UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 333-11625
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CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
(Exact name of registrant as specified in its charter)
Delaware 94-3240473
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(State or other Jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
50 California Street
Suite 2020
San Francisco, California 94111
(Address of principal executive office) (zip code)
(415) 288-9575
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
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Common Stock $0.01 par value American Stock Exchange
(Approved for listing upon notice of issuance)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No .
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (P. 229.405 of this chapter) is not contained herein, and will
not be contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.
[ ].
As of March 31, 1999, the aggregate market value of the Registrant's shares of
Common Stock, $.001 par value, held by nonaffiliates of the registrant was
approximately $6,681,330. At that date 1,484,740 shares were outstanding. The
shares are listed and publicly traded on the American Stock Exchange.
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TABLE OF CONTENTS
PART I...................................................................5
ITEM 1. BUSINESS...................................................5
General....................................................5
MORTGAGE INVESTMENT BUSINESS....................................5
General....................................................5
Mortgage Loan Portfolio....................................5
Financing..................................................6
MORTGAGE CONDUIT BUSINESS.......................................7
General....................................................7
Marketing and Production...................................8
Underwriting...............................................9
Whole Loan Sales..........................................10
WAREHOUSE LENDING BUSINESS.....................................10
HEDGING........................................................11
SERVICING......................................................11
Servicing Portfolio.......................................12
Geographical Distribution.................................13
Interest..................................................13
Maturity..................................................13
Delinquencies.............................................14
REGULATION.....................................................14
COMPETITION....................................................15
EMPLOYEES......................................................15
ITEM 2. PROPERTIES................................................15
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ITEM 3. LEGAL PROCEEDINGS.........................................15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.......16
ITEM 5. MARKET FOR REGISTRANT'S COMMON
EQUITY AND RELATED STOCKHOLDER MATTERS.............................16
PART II.................................................................18
ITEM 6. SELECTED FINANCIAL DATA...................................18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...................21
GENERAL........................................................21
Predecessors..............................................21
Organization..............................................21
Operating Strategy........................................21
Loan Origination and Loan Servicing.......................22
Contingencies and Commitments.............................22
RESULTS OF OPERATIONS..........................................22
YEAR ENDED DECEMBER 31, 1998
COMPARED TO YEAR ENDED DECEMBER 31, 1997.......................23
YEAR ENDED DECEMBER 31, 1997
COMPARED TO YEAR ENDED DECEMBER 31, 1996.......................23
INFLATION .....................................................24
LIQUIDITY AND CAPITAL RESOURCES................................24
LIQUIDITY AND CAPITAL RESOURCES
FOR THE YEAR ENDED DECEMBER 31, 1998...........................24
LIQUIDITY AND CAPITAL RESOURCES
FOR THE YEAR ENDED DECEMBER 31, 1997...........................25
YEAR 2000......................................................25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...............26
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS.............27
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PART III................................................................28
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT...........28
DIRECTORS......................................................28
EXECUTIVE OFFICERS.............................................29
ITEM 11. EXECUTIVE COMPENSATION...................................31
COMPENSATION OF OFFICERS.......................................31
COMPENSATION OF DIRECTORS......................................31
Director Fees.............................................31
Committee and Other Meeting Fees..........................31
Reimbursements............................................31
ITEM 12. SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...........................31
ITEM 13. CERTAIN RELATIONSHIPS
AND RELATED TRANSACTIONS...........................................32
Arrangements and Transactions with CAAI...................32
Investment in Related Mortgage Banking Firms..............33
Sale and Purchase of Loans................................33
Other Business Activities.................................34
PART IV.................................................................35
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS
SCHEDULES, AND REPORTS ON FORM 8-K.................................35
(a)(Financial Statements..................................35
(a)(3) Exhibits...........................................35
SIGNATURES.....................................................37
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PART I
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ITEM 1. BUSINESS
General. Unless the context otherwise requires, references herein to
the "Company" refer to Capital Alliance Income Trust Ltd., A Real Estate
Investment Trust (the "Trust"), and Capital Alliance Funding Corporation
("CAFC"), collectively.
Capital Alliance Income Trust Ltd., A Real Estate Investment Trust is a
specialty mortgage finance company which, together with its subsidiary, operates
a mortgage banking concern with three divisions which are referred to herein as
(1) the Mortgage Investment Business, (2) the Mortgage Conduit Business, and (3)
the Warehouse Lending Business. The Trust directly conducts its Mortgage
Investment Business, which invests for the Trust's portfolio of
collateral-oriented, high-yielding, non-conforming residential mortgage loans
and home equity loans and its Warehouse Lending Business which provides secured
warehouse and repurchase financing to CAFC and affiliated mortgage bankers. The
Mortgage Conduit Business, which originates and purchases as a wholesale
mortgage banker, non-conforming mortgage loans is conducted through CAFC in
which the Trust holds a 99% economic interest. Both the Company and CAFC are
externally advised by Capital Alliance Advisors, Inc. ("CAAI").
The Trust resulted from the consolidation in April 1996 of two private
affiliated mortgage lending firms ("Predecessors"). The Trust was incorporated
in Delaware in 1995. The Predecessors to the Trust were formed and managed by
CAAI. On September 30, 1998 the Trust concluded an initial public offering of
its Common Stock for $11,877,92 (1,484,740 shares at $8.00 per share with
warrants to purchase 148,474 additional shares of Common Stock).
References to financial information of the Trust for the year ended
1997 and 1998, reflect the financial operations of the Trust and its Mortgage
Investment and Mortgage Warehouse businesses and the Trust's equity interest in
the Mortgage Conduit Business conducted by CAFC. References to financial
information of the Trust for the year ended 1996, reflect the financial
operations of the Trust and its Predecessors.
MORTGAGE INVESTMENT BUSINESS
General. The Trust, through its Mortgage Investment Business, acquires
mortgage loans which are principally nonconforming, A- B/C credit-rated
residential mortgage loans with a maximum 75% combined loan-to-value ratio for
long-term investment. The Mortgage Investment Business invests in both first and
second mortgage loans. Income is earned principally from the net interest income
received by The Trust on mortgage loans held in its portfolio and from fees
received in connection with their origination. Such acquisitions are financed
with a portion of the Trust's capital. Loans, other than warehouse lines of
credit repurchase financing obtained by CAFC, are restricted by the Trust's
Bylaws to 20% of the Trust's Net Capital Contributions. CAFC supports the
investment objectives of the Trust by supplying substantially all of the
mortgage loans held by the Trust. (See "Mortgage Conduit Business.")
Mortgage Loan Portfolio. The Trust (a) through its Manager
originates mortgage loans, through its Advisor's main office in San Francisco
and its branch office in San Diego, California and through its network of
mortgage brokers and correspondents, and (b) invests a substantial portion of
its portfolio in non-conforming mortgage loans and second mortgage loans. The
Trust also purchases such loans from third parties, including CAFC, for
long-term investment. Management believes that non-conforming mortgage loans
provide an attractive net earnings profile and produce higher yields without
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commensurately higher credit risks when compared with conforming mortgage loans.
The investment portfolio of the Mortgage Investment Business consists primarily
of "B" and "C" grade mortgage loans. The Trust believes that a structural change
in the mortgage banking industry has occurred which has increased demand for
higher yielding non-conforming mortgage loans. This change has been caused by a
number of factors, including: (1) investors' demand for higher yielding assets
due to historically low interest rates over the past few years; (2) increased
securitization of high-yielding non-conforming mortgage loans by the investment
banking industry; (3) quantification and development of standardized credit
criteria by credit rating agencies for securities backed by non-conforming
mortgage loans; and (4) increased competition in the securitization industry,
which has reduced borrower interest rates and fees, thereby making
non-conforming mortgage loans more affordable. The Trust's Manager owns a 1%
economic interest and 100% of the of voting control of CAFC.
Financing. The Mortgage Investment Business is financed principally by
the Trust's capital. The Trust's Bylaws restrict the encumbrance of the Trust's
assets to 20% of the Trust's Net Capital Contributions. The Trust's portfolio of
mortgage loans at December 31, 1998 was and currently still is unencumbered.
Such restriction does not apply to CAFC which utilizes warehouse lines of credit
from commercial lenders.
The Trust does not currently plan to issue Mortgage-Backed Securities,
such as Collateralized Mortgage Obligations ("CMOs") or mortgage pass-through
certificates representing an undivided interest in pools of mortgage loans
formed by the Trust. There is no assurance that the Trust will not adopt
financing strategies in the future which will include the issuance of
mortgage-backed securities as an alternative for the financing of its Mortgage
Investment Business. Similarly, the investment policies of the Trust for its
Mortgage Investment Business and its Bylaws may be modified by the Trust's Board
of Directors.
The Trust, through CAFC, has obtained financing with two third-party
commercial lenders, at interest rates that are consistent with its financing
objectives described herein, and has established financing facilities under
which such lenders are required to enter into new reverse repurchase agreements
as needed by CAFC during a specified period of time. CAFC's warehouse repurchase
financings are guaranteed by the Trust. For a discussion of the terms of the
Trust's reverse repurchase facilities, see "Item 7. Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources." The Trust also extends a warehouse reverse repurchase facility to
CAFC which at December 31, 1998 aggregated $2,414,435 million. A reverse
repurchase agreement, although structured as a sale and repurchase obligation,
acts as a financing vehicle under which CAFC effectively pledges its mortgage
loans as collateral to secure a short-term loan. Generally, the other party to
the agreement makes the loan in an amount equal to a percentage of the market
value of the pledged collateral.
Reverse repurchase agreements take the form of a sale of securities to
the lender at a discounted price in return for the lender's agreement to resell
the same securities to the borrower at a future date (the maturity of the
borrowing) at an agreed price. In the event of the insolvency or bankruptcy of
the Trust, certain reverse repurchase agreements may qualify for special
treatment under the Bankruptcy Code, the effect of which is, among other things,
to allow the creditor under such agreements to avoid the automatic stay
provisions of the Bankruptcy Code and to foreclose on the collateral agreements
without delay. In the event of the insolvency or bankruptcy of a lender during
the term of a reverse repurchase agreement, the lender may be permitted, under
the Bankruptcy Code, to repudiate the contract, and the Trust's claim against
the lender for damages therefrom may be treated simply as one of the unsecured
creditors. In addition, if the lender is a broker or dealer subject to the
Securities Investor Protection Act of 1970, the Trust's ability to exercise its
rights to recover its securities under a reverse repurchase agreement or to be
compensated for any damages resulting from the lender's insolvency may be
further limited by such statute. If the lender is an insured depository
institution subject to the Federal Deposit Insurance Act, the
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Trust's ability to exercise its rights to recover its securities under a reverse
repurchase agreement or to be compensated for damages resulting form the
lender's insolvency may be limited by such statute rather than the Bankruptcy
Code. The effect of these various statutes is, among other things, that a
bankrupt lender, or its conservator or receiver, may be permitted to repudiate
or disaffirm its reverse repurchase agreements, and the Trust's claims against
the bankrupt lender for damages resulting therefrom may be treated simply as one
of an unsecured creditor. Should this occur, the Trust's claims would be subject
to significant delay and, if and when received, may be substantially less than
the damages actually suffered by the Trust.
To reduce its exposure to the credit risk of reverse repurchase
agreement lenders, the Trust has entered into two such agreements with two major
warehouse lenders and a third with the Trust. Notwithstanding these measures, no
assurance can be given that the Trust will be able to avoid such third party
risks.
MORTGAGE CONDUIT BUSINESS
General. CAFC was organized on June 27, 1997 and began its mortgage
origination and whole loan sales operations on a start-up basis in August, 1997.
The Mortgage Conduit Business consists primarily of the origination and the
purchase and sale of A- and B/C credit rated mortgage loans secured by first
liens and second liens on single (one-to-four) family residential properties
that are originated in accordance with its underwriting guidelines. As a
non-conforming mortgage loan conduit, the Trust's Mortgage Conduit Business acts
as a conduit between the originators of such mortgage loans and permanent
investors in such loans. Capital Alliance Advisors, Inc. contracts with CAFC for
its management and for its mortgage origination, loan processing and
underwriting, and secondary sales services. The Management believes that
non-conforming A- and B/C credit rated mortgage loans, when properly
underwritten, provide an attractive net earnings profile, producing higher
yields without disproportionately higher credit risks when compared to mortgage
loans that qualify for purchase by FNMA or FHLMC. The Trust's policy for its
Mortgage Investment Business, which limits the financing or leveraging of its
mortgage loan portfolio, does not apply to its Mortgage Conduit Business since
such mortgage loans are generally held in CAFC for less than sixty days prior to
their sale to permanent investors who securitize such loans in the secondary
market and their acquisition or funding will generally be facilitated through a
warehouse line of credit or reverse repurchase agreements.
Correspondents originate and close mortgage loans under CAFC's mortgage
loan programs on a loan-by-loan basis. Correspondents include mortgage bankers
and mortgage brokers. During the partial years ended December 31, 1997 and 1998
, CAFC acquired from its correspondents (primarily mortgage brokers) or funded
directly (through its Manager) $1,722,200 and $9,603,114, respectively, of
non-conforming mortgage loans.
All non-conforming loans purchased or originated by CAFC which meet the
Trust's underwriting guidelines, including its 75% Combined Loan-to-Value
limitation, are made available for sale to the Trust at fair market value at the
date of sale and subsequent transfer to the Trust. See "Item 13. Certain
Relationships and Certain Transactions." Loans not purchased by the Trust for
its Mortgage Investment Business will be sold in the secondary market through
whole loan sales. During the partial year of operations in 1997, CAFC sold four
loans to the Trust totaling $326,750. During 1998, nine loans were sold to the
Trust totaling $1,252,250. Whole loan sales by CAFC during 1998 totaled
$4,175,007 as compared to $1,206,200 in 1997.
The Mortgage Conduit Business acquires all of the servicing rights on
loans it originates or purchases and such servicing rights will normally be
relinquished when loans are sold into the secondary market. The Mortgage Conduit
Business generally has no on-going risk of loss after a whole loan sale
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other than liability with respect to normal warranties and representations given
in such sales and for fraud in the origination process.
The Trust's Mortgage Conduit Business does not currently plan to
directly securitize the loans originated and purchased by it as such
securitization generally requires a mortgage portfolio of at least $50 million
together with substantial reserves to fund defaults in the portfolio. There is
no assurance that in the future, if the Mortgage Conduit Business had a large
enough portfolio and sufficient reserves it would not securitize such loans,
either directly or indirectly, (as a participant with other mortgage banking
firms in a multiple party securitization program).
Marketing and Production. CAFC's competitive strategy in its Mortgage
Conduit Business is, through its Mortgage Loan Origination Services Agreement
with CAAI, to be a substantial originator, through a mortgage loan broker and
correspondent network, of A-, B/C residential mortgage loans to be sold in the
secondary market network. This enables CAFC to shift the high fixed costs of
interfacing with the homeowner to the correspondents and brokers. The marketing
strategy for the Mortgage Conduit Business is designed to accomplish three
objectives: (1) attract a diverse group of loan originators and loan
correspondents throughout California and the western United States, (2)
establish relationships with such brokers and correspondents and, (3) originate
and/or purchase the loans on both an individual and bulk basis and sell them
into the secondary market or, where they meet the Trust's underwriting
standards, to the Trust's Mortgage Investment Business. To accomplish these
objectives, the Mortgage Conduit Business intends to expand its reach,
geographically, to develop and provide responsive and consistent underwriting
and funding services to the mortgage broker and correspondent networks which it
plans to develop.
CAFC and the Trust emphasize flexibility in their mortgage loan
products to attract correspondents and establish relationships. CAFC also
maintains relationships with numerous end-investors so that it may develop
products that they may be interested in as market conditions change, which in
turn may be offered through the correspondent network. As a consequence, CAFC
and the Trust have acquired increasing volumes of non-conforming loans.
Additionally, in response to the needs of its non-conforming mortgage loan
correspondents, CAFC's marketing strategy offers efficient response time in the
origination and purchase process, and direct and frequent contact with its
correspondents.
A substantial portion of the mortgage loans to be originated or
purchased through the Mortgage Conduit Business are expected to be "A-", "B" and
"C" grade non-conforming mortgage loans. Such non-conforming loans may involve
some greater risk as a result of underwriting and product guidelines which will
differ from those applied by FNMA and FHLMC primarily with respect to
loan-to-value ratios, borrower income or credit history, required documentation,
interest rates, and borrower occupancy of the mortgaged property. The Mortgage
Conduit Business generally will not originate or acquire mortgage loans with
principal balances above $300,000 since such loans generally entail greater
credit risks than other non-conforming loans although it is not precluded from
doing so.
In general, "A-", "B" and "C" grade loans are non-conforming
residential mortgage loans made to borrowers with lower credit ratings than
borrowers of higher quality, or so called "A" grade mortgage loans, and are
normally subject to higher rates of loss and delinquency than the other
non-conforming loans to be purchased by the Mortgage Conduit Business. As a
result, "A-", "B" and "C" grade loans normally bear a higher rate of interest,
and may be subject to higher fees (including greater prepayment fees and late
payment penalties), than non-conforming loans of "A" quality. In general,
greater emphasis is placed upon the credit history of the borrower in
underwriting "A-", "B" and "C" grade mortgage loans than in underwriting "A"
grade loans. In addition, "A-", "B" and "C" grade loans are generally subject to
lower loan-to-value ratios than "A" grade loans.
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It is anticipated that mortgage loans originated or acquired by the
Mortgage Conduit Business will generally be secured by first liens and/or second
liens on single (one-to-four) family residential properties with either fixed or
adjustable interest rates. Fixed-rate mortgage loans have a constant interest
rate over the life of the loan, which is generally 15, 20 or 30 years. The
interest rate on an adjustable rate mortgage ("ARM") is typically tied to an
index (such as LIBOR) and is adjusted periodically at various intervals. Such
mortgage loans are typically subject to lifetime interest rate caps and periodic
interest rate and/or payment caps. The interest rates on ARMs are typically
lower than the average comparable fixed rate loan initially, but may be higher
than average comparable fixed rate loans over the life of the loan. Management
anticipates that substantially all mortgage loans purchased or originated by the
Mortgage Conduit Business will fully amortize over their remaining terms.
The Mortgage Conduit Business' planned focus on the origination and
acquisition of non-conforming A- and B/C credit mortgage loans may affect CAFC's
financial performance. For example, the origination and purchase market for
non-conforming loans has typically provided for higher interest rates, thereby
potentially enhancing the interest income earned by the Mortgage Conduit
Business during the accumulation phase for loans held for sale. However, the
Mortgage Conduit Business will assume the potential risk of any increased
delinquency rates and/or credit losses as well as interest rate risk in the
event there is a delay in the sale of such loans to permanent investors.
Normally, such on-going risks, upon the sale of a loan will pass to the
purchaser without recourse to CAFC and are reduced by the relatively short
period that such loans are held and accumulated prior to sale to permanent
investors.
The Mortgage Conduit Business' loan purchase activities are expected in
the future to focus on those Western states of the United States where higher
volumes of non-conforming mortgage loans are originated, including California,
Nevada, Utah, Colorado, Oregon, Arizona and Washington.
At December 31, 1998 the Trust's loan portfolio totaled $8,986,645 with
an average loan size of $124,814 an average weighted yield of 12.43%, an average
maturity of 14.06 months and a combined loan-to-value ratio of 70.69%. 71% of
the portfolio were first deeds of trust and 29% were second deeds of trust.
The highest concentration of nonconforming mortgage loans originated or
purchased by the Trust relates to properties located in California because of
the generally higher property values and mortgage loan balances prevalent there.
The Trust's Manager through its correspondent and broker network accounted for
100% of the total mortgage loans acquired by the Trust during the year ended
December 31,1998, and together with CAFC (which is also managed by CAAI) for
100% of the total mortgage loans acquired by the Trust during the year ended
December 31, 1998. CAFC and the Trust's Manager are affiliates of the Trust.
(See "Item 13. Certain Relationships and Certain Transactions.")
Underwriting. The Trust has developed origination and purchase
guidelines for the acquisition of mortgage loans by the Trust for the Mortgage
Investment Business. Subject to certain exceptions, each loan purchased must
conform to the Trust's loan eligibility requirements with respect to, among
other things, loan amount, type of property, loan-to-value ratio, type and
amount of insurance, credit history of the borrower, income ratios, sources of
funds, appraisals and loan documentation.
The Trust's Manager, CAAI, provides documentation for the origination
or purchase of mortgage loans and performs the underwriting function for all of
the Trust's loans on a contract basis with the Trust. The Trust's Manager also
performs a full credit review and analysis to ensure compliance with its loan
eligibility requirements. This review specifically includes, among other things,
an analysis of the underlying property and associated appraisal and an
examination of the credit, employment and income history of the borrower. Under
all of these methods, loans are originated or purchased only after completion of
a legal documentation and eligibility criteria review.
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Under all of the Trust's and CAFC's underwriting methods, loan
documentation requirements for verifying the borrowers' income and assets vary
according to loan-to-value ratios, credit ratings and other factors. This
variation is necessary to be competitive and responsive to the needs of the
non-conforming mortgage loan sellers. Generally, as the standards for required
documentation are lowered, borrowers' down payment requirements are increased
and the required loan-to-value ratios are decreased. These types of loans with
less documentation are reviewed on a risk analysis underwriting basis. Reduced
documentation loans require the borrower to have a stronger credit history and
larger cash reserves and the appraisal of the property is validated by either an
enhanced desk or field review. The underwriters utilize a risk analysis approach
to determine the borrower's ability and willingness to repay the debt and to
determine if the property taken as security has sufficient value to recover the
debt in the event that the loan defaults. Each loan is reviewed for compensating
factors (i.e., credit reports, sufficient assets, appraisal, job stability,
ability to repay the loan), and overall compensating factors are reviewed to
fully analyze the risk.
CAAI reviews each loan prior to the Trust's commitment to originate or
purchase a mortgage loan to ensure that the mortgage loans meet its quality
standards. The type and extent of the quality control review depends on the
nature of the seller and the characteristics of the loans. In performing a
quality control review on a loan, CAAI analyzes the underlying property
appraisal and examines the credit and income history of the borrower. In
addition, all documents submitted in connection with the origination or purchase
of the loans, including insurance policies, title policies, deeds of trust or
mortgages and promissory notes, are examined for compliance with the Trust's and
CAFC's guidelines and to ensure compliance with state and federal regulations.
Whole Loan Sales. The Mortgage Conduit Business conducted by CAFC
primarily uses a warehouse repurchase financing from the Trust and warehouse
financing from two other commercial warehouse lenders to finance the origination
or acquisition of mortgage loans from correspondents. When a sufficient volume
of mortgage loans (generally packages of $1 million to $2 million) with similar
characteristics has been accumulated, CAFC sells such packages to investors at a
premium in whole loan sale transactions on a service-released basis.
Neither the Trust nor CAFC currently plans to sell senior interests in
its loans in the secondary market through a securitization program under which
it could retain a residual interest in each loan securitization. While the pools
of loans sold by the Trust's Mortgage Conduit Business will generally be sold on
a non-resource basis with respect to economic interest and rate risk, such bulk
whole loan sales will generally be made pursuant to agreements that provide for
recourse by the purchaser against the Trust's Mortgage Conduit Business in the
event of a breach of any representation or warranty made by the Trust's Mortgage
Conduit Business, any fraud or misrepresentation during the mortgage loan
origination process or upon early default on such mortgage loans. The Trust's
Mortgage Conduit Business will generally try to limit the remedies of such
purchasers to the remedies the Trust's Mortgage Conduit Business receives from
the persons from whom the Trust's Mortgage Conduit Business purchases a portion
of such mortgage loans. However, in some cases, the remedies available to a
purchaser of mortgage loans may be broader than those available to the Trust's
Mortgage Conduit Business against its seller, and should a purchaser exercise
its remedies and rights against it, the Mortgage Conduit Business may not always
be able to enforce whatever remedies it may have against its sellers.
WAREHOUSE LENDING BUSINESS
The Trust's third line of business is its Warehouse Lending Business.
Such operations consist primarily of warehouse financing for its affiliated
mortgage bankers, including CAFC and Sierra Capital Funding, LLC and its
separate divisions ("SCF/LLC"), all of which act as correspondents of the Trust.
The non-conforming mortgage loans funded with such warehouse financing are
acquired by the Trust for its
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portfolio when such loans meet its investment criteria. Warehouse lending
facilities provide repurchase financing for mortgage loans from the time of
closing the loan to the time of its sale or other settlement with the
pre-approved investor. The Trust's warehouse financing is non-recourse and the
Trust can only look to the sale or liquidation of the mortgage loans as a source
of repayment or repurchase. Any claim of the Trust as a secured lender in a
bankruptcy proceeding may be subject to adjustment and delay. Borrowings under
the warehouse facilities are presented on the Trust's balance sheets as finance
receivables.
The Trust provides a $3 million warehouse line to CAFC. The CAFC
warehouse financing balance outstanding on the Trust's balance sheet is
structured to qualify under the REIT asset tests and to generate income
qualifying under the 75% gross income test. The terms of the warehouse line are
based on the rate of the Mortgage Note plus a fee of $50 or such other fee (not
to exceed $500) as the parties may agree and with an advance rate of 100% of the
fair value of the mortgage loans outstanding. The terms of the Trust's other
warehouse financing, including the amount, are determined based upon the
financial strength, historical performance and other qualifications of the
borrower. (See "--Mortgage Investment Business-- Financing.")
At December 31, 1998, the Trust had $2,414,435 of warehouse facilities
utilizing reverse repurchase agreements outstanding to CAFC, and $820,100 to SCA
and $1,472,563 to Equity 1-2-3, divisions of SCF/LLC, and $450,000 to Calliance
Mortgage Trust ("CMT"). The Trust finances its Warehouse Lending Business
through equity and may utilize reverse repurchase agreements in the future.
HEDGING
The Mortgage Conduit Business to date has originated or purchased
primarily fixed-rate mortgage loans. All of the mortgage loans held by the
Mortgage Investment Business carry fixed rates and have relatively short
maturities. The average weighted maturity of loans held in the Mortgage
Investment Business at December 31, 1998 was 14.06 months. As the production of
fixed-rate mortgage loans increases or if maturities increase, it is anticipated
that various hedging strategies will be implemented to provide protection
against interest rate risks. The nature and quantity of hedging transactions
will be determined by the Manager based on various factors, including market
condition, the expected volume of mortgage loan originations and purchases and
the period of time required to accumulate and to sell mortgage loans.
However, an effective hedging strategy is complex and no hedging
strategy can completely insulate the Mortgage Conduit Business or Mortgage
Investment Business from interest rate risks. In addition, hedging involves
transaction and other costs, and such costs could increase as the period covered
by the hedging protection increases or in period of rising and fluctuating
interest rates. Therefore, the Mortgage Conduit Business or Mortgage Investment
Business may be prevented from effectively hedging its interest rate risks,
without significantly reducing its return on equity.
SERVICING
The Trust currently acquires all of its mortgage loans on a
"servicing-released" basis and thereby acquires the servicing rights. The Trust
and CAFC subcontract all of their servicing obligations under such loans to
CAAI, the Trust's Manager. Servicing includes collecting and remitting loan
payments, making required advances, accounting for principal and interest,
holding escrow or impound funds for payment of improvement holdbacks, interest,
taxes and insurance, if applicable, making required inspections of the mortgaged
property, contacting delinquent borrowers and supervising foreclosures and
property dispositions in the event of unremedied defaults in accordance with the
Trust's guidelines.
11
<PAGE>
Servicing Portfolio. The following table sets forth certain information
regarding the Trust's servicing portfolio of loans for the periods shown.
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12
<PAGE>
PERIOD FROM
JANUARY 1, 1996
YEARS ENDED THROUGH
DECEMBER 31, 1996, DECEMBER 31, 1997, AND DECEMBER 31, 1998
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1997 December 31, 1998
----------------- ----------------- ------------------
<S> <C> <C> <C>
Beginning servicing portfolio .............. $ 4,725,895 $ 4,696,238 $ 4,915,186
Loans added to the servicing portfolio ..... $ 1,952,384 $ 3,254,256 $10,342,300
Loans sold, servicing released and principal
paydowns (1) ........................... $ 1,982,041 $ 3,035,308 $ 6,270,841
Ending servicing portfolio ................. $ 4,696,238 $ 4,915,186 $ 8,986,645
Number of loans serviced ................... 50 45 72
Average loan size .......................... $ 93,925 $ 109,226 $ 124,815
<FN>
(1) Includes normal loan payoffs, principal amortization, prepayments, less
reserves and foreclosures. The Trust does not charge a prepayment penalty on its
loans.
</FN>
</TABLE>
Geographical Distribution. The following table sets forth the geographic
distribution of the Trust's servicing portfolio at the dates presented:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997 December 31, 1996
--------------------------------- ------------------------------------- -----------------------------------
Number Percentage Number Percentage Number Percentage
State of of of of of of
-----
Loans Portfolio Loans Portfolio Loans Portfolio
----- --------- ----- --------- ----- ---------
<S> <C> <C> <C> <C> <C> <C>
CA 69 95% 45 100% 49 94%
OR 1 1% 0 0% 0 0%
UT 2 4% 0 0% 1 6%
</TABLE>
Interest. The weighted average interest for the Trust's portfolio of
loans in its Mortgage Investment Business at December 31, 1998 was 12.43%, at
December 31, 1997 it was 12.32%, and at December 31, 1996 it was 12.99%.
Maturity. The weighted average maturity of the Trust's portfolio of
loans in its Mortgage Investment Business at December 31, 1998 was 14.06 months,
at December 31, 1997 it was 18.75 months, and at December 31, 1996 it was 17.62
months. The following table shows the Trust's loan maturities at the dates
presented.
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997 December 31, 1996
---------------------------------- -------------------------------- -------------------------------
Terms Amount Percentage Amount Percentage Amount Percentage
of of of of of of of
Loans Loans Portfolio Loans Portfolio Loans Portfolio
----- ----- --------- ----- --------- ----- ---------
<S> <C> <C> <C> <C> <C> <C>
0-12 months $5,530,300 61.54% $2,651,900 53.95% $1,568,128 33.39%
13-24 months 1,429,900 15.91% 896,412 18.24% 918,874 19.57%
25-36 months 824,712 9.18% 636,349 12.95% 1,321,192 28.13%
37-48 months None 0.00% None 00.00% None 00.00%
Over 48 months 1,201,733 13.37% 730,525 14.86% 888,044 18.91%
----------- ------ ------- ------ ------- -----
$8,986,645 100% $4,915,186 100% $4,696,238 100%
</TABLE>
13
<PAGE>
Delinquencies. The following table shows the Trust's delinquency statistics
for its servicing portfolio at the dates presented.
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997 December 31, 1996
------------------------------- --------------------------------- --------------------------------
Loans Number Percentage Number Percentage Number Percentage
Delinquent For: of Loans of Portfolio of Loans of Portfolio of Loans of Portfolio
-------------- -------- ------------ -------- ------------ -------- ------------
<S> <C> <C> <C> <C> <C> <C>
30-59 days 6 5% 6 7% 5 6%
60-89 days 2 2% 2 3% 3 7%
5%%
90 days+ 3 3% 2 6% 2 7%
--- ---- ---- ---- === ====
Totals: 11 10% 10 16% 10 20%
</TABLE>
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997 December 31, 1996
------------------------------ --------------------------------- -------------------------------
Number Percentage Number Percentage Number Percentage
of Loans of Portfolio of Loans of Portfolio of Loans of Portfolio
-------- ------------ -------- ------------ -------- ------------
<S> <C> <C> <C> <C> <C> <C>
Foreclosures 2 3% 3 9% 5 14%
pending:
Bankruptcies 1 1% 2 3% 2 3%
=== ===== === ==== === ====
pending:
Total
delinquencies,
foreclosures and
bankruptcies: 14 14% 15 28% 17 38%
</TABLE>
REGULATION
The Trust at all times intends to conduct its business so as not to
become regulated as an investment Trust under the Investment Trust Act. The
Investment Trust Act exempts entities that are "primarily engaged in the
business of purchasing or otherwise acquiring mortgages and other liens on and
interests in real estate" ("Qualifying Interest"). Under the current
interpretation of the staff of the Commission, in order to qualify for this
exemption, the Trust must maintain at least 55% of its assets directly in
mortgage loans, and certain other Qualifying Interests in real estate. If the
Trust fails to qualify for exemption from registration as an investment Trust,
its ability to use leverage in its Mortgage Investment Business would be
substantially reduced, and it would be unable to conduct its business as
described herein. The Trust has not requested a legal opinion from counsel
indicating that, it will be exempt from the Investment Trust Act.
Because the Trust's business is highly regulated, the laws, rules and
regulations applicable to the Trust are subject to regular modifications and
change. There are currently proposed various laws, rules and regulations which,
if adopted, could impact the Trust. There can be no assurance that these
proposed laws, rules and regulations, or other such laws, rules or regulations,
will not be adopted in the future which could make compliance much more
difficult or expensive, restrict the Trust's ability to originate, broker,
purchase or sell loans, further limit or restrict the amount of commissions,
interest and other charges earned on loans originated, brokered, purchased or
sold by the Trust, or otherwise affect the business or prospects of the Trust.
Also, members of Congress and government officials have from time to time
suggested the elimination of the mortgage interest deduction for federal income
tax purposes, either entirely or in part, based on borrower income, type of loan
or principal amount. Because many of the
14
<PAGE>
Trust's loans are made to borrowers for the purpose of consolidating consumer
debt or financing other consumer needs, the competitive advantages of tax
deductible interest, when compared with alternative sources of financing, could
be eliminated or seriously impaired by such government action. Accordingly, the
reduction or elimination of these tax benefits could have a material adverse
effect on the demand for loans of the kind offered by the Trust.
Additionally, there are various state and local laws and regulations
affecting the Mortgage Conduit Business. CAFC is licensed in those states
requiring such a license. Mortgage operations also may be subject to applicable
state usury statutes. The Trust is presently in material compliance with all
material rules and regulations to which it is subject.
COMPETITION
The Trust believes that it will continue to be able to compete in both
its Mortgage Investment Business and its Mortgage Conduit Business on the basis
of providing prompt and responsive service and flexible underwriting for
independent mortgage brokers and correspondents to offer to their customers.
Continued consolidation in the mortgage banking industry may also
reduce the number of current correspondents to the Mortgage Conduit Business,
thus reducing the Trust's potential customer base, resulting in CAFC or the
Trust purchasing a larger percentage of mortgage loans from a smaller number of
sellers. Such changes could negatively impact the Mortgage Conduit Business.
The Trust faces competition in its Mortgage Investment Business and
Mortgage Conduit Business from other financial institutions, including but not
limited to banks and investment banks. At present such competition is not
material to the Trust's Warehouse Lending Operations. Many of the institutions
with which the Trust competes have significantly greater financial resources
than the Trust.
EMPLOYEES
The Trust has no employees. The Manager employs and provides all of the
persons required for the operation of the Trust and its Mortgage Investment
Business. At March 30, 1999, the Manager employed 12 persons plus several
contract personnel. Additional employees will be required to staff the Mortgage
Conduit Business. None of the Manager's employees is subject to a collective
bargaining agreement. The Manager believes that its relations with its employees
are satisfactory.
ITEM 2. PROPERTIES
The Trust's and its Manager lease executive and administrative offices
located at 50 California Street, Suite 2020, San Francisco, California, 94111,
and consist of approximately 3,000 square feet.
The Manager also leases space for its San Diego, California branch
office on a short-term basis.
Management believes that the terms of the leases are at least as
favorable as could have been obtained from an unaffiliated third party.
Management believes that these facilities are adequate for the Manager's and the
Trust's foreseeable needs and that alternate space at reasonable rental rates is
available, if necessary.
ITEM 3. LEGAL PROCEEDINGS
None.
15
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
No matters were submitted to a vote of the Trust's security holders
during the last quarter of its fiscal year ended December 31, 1998.
ITEM 5. MARKET FOR REGISTRANT'S COMMON
EQUITY AND RELATED STOCKHOLDER MATTERS
The Trust's Common Stock was listed and began trading on the American
Stock Exchange under the symbol "CAA" on October 1, 1998. The range of high and
low sale prices of the Common Stock as quoted on the American Stock Exchange
were: Fourth Quarter of 1998: High-8, Low-4; First Quarter of 1999: High -5-5/8,
Low-4.5. At March 31, 1999 the Trust had issued and outstanding 1,484,740 shares
of the Trust's Common Stock which were issued for $11,877,920 and warrants to
acquire an additional 148,474 shares of Common Stock.
On March 22, 1999, there were approximately 153 holders of record
(including holders who are nominees for an undetermined number of beneficial
owners) of the Trust's Common Stock and 139 holders of record of the Trust's
Preferred Stock which is not publicly traded. The Trust believes that its Common
Stock is beneficially held by an excess of 700 shareholders.
To maintain its qualification as a REIT, the Trust has made and intends
to make annual distributions to stockholders of at least 95% of its taxable
income (which may not necessarily equal net income as calculated in accordance
with GAAP), determined without regard to the deduction for dividends paid and
excluding any net capital gains. the Trust declares regular quarterly dividend
distributions. Any taxable income remaining after the distribution of the
regular quarterly or other dividends will be distributed annually on or prior to
the date of the first regular quarterly dividends payment date of the following
taxable year. The dividend policy is subject to revision at the discretion of
the Board of Directors. All distributions in excess of those required for the
Trust to maintain REIT status will be made by the Trust at the discretion of the
Board of Directors and will depend on the taxable earnings of CAFC, the
financial condition of the Trust and such other factors as the Board of
Directors deems relevant. The Board of Directors has not established a minimum
distribution level for the Trust's Common Stock.
The Trust declared and on January 15, 1998 paid its initial quarterly
dividend on the Trust's Common Stock for the quarter ended December 31, 1997 at
$.054 per share, which dividend covered the period from December 4, 1997 to
December 31, 1997 only and did not reflect a full quarter of operations. The
Trust paid quarterly dividends on the Trust's Common Stock for the quarters
ending March 31, 1998, June 30, 1998, September 30, 1998 and December 31, 1998
at $.17 per share. The Trust during 1998 paid 12 consecutive monthly dividends
on the Trust's Preferred Stock at an average of $.07 per share per month.
Holders of the Preferred Shares will be entitled to the Distribution
Preference with respect to such Distributions as are declared each year equal
to: the lesser of (a) 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 10.25% or 150 basis points over the Prime Rate (determined on a
not less than quarterly basis).
After declaration for a given quarter of Distributions to the holders
of Preferred Shares in the amount of the Distribution Preference, no further
distributions may be declared on the Preferred Shares for the subject quarter
until the total dollar amount of Distributions declared on the Common Shares as
a class for that quarter equals an amount (the "Matching Distribution") as the
Distribution Preference for each Preferred Share for such quarter or period. Any
Distributions associated with a payment date that are
16
<PAGE>
declared after the Trustees have declared Distributions on Common Shares in the
amount of the Matching Distribution (i.e. excess Distributions) generally will
be allocated such that the amount of Distributions per share paid to or declared
to the holders of the Preferred Shares and Common Shares for the subject quarter
are equal. The Distribution Preferences of the Preferred Shares is not
cumulative.
Distributions to stockholders will generally be taxable as ordinary
income, although a portion of such distributions may be designated by the Trust
as capital gain or may constitute a tax-free return of capital. the Trust will
annually furnish to each of its stockholders a statement setting forth
distributions paid during the preceding year and their characterization as
ordinary income, capital gains or return of capital.
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17
<PAGE>
- --------------------------------------------------------------------------------
PART II
- --------------------------------------------------------------------------------
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected historical financial data of the
Trust and its Predecessors. The combined information gives effect to the
combination of Capital Alliance Income Trust I and Capital Alliance Income Trust
II (collectively, the "Predecessors") with the Trust due to common boards of
directors and management.
The selected historical combined financial data set forth below for the
Trust for each of the years in the period ended December 31, 1995 and the four
months ended April 30, 1996 are derived from the audited financial statements of
the Predecessors. The selected financial data for the eight months ended
December 31, 1996 and for the years ended December 31, 1997 and December 31,
1998 are derived from audited financial statements of the Trust.
Novogradac & Company, LLP audited the aforementioned financial
statements. The historical combined financial information is not necessarily
indicative of future operations and should not be so construed. The selected
financial data should be read in conjunction with "MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
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18
<PAGE>
SELECTED FINANCIAL DATA
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
<TABLE>
<CAPTION>
Five Year Financial Summary Combined (Predecessors)
Year Ended December 31
1994 1995
---------- ----------
<S> <C> <C>
Operations:
Revenue .................................. $ 174,997 $ 489,363
Net income ............................... 147,056 414,414
Per Share Data:
Net Income
Basic ................................ -- --
Diluted .............................. -- --
Balance Sheet Data:
Mortgage notes receivable ................ $1,889,485 $4,790,070
Total assets ............................. 3,148,661 6,254,052
Total liabilities ........................ 55,741 164,022
Shareholders' capital .................... 3,092,920 6,090,030
</TABLE>
(continued on following page)
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19
<PAGE>
SELECTED FINANCIAL DATA
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
<TABLE>
<CAPTION>
Five Year Combined (Predecessors) Successor Successor Successor
Financial Summary Four Months Ended Eight Months Ended Year Ended Year Ended
April 30, 1996 December 31, 1996 December 31, 1997 December 31, 1998
-------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Operations:
Revenue ................. $ 273,709 $ 490,300 $ 776,405 $ 1,677,233
Net income .............. 226,643 373,132 535,789 $ 1,003,706
Per Share Data:
Basic ............... -- -- -- .351
Diluted ............. -- -- -- .341
Balance Sheet Data:
Mortgage notes receivable $ 4,757,895 $ 4,696,238 $ 4,915,186 $ 8,986,645
Total assets ............ 6,267,251 6,702,261 10,132,419 16,804,983
Total liabilities ....... 263,316 756,073 311,096 757,532
Shareholder's capital ... 6,003,935 5,946,188 9,821,323 16,047,451
</TABLE>
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20
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The preparation of Trust's financial statements were based upon the
operating results of the Trust and 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 their common
management and directors.
GENERAL
Predecessors. The Trust resulted from the consolidation of CAIT I and
CAIT II (the "Combination") on April 30, 1996 when the Trust ("Successor")
exchanged shares of preferred stock for all of the outstanding whole shares of
CAIT I and CAIT II. Holders of fractional shares of CAIT I and CAIT II received
cash in lieu of fractional shares of preferred stock of the Trust and 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 non-conforming loans secured by deeds of trust on residential
property. CAIT I and CAIT 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. The Trust was incorporated in Delaware on December
12, 1995.
Organization. Effective February 12, 1997, the Trust registered its
common shares with the Securities and Exchange Commission under 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 during May 1997.
On April 15, 1997 the Trust formed its non-qualified REIT subsidiary to
conduct its mortgage conduit business. On June 27, 1997 the Trust capitalized
CAFC with real estate 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 December 4, 1997 the Trust's common share offering exceeded the
Minimum Subscription Amount of $4,000,000 and 522,497 common shares were issued.
This was the initial offering of common shares. As of December 31, 1997 562,760
shares were outstanding, $4,051,878 of net proceeds were received and the trust
recognized a $57,081 reduction of deferred offering costs. On September 30,
1998, the Common Share offering was terminated. During 1998, 921,980 Common
Shares were issued and $6,638,256 of net proceeds were received and the Trust
recognized a $176,050 reduction of deferred offering costs. As of December 31,
1998, 1,484,740 Common Shares were outstanding.
Operating Strategy. The Trust invests as a portfolio lender in
non-conforming A-, B and C grade credit mortgage loans on one-to-four unit
residential properties secured by first and second deeds of trust. Management
believes that this segment of the mortgage market is inadequately served and
that there is a large demand for non-conforming A-, B and C grade mortgage
loans.
CAFC's operating strategy is to originate, through mortgage loan
brokers and a correspondent network, A-, B and C grade non-conforming home
equity loans to be sold in the secondary mortgage market. Although the loans
currently made are concentrated in California, CAFC plans to originate and/or
purchase loans on both an individual and bulk basis throughout the western
United States. Loans will then be sold into the secondary market for a premium
or to the Trust at fair market value, when they meet the Trust's underwriting
standards (which include a combined loan-to-value ratio that does not exceed 75%
of the underlying collateral).
21
<PAGE>
Home mortgage loans rated A-, B or C tend to have higher rates of loss
and delinquency, but also offer higher rates of interest and higher secondary
market premiums than loans to borrowers of higher credit quality. Management
believes that non-conforming mortgage loans can produce overall higher returns
after adjustment for potentially higher rates of loss than the returns available
on conforming loans. Management also believes there is increased investor demand
for high-yield non-conforming mortgage loans on account of: (1) investor demand
for higher yields arising from historically low nominal interest rates over the
past few years and (2) 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 collateral for 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 borrowed proceeds in escrow
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.
Contingencies and Commitments.
As of December 31, 1998, the Trust's real estate investments included
one property held for sale at a capitalized cost of $149,663 and a loan
portfolio of $8,986,645 consisting of seventy-two loans of which six loans
totaling $717,453 or 7.98% of the portfolio were delinquent. There were two
delinquent loans in process of foreclosure at December 31, 1998.
As of December 31, 1997, the Trust's real estate investments included
one property held for sale at a capitalized cost of $322,550 and a loan
portfolio of $4,915,186 consisting of forty-five loans, of which four loans
totaling $441,127 or 8.97% of the portfolio were delinquent. There were three
delinquent loans which were in the process of foreclosure at December 31, 1997.
In assessing the collectibility of the real estate held for sale and
the delinquent mortgage loans, management estimates a net gain will be
recognized upon sale of the real estate and the properties securing these loans,
if it is necessary to foreclose the mortgage loans due the Trust. Management's
estimate is based on an anticipated sales price of the property that includes a
discount from the latest appraised value of the property, 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 all conditions.
Accordingly, the Trust did not have any commitments to fund loans as of December
31, 1998 and December 31, 1997.
RESULTS OF OPERATIONS
The results of operation for the four months ended April 30, 1996
represent the combined financial statements of the Predecessors. The financial
statements for the eight months ended December 31, 1996 and the year ended
December 31, 1997 are the operating results of the Successor. In the comparison
that follows, references to the year ended December 31, 1996 refer to the four
months ended April 30, 1996 (Predecessors) 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.
22
<PAGE>
YEAR ENDED DECEMBER 31, 1998
COMPARED TO YEAR ENDED DECEMBER 31, 1997
Revenues for the year ended December 31, 1998 increased to $1,677,233
as compared to $776,405 for 1997, primarily from the increased interest income
of a larger mortgage portfolio and larger warehouse lines of credit outstanding
during 1998. Other income for the year ended December 31, 1998 decreased on
account of lower rental income from real estate held for sale and the
elimination of portfolio loan sales.
At year ended December 31, 1998 the mortgage notes receivable balance
was $4,071,459 greater than the year ended December 31, 1997 mortgage notes
receivable balance. At year ended December 31, 1998 the warehouse lines of
credit balance was $2,971,141 greater than the year ended December 31, 1997
warehouse lines of credit. At year ended December 31, 1998 the real estate held
for sale balance was $172,887 less than the year ended December 31, 1997 real
estate held for sale balance.
Expenses for the year ended December 31, 1998 increased to $686,708 as
compared to $259,611 for the previous year. The increase in 1998 compared to
1997 is primarily due to a $205,855 provision for loan losses and loss reserves,
from higher compensation of $124,978 to the Manager and higher general and
administrative expenses of operating a larger enterprise. The 1998 and 1997 gain
from sale of real estate held were reported as a separate line item and did not
reduce either year's expenses or increase either year's revenues.
Net income for the year ended December 31, 1998 was $1,003,706. Net
Income for the year ended December 31, 1996 was $535,789.
YEAR ENDED DECEMBER 31, 1997
COMPARED TO YEAR ENDED DECEMBER 31, 1996
Revenues for the year ended December 31, 1997 increased to $776,405 as
compared to $764,009 for 1996, primarily as a result of increased other income
offsetting lower interest income.
Other income for the year ended December 31, 1997 increased primarily
from origination income received from borrowers and secondarily from premiums
from the sale of portfolio loans and higher rental income from real estate held
for sale. Prior to the Combination, origination income received from borrowers
inured to the Manager.
At year end December 31, 1997 the mortgage notes receivable balance was
greater than the year end December 31, 1996 mortgage notes receivable balance.
At year end December 31, 1997 the real estate held for sale balance was less
than the year end December 31, 1996 real estate held for sale balance. However,
1997's interest income was constrained by an average annual mortgage notes
receivable balance that was lower than 1996's average annual mortgage notes
receivable balance and during 1997 the Trust maintained a higher average real
estate owned balance than the average real estate owned balance during 1996.
This allocation of the Trust's assets and a reduction of the loan portfolio's
weighted average interest rate from 12.99% to 12.32% during 1997 contributed to
lower interest income and resulted in higher rental income.
Expenses for the year ended December 31, 1997 increased to $259,611 as
compared to $164,234 for the previous year. The increase in 1997 compared to
1996 is primarily due to the financing and operating expenses associated with
real estate owned, and from different compensation arrangements with the Manager
prior to the commencement of the Trust's current offering. The Trust's 1996
expenses also included $46,448 as a loan loss provision. During 1997 the trust
did not change its reserve for loan loss, but recognized a $18,995 cumulative
gain from the disposition of real estate held for sale. The gain from
23
<PAGE>
sale of real estate held was reported as a separate line item and did not reduce
1997's expenses or increase 1997's revenues.
Net income for the year ended December 31, 1997 was $535,789. Net
Income for the year ended December 31, 1996 was $599,775.
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 operation primarily through
the effect on interest rates, since interest rates normally increase during
periods of high inflation and decrease during periods of low inflation. When
interest rate increase, the demand for mortgage loans and a borrower's ability
to qualify for mortgage financing may be adversely affected.
LIQUIDITY AND CAPITAL RESOURCES
Management believes that cash flow from operations, the mortgage loans
that are paid off, the disposition of real estate owned plus the extension of a
$3,000,000 warehouse lines of credit with Warehouse Lending Corporation of
America for the Mortgage Conduit Business will be sufficient to meet the
liquidity needs of the Trust's businesses for the next twelve months.
LIQUIDITY AND CAPITAL RESOURCES
FOR THE YEAR ENDED DECEMBER 31, 1998
As of January 1, 1998, the Trust had $1,748,485 of cash and cash
equivalents. After taking into effect the various transactions discussed below,
cash and cash equivalents at December 31, 1998 were $570,710. The following
summarizes the changes in net cash provided by operating activities, net cash
used for investing activities and net cash provided by financing activities.
The principal source of the Trust's enhanced liquidity are the proceeds
from the issuance of common stock. From January 1, 1998 through September 30,
1998, the Trust received net common stock proceeds of $6,638,256. Management's
strategy is to invest the common stock proceeds primarily in the Trust's
Mortgage Investment Business. In the interim, the Trust's has used the net
proceeds of its current public offering to provide funding for the Trust's
recently established Warehouse Lending Business and to invest in subordinated
debt of a strategic partner mortgage banking firm which yields 15% per annum. At
December 31, 1998 the Trust had $2,414,435 of warehouse facilities outstanding
to CAFC, $820,100 to SCA, $1,472,564 to Equity 1-2-3, and $450,000 to CMT.
Net cash provided by the operating activities during the twelve months
ended December 31, 1998 was $1,099,341. Net income of $1,003,706 was the primary
supplier of cash and the largest user of cash from operating activities was the
$114,119 increase in receivables from affiliates.
Net cash used in investing activities during the twelve months ended
December 31, 1998 was $7,603,400. The principal generators of cash from
investment activities were $6,270,811 provided from the repayments of mortgage
notes receivable. Investments in new mortgage notes receivable utilized
$10,342,300 and the previously described warehouse lines of credit extended to
CAFC, SCA, Equity 1-2-3, and CMT utilized $2,971,141.
Net cash provided by financing activities during the twelve months
ended December 31, 1998 was $5,326,324. The principal source of cash from
financing activities were the gross proceeds of $7,375,840
24
<PAGE>
from the issuance of common stock. Dividends of $1,143,018 and organizational
and offering costs of $747,406 were the leading users of cash from financing
activities.
LIQUIDITY AND CAPITAL RESOURCES
FOR THE YEAR ENDED DECEMBER 31, 1997
As of January 1, 1997, the Trust had $66,798 of cash and cash
equivalents. After taking into effect the various transactions discussed below,
cash and cash equivalents at December 31, 1997 were $1,748,485. The following
summarizes the changes in net cash provided by operating activities, net cash
used for investing activities and net cash provided by financing activities.
The principal source of the Trust's enhanced liquidity are the proceeds
from the issuance of common stock. From December 4, 1997 through December 31,
1997, the Trust received net common stock proceeds of $4,051,878. Management's
strategy is to invest the common stock proceeds primarily in the Trust's
Mortgage Investment Business. In the interim, the Trust's will use the net
proceeds of its current public offering to provide funding for the Trust's
recently established Warehouse Lending Business and to invest in subordinated
debt of a strategic partner mortgage banking firm which yields 15% per annum. At
December 31, 1997 the Trust had $717,757 of warehouse facilities outstanding to
CAFC and $1,468,200 to SCA.
Net cash provided by the operating activities during the twelve months
ended December 31, 1997 was $432,320. Net income of $535,789 was the primary
supplier of cash and the largest user of cash from operating activities was the
$68,619 reduction in other liabilities.
Net cash used in investing activities during the twelve months ended
December 31, 1997 was $2,027,557. The principal generators of cash from
investment activities were $2,625,113 provided from the repayments of mortgage
notes receivable and net sales proceeds of $791,416 from the disposition of real
estate before mortgage relief. Investments in new mortgage notes receivable
utilized $ $3,254,256 and the previously described warehouse lines of credit
extended to CAFC and SCA utilized $2,185,957.
Net cash provided by financing activities during the twelve months
ended December 31, 1997 was $3,276,924. The principal source of cash from
financing activities were the gross proceeds of $4,502,087 from the issuance of
common stock. Dividends of $606,853 and organizational and offering costs of
$499,161 were the leading users of cash from financing activities.
YEAR 2000
The Trust's primary use of software systems is for accounting and loan
documentation. The Trust's software systems, local area network, and client
server is widely used and is Year 2000 compliant. Therefore, management believes
that the risk of Year 2000 compliance is not significant as it relates to its
computer software system, network and personal computers.
The Trust does not expect Year 2000 initiative costs to exceed $5,000.
At this time, no estimate can be made as to any potential adverse
impact from the failure of borrowers and third-party service providers and
vendors to prepare for the Year 2000.
25
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data listed in Item 14(a)(1)
are incorporated herein by reference and filed as part of this report.
Selected Quarterly Financial Data required by Item 302(a) of Regulation
S-K is set forth in the financial statements filed as part of Registrant's Form
10-Qs for the quarters ended March 31, 1998, June 30, 1998 and September 30,
1998 are incorporated herein by reference and filed as part of this report.
The unaudited 1997 and 1998 fourth quarter operating statement is
presented below with the accompanying notes to the operating statement
incorporated herein by reference to the Financial Statements with Independent
Auditor's Report for the three year period ended December 31, 1998.
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
<TABLE>
<CAPTION>
STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended
December 31
1998 1997
---- ----
<S> <C> <C>
REVENUES
Interest income .............................. $ 476,943 $ 147,511
Origination income ........................... 45,270 21,163
Other income ................................. 2,950 11,465
--------- ---------
Total revenues ............................ 525,163 180,139
EXPENSES
Loan servicing and origination
fees to related party ..................... 28,901 46,036
Interest expense ............................. 17,596 2,456
Provisions for loan losses ................... 170,000 --
Operating expenses of real estate owned ...... 6,061 (2,069)
General and Administrative ................... 46,339 4,257
--------- ---------
Total expenses ............................ 268,897 50,680
NET INCOME BEFORE GAIN
ON REAL ESTATE OWNED ......................... 256,266 129,453
GAIN ON REAL ESTATE OWNED ......................... 3,181 2,325
--------- ---------
NET INCOME ........................................ $ 259,447 $ 131,778
NET INCOME PER PREFERRED SHARE .................... $ 0.23 $ 0.24
WEIGHTED AVERAGE
PREFERRED SHARES OUTSTANDING ................. 631,757 641,283
BASIC EARNINGS PER
COMMON SHAR .................................. .077 --
DILUTED EARNINGS PER
COMMON SHARE ................................. .067 --
</TABLE>
26
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
None.
[REMAINDER OF THE PAGE INTENTIONALLY LEFT BLANK]
27
<PAGE>
- --------------------------------------------------------------------------------
ITEM III
- --------------------------------------------------------------------------------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
DIRECTORS
Thomas B. Swartz, 67; Chairman and Chief Executive Officer(1)
Class I Director since 1995; current term expires in 2000; Chairman and
Chief Executive Officer, Capital Alliance Advisors, Inc. (1989 to date);
Chairman, Capital Alliance Income Trust I (1991 to 1996) and Capital Alliance
Income Trust II (1994 to 1996); Chairman, Sierra Capital Acceptance (1995 to
date); Chairman and Chief Executive Officer of Sierra Capital Companies and its
Affiliates (1980 to date); Founder Chairman, Chief Executive Officer and Trustee
of seven equity real estate investment trusts (1980- 1991); Attorney at Law,
Thomas Byrne Swartz, Inc. (1980 to date), and Bronson, Bronson, & McKinnon, San
Francisco, California (Partner 1960-1980); Past President (1989-1990) and
Member, Board of Governors (1983 to 1993), National Association of Real Estate
Investment Trusts; Director (representing Federal Deposit Insurance Corporation)
of two subsidiaries of American Diversified Savings Bank (in liquidation) (1990
to 1992) Member, Real Estate Advisory Committee to California Commissioner of
Corporations (1972-1973); University of California at Berkeley Boalt School of
Law, L.L.B. 1959; Lieutenant, U.S.N.R. 1954-1956 (active) and to 1967 (reserve);
Yale University, A.B. 1954.
Dennis R. Konczal, 49; President, Director and Chief Operating Officer(1)(2)
Class II Director since 1995; current term expires in 1998; President
(1996 to date) and Executive Vice President (1989 to 1996) and Chief Operating
Officer, Capital Alliance Advisors, Inc.; Executive Vice-President, Trustee and
Chief Operating Officer of Capital Alliance Income Trust I (1991 to 1996)and of
Capital Alliance Income Trust II (1994 to 1996); President and Director, Sierra
Capital Acceptance (1995 to date); President, Director and Chief Operating
Officer of Sierra Capital Companies and of Capital Alliance Investments
Incorporated (a NASD broker-dealer and Registered Investment Advisor) (1984 to
date); Director, President and Chief Operating Officer, Granada Management
Corporation and Granada Financial Services, Inc., agribusiness concerns
(1981-1984); Licensed Principal, NASD (1981 to date); B.S.
Agricultural Economics, Michigan State University (1972).
Douglas A. Thompson, 55; Executive Vice-President, Director and Chief Investment
Officer(2)
Class III Director since 1995; current term expires 1999; Executive
Vice-President, Capital Alliance Advisors, Inc. (1995 to date); Trustee, Capital
Alliance Income Trust I and Capital Alliance Income Trust II (1995 to 1996);
Founder, First Blackhawk Financial, Inc. (mortgage banking firm) (1992 to 1995);
Owner, The Paradigm Group and Investors Mortgage Exchange, Danville, California
(whole loan brokerage for private and institutional clients) (1990 to date);
Vice President, Principal Residential Advisors, Danville, California (1988 to
1990); Secondary Mortgage Specialist, Morgan Stanley & Co. (1985-1988);
Investment Banking/Mortgage Specialist, Merrill Lynch Pierce Fenner & Smith, Los
Angeles, California (1982 to 1985 ); Manager. Watson Mortgage, Bakersfield,
California (1981 to 1982); California Real Estate Broker (1992 to date); Member,
Pepperdine University Board (1988 to 1991); B.S.E., 1967, Abeline Christian
University; M.A., 1969 University of Southern California.
28
<PAGE>
Stanley C. Brooks, 49; Director(2)
Class II Director since 1996; current term expires 1998; President and
Chairman, Brookstreet Securities Corporation (1990 to date); Executive
Vice-President, Toluca Pacific Securities Corporation (1987 to 1989); Senior
Vice-President, First Affiliated Securities (1983 to 1986); Senior
Vice-President, Private Ledger Financial Services (1976 to 1983); Member,
National Futures Association (1991 to date); Member, Securities Industry
Association (1995 to date); Member, Regional Investment Bankers Association
(1990 to date); Licensed Principal, NASD (1970 to date); California State
Polytechnic Institute, B.S. Business Administration 1970. Mr. Brooks was elected
to the Board of Directors pursuant to the Underwriting Agreement between the
Trust and Brookstreet Securities Corporation as the Managing Broker-Dealer of
the Trust's current public offering of its Common Stock.
Harvey Blomberg, 58; Director(1)(2)
Class I Director since 1996; current term expires 2000; Founder and
principal MRHB Real Estate (real estate management company) (1988 to date);
Regional Director, Connecticut Small Business Development Center (1996 to date);
Partner and Chief Financial Officer, Bay Purveyors, Inc. (1976 to 1995); General
Manager, Deerfield Communications (1987 to 1990); Consultant to numerous
companies (financial restructuring, refinancing and marketing) (1989 to date).
Renessler Polytechnic Institute, M.S. Management, 1995; Hofstra University,
M.B.A. 1985; B.S. Engineering, 1966.
- --------------------------
(1) Also is a member of the Executive Committee.
(2) Also is a member of the Audit Committee.
EXECUTIVE OFFICERS
The following persons currently serve as executive officers of the
Trust. They hold office at the discretion of the Directors.
Name Age Position
Thomas B. Swartz 67 Chairman and Chief
Executive Officer
Dennis R. Konczal 49 President and Chief
Operating Officer
Douglas A. Thompson 55 Executive Vice-President
and Chief Investment Officer
Richard J. Wrensen 43 Senior Vice President
and Chief Financial Officer
Linda St. John 43 Operations Officer
and Secretary
The principal occupations of the Executive officers of the Trust during
the last five years or more are set forth below.
29
<PAGE>
Thomas B. Swartz, 67; Chairman and Chief Executive Officer
Class I Director since 1995; current term expires in 2000; Chairman and
Chief Executive Officer, Capital Alliance Advisors, Inc. (1989 to date);
Chairman, Capital Alliance Income Trust I (1991 to 1996) and Capital Alliance
Income Trust II (1994 to 1996); Chairman, Sierra Capital Acceptance (1995 to
date); Chairman and Chief Executive Officer of Sierra Capital Companies and its
Affiliates (1980 to date); Founder Chairman, Chief Executive Officer and Trustee
of seven equity real estate investment trusts (1980- 1991); Attorney at Law,
Thomas Byrne Swartz, Inc. (1980 to date), and Bronson, Bronson, & McKinnon, San
Francisco, California (Partner 1960-1980); Past President (1989-1990) and
Member, Board of Governors (1983 to 1993), National Association of Real Estate
Investment Trusts; Director (representing Federal Deposit Insurance Corporation)
of two subsidiaries of American Diversified Savings Bank (in liquidation) (1990
to 1992) Member, Real Estate Advisory Committee to California Commissioner of
Corporations (1972-1973); University of California at Berkeley Boalt School of
Law, L.L.B. 1959; Lieutenant, U.S.N.R. 1954-1956 (active) and to 1967 (reserve);
Yale University, A.B. 1954.
Dennis R. Konczal, 49; President, Director and Chief Operating Officer
Class II Director since 1995; current term expires in 1998; President
(1996 to date) and Executive Vice President (1989 to 1996) and Chief Operating
Officer, Capital Alliance Advisors, Inc.; Executive Vice-President, Trustee and
Chief Operating Officer of Capital Alliance Income Trust I (1991 to 1996)and of
Capital Alliance Income Trust II (1994 to 1996); President and Director, Sierra
Capital Acceptance (1995 to date); President, Director and Chief Operating
Officer of Sierra Capital Companies and of Capital Alliance Investments
Incorporated (a NASD broker-dealer and Registered Investment Advisor) (1984 to
date); Director, President and Chief Operating Officer, Granada Management
Corporation and Granada Financial Services, Inc., agribusiness concerns
(1981-1984); Licensed Principal, NASD (1981 to date); B.S.
Agricultural Economics, Michigan State University (1972).
Douglas A. Thompson, 55; Executive Vice-President, Director and Chief Investment
Officer
Class III Director since 1995; current term expires 1999; Executive
Vice-President, Capital Alliance Advisors, Inc. (1995 to date); Trustee, Capital
Alliance Income Trust I and Capital Alliance Income Trust II (1995 to 1996);
Founder, First Blackhawk Financial, Inc. (mortgage banking firm) (1992 to 1995);
Owner, The Paradigm Group and Investors Mortgage Exchange, Danville, California
(whole loan brokerage for private and institutional clients) (1990 to date);
Vice President, Principal Residential Advisors, Danville, California (1988 to
1990); Secondary Mortgage Specialist, Morgan Stanley & Co. (1985-1988);
Investment Banking/Mortgage Specialist, Merrill Lynch Pierce Fenner & Smith, Los
Angeles, California (1982 to 1985 ); Manager. Watson Mortgage, Bakersfield,
California (1981 to 1982); California Real Estate Broker (1992 to date); Member,
Pepperdine University Board (1988 to 1991); B.S.E., 1967, Abeline Christian
University; M.A., 1969 University of Southern California.
Richard J. Wrensen, 43, Senior Vice-President and Chief Financial Officer
Senior Vice-President and Chief Financial Officer, Capital Alliance
Advisors, Inc. and its Affiliates (including Capital Alliance Income Trust Ltd.
and of Sierra Capital Companies and its affiliates) (1997 to date);
Vice-President of Finance, SNK Realty Group (Japanese merchant builder) (1997);
Vice-President Finance, Mattison and Shidler (national real estate investment)
(1987 to 1997); Associate, Marakon Associates (1985 to 1987); Vice-President and
Controller, Ring Brothers Corp. (real estate syndication and management (1981 to
1983); Division Controller, Great Southwest Corp. (1979 to 1981); Certified
Public Accountant (1979); Coopers & Lybrand (1978 to 1979); B.S. Accounting,
University of Florida (1978); MBA, Haas School of Business Administration,
University of California, Berkeley (1985).
30
<PAGE>
Linda St. John, 43, Operations Officer and Secretary
Operations Officer and Secretary, Capital Alliance Advisors, Inc. (1995 to
date); Secretary, Sierra Capital Companies and Affiliates (1995 to date).
Operations Manager, Gruen Gruen & Associates (1994- 1995); MIS Manager, Hannum
Associates (1991-1993); Rochester Business Institute, A.A. Business
Administration (1984).
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION OF OFFICERS
The Trust has no full time employees and is managed by Capital Alliance
Advisors, Inc. as Manager of the Trust under a Management Agreement which
requires CAAI to pay the employment expenses of its personnel. Accordingly, no
compensation was paid by the Trust to any of the named executives.
COMPENSATION OF DIRECTORS
Director Fees. The Trust pays each unaffiliated Director an annual fee of
$5,000. In 1998 Messrs. Brooks and Blomberg each received $5,000 as a Director's
fee.
Committee and Other Meeting Fees. The Directors are also entitled to be
paid $500 for each director's or committee meeting attended in person and $300
if attended by telephonic means. During 1998 Mr. Brooks was paid $1,400 and Mr.
Blomberg was paid $1,900 in committee and other meeting fees.
Reimbursements. All Directors are reimbursed for reasonable travel and
other out of pocket expenses incurred in attending board and committee meetings.
Such compensation and reimbursement arrangements for Directors may be
changed by the Board of Directors pursuant to authority granted by the Trust's
Bylaws.
ITEM 12. SECURITY OWNERSHIP OF
CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information known to the Trust
with respect to beneficial ownership of the Trust's Common Shares as of December
31, 1998, and as adjusted to reflect the sale of Common Shares being offered
hereby, by (1) each person known to the Trust to beneficially own more than five
percent of the Trust's Common Shares, (2) each Director, (3) the Trust's
executive officers, and (4) all Directors and executive officers as a group.
Unless otherwise indicated in the footnotes to the table, the beneficial owners
name have, to the knowledge of the Trust, sole voting and investment power with
respect to the shares beneficially owned, subject to community property laws
where applicable.
[REMAINDER OF THE PAGE INTENTIONALLY LEFT BLANK]
31
<PAGE>
<TABLE>
<CAPTION>
Percentage of
Shares Beneficially
Number of Owned
Shares -----
Beneficially Before After
Owned Offering Offering(1)
----- --------------------
Name of Beneficial Owner
<S> <C> <C> <C>
Thomas B. Swartz (1)(4).................... 1,086 0 0
Dennis R. Konczal (4)...................... 0 0 0
Douglas A. Thompson (4).................... 0 0 0
Stanley C. Brooks (2)...................... 0 0 0
Harvey Blomberg............................ 0 0 0
All directors and executive officers as a
group (5 persons)........................ 0 0 0
Thomas Morford (3)......................... 0 0 0
<FN>
- --------------------
(1) Mr. Swartz owns beneficially 3,004 shares of Series A Preferred Shares
as of December 31, 1998, representing less than 1% of the outstanding
Series A Preferred Shares.
(2) Mr. Brooks is the President of the Managing Dealer of the Trust's initial public offering of its
common Stock.
(3) Mr. Morford owns beneficially 50,000 shares of Series A Preferred
Shares as of December 31, 1996, representing 7.7% of the outstanding
Series A Preferred Shares.
(4) Capital Alliance Advisors, Inc., the Trust's Manager, owns beneficially
6,437 shares of Series A Preferred Shares as of December 31, 1998
representing 1% of the outstanding Series A Preferred Shares. Messrs.
Swartz, Konczal and Thompson are officers and directors of the Manager
and collectively own a majority of the outstanding Common Shares of the
Manager.
</FN>
</TABLE>
ITEM 13. CERTAIN RELATIONSHIPS
AND RELATED TRANSACTIONS
Arrangements and Transactions with CAAI. CAAI is the Manager of the
Trust and provides (a) management and advisory services to the Trust in
accordance with the Management Agreement and (b) mortgage origination and loan
servicing services to the Trust in accordance with the Mortgage Origination and
Servicing Agreement. As previously described, the Trust will utilize the
mortgage banking experience, management expertise and resources of CAAI in
conducting its Mortgage Investment and its Mortgage Conduit Business. In
addition, a majority of the Directors and the officers of the Trust also serve
as Directors and/or officers of CAAI. However, Unaffiliated Directors constitute
a majority of the Audit Committee of the Board of Directors of the Trust. CAAI
owns all of the voting common stock and a 1% economic interest in CAFC, the
Trust's Mortgage Conduit Subsidiary. The Trust owns all of the non-voting
preferred stock representing 99% of the economic interest in CAFC. CAAI has the
power to elect all of the directors of CAFC and the ability to control the
outcome of all matters for which the consent of the holders of the common stock
of such subsidiary is required. CAAI and/or the officers and directors of CAFC
who may be officers and directors of the Trust, will be separately compensated
for their management services to the subsidiary and will provide origination,
financing and administrative services to the subsidiary through separate
agreements and an intercompany allocation of the cost of such services. The
Trustees, the
32
<PAGE>
Manager and their affiliates have fiduciary duties and obligations which will
require them to resolve any conflicts of interest by exercising the utmost good
faith and integrity. Additionally, the Bylaws provide that the Manager must upon
request by the Directors disclose any investments which are within the purview
of the Trust's investment policies.
CAAI through its affiliation with Sierra Capital Companies and its
affiliates, also has interests that may conflict with those of the Trust in
fulfilling certain duties. In addition, Messrs. Swartz, Thompson and Konczal,
the officers and Directors of CAAI are also officers and Directors of the Trust.
The Officers and Directors of CAAI are also involved in other businesses which
may generate profits or other compensation.
The Trust will not share in such compensation.
It is the intention of the Trust and CAAI that any agreements and
transactions, taken as a whole, between the Trust, on the one hand, and CAAI or
its affiliates, on the other hand, are fair to both parties. However, there can
be no assurance that each of such agreements or transactions will be on terms at
least as favorable to the Trust as could have been obtained from unaffiliated
third parties.
Investment in Related Mortgage Banking Firms. The Trust, as a result of
strategic investments totaling $200,000 by its predecessors, CAIT I and CAIT II,
holds 20,000 Class "B" Preferred Shares of Sierra Capital Acceptance, a division
of Sierra Capital Funding, LLC, a Delaware limited liability company
("SCF/LLC"). SCF/LLC in 1997 merged with Sierra Capital Acceptance, a Delaware
business trust ("SCA"), in which the predecessors originally invested.). SCA is
a wholesale mortgage banking firm specializing in A-, B/C credit-rated
non-conforming residential mortgages. The SCF/LLC-SCA investment held by the
Trust has a 15% distribution preference (which has been paid quarterly) and a
liquidation preference. SCA contracts with the Manager to provide origination,
underwriting, processing, funding and sale of A- and B/C credit rated
non-conforming residential mortgages to CAFC and the Trust. Messrs. Swartz and
Konczal are principals, directors and officers of the SCA division of SCF/LLC as
well as of the Trust and its Manager.
The Trust has also committed and made a strategic investment totaling
$300,000 ($225,000 of which has been made) of subordinated debt in Equity 1-2-3,
located in Laguna Hills, California. Equity 1-2- 3 is a retail mortgage banking
firm specializing in A- to B/C credit-rated residential home equity mortgage
loans. The Trust's investment has a 15% distribution preference and a
liquidation preference. Equity 1-2-3 utilizes direct-mail advertising, the
Internet and telemarketing for origination of its mortgage loans. The business
of Equity 1-2-3 is similar to and may be competitive with CAFC and the Trust in
the origination, purchasing and sale of A-, B/C credit-rated non-conforming
residential mortgages. Messrs. Swartz and Konczal are principals, directors and
officers of the Equity 1-2-3 division of SFC/LLC as well as of the Trust and
Manager. SCSI Corporation, which is controlled by Messrs. Swartz and Konczal, is
the Managing Member of SCF/LLC and has committed a $100,000 investment in the
common shares of Equity 1-2-3, $75,000 of which has been made.
Sale and Purchase of Loans. To provide a source of mortgage loans for
the Trust's Mortgage Investment Business, CAFC, the Mortgage Conduit Subsidiary,
offers to the Trust for purchase all non-conforming mortgage loans and Home
Equity Loans meeting the Trust's investment criteria and policies. Commitments
to acquire loans will obligate the Trust to purchase such loans from the
Mortgage Conduit Subsidiary upon the closing and funding of the loans, pursuant
to the terms and conditions specified in the commitment.
The Trust accounts for the purchase of loans from CAFC on a fair market
value basis. When the Trust computes the equity and earnings or loss of the
Mortgage Conduit Subsidiary, it will eliminate any intercompany profit.
33
<PAGE>
Other Business Activities. The Bylaws provide that the Directors and
the Trust's agents, officers and employees may engage with or for others in
business activities of the types conducted by the Trust and that they will not
have any obligation to present to the Trust any investment opportunities which
come to them other than in their capacities as Directors regardless of whether
those opportunities are within the Trust's investment policies. Each Director is
required to disclose any interest he has, and any interest known to him of any
person of which he is an Affiliate, in any investment opportunity presented to
the Trust.
[REMAINDER OF THE PAGE INTENTIONALLY LEFT BLANK]
34
<PAGE>
- --------------------------------------------------------------------------------
PART IV
- --------------------------------------------------------------------------------
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS
SCHEDULES, AND REPORTS ON FORM 8-K.
(a)(1) Financial Statements. The following Company financial statements are
filed as part of this report:
Independent Auditors' Report F-1
Balance Sheets F-2
Statements of Operation F-3
Statements of Changes in Stockholders' Equity F-4-5
Statements of Cash Flows F-6
Notes to Financial Statements F-7
(a)(2) Financial Statement Schedules are listed in Part II - Item 8.
(a)(3) Exhibits.
Exhibit No.
3.1 Charter Certificate of Incorporation and Amendment No. 1(1)
3.2 Bylaws of the Registrant(1)
3.3 Certificate of Amendment of Certificate of Incorporation(6)
4.1 Form of Stock Certificate of Common Shares of the Registrant(2)
4.2 Form of Shareholder's Warrant Agreement(4)
4.4 Form of Common Warrant Certificate(4)
5.1 Opinion of Ashby & Geddes(4)
8.1 Opinion of Landels Ripley & Diamond, LLP(4)
10.1 Form of Management Agreement between the Registrant and Capital
Alliance Advisors, Inc.(1)
10.2 Form of Indemnity Agreement between the Registrant and its
Directors and Officers(1) 10.3 Form of Loan Origination and
Loan Servicing Agreement between the Registrant and
Capital Alliance Advisors, Inc.(1)
23.1 Consent of Landels Ripley & Diamond, LLP(4)
23.2 Consent of Novogradac & Company LLP(4)
23.3 Consent of Ashby & Geddes(4)
23.4 Consent of Landels Ripley & Diamond, LLP(5)
23.5 Consent of Novogradac & Company LLP(5)
24.1 Power of Attorney of Thomas B. Swartz(1)
24.2 Power of Attorney of Dennis R. Konczal(1)
24.3 Power of Attorney of Douglas A. Thompson(1)
24.4 Power of Attorney of Stanley C. Brooks(1)
24.5 Power of Attorney of Harvey Blomberg(1)
24.6 Power of Attorney of Jeannette Hagey(1)
24.7 Power of Attorney of Richard J. Wrensen(7)
27.3 Revised Financial Data Schedule-Capital Alliance Income Trust,
A Real Estate Investment Trust(3)
28.1 Impound and Escrow Agreement(4)
28.2 Impound and Escrow Agreement, as amended October 23, 1997(5)
- ------------------
35
<PAGE>
(1) These exhibits were previously contained in Registrant's Registration
Statement filed on Form S-11 with the Commission on September 9, 1996,
and are incorporated by reference herein.
(2) These exhibits were previously contained in Amendment No. 1 to the
Registrant's Registration Statement filed on Form S-11 with the
Commission on January 15, 1997, and are incorporated by reference
herein.
(3) This exhibit was previously contained in Amendment No. 2 to the
Registrant's Registration Statement filed on Form S-11 with the
Commission on February 6, 1997 and is incorporated by reference herein.
(4) These exhibits were previously contained in Post-Effective Amendment
No. 2 to the Registrant's Registration Statement filed on Form S-11
with the Commission on April 21, 1997, and are incorporated by
reference herein.
(5) These exhibits were previously contained in Post-Effective Amendment
No. 3 to the Registrant's Registration Statement filed on Form S-11
with the Commission on December 10, 1997, and are incorporated by
reference herein.
(6) These exhibits were previously contained in Form 10-Q for the period
ending June 30, 1997 filed with the Commission on August 14, 1997, and
are incorporated by reference herein.
(7) This exhibit was previously contained in Form 10-K for the period
ending December 31, 1998 filed with the Commission on April 10, 1998,
and are incorporated by reference herein.
(b) Reports on Form 8-K.
None.
(c) See a(3) above.
(d) Financial Statement Schedules.
None.
36
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(D) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, hereunto duly authorized.
Capital Alliance Income Trust, Ltd.
Dated: April 10, 1999 A Real Estate Investment Trust
By: s/s Thomas B. Swartz
--------------------------------
Thomas B. Swartz
Chairman and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange 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.
<PAGE>
/s/ Thomas B. Swartz Dated: April 10, 1999
- ---------------------
Thomas B. Swartz
Chairman and Chief Executive Officer
(Principal Executive Officer
s/s Richard J. Wrensen Dated: April 10, 1999
- -----------------------
Richard J. Wrensen
Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ Dennis R. Konczal Dated: April 10, 1999
- ----------------------
Dennis R. Konczal*
President and Director
/s/ Douglas A. Thompson Dated: April 10, 1999
- ------------------------
Douglas A. Thompson*
Executive Vice-President and Director
/s/ Stanley C. Brooks Dated: April 10, 1999
- ----------------------
Stanley C. Brooks*
Director
/s/ Harvey Blomberg Dated: April 10, 1999
- --------------------
Harvey Blomberg*
Director
37
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Capital Alliance Income Trust Ltd., A Real Estate Investment Trust:
We have audited the accompanying balance sheets of Capital Alliance Income Trust
Ltd., A Real Estate Investment Trust (see Note 1 to the financial statements) as
of December 31, 1998 and 1997, and the related statements of operations, changes
in stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. 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 Capital Alliance Income Trust
Ltd., A Real Estate Investment Trust as of December 31, 1998 and 1997, and the
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1998 in conformity with generally accepted accounting
principles.
NOVOGRADAC & COMPANY LLP
San Francisco, California
April 6, 1999
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
<TABLE>
<CAPTION>
Balance Sheets
December 31,
----------------------------
1997 1998
---- ----
<S> <C> <C>
ASSETS
Cash and cash equivalents ................................................. $ 1,748,485 $ 570,710
Restricted cash ........................................................... 205,356 594,693
Accounts receivable ....................................................... 95,207 193,241
Due from affiliates ....................................................... -- 103,301
Notes receivable:
Note receivable to related party ...................................... -- 225,000
Warehouse lines of credit to related parties .......................... 2,185,957 5,157,098
Mortgage notes receivable ............................................. 4,915,186 8,986,645
Allowance for loan losses ............................................. -- (170,000)
------------
Net receivable ................................................... 7,196,350 14,198,743
Real estate owned ......................................................... 322,550 149,663
Security deposits ......................................................... -- 32,133
Investments in affiliates ................................................. 469,150 831,936
Origination costs ......................................................... -- 120,217
Organization costs (net of accumulated amortization of $11,955 at
December 31, 1998 and $7,551 at December 31, 1997) .................... 14,478 10,346
Deferred offering costs ................................................... 176,050 --
------------ ------------
Total assets .............................................................. $ 10,132,419 $ 16,804,983
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Mortgage note holdbacks ............................................... $ 205,356 $ 594,693
Due to affiliates ..................................................... 82,966 --
Other liabilities ..................................................... 22,774 162,839
------------ ------------
Total liabilities ......................................................... 311,096 757,532
------------ ------------
Stockholders' Equity
Preferred stock, $.01 par value (liquidation value $9.50 per share)
675,000 shares authorized; 641,283 shares issued; 631,757 and
641,283 shares outstanding at December 31, 1998 and 1997 .............. 6,413 6,413
Additional paid in capital-preferred stock ............................ 5,868,711 5,868,711
Less: treasury stock, 9,526 shares at cost ........................... -- (86,944)
Common stock, $.01 par value
5,000,000 shares authorized; 1,484,740 and 562,760 shares issued
and outstanding at December 31, 1998 and 1997 ......................... 5,628 14,847
Additional paid in capital-common stock ............................... 3,940,571 10,244,424
------------ ------------
Total stockholders' equity ................................................ 9,821,323 16,047,451
------------ ------------
Total liabilities and stockholders' equity ................................ $ 10,132,419 $ 16,804,983
============ ============
</TABLE>
See accompanying notes.
F-2
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
<TABLE>
<CAPTION>
Statements of Operations
Combined
(Predecessors) (Successor)
----------- ---------------------------------------
Four Months Eight Months
Ended Ended Year Ended Year Ended
April 30, December 31, December 31, December 31,
--------- ---------- ------------ ------------
1996 1996 1997 1998
---- ----
<S> <C> <C> <C> <C>
REVENUES
Interest income ......................... $ 242,136 $ 440,064 $ 655,225 $1,243,495
Interest income from affiliates ......... 7,500 22,500 45,624 409,278
Other income (loss) ..................... 24,073 27,736 75,556 24,460
---------- ---------- ---------- ----------
Total revenues ...................... 273,709 490,300 776,405 1,677,233
---------- ---------- ---------- ----------
EXPENSES
Loan servicing fees to related party .... 20,107 40,244 102,027 131,864
Management fees to related party ........ -- -- 48,343 143,484
Interest expense ........................ -- 23,932 46,060 34,607
Provision for loan loss ................. 20,000 26,448 -- 205,855
Operating expenses of real estate owned . -- -- 31,821 10,466
Taxes ................................... -- -- 6,629 26,920
General and administrative .............. 6,959 26,544 24,731 123,512
---------- ---------- ---------- ----------
Total expenses ...................... 47,066 117,168 259,611 686,708
---------- ---------- ---------- ----------
INCOME BEFORE GAIN ON REAL ESTATE OWNED
226,643 373,132 516,794 1,000,525
Gain on real estate owned ............... -- -- 18,995 3,181
---------- ---------- ---------- ----------
NET INCOME ................................... $ 226,643 $ 373,132 $ 535,789 $1,003,706
========== ========== ========== ==========
NET INCOME PER PREFERRED SHARE ............... $ 0.350 $ 0.582 $ 0.835 $ 0.945
WEIGHTED AVERAGE PREFERRED SHARES OUTSTANDING
646,971 641,464 641,283 626,873
BASIC EARNINGS PER COMMON SHARE .............. $ -- $ -- $ -- $ 0.351
DILUTED EARNINGS PER COMMON SHARE ............ $ -- $ -- $ -- $ 0.341
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - BASIC EARNINGS
PER SHARE ............................... -- -- 45,219 1,171,733
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING - DILUTED EARNINGS
PER SHARE ............................... -- -- 45,219 1,206,886
</TABLE>
See accompanying notes.
F-3
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
<TABLE>
<CAPTION>
Statements of Changes in Stockholders' Equity
Combined
(Predecessors) Successor
-------------- ------------------------------------------------------------------
(Preferred)
Additional
Class A Class B Preferred Preferred Paid in Retained
Amount Amount Shares Stock Capital Earnings Total
------ ------ ------ ----- ------- -------- -----
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AS OF JANUARY 1, 1996 ... $ 6,087,073 $ 2,957 -- $ -- $ -- $ -- $ 6,090,030
Redemption of class "A" shares .. (44,825) -- -- -- -- -- (44,825)
Organizational and offering costs (5,625) -- -- -- -- -- (5,625)
Net income, four months ended
April 30, 1996 ................ 224,376 2,267 -- -- -- -- 226,643
Dividends ....................... (259,061) (3,227) -- -- -- -- (262,288)
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE AS OF APRIL 30, 1996 ... 6,001,938 1,997 -- -- -- -- 6,003,935
Exchange to preferred shares .... (6,001,938) (1,997) 643,730 6,437 5,997,498 -- --
Redemption of shares ............ -- -- (2,447) (24) (23,162) -- (23,186)
Organizational and offering costs -- -- -- -- (2,314) -- (2,314)
Net income, eight months ended
December 31, 1996 ............. -- -- -- -- -- 373,132 373,132
Dividends ....................... -- -- -- -- (32,247) (373,132) (405,379)
----------- ----------- ----------- ----------- ----------- ----------- -----------
BALANCE AS OF DECEMBER 31, 1996 . $ -- $ -- 641,283 $ 6,413 $ 5,939,775 $ -- $ 5,946,188
=========== =========== =========== =========== =========== ===========
</TABLE>
See accompanying notes.
F-4
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
<TABLE>
<CAPTION>
Successor
--------------------------------------------------------------------------------------
(Common) (Preferred)
Additional Additional
Common Common Paid in Preferred Preferred Paid in
Shares Stock Capital Shares Stock Capital
------ ----- ------- ------ ----- -------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AS OF JANUARY 1, 1997 . -- $ -- $ -- 641,283 $ 6,413 $ 5,939,775
Issuance of common shares ..... 562,760 5,628 4,496,459 -- -- --
Offering costs ................ -- -- (555,888) -- -- --
Net income .................... -- -- -- -- -- --
Dividends ..................... -- -- -- -- -- (71,064)
------------ ------------ ------------ ------------ ------------ ------------
BALANCE AS OF DECEMBER 31, 1997 562,760 5,628 3,940,571 641,283 6,413 5,868,711
Issuance of common shares ..... 921,980 9,219 6,628,689 -- -- --
Purchase of 9,526 shares of
treasury stock ................ -- -- -- -- -- --
Offering costs ................ -- -- (185,524) -- -- --
Net income .................... -- -- -- -- -- --
Dividends ..................... -- -- (139,312) -- -- --
------------ ------------ ------------ ------------ ------------ ------------
BALANCE AS OF DECEMBER 31, 1998 1,484,740 $ 14,847 $ 10,244,424 641,283 $ 6,413 $ 5,868,711
============ ============ ============ ============ ============ ============
Successor
-------------------------------------------
Retained Treasury
Earnings Stock Total
-------- ----- ---------
<S> <C> <C> <C>
BALANCE AS OF JANUARY 1, 1997 . $ -- $ -- $ 5,946,188
Issuance of common shares ..... -- -- 4,502,087
Offering costs ................ -- -- (555,888)
Net income .................... 535,789 -- 535,789
Dividends ..................... (535,789) -- (606,853)
------------ ------------ ------------
BALANCE AS OF DECEMBER 31, 1997 -- -- 9,821,323
Issuance of common shares ..... -- -- 6,637,908
Purchase of 9,526 shares of
treasury stock ................ -- (86,944) (86,944)
Offering costs ................ -- -- (185,524)
Net income .................... 1,003,706 -- 1,003,706
Dividends ..................... (1,003,706) -- (1,143,018)
------------ ------------ ------------
BALANCE AS OF DECEMBER 31, 1998 $ -- $ (86,944) $ 16,047,451
============ ============ ============
</TABLE>
See accompanying notes.
F-5
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
<TABLE>
<CAPTION>
Statements of Cash Flows
Combined
(Predecessors) (Successor)
--------------------------------------------------------------
Eight Months
Four Months Ended Year Ended Year Ended
Ended December 31, December 31, December 31,
April 30, 1996 1996 1997 1998
-------------- ------------- --------- -------
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ................................................ $ 226,643 $ 373,132 $ 535,789 $ 1,003,706
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization ........................................... 187 3,216 4,335 4,404
Amortization ........................................... 187 3,216 4,335 4,404
Gain on real estate owned .............................. -- -- (18,995) (3,181)
(Increase) decrease in interest receivable ............. (43,733) 7,485 14,799 (98,034)
Accrued interest capitalized to real estate owned ...... -- (83,681) (24,513) (6,950)
Provision for loan loss ................................ 20,000 26,448 -- 205,855
Increase in organization costs ......................... -- -- -- (272)
Increase in security deposits .......................... -- -- -- (32,133)
Increase (decrease) in due to /from affiliates ......... 10,476 (40,653) (10,476) (114,119)
Increase (decrease) in other liabilities ............... (3,227) 4,762 (68,619) 140,065
------------ ------------ ------------ ------------
Net cash provided by operating activities .......... 210,346 290,709 432,320 1,099,341
------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
(Increase) decrease in restricted cash .................... (92,046) 121,159 (140,247) (389,337)
Increase (decrease) in mortgage note holdbacks ............ 92,045 (121,336) 140,365 389,337
Increase in origination costs ............................. -- -- -- (120,217)
Increase in warehouse lines of credit ..................... -- -- (2,185,957) (2,971,141)
Increase in investments ................................... -- -- -- (286,848)
Increase in related party note receivable ................. -- -- -- (225,000)
Return of capital on related party investment ............. -- -- 19,965 --
Investments in mortgage notes receivable .................. (1,022,056) (1,952,384) (3,254,256) (10,342,300)
Repayments of mortgage notes receivable ................... 1,066,231 1,336,796 2,625,113 6,270,841
Net proceeds from sale of real estate owned ............... -- 229,129 791,416 77,181
Capital costs of real estate owned ........................ -- (50,230) (23,956) (5,956)
------------ ------------ ------------ ------------
Net cash provided by (used in) investing activities .... 44,174 (436,866) (2,027,557) (7,603,440)
------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Note payable to related party ............................. -- -- 72,148 (72,148)
Payment of mortgage notes payable ......................... -- (210,546) (191,297) --
Redemption of shares ...................................... (44,825) (23,186) -- --
Receipt of subscriptions receivable ....................... 265,511 -- -- --
Purchase of treasury stock ................................ -- -- -- (86,944)
Proceeds from issuance of shares .......................... -- -- 4,502,087 7,375,840
Organizational and offering costs ......................... (5,625) (185,205) (499,161) (747,406)
Common dividends paid ..................................... -- -- -- (550,484)
Preferred dividends paid .................................. (262,288) (405,379) (606,853) (592,534)
------------ ------------ ------------ ------------
Net cash provided by (used in) financing activities .... (47,227) (824,316) 3,276,924 5,326,324
------------ ------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH ............................... 207,293 (970,473) 1,681,687 (1,177,775)
CASH AT BEGINNING OF PERIOD ................................... 829,978 1,037,271 66,798 1,748,485
------------ ------------ ------------ ------------
CASH AT END OF PERIOD ......................................... $ 1,037,271 $ 66,798 $ 1,748,485 $ 570,710
============ ============ ============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest expense paid ..................................... $ -- $ 19,554 $ 43,604 $ 28,224
Taxes paid ................................................ $ -- $ 2,814 $ 800 $ 15,238
NON-CASH INVESTING AND FINANCING ACTIVITY (See Note 3):
Deferred offering costs accrued ........................... $ -- $ 71,589 $ -- $ --
Deferred offering costs offset against proceeds of offering $ -- $ -- $ 555,888 $ 185,524
</TABLE>
See accompanying notes.
F-6
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
Notes to Financial Statements
For the three-year period ended December 31, 1998
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, pursuant to the issuance of a permit by the California
Commissioner of Corporations which qualified the issuance of the preferred
shares of the Trust issued in the Combination. Under the Agreement and Plan
of Reorganization among the Trust and the Predecessors, each outstanding
share of the Predecessors' Class "A" shares was exchanged into one (1)
share of the Trust's Series A preferred stock (the "Preferred Shares") and
the outstanding shares of the Predecessors' Class "B" shares were exchanged
into Preferred Shares equal to one percent (1%) of the total number of
Preferred Shares to be issued in the Combination of the Predecessors.
At midnight April 30, 1996, the Trust ("Successor") exchanged 347,715 and
296,015 Preferred Shares for all whole shares of CAIT I and CAIT II,
respectively. 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 and warrants to purchase an
additional 150,000 common shares at $5.60 per share.
2. Basis of presentation
---------------------
The operations of the Predecessors have been combined with the Trust due to
the 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.
F-7
<PAGE>
3. Summary of significant accounting policies & nature of operations
-----------------------------------------------------------------
The financial statements for the four months ended April 30, 1996 represent
the combined financial statements of the Predecessors (immediately prior to
the merger). The financial statements for the periods subsequent to April
30, 1996 represent the financial statements of the Trust (Successor) after
the merger described in Note 1.
Use of estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
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.
Fair value of financial instruments. For cash and cash equivalents, the
carrying amount is a reasonable estimate of fair value. For mortgage notes
receivable, fair value is estimated by discounting the future cash flows
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.
Concentration of credit risk. The Trust holds numerous mortgage notes
receivable. These notes are secured by deeds of trust on residential
properties located primarily in California which results in a concentration
of credit risk. The value of the loan portfolio may be affected by changes
in the economy or other conditions of the geographical area. A portion of
the loan portfolio is secured by second trust deeds on real estate.
Loan loss reserve. Management reviews its loan loss provision periodically
and the Trust maintains an allowance for losses on notes receivable at an
amount that management believes is sufficient to protect against losses in
the loan portfolio. Accounts receivable deemed uncollectible are written
off or reserved. The Trust does not accrue interest income on impaired
loans (Note 7). At December 31, 1998, management determined that $170,000
in loan loss reserve was appropriate.
Real estate owned. Real estate owned 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. Subsequent to
foreclosure, the foreclosed asset value is periodically reviewed and is
adjusted to fair value. No depreciation is taken on the real estate owned.
Income and expenses related to real estate owned are recorded as interest
income, interest expense and general and administrative expenses on the
Statements of Operations.
F-8
<PAGE>
3. Summary of significant accounting policies & nature of operations (continued)
-----------------------------------------------------------------------------
Investments. Prior to December 31, 1997, the Trust held an investment in
Sierra Capital Acceptance ("SCA"). On December 31, 1997, SCA completed a
tax-free merger with Sierra Capital Funding, LLC ("SCF"), a Delaware
limited liability company which originates and sells residential mortgage
loans, by exchanging all of the Class A and Class B shares of SCA for the
common and preferred shares of the Sierra Division of SCF. SCA will
continue operations as a separate operating division of SCF. The Trust
holds an investment in the Sierra Division of SCF, which receive a 15%
interest distribution per annum. Sierra Capital Services, Inc., a related
party, owns 99% of the common shares of the Sierra Division of SCF and
maintains voting control.
Origination costs. Origination costs relating to mortgage notes receivable
are deferred and recognized as an adjustment of yield over the term of the
notes.
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 of the Trust during 1997 and 1998. Until
the initial public offering of common stock broke impound on December 4,
1997, these costs were deferred. While the offering was underway, these
costs were offset pro-rata against the proceeds from the issuance of common
stock and as a reduction of stockholders' equity. Through December 31, 1997
stockholders' equity was reduced by $555,888 for deferred offering costs.
The remaining deferred costs of $176,050 was offset against proceeds from
the offering during 1998.
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.
State taxes. During 1998 the state of Delaware imposed a tax on the
increased capitalization of the Trust. The Trust made four quarterly
payments totaling $14,375. In addition, the Trust paid $863 in franchise
tax to the state of California in 1998.
Income taxes. The Trust 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 if the Trust distributes at least
100% of its taxable income to its 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 stockholders. The
Trust must maintain certain records and request certain information from
its stockholders designed to disclose actual ownership of its stock. In
addition the Trust must satisfy certain gross income requirements annually
and certain asset tests at the close of each quarter of its taxable year.
F-9
<PAGE>
3. Summary of significant accounting policies & nature of operations (continued)
-----------------------------------------------------------------------------
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 be taxed as a REIT since inception, no provision for federal income
taxes has been made in the financial statements.
For the eight-month period ended December 31, 1996, the distributions per
Preferred Share are allocated 87.202% as ordinary income and 12.798% as a
return of capital for tax purposes. For the year ended December 31, 1997,
the distributions per Preferred Share are allocated 87.673% as ordinary
income and 12.327% as a return of capital for tax purposes. For the year
ended December 31, 1998, the distributions per Preferred Share are
allocated 100% as ordinary income for tax purposes. The distributions per
Common Share are allocated 74.693% as ordinary income and 25.307% as a
return of capital for tax purposes.
Reclassifications. Certain 1997 amounts have been reclassified to conform
with 1998 classifications. Such reclassifications had no effect on reported
net income.
4. Restricted cash and mortgage note holdbacks
----------------------------------------------
Pursuant to mortgage loan agreements between the Trust and its borrowers, a
portion of the loan proceeds are held by the Trust in segregated accounts
to be disbursed to borrowers upon completion of improvements on the secured
property. As of December 31, 1998 and 1997, mortgage note holdbacks from
the consummation of mortgage loans made amounted to $594,693 and $205,356,
respectively.
5. Interest receivable
-------------------
Interest receivable consist of accrued interest on mortgage notes
receivable and other amounts due from borrowers.
F-10
<PAGE>
6. Warehouse lines of credit to related parties
---------------------------------------------
The Trust entered into a loan purchase agreement on November 1, 1997 with
Sierra Capital Acceptance LLC ("SCA"), a division of Sierra Capital Funding
LLC, a related party. Under the terms of the agreement, the Trust advances
funds to SCA to acquire mortgage loans secured by real estate. The Trust
then acquires all of SCA's right, title and interest in such loans. SCA
must reacquire the loans from the Trust at a preset price. As of December
31, 1998 and 1997, the Trust advanced to SCA $820,100 and $1,468,200,
respectively. Annual interest per annum on this warehouse line of credit is
at prime plus one half of one percent for the first 60 days and prime plus
four percent after 60 days. Interest is payable monthly. The Trust earned
interest in the amount of $55,343 during 1998, of which $18,723 was
outstanding as of December 31, 1998.
The Trust entered into a loan purchase agreement on December 12, 1997 with
Capital Alliance Funding Corporation ("CAFC"). Under the terms of the
agreement, the Trust advances funds to CAFC to acquire mortgage loans
secured by real estate. The Trust then acquires all of CAFC's right, title
and interest in such loans. CAFC must reacquire the loans from the Trust at
a preset price. As of December 31, 1998 and 1997, the Trust advanced to
CAFC $2,414,435 and $717,757, respectively. Annual interest per annum on
this warehouse line of credit is equal to the interest rate of the mortgage
loans pledged and is payable monthly. The Trust earned interest in the
amount of $187,316 during 1998, of which $65,400 was outstanding as of
December 31, 1998.
The Trust entered into a loan purchase agreement on February 1, 1998 with
Equity 1-2-3, a division of Sierra Capital Funding LLC, a related party.
Under the terms of the agreement, the Trust advances funds to Equity 1-2-3
to acquire mortgage loans secured by real estate. The Trust then acquires
all of Equity1-2-3's right, title and interest in such loans. Equity 1-2-3
must reacquire the loans from the Trust at a preset price. As of December
31, 1998, the Trust advanced to Equity 1-2-3 $1,472,563 of funds. Annual
interest per annum on this warehouse line of credit is at prime plus one
percent for the first 60 days and prime plus four percent after 60 days.
Interest is payable monthly. The Trust earned interest in the amount of
$92,026 during 1998, of which $37,360 was outstanding as of December 31,
1998.
The Trust entered into a loan purchase agreement on January 1, 1998 with
Calliance Mortgage Trust ("CMT"). Under the terms of the agreement, the
Trust advances funds to CMT to acquire mortgage loans secured by real
estate. The Trust then acquires all of CMT's right, title and interest in
such loans. CMT must reacquire the loans from the Trust at a preset price.
As of December 31, 1998, the Trust advanced to CMT $450,000 of funds.
Annual interest per annum on this warehouse line of credit is equal to the
interest rate of the mortgage loans pledged and is payable monthly. The
Trust earned interest in the amount of $22,093 during 1998, all of which
was outstanding as of December 31, 1998.
F-11
<PAGE>
7. Mortgage notes receivable
-------------------------
Mortgage notes receivable represent home equity loans secured by
residential real estate. At the time of origination, all loans have a
combined loan-to-value equal to or less than 75% of the underlying
collateral. 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.
A reconciliation of mortgage notes receivable is as follows:
<TABLE>
<CAPTION>
Combined
(Predecessors) (Successor)
April 30, December 31, December 31, December 31,
1996 1996 1997 1998
---------------- ------------- --------------- ---------------
<S> <C> <C> <C> <C>
Balance, beginning of period $ 4,790,070 $ 4,725,895 $ 4,696,238 $ 4,915,186
Additions during period:
New mortgage loans 1,022,056 1,952,384 3,254,256 10,342,300
Deductions during period:
Collections of principal 1,086,231 1,336,796 2,405,113 5,997,178
Foreclosures, net of reserve --- 645,245 410,195 273,663
Cost of mortgages sold --- --- 220,000 ---
---------------- ------------- --------------- ---------------
Balance, close of period $ 4,725,895 $ 4,696,238 $ 4,915,186 $ 8,986,645
================ ============= =============== ===============
</TABLE>
F-12
<PAGE>
CAPITAL ALLIANCE INCOME TRUST LTD.,
A REAL ESTATE INVESTMENT TRUST
Notes to Financial Statements
For the three-year period ended December 31, 1998
7. Mortgage notes receivable (continued)
------------------------------------
The Trust's mortgage notes receivable all relate to loans secured by deeds
of trust on single family residences. The following is a summary of the
Trust's mortgage notes receivable at December 31, 1998.
<TABLE>
<CAPTION>
Principal amount
Monthly Carrying of loans with
Final payment Prior Face amount of amount delinquent
Principal outstanding Interest rate maturity date terms liens mortgage(s) of mortgage(s) principal
- --------------------- ------------- -------------- ---------- ------- ----------- ----------- or interest
(Note A)
--------------
<S> <C> <C> <C> <C> <C> <C> <C>
Individual loans greater than
$269,599 (3% of total mortgage
notes receivable of $8,986,645): ...... 12.50% 04/01/00 $ 3,620 First $ 347,500 $ 347,500 $ --
12.00% 09/01/99 $ 3,410 None 341,000 341,000 --
12.50% 07/01/99 $ 3,125 First 300,000 300,000 --
Loans from $200,000-$269,599 .......... 8.0% to 13.75% 0 to 58 months 2,370,950 2,370,950 250,000
Loans from $100,000-$199,999 .......... 10.0% to 13.5% 0 to 58 months 4,023,600 4,023,600 359,600
Loans from $50,000-$99,999 ............ 11.0% to 16.0% 0 to 53 months 1,178,250 1,178,250 67,900
Loans from $18,650-$49,999 ............ 11.75% to 15.0% 2 to 51 months 425,345 425,345 39,953
---------- ---------- ------------
Total Mortgage Notes Receivable at December 31, 1998 $8,986,645 $8,986,645 $ 717,453
========== ========== ============
<FN>
(A) Delinquent loans are loans where the monthly interest payments in
arrears are 90 or more days overdue. As of December 31, 1998, there
were five loans totaling $467,453 of principal and $22,122 of
interest that were 90 to 180 days delinquent on interest payments.
One loan with the principal amount of $250,000 and $34,075 of
interest has been delinquent for over 180 days. Management has
reviewed all of the delinquent loans and believes that in all
instances the fair value (estimated selling price less cost to
dispose) of the collateral is equal to or greater than the carrying
value of the loan including any accrued interest.
</FN>
</TABLE>
F-13
<PAGE>
8. Loan loss reserve
------------------
The Trust measures impairment based on the fair value of the related
collateral since all loans subject to this measurement are collateral
dependent. Management believes $170,000 of loan loss reserve is adequate to
reflect the probable impairment in all receivable as of December 31, 1998.
Activity in the loan loss reserve was as follows:
<TABLE>
<CAPTION>
Combined
(Predecessors) (Successor)
April 30, December 31, December 31, December 31,
1996 1996 1997 1998
---------------- ------------- --------------- ---------------
<S> <C> <C> <C> <C>
Balance, beginning of period $ 12,000 $ 32,000 $ --- $ ---
Provision for loan loss 20,000 26,448 --- 170,000
Transfer to foreclosed asset --- (58,448) --- ---
---------------- ------------- --------------- ---------------
Balance, end of period $ 32,000 $ --- $ --- $ 170,000
================ ============= =============== ===============
</TABLE>
9. Real estate owned
-----------------
During 1996 the Trust foreclosed on five mortgage notes receivable and sold
one of the foreclosed properties in October 1996. During 1997 the Trust
foreclosed on three mortgage notes receivable, sold three properties and
contributed three properties to capitalize CAFC. At December 31, 1997, the
Trust owned one property. During 1998 the Trust foreclosed on three
mortgage notes receivable, sold one property and contributed two properties
to capitalize CAFC. At December 31, 1998, the Trust owned one property. The
following table shows the cash and non-cash activities in the real estate
owned account.
As of January 1, 1997 the Trust held mortgage notes payable totaling
$578,395. The notes are secured by residential properties with interest
accruing at 8.25% to 8.95% per annum. During 1997 one loan of $91,297 was
paid in full upon the sale of the real estate owned and the remainder of
$487,098 was contributed to capitalize CAFC. There was no mortgage note
payable in 1998.
F-14
<PAGE>
9. Real estate owned (continued)
-----------------------------
A reconciliation of real estate owned is as follows:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Real estate owned at beginning of year $ --- $ 1,312,520 $ 322,550
Foreclosed mortgage notes, net of reserve (non-cash) 618,797 410,195 273,663
Accrued interest capitalized (non-cash) 83,681 24,513 6,950
Mortgage notes payable (non-cash) 578,395 195,728 292,949
Mortgage notes payable (cash paid) 210,546 100,000 ---
Capital costs of real estate owned (cash paid) 50,230 23,956 5,956
Gain on sale (non-cash) --- 18,995 3,181
------------- ------------- -----------
1,541,649 2,085,907 905,249
------------- ------------- -----------
Less: Proceeds from sale of real estate owned (net of closing
costs of $2,819, $24,584 and $25,871 in 1998, 1997 and 1996,
respectively) 229,129 791,416 77,181
Book value of properties transferred to CAFC (non-cash) --- 971,941 678,405
------------- ------------- -----------
229,129 1,763,357 755,586
------------- ------------- -----------
Real estate owned at end of year $ 1,312,520 $ 322,550 $ 149,663
============= ============= ===========
</TABLE>
10. Gain on real estate owned
-------------------------
Three real estate properties were sold during 1997 for a combined gain of
$18,995. One real estate property was sold during 1998 for a gain of
$3,181.
11. Investment in affiliates
------------------------
On April 11, 1997 the Trust formed a non-qualified REIT subsidiary, Capital
Alliance Funding Corporation ("CAFC"), to conduct its planned mortgage
conduit business. The Trust owns all of the outstanding Series "A"
Preferred Stock (2,000 shares of non-voting stock) which constitute a 99%
economic interest in CAFC. The Trust's Manager owns all of the Common
Shares (1,000 shares) of CAFC, which constitutes a 1% economic interest,
and has 100% voting control. The Trust's Manager also manages CAFC and
provides mortgage origination and sale services for CAFC. The Trust
accounts for its investment in CAFC under the equity method.
CAFC commenced operations in the second quarter of 1997. To capitalize
CAFC, the Trust contributed three real estate properties with a net
carrying amount of $289,114 (fair value of $971,941 less the corresponding
mortgage loans of $682,827) in 1997. In 1998, the Trust contributed two
real estate properties net of liabilities equal to $385,940 (book value of
$678,405 less adjustment of $35,855 and the corresponding mortgage loans of
$256,610).
F-15
<PAGE>
11. Investment in affiliates (continued)
------------------------------------
<TABLE>
<CAPTION>
CAPITAL ALLIANCE FUNDING CORPORATION
1997 1998
---- ----
<S> <C> <C>
Total assets $ 1,521,158 $ 5,144,909
============ =============
Total liabilities $ 1,252,008 $ 4,512,973
Total stockholders' equity 269,150 631,936
------------ -------------
Total liabilities and equity $ 1,521,158 $ 5,144,909
============ =============
Revenue $ 111,725 $ 496,433
Expenses (95,278) (435,924)
Other income and expenses
Loss on sale of assets (16,447) (83,663)
------------ -----------
Net income (loss) $ --- $ (23,154)
============ ===========
</TABLE>
As described in Note 3, the Trust also holds an investment in preferred
shares of Sierra Capital Acceptance, a division of Sierra Capital Funding
LLC, totaling $200,000 and receives distribution equal to 15% return per
annum. For the four months ended April 30, 1996, the Predecessors received
guaranteed distribution of $7,500 from this investment. For the eight
months ended December 31, 1996, the Trust earned interest of $22,500 from
this investment. For each of the years ended December 31, 1998 and 1997,
the Trust earned $30,000 from this investment. Distributions are reported
as interest.
12. Related party transactions
--------------------------
The Manager, which is owned by several of the Trustees and their
affiliates, contracted with the Trust to provide management and advisory
services and receives fees for these services from the Trust. The Manager
is also entitled to reimbursement for clerical and administrative services
at cost based on relative utilization of facilities and personnel. The
Manager bears all expenses of services for which it is separately
compensated.
The Manager is entitled to a management fee equal to one-twelfth (1/12) of
1% annually of the book value of mortgages, mortgage-related investments
and real property ("Gross Mortgage Assets") of the Trust plus one-twelfth
(1/12) of one-half percent (1/2%) of the book value of the non-mortgage
assets of the Trust computed at the end of each month. The Trust paid the
Manager a management fee of $143,484 and $48,343 for the year ended
December 31, 1998 and 1997, respectively.
F-16
<PAGE>
12. Related party transactions (continued)
--------------------------------------
Also, the Manager receives a loan origination and servicing fee equal to
one-twelfth (1/12) of 2% annually of the Gross Mortgage Assets of the Trust
computed at the end of each month. Prior to February 12, 1997, the Manager
received a loan origination and servicing fee equal to 0.083% of the
monthly (1% annually) value of all assets less liabilities and reserves.
During the four months ended April 30, 1996, the Predecessors paid $20,107
to the Manager. During the eight months ended December 31, 1996, the Trust
paid $40,244 to the Manager. For the years ended December 31, 1998 and
1997, the Trust paid a loan servicing fee of $63,020 and $102,027 to the
Manager, respectively. As of December 31, 1998, the Trust capitalized
$120,217 of loan origination fees.
Additionally, the Predecessors paid the Manager for organizing the business
and marketing their securities. For the four months ended April 30, 1996,
the Predecessors paid $5,625 to the Manager. For the eight months ended
December 31, 1996, the Trust paid $2,314 to the Manager for liabilities
incurred by the Predecessors.
As of December 31, 1997, the Trust had a note payable of $72,148 to a
related party that accrued interest at 11.5% per annum. During the year
ended December 31, 1997 the Trust paid $2,456 of interest related to this
note. The note was repaid during 1998.
During 1998, the Trust advanced $225,000 to Equity 1-2-3, a division of
Sierra Capital Funding LLC, a related party, and recorded it as a note
receivable. The note bears interest at 15 percent per annum and interest is
payable quarterly. $22,500 of interest was earned and received from this
note in 1998.
On occasions the Trust and its affiliates had related receivables and
payables arising from ordinary business transactions. As of December 31,
1998, the Trust had a receivable of $7,500 from Sierra Capital Acceptance,
a payable of $36,756 to Capital Alliance Funding Corporation, and a payable
of $11,018 to the Manager. As of December 31, 1997, the Trust had a
receivable of $2,500 from Sierra Capital Acceptance, a receivable of
$34,029 from Capital Alliance Funding Corporation, a payable of $39,465 to
the Manager, and a payable of $7,882 to Calliance Mortgage Trust.
As described in Note 6, the Trust advanced $2,185,957 of funds under
warehouse lines of credit to related parties and earned interest of $15,624
on such financing for the year ended December 31, 1997. For the year ended
December 31, 1998, the Trust advanced $5,157,098 of funds under warehouse
lines of credit to related parties and earned interest of $356,778 on such
financing.
13. Preferred, common and treasury stock
------------------------------------
The Preferred Shareholders 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.
F-17
<PAGE>
13. Preferred, common and treasury stock (continued)
------------------------------------------------
After declaring dividends for a given month to the Preferred Shareholders
in the amount of the distribution preference, no further distributions may
be declared on the Preferred Shares for the month until the distributions
declared on each Common Share for that month equals the distribution
preference for each Preferred Share for such month. Any additional
distributions generally will be allocated such that the amount of
distributions per share to the Preferred Shareholders and Common
Shareholders for the month are equal. The distribution preference of the
Preferred Shares is not cumulative.
Preferred Shareholders are entitled to receive all liquidating
distributions until they have received all amount equal to their aggregate
adjusted net capital contribution. Thereafter, Common Shareholders are
entitled to all liquidation distributions until the aggregate adjusted net
capital contributions of all Common Shares has been reduced to zero. Any
subsequent liquidating distributions will be allocated among Common
Shareholders and Preferred Shareholders pro rata.
The Preferred Shares are redeemable by a shareholder, subject to the
consent of the Board of Directors, annually on June 30 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: 3% of redemption amount in
1996, 2% of redemption amount in 1997, 1% of redemption amount in 1998; and
none thereafter.
The Trust has the power to redeem or prohibit the transfer of a sufficient
number of Common and/or Preferred Shares or the exercise of warrants and to
prohibit the transfer of shares to persons that would result in a violation
of the Trust's shareholding requirements. In addition, the Bylaws provide
that no shareholder may own more than 9.8% of the total outstanding shares
after the conclusion of the initial public offering of Common Shares.
One Shareholder Warrant was issued for every 10 Common Shares purchased.
Each Shareholder Warrant entitles the holder to purchase one Common Share.
The exercise price for each Shareholder Warrant is $5.60, which may be
exercised during the 25th through the 48th month after April 28, 1997. In
order to protect the Warrant holders against dilution, the exercise price
of the Warrants and the number of shares which may be purchased upon the
exercise of the Warrants will be adjusted should certain events occur (i.e.
stock dividends, split-ups, combinations and reclassifications). Provision
is also made to protect against dilution in the event of a merger,
consolidation or disposition of all or substantially all of the Trust's
assets. Warrant holders do not have the rights of a shareholder and they
are not entitled to participate in a distribution of the Trust's assets in
a
F-18
<PAGE>
13. Preferred, common and treasury stock (continued)
------------------------------------------------
liquidation, dissolution or winding up of the Trust, unless the Warrants
have been exercised. The Trust may refuse to allow the exercise of a
Warrant if the effect of such exercise would disqualify the Trust as a REIT
under the Internal Revenue Code.
Under the 1998 Incentive Stock Option Plan, adopted by the board of
directors and approved by stockholders, options for the purchase of a total
of 150,000 Common Shares of the Trust were granted effective September 30,
1998. Officers and employees of the Manager, and Directors of the board are
the eligible recipients of the options. The options have a term of 10 years
with a first exercise date six (6) months after the date of the grant. The
initial options for the purchase of 75,000 Common Shares can be exercised
at $8.00 per share. The options for the purchase of remaining 75,000 of
Common Shares can be exercised at the closing price of the Trust's Common
Shares on the American Stock Exchange on April 1, 1999, which was $4.50 per
share.
During 1998, the Trust purchased 9,526 preferred shares as treasury stock.
The purchase was recorded at cost and as a reduction to preferred shares
and additional paid in capital from preferred shares.
14. Earnings per share
------------------
The following table represents a reconciliation of the numerators and
denominators of the basic and diluted earnings per common share.
<TABLE>
<CAPTION>
Combined
(Predecessors) (Successor)
-------------- ------------------------------------------------
Four Months Eight Months
Ended Ended Year Ended Year Ended
April 30, 1996 December 31, December 31, December 31,
1996 1997 1998
---- ---- ----
<S> <C> <C> <C> <C>
Numerator:
Net income $ 226,643 $ 373,132 $ 535,789 $ 1,003,706
Preferred dividends attributable
to income 226,643 373,132 535,789 592,534
----------- ------------ ------------- -------------
Numerator for basic and diluted
earnings per share- income
available to common stockholders $ --- $ --- $ --- $ 411,172
=========== ============ ============= =============
Denominator:
Basic weighted average --- --- 45,219 1,171,733
shares
Effect of dilutive warrants --- --- --- 35,153
----------- ------------ ------------- -------------
Diluted weighted average shares --- --- 45,219 1,206,886
=========== ============ ============= =============
Basic earnings per common share --- --- --- $ 0.351
=========== ============ ============= =============
Diluted earnings per common share --- --- --- $ 0.341
=========== ============ ============= =============
</TABLE>
F-19
<PAGE>
15. Year 2000
---------
The worldwide challenge facing organizations commonly referred to as the
Year 2000 (Y2K) issue is a result of problems that may be encountered with
date-related transactions on systems that have historically recognized
years using two digits versus four digits (i.e., 98 rather than 1998).
These systems will potentially recognize "00" as the year 1900 instead of
2000. On the surface the Y2K problem sounds simple enough; however, the
implications of this problem are far reaching and could impact a broad
range of business services and activities.
Like other organizations and individuals around the world, the Trust and
its operations could be adversely affected if the computer systems it uses
and those used by significant third parties (e.g., vendors, customers,
third party administrators, etc.) do not properly process and calculate
date-related information and data. Management is assessing its computer
systems and business processes and intends to initiate actions to address
the Y2K needs of the Trust as they are identified.
Management is also assessing the actions being taken by third parties that
are significant to its business. At this time, management is not able to
determine the impact, including the costs of remediation, of the Y2K issue
on the Trust. Management intends to fund the costs of needed Y2K efforts
from cash flows from operations and these costs will be expensed as
incurred.
F-20
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<CURRENCY> U.S.
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 570,710
<SECURITIES> 0
<RECEIVABLES> 14,368,743
<ALLOWANCES> 170,000
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 149,663
<DEPRECIATION> 0
<TOTAL-ASSETS> 16,804,983
<CURRENT-LIABILITIES> 757,532
<BONDS> 0
0
631,757
<COMMON> 1,484,740
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 16,804,983
<SALES> 0
<TOTAL-REVENUES> 1,677,233
<CGS> 0
<TOTAL-COSTS> 446,246
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 205,855
<INTEREST-EXPENSE> 34,607
<INCOME-PRETAX> 1,000,525
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,000,525
<DISCONTINUED> 0
<EXTRAORDINARY> 3,181
<CHANGES> 0
<NET-INCOME> 1,003,706
<EPS-PRIMARY> .351
<EPS-DILUTED> .341
</TABLE>
