best efforts to seek out and present to the Company suitable
and a sufficient number of investment opportunities which are
consistent with the investment policies and objectives of the
Company. The Company may acquire Mortgage Investments from SCMI
and will utilize the services of SCMI to service some or all of the
Mortgages acquired by the Company.
The Company's Declaration of Trust provides for not less than
three nor more than nine Trustees, a majority of whom must be
Independent Trustees, except for a period of 60 days after the
death, removal or resignation of an Independent Trustee. Each
Trustee will serve for a one year term. There are currently five
Trustees of the Company, three of whom are Independent Trustees.
Trustees and Officers of the Company
The Trustees and officers of the Company are as follows:
Name Age Offices Held
Christine "Cricket" Griffin 45 Trustee, Chairman of
the Board and
President
Richard D. O'Connor, Jr. 43 Trustee
Paul R. Guernsey 47 Independent Trustee
Douglas R. Evans 52 Independent Trustee
Michele A. Cadwell 46 Independent Trustee
Christine "Cricket" Griffin has been President and a Trustee
of the Company since July, 1996. In her capacity as President, she
is also the Administrator of the Company. From June, 1995 until
July, 1996, Ms. Griffin served as Chief Financial Officer of SCMI,
a Texas based mortgage banking firm that is an Affiliate of the
Advisor and that sells Mortgages and provides mortgage servicing
services to the Company. Her responsibilities at SCMI included day
to day bookkeeping through financial statement preparation,
mortgage warehouse lines administration, and investor
communications and reporting. Additionally, Ms. Griffin was
responsible for researching and implementing a note servicing
system for SCMI and its subservicer. Before joining SCMI, Ms.
Griffin was Vice President of Woodbine Petroleum, Inc., a publicly
traded oil and gas company for 10 years, during which time her
responsibilities included regulatory reporting, shareholder
relations, and audit supervision. Ms. Griffin is a 1978 graduate of
George Mason University, Virginia with a Bachelor of Arts degree,
summa cum laude, in Politics and Government.
Richard D. O'Connor, Jr. has been a Trustee of the Company
since July, 1996 and, prior to August, 1997 was an Independent
Trustee of the Company. In 1998 Mr. O'Connor became a shareholder
of Stollenwerck, Moore & Silverberg, P.C., a Dallas law firm. From
1993 to 1998, Mr. O'Connor practiced law as a sole practitioner
specializing in the areas of real estate, business and contract
law. Between 1985 and 1993, Mr. O'Connor was a partner with the
Dallas law firm of Scoggins, O'Connor and Blanscet. Between 1989
and 1993, Mr. O'Connor was an attorney in the real estate
department of J.C. Penney Corporation. Mr. O'Connor received a
Bachelor of Business Administration degree from the University of
Texas at Austin in 1976, and a J.D. degree from the University of
Houston in 1978. Mr. O'Connor has been Board Certified in
Commercial Real Estate law by the Texas Board of Legal
Specialization since 1987.
Paul R. Guernsey has been an Independent Trustee of the
Company since July, 1996. Since 1993 Mr. Guernsey has been a
partner and chief financial officer of The Hartnett Group, Ltd. and
related companies. These companies invest primarily in the
financial markets, income and non-income producing real estate
development, and residential mortgage loans. From 1991 through
1993 Mr. Guernsey was chief financial officer of American Financial
Network, Inc. a public company which operated a computerized loan
origination network, seven residential mortgage brokerage
companies, and a wholesale mortgage brokerage operation. From 1987
through 1991 he was chief financial officer and then vice president
of operations for Discovery Learning Centers, Inc., a chain of
child care centers. From 1986 to 1987 he worked with James Grant &
Associates, a Dallas based merchant banking firm. From 1973
through 1985 he served in the audit, tax and management services
departments of both a regional CPA firm, and as a partner of a
local firm in Michigan. Mr. Guernsey is an Independent Trustee.
Mr. Guernsey graduated with a Bachelors Degree in Business
(Accounting) from Ferris State University, Michigan in 1973 and is
a member of the American Institute of CPA's and Texas Society of
CPA's.
Douglas R. Evans has been an Independent Trustee of the
Company since July, 1996. Since February 1995, Mr. Evans has been
a Principal of PetroCap, Inc., a firm that provides investment and
merchant banking services to a variety of clients active in the oil
and gas industry. From 1987 until February 1995 Mr. Evans was
President and Chief Executive Officer of Woodbine Petroleum, Inc.,
which was a publicly traded oil and gas company until it was taken
private through a merger in September, 1992. As part of his
responsibilities at Woodbine, Mr. Evans managed and negotiated the
sale of the parent company's REIT portfolio including mortgages and
real property. Mr. Evans has been a licensed real estate broker in
Texas since 1979 and a licensed real estate agent since 1976. Mr.
Evans is an Independent Trustee. Mr. Evans received an MBA from
Southern Methodist University in 1972 and a Bachelors of Arts
degree from the University of North Carolina in 1967.
Michele A. Cadwell has been an Independent Director of the
Company since August, 1997. Ms. Cadwell is an attorney who has
worked in the oil and gas industry since 1980 as an employee of
Enserch Exploration, Inc. Ms. Cadwell's position with Enserch was
Senior Land Representative. Her primary responsibilities have
included drafting and negotiating exploration and marketing
agreements, analysis of legislation and regulatory proposals,
researching complex mineral titles, organization and management of
non-core property divestitures, settlement of land owner disputes
and advising and testifying on matters before the Oklahoma
Corporation Commission. Ms. Cadwell is a 1974 graduate of the
University of Oklahoma with a Bachelors of Arts Degree in English
and a Juris Doctor Degree in 1978. She is admitted to both the
Oklahoma and Texas bars.
The Administrator
The Company is self-administered with the Company's President
acting as Administrator and managing the day-to-day operations of
the Company, subject to the supervision of the Company's Board of
Trustees. The Administrator, Christine "Cricket" Griffin, is the
President and a Trustee of the Company.
The Advisor
The Advisor is Mortgage Trust Advisors, Inc., a Texas
corporation. The Advisor has been retained to use its best efforts
to seek out and present to the Company, whether through its own
efforts or those of third parties retained by it, suitable and a
sufficient number of investment opportunities which are consistent
with the investment policies and objectives of the Company and
consistent with such investment programs as the Trustees may adopt
from time to time in conformity with the Declaration of Trust. The
services of the Advisor include managing the Company's development
of investment guidelines, overseeing servicing, negotiating
purchases of loans and overseeing the acquisition or disposition of
investments, and managing the assets of the Company.
The directors and officers of the Advisor are set forth below.
These officers of the Advisor may also provide services to the
Company on behalf of the Advisor.
Name Age Offices Held
Todd Etter 47 President
Timothy J. Kopacka 38 Vice President/Secretary
James P. Hollis 57 Vice President
Dan H. Hill 47 Vice President/Treasurer
Todd Etter is a 1972 graduate of Michigan State University.
Since 1992 Mr. Etter has been President of South Central Mortgage,
Inc. ("SCMI"), a Dallas based mortgage banking firm that he founded
and of which he is the sole beneficial shareholder. From 1980
through 1987, Mr. Etter was President of South Central Securities,
a NASD member firm Broker-Dealer that he founded. From 1972
through 1979 he was Vice President of Crawford, Etter and
Associates, a developer, builder and marketer of residential
properties.
Timothy J. Kopacka, a Certified Public Accountant, received a
Bachelors of Arts degree in Accounting and Finance from Michigan
State University. He is a member of the Michigan Association of
CPA's, the Hawaii Association of Public Accountants and the
American Institute of CPA's. Mr. Kopacka is a registered
securities representative and insurance agent. Since 1984 he has
been President of Kopacka & Associates, Inc., dba Grosse Pointe
Financial, a financial advisory firm. From 1980 to 1983 he was
employed with Deloitte, Haskins & Sells, an international
accounting and consulting firm. From 1983 through 1986, Mr. Kopacka
was Chief Financial Officer for Federal Tax Workshops, Inc., an
educational and consulting firm for CPA's. From 1987 to 1990 he
served as Vice President of Marketing and Operations for Kemper
Financial Services in their retirement plans division.
James P. Hollis is a Chartered Life Underwriter (CLU) and a
Fellow, Life Management Institute (FLMI) in pension planning. Mr.
Hollis has a business degree from Chattanooga State College,
Tennessee. Since 1995, he has been Vice President of First
Financial USA, Inc. ("FFUSA"), a financial products marketing
company with offices in Houston, Texas and Longwood, Florida. Mr.
Hollis is also Vice President of H&H Services, Inc., the general
partner of the Selling Group Manager. Mr. Hollis is also a
Regional Director for Surety Life Insurance Company, a member of
the Allstate Insurance Group, and Marketing General Agent for All
American Life Insurance Company, a member of the US Life Group
since 1991.
Dan H. Hill has a Bachelor of Business Administration degree
in accounting. Mr. Hill currently maintains an insurance license,
a securities license and a real estate brokers license. Since
1995, Mr. Hill has been President of First Financial USA, Inc., a
national financial products marketing company, in charge of
financial operations. Mr. Hill is also President of H&H Services,
Inc., the general partner of the Selling Group Manager. In 1994 he
founded First Financial Management Group, a financial planning firm
specializing in tax planning for small businesses. Since 1978, he
has owned and operated D.H. Hill Financial Services, a diversified
financial services firm, involved in insurance, real estate and
securities. Prior to that he was the Project Accountant for the
Brown & Root, Inc. North Slope Project.
Summary of the Advisory Agreement
The Company with the approval of the Trustees, including all
of the Independent Trustees, has entered into a contract with the
Advisor (the "Advisory Agreement') under which the Advisor is
obligated to use its best efforts to develop and present to the
Company, whether through its own efforts or those of third parties
retained by it, suitable and a sufficient number of investment
opportunities which are consistent with the investment policies and
objectives of the Company and consistent with such investment
programs as the Trustees may adopt from time to time in conformity
with the Declaration of Trust. Although the Trustees have
continuing exclusive authority over the management of the Company,
the conduct of its affairs and the management and disposition of
the Company's assets, the Trustees have initially delegated to the
Advisor, subject to the supervision and review of the Trustees and
consistent with the provisions of the Company's Declaration of
Trust, the power and duty to: (i) develop underwriting criteria and
a model for the Company's investment portfolio; (ii) acquire,
retain or sell Mortgage Investments; (iii) seek out, present and
recommend investment opportunities consistent with the Company's
investment policies and objectives, and negotiate on behalf of the
Company with respect to potential investments or the disposition
thereof; (iv) pay the debts and fulfill the obligations of the
Company, and handle, prosecute and settle any claims of the
Company, including foreclosing and otherwise enforcing mortgages
and other liens securing investments; (v) obtain for the Company
such services as may be required for mortgage brokerage and
servicing and other activities relating to the investment portfolio
of the Company; (vi) evaluate, structure and negotiate prepayments
or sales of Mortgage Investments; (vii) from time to time, or as
requested by the Trustees, make reports to the Company as to its
performance of the foregoing services and (viii) to supervise other
aspects of the business of the Company.
The original term of the Advisory Agreement terminates on
August 8, 1998 (one year from the date on which the first closing
on Shares sold pursuant to the Company's initial public offering
occurred). Thereafter, the Advisory Agreement may be renewed
annually by the Company, subject to an evaluation of the
performance of the Advisor by the Trustees. The Advisory Agreement
may be terminated (i) without cause by the Advisor or (ii) with or
without cause by a majority of the Independent Trustees, each
without penalty, and each upon 60 days' prior written notice to the
non-terminating party.
For a description of the compensation to be paid to the
Advisor in consideration of the services it will render to the
Company, see " Item 12. Certain Relationships And Related
Transactions".
The Declaration of Trust provides that the Independent
Trustees are to determine, at least annually, that the amount of
compensation which the Company contracts to pay the Advisor is
reasonable in relation to the nature and quality of the services
performed, based on the factors set forth in the Declaration of
Trust and such other factors as they deem relevant, including the
size of the fee in relation to the size, composition and
profitability of the portfolio of the Company, the success of the
Advisor in generating opportunities that meet the investment
objectives of the Company, the rates charged to other REITs and to
investors other than REITs by advisors performing similar services,
the amount of additional revenues realized by the Advisor and its
Affiliates for other services performed for the Company, the
quality and extent of service and advice furnished by the Advisor,
the performance of the investment portfolio of the Company and the
quality of the portfolio of the Company in relationship to the
investments generated by the Advisor for its own account.
The Company shall reimburse the Advisor for: (i) the actual
costs to the Advisor or its Affiliates of goods, materials and
services used for and by the Company obtained from unaffiliated
parties except for note servicing, which shall be performed by an
Affiliate of the Advisor and unaffiliated third parties on terms no
less favorable than those that would be paid to independent third
parties for comparable services; (ii) administrative services, if
any, necessary to the operation of the Company (other than the
costs of the Advisor's personnel and other expense items generally
falling under the category of the Advisor's overhead directly
related to performance of services for which it is otherwise
receiving fees hereunder, which costs will be borne by the Advisor)
and (iii) the costs of certain personnel employed by the Company
and directly involved in the organization and business of the
Company (including persons who may also be employees or officers of
the Advisor and its Affiliates) and for legal, accounting, transfer
agent, reinvestment and redemption plan administration, data
processing, duplicating and investor communications services
performed by employees or officers of the Advisor and its
Affiliates which could be performed directly for the Company by
independent parties. The amounts charged to the Company for
services performed pursuant to clause (ii) above will not exceed
the lesser of (a) the actual cost of such services, or (b) the
amount which the Company would be required to pay to independent
parties for comparable services. No reimbursement will be allowed
to the Advisor for services performed pursuant to clause (ii) above
unless the Advisor or its personnel or Affiliates have the
appropriate experience and expertise to perform such services. The
Company will reimburse the Advisor for any travel expenses incurred
in connection with the services provided hereunder and for
advertising expenses incurred by it in seeking any investments or
seeking the disposition of any investments held by the Company.
SCMI
The Company acquires Mortgage Investments from SCMI and
utilizes the services of SCMI to service some or all of the
Mortgages acquired by the Company. SCMI is a Texas based mortgage
bank of which the sole beneficial shareholder is Todd Etter, an
officer and principal shareholder of the Advisor. Ms. Christine
Griffin, a Trustee and Administrator of the Company was previously
the Chief Financial Officer of SCMI. Since its inception in 1992,
SCMI has purchased more than 1,500 residential mortgage notes
totaling approximately $60,000,000. SCMI sells whole notes to
institutional and private investors. SCMI also offers note
servicing on notes it sells. SCMI currently services over 1,500
loans totaling approximately $60,000,000. SCMI originates loans
only to facilitate the sale of foreclosed property or real estate
owned by SCMI.
ITEM 10. EXECUTIVE COMPENSATION.
The following Summary Compensation Table sets forth
information concerning compensation earned in the year ended
December 31, 1997 and for the period from July 12,1996 (date of
inception) to December 31, 1996 by the Company's Chief Executive
Officer, who is the Company's only executive officer.
Summary Compensation Table
Annaul Compensation Long Term
Compensation
Shares
Underlying
Name and Pricnipal Year Salary Bonus(1) Options
Position
Christine Griffin, 1997 $60,000 $0 2,500
President
1996 $30,000 $0 0
(1) Pursuant to her employment agreement, Ms. Griffin is entitled
to receive a bonus equal to 25% of the amount by which the
Company's administrative expenses for the year fall below the
approved administrative budget
The following table sets forth, for each of the executive
officers named in the Summary Compensation Table above, certain
information concerning stock options granted during the 1997 fiscal
year.
Name
Number of
Shares
Underlying
Options
Granted
Percent of
Total Options
Granted to
Employees in
1997
Exercise
Price
Per Share
Expiration
Date
Christine
Griffin
2,500
100%
$20.00
12/31/02
The following table sets forth, for the executive officers
named in the Summary Compensation Table above, certain information
regarding the exercise of stock options during the 1997 fiscal year
and the value of options held at fiscal year end:
Aggregated Option Exercises In Last Fiscal Year And
Fiscal Year-End Option Values
Number of Shares Value of
Shares Value Underlying Unexercised
Acquired Realized Unexercised In-the-Money
on Exercise Options at Fiscal Year End
Exercisable/Unexercisable
Name
Christine
Griffin 0 $0 2,500/0 $0/$0
(1) The value of unexercised options is based on the market
value of the underlying shares at fiscal year end, minus the
exercise price.
Employment Agreement
The Administrator has entered into an employment agreement
with the Company whereby she serves as Trustee, President, Chief
Operating Officer and Administrator of the Company. That agreement
is for a term of one year, to be reviewed annually with the
approval of a majority of Independent Trustees. The agreement
provides for the Administrator to receive: (1) an annual salary of
$60,000; (2) a bonus equal to 25% of the amount by which the
Company's administrative expenses for the year fall below the
approved administrative budget; and (3) for each year of service,
5-year stock options to purchase 2,500 Shares at an exercise price
of $20 per Share (up to a maximum of options for 12,500 Shares).
The Agreement was renewed by the Trustees of the Company as of July
1, 1997 for a one year term.
Compensation of Trustees
Trustees who are not Independent Trustees do not receive any
compensation for acting as Trustees. Independent Trustees are
entitled to receive the greater of $1,000 per meeting or $4,000 per
year. For each year in which they serve, each Independent Trustee
shall also receive 5-year options to purchase 2,500 Shares at an
exercise price of $20 per Share (not to exceed 12,500 shares per
Trustee). During 1997, the Independent Trustees each received
$1,000 and waived their rights to additional fees and each
Independent Trustee who served during all of 1997 also received 5-
year stock options to purchase 2,500 Shares at an exercise price of
$20 per Share.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.
As of December 31, 1997, the Company had 202,508 Shares issued
and outstanding. The following table sets forth certain
information regarding the beneficial ownership of the Shares as of
December 31, 1997 by (i) each person known by the Company to be the
beneficial owner of more than 5% of the outstanding Shares, (ii)
each of the Company's Trustees and executive officers named in Item
10, and (iii) all of the Company's trustees and executive officers
as a group. Except as indicated in the footnotes to this table, the
persons named in the table, based on information provided by such
persons, have sole voting and sole investment power with respect to
all Shares shown as beneficially owned by them, subject to
community property laws where applicable.
Number of Percent
Name and Address Shares (1) of Class
Christine "Cricket"
Griffin(2) 2,500 (3) 1.2%
Richard D. O'Connor, Jr.(2) 0 (3) 0%
Paul R. Guernsey(2) 2,500 (3) 1.2%
Douglas R. Evans(2) 2,500 (3) 1.2%
Michele A. Cadwell(2) 2,500 (3) 1.2%
All Trustees and
Executive Officers as a
Group (5 persons) 10,000 (4) 4.7%
(1) For purposes of this table, Shares indicated as being owned
beneficially include Shares not presently outstanding but which are
subject to exercise within 60 days through options, warrants,
rights or conversion privileges. For the purpose of computing the
percentage of the outstanding Shares owned by a shareholder, Shares
subject to such exercise are deemed to be outstanding securities of
the class owned by that shareholder but are not deemed to be
outstanding for the purpose of computing the percentage by any
other person.
(2) A trustee and/or executive officer of the Company. The address
of all trustees and executive officers of the Company is c/o the
Company, 1701 N. Greenville, Suite 403, Richardson, Texas 75081.
(3) Includes 2,500 Shares issuable upon the exercise of stock
options at an exercise price of $20.00 per Share.
(4) Includes the Shares described in footnote (3) above.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Rent Payable to SCMI
The Company leases its offices from SCMI for a monthly rent of
$385 pursuant to an oral lease.
Commissions, Fees and Shares Issued to Selling Group Manager
The Shares that the Company is selling in its initial public
offering are being distributed by First Financial United
Investments Ltd., L.L.P. (the "Selling Group Manager"), a
registered broker-dealer and member of the National Association of
Securities Dealers, Inc. ("NASD"), on a "best efforts" basis
through participating NASD member firms ("Selected Dealers") that
are selected by the Selling Group Manager. Messrs. James Hollis
and Dan Hill, directors and officers of the Advisor, are principal
shareholders and officers of the general partner of the Selling
Group Manager.
The Selling Group Manager receives a commission of 10% of the
Gross Offering Proceeds (subject to any volume discounts for
Institutional Investors), plus 0.5% of the Gross Offering Proceeds
as a due diligence fee. The Selling Group Manager may, in its sole
discretion, provide volume discounts of up to 2% on a negotiated
basis to Institutional Investors who purchase at least 50,000
Shares. The application of any volume discounts will reduce the
amount of commissions that would be paid to the Selling Group
Manager but will not change the Net Offering Proceeds to the
Company. The Selling Group Manager will pay to Selected Dealers a
commission equal to 4% of the offering price of Shares sold through
them unless a higher commission (up to, but not exceeding, 8%) is
designated by the Selling Group Manager. The Selling Group Manager
will also receive, for nominal consideration, Shares (the "SGM
Shares") equal to 0.5% of all Shares sold (12,500 Shares if all
Shares offered in the initial public offering are sold). The
Selling Group Manager may allocate all or a portion of the SGM
Shares to Selected Dealers and registered representatives of the
Selling Group Manager. The Company has agreed to indemnify the
Selling Group Manager with respect to certain liabilities,
including liabilities under the Securities Act of 1933.
During the year ended December 31, 1997, the Selling Group
Manager received a total of $385,017 in commissions, $19,250 in due
diligence fees and no SGM Shares from the Company.
Purchase of Mortgage Investments From SCMI
The Company obtains Mortgage Investments from several sources,
including SCMI or other Affiliates of the Advisor. All Mortgage
Investments purchased from SCMI or other Affiliates of the Advisor
are purchased at prices no higher than those that would be paid to
unaffiliated third parties for mortgages with comparable terms,
rates, credit risks and seasoning. SCMI may realize a gain or a
loss on the sale of a Mortgage Investment that it sells to the
Company, with the amount of that gain or loss depending upon the
price it paid for that Mortgage Investment and the price at which
it sells it to the Company.
SCMI has agreed that, in the event that the obligor on any
Mortgage seasoned less than 12 months sold by or through SCMI or
any of its Affiliates to the Company defaults in the making of any
payment or other obligation thereon during the period ending one
year after the acquisition of such Mortgage by the Company, then
SCMI shall purchase or repurchase the Mortgage from the Company or
the Company's assignee at a price on the date of such purchase
computed as the total unpaid principal balance due thereon, plus
accrued interest to the date of the purchase, plus insurance
premiums, taxes and any other amounts expended by the Company in
the maintenance, protection or defense of its interest therein or
in the real property, including reasonable attorneys' fees. SCMI
may satisfy its obligations under the foregoing purchase or
repurchase requirement by either:
(a)Assigning and transferring to the Company a replacement
Mortgage or Mortgages, provided: (i) the real property
securing the replacement Mortgage(s), the creditworthiness of
the obligor on the replacement Mortgage(s) and other general
underwriting criteria are reasonably acceptable to the
Company; and (ii) the value of the replacement Mortgage(s) at
the date of transfer to the Company shall be computed by the
Company in accordance with its then applicable pricing
schedule for acquisition of such Mortgages, giving due regard
to principal balance, interest rate, term, amortization and
other general factors used by the Company for acquisition of
such Mortgages at such time; or
(b) Funding by SCMI, on a month to month basis, to the Company
of all lost interest, tax and insurance escrow payments, as
well as any costs incurred by the Company related to curing
the default or obtaining title to and possession of the
property securing the defaulted obligation, including by not
limited to foreclosure, deed in lieu of foreclosure,
bankruptcy claims or motions, evictions, maintaining and/or
securing the property and remarketing costs less any
additional down payments or settlements received by the
Company.
During the year ended December 31, 1997, the Company paid SCMI
a total of $2,607,692 to purchase 71 Mortgage Investments with an
aggregate outstanding principal balance of $2,793,868.
Loan Servicing Fee Payable to SCMI.
The Company utilizes the services of SCMI and nonaffiliated
third parties to service the mortgages acquired by the Company.
For its efforts in servicing those mortgages, SCMI is paid a fee
equal to 0.5% of the principal balance of the mortgages being
serviced by SCMI, a rate the Company believes is a competitive rate
that is no higher than the rates charged by unaffiliated third
parties. The servicing of the mortgages includes the collection of
monthly payments from the borrower, the distribution of all
principal and interest to the Company, the payment of all real
estate taxes and insurance to be paid out of escrow, regular
distribution of information regarding the application of all funds
received and enforcement of collection for all delinquent accounts,
including foreclosure of such account when and as necessary. The
amount of loan servicing fees paid to SCMI will depend upon the
principal balance of the mortgages serviced by SCMI.
During the year ended December 31, 1997, the Company paid SCMI
$3,834 in loan servicing fees.
Real Estate Brokerage Commissions
If the Company forecloses on a property securing a mortgage
loan and sells such property, the Company may pay real estate
brokerage fees which are reasonable, customary and competitive,
taking into consideration the size, type and location of the
property (the "Competitive Commission"), which shall not in the
aggregate exceed 6% of the gross sales price of the property;
however, as to the Advisor, a Trustee, or an Affiliate thereof,
such fees shall be paid only if such person provides a substantial
amount of services in the sales effort, in which case such fees
shall not exceed the lesser of (i) a percentage of the gross sales
price of a property equal to 50% of the Competitive Commission, or
(ii) 3 percent of the gross sales price of a property.
During the year ended December 31, 1997, the Company did not
pay any real estate brokerage commissions.
Acquisition Fees Payable to Advisor
Acquisition Fees equal to 3.0% of the principal amount of each
Mortgage Investment are payable to the Advisor or its Affiliates
for sourcing, evaluating, structuring and negotiating the
acquisition terms of Mortgage Investments. The actual amounts of
the fees paid will depend on the amount of Net Offering Proceeds
and any borrowed funds that are invested.
During the year ended December 31, 1997, the Company paid the
Advisor a total of $82,771 in Acquisition Fees.
Potential Reimbursement of Expenses by Advisor
The Declaration of Trust provides that the Total Operating
Expenses may not exceed in any fiscal year the greater of (a) 2% of
the Average Invested Assets of the Company (defined generally as
the average book value of the Company's Mortgage Investments,
without regard for non-cash reserves) or (b) 25% of the Company's
Net Income. The Administrator will have the responsibility of
preparing an annual budget and submitting such budget to the
Trustees. In the event the Total Operating Expenses exceed the
limitations described above, then within 60 days after the end of
the Company's fiscal year, the Advisor shall reimburse the Company
the amount by which the aggregate annual Total Operating Expenses
paid or incurred by the Company exceed the limitation.
During 1997, the Company entered into a Funding Agreement with
the Advisor whereby the Advisor agreed to fund the Company's
general and administrative expenses. In consideration of the
agreement, the Company will contribute to the Advisor, on a monthly
basis, .5% of the Company's average invested assets for the
immediately preceding month. An expense reimbursement of $150,129
was made for the year ended December 31, 1997. This amount includes
an amount carried over from the year ending December 31, 1996 of
$44,917.
Subordinated Incentive Fee and Options Payable to Advisor
Subject to certain conditions described below, the Advisor
will receive a Subordinated Incentive Fee equal to 25% of the
amount by which the Company's Net Income for a year exceeds a 10%
per annum non-compounded cumulative return on its Adjusted
Contributions. For each year which it receives a Subordinated
Incentive Fee, the Advisor shall also receive 5-year options to
purchase 10,000 Shares at the initial offering price of the Shares
(not to exceed 50,000 Shares). When the audited annual financial
statements of the Company are received each year, the Advisor shall
determine if the following conditions are satisfied:
(i) (A) the total of the Adjusted Contributions as of the end
of the most recent fiscal year and any undistributed cash as
of that date equals (B) the Gross Offering Proceeds as of that
date less cumulative Capital Distributions made through that
date; and
(ii) for the year then ended, the Company's Net Income equals
or exceeds a 10% per annum non-compounded cumulative return on
its Adjusted Contributions. The determination of the
Company's annual non-compounded cumulative return on its
Adjusted Contributions shall be made by dividing the Company's
total Net Income for that year by the average of the month end
Adjusted Contributions during that year.
If the Company's Trustees agree that both of those conditions
are satisfied, the Company will, subject to the restrictions set
forth in the following sentence, pay the Advisor the Subordinated
Incentive Fee. In no event may the Subordinated Incentive Fee
exceed the amount permitted under Section IV.D. of the Statement of
Policy on Real Estate Investment Trusts adopted by the North
American Securities Administrators Association and in effect on
March 5, 1997 (the commencement date of the Company's initial
public offering). No Subordinated Incentive Fees was paid by the
Company in the year ending December 31, 1997.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits. See the Exhibit Index on the following page for a
list of the exhibits that are filed as part of this report:
(b) Reports filed on Form 8-K.
(1) Report dated August 15, 1997 reporting acquisition of assets,
election of independent trustee, and status of the offering.
(2) Report dated September 10, 1997 reporting acquisition of
assets, and status of the offering.
(3) Report dated October 10, 1997 reporting acquisition of assets,
and status of the offering.
(4) Report dated November 10, 1997 reporting acquisition of assets,
and status of the offering.
(5) Report dated December 10, 1997 reporting acquisition of assets,
and status of the offering.
Exhibit
Number Description Page*
3.1 Form of Second Amended and
Restated Declaration of Trust 3.1C*
3.2 Bylaws of the Company 3.2*
4.1 Form of certificate representing the
Shares 4.1*
4.2 Instruments defining the rights of
security holders (See Exhibits 3.1,
3.2 and 4.1)
10.1 Form of Escrow Agreement between the
Company and Texas Commerce Bank
National Association 10.1*
10.2 Advisory Agreement dated August 6, 1996
between the Company and Mortgage Trust
Advisors, Inc. 10.2*
10.3 Agreement of Employment dated
August 6, 1996 between the
Company and Christine Griffin 10.3*
10.4 Note Sale, Recourse and Remarketing
Agreement dated August 6, 1996 between
the Company and South Central
Mortgage, Inc. 10.4*
10.5 Form of Mortgage Servicing Agreement
to be entered into between the Company and
South Central Mortgage, Inc. 10.5*
10.6 $150,000 Revolving Loan Agreement
dated March 20, 1997 between the Company
and Abrams Centre National Bank E-1
10.7 Funding Agreement dated December 15, 1997
but effective January 1, 1997 between the
Company and Mortgagea Trust Advisors, Inc. E-2
All exhibits that have page numbers followed by an "*" are
incorporated by reference from the Company's Registration
Statement on Form S-11 (File No. 333-10109) that was declared
effective on March 5, 1997. The numbers set forth as page
numbers for those exhibits are the exhibit numbers those
documents were given in that filing. All other exhibits are
included in this Form 10-KSB at the page numbers shown.
SIGNATURES
Pursuant to the requirements of Section 13 of 15(d) of the
Securities Exchange Act of 1934, the Company has duly caused this
report to be signed on its behalf by the undersigned thereunto duly
authorized on March 27, 1998.
UNITED MORTGAGE TRUST
By:/S/CHRISTINE A. GRIFFIN
Christine A. Griffin,
President
Pursuant to the requirements of the Securities Act of 1934,
this report has been signed by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Signature Title Date
Principal Executive Officer:
/S/CHRISTINE A. GRIFFIN Trustee, Chairman
Christine A. Griffin of the Board
and President March 27, 1998
Principal Financial and
Accounting Officer:
/S/CHRISTINE A. GRIFFIN Trustee, Chairman
Christine A. Griffin of the Board
and President March 27, 1998
/S/PAUL R. GUERNSEY Trustee March 27, 1998
Paul R. Guernsey
/S/DOUGLAS R. EVANS Trustee March 27, 1998
Douglas R. Evans
/S/RICHARD D. O'CONNOR, JR. Trustee March 27, 1998
Richard D. O'Connor, Jr.
/S/MICHELE A. CADWELL Trustee March 27, 1998
Michele A. Cadwell
EXHIBIT 1
$150,000
REVOLVING LOAN AGREEMENT
THIS REVOLVING LOAN AGREEMENT, dated March 20, 1997, by and between
UNITED MORTGAGE TRUST (the "Borrower"), and ABRAMS CENTRE NATIONAL
BANK (the "Bank").
WITNESSETH:
BACKGROUND. Borrower is in the business of providing first
lien residential mortgages and/or buying discounted first lien
mortgage notes secured by first liens on residential properties
collectively called the "Residential Paper" and retaining the
Residential Paper as an investment. Borrower has requested the Bank
to lend it up to the sum of ONE HUNDRED FIFTY THOUSAND
($150,000.00) DOLLARS on a revolving loan basis (the "Loan") from
which to reimburse Borrower for all or part of Borrower's cost of
originating and/or acquiring Residential Paper (secured by First
Deed of Trust Liens against residences) as below provided; and,
Bank is willing to do so upon the terms and conditions hereinafter
set forth.
NOW, THEREFORE, in consideration of the promises herein contained,
and each intending to be legally bound hereby, the parties agree as
follows:
Section I: The Loan
1.01 Disbursement of the Loan. The Bank will credit the proceeds
of the revolving Loan advanced from time to time to the Borrower's
deposit account with the Bank or a title company designated by
Borrower.
1.02 General Terms. Subject to the terms hereof and the Note
(defined below), the Bank will lend the borrower, from time to time
until one (1) year after this date (the "Loan Termination Date"),
such sums as the Borrower may request by draw ("Draw") request to
the Bank, received by the Bank not less than three (3) banking days
before Bank is requested to fund such Draw and which shall not
exceed, in the aggregate principal amount at any one time
outstanding an amount equal to the lesser of $150,000.00 (the "Loan
Commitment") or the Borrowing Base, defined in 11 1.06. The
Borrower may borrow, repay without penalty or premium and reborrow
hereunder, from the date of this Agreement until the Loan
Termination Date, either the full amount of the Loan Commitment or
any lesser sum. It is the intention of the parties that the
outstanding principal amount of the Loan shall at no time exceed
the amount of the then existing Borrowing Base, and if, at any
time, an excess shall for any reason exist, the full amount of such
excess, together with accrued and unpaid interest thereof as herein
provided, together with accrued and unpaid interest thereon as
herein provided, shall be immediately due and payable in full.
1.03 Draws and Draw Fees. Draws will be submitted on forms
acceptable to Bank; and, Bank will invoice Borrower for a $100.00
fee to process each Draw, as requested by Borrower. Separate Draws
will be submitted for each Item (defined below) of Residential
Paper (i.e. each indebtedness) to be resold by Borrower in
connection with the Loan furnished by Bank.
1.04 The Note. The Loan shall be evidenced by a $150,000.00 note
("Note"), having a stated maturity on the Loan Termination Date, in
form acceptable to Bank.
1.05 The Commitment Fee. Borrower will pay Bank a commitment fee
in the amount of $1,500.00 for setting aside and allocating funding
for the Loan upon execution of this Agreement.
1.06 Borrowing Base. The Borrowing Base is an amount equal to the
lesser of (a) one hundred (100%) percent the sum of all amounts
paid by Borrower for all of Borrower's Residential Paper originated
or acquired in connection with the Loan subject to Bank's liens
("Liens") mentioned herein without considering any Residential
Paper owned by Borrower for more than six (6) months or (b) eighty
(80%) percent of the unpaid principal balances of all Borrower's
Residential Paper acquired in connection with the Loan subject to
Bank's Liens without considering any Residential Paper owned by
Borrower for more than six (6) months; provided further however,
that Draws shall only be honored for the acquisition of Residential
Paper by Borrower based upon appraisals of the real property
securing such Residential Paper according to appraisals/appraisers
approved by and without cost to Bank and provided further, that in
the case of Residential Paper originated by Borrower involving
acquisition and/or restoration/repair of residences, the Borrowing
Base will not exceed the lesser of fifty (50%) percent of loan to
value of said acquired, restored or repaired residence(s) or one
hundred (100%) percent of amounts advanced by Borrower for such
Paper. It is expressly understood that the Borrowing Base will be
reduced automatically in an amount equal to one hundred (100%)
percent of all amounts loaned on any Residential Paper pledged to
Bank that has passed its stated maturity date or otherwise is in
default. Borrower will submit a reconciliation of collateral and
debt appurtenant to the Loan on the first day of each month (the
"Settlement Date") on which will be reported the Borrowing Base for
that month. If the reconciliation shows available borrowing, the
Borrower may draw up to the available amount for borrowing. If the
reconciliation shows available borrowing to be less than the amount
outstanding, the Loan will be paid down to the available amount,
i.e. the Borrowing Base, at that time.
1.07 Late Repayment Fees. In order to induce Bank to enter into
this Agreement, Borrower has represented to Bank that Borrower is
in a position to repay each Draw used to acquire each individual
indebtedness item ("Item") of Residential Paper within one hundred
eighty (180) days after making the Draw for each such Item by
Borrower. Consequently, Borrower will pay Bank on the 1st day of
each month during the term of this Loan a Late Repayment Fee, in an
amount equal to $100.00 per Item per month for each month or part
thereof that Borrower carries any Draw(s) for any Item(s) of
Residential Paper for more than one hundred eighty (180) days from
the date Borrower acquired such Item(s) through the date of
Borrower's repayment of the Draw(s) made for such Item(s) to Bank.
1.08 Interest Rate and Payments of Interest.
(A) Except as otherwise provided under S 1.08(B), interest on the
principal balance of the Loan from time to time outstanding will be
payable monthly at a varying rate per annum which is one (1%)
percent per annum (the "Margin Percentage") in excess of Bank's
prime rate of interest, as established by Bank from time to time as
its prime commercial rate but in no event to exceed the maximum
rate of nonusurious interest allowed by law, as may hereafter be in
effect, hereinafter called the ("Highest Lawful Rate"), with
adjustments in such varying rate to be made on the same day as any
change in such prime commercial rate. All past due principal and
interest shall bear interest at a rate per annum which is equal to
the Highest Lawful Rate from maturity until paid. Notwithstanding
the foregoing provisions concerning such varying rate, if at any
time the sum of the Margin Percentage plus such prime commercial
rate exceeds the Highest Lawful Rate, the rate of interest to
accrue on the note shall be limited to the Highest Lawful Rate, but
if thereafter if the sum of the Margin Percentage plus such prime
commercial rate is less than the Highest Lawful Rate, the rate of
interest to accrue on the Note shall be the Highest Lawful Rate
until the total amount of interest accrued on the Note equal the
amount of interest which would have accrued if a varying rate per
annum equal to the sum of the Margin Percentage plus such prime
commercial rate had at all times been in effect.
(b) It is the intention of the parties hereto to comply with the
usury laws applicable to the Loan; accordingly, it is agreed that
notwithstanding any provision to the contrary in Agreement or in
any of the documents securing payment of the Loan, no such
provision shall require the payment or permit the collection of
interest in excess of the maximum permitted by law. If any excess
interest is provided for, contracted for, charged for or received,
then the provisions of this paragraph shall govern and control and
neither the Borrower hereof nor any other party liable for the
payment thereof shall be obligated to pay the amount of such excess
interest. Any such excess interest which may have been collected
shall be, at the Bank's option, either applied as a credit against
the then unpaid amount hereof or refunded to Borrower. The
effective rate of interest shall be automatically subject to
reduction to the aximum lawful contract rate allowed under the
usury laws as now or hereafter construed. It is further agreed that
without limitation of the foregoing, all calculations of the rate
of interest contracted for, charged for, or received under this
Agreement which are made for the purposes of determining whether
such rate exceeds the maximum lawful rate, shall be made, to the
extent permitted by law, by amortizing, prorating, allocating and
spreading in equal parts during the full stated term of the Loan,
all interest contracted for, charged for or received from the
Borrower or otherwise by the Bank.
1.09 Payment to the Bank. All sums payable to the Bank hereunder
shall be paid directly to the Bank in immediately available funds.
The Bank may send the Borrower statements of all amounts due
hereunder, which statements shall be considered correct and
conclusively binding on the Borrower unless the Borrower notifies
the Bank to the contrary within thirty (30) days of its receipt of
any statement that it deems to be incorrect.
Alternatively, at its sole discretion, the Bank may charge against
any deposit account of the Borrower all or any part of any amount
due under the Note or hereunder.
Section II. Conditions Precedent
2.01 Conditions. The obligation of the Bank to make any advance on
the Loan in connection with any closing ("Closing") of any Draw is
subject to the prior occurrence of the following conditions
precedent, viz. Borrower having first delivered to Bank:
(A) The Note, duly executed by the Borrower, in the form acceptable
to Bank;
(B) A duly executed Guaranty Agreement ("Guaranty"), in form
acceptable to Bank signed by Theodore F. Etter, Jr. ("Guarantor")
together with his current financial statement in form/substance
acceptable to Bank;
(C) Financial reporting, as follows:
(i) quarterly financial statements of Borrower;
(ii) annual audited financial statements of Borrower;
(iii) annual tax returns of Borrower;
(iv) annual financial/cash flow statements and tax returns of
Guarantor;
(v) monthly inventory listing from Borrower; and
(vi) all other items required by Bank's policy,
all of which financial statements and other information shall be
prepared and/or reviewed in such manner as Bank may direct or
accept in Bank's discretion.
D) All loan documents, (the "Loan Documents"), to be delivered
pursuant hereto shall be in form acceptable to Bank and its
counsel.
Section III. Collateral Security
3.01 Composition of the Collateral. The property in which a
security interest is granted pursuant to the provisions of 3.02
and S 3.03 (including Bank's Liens) is herein collectively called
the "Collateral". The Collateral, together with all other property
of the Borrower of any kind held by the Bank, shall stand as one
general, continuing collateral security for all obligations (the
"Obligations") of Borrower to Bank herein created or mentioned
herein or hereafter made including the Note, Security Agreement,
etc. and may be retained by the Bank until all Obligations have
been satisfied in full.
3.02 Rights in Residential Paper Held Either by the Borrower or
by the Bank. As security for the prompt satisfaction of all
Obligations, the Borrower hereby assigns to the Bank all of its
rights, title, and interest in and to, and grants the Bank a lien
upon and a security interest in, all Residential Paper acquired by
Borrower in connection with the Loan, together with all
replacements therefor and proceeds (including, but without
limitation, insurance proceeds) and products thereof.
3.03 Rights in Property Held by the Bank. As security for the
prompt satisfaction of all Obligations, the Borrower hereby
assigns, transfers, and sets over to the Bank all of its right,
title, and interest in and to, and grants the Bank a lien on and a
security interest in, all amounts that may be owing, from time to
time, by the Bank to the Borrower in any capacity, including, but
without limitation, any balance or share belonging to the Borrower,
or any deposit or other account with the Bank, which lien and
security interest shall be independent of, and in addition to, any
right of set-off that the Bank has hereunder or otherwise. The
foregoing liens shall not apply to any "escrow" accounts maintained
by Borrower at the Bank.
3.04 Priority of Liens. The foregoing liens shall be first and
prior liens except for any liens heretofore approved by Bank in
writing.
3.05 Financing Statements.
(A) The Borrower will:
(1) Join with the Bank in executing such financing statements
(including amendments thereto and continuation statements thereof)
in form satisfactory to the Bank as the Bank, from time to time,
may specify;
(2) Pay, or reimburse the Bank for paying, all costs and taxes of
filing or recording the same in such public offices as the Bank may
designate; and
(3) Take such other steps as the Bank, from time to time, may
direct to perfect, to the satisfaction of the Bank, the Bank's
interest in the Collateral.
3.06 Residential Paper Draw Agreements. No Draw will be
submitted, processed or approved until all of the following special
conditions relating to the Residential Paper which is the subject
of such Draw have been first satisfied without cost to Bank:
(A) Bank has approved the form/content of such Residential Paper;
(B) such Residential Paper has been assigned to Bank as follows:
(1) the indebtedness has been delivered and endorsed to Bank with
full recourse against Borrower;
(2) the mortgage ("Mortgage") securing payment of such indebtedness
has been transferred to Bank;
(C) each of the original payee and the maker of the Residential
Paper and Borrower has delivered an estoppel certificate in
form/content acceptable to Bank;
(D) evidence that such mortgage is an insured first lien (viz. the
title insurance policy)has been delivered to Bank;
(E) the property described in such Mortgage has been insured
against loss by fire and other casualty in the full amount of the
indebtedness secured by such Mortgage and Bank is shown as a loss
payee in such policy, as its interests may appear;
(F) the property described in such Mortgage has been appraised by
an appraiser acceptable to Bank and Bank has accepted the
form/content of such appraisal; and
(G) Borrower has submitted to Bank such evidence of such
environmental safety and soundness as Bank may request regarding
any property(ies) mentioned in any such Residential Paper.
3.07 Real Property Described in the Residential Paper. Bank does
not make any warranties or representations, expressed or implied
with respect to the Residential Paper or the real property
mentioned in the Residential Paper comprising a part of the
Collateral or its quality, marketability fitness, suitability, or
condition; and, Borrower agrees that Bank is not responsible for
(and Borrower indemnifies Bank against) any claim, loss, damage,
liability or expense of any kind arising directly or remotely from
such real property and/or Residential Paper or any use, inadequacy,
defect or deficiency thereof.
Section IV. Covenants, Representations and Warranties of Borrower
4.01 Agreements. To induce the Bank to enter into this Agreement,
the Borrower represents and warrants to and covenants with the Bank
as follows:
(A) The Borrower is a trust duly organized, validly existing, and
in good standing under the laws of the State of Maryland, and is
authorized to do business in Texas;
(B) Borrower is not directly or indirectly controlled by, or acting
on behalf of, any person which is an "Investment Company", within
the meaning of the Investment Company Act of 1940, as amended;
(C) Borrower is not in default with respect to any of its existing
indebtedness, and the making and performance of this Agreement, the
Note, and the other Loan Documents will not (immediately or with
the passage of time, the giving of notice, or both):
(1) Violate the trust agreement of the Borrower, or violate any
laws or result in a default under any contract, agreement, or
instrument to which the Borrower is a party or by which the
Borrower or its property is bound; or
(2) Result in the creation or imposition of any security interest
in, or lien or encumbrance upon, any of the assets of the Borrower
except in favor of the Bank;
(D) The Borrower and Guarantor, to the extent applicable to him,
has the power and authority to enter into and perform this
Agreement, the Note, and the other Loan Documents, and to incur the
obligations herein and therein provided for, and has taken all
actions necessary to authorize the execution, delivery, and
performance thereof;
(E) This Agreement, the Note, and the other Loan Documents are, or
when delivered will be, valid, binding and enforceable in
accordance with their respective terms;
(F) Except as otherwise shown herein, there is no pending order,
notice, claim, litigation, proceeding, or investigation against or
affecting the Borrower, whether or not covered by insurance, that
would or could materially or adversely affect the financial
condition or business prospects of the Borrower or Guarantor if
adversely determined;
(G) As of the date hereof, except for any other indebtedness owed
by Borrower to Bank, the Borrower has no material indebtedness of
any nature, including, but without limitation, liabilities for
taxes and any interest or penalties relating thereto except the
extent disclosed in, or permitted by, this Agreement, or fully
shown in Borrower's financial statements delivered to Bank;
(H) Borrower will not demand or accept any prepayment of any
amounts on any of the Residential Paper comprising the Collateral
without Bank's prior written consent. Borrower understands that
Borrower only may collect monthly installments due on said
indebtedness as they mature monthly and then only for so long as
Borrower is not in default under any of the Loan Documents. All
amounts, if any, collected by Borrower after the occurrence of any
such default by Borrower represent trust funds which are assigned
and belong to Bank and any retention of such funds by Borrower
after such default represents a conversion by Borrower of Bank's
property, ipso facto;
(I) Borrower will pay all costs to keep and maintain the validity,
enforceability, security, priority and collectability of the
Collateral and will pay all other amounts which may be necessary or
desirable to preserve, maintain and protect Bank's interest in the
Collateral Borrower will pay or reimburse Bank for all costs
incurred by Bank to document, protect and enforce the Loan
including legal fees, mortgage title insurance, etc;
(J) Bank shall have all rights, benefits and remedies provided in
the Loan Documents as well as those provided by law and may (but is
not obligated to) perform any act or pay any amount which Borrower
is required and fails to pay or perform, as the case may be, at the
cost and for the account of the Borrower; and, Borrower agrees to
reimburse Bank upon demand for any and all such expenditures
together with interest thereon at the highest lawful contract rate
together with all cost of collection;
(K) Borrower will take all necessary action to prevent the
occurrence of any default/dispute under any agreement or obligation
between Borrower and any other persons or entities in connection
with any matter including but not limited to the Collateral or any
part thereof; and, Borrower will notify Bank promptly in the event
of the occurrence of any default by any maker of any Residential
Paper pledged to Bank.
(L) Borrower will take all steps reasonably necessary to determine
and before submitting any Draw will have determined that no
hazardous substances or solid wastes have been disposed of or
otherwise released on or to any property mentioned in such Draw.
The terms "hazardous substance" and "release" shall have the
meanings specified in the Comprehensive Environmental Response
Compensation and Liability Act of 1980 ("CERCLA"), and the terms
"solid waste" and "disposal" (or "disposed") shall have the
meanings specified in the Resource Conservation and Recovery Act of
1976 ("RCRA"); provided, to the extent that the laws of the State
of Texas establish a meaning for "hazardous substance," "release,"
"solid waste," or "disposal" which is broader than that specified
in either CERCLA or RCRA, such broader meaning shall apply;
(M) Borrower indemnifies Bank against any loss to Bank, including
without limitation attorney's fees and costs of site investigation
and cleanup, incurred by or imposed on Bank as a result of any use,
handling, storage, transportation, or disposal of hazardous or
toxic materials on or about any property described in the liens
comprising the Collateral. This indemnity at the election of Bank
shall survive repayment of the Loan and shall continue as long any
risk of loss or liability by Bank exists;
(N) As additional security for the punctual payment and performance
of the Note, and as part of the security therefor, Borrower hereby
grants to Bank a security interest in, and a pledge and assignment
of, any and all money, property, deposit accounts, accounts,
securities, documents, chattel paper, claims, demands, instruments,
items or deposits of the Borrower, now held or hereafter coming
within Bank's custody or control, including without limitation, all
certificates of deposit and other depository accounts whether such
have matured or the exercise of Bank's rights result in loss of
interest or principal or other penalty on such deposits, but
excluding deposits subject to tax penalties if assigned; provided
however, that such lien shall not apply to any "escrow" accounts
maintained by Borrower at the Bank. Without prior notice or demand
upon the Borrower, Bank may exercise its rights granted above at
any time when a default has occurred. Bank's rights and remedies
under this paragraph shall be in addition to and cumulative of any
other rights or remedies at law and equity, including, without
limitation, any rights of set-off to which Bank may be entitled;
and,
(O) Borrower will give immediate notice to the Bank of (1) any
default of Borrower hereunder; (2) any litigation or proceeding in
which it is a party if any adverse decision therein would require
it to pay more than $5,000.00 or deliver assets the value of which
exceeds such sum (whether or not the claim is considered to be
covered by insurance); and (3) the institution of any other suit or
proceeding involving it that might materially and adversely affect
its operation, financial condition, property, or business
prospects.
4.02 Survival. All of the covenants representations and warranties
set forth in Section 4.01 shall survive until all Obligations are
satisfied in full and there remain no outstanding Commitments
hereunder; and, in the case sub 114.01 (M), such indemnity will
remain in effect for so long as the risk of loss to be indemnified
against exists.
Section V Default
5.01 Events of Default. The occurrence of any one or more of the
following events shall constitute an Event of Default hereunder:
(A) The Borrower shall fail to pay when due any installment of
principal or interest or fee payable hereunder, and such failure
shall continue for a period of ten (10) days;
(B) The Borrower shall fail to observe or perform any other
obligation to be observed or performed by it hereunder or under any
of the Loan Documents, and such failure shall continue for ten (10)
days after: (1) notice of such failure from Bank; or(2) the Bank is
notified of such failure or should have been so notified pursuant
to the provision of $ 4.01 (O), whichever is earlier;
(C) The Borrower shall fail to pay any indebtedness due any third
persons, and such failure shall continue beyond any applicable
grace period, or the Borrower shall suffer to exist any other event
of default under any agreement binding the Borrower;
(D) Any financial statement, representation, warranty, or
certificate made or furnished by or with respect to any Guarantor
or Borrower to the Bank in connection with this Agreement, or as an
inducement to the Bank to enter into this Agreement, or in any
separate statement or document to be delivered to the Bank
hereunder, shall be materially false, incorrect, or incomplete when
made;
(E) The dissolution of Borrower or death of any Guarantor; or,
Borrower shall admit its inability to pay its debts as they mature
or shall make an assignment for the benefit of itself or any of its
creditors;
(F) Proceedings in bankruptcy, or for reorganization of the
Borrower or any Guarantor, or for the readjustment of any of their
respective debts under the Bankruptcy Code, as amended, or any
party thereof, or under any other laws, whether state or federal,
for the relief of debtors, now or hereafter existing, shall be
commenced against or by the Borrower or any Guarantor and, except
with respect to any such proceedings instituted by the Borrower
shall not be discharged within thirty (30) days of their
commencement;
(G) In Bank's discretion, if any Item of Residential Paper pledged
to Bank has passed its stated maturity date or otherwise is in
default or any Item remains on Borrower's books (unsold to any
Investor) for more than six (6) months, and such aging also creates
a deficiency in the Borrowing Base;
(H) Any Guarantor shall terminate or fail to comply fully with the
requirements of his Guaranty. The occurrence of any default by
Borrower or any Guarantor under any other obligations of Borrower
to Bank automatically constitutes a default by Borrower under the
Loan Documents.
5.02 Acceleration. Immediately, at the option of Bank and without
notice upon the occurrence of an Event of Default specified in the
foregoing 5.01(E) or (F) or at the option of the Bank, but only
upon notice to the Borrower, upon the occurrence of any other Event
of Default, all obligations, whether hereunder or otherwise, shall
immediately become due and payable without further action of any
kind.
5.03 Remedies. After any acceleration, as provided for in S 5.02,
the Bank shall have, in addition to the rights and remedies given
it by this Agreement and the Loan Documents, all those allowed by
all applicable laws, including, but without limitation, the Uniform
Commercial Code.
Section VI. Release Agreements
6.01 Bank will release its Liens against any Residential Paper
under the following agreements:
(i) no default or dispute is pending or threatened under the Loan
Documents;
(ii) no such release will cause the Borrowing Base to be less than
the outstanding Loan;
(iii) such release is documented, recorded and otherwise
accomplished without cost to Bank; and
(iv) Borrower reduces the principal Loan balance in an amount equal
to the amount loaned by Bank to Borrower against the item of
Residential Paper sought to be released.
Section VII. Miscellaneous
7.01 Construction. The provisions of this Agreement shall be in
addition to those of any guaranty, security agreement, note, or
other evidence of liability now or hereafter held by the Bank, all
of which shall be construed as complementary to each other. Nothing
herein contained shall prevent the Bank from enforcing any or all
other guaranty, pledge or security agreements, notes, or other
evidences of liability in accordance with their respective terms.
7.02 Further Assurance. From time to time, the Borrower will
execute and deliver to the Bank such additional documents and will
provide such additional information, includingbut not limited, to
supplementary Financial Statement information as the Bank may
reasonably require to carry out the terms of this Agreement and be
informed of the status and affairs of the Borrower and Guarantor.
7.03 Enforcement and Waiver by the Bank. The Bank shall have the
right at all times to enforce the provisions of this Agreement and
the Loan Documents in strict accordance with the terms hereof and
thereof, notwithstanding any conduct or custom on the part of the
Bank in refraining from so doing at any time or times. The failure
of the Bank at any time or times to enforce its rights under such
provisions, strictly in accordance with the same, shall not be
construed as having created a custom in any way or manner modified
or waived the same. All rights and remedies of the Bank are
cumulative and concurrent and the exercise of one right or remedy
shall not be deemed a waiver or release of any other right or
remedy. In the event and to the extent, if any, that Borrower is
indebted to Bank under any obligation arising prior to the
execution of this Loan Agreement ("Prior Indebtedness"), Borrower
agrees that Borrower has no off-sets, defense or counterclaims to
payment of the Prior Indebtedness.
7.04 Future Advances Secured. The Collateral mentioned herein
secures and enforces The payment of the Obligations including,but
not limited to, all sums advanced by Bank to Borrower pursuant to
the Note and all other present and future debts, obligations and
Liabilities of Borrower to Bank (a) as principal, surety, endorser,
guarantor, accommodation Party or otherwise, (b) arising by
operation of law or otherwise, (c) as a member of any Partnership,
joint venture, firm, trust or other association or (d) payable to
or in favor of third Parties and hereafter acquired by Bank with or
without the knowledge, consent or insistence Of Borrower, it being
contemplated that Borrower will from time to time become
additionally Indebted to bank directly or remotely all of which
indebtedness shall be secured by said Collateral unless and until
released by Bank.
7.05 Expenses of the Bank. The Borrower will, on demand, reimburse
the Bank for All expenses, including the reasonable fees and
expenses of legal counsel for the Bank, incurred By the Bank in
connection with the preparation, administration, amendment,
modification, Or enforcement of this Agreement and the Loan
Documents and the collection or attempted Collection of the Note.
7.06 Notices. Any notices or consents required or permitted by this
Agreement shall be in writing and shall be deemed delivered if
delivered in person or if sent by certified mail, postage prepaid,
return receipt requested, or telegraph to the parties at heir
address shown by their names below, unless such address is changed
by written notice hereunder.
7.07 Waiver, Release and Indemnity by the Borrower. To the maximum
extent permitted by applicable laws, the Borrower:
(A) Waives (1) protest of all commercial paper at any time held by
the Bank on which the Borrower is in any way liable; (2) except as
the same may herein be specifically granted, notice of acceleration
and of intention to accelerate; and (3) notice and opportunity to
be heard, after acceleration before exercise by the Bank of the
remedies of self-help, set-off, or of other summary procedures
permitted by any applicable laws or by any agreement with the
Borrower, and, except where required hereby or by any applicable
laws, notice of any other anion taken by the Bank;
(B) Releases the Bank and its officers, attorneys, agents, and
employees from all claims for loss or damage caused by any act or
omission on the part of any of them except for willful misconduct;
and
(C) Indemnifies Bank against any loss, claim, cost, damage or
liability incurred by Bank in connection with or arising from any
failure, breach or default of any statement, warranty, agreement,
obligation or agreement of Borrower contained herein or
made/delivered to Bank in connection herewith without regard to any
act or omission of Bank and waives trial by jury.
7.08 Applicable Law. This Agreement is entered into and performable
in Dallas, Dallas County, Texas and shall be subject to and
construed and enforced in accordance with the laws of the State of
Texas.
7.09 Binding Effect, Assignment. and Entire Agreement. This
Agreement shall inure to the benefit of, and shall be binding upon,
the respective successors and permitted assigns of the parties
hereto. The Borrower has no right to assign any of its rights or
obligations hereunder without the prior written consent of the
Bank. This Agreement, including any Exhibits hereto, all of which
are hereby incorporated herein by reference, and the documents
executed and delivered pursuant hereto, constitute the entire
agreement between the parties and may be amended only by a writing
signed on behalf of each party.
7.10 Severability. If any provision of this Agreement shall be
held invalid under any applicable laws, such invalidity shall not
affect any other provision of this Agreement that can be given
effect without the invalid provision, to this end, the provisions
hereof are severable.
7.11 Counterparts. This Agreement may be executed in any number of
counterparts, each of which shall be deemed to be an original, but
all of which together shall constitute but one and the same
instrument.
7.12 Waiver. Borrower is represented by separate independent legal
counsel who has explained to Borrower fully the provisions of the
Texas Deceptive Trade Practices - Consumer Protection An and
Borrower is not in a significantly disparate bargaining position
with Bank; and, after meeting alone with Borrower's attorney,
Borrower hereby makes and delivers the following agreement, with
Bank, to the extent, if any, the below mentioned statute is
applicable with respect to this Loan Agreement and/or the
obligations of Borrower mentioned herein, in whole or in part, to
wit:
"I (BORROWER) WAIVE MY RIGHTS UNDER THE DECEPTIVE TRADE PRACTICES-
CONSUMER PROTECTION ACT, SECTION 17.41 ET SEQ., BUSINESS & COMMERCE
CODE, A LAW THAT GIVES CONSUMERS SPECIAL RIGHTS AND PROTECTION.
AFTER CONSULTATION WITH AN ATTORNEY OF MY OWN SELECTION, I
VOLUNTARILY CONSENT TO THIS WAIVER."
THIS WRITTEN LOAN AGREEMENT (AND ALL RELATED DOCUMENTS MENTIONED
HEREIN OR PREPARED OR APPROVED IN WRITING BY BANK CONCURRENTLY
HEREWITH INCLUDING THE NOTE) REPRESENTS THE FINAL AGREEMENT BETWEEN
THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR,
CONTEMPORANEOUS, OR SUBSEOUENT ORAL AGREEMENTS OF THE PARTIES.
THERE ARE NO UNWRTTTEN ORAL AGREEMENTS BETWEEN THE PARTIES.
IN WITNESS WHEREOF, the parties hereto have duly executed this
Agreement as of the day and year first above written.
Bank:
ABRAMS CENTRE NATIONAL BANK
9330 LBJ Freeway, Suite 150
Dallas, TX 75243
By: /S/ William E. Lowe
Its: Senior Vice President
Borrower:
UNITED MORTGAGE TRUST
1701 N. Greenville Avenue, Suite 403
Richardson, Texas 75081
By: /S/ Christine A. Griffin
Its: President
Approved and Agreed
Guarantor:
/S/ Theodore F. Etter, Jr.
EXHIBIT 2
FUNDING AGREEMENT BETWEEN
UNITED MORTGAGE TRUST
AND
MORTGAGE TRUST ADVISORS, INC.
AGREEMENT dated as of the 15th day of December, 1997, but
effective on January 1, 1997, between UNITED MORTGAGE TRUST (the
"Company"), a Maryland real estate investment trust, and MORTGAGE
TRUST ADVISORS, INC. (the "Advisor"), a Texas corporation.
WITNESSETH:
WHEREAS, the Company is a real estate investment trust
organized under the laws of the State of Maryland; and
WHEREAS, the Advisor is acting as an advisor for the Company
pursuant to an Advisory Services Agreement dated as of the 6th day
of August, 1996; and
WHEREAS, the parties wish to enter into an agreement providing
for certain funding to the Company by the Advisor under the terms
and conditions hereinafter set forth;
NOW, THEREFORE, in consideration of the mutual covenants
herein contained, it is agreed as follows:
1. Funding. The Advisor hereby agrees to fund through
advances to the Company on a monthly or other periodic basis as the
parties may from time to time agree, the Company's general and
administrative expenses.
2. Contribution by the Company. In consideration of the
Advisor's funding of the Company's general and administrative
expenses, the Company will contribute to the Advisor as a
contribution to the Advisor's overhead costs, on a monthly basis,
an amount equal to one-half of 1% of the Company's Average Invested
Assets for the immediately preceding month. Notwithstanding the
foregoing, total contributions to the Advisor from the Company
shall not exceed the lesser of a) the total of general,
administrative expenses funded by the Advisor, or b) an amount
equal to the maximum allowable Total Operating Expenses under the
Declaration of Trust.
3. Preexisting Advances. The parties acknowledge that as of
the date of this Agreement, the Advisor had made advances to the
Company aggregating $135,012.80. The parties agree that those
advances shall be treated as advances to fund the Company's general
administrative expenses under this Agreement.
4. Term and Termination. The term of this Agreement shall be
coterminous with that of the Advisory Services Agreement, including
all renewal periods. This Agreement shall terminate upon
termination of the Advisory Services Agreement. Provided, however,
termination of this Agreement shall not operate to relieve the
Company from making the contributions required under this Agreement
to the Advisor until total contributions equal the total of general
and administrative expenses that have been funded by the Advisor.
5. Amendments. This Agreement shall not be changed,
modified, terminated or discharged in whole or in part except by an
instrument in writing signed by both parties hereto, or their
respective successors or permitted assigns, or otherwise as
provided herein.
6. Assignment. This Agreement may not be assigned by either
of the parties hereto without the written consent of the other
party.
7. Notices. Any notice, report or other communication
required or permitted to be given hereunder shall be in writing,
and shall be given by delivering such notice by hand or by
certified mail, return receipt requested, postage pre-paid, at the
following addresses of the parties hereto:
United Mortgage Trust
1701 N. Greenville, Suite 403
Richardson, Texas 75081
Attention: Christine A. Griffin
Mortgage Trust Advisors, Inc.
1701 N. Greenville, Suite 403
Richardson, Texas 75081
Attention: Todd Etter
Either party may at any time change its address for the
purpose of this Section 7 by like notice.
8. Headings. The section headings herein have been inserted
for convenience of reference only and shall not be construed to
affect the meaning, construction or effect of this Agreement.
9. Governing Law. The provisions of this Agreement shall be
construed and interpreted in accordance with the laws of the State
of Texas as at the time in effect.
IN WITNESS WHEREOF, the undersigned have caused this Agreement
to be signed as of the day and year first above written.
UNITED MORTGAGE TRUST
By: /S/Christine A. Griffin
Christine A. Griffin,
President
MORTGAGE TRUST ADVISORS, INC.
By: /S/Todd Etter
Todd Etter, President
ii
