CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
November 3, 1997
SECURITIES & EXCHANGE COMMISSION
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Capital Alliance Income Trust Ltd., A Real Estate Investment Trust
------------------------------------------------------------------
SEC File No. 333-11625
Our File No. 76021.0002
Dear Sir/Madam:
Pursuant to Sections 13 and 15(d) of the Securities Exchange Act of 1934,
enclosed for filing via EDGAR please find a Form 10-Q for the quarter ended
September 30, 1997. If you have any questions, please do not hesitate to call.
Very truly yours,
/s/ Thomas B. Swartz
Thomas B. Swartz
Chairman
Enclosures
cc: Stephen C. Ryan, Esq.
50 California Street, Suite 2020 # San Francisco, CA 94111
# (415) 288-9575 # fax: (415) 288-9590
<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-------------------
FORM 10-Q
(Mark One)
(X) Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of
1934 For the quarterly period ended September 30, 1997
Commission File Number: 333-11625
-------------------
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 94-3240473
-------- ----------
(State or other Jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
50 California Street
Suite 2020
San Francisco, California 94111
------------------------- -----
(Address of principal executive office) (zip code)
(415) 288-9575
--------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes _X_ No ___
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
As of September 30, 1997, there were no shares of common stock outstanding.
<PAGE>
PART I
ITEM 1.
FINANCIAL STATEMENTS
2
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
<TABLE>
<CAPTION>
Balance Sheets
(Unaudited) (Audited)
September 30, 1997 December 31, 1996
<S> <C> <C>
ASSETS
Cash and cash equivalents ................................. $ 43,654 $ 66,798
Restricted cash ........................................... 171,959 65,109
Accounts receivable ....................................... 169,522 110,006
Investments ............................................... 489,114 200,000
Mortgage notes receivable ................................. 4,654,228 4,696,238
Real estate held for sale ................................. 316,030 1,312,520
Organization costs (net of accumulated amortization
of $6,456 at September 30, 1997 and $3,216 at
December 31, 1996) .................................. 15,573 18,459
Deferred offering costs ................................... 409,190 233,131
---------- ----------
Total assets .............................................. $6,269,269 $6,702,261
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Mortgage note holdbacks .............................. $ 171,840 $ 64,991
Due to affiliates .................................... 46,594 21,294
Other liabilities .................................... 148,548 91,393
Mortgage notes payable ............................... -- 578,395
---------- ----------
Total liabilities ......................................... 366,983 756,073
---------- ----------
Stockholders' Equity
Preferred stock, $.01 par value (liquidation value
$9.50 per share), 675,000 shares authorized;
641,283 and 641,283 shares issued and
outstanding at September 30, 1997 and
December 31, 1996, respectively ............... 6,413 6,413
Common stock, $.01 par value, 5 million and 2 million
shares authorized at September 30, 1997
and December 31, 1996, respectively,
none issued and outstanding .................. -- --
Additional paid in capital (Preferred stock) ........ 5,895,873 5,939,775
---------- ----------
Total stockholders' equity ................................ 5,902,286 5,946,188
---------- ----------
Total liabilities and stockholders' equity ................ $6,269,269 $6,702,261
========== ==========
</TABLE>
See accompanying notes to financial statements.
3
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
<TABLE>
<CAPTION>
Statements of Operations
(Unaudited)
(Combined)
(Successor) (Predecessors)(Successor)
Nine Months Four Months Five Months
Three Months Ended Ended Ended Ended
September 30, September 30, April 30, September 30,
1997 1996 1997 1996 1996
<S> <C> <C> <C> <C> <C>
REVENUES
Interest income ....................... $ 110,844 $ 191,681 $ 438,893 $ 242,136 $ 280,111
Origination income .................... 39,673 -- 72,628 -- --
Other income .......................... 37,827 (1,397) 84,745 31,573 20,624
--------- --------- --------- -------- -------
Total revenues .................... 188,343 190,284 596,266 273,709 300,735
EXPENSES
Loan servicing and origination fees and
other expenses to related party ..... 38,258 15,114 104,334 20,107 25,190
Interest expense ...................... 4,183 -- 43,604 -- --
Provision for loan losses ............. -- 23,000 -- 20,000 33,000
Operating expenses of real estate held 7,646 -- 33,890 -- --
General and administrative ............ 4,893 21,595 27,103 6,959 17,861
--------- --------- --------- --------- ---------
Total expenses .................. 54,980 59,709 208,931 47,066 76,051
--------- --------- --------- --------- ---------
Net Income Before Gain on Real
Estate Held for Sale .................. 133,363 130,575 387,336 226,643 224,684
Gain on Real Estate Held for Sale ..... 23,063 -- 16,670 -- --
--------- --------- ---------- -------- --------
NET INCOME ................................. $ 156,426 $ 130,575 $ 404,006 $ 226,643 $ 224,684
========= ========= ========= ======== ========
NET INCOME PER
PREFERRED SHARE ....................... $ 0.244 $ 0.203 $ 0.630 $ 0.350 $ 0.350
WEIGHTED AVERAGE PREFERRED
SHARES OUTSTANDING .................... 641,464 641,804 641,464 646,971 641,804
</TABLE>
See accompanying notes to financial statements.
4
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
<TABLE>
<CAPTION>
Statements of Cash Flows
Combined
(Successor) (Predecessors) (Successor)
Nine Months Four Months Five Months
Ended Ended Ended
September 30, April 30, September 30,
1997 1996 1996
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income ............................................. $ 404,005 $ 226,643 $ 224,684
Adjustments to reconcile net income to net cash provided
by operating activities:
Amortization ......................................... 3,240 187 --
(Increase) decrease in accounts receivable .......... (55,483) (43,733) (146,120)
Increase (decrease) in loan loss reserve ............. -- 20,000 33,000
Increase (decrease) in due to affiliates ............. 25,300 10,476 5,713
Increase (decrease) in other liabilities ............. 57,155 (3,227) 35,052
----------- ----------- -----------
Net cash provided by (used in) operating activities 434,217 210,346 152,329
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
(Increase) decrease in restricted cash ................. (106,850) (92,046) 131,998
Increase (decrease) in mortgage note holdbacks ......... 106,850 92,045 (132,053)
Investments in mortgage notes receivable ............... (3,664,006) (1,022,056) (1,747,144)
Repayments of mortgage notes receivable ................ 3,295,791 1,066,231 1,210,179
Net proceeds from sale of real estate held ............. 597,398 -- --
Capital costs of real estate held ..................... (16,807) -- --
Increase in organization costs ......................... -- -- (9,238)
----------- ----------- -----------
Net cash provided by (used in) investing ............. 212,376 44,174 (546,258)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Redemption of shares ................................... -- (44,825) (23,250)
Deferred offering costs ................................ (213,933) -- (89,536)
Receipt of subscriptions receivable .................... -- 265,511 --
Payment of mortgage notes payable ...................... (7,542) -- --
Organizational and offering costs ...................... (354) (5,625) (2,314)
Dividends paid ......................................... (447,908) (262,288) (259,809)
----------- ----------- -----------
Net cash provided by (used in) financing activities .. (669,737) (47,227) (374,909)
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH ............................. (23,144) 207,293 (768,838)
CASH AT BEGINNING OF PERIOD ................................. 66,797 829,978 1,037,271
----------- ----------- -----------
CASH AT END OF PERIOD ....................................... $ 43,653 $ 1,037,271 $ 268,433
=========== =========== ===========
NON-CASH INVESTING AND FINANCING ACTIVITIES
Real estate acquired through foreclosure $ -- $ -- $ 1,065,193
Increase in mortgage payable $ -- $ -- $ 725,267
</TABLE>
See accompanying notes to financial statements.
5
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
Notes to Financial Statements
For the nine months ended September 30, 1997 and 1996
(Unaudited)
1. Organization
------------
Capital Alliance Income Trust Ltd., A Real Estate Investment Trust (the
"Trust"), a Delaware corporation, primarily invests in mortgage loans
secured by real estate. The Trust was formed December 12, 1995 to
facilitate the combination of the mortgage investment operations of
Capital Alliance Income Trust I, a Delaware business trust, and Capital
Alliance Income Trust II, a Delaware business trust, (collectively
referred to as the "Predecessors", individually referred to as "CAIT I"
and "CAIT II", respectively). CAIT I and CAIT II were both privately-held
mortgage investment trusts which invested primarily in loans secured by
deeds of trust on one-to-four unit residential properties. The Manager,
Capital Alliance Advisors, Inc. (the "Manager") originates, services and
sells the Trust's loans.
The effective date of the combination (the "Combination") was midnight
April 30, 1996, at which time the Trust (Successor) exchanged 643,730
Preferred Shares for all whole shares of the Predecessors' outstanding
Class "A" and Class "B" shares. Thereafter, all assets and liabilities of
the Predecessors were transferred to the Trust.
Effective February 12, 1997, the Trust registered its common shares with
the Securities and Exchange Commission pursuant to the Securities Act of
1933, as amended in connection with a "best efforts" offering of up to
1,500,000 common shares at $8.00 per share. Listing of the shares on the
American Stock Exchange has been approved subject to official notice of
issuance. The Trust actively commenced marketing its shares in May, 1997.
On April 15, 1997 the Trust formed its non-qualified REIT subsidiary
Capital Alliance Funding Corporation ("CAFC") to conduct its planned
Mortgage Conduit Business. On June 27, 1997 the Trust capitalized CAFC
with real estate assets carried by the Trust at a book value $304,550 in
exchange for 2,000 shares of Series "A" Preferred Stock having a 99%
economic interest in CAFC. The Trust's Manager invested $1,000 for 1,000
Common Shares of CAFC having a 1% economic interest in CAFC. On June 30,
1997 and September 30, 1997, CAFC declared dividends of $5,564 and
$14,400, respectively, to the Trust. CAFC has applied to the California
Department of Corporations for a Consumer Finance Lender's License and the
California Department of Real Estate for a Corporate Real Estate Broker's
License. Pending receipt of such licenses, CAFC's mortgage banking
activities are being conducted under the Manager's Real Estate Broker's
License. The Trust's Manager also manages CAFC and provides mortgage
origination and sale services for CAFC.
2. Basis of presentation
---------------------
The accompanying financial statements include the accounts of the Trust
and the Predecessors. The financial information presented as of any date
other than December 31 has been prepared from the books and records
without audit. The accompanying financial statements have been prepared in
6
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
Notes to Financial Statements
For the nine months ended September 30, 1997 and 1996
(Unaudited)
accordance with the instructions to Form 10-Q and do not include all of the
information and the footnotes required by generally accepted accounting
principles for complete statements. In the opinion of management, all
adjustments, consisting only of normal recurring adjustments, necessary for
a fair presentation of such financial statements, have been included.
The preparation of the 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 the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
These financial statements should be read in conjunction with the financial
statements and notes thereto for the year ended December 31, 1996 contained
in the Trust's 1996 Special Financial Report pursuant to 15d-2 on Form 10-K
of the Securities and Exchange Commission.
The unaudited interim financial statements for the nine months ended
September 30, 1996 represent the combined financial statements of the
Predecessors for the four months ended April 30, 1996 and financial
statements of the Trust for the five months ended September 30, 1996. The
unaudited interim financial statements for the nine months ended September
30, 1997 represent the financial statements of the Trust (Successor) after
the merger described in Note 1.
The operations of the Predecessors have been combined with the Trust due to
their common management and directors. The Combination has been accounted
for as a purchase. CAIT I is considered the acquiring entity and CAIT II
the acquired entity. The purchase price represents the net assets of CAIT
II as of April 30, 1996 approximating $2,771,351. This amount is the
carrying amount of assets less liabilities which approximates fair market
value. Therefore, there is no excess purchase price or goodwill. The fair
market value of net assets acquired was used to determine the purchase
price since the value of the Trust's Preferred Shares exchanged is not
readily determinable and the fair value of net assets acquired is more
clearly evident.
3. Summary of significant accounting policies
------------------------------------------
Cash and cash equivalents. Cash and cash equivalents include cash and
liquid investments with an original maturity of three months or less. The
Trust deposits cash in financial institutions insured by the Federal
Deposit Insurance Corporation. At times, the Trust's account balances may
exceed the insured limits. Restricted cash represents segregated cash and
is to be disbursed only to mortgage loan borrowers upon completion of
certain improvements to the secured property (see Note 4).
Revenue recognition. Interest income is recorded on the accrual basis of
accounting in accordance with the terms of the loans. When the payment of
principal or interest is 90 or more days past due, management reviews the
likelihood that the loan will be repaid. For these delinquent loans,
management continues to record interest income and establishes a loan loss
reserve as necessary to protect against losses in the loan portfolio
including accrued interest.
7
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
Notes to Financial Statements
For the nine months ended September 30, 1997 and 1996
(Unaudited)
Loan loss reserve. Management reviews its loan loss provision periodically
and the Trust maintains an allowance for losses on mortgage notes
receivable at an amount that management believes is sufficient to protect
against losses in the loan portfolio given the individual loan to value of
the Trust's loan portfolio based on the latest independent appraisals.
Accounts receivable deemed uncollectible are written off or reserved. The
Trust does not accrue interest income on impaired loans (Note 5).
Investments. The Trust holds all of the outstanding preferred shares
(22,500 shares of non voting stock) and a 99% economic interest in Capital
Alliance Funding Corporation ("CAFC"), a Delaware corporation which
originates and sells residential mortgage loans. Capital Alliance
Advisors, Inc., the Trust's Manager, and a related party, owns all of the
common shares and a 1% economic interest in CAFC and maintains voting
control. The preferred shares are entitled to a preference equal to 99% of
Distributions paid in any month or other period. CAFC is taxed as a
corporation. The Trust accounts for its investment under the equity method
and accrues earnings as described above in accordance with CAFC's
certificate of incorporation. Earnings from this investment are recorded
as income on the Statements of Operations.
The Trust holds an interest in 99% of the outstanding Class B preferred
shares (20,000 shares of non voting stock) of beneficial interest of
Sierra Capital Acceptance ("SCA"), a Delaware business trust which
originates and sells residential mortgage loans. Sierra Capital Services,
Inc., a related party, owns 99% of the Class A common shares of beneficial
interest of the Investee and maintains voting control. The Class B
preferred shares are entitled to guaranteed payments equal to a 15% return
per annum. All net profits and losses are allocated to the Class A common
shares. Class A common shareholders are required to contribute or loan
additional capital to cover any operating losses. SCA is taxed as a
partnership. The Trust accounts for its investment under the equity
method. Earnings from this investment are recorded as interest income on
the Statements of Operations.
Income taxes. The Trust in its 1996 federal income tax return elected to
be taxed as and intends at all times to qualify as a real estate
investment trust ("REIT") for federal income tax purposes, under Sections
856 through 860 of the Internal Revenue Code of 1986, as amended and
applicable Treasury Regulations. Therefore, the Trust generally will not
be subject to federal corporate income taxes on its net income that is
currently distributed to stockholders. To qualify as a REIT, the Trust
must elect to be so treated and must meet on a continuing basis certain
requirements relating to the Trust's organization, sources of income,
nature of assets, and distribution of income to shareholders. In addition,
the Trust must maintain certain records and request certain information
from its stockholders designed to disclose actual ownership of its stock.
In order to maintain its qualification as a REIT, the Trust must annually
satisfy three gross income requirements. First, at least 75% of the
Trust's gross income (excluding gross income from prohibited transactions)
for each taxable year must be derived from, among other things, interest
on obligations secured by mortgages on real property and rents from real
property. Second, at least 95% of the Trust's gross income (excluding
gross income from prohibited transactions) for each taxable year must be
derived from the sources described under the 75% gross income test,
dividends, interest, and gain from the sale or disposition of stock or
securities. Third, short-term gain from the disposition of securities,
8
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
Notes to Financial Statements
For the nine months ended September 30, 1997 and 1996
(Unaudited)
gain from prohibited transactions, and gain on the disposition of real
property held for less than four years (apart from involuntary conversions
and disposition of foreclosure property) must represent less than 30% of
the Trust's gross income (including gross income from prohibited
transactions) for each taxable year. The Trust, at the close of each
quarter of its taxable year, must also satisfy three tests relating to the
nature of its assets. First, at least 75% of the value of the Trust's total
assets must be represented by, among other things, mortgages on real
property, real property, cash, cash items and government securities.
Second, not more than 25% of the Trust's total assets may be represented by
securities other than those in the 75% asset class. Third, of the
investments included in the 25% asset class, the value of any one issuer's
securities owned by the Trust may not exceed 5% of the value of the Trust's
total assets and the Trust may not own more than 10% of any one issuer's
outstanding voting securities.
The Trust, in order to qualify as a REIT, is required to distribute
dividends (other than capital gain dividends) to its stockholders in an
amount at least equal to the sum of 95% of the Trust's AREIT taxable income
(excluding the Trust's net capital gain) and 95% of the net income (after
tax), if any, from foreclosure property.
If the Trust fails to qualify for taxation as a REIT in any taxable year,
and the relief provisions do not apply, the Trust will be subject to tax on
its taxable income at regular corporate rates. Distributions to
stockholders in any year in which the Trust fails to qualify will not be
deductible by the Trust nor will they be required to be made. Unless
entitled to relief under specific statutory provisions, the Trust will also
be disqualified from taxation as a REIT for the four taxable years
following the year during which qualification was lost.
Based on the Trust's belief that it has operated in a manner so as to allow
it to elect to be taxed as a REIT since inception, no provision for federal
income taxes has been made in the financial statements.
As part of the Taxpayer Relief Act of 1997 (the "1997 Tax Act"), various
changes have been made to the tax treatment of REITs effective for taxable
years beginning January 1, 1998. These changes include the repeal of the
rule that requires less than 30% of a REIT's income to be derived from gain
on the sale of other disposition of stock or securities held for less than
one year, certain real property held less than four years, and property
that is sold or disposed of in a prohibited transaction. In addition, the
1997 Tax Act expands the class of excess noncash items that are not subject
to the 95% distribution requirement to include income from the cancellation
of indebtedness.
Until final regulations or other pronouncements are issued by the Internal
Revenue Service concerning the provisions of the 1997 Tax Act, there may be
uncertainties affecting the interpretation of such provisions and their
effect on a REIT in general. The Trust cannot give assurance that its
positions or actions in reliance on the 1997 Tax Act provisions will not be
challenged by the Internal Revenue Service.
Fair value of financial instruments. For cash and cash equivalents, the
carrying amount is a reasonable estimate of fair value. For mortgage note
receivables, fair value is estimated by discounting the future cash flows
9
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
Notes to Financial Statements
For the nine months ended September 30, 1997 and 1996
(Unaudited)
using the current interest rates at which similar loans would be made to
borrowers with similar credit ratings and for the same remaining
maturities. It was determined that the difference between the carrying
amount and the fair value of the mortgage notes receivable is immaterial.
Organizational costs. Organization costs are capitalized and amortized on a
straight-line basis over five years.
Deferred offering costs. Deferred offering costs relate to an initial
public offering of common stock. When the offering is completed the costs
will be offset against the proceeds and recorded as a reduction of
stockholders' equity.
Real estate held for sale. Real estate held for sale results from
foreclosure of loans and at time of foreclosure is recorded at the lower of
carrying amount or fair value of the property minus estimated costs to
sell. At this time senior debt to which the asset is subject is reported as
mortgage payable. Subsequent to foreclosure, the foreclosed asset value is
periodically reviewed and is adjusted to fair value. No depreciation is
taken on the real estate held for sale. Income and expenses related to real
estate held for sale are recorded as interest income, interest expense and
general and administrative expenses on the Statements of Operations.
Pro-forma earnings per share. Prior to the merger of the Predecessors, the
Preferred Shares received 100% of the Trust's net income. The Preferred
Shares currently receive an annual preferred allocation of income and
distributions. After completion of the current offering of common shares
and after meeting such preference, 100% of any additional income earned
will be distributed to the Common Shares until the distribution on the
Common Shares matches that of the Preferred Shares (see Note 9). No common
shares were outstanding in prior periods.
4. Mortgage note holdbacks
-----------------------
Pursuant to mortgage loan agreements between the Trust and certain of its
borrowers, a portion of the loan proceeds are held by the Trust in
segregated accounts to be disbursed only to such borrowers upon completion
of certain improvements on the secured property. As of September 30, 1997
and December 31, 1996, mortgage note holdbacks from the consummation of
mortgage loans made amounted to $171,840 and $64,991, respectively.
5. Mortgage notes receivable
-------------------------
Mortgage notes receivable represent transactions with customers in which
the Trust has invested in home equity loans on residential real estate. The
Trust is subject to the risks inherent in finance lending including the
risk of borrower default and bankruptcy.
Mortgage notes receivable are stated at the principal outstanding. Interest
on the mortgages is due monthly and principal is due as a balloon payment
at loan maturity. The notes are secured by deeds of trust on residential
properties located primarily in California which results in a concentration
10
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
Notes to Financial Statements
For the nine months ended September 30, 1997 and 1996
(Unaudited)
of credit risk. The value of the loan portfolio may be affected by changes
in the economy or other conditions of the geographical area. A portion of
the notes are secured by a second position on the underlying properties and
loans are non-conforming loans to B/C-credit borrowers.
The Trust measures impairment based on the fair value of the related
collateral since all loans subject to this measurement are collateral
dependent. There was no investment in impaired loans for all periods
presented.
6. Accounts receivable
-------------------
Accounts receivable consists of accrued interest on mortgage notes
receivable and other amounts due from borrowers.
7. Mortgage notes payable
----------------------
As of September 30, 1997 the Trust held no mortgage notes payable.
8. Related party transactions
--------------------------
The Manager, which is owned by several of the Trustees and their affiliate,
contracted with the Trust to provide administration services and receives a
fee for these services from the Trust. The Manager is entitled to a per
annum Base Management Fee payable monthly in arrears of an amount equal to
1% of the Gross Mortgage Assets of the Trust (computed monthly) plus 2% of
cash or money-market or equivalent assets and incentive compensation for
each fiscal quarter, equal to 25% of the net income of the Trust in excess
of an annualized return on equity for such quarter equal to the ten year
U.S. Treasury Rate plus 2% provided that the payment of such incentive
compensation does not reduce the Trust's annualized return on equity for
such quarter to less than the ten year U.S. Treasury Rate plus 2% and
amounts payable on account of the Series A Preferred Preference Amount have
been paid. The Manager is also entitled to reimbursement for clerical and
administrative services at cost based on relative utilization of facilities
and personnel. Additionally, the Manager will receive a Loan Origination
and Servicing Fee payable monthly equal to 2% of the Gross Mortgage Assets
together with certain miscellaneous fees from borrowers customarily payable
in connection with origination and servicing of mortgages and fees for
other services requested by the Trust. The Manager bears all expenses of
services for which it is separately compensated. During the nine months
ended September 30, 1996, the Trust paid $39,254 to the Manager under
contracts with different compensation arrangements from those which became
effective in February, 1997. During the nine months ended September 30,
1997, the Trust paid $99,611 to the Manager.
As described in Note 3, the Trust holds an investment in Sierra Capital
Acceptance and receives a 15% guaranteed return per annum. For the four
months ended April 30, 1996, the Predecessors earned interest of $7,500
from the investment. For the five months ended September 30, 1996, the
Trust earned interest of $12,500 from the investment. For the nine months
ended September 30, 1997, the Trust received distributions of $22,500 from
this investment.
11
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
Notes to Financial Statements
For the nine months ended September 30, 1997 and 1996
(Unaudited)
As described in Note 1, the Trust formed its non-qualified REIT
subsidiary, Capital Alliance Funding Corporation, which commenced
operations in the third quarter of 1997. For the nine months ended
September 30, 1997, the Trust received distributions of $19,964 from this
investment.
9. Preferred Stock
---------------
The Preferred Shares are entitled to a distribution preference in an
amount equal to an annualized return on the Net Capital Contribution of
Preferred Shares at each dividend record date during such year (or, if the
Directors do not set a record date, as of the first day of the month)
equal to the lesser of 10.25% or 150 basis points over the Prime Rate
(determined on a not less than quarterly basis). The distribution
preference on the Preferred Shares is not cumulative.
After declaration of dividends for a given quarter to the Preferred Shares
in the amount of the distribution preference, no further distributions may
be declared on the Preferred Shares for the quarter until the current
Distributions declared on each Common Share for that quarter equals the
distribution preference for each Preferred Share for such quarter. Any
additional distributions generally will be allocated such that the amount
of distributions per share to the holders of the Preferred Shares and
Common Shares for the quarter are equal.
Holders of Preferred Shares are entitled to receive all liquidating
distributions until the aggregate adjusted net capital contribution of all
Preferred Shares has been reduced to zero. Thereafter, holders of Common
Shares are entitled to all liquidation distributions until the aggregate
adjusted net Capital contributions of all Common Shares has been reduced
to zero. Any subsequent liquidating distributions will be allocated among
the holders of the Common Shares and Preferred Shares pro rata.
The Preferred Shares, at the option of the Board of Directors, are
redeemable by a Shareholder annually on June 30 for redemption requests
received by May 15 of such year. The Board of Directors may in their sole
discretion deny, delay, postpone or consent to any or all requests for
redemption. The redemption amount to be paid for redemption of such
Preferred Shares is the adjusted net capital contribution plus unpaid
accrued dividends, divided by the aggregate net capital contributions plus
accrued but unpaid dividends attributable to all Preferred Shares
outstanding, multiplied by the net asset value of the Trust attributable
to the Preferred Shares which shall be that percentage of the Trust's net
asset value that the aggregate adjusted net capital contributions of all
Preferred Shares bears to the adjusted net capital contributions of all
Shares outstanding. A liquidation charge is charged by the Trust in
connection with each redemption as follows: 2% of redemption amount in
1997, 1% of redemption amount in 1998, and none thereafter.
12
<PAGE>
PART I
ITEM 2.
MANAGEMENT' DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION
13
<PAGE>
MANAGEMENT' DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The financial statements of Capital Alliance Income Trust Ltd., A Real
Estate Investment Trust (the "Trust") dated herein were prepared based upon the
combined historical operations of Capital Alliance Income Trust I ("CAIT I") and
Capital Alliance Income Trust II ("CAIT II") (CAIT I and CAIT II are
collectively referred to as the "Predecessors"). The operations of the
Predecessors have been combined due to the common management and directors. The
unaudited interim financial statements subsequent to the merger represent the
operations of the Trust (Successor). (See Note 2 to the financial statements).
General
Predecessors: The Combination. The Trust resulted from the consolidation
of CAIT I and CAIT II (the "Combination") on April 30, 1996. The Trust exchanged
shares of preferred stock for all of the outstanding whole shares of CAIT I and
CAIT II at April 30, 1996. Holders of the fractional shares of CAIT I and CAIT
II received cash in lieu of fractional shares of preferred stock of the Trust.
Thereafter, all assets and liabilities of CAIT I and CAIT II were transferred to
the Trust. CAIT I and CAIT II were both privately-held mortgage investment
trusts which invested primarily in loans secured by deeds of trust on
residential property. The Trust was incorporated in Delaware on December 12,
1995. CAIT II was formed October 18, 1994 and began its first year of operations
in 1995. CAIT I and CAIT II were formed and managed by Capital Alliance
Advisors, Inc. ("CAAI") which also manages the Trust and originates, services
and sells the Trust's mortgage loans.
Recent Trends. The Trust invests in non-conforming mortgage loans on
one-to-four unit residential properties because management believes that there
is a large demand for non-conforming mortgage loans on these kinds of properties
which produce higher yields without comparably higher credit risks when compared
with conforming mortgage loans. Management invests primarily in A-, B/C (or
less) credit rated home equity loans secured by deeds of trust. In general, B
and C credit rated home equity loans are made to borrowers with lower credit
ratings than borrowers of higher credit quality, such as A credit rated home
equity loans. Home equity loans rated A-, B/C (or less) tend to have higher
rates of loss and delinquency, but higher rates of interest than borrowers of
higher credit quality.
Management believes there is increased demand for high-yielding
non-conforming mortgage loans caused by a demand by investors for higher yields
due to low interest rates over the past few years and increased securitization
of high-yielding non-conforming mortgage loans by the investment banking
industry.
Loan Origination and Loan Servicing. Mortgage loan origination consists of
establishing a relationship with a borrower or his broker, obtaining and
reviewing documentation concerning the credit rating and net worth of borrowers,
inspecting and appraising properties that are proposed as the subject of a home
equity loan, processing such information and underwriting and funding the
mortgage loan. Mortgage loan servicing consists of collecting payments from
borrowers, accounting for interest payments, holding escrow funds until
fulfillment of mortgage loan requirements, contacting delinquent borrowers,
foreclosing in the event of unremedied defaults and performing other
administrative duties. Mortgage loan origination and loan servicing were
provided to the Trust by CAAI, its Manager.
Commitments and Contingencies. As of September 30, 1997, the Trust's loan
portfolio included total loans of $4,654,228 of which $463,584 representing 10%
of the loans were delinquent. There were no delinquent loans which were in the
process of foreclosure at September 30, 1997. In assessing the collectibility of
these delinquent mortgage loans, management estimates a net gain will be
realized upon sale of the properties securing these loans if it is necessary to
foreclose the mortgage loans due to the Trust. Management's estimate is based on
14
<PAGE>
an anticipated sales price of the property based on the latest appraised value
of the property discounted at 15% less the sum of pre-existing liens, costs of
sale, the face amount of the mortgage loan and accrued interest receivable. The
Trust generally issues loan commitments only on a conditional basis and
generally funds such loans promptly upon removal of any conditions. Accordingly,
the Trust did not have any commitments to fund loans as of September 30, 1996
and September 30, 1997.
Results of Operations
The results of operations of the Trust for all periods through December
31, 1996 were prepared based upon the combined historical operations of the
Predecessors through April 30, 1996 and of the Trust for subsequent periods. In
the comparison that follows references to the year ended December 31, 1996 refer
to the four months ended April 30, 1996 (Predecessor) and the eight months ended
December 31, 1996 (Successor) added together. The operations of the Predecessors
have been combined due to the common management and directors. The historical
information presented herein is not necessarily indicative of future operations.
Three months and Nine months ended September 30, 1997 and 1996. Revenues
for the third quarter decreased to $188,343 as compared to $190,284 for the same
period in the previous year. Revenues for the nine months of 1997 increased to
$596,266 as compared to $574,444 the same period of the previous year. Total
revenues remained constant in third quarter due to higher interest income in
1996 but offset by origination income and other income in third quarter 1997.
The increase in revenue in the nine month period in 1997 was primarily due to
origination income received from borrowers and to dividends received from the
Trust's newly-formed Mortgage Conduit Business compared to none in the same
period in the previous year.
Expenses for the third quarter 1997 decreased $54,980 compared to $59,709
for the same period in previous year. For the nine month period, expenses
increased to $208,931 compared to $123,117 for the predecessors from the
previous year. The decrease in the third quarter 1997 compared to third quarter
1996 is primarily due to lower general and administrative expenses. The increase
in the nine months of 1997 compared to 1996 is primarily due to loan servicing,
origination fees and management fees resulting from the increase in the Trust's
asset value from the Combination in April 30, 1996 and from different
compensation arrangements with the Manager prior to the commencement of the
Trust's current offering.
Inflation
The financial statements of the Trust, prepared in accordance with
generally accepted accounting principles, report the Trust's financial position
and operating results in terms of historical dollars and does not consider the
impact of inflation. Inflation affects the Trust's operations primarily through
its effect on interest rates, since interest rates normally increase during
period of high inflation and decrease during periods of low inflation. When
interest rates increase, the demand for mortgage loans and a borrower's ability
to qualify for mortgage financing may be adversely affected.
Liquidity and Capital Resources
The liquidity of the Trust will be based upon the need to fund investments
in mortgage loans. In previous years, the Trust's mortgage investment operations
have been funded by capital contributions and the payoff of prior loans. The
major portion of the proceeds from issuance of common stock in the Trust's
current Offering will be used to fund future investments in mortgage loans by
the Trust's Mortgage Investment Business. The Trust's liquidity requirements
will also be funded by periodical payoffs of existing loans which are generally
short term in duration, by the sale of foreclosed properties and additional
capital from the proceeds of the Trust's current Offering. Management believes
that the Trust's liquidity is sufficient to meet its cash requirements for the
15
<PAGE>
next twelve months regardless of whether the Minimum Subscription Level in the
Trust's current Offering is achieved. Restrictions on cash attributed to
holdbacks do not significantly impact the Trust's liquidity.
Net cash provided by operating activities during the nine months ended
September 30, 1997 and 1996 was $434,217 and $362,675, respectively. Net cash
for all periods was positively affected by improved marketing conditions and the
volume of loan activity in 1997.
Net cash provided by (used in) investing activities for the nine months
ended September 30, 1997 and 1996 was $212,376 and $(502,084), respectively. The
large increase in 1997 compared to the prior year is due to the volume of loans
and the proceeds from three real estate properties sold in 1997.
Net cash (used in) provided by financing activities during the nine months
ended September 30, 1997 and 1996 was $(669,737) and $(422,136), respectively.
The increase in the end of the year 1996 and nine months ended September 30,
1997 is primarily due to the offering costs related to the Trust.
The Trust will use the net proceeds of its current public offering to
provide additional funding for the Trust's Mortgage Investment Business. As of
September 1, 1997, CAFC entered into an agreement for a $1,000,000 warehouse
line of credit from Warehouse Lending Corporation of America, which line of
credit is documented and which will be guaranteed by the Trust. The Trust
additionally plans to enter into a warehouse line of credit agreement with the
CAFC for up to $4,000,000. Management believes that cash flow from operations
and the net proceeds of the public offering and of loans that are paid off plus
the establishment of the warehouse lines of credit for the Mortgage Conduit
Business will be sufficient to meet the liquidity needs of the Trust's
businesses for the next twelve months.
16
<PAGE>
PART II
OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
The trust is not involved in any legal proceedings at this time.
ITEM 2 CHANGES IN SECURITIES
There have been no changes in the outstanding securities of the Trust
at this time. The Trust's Certificate of Incorporation was amended,
effective July 31, 1997, to increase the Trust's authorized capital to
5,675,000 shares, 5,000,000 of which are Common Shares, $.01 par
value, and 675,000 of which are Series "A" Preferred Shares, $.01 par
value
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Trust held its 1997 annual meeting on August 6, 1997. The
outstanding Series "A" Preferred Shares constituted the only class of
voting stock outstanding and are not registered under Section 12.
Messrs. Thomas B. Swartz and Harvey Blomberg were elected to new terms
as Class I Directors. Messrs. Dennis R. Konczal, Douglas A. Thompson
and Stanley C. Brooks continue as Class II and III Directors.
The other matters voted on at the meeting also included (1) the
approval of an amendment of the Trust's Certificate of Incorporation;
and (2) the approval of Novogradac & Company LLP as auditors for 1997.
402,195 shares voted in favor of both propositions with no negative
votes.
ITEM 5 OTHER INFORMATION
Not applicable.
ITEM 6 REPORTS ON FORM 8-K
(a) Form 8-K The Registrant has not filed any reports on Form 8-K
during the quarter ended September 30, 1997.
17
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CAPITAL ALLIANCE INCOME TRUST LTD.,
A Real Estate Investment Trust
Dated: November 3, 1997 By: /s/ Thomas B. Swartz
--------------------
Thomas B. Swartz,
Chief Executive Officer
Dated: November 3,1997 By: /s/ Jeannette Hagey
-------------------
Jeannette Hagey,
Chief Financial Officer
18
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