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,
1999.
/__/ 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)
5740 Prospect Avenue, Suite 1000, Dallas TX 75206
(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, 1999 were
$2,502,504.
As of February 15, 2000, 1,242,957 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 /
<PAGE>
TABLE OF CONTENTS
Page
PART I
Item 1. Description of Business............................................3
Item 2. Description of Property...........................................46
Item 3. Legal Proceedings.................................................48
Item 4. Submission of Matters to a Vote of Security Holders...............48
PART II
Item 5. Market for Common Equity and Related Stockholder Matters..........49
Item 6. Management's Discussion and Analysis of Financial
Condition Of The Company..........................................50
Item 7. Financial Statements..............................................53
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...............................66
PART III
Item 9. Directors, Executive Officers, Promoters and Control
Persons; Compliance With Section 16(a) of the Exchange Act........66
Item 10. Executive Compensation...........................................71
Item 11. Security Ownership of Certain Beneficial Owners
and Management...................................................73
Item 12. Certain Relationships and Related Transactions...................73
Item 13. Exhibits and Reports on Form 8-K.................................77
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS.
GENERAL
United Mortgage Trust 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"). We had the
initial closing of the sale of shares of our initial public offering on
August 8, 1997. Our principal executive offices are located at 5740
Prospect Avenue, Suite 1000, Dallas, Texas 75206, telephone number (214)
237-9305.
Statements in this report regarding our business which are not
historical facts are "forward-looking statements" as contemplated in
the Private Securities Litigation Reform Act of 1995. The statements
should be read in light of the risks and uncertainties attendant to
our business, 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 our relationship with our officers, our
Advisor and their Affiliates, including the payment of fees, the
purchase of mortgages from an Affiliate and other related party
transactions, limited diversity in our 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 our business, see "Risk Factors" commencing on page 20.
Reference is made to the Glossary beginning on page 40 of this report for
definitions of capitalized terms used in the following description of our
business and elsewhere in this report.
We invest exclusively in the following types of investments: (1) first
lien, fixed rate mortgages secured by single-family residential property
throughout the United States (we refer to those investments as "Residential
Mortgages"); (2) the seller's unencumbered interest in fixed rate contracts
for deed (also known as land contracts) for the purchase of single-family
residential property throughout the United States (we refer to those
investments as "Contracts for Deed"); and (3) loans of 12 months or less in
term, made to investors for the purchase, renovation and sale of single-family
homes (we refer to those investments as "Interim Mortgages"). Any reference in
this Form 10-KSB to "Mortgage Investments" will refer to Residential
Mortgages, Contracts for Deed and Interim Mortgages. Most, if not all, of the
Residential Mortgages and Contracts for Deed will not be insured or guaranteed
by a federally owned or guaranteed mortgage agency and will involve borrowers
who do not satisfy all of the income ratios, credit record criteria, loan-to-
value ratios, employment history and liquidity requirements of conventional
mortgage financing
We produce net interest income on our Mortgage Investments while
maintaining strict cost controls in order to generate net income for monthly
distribution to our shareholders. We operate in a manner that will permit us
to qualify as a REIT for federal income tax purposes. As a result of REIT
status, we would be permitted to deduct dividend distributions we pay to our
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.
We are self-administered with our President managing our day-to-day
operations, subject to the supervision of our Board of Trustees. We use the
services of Mortgage Trust Advisors, Inc., a Texas corporation formed on June
11, 1996, to act as our advisor in selecting the investments we purchase. The
Advisor is owned and controlled by Todd F. Etter, Dan H. Hill, James P. Hollis
and Timothy J. Kopacka. Mr. Hill is an Affiliate of First Financial United
Investment Ltd., L.L.P., ("First United") one of the Selling Group Managers
that is handling the sale of our Shares to the public. Mr. Etter is an
Affiliate of South Central Mortgage, Inc. ("SCMI"), a Texas corporation that
sells Mortgage Investments to us and services some of our Residential
Mortgages. Mr. Etter is also an Affiliate of Capital Reserve Corp. ("CRC"), a
Texas corporation that sells Interim Mortgages to us and services those
Interim Mortgages for us.
We intend to continue to acquire Mortgage Investments from several
sources, including South Central Mortgage, Inc. ("SCMI") and Capital Reserve
Corporation ("CRC"), Affiliates of the Advisor. The amount of Mortgage
Investments to be acquired from SCMI and CRC cannot be determined at this time
and will depend upon the Mortgage Investments that are available from them or
other sources at the time we have funds to invest. At this time, SCMI and CRC
are the only Affiliates that are expected to sell Mortgage Investment to us.
SCMI is a Texas corporation that is in the business of purchasing, selling and
servicing mortgages. CRC is a Texas corporation in the business of financing
home purchases and renovations by real estate investors.
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.
We use the services of SCMI and nonaffiliated third parties to service
the Mortgage Investments we acquire. The servicing of the Mortgages
Investments includes the collection of monthly payments from the borrower,
the distribution of all principal and interest to us, 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 those accounts when and as necessary.
PROCEEDS FROM PUBLIC OFFERING OF SHARES
On March 5, 1997, we 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. ("First United") and IMS Securities, Inc. ("IMS Securities")
(First United and IMS Securities are collectively referred to herein as the
"Selling Group Managers") and other broker-dealer firms that are members of
the National Association of Securities Dealers, Inc. ("NASD") and selected
by the Selling Group Managers.
On March 2, 1999 our Board of Trustees unanimously agreed to extend the
offering period of our public offering which was due to terminate on March
5, 1999. We have extended the offering period to December 31, 2000, or until
2,500,000 shares have been sold, whichever occurs earlier.
Pursuant to the prospectus for the public offering, the subscription
payments by investors were held in an escrow account at Chase 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 our
Company and of each other. On August 8, 1997, those requirements were
satisfied and we closed the initial sale of 126,863 Shares. After the first
closing in August 1997, additional closings have occurred on the first day
and fifteenth day of each subsequent month and will continue on this basis
(or more frequently) 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
subscriber's funds are held in escrow, subject to any applicable withholding
provisions of the Code.
During the year ended December 31, 1999, we sold a total of 451,273
Shares in our public offering for Gross Offering Proceeds of $9,025,460.
From the Gross Offering Proceeds, we paid $948,564 in commissions and other
offering expenses and received Net Offering Proceeds of $8,076,896. By
comparison, during 1998 we sold a total of 531,763 Shares in our public
offering for Gross Offering Proceeds of $10,635,260. From the Gross Offering
Proceeds, we paid $1,122,968 in commissions and other offering expenses and
received Net Offering Proceeds of $9,512,292.
We use our 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 in short term investments appropriate for a trust
account or investments which yield "qualified temporary investment income"
within the meaning of Section 856(c)(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 us to maintain our 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
Our primary investment policy is to purchase Residential Mortgages,
Contracts for Deed and Interim Mortgages 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 homebuyers. 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. We acquire what we consider 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. We attempt to reduce the rate
and expense of early payment defaults through the adherence to investment
policies that require the seller of a note to us with a payment history of
less than 12 months to replace or repurchase any non-performing note and
reimburse us for any interest, escrows, foreclosure, eviction, and property
maintenance costs.
UNDERWRITING CRITERIA
The underwriting criteria for our purchase of Mortgages Investments 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. We 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. Our Advisor will seek to acquire Mortgage Investments that
will provide a satisfactory net yield to us. 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
our 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 we do 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
Mortgages 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 an 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 or investment-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 Mortgages (loans to real estate
investors for purchase of homes for resale) may be purchased if they will
not exceed a 60% LTV and will have a maturity of one year or less.
5. Seasoning. Residential Mortgages and Contracts for Deed 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 us to replace or repurchase any non-
performing note and reimburse us 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 us 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 Residential Mortgage and
Contract for Deed 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
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:
- Current credit report with acceptable explanations for any adverse
ratings, no active bankruptcies, no prior foreclosures.
- Employment, verified, with current employer, or no lapse in
employment for the last 12 months.
- Income ratio, verified, indicating income at least 2.5 times the
monthly payment inclusive of escrows.
- 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 our
benefit in an amount not less than the outstanding principal balance on the
loan. We reserve 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. We 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 purchased 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 our loan portfolio among other factors.
Our 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 our
Declaration of Trust.
In addition to other investment restrictions imposed by the Trustees
from time to time consistent with our objective to qualify as a REIT, we
will observe the following restrictions on our investments set forth in our
Declaration of Trust:
(a) We may not invest in real estate contracts of sale unless those
contracts of sale are recordable in the chain of title and unless that
investment is made in conjunction with the acquisition or sale of real
property or when held as security for Mortgages made or acquired by
us.
(b) Not more than 10% of our 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 a
contract for development or under a plan for development within one
year.
(c) We may not invest in equity securities unless a majority of
Trustees, including a majority of Independent Trustees not otherwise
interested in that transaction, approve the transaction as being fair,
competitive and commercially reasonable.
(d) We 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 we invest in real property, a majority of the
Trustees shall determine the consideration paid for that 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, a Trustee or Affiliates
thereof, the fair market value shall be determined by a qualified
independent real estate appraiser selected by the Independent
Trustees.
(f) We 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 the junior debt, plus the outstanding amount of the
senior debt, does not exceed 85% of the appraised value of that
property, if after giving effect thereto, the value of all those
investments (as shown on our books in accordance with generally
accepted accounting principles after all reasonable reserves but
before provision for depreciation) would not then exceed 25% of our
tangible assets.
(g) We will not commingle our 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 our funds and
funds of other entities sponsored by a Sponsor or our 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 our funds are protected from claims of those
other entities and creditors of those other entities.
(h) We 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. We may not
purchase CMO securities at a significant premium.
(i) We may not use or apply land for farming, horticulture or similar
purposes.
(j) We will not engage in trading, as compared with investment
activities.
(k) We will not engage in underwriting or the agency distribution of
securities issued by others.
OTHER POLICIES
Although we do not intend to invest in real property, to the extent we
do, a majority of the Trustees shall determine the consideration paid for
that 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, a Trustee or Affiliates thereof, the fair market
value shall be determined by a qualified independent real estate appraiser
selected by the Independent Trustees.
We will use our best efforts to conduct our 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.
We will not engage in any transaction which would result in the receipt
by the Advisor or our 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 us and the
Advisor and our 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 our investment policies may vary as new investment
techniques are developed.
OTHER RESTRICTIONS IN DECLARATION OF TRUST
LIMITATION ON TOTAL OPERATING EXPENSES
Our goal is to limit our 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 we will be able fully
to achieve that goal, at least in the initial years of operation. In order
to achieve this goal, we entered into a Funding Agreement effective January
1, 1997, which provides that the Advisor will fund all of our general and
administrative expenses. In turn, we 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 our Average Invested Assets for the immediately
preceding month. Our total contributions to the Advisor shall not exceed the
lesser of (a) the total of general and administrative expenses funded by the
Advisor, or (b) an amount equal to the maximum allowable Total Operating
Expenses under the Declaration of Trust.
In any event, however, the Declaration of Trust provides that our
annual Total Operating Expenses shall not exceed in any fiscal year the
greater of 2% of our Average Invested Assets or 25% of our Net Income. In
the event the Total Operating Expenses exceed the limitations described
above then within 60 days after the end of our fiscal year, the Advisor
shall reimburse us the amount by which the aggregate annual Total Operating
Expenses paid or incurred 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 us. However, notwithstanding the foregoing, the Acquisition
Fees to be paid to the Advisor or our 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
Our Declaration of Trust imposes certain restrictions upon dealings
between us and the Advisor, any Trustee or Affiliates thereof. In
particular, the Declaration of Trust provides that we shall not engage in
transactions with any Sponsor, the Advisor, a Trustee or Affiliates thereof,
except to the extent that each transaction has, after disclosure of that
affiliation, been approved or ratified by the affirmative vote of a majority
of the Independent Trustees, not otherwise interested in that transaction,
who have determined that (a) the transaction is fair and reasonable to us
and our shareholders; (b) the terms of that 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 we acquire for an
annual service fee equal to 0.5% of the outstanding principal balance of
each note that it services for us 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 that 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
We may borrow funds to make Distributions to our Shareholders or to
acquire additional Mortgage Investments. However, our ability to borrow
funds is subject to the limitations set forth in the Declaration of Trust
which provides that we may not incur indebtedness unless: (i) that
indebtedness is not in excess of 50% of our Net Asset Value; or (ii) a
majority of the Independent Trustees have determined that the indebtedness
is otherwise necessary to satisfy the requirement that we distribute at
least 95% of our REIT Taxable Income or is advisable to assure that we
maintain our qualification as a REIT for federal income tax purposes. In
addition, our aggregate borrowings, secured and unsecured, shall be
reasonable in relation to our Net Assets and shall be reviewed by the
Trustees at least quarterly. The maximum amount of those 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 that 50% level shall be approved by a majority of Independent Trustees
and disclosed to Shareholders in our next quarterly report, along with
justification for that excess.
COMPETITION
We believe that our principal competition in the business of acquiring
and holding Mortgage Investments is 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 we do, we
anticipate that we will be able to compete effectively and generate
relatively attractive rates of return for stockholders due to our relatively
low level of operating costs, our relationships with our sources of Mortgage
Investments and the tax advantages of our 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 those Mortgage Investments.
EMPLOYEES
As of March 31, 2000, we had two full-time and one part-time employees.
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 we 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 AND CONTRACT FOR DEED GENERALLY
Mortgage loans are secured by either mortgages or deeds of trust or
contracts for deed (also known as a land contract) 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 borrower delivers to the lender 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 lender 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 lender'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 lender.
A Contract for Deed (also known as a land contract) is a document
evidencing the agreement between a seller of real estate (the "lender") and
a buyer (the "borrower") pursuant to which the seller retains legal title to
the property and agrees with the purchaser to transfer the property in
exchange for the payment of the purchase price, plus interest, over the
term. Upon full performance of the contract by the purchaser, the seller is
obligated to convey title to the property. As with mortgage or deed of
trust financing, during the effective period of the contract of deed, the
purchaser is typically responsible for maintaining the property in good
condition and for paying real estate taxes, assessments and hazard insurance
premiums associated with the property.
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 that lease. A mortgage
covering an interest in real property other than the fee estate requires
special provisions in the instrument creating that interest or in the
mortgage to protect the lender against termination of that interest before
the mortgage is paid.
The priority of liens on real estate 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 lender'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 all of the
necessary parties. When the lender'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 lender
prevails, the court ordinarily issues a judgment of foreclosure and appoints
a referee or other designated official to conduct the sale of the property.
Those sales are made in accordance with procedures which vary from state to
state. The purchaser at the 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 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 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 lien holders. 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.
The method of enforcing the rights of the lender under a contract for
deed varies on a state-by-state basis depending upon the extent to which
state courts are willing or able to enforce the contract for deed strictly
according to its terms. The terms of contracts for deed generally provide
that upon default by the borrower, the borrower loses his or her right to
occupy the property, the entire indebtedness is accelerated, and the
borrower's equitable interest in the property is forfeited. The lender in
such a situation does not have to foreclose in order to obtain title to the
property, although in some cases, both a quiet title action to clear title
to the property (if the borrower has recorded notice of the contract for
deed) and an ejectment action to recover possession may be necessary. In a
few states, particularly in cases of default during the early years of a
contract for deed, ejectment of the borrower and a forfeiture of his or her
interest in the property will be permitted. However, in most states, laws
(analogous to mortgage laws) have been enacted to protect borrowers under
contracts for deed from the harsh consequences of forfeiture. These laws
may require the lender to pursue a judicial or nonjudicial foreclosure with
respect to the property and give the borrower a notice of default and some
grace period during which the contract for deed may be reinstated upon full
payment of the default amount.
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 that debt, interest and expenses, the lender'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, forfeiture 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, or under a contract for deed 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. Those 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 that 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 has priority over the lien of an existing mortgage against that
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.
If we take an equity interest in, management control of, or foreclose on any
of the Mortgage Investments, we may be considered the owner of the real
property securing that Mortgage Investment. If foreclosure on any Mortgage
Investment becomes necessary and we acquire record ownership of the property
through a foreclosure sale to protect our investment, we will conduct our
management of the property primarily to protect our security interest in the
property. We will oversee the management of any facility on the property in
order to minimize the potential for liability for cleanup of any
environmental contamination under applicable federal, state, or local laws.
In the event of any environmental contamination, there can be no assurance
that we would not incur full recourse liability for the entire cost of any
such removal and cleanup, even if we did not know about or participate in
the contamination. Full recourse liability means that any of our property,
including the contaminated property, could be sold in order to pay the costs
of cleanup in excess of the value of the property at which such
contamination occurred. Additionally, we would have to bear the cost of such
removal and cleanup which may exceed the value of the property. In addition,
we could incur liability to tenants and other users of the affected
property, or users of neighboring property, including liability for
consequential damages. Consequential damages are damages which are a
consequence of the contamination but are not costs required to clean up the
contamination, such as lost profits of a business.
We expect 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 the federal Comprehensive
Environmental Response, Compensation, and Liability Act of 1980, as amended
("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 those persons or entities may
be bankrupt or otherwise judgment proof. Furthermore, that 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 that priority may in some
states be altered by the lender'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.
We do not presently intend to acquire junior mortgages or deeds of
trust which are subordinate to senior mortgages or deeds of trust held by
other lenders. Our rights as lender under a junior mortgage or deed of
trust will be subordinate to those of the lender under the senior mortgage
or deed of trust, including the prior rights of the senior lender to receive
rents, hazard insurance and condemnation proceeds and to cause the property
securing the mortgage loan to be sold upon default of the borrower, thereby
extinguishing our junior lender's lien unless we assert our subordinate
interest in foreclosure litigation or satisfy the defaulted senior loan. As
discussed more fully below, in many states a junior lender may satisfy a
defaulted senior loan in full, or may cure that 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 lender.
The form of mortgage or deed of trust used by many institutional
lenders confers on the lender the right both to receive proceeds collected
under any hazard insurance policy and awards made in connection with any
condemnation proceedings, and to apply those proceeds and awards to any
indebtedness secured by the mortgage or deed of trust, in such order as the
lender 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 lender 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 lenders to apply the proceeds of hazard insurance
and partial condemnation awards to the secured indebtedness. In those
states, the borrower must be allowed to use the proceeds of hazard insurance
to repair the damage unless the security of the lender has been impaired.
Similarly, in certain states, the lender 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 borrower by the lender
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 lender is 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
lender had actual knowledge of those intervening junior mortgages or deeds
of trust and other liens at the time of the advance. Where the lender 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 those 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 borrower 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 lender under the mortgage. Upon a
failure of the borrower to perform any of these obligations, the lender is
given the right under the mortgage or deed of trust to perform the
obligation itself, at its election, with the borrower agreeing to reimburse
the lender for any sums expended by the lender on behalf of the borrower.
All sums so expended by the lender become part of the indebtedness secured
by the mortgage or deed of trust.
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. Under
the laws of some states, borrowers under contracts for deed may also have a
post-foreclosure right of redemption and a borrower with a sufficient equity
investment in the property may be permitted to share in the proceeds of any
sale of the property after the indebtedness is paid or may otherwise be
entitled to a prohibition of the enforcement and the forfeiture clause.
ANTI-DEFICIENCY LEGISLATION
We 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 lender 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 lender 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 that security; however, in some of these
states, the lender, following judgment on that 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 excess 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 lender from
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 borrowers, may interfere with and delay the ability of a
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 an automatic stay can be significant. However, that
automatic stay can be removed unless the borrower can provide adequate
security to the lender, usually in the form of post-petition payments on the
debt. 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 lender, may stay the senior lender from taking action
to foreclose that 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 borrower 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
that 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 borrower 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 borrower'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 borrower
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 borrower. 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". We 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 those fees, those 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 a bankruptcy
proceeding.
Acceleration on Default
We may invest in mortgage loans that contain a "debt-acceleration"
clause, which permits the lender to accelerate the full debt upon a monetary
or non-monetary 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 those
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, those 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 cancelled upon paying our 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 cancelled without any payment and
prohibiting the lender from foreclosing.
RISK FACTORS
An investment in our Shares 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 together with all of the
information set forth in this document in determining whether to purchase
any Shares. Information contained herein may contain forward-looking
statements within the meaning of the Private Securities Litigation Reform
Act of 1995, which statements can be identified by the use of forward-
looking terminology such as "may," "will," "expect," "anticipate,"
"estimate," or "continue" or the negative thereof or other comparable
terminology. The following matters and certain other factors noted
throughout this document constitute cautionary statements identifying
important factors with respect to any forward-looking statements, including
certain risks and uncertainties, that could cause our actual results to
differ materially from those contained in any forward-looking statements.
A. INVESTMENT AND BUSINESS RISKS
1. Lack of Liquidity. There is currently no established trading
market for the Shares and we have no plans to liquidate by selling all of
our assets and distributing the proceeds to our shareholders. Although we
intend to seek to have the Shares listed on NASDAQ or an exchange after the
sale of all of the Shares offered in our 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 a result, you may not be
able to resell your Shares or use them as collateral for a loan.
Furthermore, even if a market for the sale of Shares develops, you 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. We are in the
business of lending money and, as such, take the risk of defaults by the
borrower. Most, if not all, of the Residential Mortgages and Contracts for
Deed that we purchase will not be insured or guaranteed by a federally owned
or guaranteed mortgage agency and will involve borrowers who do not satisfy
all of the income ratios, credit record criteria, loan-to-value ratios,
employment history and liquidity requirements of conventional 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 conventional mortgage financing. If the borrower defaults on a
Residential Mortgage, we may be forced to purchase the property at a
foreclosure sale. If the borrower defaults on a Contract for Deed, we may
be forced to forfeit or cancel the borrower's interest in that Contract for
Deed and eliminate the borrower's interest in that property. If we cannot
quickly sell or refinance that property, and the property does not produce
any significant income, our 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 sale of our Shares
and our operations, including: (1) commissions, due diligence fees and SGM
Shares payable to First United as a Selling Group Manager; (2) Acquisition
Fees payable to the Advisor equal to 3% of the principal amount of each
Residential Mortgage or Contract for Deed we acquire (no Acquisition Fees
are paid with respect to Interim Mortgages); (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 we are not profitable.
The structure of those fees may cause conflicts of interest between us, the
Advisor and its Affiliates. In addressing these conflicts of interest, the
Trustees, the President and the Advisor will be required to abide by their
fiduciary duties to us and our shareholders.
4. Purchase of Mortgage Investments from Affiliates. We intend to
acquire our Mortgage Investments from several sources, including SCMI and
CRC, Affiliates of the Advisor. See "Item 9." The amount of Mortgage
Investments that we will acquire from SCMI and CRC cannot be determined at
this time and will depend upon the amount of funds we have available to
invest and the amount of Mortgage Investments that are available from SCMI
and CRC or other sources at the time we have funds to invest. At this time,
SCMI and CRC are the only Affiliates that are expected to sell Mortgage
Investment to us.
During the year ended December 31, 1999, of the 151 Residential
Mortgages and 116 Contracts for Deed that were acquired, 104 Residential
Mortgages and 36 Contracts for Deed were purchased from SCMI. They had an
unpaid principal balance of $4,956,432 and $1,610,136, respectively. The
other 47 Residential mortgages and 80 Contracts for Deed were acquired from
private individuals, representing unpaid principal balances of $2,239,926
and $3,578,080, respectively. In addition, at the year ended December 31,
1999, we had 100 Interim Mortgages with an aggregate $4,199,632 principal
amount. Ninety-six of the Interim Mortgages were acquired from CRC and 4
were acquired from SCMI. During the year ended December 31, 1998, of the 171
Residential Mortgages and 30 Contracts for Deed that were acquired, 125
Residential Mortgages and 7 Contracts for Deed were purchased from SCMI.
They had an unpaid principal balance of $5,447,000 and $299,000,
respectively. The other 46 Residential mortgages and 23 Contracts for Deed
were acquired from private individuals, representing unpaid principal
balances of $2,005,000 and $982,000, respectively. In addition, at the year
ended December 31, 1998, we had 102 Interim Mortgages with an aggregate
$3,285,023 principal amount. Ninety-seven of the Interim Mortgages were
acquired from CRC, representing $3,169,591 principal investment.
Due to the affiliation between the Advisor, SCMI and CRC and the fact
that SCMI and CRC may make a profit on the sale of Mortgage Investments to
us, the Advisor will have a conflict of interest in determining if Mortgage
Investments should be purchased from SCMI or CRC or unaffiliated third
parties. However, all Mortgage Investments purchased from SCMI, CRC 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 ourselves 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
those Independent Trustees without ratification by the shareholders. See
"Risk Factors - Shareholders Must Rely on Management" and "Item 9."
6. Competition for the Time and Services of Common Officers and
Trustees. We will rely on the Advisor and its Affiliates for supervision of
the management of our operations. 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 that we will purchase. 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 those entities. Our Trustees, President
and Advisor will devote such time to our affairs and to the other entities
in which they are involved as they determine in their sole discretion to be
necessary for our benefit and the benefit of those other entities. In
exercising that discretion, they must act in good faith and in compliance
with their fiduciary obligations to us.
The Advisor and its Affiliates believe they have sufficient staff
personnel to be fully capable of discharging their responsibilities to us
and to all other entities to which they or their officers or Affiliates are
responsible.
7. Competition 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 us and which may have the same management
personnel as we do. To the extent that any other REITs, partnerships or
entities with similar investment objectives (or programs with dissimilar
objectives for which a particular Mortgage Investment may nevertheless be
suitable) (which we will collectively refer to herein as the "Affiliated
Programs") have funds available for investment at the same time as we do and
a potentially suitable investment has been offered to us or an Affiliated
Program, conflicts of interest will arise as to which entity should acquire
the investment.
If any conflict arises between us and any of the other Affiliated
Programs, the Advisor will initially review our investment portfolio and the
investment portfolios of each of those Affiliated Programs and will
determine whether or not that investment should be made by us or by the
Affiliated Program. That decision will be based upon such factors as the
amount of funds available for investment, yield, portfolio diversification,
type and location of the property that is the subject of that Mortgage
Investment, and proposed loan terms. The Trustees (including the
Independent Trustees) will be responsible for monitoring this allocation
method (and also the allocation method described below with respect to new
Affiliated Programs established in the future) to be sure that each is
applied fairly to us. See "Summary of Declaration of Trust - Responsibility
of Trustees".
If the Advisor or its Affiliates establish new Affiliated Programs and
the making of a Mortgage Investment appears equally appropriate for us and
one or more of those 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, our Trustees and the officers, directors and employees of the
Advisor and its Affiliates may for their own account or the account of
others originate and acquire Mortgage Investments similar to the Mortgage
Investments that we will purchase. The Trustees and the Advisor are,
however, subject to a fiduciary duty to us and our shareholders. See
"Fiduciary Responsibility of Trustees". 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 us before
recommending or presenting those opportunities to others or taking advantage
of those opportunities on their own behalf, except as otherwise described
with respect to Affiliated Programs or in connection with the existing
business of SCMI and CRC. See "Management - Summary of the Advisory
Agreement". Except as described above, and subject to their fiduciary duty
to us and our shareholders, neither the Trustees, the Advisor nor its
Affiliates will be obligated to present to us any particular investment
opportunity which comes to their attention, even if that opportunity is of a
character which might be suitable for investment by us.
The Advisor may also have conflicts of interest between us and any
other Affiliates of the Advisor when we attempt to sell Mortgage
Investments, as well as in other circumstances.
See "Investment Objectives and Policies - Other Policies" and "Summary
of Declaration of Trust".
8. Additional Conflicts with Affiliates. Although we do not presently
expect to do so, we are permitted to invest in mortgage loans on properties
owned by Affiliates. However, we may only do so if those transactions are
approved by a majority of the Trustees who are not otherwise interested in
the transactions and they determine that those transactions are fair and
reasonable to us and on terms and conditions that are not less favorable to
us than those that are available from third parties. See "Summary of
Declaration of Trust - Restrictions on Transactions with Affiliates".
9. Unspecified Investment; Investors Cannot Assess Mortgage
Investments. Other than the Mortgage Investments we already own, we have
not made any commitments to invest in any specific Mortgage Investments.
Therefore, you will not have an opportunity to evaluate any of the Mortgage
Investments that we will purchase with the proceeds from the sale of
additional Shares and must rely entirely on the judgment of Management. See
"Investment Objectives and Policies" and "Management".
10. Lack of Diversification. We will sell a maximum of 2,500,000
Shares to the public in our current offering of Shares. As of December 31,
1999, we have sold 1,185,544 Shares for $23,731,880. We can terminate the
offering at any time in our sole discretion for any reason whatsoever. In
the event we do not sell any additional Shares, our ability to reduce our
risk of loss by spreading that risk over a larger number of Mortgage
Investments would be reduced. See "Estimated Use of Proceeds".
11. Experience of Management. The Advisor was formed for the purpose
of advising us in the selection and purchase of Mortgage Investments and has
performed those duties for us since we commenced operations. Our Trustees
and President and the management team of the Advisor have considerable
expertise in the acquisition and management of mortgage assets, mortgage
finance, asset/liability management, public company management and
administration and the management of corporations in the real estate lending
business. However, although our Trustees, President and the officers,
directors and shareholders of the Advisor have had substantial prior
experience in connection with the types of investments we make and the
administration of those investments, they have not previously sponsored nor
managed any private or public real estate investment programs and, except
for their services to us, do not have any experience in the management of a
REIT. See "Risk Factors - Shareholders Must Rely on Management."
12. A Selling Group Manager is an Affiliate of the Advisor. First
Financial, one of the two Selling Group Managers of the offering, is an
Affiliate of the Advisor. As an Affiliate of the Advisor, First Financial
may experience a conflict in performing its obligations to exercise due
diligence with respect to the statements made in the prospectus used in the
offering of shares.
13. Delays in Investment Could Reduce Return to Investors. We may be
delayed in making Mortgage Investments due to delays in the completion of
the underwriting process, delays in obtaining the necessary purchase
documentation, a shortage of suitable investments or other factors. During
the time our funds are held pending investment in Mortgage Investments,
those funds will be invested in temporary investments. Temporary investment
of funds pending investment in Mortgage Investments may result in a lower
rate of return.
14. Shareholders Must Rely on Management. The Trustees will be
responsible for our management, but employ our President to manage our day-
to-day affairs. The Trustees retain the Advisor to use its best efforts to
seek out and present to us a sufficient number of suitable investment
opportunities which are consistent with our investment policies and
objectives 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 our
Declaration of Trust, the power and duty to: (1) develop underwriting
criteria and a model for our investment portfolio; (2) acquire, retain or
sell Mortgage Investments; (3) seek out, present and recommend investment
opportunities consistent with our investment policies and objectives, and
negotiate on our behalf with respect to potential investments or the
disposition thereof; (4) pay our debts and fulfill our obligations, and
handle, prosecute and settle any of our claims, including foreclosing and
otherwise enforcing mortgages and other liens securing investments; (5)
obtain for us such services as may be required for mortgage brokerage and
servicing and other activities relating to our investment portfolio; (6)
evaluate, structure and negotiate prepayments or sales of Mortgage
Investments; (7) from time to time, or as requested by the Trustees, make
reports to us as to its performance of the foregoing services and (8) to
supervise other aspects of our business. Our success 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 our shareholders elect our Trustees annually, shareholders have no
right or power otherwise to take part in our management, 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 our business to the Trustees,
the President and the Advisor. See "Item 9."
15. Limited Ability to Meet Fixed Expenses. Our operating expenses,
including certain compensation to our President, servicing and
administration expenses payable to an Affiliate and unaffiliated mortgage
servicers and the Independent Trustees, must be met regardless of our
profitability. We are also obligated to distribute 95% of our REIT Taxable
Income (which may under certain circumstances exceed our Cash Flow) in order
to continue to qualify as a REIT for federal income tax purposes.
Accordingly, it is possible that we may be required to borrow funds or
liquidate a portion of our investments in order to pay our expenses or to
make the required cash distributions to shareholders. Although we generally
may borrow funds, there can be no assurance that those funds will be
available to the extent, and at the time, required by us.
16. Investment Company Regulatory Considerations. We are 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 our
portfolio that is placed in various investments so that we do not come
within the definition of an investment company under the Investment Company
Act. As a result, we may have to forego certain investments that would
produce a more favorable return.
17. Anti-Takeover Considerations and Restrictions on Share
Accumulation. Provisions of the Maryland corporation law that apply to us
make it more difficult for others to engage in a business combination with
us and place restrictions on persons acquiring more than 10% of our
outstanding Shares. Further, in order for us 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 our taxable
year. To ensure that we will not fail to qualify as a REIT under this test,
our 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 others from attempt to
gain control of us. The restrictions and provisions under law and these
adopted by us may also (1) deter individuals and entities from making tender
offers for Shares, which offers may be attractive to shareholders or (2)
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.
18. Limited Liability of Trustees And Officers. Our Declaration of
Trust provides that our Trustees and officers shall have the fullest
limitation on liability permitted by the laws of the State of Maryland.
Pursuant to the Maryland statute under which we were formed, a Trustee is
not personally liable for our obligations except, if a Trustee otherwise
would be liable, that provision does not relieve the Trustee from any
liability to us or our 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, our Declaration of Trust further limits the liability of our
Trustees and officers by providing that the Trustees and the officers shall
be liable to us or our shareholders only (1) 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
(2) 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
us or to our shareholders shall be limited to equitable remedies, such as
injunctive relief or rescission, and shall not include the right to recover
money damages. As a result of that limitation on liability, we and our
shareholders may be limited in our ability to recover from our Trustees and
officers for any damages caused by a breach of the duties those persons owe
to us.
19. Majority Rule Prevails. Shareholders by a majority vote may take
certain actions, including termination of our existence or approving
amendments to our Declaration of Trust, except for such actions and
amendments that require supermajority approval. Any such change, if approved
by the holders of the requisite number of Shares, would be binding on all
non-consenting shareholders. Certain of these provisions may discourage or
make it more difficult for a person to acquire control of us or to effect a
change in our operation.
20. Short Term Investments; Fixed Rate Trading. Pending acquisition
of Mortgage Investments, we are authorized to invest our funds in short-term
investments. We view short-term investments as those with a maturity date
that is less than 2 years. We expect to dispose of those short-term
investments in order to acquire Mortgage Investments and may incur a loss
upon such disposition. Additionally, we will acquire fixed rate instruments
for both short-term investments and Mortgage Investments. We may dispose of
these fixed rate instruments, for, among other purposes, acquiring other
Mortgage Investments, or liquidating our portfolio.
21. Risk of Potential Future Offerings. We may in the future increase
our capital resources by making additional offerings of Shares on terms
deemed advisable by our 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 our shareholders or the
reduction of the price of our Shares, or both. We are unable to estimate
the amount, timing or nature of additional offerings as they will depend
upon market conditions and other factors.
B. OPERATIONS RISKS
23. Economic Risks. The results of our operations are affected by
various factors, many of which are beyond our control. The results of our
operations depend on, among other things, the level of net interest income
generated by our Mortgage Investments, the market value of those Mortgage
Investments and the supply of and demand for those Mortgage Investments.
Our 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 affect our
activities, our operating results depend, in large part, upon our ability
effectively to manage our interest rate risks while maintaining our status
as a REIT. See "Risk Factors - Fluctuations in Interest Rates May Affect
Return on Investment".
24. 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 our 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 if we used money borrowed at variable
rates to fund fixed rate Mortgage Investments. In that event, if prevailing
interest rates rise, our cost of money could exceed the income we earned
from that money, thus reducing our profitability or causing losses through
liquidation of Mortgage Investments in order to repay the debt on the
borrowed money or default if we cannot cover the debt on the borrowed money.
25. Risk of Loss on Non-Insured, Non-Guaranteed Mortgage Loans. We
generally do not intend to obtain credit enhancements for our Mortgage
Investments, because the majority, if not all, of those 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 we hold Mortgage
Investments for which third party insurance is not obtained, we 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 Mortgage Investment held by us, including, without
limitation, defaults resulting from declining property values and worsening
economic conditions, we 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 us out of other funds until those loans are ultimately
liquidated, which could cause increased financing costs and reduced net
income or a net loss. See "Certain Legal Aspects of Mortgage Loans".
26. Bankruptcy Of Borrowers May Delay Or Prevent Recovery. The
recovery of money owed to us may be delayed or impaired by the operation of
the federal bankruptcy laws. Any borrower has the ability to delay a
foreclosure sale for a period ranging from a few months to several months 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 our
profitability. See "Certain Legal Aspects of Mortgage Loans".
27. Ability to Acquire Mortgage Investments; Competition and Supply.
In acquiring Mortgage Investments, we 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 we do. In
addition, there are mortgage REITs similar to us, 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 we have. 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 us. See also "Conflicts of Interest - Competition with
Affiliates for the Purchase and Sale of Mortgage Investments".
28. Environmental Liabilities. In the event that we are forced to
foreclose on a defaulted Mortgage Investment to recover our investment, we
may be subject to environmental liabilities in connection with that real
property which may cause its value to be diminished. While we intend 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 our
ownership or after a sale of that property to a third party. If those
hazardous substances are discovered on a property, we may be required to
remove those substances or sources and clean up the property. There can be
no assurances that we would not incur full recourse liability for the entire
cost of any removal and clean up, that the cost of that removal and clean up
would not exceed the value of the property or that we could recover any of
those costs from any third party. We may also be liable to tenants and
other users of neighboring properties. In addition, we 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".
29. Risk of Leverage. Subject to certain restrictions, including the
affirmative vote of the Independent Trustees, we would be allowed to incur
financing with respect to the acquisition of Mortgage Investments in an
aggregate amount not to exceed 50% of our Net Assets. 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 us to meet our
obligations and the greater the chance of default. That financing may be
secured by liens on our Mortgage Investments. Accordingly, we could lose
our Mortgage Investments if we default on the indebtedness. To the extent
possible, that debt will be of non-recourse type, meaning that we 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
30. Reliance On Appraisals Which May Not Be Accurate Or Which May Be
Affected By Subsequent Events. Since we are an "asset" rather than a
"credit" lender, we will rely primarily on the real property securing the
Mortgage Investments to protect our investment. Thus, we will rely on
appraisals and Broker Price Opinions ("BPO's"), to determine the fair market
value of real property used to secure the Mortgage Investments we purchase.
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, we may not be able to recover our entire investment.
31. Mortgages May Be Considered Usurious. Most, if not all, of the
Mortgage Investments we 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, we anticipate that we will
only purchase Mortgage Investments if they provide that the amount of the
interest charged thereon 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".
32. Risks of Bankruptcy of Mortgage Servicer. Our Residential
Mortgages and Contracts for Deed will be serviced by SCMI or by other
entities. We intend to obtain fidelity bonds and directors' and officers'
indemnity insurance to lower risks of liability from the actions of such
entities. However, there may be additional risks in the event of the
bankruptcy or insolvency of any of those entities or in the event of claims
by their creditors. Those additional risks which would not be present if we
were qualified in all instances to service our Residential Mortgages and
Contracts for Deed directly. For example, SCMI will, from time to time,
receive on our behalf, payments of principal, interest, prepayment premiums
and sales proceeds. In the event of bankruptcy or insolvency of SCMI, its
creditors could seek to attach those funds to pay of their claims against
SCMI. That could delay payment of those funds to us. If SCMI or any other
entities acting on our behalf hold these payments in segregated accounts as
they are contractually obligated to do, then the Advisor believes any such
claim should be resolved in our favor as the beneficial owner.
C. TAX RISKS
33. 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 that
investment. For a more detailed description of the tax consequences of an
investment in Shares. See "Federal Income Tax Considerations".
34. Risk of Inability to Qualify as a REIT. We were organized and
conduct our operations in a manner that we believe will enable us to be
taxed 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
we distribute to our shareholders, we must continually satisfy three income
tests, two asset tests and one distribution test. See "Federal Income Tax
Considerations - Qualification as a REIT". We have received an opinion of
our legal counsel that it is more likely than not that we will qualify as a
REIT. See "Risk Factors - Limitations on Opinion of Counsel as to Tax
Matters" and "Federal Income Tax Considerations - General".
If, in any taxable year, we fail to distribute at least 95% of our
taxable income, we would be taxed as a corporation and distributions to our
shareholders would not be deductible in computing our 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 our payment of amounts which do not
give rise to a current deduction (such as principal payments on
indebtedness) it is possible that we may not have sufficient cash or liquid
assets at a particular time to distribute 95% of our taxable income. In
that event, we could declare a consent dividend or we could be required to
borrow funds or liquidate a portion of our investments in order to pay our
expenses, make the required Distributions to shareholders, or satisfy our
tax liabilities, including the possible imposition of a 4 percent excise
tax. There can be no assurance that those funds will be available to the
extent, and at the time, required by us. In the event of any adjustment of
deductions of gross income by the IRS we could declare a deficiency
dividend. See "Federal Income Tax Considerations - Qualification as a REIT
- - Distributions to Shareholders".
If we were taxed as a corporation, our payment of tax 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 our qualification as a REIT, we might be required to borrow
additional funds or to liquidate certain of our investments in order to pay
the applicable tax. Moreover, should our election to be taxed as a REIT be
terminated or voluntarily revoked, we 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".
35. Restrictions on Maximum Share Ownership. In order for us 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 our taxable year. To ensure that we will not fail to qualify
as a REIT under this test, our Declaration of Trust grants the Trustees the
power to place restrictions on the accumulation of Shares. These
restrictions may (1) deter others from making tender offers for Shares,
which offers may be attractive to shareholders or (2) 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 "Risk Factors - Anti-Takeover Considerations and Restrictions
on Share Accumulation".
36. Limitations on Opinion of Counsel as to Tax Matters. As set forth
more fully in "Federal Income Tax Considerations - General", our attorneys
have expressed their opinion based on the facts described in our prospectus,
on the Declaration of Trust, and on certain representations by us and the
Advisor, that it is more likely than not (1) that we will qualify as a REIT;
and (2) that Distributions to a Shareholder which is a Tax-Exempt Entity
will not constitute unrelated business taxable income ("UBTI"), provided
that Shareholder has not financed the acquisition of its Shares with
"acquisition indebtedness" within the meaning of the Code. Our attorneys
have not given an opinion as to certain other issues because of the factual
nature of those issues or the lack of clear authority in the law.
Accordingly, there may be a risk that our treatment of certain tax items
could be challenged by the IRS and that we or our shareholders could be
adversely affected as a result. It should be noted, in any event, that our
attorneys' 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
37. Risks Of Investment By Tax-exempt Investors. If you are a plan
fiduciary 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), you
should consider the following items before deciding whether to purchase
Shares: (1) 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
you can sell or otherwise dispose of the Shares; (iii) whether interests in
us or the underlying assets owned by us 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 us 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 the Shares and the appreciation of any property may not be shown
in the value of the Shares until we sell or otherwise dispose of our
investments. See "ERISA Considerations".
FEDERAL INCOME TAX CONSIDERATIONS
The following discussion summarizes material Federal income tax
considerations to us and our shareholders. 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 shareholder 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
We elected to become subject to tax as a REIT, for Federal income tax
purposes, commencing with the taxable year ending December 31, 1996. Our
Board of Trustees currently expects that we will operate in a manner that
will permit us to qualify a REIT for the taxable year ending December 31,
1999, and in each taxable year thereafter. This treatment will permit us to
deduct dividend distributions to our 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.
We have 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) we have been organized in conformity with the requirements
for qualification as a REIT, and our method of operation described herein
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 we make the
necessary election; and (ii) Distributions to a shareholder which is a Tax-
Exempt Entity will not constitute UBTI, provided that shareholder has not
financed the acquisition of its Shares with "acquisition indebtedness"
within the meaning of the Code. In rendering this opinion, Counsel relied
upon information and undertakings supplied by the Advisor and us, and the
facts contained in our prospectus concerning our organization and operation.
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. We do
not intend to apply for a ruling from the IRS that we qualify 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, our income that is distributed to our
shareholders will be taxed to those shareholders without being subject to
tax at the company level. We will be taxed on any of our income that is not
distributed to our shareholders. Once made, the REIT election continues in
effect until voluntarily revoked or automatically terminated by our failure
to qualify as a REIT for a taxable year. If our election to be treated as a
REIT is terminated automatically, we will not be eligible to elect REIT
status until the fifth taxable year after the year for which our election
was terminated. However, this prohibition on a subsequent election to be
taxed as a REIT is not applicable if (1) we did not willfully fail to file a
timely return with respect to the termination taxable year, (2) inclusion of
incorrect information in that return was not due to fraud with intent to
evade tax, and (3) we establish that failure to meet the requirements was
due to reasonable cause and not to willful neglect. While we have no
intention of voluntarily revoking our REIT election, if we do so, we will be
prohibited from electing REIT status for the year to which that revocation
relates and for the next four taxable years.
There can be no assurance, however, that we 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 our circumstances. If we were not
to qualify as a REIT in any particular year, we would be subject to Federal
income tax as a regular, domestic corporation, and our stockholders would be
subject to tax in the same manner as stockholders of a corporation. In this
event, we could be subject to potentially substantial income tax liability
in respect of each taxable year that we fail to qualify as a REIT, and the
amount of earnings and cash available for distribution to our stockholders
could be significantly reduced or eliminated.
The following is brief summary of certain technical requirements that
we must meet on an ongoing basis in order to qualify, and remain qualified,
as a REIT under the Code.
SHARE OWNERSHIP TESTS. Our Shares (1) must be transferable, (2) 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 (3) 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 our taxable year. The requirements of (2) and (3) are not
applicable to the first taxable year for which an election to be treated as
a REIT is made. On the date of the initial closing of the sale of the
Shares, we had at least 100 shareholders who were independent of each other
and of us. In addition, the Declaration of Trust permits a restriction on
transfers of Shares that would result in violation of the rule in (3) above.
Applicable Treasury Regulations state that such a restriction will not cause
the shares to be nontransferable as required by (i).
ASSET TESTS. We 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 our 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 us but not taken into account for
purposes of the 75% Asset Test must not exceed (i) 5% of the value of
our 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. We must generally meet the following gross income
tests (the "REIT Gross Income Tests") for each taxable year.
(a) at least 75% of our 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 our 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 our 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").
We intend to maintain our REIT status by carefully monitoring our
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, we must distribute to our
shareholders an amount equal to (a) 95% of the sum of (i) our 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 non-cash 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 (1) paid during the taxable year or (2)
declared before our tax return for the taxable year must be filed (including
extensions) and paid within 12 months of the end of that taxable year and no
later than our next regular distribution payment, are considered
distributions for purposes of the 95% Distribution Test. Those dividends
are taxable to our shareholders (other than Tax-Exempt Entities) in the
years in which they are paid, even though they reduce our 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 us to
distribute our fourth quarter dividend in each year on or before January
31st of the following year.
The Trustees intend to make Distributions to our shareholders on a
monthly basis sufficient to meet the 95% Distribution Test. Because of (1)
the possible receipt of income from certain sources without corresponding
cash receipts, (2) 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 (3) possible adjustments by the IRS to deductions and
gross income reported by us, it is possible that we may not have sufficient
cash or liquid assets at a particular time to distribute 95% of our REIT
Taxable Income. In that event, we may attempt to declare a consent
dividend, which is a hypothetical distribution to shareholders out of our
earnings and profits. The effect of such a consent dividend, to those
shareholders who agree to that treatment, and as long as that consent
dividend is not preferential, would be that those shareholders would be
treated for federal income tax purposes as if that amount had been paid to
them in cash and they had then immediately contributed that amount back to
us 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 we fail to meet the 95% Distribution Test due to an adjustment to
our income by reason of a judicial decision or by agreement with the IRS, we
may pay a "deficiency dividend" to shareholders in the taxable year of the
adjustment, which would relate back to the year being adjusted. In that
case, we 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 that test was not due to a later adjustment to
our income but rather was attributable to our failure to distribute
sufficient amounts to our shareholders. If we cannot declare a consent
dividend or if we lack sufficient cash to distribute 95% of our REIT Taxable
Income or to pay a "deficiency dividend" in appropriate circumstances, we
could be required to borrow funds or liquidate a portion of our investments
in order to pay our expenses, make the required cash distributions to
shareholders, or satisfy our tax liabilities. There can be no assurance
that those funds will be available to the extent, and at the time, that we
would require them.
In addition, if the IRS successfully challenged our deduction of all or
a portion of the fees we pay to the Advisor, those payments could be
recharacterized as dividend distributions to the Advisor in its capacity as
shareholder. If those 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 those fees.
TERMINATION OF THE COMPANY
In any year in which we qualify as a REIT, we will generally not be
subject to Federal income tax on that portion of our REIT taxable income or
capital gain which is distributed to our shareholders. We will, however, be
subject to Federal income tax at normal corporate income tax rates upon any
undistributed taxable income or capital gain.
Notwithstanding our qualification as a REIT, we may also be subject to
tax in certain other circumstances. If we fail to satisfy either the 75% or
the 95% Gross Income Test, but nonetheless maintain our qualification as a
REIT because certain other requirements are met, we will generally be
subject to a 100% tax on the greater of the amount by which we fail either
the 75% or the 95% Gross Income Test. We will also be subject to a tax of
100% on net income derived from any "prohibited transaction", and if we have
(1) 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 (2) other non-qualifying income from foreclosure property, we
will be subject to Federal income tax on that income at the highest
corporate income tax rate. In addition, if we fail to distribute during
each calendar year at least the sum of (1) 85% of our REIT ordinary income
for that year and (2) 95% of our REIT capital gain net income for that year,
we would be subject to a 4% Federal excise tax on the excess of tnat
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. We 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 we pay to our shareholders will be
taxable to shareholders who are not Tax-Exempt Entities as ordinary income
to the extent of our current or accumulated earnings and profits.
Distributions we pay which are designated as capital gains dividends by us
will be taxed as long-term capital gains to taxable shareholders to the
extent that they do not exceed our 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. Those
distributions, whether characterized as ordinary income or as capital gain,
are not eligible for the 70% dividends received deduction for corporations.
Distributions we pay to shareholders which are not designated as
capital gains dividends and which are in excess of our 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 shareholder that is not a Tax-Exempt Entity as a gain realized from the
sale of the Shares.
Our declaration 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. That 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 that
shareholder. Those 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 of our net losses.
SALE OF SHARES. Shareholders who sell their Shares will recognize
taxable gain or loss equal to the difference between the amount realized on
that sale and their basis in those 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 will ordinarily not be subject to
withholding of federal income taxes. Withholding of that tax at a rate of
31% may be required, however, by reason of a failure of a shareholder to
supply us or our agent with the shareholder's Taxpayer Identification
Number. That "Backup" withholding may also apply to a shareholder who is
otherwise exempt from backup withholding if that 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 that is a Tax-Exempt Entity will not be
subject to tax on Distributions received from us. 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 we incur indebtedness in connection with the acquisition of real property
or the acquisition or making of a Mortgage Investment, provided that the
Tax-Exempt Entity has not financed the acquisition of its Shares.
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 Shares 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 Shares. 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 that 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 rule applies to taxable years beginning in 1994 only if (1)
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
(2) 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 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 (1) we
expect the Shares to be widely held, and (2) the Declaration of Trust
prohibits any shareholder from owning more than 9.8 percent of the Shares
entitled to vote, this provision should not result in UBTI to any Tax-Exempt
Entity.
STATEMENT OF STOCK OWNERSHIP
We are required to demand annual written statements from the record
holders of designated percentages of our Shares disclosing the actual owners
of the Shares. We must also maintain, within the Internal Revenue District
in which we are required to file our federal income tax return, permanent
records showing the information we have received regarding the actual
ownership of those Shares and a list of those persons failing or refusing to
comply with those demands.
STATE AND LOCAL TAXES
Our tax treatment and the tax treatment of our shareholders in states
having taxing jurisdiction over them may differ from the federal income tax
treatment. Accordingly, no discussion of state taxation is provided herein
nor is any representation made as to our tax status or the tax status of the
Shares or shareholders in those states. Each shareholder should consult his
own tax advisor as to the status of the Shares under the 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 (1) whether the
investment is in accordance with the documents and instruments governing the
Qualified Plan; (2) 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; (3) the need to
value the assets of the Qualified Plan annually; and (4) the effect if our
assets are treated as "plan assets" following that 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, we have received an
opinion of Berry Moorman P.C. ("Counsel") that, under current law (and
subject to certain reservations and requirements set forth therein), it is
more likely than not that our assets will not be deemed to be "plan assets"
if Qualified Plans invest in Shares. In the event that our assets are
nevertheless deemed to be plan assets under ERISA despite that 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 of our 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 us which do not conform to those 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 us and the Trustees and the Advisor or any of their Affiliates could
constitute "prohibited transactions" under ERISA and the Code. In that
event, certain of the parties involved in the transaction could be required
to take any or all of the following actions: (1) undo the transaction, (2)
restore to the Qualified Plan any profit realized on the transaction, (3)
make good to the Qualified Plan any loss suffered by it as a result of that
transaction, and (4) 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 that 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, we
will not permit the purchase of Shares with assets of any Qualified Plan
(including an IRA) if we, the Sponsor, the Advisor or any of their
Affiliates (1) has investment discretion with respect to the assets of the
Qualified Plan to be invested, (2) regularly gives individualized investment
advice which serves as the primary basis for the investment decisions made
with respect to those assets, or (3) is otherwise a fiduciary with respect
to the assets for purposes of the prohibited transaction provisions of ERISA
or the Code.
PLAN ASSETS REGULATION/OPINION OF COUNSEL
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 that 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 that term
is used in the Final Regulation), or (3) equity participation by benefit
plan investors is "not significant" (as that term is used in the Final
Regulation).
The Final Regulation provides that a "publicly offered security" is a
security that is (1) freely transferable, (2) part of a class of securities
that is owned by 100 or more investors independent of the issuer and of one
another, and (3) 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 that 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 those securities to the public occurred. The initial closing
for the sale of Shares did not take place until a minimum of 100 investors
independent of us and of each other subscribed for Shares and condition (3)
in the preceding sentences was met with respect to the Shares.
Our underlying assets 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 those 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.
We have 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 our underlying assets 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 that Qualified
Plan as of the end of that Plan's fiscal year and to file annual reports
reflecting that 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 we may, but need not, make available to fiduciaries of Qualified Plans
an annual good faith estimate of the value of our 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 we do provide this
estimate, (1) that value could or will actually be realized by us 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
of our assets), (2) shareholders could realize that value if they were to
attempt to sell their Shares, or (3) that value would comply with the ERISA
or IRA requirements described above.
GLOSSARY
The definitions of terms used in this Annual Report are set forth below.
"Acquisition Expenses" shall mean expenses related to our 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 Residential Mortgages or Contracts for Deed by us. Included
in the computation of those 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", used in calculating the Subordinated
Incentive Fee, shall mean (1) the product of $20 times the number of
outstanding Shares, reduced by (2) 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.
"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 our 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 those functions. Initially the Advisor shall be Mortgage Trust
Advisors, Inc., or anyone which succeeds it in that capacity.
"Advisory Agreement" shall mean the agreement between the Advisor and
us whereby pursuant the Advisor will act as our investment advisor.
"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.
"Affiliated Programs" shall mean any and all REITs, partnerships or
other entities which may in the future be formed by the Advisor, a Sponsor
or their Affiliates to engage in businesses which may be competitive with us
and which have similar investment objectives as we do (or programs with
dissimilar objectives for which a particular Mortgage Investment may
nevertheless be suitable). An Affiliated Program may have the same
management as we do.
"Average Invested Assets" shall mean the average of the aggregate book
value of our assets 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 those values at
the end of each month during that period.
"Capital Distributions" shall mean Distributions of: (1) non-reinvested
principal payments and (2) Proceeds of Mortgage Prepayments, Sales and
Insurance.
"Cash Flow" shall mean, with respect to any period, (a) all cash
receipts derived from payments of principal and base interest on Mortgages
held by us (exclusive of any Proceeds of Mortgage Prepayments, Sales and
Insurance) plus (b) cash receipts from operations (including any interest
from our temporary investments) without deduction for depreciation or
amortization, less (c) cash receipts used to pay operating expenses.
"Code" shall mean the Internal Revenue Code of 1986, as amended, or
corresponding provisions of subsequent revenue laws.
"Contract for Deed" refers to the Seller's unencumbered interest in
contracts for deed (also known as land contracts) for the purchase of
single-family residential property throughout the United States in which we
will invest.
"Counsel" shall mean Berry Moorman P.C.
"CRC" shall mean Capital Reserve Corporation, a Texas corporation that
is 50% owned by Todd Etter, a principal shareholder of the Advisor. CRC is
engaged in the business of financing home purchase and renovations.
"Declaration of Trust" shall mean our Declaration of Trust, 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 us with respect to Mortgage Investments and other Mortgages.
"Distributions" shall mean any cash distributed to shareholders arising
from their interest in the Shares.
"Escrow Agent" shall mean Chase Bank of Texas, NA or any other
qualified financial institution designated by us and the Selling Group
Managers as escrow agent.
"First Financial" means First Financial United Investment Ltd., L.L.P.,
one of the Selling Group Managers.
"Gross Offering Proceeds" shall mean the total proceeds from the sale
of Shares during the offering period before deductions for Organization and
Offering Expenses. For purposes of calculating Gross Offering Proceeds, the
purchase price of all Shares shall be deemed to be $20 per Share.
"IMS Securities" refers to IMS Securities, Inc., one of the Selling
Group Managers.
"Independent Trustees" shall mean the Trustees who (1) 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,
(2) do not serve as a director or Trustee of more than two other REITs
organized by a Sponsor or advised by the Advisor and (3) perform no other
services for us, 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 us.
"Institutional Investors" shall mean a bank, trust company, savings
institution, insurance company, securities dealer, investment company or
business development company as defined in the Investment Company Act of
1940, or a pension or profit sharing trust with assets of at least
$5,000,000.
"Interim Closing" refers to the closings of the sale of Shares that are
anticipated to be held on the first and fifteenth of each month (or the next
business day). All Subscriber's funds will be deposited into the escrow
account maintained by the Escrow Agent and will be disbursed by the Escrow
Agent to us and the Selling Group Managers at the next Interim Closing.
"Interim Mortgages" shall mean loans of 12 months or less in term, made
to investors for the purchase, renovation and sale of single-family homes.
"Investment-to-Value Ratio" means the amount paid by us to purchase a
Mortgage Investment divided by the value of the real estate that is the
security for that Mortgage Investment.
"Mortgage Investments" shall mean our investments in Residential
Mortgages, Contracts for Deed and Interim Mortgages.
"Mortgage Prepayments, Sales or Insurance" shall mean any transaction
by us (other than the receipt of base interest, principal payments when due
on a Mortgage Investment and the issuance of Shares) including without
limitation prepayments, sales, exchanges, foreclosures, or other
dispositions of Mortgage Investments held by us or the receipt of insurance
proceeds or of guarantee proceeds from any insurer or recoursing party or
otherwise, or any other disposition of our 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 our qualification as a
REIT (e.g. regular interests in real estate mortgage investment conduits
("REMICs")).
"Net Assets" or "Net Asset Value" shall mean our total assets (other
than intangibles) valued at cost before deducting depreciation or other non-
cash reserves less our total liabilities. The Net Asset Value shall be
calculated at least quarterly on a basis consistently applied.
"Net Income" shall mean, for any period, total revenues applicable to
that period, less the expenses applicable to that 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 our
Mortgage Investments or other assets.
"Net Offering Proceeds" shall mean the Gross Offering Proceeds received
by us with respect to the sale of Shares less Organization and Offering
Expenses.
"Organization and Offering Expenses" shall mean all expenses incurred
by and to be paid from our assets in connection with and in preparing
ourselves for registration and subsequently offering and distributing the
Shares to the public, including, but not limited to, total underwriting and
brokerage discounts and commissions (including fees of the underwriters'
attorneys), expenses for printing, engraving, mailing, salaries of employees
while engaged in sales activity, charges of transfer agents, registrars,
trustees, escrow holders, depositaries, experts, expenses of qualification
of the sale of the securities under Federal and State laws, including taxes
and fees, accountants' and attorneys' fees. For the purposes of determining
"Organization and Offering Expenses", any volume discounts that are given by
the Selling Group Managers shall be deemed to be part of the selling
commissions paid to brokers for selling the Shares.
"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 those Mortgage Prepayments, Sales or Insurance; and
(ii) the amount necessary for the payment of all of our debts and
obligations 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.
"Qualified Plan" shall mean any qualified pension, profit sharing or
other retirement plan (including a Keogh plan) and any trust, bank
commingled trust fund for such a plan and any IRA.
"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, (1) without the deductions allowed by
sections 241 through 247, 249 and 250 of the Code (relating generally to the
deduction for dividends received); (2) excluding amounts equal to (a) the
net income from foreclosure property, and (b) the net income derived form
prohibited transactions; (3) 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 (4) disregarding the dividends paid, computed without
regard to the amount of the net income from foreclosure property which is
excluded from REIT Taxable Income.
"Residential Mortgage" shall mean the first lien, fixed rate mortgages
secured by single-family residential property throughout the Unites States
that we will invest in.
"Roll-Up" shall mean a transaction involving the acquisition, merger,
commission or consolidation either directly or indirectly of us and the
issuance of securities of a Roll-Up Entity. That term does not include:
(i) a transaction involving our securities of that have been for at
least 12 months listed on a national securities exchange or traded
through the National Association of Securities Dealers Automated
Quotation Market System; or
(ii) a transaction involving the conversion to corporate, trust or
association form of only ourselves, if as a consequence of the
transaction, there will be no significant adverse change in any of the
following:
(A) shareholders' voting rights;
(B) our term and existence;
(C) Sponsor or Advisor compensation; or
(D) our investment objectives.
"Roll-Up Entity" shall mean a partnership, real estate investment
trust, corporation, trust or other entity that would be created or would
survive after the successful completion of a proposed Roll-Up transaction.
"Selling Group Managers" shall mean First Financial and IMS Securities,
the Selling Group Managers of the public offering of the Shares. First
Financial has been a Selling Group Manager since the commencement of the
sale of the Shares. IMS Securities became a Selling Group Manager in
November, 1999.
"Shares" shall mean our shares of beneficial interest.
"Selected Dealers" shall mean the dealer members of the National
Association of Securities Dealers, Inc. that are designated by the Selling
Group Managers to participate in the sale of the Shares.
"Sponsor" shall mean any person directly or indirectly instrumental in
organizing us, wholly or in part, or any Person who will control, manage or
participate in our management and any Affiliate of such Person, but does not
include (1) any person whose only relationship with us is that of an
independent asset manager whose only compensation from us is as such, and
(2) wholly-independent third parties such as attorneys, accountants, and
underwriters whose only compensation from us is for professional services.
A Person may also be deemed one of our Sponsors by: (1) taking the
initiative, directly or indirectly, in founding or organizing our business
or enterprise, either alone or in conjunction with one or more other
Persons; (2) receiving a material participation in us in connection with the
founding or organizing of our business, in consideration of the services or
property, or both services and property; (3) having a substantial number of
relationships and contacts with us; (4) possessing significant rights to
control our Company properties; (5) receiving fees for providing services to
us which are paid on a basis that is not customary in the industry; or (6)
providing goods or services to us on a basis which was not negotiated at
arms length with us.
"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 our Net Income for a year exceeds a 10%
per annum non-compounded cumulative return on our 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".
"Tax-Exempt Entities" shall mean any investor that is exempt from
federal income taxation, including without limitation a Qualified Plan, an
endowment fund, or a charitable, religious, scientific or educational
organization.
"Total Operating Expenses" shall mean all of our operating, general,
and administrative expenses 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 Investment by us, such as expenses for originating, acquiring,
servicing or disposing of a Mortgage.
"Trustees" shall mean our trustees.
"UBTI" shall mean unrelated business taxable income as described in the
Code.
ITEM 2. DESCRIPTION OF PROPERTY.
OFFICE LEASE
We entered into a lease agreement with Todd Etter, an affiliate, with
a term of 36 months commencing January 15, 2000 at a monthly rent of
$5,409. We further entered into a sub-lease agreement with South Central
Mortgage, Inc. wherein they are subleasing approximately 2,500 square feet
of lease space from us with the same term at a rate of $4,668 per month.
The sub-lease rental rate is approximately 5% higher than the amount paid
by us to the affiliate.
MORTGAGE INVESTMENTS
Our primary investment policy is to purchase Mortgage Investments
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 homebuyers. 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. We acquire
what we consider 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. We attempt to reduce the rate and expense of early payment
defaults through the adherence to investment policies that require any
person who sells us a note with a payment history of less than 12 months to
replace or repurchase any non-performing note and reimburse us for any
interest, escrows, foreclosure, eviction, and property maintenance costs. In
addition to investing in residential mortgages and contracts for deed, we
will also temporarily invest funds in Interim Mortgages 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
our investment policies, see "Investment Objectives and Policies" contained
in Item 1 of this Form 10-KSB.
Mortgage Investments at Year End
The following table sets forth certain information about our portfolio of
Mortgage Investments in the aggregate as of December 31, 1999 and 1998, net of
investments that had paid off.
<TABLE>
<CAPTION>
December 31,
1999 1998
<S> <C> <C>
Residential Mortgages
Number 367 243
Interest rate 11.41% 11.46%
Principal balance (1) $16,162,168 $10,276,000
Remaining term (1) 336 Months 326 Months
Current yield (1) 11.98% 12.14%
Investment-to-value ratio (1)(2) 83.40% 83.50%
Contracts for Deed
Number 134 30
Interest rate 11.81% 11.49%
Principal balance (1) $5,990,673 $1,281,000
Remaining term (1) 355 Months 348 Months
Current yield (1) 12.00% 11.71%
Investment-to-value ratio (1)(2) 88.20% 89.30%
Interim Mortgages
Number 100 102
Interest rate 12.87% 12.78%
Principal balance (1) $4,199,632 $3,285,000
Remaining term (1) 6.62 Months 10.8 Months
Current yield (1) 13.05% 13.04%
Investment-to-value ratio (1)(2) 53% 50%
<FN>
(1) These amounts were determined at the time the Mortgage Investments were
purchased.
(2) The investment-to-value ratio is determined at the time a Mortgage
Investment is bought and is determined by dividing the amount paid to buy
that Mortgage Investment by the value of the underlying real estate that is
security for that Mortgage Investment.
</FN>
</TABLE>
Defaults
Residential Mortgage and Contracts for Deed which have less than a 12
month payment history and/or less than 85% loan-to-value ratio when
purchased by us are required to have seller recourse through the twelfth
payment. Those seller recourse agreements require the seller to replace or
repurchase any non-performing note and reimburse us for any interest,
escrows, foreclosure, eviction, and property maintenance costs. A loan is
considerd non-performing if any portion of the principal, interest, or
escrow payment is 30 days past due. SCMI, as seller, has the further option
of either assigning and transferring to us a replacement note or funding on
a month-to-month basis lost interest, tax, and insurance escrow payments. No
seasoning is required for Interim Mortgages.
Under the terms of our agreement, SCMI elected to fund on a month-to-
month basis loans that were non-performing and covered by a recourse
agreement. During 1999 we remarketed 30 properties securing non-performing
loans resulting in a gain of $29,358. As of December 31, 1999 we had 29 non-
performing loans, representing 4.5% of our portfolio. Of the 29, twenty are
covered under a recourse agreement. As of December 31, 1999 two hundred
fifty-one of our 601 Mortgage Investments were covered under a recourse
agreement. No provision for loan losses was provided as of year-end because
we experienced a gain in remarketing the properties associated with non-
performing loans. We intend to continue monitoring potential losses related
to non-recoursed properties and, if deemed material, to reserve for
anticipated losses in the fiscal year ending December 31, 2000.
By comparison, as of December 31, 1998 we had 11 Mortgage Investments
(representing 2.9% of our total portfolio) that were in default. The
recourse provisions under which they were purchased covered all of those
Mortgage Investments. As a result of the recourse provisions, we did not
experience a loss of interest income because of the defaults.
Geographic Location
All of the properties that are security for the Residential Mortgages
and Interim Mortgages are located in Texas. Each of the properties is
adequately covered by a mortgagees 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 our shareholders during the fourth
fiscal quarter.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Market
There is currently no established trading market for our Shares.
Although we intend to seek to have our Shares listed on NASDAQ or an
exchange after the sale of all of the Shares offered in our public offering,
there can be no assurance that those efforts will be successful or that an
established trading market for the Shares will develop.
Shareholders
As of December 31, 1999, we had 1,185,544 shares outstanding, held by
635 beneficial owners of 445 shareholders of record, as compared to the same
period in 1998, when we had 734,271 Shares outstanding, held by 434
beneficial owners or 337 shareholders of record.
Dividends
We intend to continue to reinvest our Disposition Proceeds except to
the extent they represent capital gains on loans purchased at a discount.
We intend to distribute substantially all of our taxable income with respect
to each year (which does not ordinarily equal net income as calculated in
accordance with GAAP) to our shareholders so as to comply with the REIT
provisions of the Code. To the extent we have funds available, we 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 us at the discretion of the Board of Trustees
and will depend on the our taxable earnings, our financial condition,
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 those Distributions may be designated
by us as capital gain or may constitute a tax-free return of capital. We do
not intend to declare dividends that would result in a return of capital.
Any Distribution to Shareholders of income or capital assets from us 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, we will annually furnish to each of our stockholders a
statement setting forth Distributions paid during the preceding year and
their characterization as ordinary income, capital gains, or return of
capital.
We began making distributions to our shareholders on September 29, 1997.
Monthly distributions have continued each month thereafter. Distributions for
the year ended December 31, 1999 and December 31, 1998 resulted in an
annualized rate of return for Shareholders of 10.1% and 10.3% respectively.
The following table shows the dividends per Share that have been paid by
us since that date.
<TABLE>
<CAPTION>
Month Dividend Annual Rate
Per Share of Return
<S> <C> <C>
September 1997 $ 0.1688 10.13%
October 1997 $ 0.1791 10.75%
November 1997 $ 0.1667 10.00%
December 1997 $ 0.1667 10.00%
January 1998 $ 0.1669 10.01%
February 1998 $ 0.1668 10.01%
March 1998 $ 0.1750 10.50%
April 1998 $ 0.1850 11.10%
May 1998 $ 0.1750 10.50%
June 1998 $ 0.1780 10.68%
July 1998 $ 0.1667 10.00%
August 1998 $ 0.1667 10.00%
September 1998 $ 0.1667 10.00%
October 1998 $ 0.1690 10.14%
November 1998 $ 0.1690 10.14%
December 1998 $ 0.1680 10.08%
January 1999 $ 0.1680 10.08%
February 1999 $ 0.1680 10.08%
March 1999 $ 0.1680 10.08%
April 1999 $ 0.1680 10.08%
May 1999 $ 0.1680 10.08%
June 1999 $ 0.1680 10.08%
July 1999 $ 0.1680 10.08%
August 1999 $ 0.1680 10.08%
September 1999 $ 0.1680 10.08%
October 1999 $ 0.1680 10.08%
November 1999 $ 0.1680 10.08%
December 1999 $ 0.1680 10.08%
</TABLE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION OF THE
COMPANY
The following table sets forth certain information about the Mortgage
Investments that we purchased during the periods set forth below.
<TABLE>
<CAPTION>
Years Ended
December 31,
1999 1998
Residential Mortgages
<S> <C> <C>
Residential Mortgages
Purchase Price $6,965,000 $7,087,000
Total Number 151 171
Number Purchased From Affiliates 104 125
Number Purchased From Other Sources 47 46
Interest Rate 11.34% 11.48%
Unpaid Principal Balance (1) $7,196,000 $7,452,000
Average Principal Balance (1) $46,100 $43,600
Remaining Term (1) 350 months 333 months
Current Yield (1) 11.80% 12.12%
Purchase Price/Principal Balance (1) 96.78% 95.10%
Investment-to-Value Ratio (1)(2) 84.8% 83.61%
Contracts for Deed
Purchase Price $5,120,000 $1,257,000
Total Number 116 30
Number Purchased From Affiliates 36 7
Number Purchased From Other Sources 80 23
Interest Rate 11.90% 11.49%
Unpaid Principal Balance (1) $5,188,000 $1,281,000
Average Principal Balance (1) $44,700 $42,700
Remaining Term (1) 356 348
Current Yield (1) 12.06% 11.71%
Purchase Price/ Principal Balance (1) 98.70% 98.12%
Investment to Value Ratio (1)(2) 88.30% 89.34%
Interim Mortgages
Purchase Price $8,449,544 $6,755,077
Loan Balance at year end $4,199,632 $3,285,000
Total Number Participated In 300 227
Balance at Year End 100 102
Number Purchased From Affiliates 299 227
Number Purchased From Other Sources 1 0
Interest Rate at year-end 12.87% 12.78%
Remaining Term (1) 6.62 Months 10.8 Months
Current Yield at year-end(1) 13.05% 13.04%
Purchase Price/Principal Balance (1) 100% 100%
Investment to Value Ratio (1)(2) 53% 46%
<FN>
(1) These amounts were determined at the time the Mortgage Investments were
purchased.
(2) The investment-to-value ratio is determined at the time a Mortgage
Investment is acquired and is determined by dividing the amount paid to
acquire that Mortgage Investment by the value of the underlying real estate
that is security for that Mortgage Investment.
</FN>
</TABLE>
For information about the Mortgage Investments that we held as of December 31,
1999 and 1998, see Item 2 - DESCRIPTION OF PROPERTY.
RESULTS OF OPERATIONS - THE YEARS ENDED DECEMBER 31, 1999 AND 1998
We were formed on July 12, 1996, however our business operations
commenced in March 1997 when the Securities and Exchange Commission issued
our order of registration for our initial public offering of Shares. The
statements contained in this Form 10-KSB that are not purely historical are
forward looking statements, including statements regarding our expectations,
hopes, beliefs, intentions or strategies regarding the future. Among the
factors that could cause actual results to differ materially are the factors
set forth in Item 1 above under the heading "Risk Factors".
As of December 31, 1999 our mortgage portfolio in the aggregate
consisted of 367 Residential Mortgages and 134 Contracts for Deed and 100
Interim Mortgages. The carrying value of the portfolio was $26.1 million.
Four hundred thirty-four of the Mortgage Investments were purchased from
affiliates and two hundred six were purchased from unaffiliated third
parties. The average Mortgage Investment in the portfolio had an interest
rate of approximately 11.7% and a current annual yield of approximately
12.2%, and a loan-to-value ratio of 79.1% (the unpaid principal balance of
the Mortgage Investment divided by the value of the real estate that is the
security for that Mortgage Investment.)
By comparison as of December 31, 1998, our mortgage portfolio in the
aggregate consisted of 243 Residential Mortgages and 30 Contracts for Deed
and 102 Interim Mortgages. The carrying value was $14.4 million. Two hundred
thirty-four of the Mortgage Investments were purchased from affiliates and
69 were purchased from unaffiliated third parties. The average Mortgage
Investment in the portfolio had an interest rate of approximately 11.8% and
a current annual yield of approximately 11.9%, and a loan-to-value ratio of
73.6% (the unpaid principal balance of the Mortgage Investment divided by
the value of the real estate that is the security for that Mortgage
Investment.)
Our Mortgage Investments generated $2,502,504 and $1,131,154 of total
income in 1999 and 1998, respectively. The increase in income in 1999 was
attributed to the significant increase in Mortgage Investments we purchased
during the year. Expenses of $695,004 in 1999 were offset by reimbursement
from the Advisor of $169,426 resulting in net income of $1,976,926. By
comparison, expenses of $314,901 in 1998 were offset by reimbursement from
the Advisor to us of $200,282 that included a reimbursement of approximately
$50,000 from the prior twelve-month period. Overhead expense reimbursement
from our Advisor commenced when we entered into a Funding Agreement that
provides that the Advisor will fund all of our general and administrative
expenses. In turn, we 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 our Average Invested Assets for the immediately preceding
month. Our total contributions to the Advisor shall not exceed the lesser of
(a) the total of general and administrative expenses funded by the Advisor,
or (b) an amount equal to the maximum allowable Total Operating Expenses
under the Declaration of Trust. The increase in expenses in 1999 was
attributed to a 721% increase in interest expense from our larger line of
credit, which increased to $5 million at the end of 1999 from $1.4 million
at the end of 1998. Salaries and Wages grew by 37% in 1999 compared to 1998
due do hiring one employee and an increase in the president's wages. General
and administrative expenses grew by 20% over 1998 due primarily to a 72%
increase in printing and a 100% increase in appraisal fees. Earnings per
share were $2.08 and $2.12 for 1999 and 1998, respectively.
As part of our agreement to acquire notes from SCMI, SCMI agrees to
repurchase, at no loss to us, any note that is in default any time during
twelve months from our date of purchase. SCMI may satisfy its repurchase
requirement to us by either assigning to us a replacement note or by
funding to us lost interest, tax and insurance escrow payments, as well as
any costs incurred by us related to curing the default. At year-end
approximately one-half of our portfolio consisted of notes with recourse
agreements. We began the year with 9 defaulted loans, had an additional 40
default (12 were not covered by a recourse agreement), resold 20 and ended
the year with 29 defaulted loans. The resold properties resulted in a gain
in 1999. Of the 29 properties vacant at year-end 20 are covered under a
recourse agreement. The potential loss of interest on the remaining 9 is
approximately $427 per month for every month that the property is defaulted
plus foreclosure, repair and remarketing expenses less any amount in excess
of the loan balance realized from a sale of the property. Of the Company's
properties that have been resold, the average length of default is 5.6
months. Potential loss of interest per property would then be approximately
$2,400 if we fail to recover interest upon the resale of a defaulted loan.
During the year ended December 31, 1999, we paid total dividends of
$2.02 per share as compared to $2.05 per share during 1998.
CAPITAL RESOURCES AND LIQUIDITY
We utilize funds available from the sale of Shares, funds available
from our bank line of credit, and return of principal to purchase Mortgage
Investments. During 1999 we sold 451,273 Shares resulting in Gross Offering
Proceeds of $9,025,460 and Net Offering Proceeds (after the deduction of
selling commissions and fees) of $8,076,896 (89.5% of gross proceeds). This
compares to 1998 when we sold 531,763 Shares resulting in Gross Offering
Proceeds of $10,635,260 and Net Offering Proceeds (after the deduction of
selling commissions and fees) of $9,512,292 (89.4% of gross proceeds).
As of December 31, 1999 our aggregate sales were a total of 1,175,544
Shares for Gross Offering Proceeds of $23,534,019 and Net Offering Proceeds
to us (after the deduction of selling commissions and fees) of $21,059,077
(89.6% of gross proceeds). By comparison, as of December 31, 1998, our
aggregate sale totaled 724,271 Shares for Gross Offering Proceeds of
$14,485,420 and Net Offering Proceeds to us (after the deduction of selling
commissions and fees) of $12,982,181 (89.6% of gross proceeds). Total Shares
outstanding for the periods were 1,185,544 and 734,271, respectively, which
included the 10,000 initial shares acquired by our Advisor before the public
offering commenced.
On March 23, 1999 we renewed and increased our Revolving Loan Agreement
(the "Loan Agreement") with our lending bank wherein we can borrow up to
$5,000,000 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 and one-half percent (1-
1/2%) in excess of that bank's prime rate of interest. The outstanding
balance of the line of credit at December 31, 1999 was $5,000,000. We use
the line of credit to purchase Mortgage Investments prior to the receipt of
funds from the next Interim Closing of the sale of Shares.
<PAGE>
ITEM 7. FINANCIAL STATEMENTS.
UNITED MORTGAGE TRUST
INDEX TO FINANCIAL STATEMENTS
Page
Independent Auditors' Report 56
Balance Sheets as of December 31, 1999 and 1998 57
Statements of Income
Year Ended December 31, 1999 and 1998 58
Statements of Changes in Shareholders' Equity
Year Ended December 31, 1999 and 1998 59
Statements of Cash Flows
Year Ended December 31, 1999 and 1998 60
Notes to Financial Statements 61
<PAGE>
INDEPENDENT AUDITORS' REPORT
Board of Trustees
United Mortgage Trust
We have audited the accompanying balance sheets of United
Mortgage Trust as of December 31, 1999 and 1998, and the related
statements of income, changes in shareholders' equity and cash flows
for the years then ended. 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, 1999 and 1998, and the
results of its operations and its cash flows for the years then
ended are in conformity with generally accepted accounting
principles.
Jackson & Rhodes P.C.
Dallas, Texas
February 15, 2000
<PAGE>
<TABLE>
UNITED MORTGAGE TRUST
BALANCE SHEETS (Audited)
For the Years Ending
December 31, 1999 and 1998
<CAPTION>
December 31,
1999 1998
ASSETS
<S> <C> <C>
Cash $ 14,331 $ 58,054
Investment in residential mortgages
and contracts for deed 21,877,468 11,159,863
Interim mortgages 4,199,632 3,285,023
Accrued interest receivable 244,381 133,478
Receivable from affiliate (Note 5) 23,765 15,185
Equipment, less accumulated depreciation
of $1,776 and $1,256, respectively 2,219 1,986
Other assets 40,350 5,350
----------- ----------
Total Assets $26,402,146 $14,658,939
----------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Lines of credit (Note 3) $ 5,000,000 $ 1,484,308
Dividend payable 227,181 121,164
Accounts payable & accrued
liabilities 126 1,519
----------- ----------
Total Liabilities $ 5,227,307 $ 1,606,991
----------- ----------
Commitments and contingencies (Note 6)
Shareholders' equity:
Shares of beneficial interest; $.01 par
Value; 100,000,000 shares authorized
1,185,544 and 734,271 shares
outstanding $ 11,856 $ 7,343
Additional paid-in capital 21,047,321 12,974,938
Retained earnings 115,662 69,667
----------- ----------
Total Shareholders' Equity $21,174,839 $13,051,948
----------- ----------
Total Liabilities & Shareholders Equity $26,402,146 $14,658,939
----------- ----------
<FN>
See accompanying notes to financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
UNITED MORTGAGE TRUST
STATEMENTS OF INCOME (Audited)
For the Years Ended
December 31, 1999 and 1998
<CAPTION>
December 31,
1999 1998
<S> <C> <C>
Revenues:
Interest income $2,502,504 $1,131,154
---------- ----------
Expenses:
Salaries and wages 92,330 67,361
General and administrative 244,972 203,963
Interest expense 357,702 43,577
Expense reimbursement from
affiliate (Note 5) (169,426) (200,282)
---------- ----------
525,578 114,619
---------- ----------
Net income $1,976,926 $1,016,535
---------- ----------
Net income per share of
beneficial interest $2.02 $2.12
---------- --------
Weighted average shares
outstanding 952,098 480,057
---------- --------
<FN>
See accompanying notes to financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
UNITED MORTGAGE TRUST
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Audited)
For the Years Ending
December 31, 1999 and 1998
<CAPTION>
Shares of Additional Retained
Beneficial Interest Paid-in Earnings
Shares Amount Capital (Deficit) Total
------------------ ---------- --------- -----------
<S> <C> <C> <C> <C> <C>
Balance, Dec 31, 1997 202,508 2,025 3,467,964 11,937 3,481,926
Proceeds from shares issued 531,763 5,318 9,506,974 -- 9,512,292
Dividends ($2.05 per share) -- -- -- (958,805) (958,805)
Net income -- -- -- 1,016,535 1,016,535
------- ------ ----------- ---------- -----------
Balance, Dec 31, 1998 734,271 $7,343 $12,974,938 $ 69,667 $13,051,948
Proceeds from shares issued 451,273 4,513 8,072,383 -- 8,076,896
Dividends ($2.02 per share) -- -- -- (1,930,931) (1,930,931)
Net income -- -- -- 1,976,926 1,976,926
------- ------ ----------- ---------- -----------
Balance, Dec 31, 1999 1,185,544 $11,856 $21,047,321 $ 115,662 $21,174,839
--------- ------ ----------- ---------- -----------
<FN>
See accompanying notes to financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
UNITED MORTGAGE TRUST
STATEMENTS OF CASH FLOWS (Audited)
For the Years Ending
December 31, 1999 and 1998
<CAPTION>
December 31,
1999 1998
<S> <C> <C>
Cash flow from operating activities:
Net income $ 1,976,926 $ 1,016,535
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization 520 1,257
Net amortization of discount on
mortgage investments (51,690) (55,864)
Changes in assets and liabilities:
Accrued interest receivable (110,903) (94,732)
Other assets (35,000) (3,750)
Accounts payable and accrued
liabilities (1,393) 88,001
Net cash provided by ------------ -----------
operating activities: 1,778,460 951,447
------------ -----------
Cash flow from investing activities:
Investment in residential mortgages and
contracts for deed (12,084,748) (8,344,441)
Principal receipts on residential
mortgages and contracts for deed 1,746,963 223,063
Investment in interim mortgages (8,449,544) (6,755,077)
Principal receipts on interim
mortgages 7,534,936 4,347,329
Loan acquisition costs (328,129) (260,585)
Purchase of equipment (753) (656)
Net cash used in investing ------------- -----------
activities: (11,581,275) (10,790,367)
------------- -----------
Cash flow from financing activities:
Proceeds from issuance of shares of
beneficial interest 8,076,896 9,512,292
Net borrowings on note payable -- 251,000
Net borrowings on lines of credit 3,515,691 1,346,308
Receivable from affiliate (8,581) (3,069)
Dividends (1,824,914) (958,805)
Net cash provided by ------------ -----------
financing activities: 9,759,092 9,896,726
------------ -----------
Net increase (decrease) in cash (43,723) 57,806
Cash at beginning of year 58,054 248
------------ -----------
Cash at end of period $ 14,331 58,054
------------ -----------
Interest paid $ 357,731 43,577
------------ -----------
<FN>
See accompanying note to financial statements.
</FN>
</TABLE>
<PAGE>
UNITED MORTGAGE TRUST
Notes to Financial Statements
December 31, 1999 and 1998
1. Description of Business
The Company
United Mortgage Trust (the "Company") is a Maryland real estate investment
trust which intends to continue 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 "Advisor"), a Texas
corporation. The Company invests in first lien, fixed rate Mortgage
Investments secured by single-family residential property throughout the
United States. Those loans are originated by others to the Company's
specifications or to specification approved by the Company. Most, if not
all, of those loans are not 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. As of February 15, 2000,
the Company has sold 1,258,394 shares aggregating net proceeds of
$22,367,060.
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.
Residential Mortgages, Contracts for Deed and Interim Mortgages
Residential Mortgages, Contracts for Deed and Interim Mortgages are
recorded at the lower of cost or estimated net realizable value, net of
discounts and including loan acquisition costs. The Mortgage Investments
are collateralized by real property owned by the borrowers. Loan
acquisition fees are incurred when we purchase Residential Mortgages and
Contracts for Deed but not when it purchases Interim Mortgages. Loan
acquisition fees and discounts on the notes are amortized using the
interest method over the estimated life of the mortgages (5-1/2 years).
Unamortized discount amounted to $628,958 and $434,029 at December 31, 1999
and 1998, respectively. Unamortized loan acquisition costs were $508,535
and $251,893 at December 31, 1999 and 1998, respectively.
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 continue 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 we believe we are in compliance
with the Code.
Basic Earnings Per Share
In March 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128, Earnings Per Shares
("SFAS 128"). SFAS 128 provides a different method of calculating earnings
per share than was formerly used in APB Opinion 15. SFAS 128 provides for
the calculation of basic and diluted earnings per share. Basic earnings per
share include no dilution and are computed by dividing income available to
common stockholders by the weighted average number of common shares
outstanding for the period. Dilutive earnings per share reflect the
potential dilution of securities that could share in the earning of the
company. The Company was required to adopt this standard in the fourth
quarter of calendar 1997. Because the Company's potential dilutive
securities are not dilutive, the accompanying presentation is only the
basic earnings per share.
3. Lines of Credit
The Company had a $500,000 line of credit maturing on March 27, 1999, that
was collateralized with the assignment of certain Residential Mortgages.
Interest was calculated at 1-1/2 per cent above the bank's prime interest
rate, which translated to a 9.25% rate when the loan terminated. The
Company chose not to renew that line of credit. The Company had an
additional $1,500,000 line of credit maturing on October 28, 1999, which it
renewed and increased to $5,000,000 on March 23, 1999. The line of credit
is collateralized with the assignment of certain Residential Mortgages.
Interest is calculated at 1-1/2 per cent above the bank's prime interest
rate, which translated to a 10.00% rate at year-end.
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 the Company 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 the Company's 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's stock at
$20 per share. Following is a summary of the option transactions for 1999
and 1998:
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
Outstanding at beginning of year 20,000 10,000
Granted 10,000 10,000
Expired -- --
Exercised -- --
------ ------
Outstanding at end of year 30,000 20,000
------ ------
Exercisable at end of year 30,000 20,000
------ ------
Exercise price per share $20.00 $20.00
</TABLE>
In October 1995, the FASB issued SFAS 123, "Accounting for Stock-Based
Compensation." SFAS 123 defines a fair value based method of accounting for
an employee stock option or similar equity instrument and encourages all
entities to adopt that method of accounting for all of their employee stock
compensation plans. Under fair value based method, compensation cost is
measured at the grant date based on the value of the award. However, SFAS
123 also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed
by APB Opinion No. 25, "Accounting for Stock Issued to Employees."
Under the intrinsic value based method, compensation cost is the excess, if
any, of the quoted market price of the stock at grant date or other
measurement date over the amount an employee must pay to acquire the stock.
Entities electing to continue to follow the accounting method provided in
APB Opinion 25 must make pro forma disclosures of net income and earnings
per share as if the fair value based method of accounting had been applied.
The pro forma disclosure requirements are effective for financial
statements for fiscal years beginning after December 15, 1995. The Company
has elected to measure compensation cost, including options issued, under
APB Opinion 25.
No pro forma disclosures are provided herein since the calculated fair
value of the options was nominal.
5. Related Party Transactions
The Company currently leases its office space from an affiliate under the
terms of a 36-month lease at $5,409 per month and subleases a major portion
of space to South Central Mortgage, Inc. ("SCMI"), a related party, for
$4,668 per month. The sublease rental rate is approximately five percent
higher than the amount paid by the Company. Rent expense amounted to $6,681
and $7,101 for the years ended December 31, 1999 and 1998, respectively.
Minimum lease payments in the future under the leases are as follows:
<TABLE>
<CAPTION>
Minimum Minimum
Lease Sublease Net
Year Ending December 31: Payments Payments Amount
<C> <C> <C> <C>
2000 $64,908 $56,016 $8,892
2001 64,908 56,015 8,892
2002 59,418 56,016 3,402
The Company purchased Residential Mortgages and Contracts for Deed from
South Central Mortgage, Inc., a related party, and from unaffiliated third
parties for $12,084,748 and $8,344,441 for the years ended December 31,
1999 and 1998, respectively. The Company has also entered into a Mortgage
Servicing Agreement with SCMI, incurring service fees of $82,735 and
$32,341 during 1999 and 1998, respectively. The Company also paid
acquisition fees to the Advisor of $323,068 and $260,585 during 1999 and
1998, respectively.
In 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, 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.
6. Commitments and Contingencies
Concentration of Credit Risk
Financial instruments that 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 residential
mortgages and contracts for deed receivable are "Sub-Prime, B and C Grade"
notes secured by single-family homes, principally in the Dallas/Fort Worth
and Houston Metropolitan areas.
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 mortgage investments approximates carrying
value based on their effective interest rates compared to current market
rates.
As part of the Company's agreement to acquire notes from SCMI (Note 6),
SCMI agrees to repurchase, at no loss to the Company, any note that is in
default any time during twelve months from the Company's date of purchase.
SCMI may satisfy its repurchase requirement by either assigning to the
Company a replacement note or by funding to the Company lost interest, tax
and insurance escrow payments, as well as any costs incurred by the Company
related to curing the default. At year-end approximately one-half of the
Company's portfolio consisted of notes with recourse agreements. The
Company began the year with 9 defaulted loans, had an additional 40 default
(12 were not covered by a recourse agreement), resold 20 and ended the year
with 29 defaulted loans. The resold properties resulted in a gain in 1999.
Of the 29 properties vacant at year-end 20 are covered under a recourse
agreement. The potential loss of interest on the remaining 9 is
approximately $427 per month for every month that the property is defaulted
plus foreclosure, repair and remarketing expenses less any amount in excess
of the loan balance realized from a sale of the property. Of the Company's
properties that have been resold, the average length of default is 5.6
months. Potential loss of interest per property would then be approximately
$2,400 if the Company fails to recover interest upon the resale of a
defaulted loan. No provision for loan losses has been provided as the
Company believes its exposure to losses as of December 31, 1999 and 1998
was nominal.
7. New Accounting Pronouncements
SFAS 131
SFAS 131, "Disclosure about Segments of a Business Enterprise,"
establishes standards for the way that public enterprises report
information about operating segments in annual financial statements
and requirements of selected information about operating segments in
interim financial statements issued to the public. It also
establishes standards for disclosure regarding products and services,
geographic areas and major customers. SFAS 131 defines operating
segments as components of an enterprise about which separate
financial information is available that is evaluated regularly by the
chief operating decision maker in deciding how to allocate resources
and in assessing performance. This accounting pronouncement will not
have an effect on the Company's financial statements, since the
Company only operates in one segment of business, investing in
Mortgage Investments.
SFAS 132
Statement of Financial Accounting Standards (SFAS) 132, "Employer's
Disclosure about Pensions and Other Postretirement Benefits," revises
standards for disclosures regarding pensions and other postretirement
benefits. It also requires additional information on changes in the
benefit obligations and fair values of plan assets that will
facilitate financial analysis. This statement does not change the
measurement or recognition of the pension and other postretirement
plans. The financial statements are unaffected by implementation of
this new standard.
SFAS 133
Statement of Financial Accounting Standards (SFAS) 133, "Accounting
for Derivative Instruments and Hedging Activities," establishes
accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognize all derivatives as either assets
or liabilities in the statement of financial position and measure
those instruments at fair value. If certain conditions are met, a
derivative may be specifically designated as (a) a hedge of the
exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment, (b) a hedge of the
exposure to variable cash flows of a forecasted transaction, or (c) a
hedge of the foreign commitment, an available for sale security, or a
foreign-currency-denominated forecasted transaction. Because the
Company has no derivatives, this accounting pronouncement has no
effect on the Company's financial statements.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
We have not had any changes in our accountants or any disagreements with
our 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
our business. The Trustees employ our President to manage our day-to-day
operations and have retained the Advisor to use its best efforts to seek out
and present to us suitable and a sufficient number of investment
opportunities which are consistent with our investment policies and
objectives. We may acquire Mortgage Investments from SCMI and will utilize
the services of SCMI to service some or all of our Mortgages Investments.
Our 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, three of whom are Independent Trustees.
OUR TRUSTEES AND OFFICERS
Our Trustees and officers are as follows:
</TABLE>
<TABLE>
<CAPTION>
Name Age Offices Held
<S> <C> <C>
Christine "Cricket" Griffin 47 Trustee, Chairman of the Board
and President
Richard D. O'Connor, Jr. 45 Trustee
Paul R. Guernsey 49 Independent Trustee
Douglas R. Evans 54 Independent Trustee
Michele A. Cadwell 48 Trustee
</TABLE>
Christine "Cricket" Griffin has been our President and a Trustee since
July 1996. 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 us. 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 one of our Trustees since July 1996
and, prior to August 1997 was one of our Independent Trustees. 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 one of our Independent Trustees 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
childcare 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
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.
Douglas R. Evans has been one of our Independent Trustees 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 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 one of our Trustees since August 1997. Prior
to January 2000 she was an Independent Trustee. Ms. Cadwell is an attorney
who has worked in the oil and gas industry since 1980. From 1998 to 1999, Ms.
Cadwell was Manager - Onshore Land Operations with EEX Corp. Her primary
responsibilities include drafting and negotiating exploration and marketing
agreements, analyzing legislation and regulatory proposals, researching
complex mineral titles, organizing and managing property divestitures,
settling land owner disputes and advising and testifying on matters before the
Oklahoma Corporation Commission. From 1980 until 1998 she was employed with
Enserch Exploration, Inc. as Senior Land Representative. At present, Ms.
Cadwell maintains an independent practice of law and operates a closing office
for Commonwealth Land Title Company. She currently provides services to us in
her capacity as a closing agent for Commonwealth. 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 ADVISOR
Our 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
us, 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 our investment policies and objectives 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 our development of investment guidelines, overseeing
servicing, negotiating purchases of loans and overseeing the acquisition or
disposition of investments, and managing our assets.
The directors and officers of the Advisor are set forth below. These
officers of the Advisor may also provide services to us on behalf of the
Advisor.
<TABLE>
<CAPTION>
Name Age Offices Held
<S> <C> <C>
Todd Etter 49 President
Timothy J. Kopacka 40 Vice President/Secretary
James P. Hollis 59 Vice President
Dan H. Hill 49 Vice President/Treasurer
</TABLE>
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. From 1987 to 1992, Mr.
Etter served as President of South Central Financial Group, a Dallas based
investment banking firm. 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. 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. Mr. Hollis is
the sole proprietor of First Financial USA - Florida, a financial products
marketing company within the state of Florida. He is Vice President of S&S
Financial USA, Inc., a financial products marketing company located in
Melbourne, Florida. He is Advisor to SAFECO Life Insurance Company's
President Advisory Board since 1998. Mr. Hollis is a Brokerage General Agent
for several medium to large size life insurance companies, including SAFECO
Life, Conseco Life, F&G Life, General Electric Capital Assurance and
Jefferson Pilot Life. Mr. Hollis has been in the investments and insurance
business since 1969.
Dan H. Hill has a Bachelor of Business Administration degree in
accounting. Mr. Hill is currently licensed as an insurance general agent, a
securities principal and a Texas real estate broker. In 1998, Mr. Hill began
First Financial United Management, Inc. as a Registered Investment Advisor
to provide investment advice and fee based financial planning services.
Since 1995, Mr. Hill has been President of First Financial USA, Inc., a
national financial products marketing company. Mr. Hill is also President of
H&H Services, Inc., the general partner of First Financial United
Investments Ltd., L.L.P., a broker-dealer that is one of the two Selling
Group Managers. In addition, he owns First Financial Management Group, a
financial planning firm specializing in the small business market. Since
1978, he has been actively involved in the financial services industry,
including accounting, insurance, real estate and securities. Prior to that
he was a corporate accountant for several Halliburton companies.
SUMMARY OF THE ADVISORY AGREEMENT
With the approval of our Trustees, including all of the Independent Trustees,
we 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 us, whether through its own efforts or those of third parties retained by
it, a sufficient number of suitable investment opportunities which are
consistent with our investment policies and objectives and also consistent
with any investment programs that the Trustees may adopt from time to time in
conformity with the Declaration of Trust. Although the Trustees have
continuing exclusive authority over our management, the conduct of our affairs
and the management and disposition of our assets, the Trustees have initially
delegated to the Advisor, subject to the supervision and review of the
Trustees and consistent with the provisions of our Declaration of Trust, the
power and duty to: (1) develop underwriting criteria and a model for our
investment portfolio; (2) acquire, retain or sell Mortgage Investments; (3)
seek out, present and recommend investment opportunities consistent with our
investment policies and objectives, and negotiate on our behalf with respect
to potential investments or the disposition thereof; (4) pay our debts and
fulfill our obligations, and handle, prosecute and settle any of our claims,
including foreclosing and otherwise enforcing mortgages and other liens
securing investments; (5) obtain for us such services as may be required for
mortgage brokerage and servicing and other activities relating to our
investment portfolio; (6) evaluate, structure and negotiate prepayments or
sales of Mortgage Investments; (7) from time to time, or as requested by the
Trustees, make reports to us regarding the Advisor's performance of the
foregoing services and (8) supervise other aspects of our business.
The original term of the Advisory Agreement expired on August 8, 1998
(one year from the date on which the first closing of the sale of Shares
offered to the public occurred) and was renewed for a term expiring August 8,
1999. Thereafter, the Advisory Agreement may be renewed annually by us,
subject to an evaluation of the performance of the Advisor by the Trustees.
The Advisory Agreement may be terminated (1) without cause by the Advisor or
(2) with or without cause by a majority of the Independent Trustees.
Termination under either of those provisions may be made without penalty and
upon 60 days' prior written notice to the non-terminating party. The agreement
was renewed through August 8, 2000.
The Advisor may engage in other business activities related to real
estate, Mortgage Investments or other investments whether similar or
dissimilar to those made by us or act as advisor to any other person or entity
having investment policies whether similar or dissimilar to ours (including
other REITs). See "Investment Objectives and Policies". However, except for
the allocation of investments between us and other Affiliated Programs as
described under the caption "Conflicts of Interest - Competition with
Affiliates for the Purchase and Sale of Mortgage Investments" or except for
the operations of SCMI or CRC, before the Advisor, the officers and directors
of the Advisor and all persons controlled by the Advisor and its officers and
directors may take advantage of an opportunity for their own account or
present or recommend it to others, they are obligated to present an investment
opportunity to us if (1) that opportunity is of a character which could be
taken by us, (2) that opportunity is compatible with our investment objectives
and policies and (3) we have the financial resources to take advantage of that
opportunity. SCMI is currently in the business of purchasing, selling and
servicing mortgages and CRC is currently in the business of financing home
purchases and renovations by investors. SCMI and CRC will each continue in
their business. However, SCMI and CRC have each agreed that, if they have any
loans that they desire to sell, they will give us the right of first refusal
to purchase that loan if (1) it is of a character which could be bought by us,
(2) it is compatible with our investment objectives and policies and (3) we
have the financial resources to purchase it.
For a description of the compensation to be paid to the Advisor in
consideration of the services it will render to us, see "Acquisition Fees
Payable to the Advisor", below.
The Declaration of Trust provides that the Independent Trustees are to
determine, at least annually, that the amount of compensation which we agree
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 our investment
portfolio, the success of the Advisor in generating opportunities that meet
our investment objectives, 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 us, the quality and extent of service and advice
furnished by the Advisor, the performance of our investment portfolio and the
quality of our investment portfolio in relationship to the investments
generated by the Advisor for its own account.
The Advisory Agreement provides for us to pay all of our expenses and to
reimburse the Advisor for any expenses that should have been paid by us but
which were instead paid by the Advisor. However, the Advisor remains
obligated to pay: (1) the employment expenses of its employees, (2) its rent,
utilities and other office expenses (except those relating to office space
occupied by the Advisor that is maintained by us) and (3) the cost of other
items that generally fall under the category of the Advisor's overhead that is
directly related to the performance of services for which it is otherwise
receiving fees from us.
SCMI
We have and will continue to acquire Mortgage Investments from SCMI and
will utilize the services of SCMI to service some or all of the Residential
Mortgages that we purchase. See "Description of Business" and "Investment and
Business Risks - Purchase of Mortgage Notes from Affiliates", and "Investment
Portfolio", above. See "Loan Servicing Fee Payable to SCMI", below, for a
discussion of fees paid to SCMI and its affiliates for servicing Mortgage
Investments.
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, our President and one of our Trustees, 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.
CRC
We have and will continue to purchase Interim Mortgages from CRC. See
"Description of Business" and "Investment and Business Risks - Purchase of
Mortgage Notes from Affiliates", and "Investment Portfolio", above.
CRC is a Texas corporation that is 50% owned by Todd Etter, an officer
and principal shareholder of the Advisor. CRC is in the business of financing
home purchases and renovations by real estate investors.
ITEM 10. EXECUTIVE COMPENSATION.
The following Summary Compensation Table sets forth information
concerning compensation earned in the year ended December 31, 1998 and by
our Chief Executive Officer, who is our only executive officer.
Summary Compensation Table
<TABLE>
<CAPTION>
Long-term
Annual Compensation Compensation
Shares
Underlying
Name and Principal Position Year Salary Bonus(1) Options
- --------------------------- ---- ------ -------- ----------
<S> <C> <C> <C> <C>
Christine Griffin, President 1999 $79,860 $0 2,500
1998 $60,000 $0 2,500
<FN>
(1) Pursuant to her employment agreement, Ms. Griffin is entitled to
receive a bonus equal to 25% of the amount by which our Company's
administrative expenses for the year fall below the approved administrative
budget
</FN>
</TABLE>
The following table sets forth, for the executive officer named in the
Summary Compensation Table above, certain information concerning stock
options granted during the 1999 and 1998 fiscal years.
<TABLE>
<CAPTION>
Number of Shares Percent of Total Exercise
Underlying Options Granted to Price Per Expiration
Name Options Granted Employees Share Date
<S> <C> <C> <C> <C>
Christine Griffin 1999 2,500 100% $20.00 12/31/03
1998 2,500 100% $20.00 12/31/04
</TABLE>
The following table sets forth, for the executive officer named in the
Summary Compensation Table above, certain information regarding the exercise
of stock options during the 1999 and 1998 fiscal years and the value of
options held at fiscal year end:
Aggregated Option Exercises in Last Fiscal Year
And Fiscal Year-end Option Values
<TABLE>
<CAPTION>
Number of
Shares Value of
Underlying Unexercised
Exercised In-the-Money
Shares Options at Options at
Acquired Fiscal Year-end Fiscal Year-end
On Value Exercisable/ Exercisable/
Name Exercise Realized Unexercisable Unexercisable
<S> <C> <C> <C> <C> <C>
Christine Griffin 1999 0 $0 2,500/0 $0/$0
1998 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
We have an employment agreement with Christine Griffin whereby she
serves as Trustee, President and Chief Operating Officer. That agreement is
for a term of one year, to be reviewed annually with the approval of a
majority of Independent Trustees. The agreement was amended and renewed,
for a term of one year, on July 1, 1999 in order to increase her salary. The
agreement provides for her to receive: (1) an annual salary of $79,860; (2)
a bonus equal to 25% of the amount by which our 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).
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 1999, the Independent Trustees
each received $3,000 each and waived their rights to additional fees and
each Independent Trustee who served during all of 1998 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, 1999, we had 1,185,544 Shares issued and outstanding
compared to 734,271 Shares issued and outstanding at December 31, 1998. The
following table sets forth certain information regarding the beneficial
ownership of the Shares as of December 31, 1999 by (i) each person known by
us to be the beneficial owner of more than 5% of the outstanding Shares,
(ii) each of our Trustees and executive officers named in Item 10, and (iii)
all of our 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.
</TABLE>
<TABLE>
<CAPTION>
Number of Percent
Name and Address Shares (1) of Class
- ---------------- ---------- --------
<S> <C> <C>
Jill Major Revocable Living
Trust/Harry Major Machine Company/
Major Industrial Real Estate 80,000 6.75%
Christine "Cricket" Griffin (2) 7,500(3) 0.63%
Richard D. O'Connor, Jr. (2) 0(3) 0.00%
Paul R. Guernsey (2) 7,500(3) 0.63%
Douglas R. Evans (2) 7,500(3) 0.63%
Michele A. Cadwell (2)(5) 7,500(3) 0.63%
All Trustees and
Executive Officers as a
Group (5 persons) 30,000(4) 2.53%
<FN>
(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 that 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 our Company. The addresses of all
trustees and executive officers are c/o United Mortgage Trust, 5740 Prospect
Avenue, Suite 1000, Dallas, Texas 75206.
(3) Includes 5,000 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.
(5) Ms. Cadwell will no longer receive options as of January 1, 2000 because
she is no longer considered an Independent Trustee because she is providing
services to us in her capacity as a fee agent with a title company.
</FN>
</TABLE>
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
RENT PAYABLE TO SCMI AS PROPERTY MANAGER FOR TODD ETTER
The Company currently leases its office space from Todd Etter, a related
party, under the term of a 36-month lease commencing January 15, 2000 at
$5,409 per month and subleases a major portion of space to SCMI, a related
party, for $4,668 per month. The sublease rental rate is approximately five
percent higher than the amount paid by the Company.
COMMISSIONS, FEES AND SHARES THAT MAY BE ISSUED TO FIRST FINANCIAL AND IMS
SECURITIES
The Shares being sold in our initial public offering are being
distributed by the Selling Group Managers on a "best efforts" basis through
participating NASD member firms ("Selected Dealers") that are selected by
the Selling Group Managers. Mr. Dan Hill, director and officer of the
Advisor, is the principal shareholder and officer of the general partner of
First Financial, one of the two Selling Group Managers.
The Selling Group Managers receive 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 Managers may, in their 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 Managers but will not change the Net Offering Proceeds to us. The
Selling Group Managers 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 Managers.
The Selling Group Managers 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). They may
allocate all or a portion of the SGM Shares to Selected Dealers and
registered representatives of the Selling Group Managers. We have agreed to
indemnify the Selling Group Managers with respect to certain liabilities,
including liabilities under the Securities Act of 1933.
During the year ended December 31, 1999 the First Financial received a
total of $902,546 in commissions, $45,127 in due diligence fees and no SGM
Shares. IMS Securities did not earn commissions or fees during 1999. During
the year ended December 31, 1998, First Financial, which was then the only
Selling Group Manager, received a total of $1,069,526 in commissions,
$53,476 in due diligence fees and no SGM Shares.
PURCHASE OF MORTGAGE INVESTMENTS FROM SCM
We obtain 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 us,
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 us.
SCMI has agreed that, in the event that the obligor on any Mortgage
seasoned less than 12 months sold through SCMI or any of its Affiliates to
our Company defaults in the making of any payment or other obligation
thereon during the period ending one year after the acquisition of that
Mortgage by us, then SCMI shall purchase or repurchase the Mortgage from us
or our assignee at a price on the date of that 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 us in the maintenance, protection or defense of its interest
therein or in the real property, including reasonable attorneys' fees. SCMI
has further agreed that any notes sold to us by SCMI shall be guaranteed for
the first 12 payments regardless of seasoning. SCMI may satisfy its
obligations under the foregoing purchase or repurchase requirement by
either:
(a) Assigning and transferring to our 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 us; and (ii) the value of the replacement Mortgage(s) at
the date of transfer to our Company shall be computed by our Company
in accordance with our then applicable pricing schedule for
acquisition of those Mortgages, giving due regard to principal
balance, interest rate, term, amortization and other general factors
used by our Company for acquisition of those Mortgages at that time;
or
(b) Funding by SCMI, on a month-to-month basis, to our Company of all
lost interest, tax and insurance escrow payments, as well as any costs
incurred by us 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 us.
Since we began purchasing loans in August 1997 and though 1999, fifty-
eight loans have defaulted. Of the defaulted loans twelve were not covered
under a recourse agreement.
LOAN SERVICING FEE PAYABLE TO SCMI
We utilize the services of SCMI and nonaffiliated third parties to
service the Residential Mortgages and Contracts for Deed we acquire. For
its efforts in servicing those investments, SCMI is paid a fee equal to 0.5%
of the principal balance of the mortgages being serviced by SCMI, a rate we
believe is a competitive rate that is no higher than the rates charged by
unaffiliated third parties. The servicing of the investments includes the
collection of monthly payments from the borrower, the distribution of all
principal and interest to us, 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 that
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. Interim Mortgages are serviced by CRC on a no fee basis.
During the year ended December 31, 1999, we paid SCMI $82,735 in loan
servicing fees. By comparison, $32,423 in loan servicing fees were paid in
1998.
REAL ESTATE BROKERAGE COMMISSIONS
If we foreclose on a property securing a Residential Mortgage and sell
that property, we 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, those fees shall be
paid only if that person provides a substantial amount of services in the
sales effort, in which case those 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 years ended December 31, 1999 and 1998, we 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
Residential Mortgage and Contract for Deed are payable to the Advisor or its
Affiliates for sourcing, evaluating, structuring and negotiating the
acquisition terms of Mortgage Investments. No Acquisition Fee is paid to CRC
on Interim Mortgages. The actual amounts of the fees paid will depend on the
amount of Net Offering Proceeds and any borrowed funds that are invested.
We paid the Advisor a total of $328,129 and $260,586 in Acquisition
Fees during the twelve months ending December 31, 1999 and 1998,
respectively.
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 our Company (defined generally as our average book value of
Mortgage Investments, without regard for non-cash reserves) or (b) 25% of
our Net Income. Our President will have the responsibility of preparing an
annual budget and submitting that budget to the Trustees. In the event the
Total Operating Expenses exceed the limitations described above, then within
60 days after the end of our fiscal year, the Advisor shall reimburse to us
the amount by which the aggregate annual Total Operating Expenses paid or
incurred by us exceeds the limitation.
During 1997, we entered into a Funding Agreement with the Advisor
whereby the Advisor agreed to fund our general and administrative expenses.
In consideration of the agreement, we will contribute to the Advisor, on a
monthly basis, 0.5% of our average invested assets for the immediately
preceding month. Expense reimbursements of $169,426 and $200,282 were made
during the twelve months ending December 31, 1999 and 1998, respectivley.
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 our Net
Income for a year exceeds a 10% per annum non-compounded cumulative return
on our 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 our audited annual financial statements 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, our Net Income equals or exceeds a 10%
per annum non-compounded cumulative return on our Adjusted
Contributions. The determination of our annual non-compounded
cumulative return on our Adjusted Contributions shall be made by
dividing our total Net Income for that year by the average of the
month end Adjusted Contributions during that year.
If our Trustees agree that both of those conditions are satisfied, we
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 our initial public offering). No
Subordinated Incentive Fees was paid by us in the year ending December 31,
1999 or 1998.
ITEM 13. EXHIBITS
EXHIBITS. See the Exhibit Index on the following page for a list of the
exhibits that are filed as part of this report.
<TABLE>
<CAPTION>
Exhibit
NUMBER DESCRIPTION PAGE*
<S> <C> <C>
3.1 Form of Second Amendment 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 Chase
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 10.6*
10.7 Funding Agreement dated December 15, 1997
but effective January 1, 1997 between the
Company and Mortgage Trust Advisors, Inc. 10.7*
</TABLE>
The exhibits marked with "*" 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.
<PAGE>
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 31,
2000.
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 March 31, 2000
and President
Principal Financial and
Accounting Officer:
/S/CHRISTINE A. GRIFFIN Trustee, Chairman
Christine A. Griffin of the Board March 31, 2000
and President
/S/PAUL R. GUERNSEY Trustee March 31, 2000
Paul R. Guernsey
/S/DOUGLAS R. EVANS Trustee March 31, 2000
Douglas R. Evans
/S/RICHARD D. O'CONNOR, JR. Trustee March 31, 2000
Richard D. O'Connor, Jr.
/S/MICHELE A. CADWELL Trustee March 31, 2000
Michele A. Cadwell
36
