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As filed with the Securities and Exchange Commission on August 30, 2000
Registration No. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-11
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
OF SECURITIES OF CERTAIN REAL ESTATE COMPANIES
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SPECIALTY MORTGAGE TRUST, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS GOVERNING INSTRUMENTS)
6160 PLUMAS STREET
RENO, NEVADA 89509
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
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NELLO GONFIANTINI III
CHAIRMAN OF THE BOARD, PRESIDENT AND CHIEF FINANCIAL OFFICER
SPECIALTY MORTGAGE TRUST, INC.
6160 PLUMAS STREET
RENO, NEVADA 89509
(775) 826-0809
(NAME AND ADDRESS OF AGENT FOR SERVICE)
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COPY TO:
PHILLIP R. POLLOCK, ESQ.
TOBIN & TOBIN
500 SANSOME STREET, 8TH FLOOR
SAN FRANCISCO, CA 94111
(415) 433-1400
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
At any time and from time to time after the effective date of this Registration
Statement in light of market conditions and other factors
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the same
offering. [ ] __________
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement for the same
offering. [ ] __________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check box: [X]
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CALCULATION OF REGISTRATION FEE
<TABLE>
<S> <C> <C> <C> <C>
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PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF SECURITIES BEING AMOUNT BEING OFFERING PRICE AGGREGATE AMOUNT OF
REGISTERED REGISTERED PER UNIT OFFERING PRICE REGISTRATION FEE
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Collateralized Investment
Notes....................... $250,000,000 100% $250,000,000 $66,000
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
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THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED.
WE HAVE FILED A REGISTRATION STATEMENT RELATING TO THESE SECURITIES
WITH THE SECURITIES AND EXCHANGE COMMISSION. WE CANNOT SELL THESE
SECURITIES UNTIL THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS
PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND WE ARE NOT
SOLICITING OFFERS TO BUY THESE SECURITIES IN ANY STATE WHERE SUCH OFFER
OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, AUGUST 30, 2000
PROSPECTUS
AUGUST , 2000
UP TO $250,000,000
SPECIALTY MORTGAGE TRUST, INC.
COLLATERALIZED INVESTMENT NOTES
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CONSIDER CAREFULLY THE RISK FACTORS
BEGINNING ON PAGE 5 OF THIS PROSPECTUS,
INCLUDING THE FOLLOWING:
- Specialty Mortgage Trust's operations
depend heavily upon the contributions
of Nello Gonfiantini III who would be
difficult to replace.
- We face loss exposure due to the
credit risks of real estate mortgage
loans, which could affect our ability
to repay the Notes.
- Most of our mortgage loans are
secured by properties located
primarily in Nevada, which makes us
dependent upon the Nevada economy.
- Investors have limited recourse as
the Notes are not insured by any
governmental agency or
instrumentality or any other person
or entity.
- The Notes have limited liquidity as
there is no secondary trading market
and none is likely to develop.
Specialty Mortgage Trust, Inc. is offering up to $250,000,000 of its
Collateralized Investment Notes with issuances expected to take place on a
monthly basis. The maximum principal of Notes that can be outstanding at any
time may not exceed $50 million.
THE COLLATERALIZED INVESTMENT NOTES:
- will be secured by pledged assets of Specialty Mortgage Trust, Inc.,
consisting of mortgage loans, short-term money market instruments and/or
cash;
- will be issued in minimum denominations of $25,000;
- are not redeemable at the option of the issuer prior to their stated
maturity;
- will bear interest rates as established from time to time, with interest
payable, at the election of the noteholder, either monthly in arrears on the
20th day of each month or, compounding monthly, at maturity; and
- will have a maturity that is fixed on the date of issuance within a range of
a minimum of 1 month to a maximum of 12 months from the date of issuance.
Notes will be issued on the 20(th) of the month, or the first business day
thereafter. Investors may select the term and corresponding interest rate
offered in a supplement to this prospectus.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISPROVED THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS ACCURATE OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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TABLE OF CONTENTS
<TABLE>
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PAGE
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<S> <C>
PROSPECTUS SUMMARY.................... 1
Summary of the Offering............. 1
Overview of Specialty Mortgage
Trust, Inc. ..................... 2
Summary Risk Factors................ 3
Ratio of Earnings to Fixed
Charges.......................... 4
RISK FACTORS.......................... 5
Investment in Collateralized
Investment Notes................. 5
Overall Enterprise of Specialty
Mortgage Trust, Inc. ............ 5
The Business of Mortgage Lending and
Managing a Mortgage Loan
Portfolio........................ 7
THE COMPANY........................... 12
USE OF PROCEEDS....................... 12
DIVIDEND POLICY AND DISTRIBUTIONS..... 12
CAPITALIZATION........................ 13
SELECTED FINANCIAL AND OTHER DATA..... 14
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS....................... 15
"Safe Harbor" Statement Under
Private Securities Litigation
Reform Act of 1995............... 15
Overview............................ 15
Financial Condition................. 15
Assets.............................. 15
Liabilities......................... 16
Results of Operations............... 16
Recent Developments................. 18
Interest Rate/Market/Credit Risk.... 18
Liquidity and Capital Resources..... 18
BUSINESS.............................. 19
Mortgage Lending.................... 19
The Mortgage Loan Portfolio......... 22
Managing the Mortgage Loan
Portfolio........................ 24
Using Leverage to Finance Mortgage
Loan Acquisitions................ 25
Company Policies.................... 25
Legal Proceedings................... 25
THE MANAGER........................... 26
Management Fees..................... 26
Administrative Services Provided by
the Manager...................... 27
Expenses............................ 28
Indemnification..................... 28
Term and Termination................ 28
</TABLE>
<TABLE>
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PAGE
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MANAGEMENT............................ 29
Directors and Officers.............. 29
Terms of Directors and Officers..... 30
Committees of the Board............. 30
Compensation Committee Interlocks... 31
Compensation of Directors........... 31
Executive Compensation.............. 31
Stock Option Plan................... 31
PRINCIPAL SECURITYHOLDERS............. 34
Beneficial Ownership of Capital
Stock by Large Securityholders... 34
Beneficial Ownership of Capital
Stock by Directors and
Management....................... 34
CERTAIN TRANSACTIONS.................. 36
DESCRIPTION OF THE NOTES.............. 37
General............................. 37
Collateral.......................... 38
Calculation of the Value of the
Collateral....................... 39
Withdrawals and Substitutions of
Collateral....................... 40
Payments on Pledged Assets.......... 40
Purchase and Resale of Notes........ 40
Redemption.......................... 40
Financial Reports................... 40
Events of Default................... 41
Priority............................ 42
Merger.............................. 42
The Trustee......................... 42
Modification........................ 42
List of Noteholders................. 43
Annual Compliance Statement......... 43
Trustee's Annual Report............. 43
Trustee............................. 43
FEDERAL INCOME TAX CONSEQUENCES....... 44
Tax Classification of the Notes..... 44
Tax Classification of Specialty
Mortgage Trust................... 44
Tax Classification of the Collateral
Pool............................. 45
Tax Consequences to Noteholders..... 45
STATE AND LOCAL TAXES................. 46
ERISA INVESTORS....................... 46
PLAN OF DISTRIBUTION.................. 47
LEGAL MATTERS......................... 48
EXPERTS............................... 48
WHERE YOU CAN FIND MORE INFORMATION... 48
GLOSSARY.............................. 49
FINANCIAL STATEMENTS.................. F-1
</TABLE>
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PROSPECTUS SUMMARY
This summary highlights selected information from this prospectus and does
not contain all of the information that you need to consider in making your
investment decision. You should read this entire prospectus carefully to
understand all of the terms of the offering. We include a glossary beginning on
page 49.
SUMMARY OF THE OFFERING
Securities offered. This prospectus relates to up to $250,000,000 of
Specialty Mortgage Trust, Inc.'s Collateralized Investment Notes. The maximum
principal amount outstanding at any time may not exceed $50,000,000.
Term. The Notes are expected to be issued monthly with maturities ranging
from one month to twelve months from the date of issuance.
Minimum denominations. $25,000.
Date of Issuance. The 20th day of the month, or the first business day
thereafter.
Interest. We will establish interest rates on the Notes offered in this
prospectus from time to time, based on market conditions and our financial
requirements. Once fixed at issuance, the interest rate on a Note will not
change unless the term of the Note is extended. Interest on the Notes is payable
at the election of the noteholder either (a) monthly in arrears on the 20th day
of each month and at stated maturity or (b) compounding monthly, at stated
maturity. Accrued interest is to be computed on the basis of a 360-day year
consisting of twelve 30-day months. Investors may select the term and
corresponding interest rate offered in a supplement to this prospectus.
Collateral. The Notes will be collateralized by pledged assets consisting
of (a) our mortgage loans in an aggregate principal amount at least equal to one
and a half (1 1/2) times the aggregate principal amount outstanding on the
Notes, (b) short-term money market instruments and cash at least equal to the
aggregate principal amount outstanding on the Notes or (c) a combination of the
foregoing. We anticipate that initially the pledged assets will consist
primarily of various mortgage loans.
The Trustee. Pursuant to the terms of an indenture, Bankers Trust Company
of California, N.A. shall serve as trustee and shall hold the pledged assets for
the benefit of the noteholders.
Valuation of collateral. On the 20th day of each month, we are required to
calculate and certify to the trustee the value of the collateral securing the
Notes within the last five business days using the current principal amount of
the pledged mortgage loans, the principal or face amount of the pledged short-
term money market instruments and the face value of pledged cash.
Maintenance of collateral. If on any valuation date the value of the
pledged assets is less than that required to be maintained, we shall, not later
than the month-end following the valuation date, (i) deliver to the trustee
additional eligible collateral and/or (ii) purchase outstanding Notes, such that
after taking such actions the value of the collateral is equal to or greater
than that required to be maintained.
Withdrawal or substitution of pledged assets. We may, upon request to the
trustee, withdraw or substitute pledged assets at any time if, after giving
effect to any such withdrawal or substitution, the value of the pledged assets
is at least equal to the amount required to be maintained.
Payments and distributions on the pledged assets. Unless an event of
default has occurred and is continuing with respect to the Notes, we shall be
entitled to collect all payments on the pledged assets. Upon the occurrence of
an event of default and while it shall be continuing, the trustee may require
that payments on pledged assets be paid directly to it and, if we then receive
any payments on the pledged assets, we shall hold such payments in trust for the
benefit of the trustee and the holders of the Notes.
Redemption. The Notes are not subject to redemption at our option or at the
option of a noteholder or otherwise.
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<PAGE> 5
Form. Book-entry and non-negotiable. We will provide the holder with a
confirmation of the transaction. We will not issue promissory notes to
individual holders.
Automatic Extension. We will automatically extend the term of a Note on
maturity for a period equal to the original term if we do not receive notice
from the noteholder to redeem or convert the Note at least one business day
before the maturity date of the Note and if we do not give the holder notice of
redemption at maturity at least five business days before the Note's maturity.
We will extend Notes at their maturity dates at the interest rate we are
offering on newly-issued Notes of the same term and denomination as the maturing
Note. A noteholder shall be paid the interest due at maturity and only the
principal amount shall be rolled over.
OVERVIEW OF SPECIALTY MORTGAGE TRUST, INC.
We are a specialty mortgage finance company that acquires and holds
mortgage loans secured by property located primarily in the State of Nevada. Our
strategy is to focus on small commercial mortgage loans (generally less than $5
million per loan), land loans and nonconforming single-family and small
multifamily (generally less than 20 units) residential mortgage loans. These
loans are generally higher yielding than conventional residential mortgage
loans. We manage the mortgage loan portfolio in a tax-advantaged real estate
investment trust or REIT structure. Our income is generally not subject to
federal income tax to the extent it is distributed to our shareholders and we
otherwise maintain our qualification as a REIT. The mortgage loans are
originated and serviced by the manager, Gonzo Financial, Inc., a private
mortgage finance business.
Nello Gonfiantini III, Specialty Mortgage Trust's founder, serves as
Chairman of the Board, President and Chief Executive Officer of Specialty
Mortgage Trust. Mr. Gonfiantini has owned and managed Gonzo Financial, Inc., a
private mortgage finance and real estate development business in Nevada, since
January 1995. From 1986 until 1994, Mr. Gonfiantini was the Chairman, CEO and
President of Home Federal Savings Bank of Nevada, where he oversaw the
commercial and residential real estate lending operations. Prior to taking that
position in 1986, Mr. Gonfiantini was the Executive Vice President of Home
Mortgage Company, a mortgage banking firm and predecessor to Home Federal
Savings Bank of Nevada. Since June 1994, Mr. Gonfiantini has served as a
director of Redwood Trust, Inc., a publicly-traded REIT with mortgage assets
currently in excess of $2 billion. Messrs. George E. Bull, Roger M. Peltyn,
Stephen V. Novacek, Ernest Martinelli and Harvey Fennell serve on the board of
directors of Specialty Mortgage Trust as independent directors.
Mr. Gonfiantini's mortgage finance business, Gonzo Financial, Inc., as the
manager for the REIT, originates and services Specialty Mortgage Trust's
mortgage loans. Gonzo Financial bears all administrative expenses connected with
building and managing a mortgage loan portfolio, which does not include the debt
service on these notes or any other borrowings, and receives a monthly
management fee equal to (i) the loan origination fees or points charged to a
borrower (up to two and one-half points per loan, any balance to benefit
Specialty Mortgage Trust), (ii) a one-half of one percent servicing fee on all
loans being serviced by Gonzo Financial, and (iii) any late payment charges paid
by borrowers. We also pay to Gonzo Financial as incentive compensation for each
quarter an amount equal to 50% of the taxable income of Specialty Mortgage
Trust, before payment of dividends and deduction of such incentive compensation,
in excess of an annualized return on equity equal to 12%.
The section entitled "Business" in this prospectus includes a table which
describes Specialty Mortgage Trust's current mortgage loan portfolio.
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SUMMARY RISK FACTORS
Prior to making an investment decision, prospective investors should
carefully consider all of the information set forth in this prospectus and, in
particular, should evaluate the factors set forth in "Risk Factors." These risk
factors include:
- We have a limited operating history. Specialty Mortgage Trust commenced
operations January 31, 1998. Although Mr. Gonfiantini has extensive
experience in mortgage lending, there can be no assurance that the past
experience of the manager will be indicative of our future results.
- We depend on key personnel for successful operations. Our operations
depend heavily upon the contributions of Mr. Gonfiantini who would be
difficult to replace. There can be no assurance that he will remain in
the employ of Specialty Mortgage Trust or the manager. The loss of this
individual or of other key personnel could have a material adverse effect
upon our business and results of operations.
- Failure to refinance outstanding borrowings may materially adversely
impact our operations and solvency. Our ability to achieve our investment
objectives depends not only on our ability to borrow money in sufficient
amounts and on favorable terms from investors in our Notes but also on
our ability to renew or replace on a continuous basis our maturing
short-term bank borrowings. In the event we are not able to renew or
replace maturing borrowings, we could be required to sell mortgage loans
under adverse market conditions and could incur losses as a result.
- We face loss exposure due to the credit risks of real estate mortgage
loans on property located primarily in Nevada. Properties underlying
mortgage loans are located primarily in the State of Nevada. To the
extent that properties underlying mortgage loans are located in the same
geographical region, such mortgage loans may be subject to a greater risk
of delinquency or default in the event of adverse economic, political or
business developments in the region or natural hazards that affect the
region.
- Should we fail to maintain REIT status, we would be subject to tax as a
regular corporation. If we fail to conduct our business at all times in a
manner consistent with the REIT provisions of the Code and to maintain
our qualification as a REIT, we would be subject to federal income tax as
a regular corporation.
- Investors have limited recourse. The Notes offered by this offering are
obligations of Specialty Mortgage Trust and are not insured or guaranteed
by any governmental agency or instrumentality or any other person or
entity.
- Investors face limited liquidity. There is no secondary market for the
Notes and none is likely to develop.
- Our Notes are unrated. No rating agency or other third party has reviewed
this transaction for the purpose of assessing the likelihood of our
repaying the Notes.
3
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RATIO OF EARNINGS TO FIXED CHARGES
The following table shows our ratio of earnings to fixed charges for the
periods indicated:
<TABLE>
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SIX MONTHS
YEAR ENDED DECEMBER 31, ENDED
------------------------ JUNE 30,
1998 1999 2000
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Fixed Charges:
Interest Expense............................. $ 76,877 $ 263,633 $ 208,036
Capitalized Expenses Related to
Indebtedness.............................. 10,189 56,398 22,832
Total Adjusted Fixed Charges.............. 87,066 320,031 230,868
Earnings:
Net Earnings................................. 2,025,870 3,809,424 1,918,512
Fixed Charges................................ 87,066 320,031 230,868
---------- ---------- ----------
Total Adjusted Earnings................... $2,112,936 $4,129,455 $2,149,380
========== ========== ==========
Ratio of Earnings to Fixed Charges............. 24.27% 12.90% 9.31%
</TABLE>
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RISK FACTORS
Before you invest in any of the securities offered in this prospectus, you
should be aware that there are various risks, including those described below.
You should consider carefully these risk factors, together with all of the other
information included in this prospectus and the applicable prospectus supplement
before you decide to purchase any of the securities.
INVESTMENT IN COLLATERALIZED INVESTMENT NOTES
YOUR RECOURSE FOR PAYMENT IS LIMITED TO OUR ASSETS.
The Notes represent obligations solely of Specialty Mortgage Trust and are
not insured or guaranteed by any governmental agency or instrumentality or any
other person or entity.
THE NOTES HAVE LIMITED LIQUIDITY AND YOU MAY NOT BE ABLE TO TRANSFER YOUR
NOTES.
There is no secondary trading market for the Notes and one is unlikely to
develop. As a result, the ability of a noteholder to transfer the Note, or to
pledge a Note as collateral, is expected to be very limited.
POSSIBLE VOLATILITY OF THE MARKET VALUE OF THE PLEDGED ASSETS MAY ADVERSELY
IMPACT THE LIQUIDITY OF THE NOTES AND ANY DEFICIENCY UPON LIQUIDATION OF
OUR MORTGAGES MAY RESULT IN LOSSES TO NOTEHOLDERS.
The market value of the pledged assets, and of our mortgage assets
generally, may fluctuate significantly. In addition, our mortgage assets may
prove to be illiquid. Consequently, such pledged assets may need to be
liquidated at a discount, in which case the proceeds of liquidation might be
less than the outstanding principal amount of, and interest payable on, the
Notes.
THE INDENTURE GOVERNING THE SECURITIES CONTAINS LIMITED EVENTS OF DEFAULT.
The securities offered in this prospectus are governed by a trust indenture
which is an agreement between us and the trustee about the terms of the
securities. The indenture governing the securities contains only limited events
of default other than our failure to pay principal or interest on time.
OUR NOTES ARE UNRATED.
No rating agency or other third party has reviewed this transaction for the
purpose of assessing the likelihood of our repaying the Notes.
TIMELY PAYMENT OF AMOUNTS DUE ON THE NOTES COULD BE ADVERSELY AFFECTED BY
BANKRUPTCY LAWS.
In the event of the bankruptcy or insolvency of Specialty Mortgage Trust,
the trustee on behalf of noteholders will have a perfected security interest in
the pledged assets. Nonetheless, a bankruptcy court could defer timely payment
of amounts due on the Notes effectively reducing amounts otherwise payable to
noteholders.
OVERALL ENTERPRISE OF SPECIALTY MORTGAGE TRUST, INC.
WE HAVE A LIMITED OPERATING HISTORY.
Specialty Mortgage Trust commenced operations January 31, 1998. Although
Mr. Gonfiantini has extensive experience in mortgage lending, there can be no
assurance that the past experience of the manager will be indicative of the
future results.
WE DEPEND ON KEY PERSONNEL FOR SUCCESSFUL OPERATIONS.
Our operations depend heavily upon the contributions of Mr. Gonfiantini who
would be difficult to replace. Mr. Gonfiantini has made substantial personal
investments in Specialty Mortgage Trust. There can be no assurance, however,
that he will remain in the employ of Specialty Mortgage Trust or the manager.
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<PAGE> 9
The loss of this individual or of other key personnel could have a material
adverse effect on our business and results of operations.
FAILURE TO REFINANCE OUTSTANDING BORROWINGS MAY MATERIALLY ADVERSELY IMPACT
OUR OPERATIONS AND SOLVENCY.
Our ability to achieve our investment objectives depends not only on our
ability to borrow money in sufficient amounts and on favorable terms from
investors in our Notes but also on our ability to renew or replace on a
continuous basis our maturing short-term bank borrowings, known as warehouse
facilities. If we are unable to obtain additional lending facilities on terms
similar to the existing facilities, it may negatively impact our ability to
continue to fund our operations and, as a result, our ability to repay
indebtedness, including principal and interest due on the securities offered in
this prospectus. In the event we are not able to renew or replace maturing
borrowings, we could be required to sell mortgage loans under adverse market
conditions and could incur losses as a result. An event or development such as a
sharp rise in interest rates or increasing market concern about the value or
liquidity of a type or types of mortgage loans in which our portfolio is
concentrated will reduce the market value of the mortgage loans, which would
likely cause lenders to require additional collateral. A number of such factors
in combination may cause us difficulties, including a possible liquidation of a
major portion of our mortgage loan portfolio at disadvantageous prices with
consequent losses, which could have a material adverse effect on Specialty
Mortgage Trust and its solvency.
SHOULD WE FAIL TO MAINTAIN REIT STATUS, WE WOULD BE SUBJECT TO TAX AS A
REGULAR CORPORATION.
We intend, at all times, to operate so as to qualify as a REIT for federal
income tax purposes. In order to maintain our qualification as a REIT, we must
satisfy tests with respect to the sources of our income, the nature and
diversification of our assets, the amount of our distributions to stockholders
and the ownership of our stock. If we fail to qualify as a REIT in any taxable
year and specific relief provisions of the Code do not apply, we would be
subject to federal income tax as a regular, domestic corporation. As a result,
we could be subject to income tax liability, thereby significantly reducing or
eliminating the amount of cash available to make payments on the Notes. Further,
we could also be disqualified from re-electing REIT status for the four taxable
years following the year during which we became disqualified.
REIT qualification requirements with respect to (i) our source of income,
the nature of assets and the requirement to distribute earnings may limit
operational and financial opportunities otherwise available to us and (ii)
shareholder diversification may limit our access to some equity investors.
No assurance can be given that future legislation, regulations,
administrative interpretations or court decisions will not significantly change
the tax laws with respect to our qualification as a REIT or the federal income
tax consequences of such qualification, which changes may reduce or eliminate
our competitive advantage over non-REIT competitors.
IF WE SHOULD FAIL TO QUALIFY FOR AN INVESTMENT COMPANY ACT EXEMPTION, OUR
ABILITY TO USE LEVERAGE AND TO CONDUCT OUR BUSINESS WOULD BE MATERIALLY
ADVERSELY AFFECTED.
We at all times intend to conduct our business so as not to become
regulated as an investment company under the Investment Company Act.
Accordingly, we do not expect to be subject to the restrictive provisions of the
Investment Company Act. The Investment Company 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." If we fail to
qualify for exemption from registration as an investment company, our ability to
use leverage would be substantially reduced and we would be unable to conduct
our business as described herein. Any such failure to qualify for such exemption
could have a material adverse effect on our business.
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WE HAVE A POTENTIAL CONFLICT OF INTEREST WITH OUR MANAGER.
We are subject to conflicts of interest with the manager and our executive
officers. Our executive officers are also executive officers, employees and
stockholders of the manager. Under the management agreement, the manager
receives a management fee and the manager has the opportunity to earn incentive
compensation based on our annualized net income. In evaluating mortgage loans,
an undue emphasis on maximizing income at the expense of other criteria, such as
preservation of capital, in order to achieve higher incentive compensation for
the manager, could result in increased exposure to losses on our mortgage loan
portfolio. Similarly, the size of the mortgage origination fees (points) which
are paid to the manager as part of the management fee may have a direct impact
upon the interest rate the borrower is willing to pay to Specialty Mortgage
Trust. The portion of origination fees paid to the manager is limited to 2.5%
(2 1/2 points).
THE BUSINESS OF MORTGAGE LENDING AND MANAGING A MORTGAGE LOAN PORTFOLIO
WE FACE LOSS EXPOSURE DUE TO THE CREDIT RISKS OF MORTGAGE LENDING.
Real Estate Security. Many of the risks of holding mortgage loans reflect
the risks of investing directly in the real estate securing the mortgage loans.
This may be especially true in the case of a relatively small or less diverse
pool of mortgage loans. In the event of a default on the underlying mortgage
loan, the ultimate extent of the loss, if any, may only be determined after a
foreclosure of the mortgage encumbering the property and, if the lender takes
title to the property, upon liquidation of the property. Factors such as the
title to the property or its physical condition (including environmental
considerations) may make a third party unwilling to purchase the property at a
foreclosure sale or for a price sufficient to satisfy the obligations with
respect to the related mortgage loan. Foreclosure laws may protract the
foreclosure process. In addition, the condition of a property may deteriorate
during the pendency of foreclosure proceedings. Some borrowers may become
subject to bankruptcy proceedings, in which case the amount and timing of
amounts due may be materially adversely affected. Even assuming that the
underlying real estate provides adequate security for the mortgage loan,
substantial delays could be encountered in connection with the liquidation of a
defaulted mortgage loan and a corresponding delay in the receipt and
reinvestment of principal and interest payments could occur.
Real Estate Market Conditions. Our business may be adversely affected by
periods of economic slowdown or recession which may be accompanied by declining
real estate values. Any material decline in real estate values reduces the
ability of borrowers to use real estate equity to support borrowings and
increases the loan-to-value ratios of mortgage loans previously made, thereby
weakening collateral coverage and increasing the possibility of a loss in the
event of default. In addition, delinquencies, foreclosures and losses generally
increase during economic slowdowns and recessions.
Multifamily and Nonresidential Mortgage Loans. Multifamily mortgage loans
share many of the characteristics and risks associated with commercial mortgage
loans and are often categorized as commercial loans rather than residential
loans. Commercial mortgage loans have distinct risk characteristics. Commercial
mortgage loans generally lack standardized terms, which may complicate their
structure. Commercial properties themselves tend to be unique and are more
difficult to value than residential properties. Commercial mortgage loans also
tend to have shorter maturities than residential mortgage loans and may not be
fully amortizing, meaning that they may have a significant principal balance, or
"balloon," due on maturity. In addition, commercial properties, particularly
industrial and warehouse properties, are generally subject to relatively greater
environmental risks than non-commercial properties and the corresponding burdens
and costs of compliance with environmental laws and regulations. We refer you to
"-- Environmental Liabilities" in this prospectus for more detail.
Commercial mortgage loans are sometimes non-recourse to borrowers. In the
event of foreclosure on a commercial mortgage loan, the value at that time of
the collateral under the mortgage may be less than the principal amount
outstanding on the mortgage loan and the accrued but unpaid interest. Also,
there may be costs and delays involved in enforcing rights of a property owner
against tenants in default under
7
<PAGE> 11
the terms of leases with respect to commercial properties and such tenants may
seek the protection of the bankruptcy laws which can result in termination of
lease contracts.
Commercial mortgage loans are also subject to the effects of: (i) local and
other economic conditions on real estate values, (ii) the ability of tenants to
make lease payments, (iii) the ability of a property to attract and retain
tenants, which may in turn be affected by local conditions such as oversupply of
space or a reduction in demand for rental space in the area, the attractiveness
of properties to tenants, competition from other available space, the ability of
the owner to pay leasing commissions, provide adequate maintenance and
insurance, pay tenant improvements costs and to make other tenant concessions,
and (iv) increased operating costs, including energy costs and real estate
taxes. While owners of real property generally will carry comprehensive
liability and casualty coverage, such coverage may not provide full protection
for the value of the underlying property and may not protect against all
casualty losses. If underlying commercial properties do not generate sufficient
income to meet operating expenses, debt service, capital expenditures and tenant
improvements, borrowers under commercial mortgage loans may be unable to make
payments of principal and interest in a timely fashion. Income from and values
of commercial properties are also affected by such factors as applicable laws,
including tax laws, interest rate levels, the availability of financing for
owners and tenants, and the impact of and costs of compliance with environmental
controls and regulations.
Nonconforming Residential Loans. Credit risks associated with
non-conforming mortgage loans may be greater than those associated with
conventional mortgage loans that conform to Fannie Mae and Freddie Mac
guidelines. The principal difference between non-conforming mortgage loans and
conforming mortgage loans include the applicable loan-to-value ratios, the
credit and income histories of the mortgagors, the documentation required for
approval of the mortgagors, the types of properties securing the mortgage loans,
loan sizes and the mortgagors' occupancy status with respect to the mortgaged
property. As a result of these and other factors, the interest rates charged on
non-conforming mortgage loans are often higher than those charged for conforming
mortgage loans. The combination of different underwriting criteria and higher
rates of interest may lead to higher delinquency rates and/or credit losses for
non-conforming as compared to conforming mortgage loans and could have an
adverse effect on our business to the extent that we invest in such mortgage
loans.
Lack of Geographic, Industry or Borrower Diversification. Properties
underlying mortgage loans are located primarily in the State of Nevada. To the
extent that properties underlying such mortgage loans are located in the same
geographical region, such mortgage loans may be subject to a greater risk of
delinquency or default in the event of adverse economic, political or business
developments and natural hazard risks that may affect such region. If the
region's real estate market should experience an overall decline in property
values, the rates of delinquency, foreclosure, bankruptcy and loss on the
mortgage loans may be expected to increase substantially, as compared to such
rates in a stable or improving real estate market. In addition, to the extent
that the end use of commercial properties underlying mortgage loans tend to be
concentrated in the same or similar industries and such industries suffer
adverse economic or business developments, the ability of property owners to
make principal and interest payments on the underlying mortgages will be
impaired. Further, we do not have limitations on the amount of, or the
percentage of its portfolio of mortgage loans represented by, any single
mortgage loan or mortgage loans to any one borrower.
Balloon Loans. Most of the loans in our portfolio require the borrower to
make a "balloon payment" on the principal amount upon maturity of the loan. To
the extent that a borrower has an obligation to pay a mortgage loan in a large
lump sum payment, its ability to satisfy this obligation may be dependent upon
its ability to obtain suitable refinancing or otherwise raise a substantial cash
amount. An increase in interest rates over the mortgage rate applicable at the
time the loan was originated may have an adverse effect on the borrower's
ability to obtain refinancing or to pay the required monthly payments. As a
result, such loans may involve a higher risk of default than fully amortizing
loans.
Environmental Liabilities. Some properties securing mortgage loans may be
contaminated by hazardous substances. As a result, the value of the real
property may be diminished. In the event that we
8
<PAGE> 12
are forced to foreclose on a defaulted mortgage loan on that property, we may be
subject to environmental liabilities regardless of whether we were responsible
for the contamination. While we intend to exercise due diligence to discover
potential environmental liabilities prior to the acquisition of any property
through foreclosure, hazardous substances or wastes, contaminants, pollutants or
sources thereof, as defined by state and federal laws and regulations, may be
discovered on properties during our ownership or after a sale thereof to a third
party. If such hazardous substances are discovered on a property, the Company
may be required to remove those substances or sources and clean up the property.
We may also be liable to tenants and other users of neighboring properties. In
addition, we may find it difficult or impossible to sell the property prior to
or following any such clean up.
INTENSE COMPETITION IN THE MORTGAGE LOAN INDUSTRY MAY RESULT IN REDUCED NET
INCOME OR IN REVISED UNDERWRITING STANDARDS WHICH WOULD ADVERSELY AFFECT
OUR OPERATIONS.
We face competition, primarily from commercial banks, savings and loans,
other independent mortgage lenders, and other mortgage REITs. If we expand into
particular geographic markets, we face competition from lenders with established
positions in these locations. Competition can take place on various levels,
including convenience in obtaining a mortgage loan, service, marketing,
origination channels and pricing. Many of our competitors in the financial
services business are substantially larger and have more capital and other
resources than we do. There can be no assurance that we will be able to compete
successfully in this market environment and any failure in this regard could
have a material adverse effect on our results of operations and financial
condition.
GENERAL ECONOMIC AND FINANCIAL CONDITIONS IN MORTGAGE AND FINANCIAL MARKETS
MAY AFFECT OUR RESULTS OF OPERATIONS.
The performance of our mortgage loan portfolio will depend on, among other
things, the level of net interest income generated by our mortgage loans, the
market value of such mortgage loans and the supply of and demand for such
mortgage loans. Prepayment rates, interest rates, borrowing costs and credit
losses depend upon the nature and terms of the mortgage loans, the geographic
location of the properties securing the mortgage loans, conditions in financial
markets, the fiscal and monetary policies of the United States government and
the Board of Governors of the Federal Reserve System, international economic and
financial conditions, competition and other factors, none of which can be
predicted with any certainty.
WE FACE ADVERSE EFFECTS OF USING LEVERAGE TO FINANCE MORTGAGE LOAN
ORIGINATIONS.
General. We employ a financing strategy to increase the size of our
mortgage loan portfolio by borrowing a portion of the market value of our
mortgage loans. If the returns on the mortgage loans originated or purchased
with borrowed funds fail to cover the cost of the borrowings, we will experience
net interest losses and may experience net losses. In addition, we may not be
able to achieve the degree of leverage we believe to be optimal, which may cause
our business to be less profitable than it might be otherwise. REIT income and
asset tests may limit our ability to effectively hedge our exposure to interest
rate changes relative to our assets and borrowings.
Availability of Funding Sources. We finance from time to time some of the
mortgage loans which we hold through interim financing facilities such as bank
warehouse credit lines. We are dependent upon a few lenders to provide the
primary credit facilities for our mortgage loans. Any failure to renew or obtain
adequate funding under these financings, or any substantial reduction in the
size of or pricing in the market for our mortgage loans, could have a material
adverse effect on our operations. We face competition for financing sources, and
the effect of the existence of additional mortgage REITs may be to deny us
access to sufficient funds to carry out our business strategy and/or to increase
the cost of funds to us.
Availability and Cost of Borrowings. Our borrowings are generally
collateralized borrowings the availability of which is based on the market value
of the mortgage loans pledged to secure the specific borrowings, availability of
financing in the market, circumstances then applicable in the lending market
9
<PAGE> 13
and other factors. The cost of such borrowings vary depending upon the lender,
the nature and liquidity of the underlying collateral, the movement of interest
rates, the availability of financing in the market and other factors.
Changes in Interest Rates. Profitability may be directly affected by the
levels of and fluctuations in interest rates, which affect our ability to earn a
spread between interest received on our loans and the costs of borrowings. Our
profitability is likely to be adversely affected during any period of unexpected
or rapid changes in interest rates. For example, a substantial or sustained
increase in interest rates could adversely affect our ability to acquire
mortgage loans and would reduce the interest rate differential between newly
originated loans and our cost of borrowing. A significant decline in interest
rates could decrease the size of our loan portfolio by increasing the level of
loan prepayments. While we monitor the interest rate environment, and generally
will earn a positive spread between interest paid on borrowed funds and interest
earned on mortgage loans, there can be no assurance that our profitability would
not be adversely affected during any period of changes in interest rates
Risk of Decline in Market Value of Mortgage Assets and Margin Calls. A
decline in the market value of our portfolio of mortgage loans may limit our
ability to borrow or result in lenders initiating margin calls, i.e., requiring
a pledge of cash or additional mortgage loans to re-establish the ratio of the
amount of the borrowing to the value of the collateral. We could be required to
sell mortgage loans under adverse market conditions in order to maintain
liquidity. Such sales may be effected by management when deemed by it to be
necessary in order to preserve our capital base. If these sales were made at
prices lower than the amortized cost of the mortgage loans, we would experience
losses. A default by us under our collateralized borrowings could also result in
a liquidation of the collateral, including any cross-collateralized assets, and
a resulting loss of the difference between the value of the collateral and the
amount borrowed.
NEW LAWS AND REGULATIONS, NEW ADMINISTRATIVE OR JUDICIAL INTERPRETATIONS OR
OUR FAILURE TO COMPLY WITH EXISTING FEDERAL, STATE, OR LOCAL LEGISLATION OR
REGULATION COULD ADVERSELY AFFECT OUR OPERATIONS.
To the extent the manager makes residential mortgage loans, its business
and, to a lesser extent, our business is subject to extensive regulation,
supervision and licensing by federal, state and local governmental authorities
and is subject to various laws and judicial and administrative decisions
imposing requirements and restrictions on part or all of its operations.
Regulated matters include, without limitation, mortgage loan origination
marketing efforts, credit application and underwriting activities, maximum
finance and other charges, disclosure to customers, rights of rescission on
mortgage loans, closing and servicing mortgage loans, collection and foreclosure
procedures, qualification and licensing requirements for doing business in
various jurisdictions and other trade practices. Mortgage loan origination
activities are subject to the laws and regulations in each of the states in
which those activities are conducted. Activities as a lender are also subject to
various federal laws. The Truth in Lending Act or TILA and Regulation Z
promulgated thereunder, as both are amended from time to time, contain
disclosure requirements designed to provide consumers with uniform,
understandable information with respect to the terms and conditions of loans and
credit transactions in order to give them ability to compare credit terms. TILA
also guarantees consumers a three-day right to cancel specific credit
transactions. TILA also imposes disclosure, underwriting and documentation
requirements on mortgage loans, known as "Section 32 loans," with (i) total
points and fees upon origination in excess of eight percent of the mortgage loan
amount or (ii) an annual percentage rate of more than ten percentage points
higher than comparably maturing U.S. treasury securities. The manager will also
be required to comply with the Equal Credit Opportunity Act of 1974, as amended
or ECOA, which prohibits creditors from discriminating against applicants on the
basis of race, color, sex, age or marital status. Regulation B promulgated under
ECOA restricts creditors from obtaining specified types of information from loan
applicants. It also requires specified disclosures by the lender regarding
consumer rights and requires lenders to advise applicants of the reasons for any
credit denial. In instances where the applicant is denied credit or the rate or
charge for a loan increases as a result of information obtained from a consumer
credit agency, the Fair Credit Reporting Act of 1970, as amended, requires the
lender to supply the applicant with a name and address of the reporting agency.
The manager
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<PAGE> 14
will also be subject to the Real Estate Settlement Procedures Act or RESPA and
the Debt Collection Practices Act and will be required to file an annual report
with the Department of Housing and Urban Development pursuant to the Home
Mortgage Disclosure Act or HMDA. The manager will also be subject to the rules
and regulations of, and examinations by, state regulatory authorities with
respect to originating, processing, underwriting, selling and servicing loans.
Failure to comply with these requirements can lead to loss of approved status,
termination or suspension of servicing contracts without compensation to the
servicer, demands for indemnifications or mortgage loan repurchases, rights of
rescission for mortgage loans, class action lawsuits and administrative
enforcement actions. There can be no assurance that Specialty Mortgage Trust and
the manager will maintain compliance with these requirements in the future
without additional expenses, or that more restrictive local, state or federal
laws, rules and regulations will not be adopted or that existing laws and
regulations will not be interpreted in a more restrictive manner, which would
make compliance more difficult for Specialty Mortgage Trust and the manager.
The laws and regulations described above are subject to legislative,
administrative and judicial interpretation, and some of these laws and
regulations have been infrequently interpreted or only recently enacted.
Infrequent interpretations of these laws and regulations or an insignificant
number of interpretations of recently enacted regulations can result in
ambiguity with respect to permitted conduct under these laws and regulations.
Any ambiguity under the regulations to which Specialty Mortgage Trust or the
manager is subject may lead to regulatory investigations or enforcement actions
and private causes of action, such as class action lawsuits, with respect to
Specialty Mortgage Trust's or the manager's compliance with the applicable laws
and regulations. Specialty Mortgage Trust or the manager may also be subject to
regulatory enforcement actions and private causes of action from time to time
with respect to its compliance with applicable laws and regulations.
OUR MORTGAGE PORTFOLIO HAS LIMITED LIQUIDITY.
A substantial portion of our portfolio is invested in mortgage loans for
which a secondary trading market is not well developed. In addition, during
turbulent market conditions, the liquidity of all of our mortgage loans may be
adversely impacted. There is no limit on the percentage of our assets that may
be invested in illiquid mortgage loans.
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<PAGE> 15
THE COMPANY
Specialty Mortgage Trust, Inc. ("Specialty Mortgage Trust") was
incorporated in the State of Maryland on October 21, 1997. Our initial 300,000
shares of common stock were issued to and continue to be owned by Mr.
Gonfiantini. We began operations on January 31, 1998 following the initial
closing of our private placement. On March 31, 1998, we completed our initial
private placement of 2,169,588 shares of Class A Convertible Preferred Stock,
par value $0.01 per share, for approximately $21.7 million. On April 1, 1999, we
completed a private placement of 1,084,794 shares for approximately $10.8
million and, on July 1, 1999, 520,690 shares for approximately $5.2 million. On
July 1, 2000 we completed a private placement of 689,320 shares for
approximately $6.9 million. Beginning with our 1998 tax year, we elected to be
subject to tax as a REIT for federal income tax purposes. Assuming we maintain
our qualification as a REIT, we generally will be permitted to deduct dividend
distributions to stockholders, thereby effectively eliminating the "double
taxation" that generally results when a corporation earns income and distributes
that income to stockholders in the form of dividends. Our principal executive
offices are located at 6160 Plumas Street, Reno, Nevada 89509.
Gonzo Financial, Inc., as manager originates and services our mortgage
loans and manages the day-to-day operations of Specialty Mortgage Trust, subject
to the supervision of our board of directors. The management team of Gonzo
Financial has considerable expertise in the origination of mortgage loans and
the management of a portfolio of mortgage loans.
USE OF PROCEEDS
We intend to use the net cash proceeds from the issuance of the Notes for
general corporate purposes, including investments in mortgage loans,
mortgage-backed securities, short-term money market instruments and cash.
DIVIDEND POLICY AND DISTRIBUTIONS
We intend to distribute substantially all of our net income, as computed
for tax purposes, each year, to our stockholders so as to qualify for the tax
benefits accorded to a REIT under the Code. We intend to make dividend
distributions quarterly. Any taxable income remaining after distribution of the
final regular quarterly dividend each year is distributed together with the
first regular quarterly dividend payments of the following taxable year or in a
special dividend distributed prior thereto. The dividend policy is subject to
revision at the discretion of the board of directors. During 1999, we declared
dividends of $230,519 for the period from January 1 to January 31 ($.10625 per
share), $620,694 for the period from January 31 to March 31 ($.2000 per share),
$976,315 for the second quarter ($.3000 per share) and $1,132,520 for the third
quarter ($.3000 per share) and $1,079,875 for the fourth quarter ($.2842 per
share). We declared dividends of $1,149,048 for the first quarter 2000 ($.30 per
share). On July 17, 2000 we declared dividends of $1,158,922 for the second
quarter ($.30 per share).
We have a dividend reinvestment plan for shareholders who choose to
reinvest all or part of their distributions in additional shares of preferred
stock instead of receiving cash payments. The reinvestment price is the fair
market value as determined by our Board of Directors. Any future discount to the
then current market price, if there is a public market for our stock, cannot
exceed 5% of the fair market value of the stock to comply with REIT
qualification requirements. Although subject to change, we expect the price to
remain at $10.00 per share. In October 1999, January, April and July 2000,
proceeds from reinvested dividends amounted to approximately $246,000, $305,000,
$329,000 and $333,000, respectively. We use the proceeds for mortgage loans,
working capital and general corporate purposes.
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<PAGE> 16
CAPITALIZATION
The following table sets forth the capitalization of Specialty Mortgage
Trust at June 30, 2000, as adjusted at that date to give effect to the issuance
of the maximum amount of the Notes offered hereby.
<TABLE>
<CAPTION>
JUNE 30, 2000
-------------------------------
HISTORICAL(1) AS ADJUSTED(2)
------------- --------------
<S> <C> <C>
BORROWINGS:
Lines of Credit.......................................... $ 5,985,627 $ 5,985,627
Collateralized Investment Notes.......................... -- 50,000,000
Class A Collateralized Mortgage Notes.................... 4,973,731 4,973,731
----------- ------------
Accounts Payable......................................... 36,455 36,455
----------- ------------
Total Borrowings.................................... $10,995,813 $ 60,995,813
STOCKHOLDERS' EQUITY:
Capital stock, $0.01 par value, 50,000,000 shares
authorized:
Preferred stock --
4,553,720 shares issued and outstanding(2).......... $ 45,537 $ 45,537
Common stock --
320,200 shares issued and outstanding(3)............ 3,202 3,202
Additional paid-in capital............................... 45,358,084 45,358,084
Accumulated other comprehensive loss..................... (19,174) (19,174)
Undistributed income..................................... 453,690 453,690
----------- ------------
Total stockholders' equity.......................... $45,841,339 $ 45,841,339
----------- ------------
Total stockholders' equity and borrowings................ $56,837,152 $106,837,152
=========== ============
</TABLE>
-------------------------
(1) Includes 689,320 shares of preferred stock issued on July 1, 2000 at $10 per
share for an aggregate $6,893,200.
(2) The maximum principal amount outstanding at any time may not exceed $50
million.
(3) Specialty Mortgage Trust's founder has purchased an aggregate of 300,000
shares of common stock at $.01 per share. This does not include shares
reserved for issuance upon exercise of options granted to non-employee
directors of Specialty Mortgage Trust and certain key employees of Gonzo
Financial.
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<PAGE> 17
SELECTED FINANCIAL AND OTHER DATA
The information in this table should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations and with the financial statements and the notes thereto included
elsewhere in this prospectus. Operating results for the six months ended June
30, 2000 are not necessarily indicative of the results that may be expected for
the year ending December 31, 2000.
<TABLE>
<CAPTION>
FOR THE TWELVE MONTHS FOR THE SIX MONTHS
ENDED DECEMBER 31, ENDED JUNE 30,
-------------------------- --------------------------
1998 1999 1999 2000
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Interest and Dividend Income.......... $ 2,279,052 $ 4,450,193 $ 2,035,194 $ 2,347,595
Interest Expense...................... 76,877 263,633 127,075 208,036
Net Revenues.......................... 2,102,175 3,936,560 1,808,119 1,989,559
Net Earnings.......................... 2,025,870 3,809,424 1,744,346 1,918,512
Preferred Stock Dividends............. 2,111,145 4,039,923 851,213 1,149,048
Mortgage Loans........................ 29,500,401 35,755,670 38,144,582 50,389,510
Allowance for Mortgage Loan Losses.... 100,000 350,000 200,000 500,000
Total Assets.......................... 29,835,306 44,132,700 42,226,766 55,151,593
Short-Term Borrowings................. 8,212,000 5,217,467 5,168,000 10,959,358
Long-Term Borrowings.................. -- -- -- --
Number of Preferred Shares
Outstanding......................... 2,169,588 3,799,700 3,254,394 3,864,400
Number of Common Shares Outstanding... 300,000 320,200 320,200 320,200
</TABLE>
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<PAGE> 18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
"SAFE HARBOR" STATEMENT UNDER PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Some of the information contained in this prospectus may contain
forward-looking statements. These statements can be identified by the use of
forward-looking phrases such as "will likely result," "may," "are expected to,"
"is anticipated," "estimate," "projected," "intends to," or other similar words.
These forward-looking statements are subject to risks and uncertainties,
including those described in the Risk Factors section of this prospectus, that
could cause actual results to differ materially from those projected. When
considering forward-looking statements, you should keep in mind these risk
factors and other cautionary statements in this prospectus. You should not place
undue reliance on any forward-looking statement.
OVERVIEW
Specialty Mortgage Trust is a mortgage finance company specializing in
non-conforming residential and commercial real estate lending for the purpose of
holding loans in it's portfolio. We fund our loans chiefly through equity and to
a lesser degree with short-term debt. This short-term debt is in the form of
bank lines of credit or mortgage-backed notes.
Specialty Mortgage Trust operates as a real estate investment trust
("REIT"). In general, our REIT status allows us to avoid corporate income taxes
since we are permitted to deduct dividend distributions to our shareholders so
long as we distribute to our shareholders an amount equal to at least 95% of
taxable income, or 90% for tax years beginning after December 31, 2000, and
otherwise continue to meet the REIT qualification requirements.
FINANCIAL CONDITION
Our balance sheet presents our mortgage finance assets and liabilities. As
of June 30, 2000 our assets totaled $55,151,593. This compares to total assets
of $44,132,700 on December 31, 1999 and $29,835,306 as of December 31, 1998.
This increase from $29,835,306 on December 31, 1998 to $55,151,593 on June 30,
2000 is due primarily to the increase in stockholder's equity and short-term
borrowings. Shareholder equity was $21,536,529 on December 1998 and increased to
$38,948,139 on June 30, 2000. This increase was due to two private placement
offerings during the 18-month period. Total liabilities were $8,298,777 on
December 31, 1998. Liabilities decreased to $6,564,296 on December 31,1999 and
then increased to 16,203,454 on June 30, 2000.
ASSETS
Cash and Cash Equivalents. At June 30, 2000, cash and cash equivalents were
$4,104,089. This compares to $7,998,709 on December 31, 1999 and $17,317 on
December 31, 1998. The fluctuation in cash at anytime is a function of the
company's ability to fund new loans. As loans payoff, the proceeds are placed in
a cash account and used to fund new loans or the cash is used to pay down bank
lines of credit. The amount of cash held by the company is determined by future
loan fundings. It is our goal to keep cash invested in loans and therefore keep
cash balances low.
Investments. On June 30, 2000 total investments were $230,300, which
compares to zero in previous periods. This investment of preferred REIT stock
was an opportunity for the company to invest in a qualifying REIT investment
where the yield and risk parameters were met. Since our main focus is on
originating our own product, we do not expect significant changes in this line
item.
Mortgage Loans. Mortgage loans held for investment net of allowance for
loan losses have been increasing from $29,500,401 on December 31, 1998 to
$35,755,670 on December 31, 1999 and $50,389,510 on June 30, 2000. This increase
in mortgage loans is due to our efforts to originate loans for our portfolio
with the available capital.
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<PAGE> 19
LIABILITIES
Dividends Payable. At year-end 1999 we had a dividend payable of
$1,079,875. This represents a carry over dividend from December 1999 to be paid
in January 2000. Due to our REIT status, the Board of Directors must declare
dividends for the fourth quarter in December of the earnings year. Therefore
this dividend carries over the fiscal year and is due in January. Dividends
payable in December 1998 and June 30, 2000 were zero.
Deposits. Deposits were zero on December 31, 1998, $225,000 on December 31,
1999 and $5,184,800 on June 30, 2000. These funds represent deposits made by
investors to purchase Specialty Mortgage Trust stock at the first of the next
month. The largest number of $5,184,800 represents stock investors money for the
purchase of stock under a private placement that closed on July 1, 2000.
Lines of Credit. Lines of credit totaled $6,518,000 on December 31, 1998,
zero on December 31, 1999 and $5,985,627 on June 30, 2000. This line item
representing short-term borrowings from banks will fluctuate over time due to
loan funding needs and loan prepayments. Additionally, when we issue stock
through private placements, the net proceeds have been used to first pay down
bank lines of credit. These lines of credit are secured by mortgage loans
pledged by Specialty Mortgage Trust.
Collateralized Notes. This represents the private placement of
mortgage-backed notes issued with maturities ranging from 2 to 12 months. These
notes are secured by mortgage loans held in Specialty Mortgage Trust's
portfolio. At December 31, 1998 total collateralized notes were $1,694,000 and
on December 31, 1999 the balance was $5,217,467. On June 30, 2000 the total was
$4,973,731. The collateralized notes increased between year end 1998 and 1999
but there was a slight decrease at June 30, 2000.
Stockholders' Equity. Total stockholders' equity has increased from
$21,536,529 in December 31, 1998 to $37,568,404 on December 31, 1999 and
$38,948,139 on June 30, 2000. The increase was primarily due to the issuance of
additional shares of preferred stock through private placements.
RESULTS OF OPERATIONS
Our operating results include all of the reported income of our mortgage
finance operation. The comparison of year ending 1999 to year ending 1998 as
well as June 30, 1999 and June 30,1998 are as follows:
Interest Income.
Year End Comparison. Total interest income on December 31, 1998 totaled
$2,279,052 and increased to $4,450,193 on December 31, 1999. This increase was
due to additional funds invested in mortgage loans as a result of increased cash
available from private placement of new stock and to a lesser degree the use of
short-term borrowings.
June 30 Comparison. For the six-month period ending June 30, 1999 total
interest income was $2,035,194 and increased to $2,347,595 at June 30, 2000. The
increase was due primarily to the availability of more capital to invest as a
result of a private placement of stock.
Total Interest Expense.
Year-End Comparison. Total interest expense increased from $76,877 at
December 31, 1998 to $263,633 at December 31, 1999. The increase was the result
of the company's ability to issue collateralized notes and the use of lines of
credit.
June 30 Comparison. Total interest expense increased from $127,075 at June
30, 1999 to $208,036 at June 30, 2000. This increase was due to the company's
use of short-term borrowings in the form of lines of credit and collateralized
notes.
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<PAGE> 20
Provision for Loan Losses.
Year-End Comparison. The provision for loan losses at December 31, 1998
was $100,000 and increased to $250,000 at December 31, 1999.
June 30 Comparison. The provision for loan losses increased from $100,000
on June 30, 1999 to $150,000 on June 30, 2000.
Net Revenue.
Year-End Comparison. Net revenues for December 31, 1998, were $2,102,175
compared to $3,936,560 at December 1999. This increase was due to an increasing
portfolio of mortgage loans funded primarily with new preferred stock issuance.
June 30 Comparison. At June 30, 1999 net revenues were $1,808,119 and
increased to $1,989,559 at June 30, 2000. This increase was due to the increase
in mortgage loans funded through new stock issuance and the use of short-term
borrowings.
Total Expenses.
Year-End Comparison. Total expenses including General and Administrative
as well as Management and Director's fees increased from $76,305 in December 31,
1998 to $124,144 on December 31, 1999. This increase was due to an increasing
loan portfolio. Total expenses are a small portion of our net revenues since the
Manager pays for most expenses directly.
June 30 Comparison. Total expenses increased slightly between June 30,
1999 to June 30, 2000. The total expenses at June 30, 1999 were $60,781 and the
total expenses at June 30, 2000 were $71,047.
Net Earnings.
Year-End Comparison. Net earnings increased from $2,025,870 on December
31, 1998 to $3,809,424 on December 31, 1999. This increase results from an
increased earning mortgage loan portfolio, increased number of preferred stock
outstanding and the use of short-term borrowings.
June 30 Comparison. At June 30, 1999 net earnings were $1,744,346 and
increased to $1,918,512 at June 30, 2000. This increase results from an
increased earning mortgage loan portfolio, increased number of preferred stock
outstanding and the use of short-term borrowings.
Preferred Stock Dividend.
Year-End Comparison. The preferred stock dividend increased from
$2,111,145 on December 31, 1998 to $4,039,923 on December 31, 1999. This
increase is the result of two factors. First, we completed our initial private
placement of 2,169,588 shares of Class A Convertible Preferred stock on March
31, 1998. Therefore, 1998 preferred dividend results are for nine months of
operation. Secondly, we issued additional shares of preferred stock in 1999
thereby having more funds to invest and resulting in an increase in the
dividend.
June 30 Comparison. The six-month comparison of preferred stock dividends
shows an increase from $851,213 on June 30, 1999 to $1,149,048 on June 30, 2000.
This increase resulted from an increase in stockholder equity due to additional
placement of preferred stock on April 1, 1999 and July 1, 1999. On a per share
basis, we issued dividend as follows:
For the first six months of 1999, we declared dividends of $230,519 for the
period of January 1, 1999 to January 31, 1999 ($.10625 per share), $620,694 for
the period from January 31, 1999 to March 31, 1999 ($.2000 per share) and
$976,315 for the second quarter ($.3000 per share). We declared dividends of
$1,149,048 for the first quarter 2000 ($.30 per share). On July 17, 2000 we
declared dividends of $1,158,922 for the second quarter ($.30 per share).
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<PAGE> 21
Net (Loss) Earnings.
Year-End Comparison. Net loss at December 31, 1998 were ($85,275) compared
to ($230,499) at December 31, 1999. This increase in our loss is primarily due
to the difference between GAAP earnings and tax earnings. As a REIT, we intend
to distribute substantially all of our taxable income each year to our
stockholders so as to qualify for the tax benefits accorded to a REIT under the
Code. The losses shown above represent those differences between tax and GAAP
earnings.
June 30 Comparison. Net earnings at June 30, 1999 was $893,133 and
decreased on June 30, 2000 to $769,464. This decrease is primarily due to the
difference in net earnings compared to the preferred stock dividend. While net
earnings increased from $1,744,346 at June 30, 1999 to $1,918,512 at June 30,
2000, a net increase of $174,166, dividends increased from $851,213.00 at June
30, 1999 to $1,149,048 at June 30, 2000, a net increase of $297,835. Therefore,
the comparative earnings increased by $174,166 but the comparative dividend
increased by $297,835. This difference accounts for the majority of change in
the net earnings figure.
RECENT DEVELOPMENTS
On July 1, 2000 we completed a private placement of 689,320 preferred
shares at $10 per share for total cash proceeds of approximately $6.9 million.
INTEREST RATE/MARKET/CREDIT RISK
We seek to manage the interest rate, credit and market risk of our
portfolio. By originating short-term loans, (generally less than three years) we
can significantly reduce the risk of changing interest rates. Additionally, we
continue to stress the quality of our borrowers by underwriting and originating
for our own portfolio. In this way we seek to control credit risk.
Since the majority of our loans are in the state of Nevada, we are
beginning to originate loans in California, Arizona and Colorado. This will help
diversify the portfolio and reduce the risk of lending in one market.
LIQUIDITY AND CAPITAL RESOURCES
We manage our liquidity in a number of ways. First, the scheduled payments
on our mortgage portfolio produce generally monthly cash flow which can be used
to originate new loans or to pay dividends to shareholders. This source produces
approximately $5.0 million on an annual basis. We generally have the ability to
apply this cash flow as needed.
Secondly, the prepayment of loans provides additional liquidity to our
portfolio. Historically, we have experienced loan payoffs and prepayments of
approximately 25% to 30% of our outstanding portfolio. Since our loan terms are
usually 1 - 3 years, the rate of principal payoffs is significant. With a
current portfolio of over $50 million we would anticipate annual cash flows form
principal pay downs in the range of $12.5 million to $15.0 million. As we issue
Collateralized Investment Notes, our portfolio will increase and so will the
cash flow from principal pay downs. Again, normally these funds are used to
originate new mortgage loans, but can be used otherwise.
Lastly, we have and are arranging lines of credit with several commercial
banks to provide another level of liquidity for the company. We expect our lines
of credit to total $12.5 million. We leave at least $2.5 million of lines unused
for liquidity needs and we expect the unused portion generally to exceed $5.0
million.
We believe the combination of these three sources of capital allows us to
manage our cash flow needs in virtually any business situation and thereby
efficiently use our capital resources.
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<PAGE> 22
BUSINESS
We believe that the REIT structure is one of the most desirable structure
for owning mortgage loans due to the elimination of corporate-level income
taxation. In addition, because we are not structured as a traditional lender
which accepts deposits, we are subject to substantially less regulatory
oversight and incur lower compliance expenses compared to banks, thrifts and
many other holders of mortgage loans. With the manager's experience in the
Nevada real estate lending market, we believe that we will be able to take full
advantage of our REIT status through our focus on acquiring and holding types of
mortgage loans that are generally higher yielding than traditional conforming
mortgage loans.
MORTGAGE LENDING
Loan Originations. Our business involves acquiring and holding loans to
borrowers primarily in the State of Nevada whose borrowing needs are generally
not being served by traditional financial institutions. Our strategy is to focus
on small commercial mortgage loans (generally less than $5 million per loan),
land loans and nonconforming single-family and small multifamily (generally less
than 20 units) residential mortgage loans. The manager targets as potential
customers borrowers with relatively significant equity value in their property,
but who either:
- require a small commercial loan;
- own real property which is difficult to evaluate under standard
underwriting guidelines or unlikely to support a mortgage saleable in the
secondary market;
- are self-employed, tend to experience some volatility in their income or
have difficult-to-document sources of income; or
- are otherwise unable to qualify for traditional mortgage loans.
Gonzo Financial, as our manager, originates new loans with relatively
higher interest rates than are typically charged by lenders for traditional
mortgage loan products while having comparable or lower loan-to-value ratios. We
believe that the Nevada mortgage market will continue to grow and to generate
relatively attractive risk-adjusted returns over the long term. We also have
mortgage loans in California, Arizona and Colorado.
Nello Gonfiantini III, Specialty Mortgage Trust's founder, has owned and
managed a private mortgage finance business in Reno, Nevada since January 1995.
That business, Gonzo Financial, serves as the manager of Specialty Mortgage
Trust, responsible for loan originations, loan servicing and our day-to-day
operations. Exhibit A to this prospectus contains a table that describes our
mortgage loan portfolio as of a recent date.
On behalf of Specialty Mortgage Trust and during the course of our
business, Gonzo Financial continuously evaluates prospective mortgage loans. The
manager generates mortgage loan originations from referrals from real estate and
mortgage loan brokers, referrals from existing customers, new loans made to or
refinancing of loans to existing customers and personal solicitations of new
borrowers.
All potential mortgage loans are evaluated to determine if the mortgage
loan is of a type made by Specialty Mortgage Trust, if the security for the loan
and the loan-to-value ratio meets the standards we established, if the borrower
is creditworthy and if the loan can be priced in a manner to meet our investment
criteria and objectives. If the manager approves the loan as presented, an
appraisal is ordered on the property securing the loan, and the property is
inspected by an officer or employee of the manager. The manager obtains
independent, on-site appraisals for each mortgage property. All independent
appraisers must be licensed or qualified as independent fee appraisers and
certified by the state in which the property being appraised is located. The
manager generally relies on its own independent analysis and not exclusively on
such appraisals in determining whether or not to arrange a particular mortgage
loan.
We do not ordinarily invest in mortgage loans with a maturity of more than
five years and most loans will have terms of 2 to 3 years. All loans provide for
monthly payments of interest and some also provide
19
<PAGE> 23
for principal amortization, although most loans provide for payments of interest
only and a payment of principal in full at the end of the loan term. We do not
limit the amount of our investment in any single mortgage loan or in mortgage
loans to one borrower. Each borrower is generally required to obtain a lenders
policy of title insurance as to the priority of the mortgage or deed of trust
and the condition of title. At any one time approximately 90% of our mortgage
loan balances are secured by first deeds of trust on the underlying real
property, with the remaining mortgage loan balances secured by second deeds of
trust.
Most of the loans we acquire and hold require the borrower to make a
"balloon payment" on the principal amount upon maturity of the loan. To the
extent that a borrower has an obligation to pay a mortgage loan in a large lump
sum payment, its ability to satisfy this obligation may be dependent upon its
ability to obtain suitable refinancing or otherwise raise a substantial cash
amount. An increase in interest rates over the mortgage rate applicable at the
time the loan was originated may have an adverse effect on the borrower's
ability to obtain refinancing or to pay the required monthly payments. As a
result, such loans may involve a higher risk of default than fully amortizing
loans.
Higher Yielding Mortgage Loan Products. We rely on the manager's experience
to generate mortgage loans primarily in the State of Nevada with higher yields
than are obtained on traditional single-family residential mortgage loans. We
may invest in commercial, multifamily, land, construction and nonconforming
single-family mortgage loans. Our mortgage loans may be secured by mortgages on
unimproved as well as improved real property and non-income producing as well as
income-producing real property. Some mortgage loans may be secured by the
borrower's leasehold interest in real property.
Commercial and Multifamily Mortgage Loans. Multifamily mortgage loans are
generally secured by a first lien on a 5-unit to 20-unit residential property.
Multifamily mortgage loans share many of the characteristics and risks
associated with commercial mortgage loans and are often categorized as
commercial loans rather than residential loans. Commercial mortgage loans have
distinct risk characteristics. Commercial mortgage loans generally lack
standardized terms, which may complicate their structure. Commercial properties
themselves tend to be unique and are more difficult to value than residential
properties. Commercial mortgage loans also tend to have shorter maturities than
residential mortgage loans and may not be fully amortizing, meaning that they
may have a significant principal balance, or "balloon," due on maturity. In
addition, commercial properties, particularly industrial and warehouse
properties, are generally subject to relatively greater environmental risks than
non-commercial properties and the corresponding burdens and costs of compliance
with environmental laws and regulations.
Commercial mortgage loans are sometimes non-recourse to borrowers. In the
event of foreclosure on a commercial mortgage loan, the value at that time of
the collateral under the mortgage may be less than the principal amount
outstanding on the mortgage loan and the accrued but unpaid interest. Also,
there may be costs and delays involved in enforcing rights of a property owner
against tenants in default under the terms of leases with respect to commercial
properties and such tenants may seek the protection of the bankruptcy laws which
can result in termination of lease contracts.
Commercial mortgage loans are also subject to the effects of:
- local and other economic conditions on real estate values;
- the ability of tenants to make lease payments;
- the ability of a property to attract and retain tenants, which may in
turn be affected by local conditions such as oversupply of space or a
reduction in demand for rental space in the area, the attractiveness of
properties to tenants, competition from other available space, the
ability of the owner to pay leasing commissions, provide adequate
maintenance and insurance, pay tenant improvements costs and to make
other tenant concessions; and
- increased operating costs, including energy costs and real estate taxes.
While owners of real property generally will carry comprehensive liability
and casualty coverage, such coverage may not provide full protection for the
value of the underlying property and may not protect against all casualty
losses. If underlying commercial properties do not generate sufficient income to
meet
20
<PAGE> 24
operating expenses, debt service, capital expenditures and tenant improvements,
borrowers under commercial mortgage loans may be unable to make payments of
principal and interest in a timely fashion. Income from and values of commercial
properties are also affected by such factors as applicable laws, including tax
laws, interest rate levels, the availability of financing for owners and
tenants, and the impact of and costs of compliance with environmental controls
and regulations.
Gonzo Financial generally invests in mortgage loans secured by commercial
or multifamily residential property when the net annual estimated cash flow
after vacancy, operating expense, and mortgage debt service deductions equals or
exceeds the annual payments required on the mortgage loan.
Land Loans. Land loans are made against either commercial real estate
available for commercial development or residential lots available for
residential development. While loan-to-value ratios are low, usually less than
50%, there is generally no cash flow from the property and the borrower's other
sources of income must be relied upon to support the periodic interest payments
due under the loans.
Construction Mortgage Loans. Construction loans are loans made for the
renovation of developed property, and for the development of undeveloped
property. Construction loans acquired and held by us will generally be secured
by first deeds of trust on real property. Such loans are generally for terms of
from six months to two years. Generally we do not disburse funds with respect to
a particular construction loan until work in the previous phase of the project
on which the loan is being made has been completed, and until an independent
inspector has verified the quality of construction and adherence to the
construction plans and has reviewed the estimated cost of completing the
project. In addition, we require the submission of signed labor and material
lien releases by the borrower in connection with each completed phase of the
project prior to making any periodic disbursements of proceeds of the loan to
the borrower.
Nonconforming Single-Family Residential Mortgage Loans. The nonconforming
mortgage loans are conventional mortgage loans that vary in one or more respects
from the requirements for participation in Fannie Mae or Freddie Mac programs.
Credit risks associated with non-conforming mortgage loans may be greater than
those associated with mortgage loans that conform to Fannie Mae and Freddie Mac
guidelines. The principal differences between non-conforming mortgage loans and
conforming mortgage loans include the applicable loan-to-value ratios, the
credit and income histories of the mortgagors, the documentation required for
approval of the mortgagors, the types of properties securing the mortgage loans,
loan sizes and the mortgagors' occupancy status with respect to the mortgaged
property. Nonconforming loans may include loans secured by timeshare vacation
property. As a result of these and other factors, the interest rates charged on
non-conforming mortgage loans are often higher than those charged for conforming
mortgage loans.
Junior Mortgage Loans. Second, third and wraparound mortgage loans are
secured by deeds of trust on single-family residences which are already subject
to prior mortgage indebtedness. A wraparound loan is a junior mortgage loan
having a principal amount equal to the outstanding balance under the existing
mortgage loans plus the amount actually to be advanced under the wraparound
mortgage loan. Under a wraparound loan, we generally make principal and interest
payments on behalf of the borrower to the holders of the prior mortgage loans.
Junior mortgage loans generally have lower qualifying loan-to-value ratios.
Other REIT Qualified Investments. As part of the acquisition or refinance
of a particular mortgage loan, we may acquire an equity interest in the real
property securing the loan in the form of a shared appreciation interest or
other equity participation. We also may invest our funds directly in real
property, if in the opinion of the board of directors it is in our best
interest. We may also purchase our own common or preferred stock or the debt or
the common or preferred stock of other mortgage REITs or other companies when we
believe that such purchases will yield attractive returns on capital employed.
REIT or other debt securities may be undervalued at points in the economic
cycle. When the stock market valuation of companies are low in relation to the
market value of other assets, stock purchases can be a way for us to acquire an
interest in a pool of mortgage assets or other types of assets at an attractive
price. Also, REITs and other companies may have attractive mortgage finance or
other businesses in which we may want to become a partial owner. We do not,
however, presently intend to invest in the securities of other issuers for the
purpose of exercising control or to underwrite securities of other issuers.
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<PAGE> 25
THE MORTGAGE LOAN PORTFOLIO
Table 1 is a summary of our mortgage loan portfolio as of June 30, 2000:
TABLE 1: MORTGAGE LOAN PORTFOLIO
JUNE 30, 2000
<TABLE>
<CAPTION>
LOAN FOOT INTEREST PRINCIPAL PORTFOLIO MATURITY LIEN
NO. NOTES DESCRIPTION OF LOAN RATE AMOUNT AMOUNT DATE LTV POSITION
----- ------ ------------------- -------- ----------- ----------- -------- --- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
95011 Motels/Weekly Rentals 12.25% $ 375,000 $ 375,000 4/1/02 54% 2nd
96043 Commercial/Retail 8.75% $ 202,049 $ 202,049 3/1/01 73% 1st
96045 (1) Residential Land Development 12.00% $ 2,464,000 $ 1,625,704 6/1/02 41% 1st
96050 Single-Family Residence 13.00% $ 15,759 $ 15,759 12/1/06 73% 2nd
97053 (1) Residential Land Development 12.00% $ 2,052,375 $ 536,891 2/1/01 41% 1st
97067 (1) Residential Land Development 12.50% $ 2,060,000 $ 1,286,689 7/1/02 41% 1st
97078 Commercial Land/RV Sales Lot 12.00% $ 875,000 $ 75,000 10/1/02 47% 1st
97080 (2)(8) Residential Land Development 12.00% $ 2,726,000 $ 2,726,000 12/1/99 89% 3rd
97081 (1) Residential Land Development 12.00% $ 250,000 $ 250,000 1/1/01 41% 1st
98089 Motels/Weekly Rentals 12.00% $ 1,570,000 $ 1,570,000 4/1/03 60% 1st
98093 (1) Residential Land Dev 12.00% $ 1,100,000 $ 1,100,000 6/1/01 41% 1st
98094 Mobile Home Park 12.00% $ 500,000 $ 500,000 5/1/03 61% 2nd
98096 (1) Residential Land Development 12.00% $ 2,434,000 $ 13,673 7/1/01 41% 1st
98102 Professional Office Building 12.00% $ 87,000 $ 87,000 9/1/01 44% 2nd
98106 Residential Lot 12.00% $ 93,000 $ 93,000 9/1/01 47% 1st
98109 (6) Commercial Land 12.25% $ 2,217,629 $ 1,267,745 12/1/00 51% 1st
98121 (9) Commercial Land 19.00% $ 1,300,000 $ 400,000 2/1/00 56% 1st
99128 Single Family Residence 12.00% $ 2,000,000 $ 1,000,000 3/1/01 51% 1st
99133 (5) Const. Office Bldg & Office Pads 17.25% $ 990,000 $ 990,000 5/1/00 70% 1st
99137 (2)(8) Residential Land Development 12.00% $ 2,260,200 $ 1,700,000 8/1/00 62% 1st
99138 (2)(8) Residential Land Development 12.00% $ 1,000,000 $ 870,000 6/1/00 89% 2nd
99140 Single Family Residence 12.50% $ 74,000 $ 74,000 5/1/01 67% 1st
99141 (3) Commercial Land 12.50% $ 3,500,000 $ 3,000,000 6/1/01 26% 1st
99142 2nd Home 12.50% $ 365,000 $ 365,000 8/1/00 50% 1st &
3rd
99147 (2) Residential Construction 12.00% $ 41,141 $ 41,141 7/1/00 80% 1st
99148 (2) Residential Construction 12.00% $ 41,141 $ 41,141 7/1/00 80% 1st
99149 (2) Residential Construction 12.00% $ 41,141 $ 41,141 7/1/00 80% 1st
99150 (2) Residential Construction 12.00% $ 41,141 $ 41,141 7/1/00 80% 1st
99151 (4) Residential Land Development 12.50% $ 7,000,000 $ 4,485,000 9/1/01 50% 1st
99152 Commercial Land 13.00% $ 5,625,000 $ 3,125,000 7/1/00 50% 1st
99153 Residential Construction 12.25% $ 582,161 $ 582,161 11/1/00 59% 1st
99157 Single Family Residence 12.25% $ 22,000 $ 22,000 10/1/02 36% 2nd
99163 Historical Mansion/Museum 13.50% $ 125,000 $ 125,000 11/1/01 40% 2nd
99164 (4) Commercial/Residential Land 12.50% $ 3,260,000 $ 515,000 1/1/02 36% 1st
99165 Single Family Residence 12.00% $ 180,000 $ 180,000 12/1/02 38% 1st
99167 (7) Commercial Land 12.50% $ 1,500,000 $ 1,500,000 12/1/00 65% 1st
99169 Residential Land 12.50% $ 170,000 $ 170,000 12/1/00 63% 1st
99172 (3) Residential Land Development 12.50% $ 364,500 $ 111,375 2/1/01 75% 1st
99174 (5) Const. Office Bldg & Office Pads 12.50% $ 950,000 $ 950,000 3/1/01 63% 1st
99175 Residential Land 12.50% $ 400,000 $ 400,000 4/1/02 21% 1st
99182 (3) Residential Construction 12.50% $ 181,450 $ 81,450 8/1/00 75% 1st
99196 Office Building/Vacant Land 12.50% $ 155,000 $ 155,000 3/1/05 34% 1st
99197 (2) Construct Office Building 12.00% $ 408,000 $ 408,000 4/1/02 80% 1st
99200 (2) Construct Office Building 12.00% $ 625,000 $ 625,000 4/1/02 81% 1st
99203 Commercial Land 12.25% $ 1,000,000 $ 1,000,000 6/1/03 56% 1st
99211 Single Family Residence 12.00% $ 126,500 $ 126,500 7/1/01 78% 1st
99212 (3) Residential Construction 12.50% $ 149,950 $ 149,950 8/1/00 75% 1st
99213 Residential 12.50% $ 150,000 $ 150,000 6/1/02 67% 2nd
99216 (3) Residential Land Development 13.00% $ 2,900,000 $ 1,000,000 5/1/02 29% 1st
99218 Commercial Land 12.75% $ 2,000,000 $ 2,000,000 6/1/01 65% 1st
99221 Residential Land 12.25% $ 4,000,000 $ 4,000,000 7/1/03 59% 1st
</TABLE>
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<PAGE> 26
<TABLE>
<CAPTION>
LOAN FOOT INTEREST PRINCIPAL PORTFOLIO MATURITY LIEN
NO. NOTES DESCRIPTION OF LOAN RATE AMOUNT AMOUNT DATE LTV POSITION
----- ------ ------------------- -------- ----------- ----------- -------- --- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
99223 (6) Residential Land Development 12.50% $ 5,700,000 $ 4,250,000 12/1/01 75% 1st
99226 (7) Medical Building 12.25% $ 1,890,000 $ 1,890,000 6/1/01 70% 1st
99227 Residential Land Development 12.25% $ 1,100,000 $ 1,100,000 7/1/01 15% 1st
99232 Residential Land Development 12.75% $ 1,500,000 $ 1,500,000 1/1/02 48% 1st
----------- -----------
$72,740,137 $50,889,510
=========== ===========
</TABLE>
-------------------------
(1) Loans to same borrower or related parties secured by different parcels of
real property aggregating to $4,812,958
(2) Loans to same borrower or related parties secured by different parcels of
real property aggregating to $6,493,564
(3) Loans to same borrower or related parties secured by different parcels of
real property aggregating to $4,342,775
(4) Loans to same borrower or related parties secured by different parcels of
real property aggregating to $5,000,000
(5) Loans to same borrower or related parties secured by different parcels of
real property aggregating to $1,940,000
(6) Loans to same borrower or related parties secured by different parcels of
real property aggregating to $5,517,745
(7) Loans to same borrower or related parties secured by different parcels of
real property aggregating to $3,390,000
(8) Loans defaulted and foreclosure may be necessary-no estimate of when
proceeds will be received or in what amount.
(9) Loan defaulted 12/1/99-interest accruing at default rate-borrower in
bankruptcy expected payoff 3rd quarter 2000
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<PAGE> 27
Table 2 is a summary of our mortgage loan portfolio by the type of property
securing the loans as of December 31, 1999.
TABLE 2: MORTGAGE LOAN TYPE OF PROPERTY
DECEMBER 31, 1999
<TABLE>
<CAPTION>
CARRYING AMOUNT
INTEREST FACE AMOUNT AMOUNT MATURITY SUBJECT TO
TYPE OF PROPERTY RATE OF MORTGAGE OF MORTGAGE DATE DELINQUENCY
---------------- ------------ ----------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
Commercial income............. 8.5%- 13.5% $ 5,447,000 $ 3,835,668 04/00 - 05/03 $ --
Land only..................... 12%- 13% 63,944,500 29,185,839 08/99 - 04/03 5,756,000
Residential income............ 12%- 12.5% 1,270,000 1,116,500 09/99 - 04/00 706,000
Residential................... 12%- 13% 4,412,500 1,967,663 11/99 - 12/06 --
</TABLE>
MANAGING THE MORTGAGE LOAN PORTFOLIO
Our strategy is to build and hold a portfolio of mortgage loans for
investment that generates a net interest margin over time and allows us to take
full advantage of our REIT status. The focus of the manager's servicing
operation is on managing credit risk in order to protect our investment in the
mortgage loans. The underwriting decision to provide a loan to an applicant is
based upon the loan-to-value ratio for the underlying collateral, the
applicant's creditworthiness, including debt service-to-income ratios and
payment history on existing credit, and an evaluation of the applicant's ability
to repay the loan. Thereafter, the manager intends to use early intervention,
aggressive collection and loss mitigation techniques in the servicing process.
Collateral Valuation. Collateral valuation receives special attention in
the manager's underwriting of its mortgage loans. The manager places great
emphasis on the ability of its collateral to protect against losses in the event
of default by borrowers. In determining the adequacy of the mortgaged property
as collateral, an appraisal is made of each property considered for financing.
The appraiser is required to inspect the property and verify that it is in good
condition and that construction, if new, has been completed. The appraisal is
based on the market value of comparable properties, the estimated rental income,
if applicable, and the cost of replacement. The appraised value of the property
being financed, must be such that if currently supports, and is anticipated to
support in the event of default, the outstanding mortgage loan balance.
Quality Control. Ongoing quality control reviews are conducted by the
manager to seek to ensure that all mortgage loans, whether originated or
purchased, meet its quality standards. The type and extent of the reviews will
depend on the characteristics of the mortgage loan. The manager also performs
appraisal reviews as part of the quality control process as well as compliance
reviews to seek to ensure adherence to all state and federal regulations. Some
of the compliance reviews may be outsourced until such time as the manager has
adequate internal staff to perform such reviews.
Servicing. The manager has established its own servicing operation in order
to service the mortgage loans. Servicing includes collecting and remitting loan
payments, making required advances, accounting for principal and interest,
holding escrow or impound funds for payment of taxes and insurance, making
required inspections of the property, contacting delinquent borrowers and
supervising foreclosures and property disposition in the event of unremedied
defaults in accordance with the Company's guidelines.
Credit Risk Management. We believe that the servicing of its mortgage loans
is the most effective method of managing our credit risk. The manager's focus as
a servicer of mortgage loans it has originated is more on effective credit risk
management than on cost control. The manager does not intend to be a low cost
servicer, but instead puts the proper resources to work to mitigate losses on
the mortgage loans it services. If properly managed from both an underwriting
and a servicing standpoint, we believe that we will be able to keep the level of
delinquencies and losses in our mortgage loans at a minimum.
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<PAGE> 28
Prepayment Risk Management. The manager seeks to minimize the effects of
faster or slower than anticipated prepayment rates in its portfolio, in part by
originating mortgage loans with prepayment penalties. The manager also utilizes
the production of new mortgage loans as a hedge against prepayment risk. Through
its servicing function, the manager pre-selects borrowers that have an incentive
to refinance and recaptures those mortgage loans by soliciting the borrowers
directly rather than losing them to another mortgage lender.
Sales of Mortgage Loans. We generally hold mortgage loans to maturity. In
addition, the REIT provisions of the Code limit in some respects our ability to
sell mortgage loans. We refer you to "Certain Federal Income Tax Consequences"
in this prospectus for more detail. From time to time, however, management may
decide to sell mortgage loans. This could occur for any number of reasons, for
example, to dispose of a mortgage loan as to which credit risk concerns have
arisen, to reduce interest rate risk, or generally to re-structure the balance
sheet when management deems such action advisable. Management will select any
mortgage loans to be sold according to the particular purpose such sale will
serve. The board of directors has not adopted a policy that would restrict
management's authority to determine the timing of sales or the selection of
mortgage loans to be sold.
USING LEVERAGE TO FINANCE MORTGAGE LOAN ACQUISITIONS
We finance our mortgage loan acquisitions through the Notes and through
financing facilities including $7.5 million bank warehouse credit lines. We
recently began to offer to accredited investors on a monthly basis our Class A
Collateralized Mortgage Notes secured by our mortgage loans for terms that may
range from one month to twelve months. The maximum principal amount outstanding
at any time is $20 million. As of June 30, 2000, $4,973,731 million of these
Class A Notes were outstanding, bearing interest at rates of 6.25% to 8.5%. No
additional Class A Notes will be issued after August 21, 2000.
We employ a debt financing strategy to increase our investment in mortgage
loans. By using our mortgage loans as collateral to borrow funds, we are able to
invest in mortgage loans with greater value than our equity. We have a targeted
ratio of equity-to-assets of approximately 1 to 1. Our financing strategy is
designed to maintain a cushion of equity sufficient to provide required
liquidity to respond to the effects under our borrowing arrangements of interest
rate movements and changes in market value of our mortgage loans. We expect that
all of our borrowing arrangements will require us to pledge cash or additional
mortgage loans in the event the market value of existing collateral declines. To
the extent that cash reserves are insufficient to cover such deficiencies in
collateral, we may be required to sell mortgage loans to reduce the borrowings.
Our goal is to strike a balance between the under-utilization of leverage,
which reduces potential returns to stockholders, and the over-utilization of
leverage, which could reduce our ability to meet our obligations during adverse
market conditions.
COMPANY POLICIES
Our Board of Directors has established the investment policies and
strategies summarized in this prospectus. The Board of Directors has the power
to modify or waive such policies and strategies without the consent of the
stockholders to the extent that the Board of Directors determines that such
modification or waiver is in the best interest of stockholders. Among other
factors, developments in the market which affect the policies and strategies
mentioned in this prospectus or which change our assessment of the market may
cause the Board of Directors to revise our policies and strategies.
LEGAL PROCEEDINGS
There are no material pending legal proceedings to which Specialty Mortgage
Trust or the manager is a party or to which any property of Specialty Mortgage
Trust or the manager is subject.
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<PAGE> 29
THE MANAGER
The manager, Gonzo Financial, Inc., is a private mortgage finance business
that has operated in Nevada since January 1995. The manager originates mortgage
loans for us and otherwise manages our day-to-day operations, subject to the
direction of our Board of Directors. The manager does not originate mortgage
loans for others without approval of the Board's independent directors. Our
executive officers are also the executive officers of the manager. Mr.
Gonfiantini beneficially owns the manager.
MANAGEMENT FEES
Pursuant to a management agreement entered into with Specialty Mortgage
Trust, Gonzo Financial receives a management fee payable monthly in arrears
consisting of:
(i) The mortgage loan origination fees or points, usually charged to a
borrower for and upon the origination, extension or refinancing of a
mortgage loan, up to 2.5% of the loan balance (i.e., 2.5 points) with any
additional fees or points paid to the benefit of Specialty Mortgage Trust.
The amount of this fee is determined by competitive conditions, may vary
and may have a direct effect on the interest rate a borrower is willing to
pay Specialty Mortgage Trust.
(ii) A fee for loan servicing, equal to one-half of one percent of the
total mortgage loan portfolio held by Specialty Mortgage Trust. Payment of
this fee, in effect, lowers the yield retained by Specialty Mortgage Trust
on its loans.
(iii) All late payment charges from payments made by borrowers.
We also pay to Gonzo Financial as incentive compensation for each fiscal
quarter, an amount equal to 50% of the net income of Specialty Mortgage Trust,
before deduction of such incentive compensation, in excess of the annualized
return to Specialty Mortgage Trust equal to 12%. The incentive compensation
calculation and payment will be made quarterly in arrears. The term "return to
Specialty Mortgage Trust" is calculated for the quarter by dividing our taxable
income for the quarter by the net worth for the quarter. For such calculations,
the "taxable income" of Specialty Mortgage Trust means the taxable income of
Specialty Mortgage Trust before the manager's incentive compensation, the
deduction for dividends paid and net operating loss deductions arising from
losses in prior periods. A deduction for Specialty Mortgage Trust's interest
expenses for borrowed money is taken when calculating taxable income. "Net
worth" for any period means the arithmetic average of the sum of the gross
proceeds from any offering of its equity securities by Specialty Mortgage Trust,
after deducting expenses and costs relating to the offering, plus Specialty
Mortgage Trust's beginning retained earnings (without taking into account any
losses incurred in prior periods and excluding amounts reflecting taxable income
to be distributed as dividends and amounts reflecting valuation allowance
adjustments). The definition "return to Specialty Mortgage Trust" is used only
for purposes of calculating the incentive compensation payable, and is not
related to the actual distributions received by stockholders. The incentive
compensation payments to Gonzo Financial are made before any income
distributions are made to our stockholders.
The manager's base fee is calculated by the manager and delivered to us
within 15 days after the end of each month. We are obligated to pay the amount
of the final base fee in excess of the amount paid to manager at the beginning
of the month pursuant to the manager's good faith estimate within 30 days after
the end of each month. We pay the incentive fee with respect to each fiscal
quarter within 15 days following the delivery to us of the manager's written
statement setting forth the computation of the incentive fee for such quarter.
The manager re-computes the quarterly incentive fee within 45 days after the end
of each fiscal year, and any required adjustments are paid by us or the manager
within 15 days after the delivery of the manager's written computation to us.
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<PAGE> 30
ADMINISTRATIVE SERVICES PROVIDED BY THE MANAGER
Gonzo Financial, as manager, is responsible for our day-to-day operations
and performs such services and activities relating to the assets and operations
of Specialty Mortgage Trust as may be appropriate, including:
(i) representing Specialty Mortgage Trust in connection with the
origination or purchase of mortgage loans;
(ii) in accordance with the directions of the board of directors,
investing or reinvesting any money of Specialty Mortgage Trust;
(iii) furnishing reports and statistical and economic research to
Specialty Mortgage Trust regarding Specialty Mortgage Trust's real estate
lending activities and the performance of its portfolio of mortgage loans;
(iv) administering the day-to-day operations of Specialty Mortgage
Trust and performing administrative functions necessary in the management
of Specialty Mortgage Trust, including the collection of revenues, the
payment of Specialty Mortgage Trust's expenses, debts and obligations and
the maintenance of appropriate computer services to perform such
administrative functions;
(v) counseling Specialty Mortgage Trust in connection with policy
decisions to be made by the Board of Directors;
(vi) assisting Specialty Mortgage Trust in its use of leverage to
finance mortgage loan acquisitions;
(vii) overseeing the servicing of Specialty Mortgage Trust's mortgage
loans;
(viii) establishing underwriting, appraisal and quality control
procedures for the mortgage loans of Specialty Mortgage Trust;
(ix) conducting a legal document review of each mortgage loan acquired
to verify the accuracy and completeness of the information contained in the
mortgage loans, security instruments and other pertinent documents in the
mortgage file;
(x) providing Specialty Mortgage Trust with data processing, legal and
administrative services to the extent required to implement the business
strategy of Specialty Mortgage Trust;
(xi) providing all actions necessary for compliance by Specialty
Mortgage Trust with all federal, state and local regulatory requirements
applicable to Specialty Mortgage Trust in respect of its business
activities, including preparing or causing to be prepared all financial
statements required under applicable regulations and contractual
undertakings;
(xii) providing all actions necessary to enable Specialty Mortgage
Trust to make required federal, state and local tax filings and reports and
generally enable Specialty Mortgage Trust to maintain its status as a REIT,
including soliciting stockholders for required information to the extent
required by the REIT Provisions of the Code;
(xiii) communicating on behalf of Specialty Mortgage Trust with the
stockholders of Specialty Mortgage Trust as required to satisfy any
reporting requirements and to maintain effective relations with such
stockholders; and
(xiv) performing such other services as may be required from time to
time for management and other activities relating to the assets of
Specialty Mortgage Trust as the board of directors shall reasonably request
or the manager shall deem appropriate under the particular circumstances.
The manager may enter into subcontracts with other parties to provide us
any such services.
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<PAGE> 31
EXPENSES
The operating expenses required to be borne by the manager include
compensation and other employment costs, the cost of office space and equipment
and all other administrative incurred in our day-to-day operations. Those
expenses do not include debt service or taxes. While most costs are paid through
the manager from fees earned by the manager, we expect to pay directly certain
REIT-related expenses such as directors' fees and legal and accounting fees. The
manager operates from office space located at 6160 Plumas Street, Reno, Nevada
89509, telephone (775) 826-0809, and licenses the use of a servicing software
system.
INDEMNIFICATION
We have agreed to indemnify the manager, and our respective directors,
officers, stockholders and employees with respect to all expenses, losses,
damages, liabilities, demands, charges and claims arising from any acts or
omissions of the manager made in good faith in the performance of its duties
under the management agreement and not constituting bad faith, willful
misconduct, gross negligence or reckless disregard of its duties.
TERM AND TERMINATION
The management agreement had an initial term of three years beginning
January 30, 1998 and is renewed automatically for successive one year periods
unless we timely deliver a notice of non-renewal. Upon non-renewal of the
management agreement without cause, a termination fee will be payable to the
manager in an amount equal to the greater of (i) the fair value of the
management agreement as established by an independent appraiser, or (ii) 4% of
the mortgage loan portfolio of Specialty Mortgage Trust. In addition, we have
the right to terminate the management agreement at any time upon the happening
of specified events, after notice and an opportunity to cure, including a
material breach by the manager of any provision contained in the management
agreement. Upon such a termination for cause, no termination fee will be payable
to the manager.
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<PAGE> 32
MANAGEMENT
DIRECTORS AND OFFICERS
The directors, executive officers and senior officers of Specialty Mortgage
Trust and their positions are:
<TABLE>
<CAPTION>
NAME POSITION
---- --------
<S> <C>
Nello Gonfiantini III(1)................... Chairman of the board of directors, President,
Secretary and Chief Financial Officer of
Specialty Mortgage Trust.
George E. Bull(2)(3)....................... Director
Roger M. Peltyn(2)(4)...................... Director
Stephen V. Novacek(2)(4)................... Director
Ernest Martinelli(2)(3).................... Director
Harvey C. Fennell(2)....................... Director
</TABLE>
-------------------------
(1) Founder of Specialty Mortgage Trust.
(2) Independent Director.
(3) Member of the Audit Committee.
(4) Member of the Manager Oversight Committee.
Information regarding the business background and experience of Specialty
Mortgage Trust's directors and executive officers follows:
NELLO GONFIANTINI III, age 45, serves as Chairman of the Board, President,
Secretary and Chief Financial Officer of Specialty Mortgage Trust. Mr.
Gonfiantini has managed a private mortgage finance and real estate development
business in Reno, Nevada, since 1994. From 1986 until 1994, Mr. Gonfiantini was
the Chairman, CEO and President of Home Federal Savings Bank of Nevada, where he
oversaw the commercial and residential real estate lending operations. Prior to
taking that position in 1986, Mr. Gonfiantini was the Executive Vice President
of Home Mortgage Company, a mortgage banking firm and predecessor to Home
Federal Savings Bank of Nevada. Since June 1994, Mr. Gonfiantini has served as a
director of Redwood Trust, Inc., a publicly-traded REIT with mortgage assets
currently in excess of $2 billion. Mr. Gonfiantini has a BA and an MBA from the
University of Denver.
GEORGE E. BULL, age 51, is Chairman of the Board and Chief Executive
Officer and a founder in 1994 of Redwood Trust, Inc., Mill Valley, California, a
mortgage REIT. Mr. Bull was the President of GB Capital until March 1997, and
had served in that capacity since he founded the predecessor of GB Capital in
1983. GB Capital assisted banks, insurance companies and savings and loans in
managing portfolios of securitized and unsecuritized mortgage loans, in
arranging collateralized borrowings, in hedging balance sheet risks and with
other types of capital markets transactions. In addition, GB Capital managed and
advised troubled commercial real estate and corporate investments. In 1991 and
1992, Mr. Bull served as Acting Chief Investment Officer of First Capital Life
Insurance Company, managing its $4 billion securities portfolio and over $200
million in commercial real estate loans. He also worked during this period in
various aspects of fixed income portfolio management with Wood Island
Associates, Inc. From 1991 through 1993, Mr. Bull oversaw the management of the
$350 million portfolio of commercial real estate investments and the $8 billion
securities portfolio of Executive Life Insurance Company (in Rehabilitation) on
behalf of the California Department of Insurance. Mr. Bull formerly served as a
director of EurekaBank in San Francisco and as a director of Home Federal
Savings Bank in Nevada.
ROGER M. PELTYN, age 58, has been President of the structural engineering
firm, Martin & Peltyn, Inc., Las Vegas, since 1981. Mr. Peltyn is a director of
Southern Nevada Seismic Safety Counsel; a director of Martin & Peltyn, Inc.,
Civil Engineers; and a member of the American Society of Civil Engineers,
American Institute of Steel Construction, and the National Society of
Professional Engineers, Las Vegas.
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<PAGE> 33
He is a member of the board of trustees of the Nevada Development Authority,
President of the Alliance for the Arts, and a director of the Clark County
Public Education Foundation.
STEPHEN V. NOVACEK, age 54, has been a shareholder in the law firm, Hale,
Lane, Peek, Dennison, Howard and Anderson, located in Reno, Las Vegas and Carson
City, Nevada, since 1978. Mr. Novacek specializes in real estate law and finance
representing various institutional lenders in residential and commercial
transactions. He is a member of the State Bar of Nevada and the American Bar
Association.
ERNEST MARTINELLI, age 72, retired as Vice Chairman of Bank of America
Nevada in 1993 after a career in the banking business in Nevada. He is Vice
Chair of the board of directors of St. Mary's Healthcare Network and President
of Martinelli Properties, Inc., a commercial real estate development and
investment company.
HARVEY C. FENNELL, age 53, is the President of Dickson Realty, Inc., Reno,
and has been a realtor since 1987. Mr. Fennell specializes in land and
commercial real estate sales. He is a member of the Reno/ Sparks Association of
Realtors and has served on its board of directors. He is a member of the Nevada
Real Estate Commission, a state regulatory agency. Prior to 1987, Fennell was a
partner in the accounting firm: Peat, Marwick, Main & Company. Mr. Fennell is
the past President of the Sierra Nevada Chapter of the American Red Cross and
served as Treasurer of the Reno Performing Arts Center and the Nevada Festival
Ballet. He formerly served as a director of Home Federal Bank in Reno.
TERMS OF DIRECTORS AND OFFICERS
Specialty Mortgage Trust's board of directors consists of such number of
persons as shall be fixed by the board of directors from time to time by
resolution to be divided into three classes, designated Class I, Class II and
Class III, with each class to be as nearly equal in number of directors as
possible. Currently there are six directors. Messrs. Gonfiantini and Novacek are
Class I directors, Messrs. Bull and Martinelli are Class II directors and Mr.
Peltyn and Mr. Fennell are Class III directors. Class I, Class II and Class III
directors will stand for reelection at the annual meetings of stockholders held
in 2002, 2003 and 2001, respectively. At each annual meeting, the successors to
the class of directors whose term expires at that time are to be elected to hold
office for a term of three years, and until their respective successors are
elected and qualified, so that the term of one class of directors expires at
each such annual meeting.
In the case of any vacancy on the board of directors, including a vacancy
created by an increase in the number of directors, the vacancy may be filled by
election of the board of directors or the stockholders, with the director so
elected to serve until the next annual meeting of stockholders, if elected by
the board of directors, or for the remainder of the term of the director being
replaced, if elected by the stockholders; any newly-created directorships or
decreases in directorships are to be assigned by the board of directors so as to
make all classes as nearly equal in number as possible. Directors may be removed
only for cause and then only by vote of a majority of the combined voting power
of stockholders entitled to vote in the election for directors. Subject to the
voting rights of the holders of the preferred stock, the Charter may be amended
by the vote of a majority of the combined voting power of stockholders, provided
that amendments to the Article dealing with directors may only be amended if it
is advised by at least two-thirds of the board of directors and approved by vote
of at least two-thirds of the combined voting power of stockholders. The effect
of the foregoing as well as other provisions of Specialty Mortgage Trust's
Charter and Bylaws may discourage takeover attempts and make more difficult
attempts by stockholders to change management. Prospective investors are
encouraged to review the Charter and Bylaws in their entirety.
Officers are elected annually and serve at the discretion of the board of
directors. There are no family relationships between the executive officers or
directors.
COMMITTEES OF THE BOARD
Audit Committee. The Audit Committee is composed of Messrs. Bull and
Martinelli. The Audit Committee makes recommendations concerning the engagement
of independent public accountants,
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<PAGE> 34
reviews with the independent public accountants the plans and results of the
audit engagement, approves professional services provided by the independent
public accountants, reviews the independence of the independent public
accountants, considers the range of audit and non-audit fees and reviews the
adequacy of Specialty Mortgage Trust's internal accounting controls.
Manager Oversight Committee. The Manager Oversight Committee is composed of
Messrs. Peltyn and Novacek. The Committee reviews periodically the Management
Agreement and the manager's performance under that Agreement.
Other Committees. The board of directors may establish other committees as
deemed necessary or appropriate from time to time, including, but not limited
to, an Executive Committee of the board of directors.
In 1999, the board of directors met 4 times, each time with full
attendance. There has not yet been separate committee meetings.
COMPENSATION COMMITTEE INTERLOCKS
No interlocking relationship exists between our board of directors or
officers responsible for compensation decisions and the board of directors or
compensation committee of any other company.
COMPENSATION OF DIRECTORS
None of our directors has received any separate compensation for service on
the board of directors or on any committee thereof. We pay directors who are not
employed by Specialty Mortgage Trust, independent directors, $500 for each
meeting attended in person. In addition, each Independent Director is granted
options to purchase 10,000 shares of common stock at the fair market value of
the common stock upon becoming a director. We refer you to "-- Executive
Compensation -- Stock Option Plan -- Automatic Grants to Non-Employee Directors"
in this prospectus for more detail All directors receive reimbursement of
reasonable out-of-pocket expenses incurred in connection with meetings of the
board of directors. No director who is an employee of Specialty Mortgage Trust
or the manager will receive separate compensation for services rendered as a
director.
EXECUTIVE COMPENSATION
Employee salaries and bonuses are paid through the manager, Gonzo
Financial, Inc., as part of and not in addition to the management fee. For the
years ended December 31, 1999 and 1998, Gonzo Financial earned $148,252 and
$73,251, respectively, in fees for loan servicing. Gonzo Financial also received
an incentive compensation bonus of $18,480 and $22,468 for the years ended
December 31, 1999 and 1998, respectively.
STOCK OPTION PLAN
General. Specialty Mortgage Trust's 1997 Stock Option Plan provides for the
grant of qualified incentive stock options, which meet the requirements of
Section 422 of the Internal Revenue Code, stock options not so qualified,
deferred stock, restricted stock, performance shares, stock appreciation and
limited stock awards, and dividend equivalent rights.
Purpose. The stock option plan is intended to provide a means of
performance-based compensation in order to attract and retain qualified
personnel at the manager or Specialty Mortgage Trust and to afford additional
incentive to others to increase their efforts in providing significant services
to Specialty Mortgage Trust.
Administration. The stock option plan will be administered by the
Compensation Committee, which shall at all times be composed solely of
"disinterested persons" as required by Rule 16b-3 under the Exchange Act.
Members of the Compensation Committee are eligible to receive only stock options
not so qualified pursuant to automatic grants of stock options discussed below.
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<PAGE> 35
Options and Awards. Options granted under the stock option plan will become
exercisable in accordance with the terms of grant made by the Committee. Awards
will be subject to the terms and restrictions of the awards made by the
Committee. Option and award recipients shall enter into a written stock option
agreement with Specialty Mortgage Trust. The Committee has discretionary
authority to select participants from among eligible persons and to determine at
the time an option or award is granted when and in what increments shares
covered by the option or award may be purchased or will vest and, in the case of
options, whether it is intended to be a qualified incentive stock option or a
stock option not so qualified provided, however, that certain restrictions
applicable to qualified incentive stock options are mandatory, including a
requirement that qualified incentive stock options not be issued for less than
100% of the then fair market value of the common stock, 110% in the case of a
grantee who holds more than 10% of the outstanding common stock, and a maximum
term of ten years, five years in the case of a grantee who holds more than 10%
of the outstanding common stock. Fair market value means as of any given date,
with respect to any option or award granted, at the discretion of the board of
directors or the Compensation Committee, (i) the closing sale price of the
common stock on such date as reported in the Western Edition of the Wall Street
Journal or (ii) the average of the closing price of the common stock on each day
of which it was traded over a period of up to twenty trading days immediately
prior to such date, or (iii) if the common stock is not publicly traded, e.g.,
prior to the initial public offering, the fair market value of the common stock
as otherwise determined by the board of directors or the Compensation Committee
in the good faith exercise of its discretion.
Eligible Persons. Officers and directors and employees of Specialty
Mortgage Trust and other persons (particularly key employees of the manager)
expected to provide significant services to Specialty Mortgage Trust are
eligible to participate in the stock option plan. Qualified incentive stock
options may be granted only to officers and key employees of Specialty Mortgage
Trust. Stock options not so qualified and awards may be granted to the
directors, officers, key employees, agents and consultants of Specialty Mortgage
Trust or any of its subsidiaries.
Under current law, qualified incentive stock options may not be granted to
any director of Specialty Mortgage Trust who is not also an employee, or to
directors, officers and other employees of entities unrelated to Specialty
Mortgage Trust, such as the manager. No options or awards may be granted under
the stock option plan to any person who, assuming exercise of all options held
by such person, would own or be deemed to own more than 25% of the outstanding
shares of equity stock of Specialty Mortgage Trust.
Shares Subject to the plan. The stock option plan authorizes the grant of
options to purchase, and awards of, an aggregate of up to 300,000 shares of
Specialty Mortgage Trust's common stock. The maximum number of shares covered by
the stock option plan will increase to 10% of Specialty Mortgage Trust's total
outstanding shares at any time, provided that no more than 300,000 shares of
common stock shall be cumulatively available for grant as incentive stock
options. If an option granted under the stock option plan expires or terminates,
or an award is forfeited, the shares subject to any unexercised portion of such
option or award will again become available for the issuance of further options
or awards under the stock option plan. In connection with any reorganization,
merger, consolidation, recapitalization, stock split or similar transaction, the
Compensation Committee shall appropriately adjust the number of shares of common
stock subject to outstanding options, awards and dividend equivalent rights and
the total number of shares for which options, awards or dividend equivalent
rights may be granted under the plan.
Term of the plan. Unless previously terminated by the board of directors,
the stock option plan will terminate on October 22, 2007, and no options or
awards may be granted under the stock option plan thereafter, but existing
options or awards remain in effect until the options are exercised or the
options or awards are terminated by their terms.
Term of Options. Each option must terminate no more than ten years from the
date it is granted, or five years in the case of qualified incentive stock
options granted to an employee who is deemed to own an excess of 10% of the
combined voting power of Specialty Mortgage Trust's outstanding equity stock.
Options may be granted on terms providing for exercise either in whole or in
part at any time or times
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<PAGE> 36
during their restrictive terms, or only in specified percentages at stated time
periods or intervals during the term of the option.
Dividend Equivalent Rights. The plan provides for granting of dividend
equivalent rights in tandem with any options granted under the plan; however,
Specialty Mortgage Trust does not expect that dividend equivalent rights will
generally be granted. Such dividend equivalent rights accrue for the account of
the optionee shares of common stock upon the payment of dividends on outstanding
shares of common stock. The number of shares accrued is determined by a formula
and such shares may be made transferable to the optionee either upon exercise of
the related option or on a "current-pay" basis so that payments would be made to
the optionee at the same time as dividends are paid to holders of outstanding
common stock. Holders of dividend equivalent rights may be made eligible to
participate not only in cash distributions but also in distributions of stock or
other property made to holders of outstanding common stock. shares of common
stock accrued for the account of the optionee are eligible to receive dividends
and distributions. Dividend equivalent rights may also be made "performance
based" by conditioning the right of the holder of the dividend equivalent right
to receive any dividend equivalent payment or accrual upon the satisfaction of
specified performance objectives.
Option Exercise. The exercise price of any option granted under the stock
option plan is payable in full in cash, or its equivalent as determined by the
Committee. Specialty Mortgage Trust may make recourse loans available to option
holders to fund the exercise of options, which loans will be evidenced by a
promissory note executed by the option holder and secured by a pledge of common
stock with fair value at least equal to the principal of the promissory note
unless otherwise determined by the Committee.
Automatic Grants to Non-Employee Directors. Each non-employee director of
Specialty Mortgage Trust is automatically granted stock options not so qualified
to purchase 10,000 shares of common stock upon becoming a director of Specialty
Mortgage Trust. Such automatic grants of stock options vest 25% on the
anniversary date in the year following the date of the grant and 25% on each
anniversary date thereafter. The exercise price for such automatic grants of
stock options is the fair market value of the common stock on the date of grant.
Amendment and Termination of Stock Option Plan. The board of directors may,
without affecting any outstanding options or awards, from time to time revise or
amend the stock option plan, and may suspend or discontinue it at any time.
However, no such revision or amendment may, without stockholder approval,
increase the number of shares subject to the stock option plan, modify the class
of participants eligible to receive options or awards granted under the stock
option plan or extend the maximum option term under the stock option plan.
Outstanding Options. Options to acquire 135,000 shares of common stock have
been granted under Specialty Mortgage Trust's stock option plan. Of these
options, 10,000 have been granted to each of the five independent directors and
an additional 85,000 have been granted to six current employees, excluding the
founder, of Gonzo Financial, Inc. The options were granted without dividend
equivalent rights and become exercisable in annual increments over a four-year
period. The options were granted at prices ranging from $0.01 to $5.00 per
share. No options have been granted to Mr. Gonfiantini.
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PRINCIPAL SECURITYHOLDERS
BENEFICIAL OWNERSHIP OF CAPITAL STOCK BY LARGE SECURITYHOLDERS
The following table sets forth certain information known to Specialty
Mortgage Trust with respect to beneficial ownership of Specialty Mortgage
Trust's capital stock as of July 31, 2000 by each person other than members of
management known to Specialty Mortgage Trust to beneficially own more than five
percent (5%) of Specialty Mortgage Trust's capital stock. Unless otherwise
indicated in the footnotes to the table, the beneficial owners named have, to
the knowledge of Specialty Mortgage Trust, sole voting and investment power with
respect to the shares beneficially owned, subject to community property laws
where applicable.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP
OF PREFERRED STOCK
--------------------
NAME OF BENEFICIAL OWNER SHARES PERCENT
------------------------ -------- --------
<S> <C> <C>
Angelo Petrini(1)(4)........................................ 334,714 7.30%
Raymond J. Poncia, Jr.(2)(4)................................ 300,000 6.54%
Nello Gonfiantini, Jr.(3)(4)................................ 296,819 6.47%
</TABLE>
-------------------------
(1) Consists of 302,714 shares of preferred stock held by the 1987 Petrini
Family Trust of which Mr. Petrini is co-trustee with his wife and 32,000
shares of preferred stock held by Delta Saloon Profit Sharing Plan of which
Mr. Petrini is trustee.
(2) Consists of 150,000 shares of preferred stock held by the Raymond J. Poncia,
Jr. Family Trust of which Mr. Poncia, Jr. is trustee and 150,000 shares of
preferred stock held by the Hotel & Casino Management Inc. of which Mr.
Poncia, Jr. is President.
(3) Consists of 149,500 shares of preferred stock held by the Gonfiantini Family
Trust of which Mr. Gonfiantini, Jr. is trustee, 84,819 shares of preferred
stock held by Mr. Gonfiantini, Jr. individually, 25,000 shares held by Gonzo
Properties of which Mr. Gonfiantini, Jr. is a partner and 37,500 shares
which represents the Gonfiantini Family Trust's 25% interest, as a tenant in
common, in 150,000 shares of preferred stock.
(4) Mailing address: 6160 Plumas Street, Reno, Nevada 89509
BENEFICIAL OWNERSHIP OF CAPITAL STOCK BY DIRECTORS AND MANAGEMENT
The following table sets forth certain information known to Specialty
Mortgage Trust with respect to beneficial ownership of Specialty Mortgage
Trust's capital stock as of July 31, 2000, by each director and by all directors
and executive officers as a group. Unless otherwise indicated in the footnotes
to the table, the beneficial owners named have, to the knowledge of Specialty
Mortgage Trust, sole voting and
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<PAGE> 38
investment power with respect to the shares beneficially owned, subject to
community property laws where applicable.
A. COMMON STOCK
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP
OF COMMON STOCK
--------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT
------------------------ -------- --------
<S> <C> <C>
Nello Gonfiantini III(1).................................... 300,000 90.04%
Ernest Martinelli(2)........................................ 5,000 1.50%
George E. Bull III(2)....................................... 5,000 1.50%
Roger M. Peltyn(2).......................................... 5,000 1.50%
Stephen V. Novacek(2)....................................... 5,000 1.50%
All Directors and Executive Officers as a Group (5
persons).................................................. 320,000 96.04%
</TABLE>
-------------------------
(1) Founders shares.
(2) Consists of 5,000 shares issued upon the exercise of stock options, but does
not include 5,000 shares issuable upon the exercise of granted but unvested
stock options.
B. PREFERRED STOCK
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP
OF PREFERRED STOCK
--------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT
------------------------ -------- --------
<S> <C> <C>
Nello Gonfiantini III(1).................................... 165,758 3.61%
Ernest Martinelli(2)........................................ 150,000 3.27%
George E. Bull III(3)....................................... 52,500 1.14%
Harvey C. Fennell(4)........................................ 24,723 *
Roger M. Peltyn(5).......................................... 10,000 *
Stephen V. Novacek(6)....................................... 4,214 *
All Directors and Executive Officers as a Group (6
persons).................................................. 407,195 8.88%
</TABLE>
-------------------------
* Less than one percent.
(1) Consists of 300,000 shares of common stock and 103,258 shares of preferred
stock held in the Nello Gonfiantini III 1981 Trust of which Nello
Gonfiantini III is trustee, and 25,000 shares of preferred stock held by
Gonzo Properties of which Nello Gonfiantini III is a partner, and 37,500
shares which represents the Nello Gonfiantini III 1981 Trust's 25% interest,
as a tenant in common, in 150,000 shares of preferred stock, but does not
include 481,944 shares of preferred stock beneficially owned by persons
related by blood or marriage to Nello Gonfiantini III with respect to which
he has neither voting nor investment power.
(2) Consists of 110,000 shares of preferred stock held in the Ernest Martinelli
Family Trust of which Mr., Martinelli is Trustee, and 40,000 shares of
preferred stock held by The Martinelli Family Partnership of which Mr.
Martinelli is general partner.
(3) Consists of 52,500 shares of preferred stock held in the Bull Trust of which
Mr. Bull is trustee.
(4) Consists of 24,723 shares of preferred stock held by Dickson Realty Profit
Sharing Plan of which Mr. Fennell is co-trustee.
(5) Consists of 10,000 shares of preferred stock held by the Peltyn Family Trust
of which Mr. Peltyn is a trustee.
(6) Consists of 4,214 shares of preferred stock.
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<PAGE> 39
CERTAIN TRANSACTIONS
The manager is a private mortgage finance business that has operated in
Nevada since January 1995. The manager originates mortgage loans for Specialty
Mortgage Trust and otherwise manages the day-to-day operations of Specialty
Mortgage Trust, subject to direction by Specialty Mortgage Trust's board of
directors. The manager does not originate mortgage loans for others without
approval of the Board's independent directors. The executive officers of
Specialty Mortgage Trust are also the executive officers of the manager. Mr.
Gonfiantini beneficially owns the manager.
Pursuant to the management agreement, the manager receives a management fee
consisting of mortgage placement fees or points, usually charged to the borrower
for and upon origination, extension or refinancing of loans, up to 2.5% of the
loan balance with any additional fees or points paid to Specialty Mortgage
Company. The manager also receives a fee for loan servicing equal to one-half of
one percent of the total mortgage loan serviced and any late payment charges. In
addition, the manager receives, as incentive compensation for each fiscal
quarter, an amount equal to 50% of the taxable net income before the dividend
deduction of Specialty Mortgage Trust in excess of the annualized return to
Specialty Mortgage Trust equal to 12%. For the years ended December 31, 1999 and
1998, the manager earned $148,252 and $73,251, respectively, in fees for loan
servicing. The manager also received an incentive compensation bonus of $18,480
and $22,468 for the years ended December 31, 1999 and 1998, respectively.
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<PAGE> 40
DESCRIPTION OF THE NOTES
GENERAL
Specialty Mortgage Trust's Collateralized Investment Notes are issued under
an indenture dated as of , 2000 between Specialty Mortgage Trust and
Bankers Trust Company of California, N.A., as trustee. We have filed a copy of
the indenture as an exhibit to the registration statement of which this
prospectus is a part. The following statements are brief summaries of some of
the key provisions of the indenture, and are subject to the detailed provisions
of the indenture. You should refer to the indenture for a complete statement of
those provisions. Whenever this prospectus refers to particular provisions of
the indenture or terms defined in the indenture, those provisions or definitions
are incorporated by reference as part of the statements made in this prospectus,
and the statements are qualified in their entirety by that reference. Copies of
the indenture will also be available for inspection during normal business hours
at our principal executive offices located at 6160 Plumas Street, Reno, Nevada
89509.
We have the right to modify the indenture as described below. Additionally,
we reserve the right to terminate this offering, or modify the terms of the
offering or the securities offered in this prospectus, at any time, by an
appropriate amendment or supplement to this prospectus. No modification will
affect the rights of the holders of then outstanding securities.
The Notes are limited to $50,000,000 aggregate principal amount at any time
outstanding and will be direct obligations of Specialty Mortgage Trust secured
by collateral pledged to the trustee from time to time, the "pledged assets". We
refer you to "Collateral" below for more detail. The Notes are issued on the
20th day of the month or the first business day thereafter. The Notes mature a
minimum of one month and a maximum of twelve months from the date of issuance,
the "stated maturity", and bear interest upon the unpaid principal amount
thereof from the date of issuance of the Notes, at the rate per annum fixed on
the date of issuance. From time to time, we will fix the interest rates payable
on newly issued and rollover Notes based on market conditions and our financial
requirements. Investors may select the term and corresponding interest rate
offered in a supplement to this prospectus. In no event will the interest rate
be less than the applicable federal rate that is periodically set by the IRS as
the minimum for short-term borrowings. Once determined, the rate of interest
payable on a Note will remain fixed until the Note matures. Interest is payable
to the persons in whose names the Notes are registered at the election of the
noteholder either (a) monthly in arrears on the 20th day of each month, each an
"interest payment date", or (b) compounding monthly, at stated maturity. Accrued
interest is to be computed on the basis of a 360-day year consisting of twelve
30-day months.
The Notes are issued in minimum denominations of $25,000. The Notes will be
uncertificated and evidenced by a confirmation of book entry and a statement
issued by us to each holder. These confirmations and statements issued by us are
not negotiable instruments. Holders cannot transfer rights of ownership by mere
endorsement and delivery of a confirmation or statement. We maintain a register
to record the owner(s) of each outstanding Note and shall treat the person(s)
whose name(s) is (are) so recorded as the owner(s) of the Note for all purposes.
Holders may transfer ownership of a Note on our register only by written notice
to us signed by the owner(s), or the owner's authorized representative, on a
form to be supplied by us. Holders may not pledge, assign or hypothecate the
Notes as collateral for a loan or otherwise.
Principal and interest on the securities offered in this prospectus will be
payable at our office, or at such other place as we may designate for that
purpose. However, we may make payments at our option by check mailed to the
person entitled to the payments at his or her address appearing in the register.
We will automatically extend the term of a Note for a period equal to the
Note's original term and at the current interest rate being offered by us on
Notes of the same term and duration as the maturing Note if we do not receive
notice from the noteholder to redeem or convert the Note at least one business
day before the maturity date of the Note and if we do not give the holder notice
of redemption at maturity at least five business days before the Note's
maturity. A noteholder will be paid the interest due at maturity and the
principal amount will be rolled over.
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<PAGE> 41
We will withhold 31% of any interest paid to any investor who has not
provided us with a fully executed Form W-9 or satisfactory equivalent or where
the Internal Revenue Service has notified us that back-up withholding is
otherwise required. Any tax or other amounts withheld from interest payments
pursuant to the requirements of a taxing authority will be considered as having
been paid by Specialty Mortgage Trust to the Noteholder.
The Indenture limits the ratio of (a) the total indebtedness of Specialty
Mortgage Trust, both secured and unsecured, to (b) the total shareholders'
equity, to no more than 5:1. The Indenture also requires that at each payment
date the Company has and shall maintain sufficient cash and unused credit
facilities to pay all interest due and all Notes maturing on the subsequent
payment date. On each payment date we will deliver to the trustee a certificate
setting forth the calculations of our compliance with these covenants.
We reserve the right to decline any investment in our sole discretion.
COLLATERAL
The pledged assets securing the Notes will be held by the trustee and will
consist of some of our mortgage loans, short-term money market instruments
and/or cash.
Mortgage Loans. Mortgage loans are evidenced by mortgage notes, each of
which is secured by a valid lien on real property located in Nevada or other
states including, but not limited to, property of which any portion thereof may
be characterized as commercial real estate, raw land or multifamily and
non-conforming single-family residential property. Each such lien is duly
recorded in the office of the proper recording officer of the county in which
the real property described in each such mortgage or deed of trust is located to
reflect of record that we are the mortgagee or the beneficiary of the deed of
trust, or the assignee of either thereof, and is insured by a lender's title
insurance policy of the kind described in the indenture.
Each mortgage loan included in the pledged assets shall bear a fixed or
variable rate of interest and shall, as of the date it is first pledged as
collateral under the indenture, among other things:
- have an unpaid principal balance of not less than $25,000;
- have had a loan to value ratio at the most recent appraisal date of not
more than 85%; and
- not be delinquent and have not been delinquent more than once during the
preceding 12-month period.
Each pledged mortgage loan or participated portion of a mortgage loan shall
be owned by Specialty Mortgage Company. We expect that substantially all of the
mortgage loans to be included in the pledged assets shall be serviced by the
manager.
Each mortgage note pledged with the trustee is endorsed without recourse in
blank or to the trustee and is delivered to the trustee together with a copy of
the deed of trust and an original assignment thereof in recordable form and,
among other things, a copy of the ALTA lender's title insurance policy (or, if
not yet available, a preliminary title report for a period of 60 days) stating
that the mortgage constitutes a valid lien on the underlying real property. The
assignments of the mortgage loans will not be recorded prior to the occurrence
of an event of default. During the period prior to recordation of the
assignments, it might be possible for us to discharge mortgage notes or transfer
mortgage notes to bona fide purchasers for value without notice, notwithstanding
the trustee's lien. However, as a general matter we would not be able under the
terms of the indenture to deliver the original documents evidencing the mortgage
notes or mortgage loans, because such documents are to be retained in the
possession of the trustee. Generally, a subsequent transferee who failed to
obtain delivery of the original evidence of indebtedness would not, in the
absence of special facts, be able to defeat the trustee's interest in a mortgage
note so long as such evidence of indebtedness remains in the possession of the
trustee.
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<PAGE> 42
The characteristics of the mortgage notes pledged to secure the Notes may
in some circumstances inhibit the liquidity and marketability of such
instruments. Such mortgage notes generally have greater principal balances on a
loan-by-loan basis, and generally present a higher degree of risk compared with
conforming single-family residential loans due, among other things, to the
susceptibility of the value of property securing the mortgage loan to changes in
the economic conditions that affect business profitability in general. Further,
commercial and multifamily residential properties may be subject to increased
risk from laws relating to environmental hazards or damages. For these reasons,
a review of the commercial or multifamily residential properties underlying the
mortgage notes and other relevant information may be required in connection with
any sale or liquidation of such properties which would delay any such sale or
liquidation; any such sale or liquidation carried out under a time frame which
does not permit such a review may result in reduced proceeds from such sale or
liquidation. We refer you to "-- Events of Default" in this prospectus for more
detail.
Short-Term Money Market Instruments. "Short-term money market instruments"
consist of any of the following instruments, provided that, on the date when
such instruments are first pledged as collateral under the indenture, they have
remaining terms to maturity of 90 days or less and, provided further, that the
obligor of any of such instruments has short-term commercial paper or other
unsecured short-term rating in the highest rating category of a recognized
rating agency and a long-term debt obligation rating in one of the two highest
rating categories: (i) time deposits of, demand deposits in, certificates of
deposit of, bankers' acceptances issued by, or next-day federal funds sold by
any FDIC-insured depository institution; (ii) repurchase agreements with respect
to Government Securities or GNMA, FNMA or FHLMC Certificates entered into with a
depository institution (acting as principal); or (iii) commercial paper.
Cash. "Cash" is coin or currency of the United States of America as at the
time shall be legal tender for payment of public and private debts.
CALCULATION OF THE VALUE OF THE COLLATERAL
The Notes are collateralized by pledged assets consisting of (a) our
mortgage loans in an aggregate principal amount at least equal to one and
one-half (1 1/2) times the aggregate principal amount outstanding on the Notes,
(b) short-term money market instruments and cash at least equal to the aggregate
principal amount outstanding on the Notes or (c) a combination of the foregoing.
We are required under the terms of the indenture to calculate, on the 20(th) day
of each month (each a "valuation date"), the value of collateral then pledged to
secure the Notes. In that calculation, we determine a "basic maintenance amount"
which is an amount equal to the aggregate unpaid principal amount of the Notes
outstanding after giving effect to any Notes to be retired or issued on such
valuation date. We also determine the "discounted value" of the pledged assets
which must at least equal the basic maintenance amount.
"Discounted value" as of any date means that amount determined with respect
to specific collateral included in the pledged assets in the manner set forth
below:
(a) as to mortgage loans that meet the eligibility criteria the
aggregate unpaid principal balance under the related mortgage note (as
determined by Specialty Mortgage Trust) divided by one and one-half
(1 1/2);
(b) as to short-term money market instruments, the outstanding
aggregate principal amount evidenced by each such instrument (as determined
by Specialty Mortgage Trust by any reasonable method which Specialty
Mortgage Trust believes reliable, which may include amounts based upon the
most recent report related to each such instrument received by Specialty
Mortgage Trust); and
(c) as to cash, the face value thereof.
The calculation of the discounted value of the pledged assets in the manner
described above is designed to ensure that at all times the pledged assets have
an aggregate market value in excess of the amount necessary to repay the
outstanding Notes. Continual reductions in the principal amounts of any category
of collateral may cause the aggregate discounted value of the pledged assets on
future valuation
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<PAGE> 43
dates to be a lower percentage of the then outstanding principal amount of the
Notes than the percentage as of preceding valuation dates.
The indenture requires that we calculate on each valuation date the basic
maintenance amount and the discounted value of the pledged assets within the
last five business days and deliver to the trustee on such valuation date a
certificate setting forth such calculations. In the event that the discounted
value of the pledged assets as calculated by us is less than the basic
maintenance amount on any valuation date which any Notes are outstanding, we are
obligated not later than the month-end following such valuation date to (i)
deliver to the trustee additional eligible collateral and/or (ii) purchase
outstanding Notes, such that after taking such actions into account the
discounted value of the pledged assets is at least equal to the basic
maintenance amount as of such valuation date.
WITHDRAWALS AND SUBSTITUTIONS OF COLLATERAL
We may, subject to specific requirements set forth more fully in the
indenture, at any time and from time to time, upon request to the trustee,
withdraw or substitute pledged assets; provided, that the aggregate discounted
value of eligible collateral, based upon the most recent valuation date,
remaining in the pledged assets following the proposed withdrawal or
substitution would at least equal the basic maintenance amount as of such
valuation date.
PAYMENTS ON PLEDGED ASSETS
Unless an event of default has occurred and is continuing with respect to
the Notes, we shall be entitled to collect all payments, including, without
limitation, payments upon maturity, prepayments, distributions and payments as a
result of default, on or in respect of any mortgage notes securing the Notes,
and the trustee shall pay over to us any such payments which may be collected or
received by the trustee. Upon the occurrence of such an event of default and
while it shall be continuing, if we shall receive any payments, including,
without limitation, payments upon maturity, prepayments, distributions and
payments as a result of default, on or in respect of such mortgage notes, we
shall hold such payments in trust for the benefit of the trustee and the holders
of the Notes, shall segregate such payments from the other property of Specialty
Mortgage Trust, and shall promptly after receipt of such payments deliver them
in the form received to the trustee. The trustee shall thereafter release and
transfer to us, upon our request, any requested amount of such payments only so
long as (i) the aggregate discounted value of the pledged assets, after giving
effect to such release and transfer, would be at least equal to the basic
maintenance amount and (ii) no event of default shall be continuing.
PURCHASE AND RESALE OF NOTES
We and our affiliates may at any time and from time to time purchase
outstanding Notes on the open market, if any, or by private sale. Notes held by
us or an affiliate shall not be deemed to be outstanding for purposes of
determining the basic maintenance amount, unless such Notes have been pledged to
a party other than us or any of our affiliates. The indenture provides that we
shall not, and we shall not permit any affiliate to, sell or pledge any Notes
acquired by us or any affiliate unless the discounted value of the pledged
assets would not be less than the basic maintenance amount after giving effect
to such sale or pledge. During the continuance of any event of default, we will
not and to the extent of our authority, will not permit any of our affiliates
to, sell or pledge any Notes owned by us or any affiliate without the prior
written consent of the trustee.
REDEMPTION
The Notes are not subject to redemption at our option. Although holders
have no contractual right to redeem a Note before maturity, we, in our sole
discretion, may honor a written request for early termination.
FINANCIAL REPORTS
Our financial statements for each year during which any Notes are
outstanding, as certified by the our independent accountants, will disclose the
unpaid principal amount of the outstanding Notes and the
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<PAGE> 44
unpaid principal amount of the eligible collateral included in the pledged
assets as of the last day of our fiscal year.
EVENTS OF DEFAULT
Any of the following will constitute an "event of default" with respect to
the Notes: (a) the failure to pay interest on any Note within five days after
such payment is due; (b) the failure to pay the principal of any Note at the
stated maturity thereof; (c) a default in our performance of the covenant in the
indenture to maintain an amount of pledged assets having an aggregate discounted
value at least equal to the basic maintenance amount; (d) the failure to deliver
a certificate calculating the basic maintenance amount and the discounted value
of the pledged assets within three business days of the date on which either is
required to be delivered pursuant to the indenture; (e) a material breach or
inaccuracy of any warranty or representation made by us in or under the
indenture as of the date of which such representation or warranty was made and
five business days after written notice thereof to us by the trustee or to us
and the trustee by the holders of at least two-thirds in aggregate principal
amount of the outstanding Notes and the circumstances or connection in respect
of which such representation or warranty was breached or inaccurate has not been
cured; (f) a default in our performance of a financial or any other covenant in
the indenture and the continuation of such default for 30 days after written
notice to us by the trustee or to us and the trustee by the holders of at least
two-thirds in aggregate principal amount of the outstanding Notes; and (g) an
occurrence of insolvency or similar event of Specialty Mortgage Trust.
In case an event of default should occur and be continuing, the trustee or
the holders of at least two-thirds in aggregate principal amount of outstanding
Notes may or, in the case of an event of default of the type described in
clauses (a), (b), (c) or (d) or (g) of the preceding paragraph, the trustee
immediately after it has knowledge thereof shall, declare the principal and
accrued interest on the Notes to be immediately due and payable by providing
written notice to us. Such declaration and its consequences may, under some
circumstances, be rescinded and annulled by the holders of a majority of the in
aggregate principal amount of such outstanding Notes. If any event of default
shall occur and not be cured or waived within thirty days thereafter, the rate
of interest borne by each outstanding Note shall be increased by 0.50% per annum
effective on the date of the event of default.
If an event of default has occurred and is continuing, the trustee,
directly or through an agent, is permitted: (a) to sell the pledged assets; (b)
to institute litigation to enforce payment of the Notes, or to realize on the
pledged assets and otherwise to protect the interest of the noteholders; (c) to
notify third parties including mortgagors, servicing companies, trustees and
paying agents of the trustee's interest in the pledged assets and to require
that all payments made on such pledged assets be paid directly to it; and (d) to
otherwise exercise all rights and remedies of a secured party under the Uniform
Commercial Code as in effect in the State of Nevada.
The trustee is also authorized to institute suits against us for the
collection of amounts due on the Notes, to collect the deficiency, if any, after
the sale of the pledged assets and to file proofs of claim in any bankruptcy,
insolvency or similar proceeding involving us. The trustee may also, upon
written request of the holders of a majority of the aggregate principal amount
of the Notes, be required to institute suits to take other appropriate action to
enforce payment of the Notes and to enforce any of the rights or powers of the
trustee or noteholders under the indenture, but shall have the right to decline
to follow any such request if the trustee determines in good faith that such
action would involve the trustee in personal liability or expenses or would not
be in the best interests of the noteholders.
The power to effect any sale of any portion of the pledged assets shall not
be exhausted by any one or more sales as to any portion of the pledged assets
remaining unsold, but shall continue unimpaired until all of the pledged assets
shall have been sold or all amounts payable on the Notes shall have been paid,
whichever shall first occur. The trustee shall not in any sale sell all or any
portion of the pledged assets unless either (a) two-thirds of the noteholders
consent to the sale or (b) the proceeds of the sale would not be less than the
entire amount which would be distributable to the noteholders. In connection
with a
41
<PAGE> 45
sale of all or any portion of the pledged assets, any noteholder may bid for and
purchase the property offered for sale, and may, in paying the purchase money
therefor, deliver Notes to the trustee.
There can be no assurance that the trustee will be able to dispose of the
pledged assets without a significant delay following an event of default or that
the proceeds obtained from the pledged assets will be sufficient to pay all
amounts owing to the noteholders.
Subject to the provisions of the indenture relating to the duties of the
trustee, in the case an event of default shall occur and be continuing, the
trustee shall be under no obligation to exercise any of the rights or powers
under the indenture at the request or direction of any of the noteholders unless
such holders shall have offered to the trustee reasonable security or indemnity.
The trustee is not required to expend or risk its own funds or incur financial
liability if it has reasonable grounds for believing that repayment of such
funds or adequate indemnity against such risk or liability is not reasonably
assured.
Subject to the provisions for indemnification of the trustee and other
limitations contained in the indenture, the holders of a majority in aggregate
principal amount of the outstanding Notes shall have the right to direct the
time, method and place of conducting any proceeding for any remedy available to
the trustee or exercising any trust or power conferred on the trustee with
respect to such Notes.
PRIORITY
If, following an event of default, the proceeds of liquidation of the
pledged assets were insufficient to pay the entire remaining amount payable on
the Notes, the holders of such Notes would be general creditors of the Company
to the extent of the deficiency and, upon any liquidation of Specialty Mortgage
Trust, such holders would rank on parity with our general creditors.
MERGER
The indenture provides that we shall not consolidate with or merge into any
other corporation or convey, or transfer its properties and assets substantially
as an entirety unless (i) the successor corporation is incorporated in the
United States and a supplemental indenture is signed by such successor
corporation by which it expressly assumes the obligations of the Company under
the Notes and the indenture; (ii) the successor corporation shall, by
supplemental indenture or agreement, confirm that the pledged assets shall
secure its obligations under the Notes and the indenture; (iii) immediately
after giving effect to such transaction, no event of default or event which with
notice or lapse of time or both would become an event of default has occurred
and is continuing and (iv) the Company shall have delivered to the trustee an
officers' certificate and an opinion of counsel, each stating that such
consolidation, merger, conveyance or transfer complies with the indenture and
that all conditions precedent therein provided for relating to such transaction
have been complied with.
THE TRUSTEE
The indenture contains provisions limiting the liability of the trustee and
provides for the indemnification of the trustee by Specialty Mortgage Trust
under specific circumstances. The trustee may resign at any time by giving
written notice to us, such resignation to be effective upon the appointment of a
successor trustee. The trustee may be removed by the holders of a majority in
principal amount of outstanding Notes or by board resolution by us unless an
event of default has occurred and is continuing.
MODIFICATION
A supplemental indenture may be entered into by Specialty Mortgage Trust
and the trustee without the consent of the holder of any Note, which modifies or
amends the indenture (including the terms and conditions of the Notes) for the
following purposes: (a) to evidence the succession of another corporation to
Specialty Mortgage Trust; (b) to add to the covenants of Specialty Mortgage
Trust for the benefit of the noteholders or to surrender any right or power
conferred upon Specialty Mortgage Trust under the indenture; (c) to convey,
transfer and assign to the trustee and to subject to the lien of the indenture
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<PAGE> 46
additional eligible collateral of Specialty Mortgage Trust and to correct or
amplify the description of any property at any time subject to the lien of the
indenture; (d) to cure any ambiguity in, to correct or supplement any provision
that may be defective or inconsistent with any other provision or to make any
other provisions with respect to matters or questions arising under the
indenture which are not inconsistent with the provisions of the indenture;
provided, that such action will not adversely affect the interests of the
noteholders; (e) to modify, eliminate or include provisions required or
permitted by the Trust Indenture Act of 1939, as amended, or other federal
statutes hereinafter enacted; and (f) to provide for the appointment of a
co-trustee.
Additional modifications and amendments may be made to the indenture,
including the modification of the noteholders' rights thereunder, with the
consent of the holders of not less than a majority of the aggregate principal
amount of the Notes then outstanding. No such modification or amendment to the
indenture may, without the consent of the holder of each Note so affected,
change the stated maturity of the principal of or any installment of interest on
any such Note; reduce the principal of or interest on any such Note; change the
coin or currency in which any Note or the interest thereon is payable; impair
the right to institute suit for the enforcement of any payment on or after the
stated maturity or any redemption date with respect to any such Note; permit the
creation of any lien prior to or pari passu with the lien of the indenture with
respect to any such Note; permit the creation of any lien of the indenture with
respect to any of the pledged assets or terminate the lien of the indenture with
respect to any pledged assets (except in such cases as permitted by, and
pursuant to, the indenture); deprive the Notes of the security afforded by the
lien of the indenture; or reduce the percentage in principal amount of the
outstanding Notes the consent of whose holders is required for any supplemental
indenture, or the consent of whose Holders is required for any waiver of
compliance with specific provisions of the indenture or defaults thereunder and
their consequences provided for in the indenture. The indenture also permits the
holders of a majority of the aggregate principal amount of the then outstanding
Notes to waive specified past defaults and their consequences and to rescind in
some circumstances the declaration of the acceleration of the amounts due under
the Notes after an event of default has occurred.
LIST OF NOTEHOLDERS
Three or more holders of the Notes who have held such Notes for a period of
at least six months may, by written request to the trustee, obtain access to the
list of all holders of the Notes, as specified in the request, maintained by the
trustee for the purpose of communicating with other noteholders with respect to
their rights under the indenture. The trustee may elect not to afford the
requesting noteholders access to the list of noteholders if it agrees to mail
the desired communication or proxy, on behalf of the requesting noteholders, to
all such noteholders.
ANNUAL COMPLIANCE STATEMENT
Specialty Mortgage Trust will be required to file annually with the trustee
a written statement as to fulfillment of its obligations under the indenture.
TRUSTEE'S ANNUAL REPORT
The trustee will be required to mail each year to all holders of Notes a
brief report relating to its eligibility and qualifications to continue as the
trustee under the indenture, any amounts owing by Specialty Mortgage to it in
the trustee's individual capacity, the property and funds physically held by the
trustee as such, any additional issue of Notes not previously reported, the
release or release and substitution of any property subject to the lien of the
indenture, and any action taken by it which materially affect the Notes or the
Collateral and which has not been previously reported.
TRUSTEE
The Bankers Trust Company of California, N.A., a subsidiary of Deutsche
Bank, located in Santa Ana, California, will be the trustee for the Notes. The
trustee also serves as the trustee under another indenture for our Class A
Collateralized Mortgage Notes.
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<PAGE> 47
FEDERAL INCOME TAX CONSEQUENCES
The following discussion summarizes the anticipated material federal income
tax consequences of your purchase, ownership and disposition of our Notes as an
initial purchaser. It has been reviewed by our tax counsel, GnazzoThill, A
Professional Corporation, and is based on their conclusions as to the likely
interpretation of applicable legal authorities to an investment in the Notes.
This discussion is based upon the Internal Revenue Code of 1986, as amended, and
related regulations, administrative rulings and court decisions in effect as of
the date of this prospectus, all of which are subject to change, possibly
retroactively. This discussion does not address every aspect of the federal
income tax laws that may be relevant to all categories of investors and it
assumes that the Notes are being held by you as property held for investment
(i.e., as a capital asset). Moreover, it does not address state, local or
foreign tax concerns. Accordingly, you are urged to consult your own tax advisor
regarding your specific federal, state, local and foreign tax consequences to
you of investing in our Notes.
Please be advised that we have not received any rulings, and will not seek
any rulings, from the Internal Revenue Service with respect to the federal
income tax consequences discussed below. Thus, there can be no complete
assurance that the Service will agree with our statements. You should also be
aware that under applicable Treasury regulations a provider of advice on
anticipated transactions is generally not considered an income tax return
preparer. Accordingly, in preparing your tax return you are advised to consult
with your own tax advisor regarding the specific consequences to you of your
purchase, ownership and disposition of our Notes, including any potential
changes in applicable tax laws.
TAX CLASSIFICATION OF THE NOTES
Our tax counsel has advised us that, in their opinion, the Notes will be
classified as debt for federal income tax purposes, and not as an ownership
interest in the collateral securing the Notes or as equity in Specialty Mortgage
Trust. By your acceptance of a Note, and any person that is a beneficial owner
of any interest in a Note, by virtue of that person's acquisition of a
beneficial interest in a Note, you or any beneficial owner will agree with us to
treat the Notes as debt for all tax purposes.
Our characterization of the Notes as debt is not binding on the Service and
the Service could assert that our Notes represent an ownership interest in the
equity of Specialty Mortgage Trust or an ownership interest in the mortgage
collateral. Successful treatment of our Notes as equity interests could
adversely affect our ability to maintain our REIT status and could result in
collateral tax consequences to our Note investors, including changes in the
characterization and timing of income received with respect to the Notes and an
adverse effect on our cash flow. The remainder of this discussion assumes that
our Notes are treated as debt for federal income tax purposes.
TAX CLASSIFICATION OF SPECIALTY MORTGAGE TRUST
The Internal Revenue Code of 1986, as amended, provides special tax
treatment for organizations that qualify and elect to be taxed as REITs. We have
made an election to be taxed as a REIT under the Code commencing with our
taxable year ending December 31, 1998. Assuming we maintain our qualification,
we generally will be permitted to deduct our dividend distributions to
stockholders from our taxable income, thereby effectively eliminating the
"double taxation" that normally results when a corporation earns income and
distributes that income to its stockholders in the form of dividends. In order
to maintain our qualification as a REIT, however, we must satisfy numerous tests
with respect to the sources of our income, the nature and diversification of our
assets, the amount of our distributions to our stockholders and the ownership of
our stock. If we fail to meet those requirements in a given year, and do not
qualify for relief under the Code, we will be subject to federal income tax as a
regular, domestic corporation, thereby losing the benefit of the dividends
received deduction. As a result, we would incur potentially substantial income
tax liabilities that would reduce the cashflow available to make payments on the
Notes.
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<PAGE> 48
TAX CLASSIFICATION OF THE COLLATERAL POOL
The Code also contains special rules applicable to entities that issue debt
secured by real estate mortgages. These rules are known as the taxable mortgage
pool rules and, if applicable, can result in entity level federal income
taxation. An entity will be classified as a taxable mortgage pool if it does not
make an election to be classified as a real estate mortgage investment conduit,
called a "REMIC," and (i) substantially all of its assets consist of debt
obligations and more than 50% of such debt obligations are real estate mortgages
or interests therein, (ii) the entity issues debt obligations with two or more
maturities and (iii) payments on the debt obligations issued by it bear a
relationship to payments received on the debt obligations owned by it. In
certain situations, a pool of assets pledged to secure debt of an entity could
also be treated as separate taxable mortgage pool.
It is possible that the pool of collateral pledged to secure the Notes
could be treated as a taxable mortgage pool. However, it is likely that any such
taxable mortgage pool would nonetheless qualify as a "qualified REIT subsidiary"
within the meaning of Section 856 (i) of the Code and would therefore not be
subject to entity level federal income taxes. Thus, only Specialty Mortgage
Trust or its shareholders would be required to include in income any "excess
inclusion income" generated by the taxable mortgage pool. On the other hand, if
the pool of collateral securing the Notes was classified as a taxable mortgage
pool but did not satisfy or maintain status as a "qualified REIT subsidiary", it
would not be permitted to be included in the consolidated federal income tax
return of any other corporation and its net income would be subject to entity
level federal income taxes, thereby reducing cashflow available to pay the
Notes.
Specialty Mortgage Trust does not intend to make an election to treat the
mortgage and other collateral securing the Notes as a REMIC. Our tax counsel has
advised us that the pool of mortgages and other collateral securing the Notes
will not be classified as a taxable mortgage pool.
TAX CONSEQUENCES TO NOTEHOLDERS
Status as Real Property Loans. Assuming the Notes are treated as debt
issued by us, for federal income tax purposes: (i) Notes held by a thrift
institution taxed as a domestic building and loan association will not
constitute "loans...secured by an interest in real property" within the meaning
of Code Section 7701 (a) (19) (C) (v) and (ii) interests on the Notes held by a
real estate investment trust will not be treated as "interest on obligations
secured by mortgages on real property or on interest in real property" within
the meaning of Code Section 856(c) (4) (B) and the Notes will not constitute
"real estate assets" or "government securities" within the meaning of Code
Section 856(c) (5) (A).
Taxation of interest income on the Notes. Because all Notes are expected to
be issued at par, interest paid or accrued on the Notes generally will be
treated as ordinary income to you, and will be includible in your income in
accordance with your regular method of accounting.
Sale of Notes. Generally, if you sell or otherwise dispose of your Note,
you will recognize gain or loss in an amount equal to the difference between the
amount you realize on the sale and your adjusted tax basis in your Note. Any
such gain or loss recognized will be capital gain or loss if your Note is held
as a "capital asset" (generally, property held for investment) with the meaning
of Code Section 1221, and will be short term capital gain or loss if your
investment has been held for not more than one year. However, certain types of
investors (such as banks, thrifts and other financial institutions), and certain
investors engaged in risk reduction strategies with respect to the Notes, may
not qualify to treat the Notes as capital assets, or the gain or loss therefrom
as capital gain or loss.
In addition, someone that purchases a Note from you at a discount may
become subject to the market discount rules of sections 1276-1278 of the Code.
As a result, some or all of the principal paid or the gain recognized upon the
disposition of the Note by such holder could be taxed as ordinary interest
income.
Foreign investors. Assuming the Notes are respected as debt, interest paid
on the Notes to a holder that is a nonresident alien individual, foreign
corporation or other non-United States person, referred to as
45
<PAGE> 49
a "foreign person," will be exempt from United States federal income and
withholding taxes under the "portfolio interest" provisions so long as (i) the
interest is not effectively connected with a trade or business of the recipient
in the United States, (ii) the foreign person is not (a) a direct or indirect
ten percent or greater shareholder of our company, (b) a controlled foreign
corporation, as that term is defined in the Code, related to our company, or (c)
a bank receiving interest on an extension of credit made pursuant to a loan
agreement entered into in the ordinary course of its trade or business. Interest
paid to a foreign person that is not engaged in a United States trade or
business and that does not qualify under the portfolio interest exemption will
generally be subject to a 30% United States withholding tax unless the foreign
person qualifies to claim a lower rate under an applicable United States income
tax treaty.
In all events, a holder that is a foreign person must provide required
information certifications in order to claim any exemptions or reductions from
withholding tax. Foreign investors are urged to consult their tax advisors
concerning recently finalized regulations on withholding and related
certification requirements generally applicable to payments made after December
31, 2000.
If a Note were recharacterized as ownership of an equity interest in
Specialty Mortgage Trust, or if exemptions from withholding tax are not
available, certain payments related to the Notes made to foreign persons would
become subject to withholding tax at the rate of 30% and, in the hands of a
corporate investor, could become subject to the branch profits tax. We are not
required to indemnify you, or gross-up payments on the Notes, for any
withholding taxes.
Backup withholding. Payments on the Notes, or proceeds from a disposition
of the Notes, may become subject to backup withholding of federal income tax if
you fail to furnish certain information, including your taxpayer identification
number, or otherwise fail to establish an exemption from backup withholding. If
required, backup withholding is currently made at a rate of 31%. Any amounts so
deducted and withheld would be allowed as a credit against the noteholder's
federal income tax. Furthermore, certain penalties may be imposed by the Service
on a noteholder that is required to supply information but does not do so in the
proper manner.
STATE AND LOCAL TAX CONSIDERATIONS
In addition to the federal income tax consequences described above, you
should also consider the potential state and local income tax consequences of
any investment in the Notes. State and local income tax laws may differ
substantially from the corresponding federal tax laws, and the above discussion
does not purport to describe any state or local income tax consequences of
investing in the Notes. Accordingly, as a prospective noteholder, you should
consult your own tax advisers concerning state and local tax matters applicable
to your investment in the Notes.
ERISA INVESTORS
A fiduciary of a pension, profit-sharing, stock bonus plan or individual
retirement account, including a plan for self-employed individuals and their
employees or any other employee benefit plan subject to the prohibited
transaction provisions of the Code or the fiduciary responsibility provisions of
the Employee Retirement Income Security Act of 1974, known as "ERISA" and,
collectively, a "plan", should consider:
(a) whether the ownership of our Notes is in accordance with the
documents and instruments governing the plan,
(b) whether the ownership of our Notes is consistent with the
fiduciary's responsibilities and satisfies the applicable requirements of
ERISA, in particular, the diversification, prudence and liquidity
requirements of section 404 of ERISA,
(c) the prohibitions under ERISA on improper delegation of control
over, or responsibility for "plan assets" and ERISA's imposition of
co-fiduciary liability on a fiduciary who participates in, or permits, by
action or inaction, the occurrence of, or fails to remedy, a known breach
of duty by another fiduciary with respect to plan assets, and
46
<PAGE> 50
(d) the need to value the assets of the plan annually.
You should understand the illiquid nature of your investment in our Notes
and that no secondary market will exist for them.
PLAN OF DISTRIBUTION
We may sell securities offered in this prospectus (1) directly to
purchasers; (2) through agents; (3) through underwriters; (4) through dealers;
or (5) through a combination of any of these methods of sale.
Except as otherwise indicated in the prospectus supplement, we will sell
these securities directly, without an underwriter or selling agent, and the
securities will be sold by our employees who, under Rule 3a4-1(a) of the
Exchange Act, are deemed not to be brokers. In accordance with the provisions of
Rule 3a4-1(a), our employees who sell securities will not be compensated by
commission, will not be associated with any broker or dealer and will limit
their activities so that, among other things, they do not engage in oral
solicitations of, and comply with specified limitations when responding to
inquiries from, potential purchasers.
We may distribute the securities offered in this prospectus in one or more
transactions: (1) at a fixed price or prices, which may be changed; (2) at
market prices prevailing at the time of sale; (3) at prices related to the
prevailing market prices; or (4) at negotiated prices.
We may solicit directly, or agents designated by us from time to time may
solicit, offers to purchase securities offered in this prospectus. We will
disclose in the applicable prospectus supplement any agent, which may be deemed
to be an underwriter as that term is defined in the Securities Act, involved in
the offer or sale of securities offered in this prospectus and any commission
payable by us to that agent. Unless otherwise indicated in the prospectus
supplement, any agent will be acting on a reasonable efforts basis.
If we use an underwriter or underwriters in the sale of the securities
offered in this prospectus, we will execute an underwriting agreement with the
underwriter(s) at the time of sale to it or them. We will disclose the name(s)
of the underwriter(s) and the terms of the transaction in the prospectus
supplement, which will be used by the underwriter(s) to make resales of the
securities in respect of which this prospectus and the prospectus supplement are
delivered to the public.
If we use a dealer in the sale of securities offered in this prospectus, we
will sell those securities to the dealer, as principal. The dealer may then
resell the securities to the public at varying prices to be determined by the
dealer at the time of resale.
The underwriters, dealers or agents used by us in any offering of
securities under this prospectus may be customers of, including borrowers from,
engage in transactions with, and perform services for, us or one or more of our
affiliates in the ordinary course of business.
Underwriters, dealers, agents and other persons may be entitled, under
agreements that they may enter into with us, to indemnification against civil
liabilities, including liabilities under the Securities Act.
If indicated in the applicable prospectus supplement, we will authorize
agents and underwriters to solicit offers by institutions to purchase securities
from us at the public offering price set forth in the prospectus supplement
pursuant to delayed delivery contracts providing for payment and delivery on the
date stated in the prospectus supplement. Each contract will be for an amount
not less than, and, unless we otherwise agree, the aggregate principal amount of
securities sold pursuant to contracts shall be not less nor more than, the
respective amounts stated in the prospectus supplement. Institutions with whom
contracts, when authorized, may be made include commercial and savings banks,
insurance companies, pension funds, investment companies, educational and
charitable institutions and other institutions, but shall in all cases be
subject to our approval. Contracts will not be subject to any conditions except
that the purchase by an institution of the securities covered by its contract
shall not at the time of delivery be
47
<PAGE> 51
prohibited under the laws of any jurisdiction in the United States to which that
institution is subject. A commission indicated in the prospectus supplement will
be paid to the underwriters and agents soliciting purchases of debt securities
pursuant to contracts accepted by us.
Until the distribution of the securities is completed, rules of the SEC may
limit the ability of the underwriters and selling group members, if any, to bid
for and purchase the securities. As an exception to these rules, the
representatives of the underwriters, if any, are permitted to engage in
transactions that stabilize the price of the securities. Such transactions may
consist of bids or purchases for the purpose of pegging, fixing or maintaining
the price of securities.
Neither we nor the underwriters, if any, make any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the securities. In addition, neither we
nor the underwriters, if any, make any representation that the representatives
of the underwriters, if any, will engage in such transactions or that such
transactions, once commenced, will not be discontinued without notice.
LEGAL MATTERS
Legal matters relating to the Notes being offered hereby will be passed
upon for the Company by Tobin & Tobin, a professional corporation, San
Francisco, California. Tax matters will be passed on by GnazzoThill, A
Professional Corporation, San Francisco, California.
EXPERTS
Our balance sheets as of December 31, 1999 and 1998 and our statement of
operations, stockholder's equity and cash flows for each of the years in the
two-year period ended December 31, 1999, have been included herein, in reliance
on the report of Grant Thornton LLP, independent accountants, given on the
authority of that firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We expect to file annual, quarterly and special reports, and other
information with the SEC. Our SEC filings will be available to the public over
the Internet at the SEC's web site at http://www.sec.gov. You may also read and
copy any document we file at the SEC's public reference rooms in Washington,
D.C., New York, New York, and Chicago, Illinois. Please call the SEC at
1-800-SEC-0300 for further information on the public reference rooms.
This prospectus is part of a registration statement on Form S-11 which we
have filed with the SEC (Registration No. 333- ). You may request a free
copy of any of the above filings by writing or calling:
Specialty Mortgage Trust, Inc.
6160 Plumas Street
Reno, Nevada 89509
(775) 826-0809
You should rely only on the information provided in this prospectus. We
have not authorized anyone else to provide you with different information. You
should not assume that the information in this prospectus is accurate as of any
date other than the date on the cover page of this prospectus.
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<PAGE> 52
GLOSSARY
As used in this prospectus, the capitalized and other terms listed below
have the meanings indicated.
"adjustable rate mortgage" means a mortgage loan, including any mortgage
loan underlying a mortgage security, that features adjustments of the underlying
interest rate at predetermined times based on an agreed margin to an established
index. An adjustable rate mortgage is usually subject to periodic interest rate
and/or payment caps and a lifetime interest rate cap.
"basic maintenance amount" means the dollar amount equal to one hundred
percent of the aggregate principal amount of all outstanding Notes, determined
as of the valuation date.
"capital stock" means the shares of capital stock issuable by Specialty
Mortgage Trust under its Charter, and includes common stock and preferred stock.
the "Code" means the Internal Revenue Code of 1986, as amended.
"company" means Specialty Mortgage Trust, Inc., a Maryland corporation.
"conforming mortgage loans" means mortgage loans that either comply with
requirements for inclusion in credit support programs sponsored by FHLMC or FNMA
or are FHA or VA Loans, all of which are secured by first mortgages or deeds of
trust on single-family (one to four units) residences; "nonconforming mortgage
loans" vary in one or more respects from those requirements.
"ERISA" means the Employee Retirement Income Security Act of 1974.
"ERISA plan" or "plan" means a pension, profit-sharing, retirement or other
employee benefit plan which is subject to ERISA.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"FHA" means the United States Federal Housing Administration.
"FHLMC" or "Freddie Mac" means the Federal Home Loan Mortgage Corporation.
"FNMA" or "Fannie Mae" means the Federal National Mortgage Association.
"GAAP" means generally accepted accounting principles.
"GNMA" or "Ginnie Mae" means the Government National Mortgage Association.
"HUD" means the Department of Housing and Urban Development.
"independent directors" means a director of Specialty Mortgage Trust who is
not an officer or employee of Specialty Mortgage Trust or any affiliate or
subsidiary of Specialty Mortgage Trust.
"interest payment date" means the date each month upon which accrued
interest on the Notes shall be paid, specifically the twentieth day of calendar
month after issuance of the Notes or, if such day is not a business day (i.e.,
Saturday, Sunday or a holiday observed by banking institutions in Nevada), then
the next succeeding business day.
"LTV" or "loan-to-value ratio" means the percentage obtained by dividing
the principal amount of a loan by the lower of the sales price or appraised
value of the mortgaged property when the loan is originated.
"manager" means Gonzo Financial, Inc., a Nevada corporation wholly owned by
Nello Gonfiantini III.
"pledged assets" means the assets used as collateral for the Notes,
consisting initially of various mortgage loans, but which may also include
short-term money market instruments and cash.
"REIT" means a real estate investment trust as defined under Section 856 of
the Code.
"REMIC" means a real estate mortgage investment conduit as defined under
the Code.
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<PAGE> 53
"Securities Act" means the Securities Act of 1933, as amended.
the "Service" means the Internal Revenue Service.
"single family" means, with respect to mortgage loans, loans secured by
one- to four-unit residential property.
"stated maturity" means the date upon which Notes will mature, ranging from
one to twelve months from the date of issuance (the applicable date will be
stated on the face of each Note).
"tax-exempt entity" means a qualified pension, profit-sharing or other
employee retirement benefit plan, Keogh plans, bank commingled trust funds for
such plans, IRAs and any other entity intended to be exempt from Federal income
taxation.
"taxable income" means for any year the taxable income of Specialty
Mortgage Trust for such year (excluding any net income derived either from
property held primarily for sale to customers or from foreclosure property)
subject to certain adjustments provided in Section 857 of the Code.
"VA" means the United States Department of Veterans Affairs.
"valuation date" means the date the Notes are issued and the twentieth day
of each succeeding calendar month thereafter for so long as the Notes remain
outstanding.
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<PAGE> 54
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors
Specialty Mortgage Trust, Inc.
We have audited the accompanying balance sheets of Specialty Mortgage
Trust, Inc. as of December 31, 1999 and 1998, and the related statements of
earnings, stockholders' equity, and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit 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 Specialty Mortgage Trust,
Inc. as of December 31, 1999 and 1998, and the results of its operations and its
cash flows for the years then ended in conformity with accounting principles
generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
Reno, Nevada
January 21, 2000
F-1
<PAGE> 55
SPECIALTY MORTGAGE TRUST, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- JUNE 30,
1998 1999 2000
----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents......................... $ 17,317 $ 7,998,709 $ 4,104,089
Accrued interest receivable....................... 253,352 343,333 398,012
Investments....................................... -- -- 230,300
Mortgage loans held for investment, net of
allowance for loan losses of $100,000,
$350,000, $500,000 at December 31, 1998, 1999,
and June 30, 2000, respectively................ 29,500,401 35,755,670 50,389,510
Deferred charges.................................. 64,236 30,338 26,674
Prepaid expenses.................................. -- 4,650 3,008
----------- ----------- -----------
Total assets................................... $29,835,306 $44,132,700 $55,151,593
=========== =========== ===========
LIABILITIES
Dividends payable................................. $ -- $ 1,079,875 $ --
Accounts payable.................................. 49,562 17,717 12,119
Deposits.......................................... -- 225,000 5,184,800
Accrued interest payable.......................... 31,996 -- 24,336
Lines of credit................................... 6,518,000 -- 5,985,627
Collateralized notes.............................. 1,694,000 5,217,467 4,973,731
Deferred revenue.................................. 5,219 24,237 22,841
----------- ----------- -----------
Total liabilities.............................. 8,298,777 6,564,296 16,203,454
----------- ----------- -----------
STOCKHOLDERS' EQUITY
Class A Convertible Preferred Stock; $0.01 par
value; 5,000,000 shares authorized; 2,169,588,
3,799,700 and 3,864,400 shares issued and
outstanding as of December 31, 1998, 1999 and
June 30, 2000, respectively ($38,644,000
liquidation preference)........................ 21,696 37,997 38,644
Common stock, $0.01 par value; 45,000,000 shares
authorized; 300,000 at December 31, 1998 and
320,200 shares issued and outstanding as of
December 31, 1999 and June 30, 2000............ 3,000 3,202 3,202
Additional paid-in capital........................ 21,597,108 37,842,979 38,471,777
Accumulated (deficit)/earnings.................... (85,275) (315,774) 453,690
Accumulated other comprehensive loss.............. -- -- (19,174)
----------- ----------- -----------
Total stockholders' equity..................... 21,536,529 37,568,404 38,948,139
----------- ----------- -----------
Total liabilities and stockholders' equity..... $29,835,306 $44,132,700 $55,151,593
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-2
<PAGE> 56
SPECIALTY MORTGAGE TRUST, INC.
STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
---------------------------- ------------------------
DECEMBER 31, DECEMBER 31, JUNE 30, JUNE 30,
1998 1999 1999 2000
------------ ------------ ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUES
Interest and dividend income
Mortgage loans...................... $2,068,265 $4,312,092 $1,998,550 $2,206,056
Cash accounts....................... 201,881 121,453 29,212 118,678
Loan points......................... 8,906 16,648 7,432 15,764
Dividends........................... -- -- -- 7,097
---------- ---------- ---------- ----------
Total interest and dividend
income......................... 2,279,052 4,450,193 2,035,194 2,347,595
---------- ---------- ---------- ----------
Interest expense
Line of credit...................... 61,308 54,528 52,637 24,336
Collateralized notes................ 15,569 209,105 74,438 183,700
---------- ---------- ---------- ----------
Total interest expense............ 76,877 263,633 127,075 208,036
---------- ---------- ---------- ----------
Net interest and dividend
income......................... 2,202,175 4,186,560 1,908,119 2,139,559
Provision for loan losses.............. 100,000 250,000 100,000 150,000
---------- ---------- ---------- ----------
Net revenues...................... 2,102,175 3,936,560 1,808,119 1,989,559
---------- ---------- ---------- ----------
EXPENSES
General and administrative............. 37,963 93,664 38,757 64,547
Management and directors' fees......... 38,342 30,480 22,024 6,500
---------- ---------- ---------- ----------
Total expenses.................... 76,305 124,144 60,781 71,047
---------- ---------- ---------- ----------
Earnings before income taxes...... 2,025,870 3,812,416 1,747,338 1,918,512
Income taxes............................. -- 2,992 2,992 --
---------- ---------- ---------- ----------
NET EARNINGS...................... 2,025,870 3,809,424 1,744,346 1,918,512
Preferred stock dividend................. 2,111,145 4,039,923 851,213 1,149,048
---------- ---------- ---------- ----------
NET (LOSS) EARNINGS ATTRIBUTABLE
TO COMMON STOCK................ $ (85,275) $ (230,499) $ 893,133 $ 769,464
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE> 57
SPECIALTY MORTGAGE TRUST, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CLASS A
CONVERTIBLE ACCUMULATED
PREFERRED STOCK COMMON STOCK ADDITIONAL ACCUMULATED OTHER
------------------- ----------------- PAID-IN (DEFICIT) COMPREHENSIVE
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS INCOME TOTAL
--------- ------- ------- ------- ----------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JANUARY 1, 1998... -- -- 300,000 3,000 -- -- -- 3,000
Preferred Stock issued (net
of offering costs of
$77,076)................. 1,160,467 11,605 -- -- 11,515,988 -- -- 11,527,593
Mortgages received for
Preferred Stock.......... 1,009,121 10,091 -- -- 10,081,120 -- -- 10,091,211
Net earnings............... -- -- -- -- -- 2,025,870 -- 2,025,870
Dividends declared......... -- -- -- -- -- (2,111,145) -- (2,111,145)
--------- ------- ------- ------- ----------- ----------- -------- -----------
BALANCE, DECEMBER 31,
1998..................... 2,169,588 21,696 300,000 3,000 21,597,108 (85,275) -- 21,536,529
Stock options exercised.... -- -- 20,200 202 828 -- -- 1,030
Preferred Stock issued (net
of offering costs of
$39,776)................. 1,454,824 14,548 -- -- 14,493,912 -- -- 14,508,460
Mortgages and
collateralized notes
received for Preferred
Stock.................... 175,288 1,753 -- -- 1,751,131 -- -- 1,752,884
Net earnings............... -- -- -- -- -- 3,809,424 -- 3,809,424
Dividends declared......... -- -- -- -- -- (4,039,923) -- (4,039,923)
--------- ------- ------- ------- ----------- ----------- -------- -----------
BALANCE, DECEMBER 31,
1999..................... 3,799,700 37,997 320,200 3,202 37,842,979 (315,774) -- 37,568,404
Comprehensive income
(unaudited):
Net earnings............. -- -- -- -- -- 1,918,512 -- 1,918,512
Net unrealized loss on
investment
available-for-sale..... -- -- -- -- -- -- (19,174) (19,174)
--------- ------- ------- ------- ----------- ----------- -------- -----------
Total comprehensive
income............... -- -- -- -- -- 1,918,512 (19,174) 1,899,338
--------- ------- ------- ------- ----------- ----------- -------- -----------
Dividends reinvested for
Preferred Stock (net of
offering costs of $4,275)
(unaudited).............. 64,700 647 -- -- 628,798 -- -- 629,445
Dividends declared
(unaudited).............. -- -- -- -- -- (1,149,048) -- (1,149,048)
--------- ------- ------- ------- ----------- ----------- -------- -----------
BALANCE, JUNE 30, 2000
(UNAUDITED)................ 3,864,400 $38,644 320,200 $ 3,202 $38,471,777 $ 453,690 $(19,174) $38,948,139
========= ======= ======= ======= =========== =========== ======== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE> 58
SPECIALTY MORTGAGE TRUST, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
--------------------------- ---------------------------
DECEMBER 31, DECEMBER 31, JUNE 30, JUNE 30,
1998 1999 1999 2000
------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings.............................................. $ 2,025,870 $ 3,809,424 $ 1,744,346 $ 1,918,512
------------ ------------ ------------ ------------
Adjustment to reconcile net earnings to net cash provided
by operating activities:
Amortization............................................ 10,189 56,398 30,641 22,414
Provision for loan losses............................... 100,000 250,000 100,000 150,000
Non-cash collateralized notes interest reinvested....... -- 42,226 -- 133,210
Changes in assets and liabilities:
Accrued interest receivable........................... (253,352) (89,981) (90,806) (54,679)
Prepaid expenses...................................... -- (4,650) (1,500) 1,642
Accounts payable...................................... 49,562 (31,845) (40,788) (5,598)
Deposits.............................................. -- 225,000 -- (225,000)
Accrued interest payable.............................. 31,996 (31,996) (22,359) 24,336
Deferred revenue...................................... 5,219 19,018 19,130 (1,396)
------------ ------------ ------------ ------------
Total adjustments................................... (56,386) 434,170 (5,682) 44,929
------------ ------------ ------------ ------------
Net cash provided by operating activities........... 1,969,484 4,243,594 1,738,664 1,963,441
------------ ------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of mortgage loans held for investment............ (22,548,000) (22,968,157) (13,757,200) (23,825,891)
Principal repayments of mortgage loans held for
investment.............................................. 3,038,810 17,961,772 6,543,019 9,042,051
Purchase of investments................................... -- -- -- (249,474)
------------ ------------ ------------ ------------
Net cash used in investing activities............... (19,509,190) (5,006,385) (7,214,181) (15,033,314)
------------ ------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Preferred Stock offering, net............... 11,527,593 14,262,180 9,428,940 --
Prepayment of Preferred Stock offering.................... -- -- 3,753,021 4,065,500
Proceeds from Common Stock options exercised.............. -- 1,030 383 --
Cash dividends paid....................................... (2,111,145) (2,713,768) (851,213) (1,599,478)
Net (payments)/proceeds on line of credit................. 6,518,000 (6,518,000) (4,230,000) 5,985,627
Proceeds on collateralized notes.......................... 1,694,000 6,548,000 1,815,000 1,977,985
Principal payments on collateralized notes................ -- (2,812,759) (555,000) (1,235,631)
Loan issue costs.......................................... (74,425) (22,500) (17,500) (18,750)
------------ ------------ ------------ ------------
Net cash provided by financing activities........... 17,554,023 8,744,183 9,343,631 9,175,253
------------ ------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS....................................... 14,317 7,981,392 3,868,114 (3,894,620)
Cash and cash equivalents at beginning of year.............. 3,000 17,317 17,317 7,998,709
------------ ------------ ------------ ------------
Cash and cash equivalents at end of year.................... $ 17,317 $ 7,998,709 $ 3,885,431 $ 4,104,089
============ ============ ============ ============
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid for interest.................................... $ 44,881 $ 253,403 $ 149,434 $ 239,297
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES:
Mortgage loans exchanged for the issuance of Preferred
Stock................................................... $10,091,211 $ 1,498,884 $ 1,330,000 $ --
Collateralized notes exchanged for the issuance of
Preferred Stock......................................... $ -- $ 254,000 $ 74,000 $ 1,119,300
Collateralized notes refinanced at maturity............... $ -- $ 1,645,000 $ 1,315,000 $ 5,124,000
Collateralized notes interest reinvested.................. $ -- $ 42,226 $ -- $ 133,210
Dividends declared but not paid........................... $ -- $ 1,079,875 $ -- $ --
Dividends reinvested for Preferred Stock.................. $ -- $ 246,280 $ -- $ 633,720
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE> 59
SPECIALTY MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1999 AND 1998
(DATA RELATED TO JUNE 30, 2000 AND 1999 IS UNAUDITED)
NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The financial statements of Specialty Mortgage Trust, Inc. are prepared in
conformity with generally accepted accounting principles (GAAP). In preparing
the financial statements in accordance with GAAP, management is required to make
estimates and assumptions that effect the reported amounts. Actual results could
differ from those estimates. The following is a summary of significant
accounting and reporting policies used in preparing the financial statements.
1. NATURE OF BUSINESS
Specialty Mortgage Trust, Inc. (the Company) is a Maryland corporation
which acquires and holds mortgage loans secured by property located in Nevada,
California, Arizona and Colorado. The Company's strategy is to focus on small
commercial mortgage loans (generally less than $5 million per loan), land loans,
and non-conforming single-family and small multi-family (generally less than 20
units) residential mortgage loans. The Company has elected to be a real estate
investment trust (REIT) under the Internal Revenue Code of 1986, as amended. The
mortgage loans are originated and serviced by Gonzo Financial, Inc. (the
Manager), a private mortgage finance business operating in Nevada and wholly
owned by the Company's President and Chairman of the Board of Directors.
2. INTERIM FINANCIAL STATEMENTS
The financial statements as of June 30 and for the six months ended June
30, 2000 and 1999 are unaudited; however, in the opinion of management, all
adjustments, consisting of normal recurring adjustments necessary for a fair
presentation of the Company's financial position and results of operations for
such period have been included. The results for the six months ended June 30,
2000 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2000.
3. CASH EQUIVALENTS
For purposes of the Statement of Cash Flows, the Company considers money
market accounts to be cash equivalents.
4. INVESTMENTS
The Company's investments in marketable equity securities are held for an
indefinite period and thus are classified as available-for-sale.
Available-for-sale securities are recorded at fair value on the balance sheet,
with the change in fair value during the period excluded from earnings as a
component of other comprehensive income.
5. MORTGAGE LOANS
Mortgage loans are classified and accounted for as held for investment and
are carried at cost.
6. REVENUE RECOGNITION
Interest is recognized as revenue when earned according to the terms of the
loan. Points are deferred and amortized over the life of the loan.
F-6
<PAGE> 60
SPECIALTY MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
(DATA RELATED TO JUNE 30, 2000 AND 1999 IS UNAUDITED)
NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
7. DEFERRED CHARGES
Deferred charges are amortized principally by the effective interest method
over the term of the related obligation.
8. INCOME TAXES
The Company has qualified as a REIT and generally is not subject to federal
income taxes on the portion of taxable income which is distributed to its
stockholders. The Company is, however, subject to federal income taxes for
taxable income not distributed.
Taxable income that is distributed is taxable to the shareholders as
ordinary income.
9. ALLOWANCE FOR LOAN LOSSES
The Company maintains an allowance for possible credit losses on mortgage
loans. Additions to the reserve are based on an assessment of certain factors
including, but not limited to, estimated future losses on the loans, and general
economic conditions. Additions to the reserve are provided through a charge to
earnings. Actual losses on loans are recorded as a charge-off or a reduction to
the loan loss reserve. Subsequent recoveries of amounts previously charged off
are added back to the reserve.
NOTE B -- FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK
Financial instruments with concentration of credit and market risk include
cash and mortgage notes.
The Company maintains cash deposit accounts which, at times, may exceed
federally insured limits.
Substantially all of the loans purchased by the Company are fixed rate
loans secured by the first deed of trust on small commercial, land,
non-conforming, and small multi-family properties. Maturities on the mortgage
loans range from one to seven years.
Concentration of mortgage loans exist in northern Nevada and southern
Nevada with approximately 49% and 33% for 1999, and 84% and 10% for 1998. As
such, the Company has a significant geographic concentration of credit risk that
may be adversely affected by periods of economic decline.
A significant portion of the Company's mortgage loans will require the
borrower to make a balloon payment of the principal at maturity. To the extent
that a borrower has an obligation to pay a mortgage loan in a large lump sum
payment, its ability to satisfy this obligation may be dependent upon its
ability to refinance or raise a substantial amount of cash. An increase in
interest rates over the mortgage rate applicable at origination of the loan may
have an adverse effect on the borrower's ability to refinance.
NOTE C -- INVESTMENTS
Available-for-sale investments at June 30, 2000 consist of:
<TABLE>
<CAPTION>
GROSS
UNRELATED FAIR
LOSSES VALUE
--------- --------
<S> <C> <C>
Preferred stock........................................ $19,174 $230,300
======= ========
</TABLE>
F-7
<PAGE> 61
SPECIALTY MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
(DATA RELATED TO JUNE 30, 2000 AND 1999 IS UNAUDITED)
NOTE D -- BANK LINE OF CREDIT
The Company maintains a revolving line of credit that bears interest at
prime (8.5% at December 31, 1999) and expires June 15, 2001. The terms of the
credit agreement allow the Company to borrow up to $5,000,000 to provide funding
for new loans originated by the Company. No balance was outstanding on this line
as of December 31, 1999. Under the terms of this agreement, the Company is
required to maintain certain financial covenants. At December 31, 1999, the
Company was in compliance with the covenants. The credit facility is
collateralized by a pledge of promissory notes evidencing indebtedness of
mortgages held by the Company.
At December 31, 1998, the Company maintained two revolving lines of credit
that both expired in 1999. Both lines bore interest at the prime rate (7.75% at
December 31, 1998), with a maximum borrowing base of $8,000,000. $6,518,000 was
outstanding on these lines at December 31, 1998.
At June 30, 2000, the Company maintained two revolving lines of credit. One
line of credit allows the Company to borrow up to $2,500,000 to provide funding
for new loans. This line bears interest indexed on the bank's base rate (9.5% at
June 30, 2000) and matures July 1, 2001. The other line of credit allows the
Company to borrow up to $5,000,000 and is collateralized by a security interest
of a mortgage loan. This line bears interest at the bank's prime rate (9.5% at
June 30, 2000) and matures December 1, 2001. On June 30, 2000, $1,190,095 and
$4,795,532 were outstanding on these lines of credit, respectively.
NOTE E -- COLLATERALIZED NOTES
The Company has issued Class A collateralized notes (the notes) due in two
to six months from the date of issue. These notes bear a fixed rate of interest
(6% to 7% and 7% at December 31, 1999 and 1998, respectively) and are payable on
the 20th of each month. The notes are collateralized by the Company's mortgage
loans in an aggregate principal amount at least equal to two times the aggregate
principal amount outstanding on the notes. A UCC financing statement is held by
a trustee for the collateral of the notes receivable. At December 31, 1999,
December 31, 1998 and June 30, 2000, $12,797,393, $5,166,294, and $12,957,393 of
mortgage notes were used as collateral, respectively.
NOTE F -- STOCKHOLDER'S EQUITY
The Preferred Stock will convert to the Company's Common Stock, par value
$.01 per share ("Common Stock") on a 1 to 1 basis: (1) upon the closing of a
firm commitment underwritten initial public offering of the Common Stock
resulting in aggregate gross proceeds to the Company of at least $20 million and
at a price per share of at least $10 or such lesser amount of proceeds and/or
lower price per share as may be approved by holders of two-thirds of the
Preferred Stock (a "Qualified IPO"); (2) after March 31, 2000 when and if the
return on equity for the previous four quarters exceeds 13%; or (3) after March
31, 2001 when and if the return on equity for the previous four quarters exceeds
12%.
The Preferred Stock has a liquidation preference over Common Stock at an
amount equal to the original purchase price of $10 per share, plus any declared
but unpaid dividends. Therefore, to the extent any assets remain in the Company,
such assets shall be distributed in equal amounts per share to holders of common
stock and Preferred Stock on an "as converted" basis, that is, as if the
Preferred Stock had converted into shares of Common Stock.
As long as Preferred Stock remains outstanding, the holders of Common Stock
are not entitled to dividends or distributions. The Preferred stockholders and
Common stockholders vote together as a class.
F-8
<PAGE> 62
SPECIALTY MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
(DATA RELATED TO JUNE 30, 2000 AND 1999 IS UNAUDITED)
NOTE G -- STOCK OPTIONS
In October 1997, the Company adopted the 1997 Executive and Non-Employee
Director Stock Option Plan (the Plan) pursuant to which 300,000 shares of the
Common Stock have been reserved for issuance upon the exercise of options
granted. Options granted may be designated as either (a) incentive stock options
(ISO's) under the Internal Revenue Code of 1986, as amended, at 100% fair market
value, or (b) non-qualified options at a Board of Director determined option
price. ISO's and non-qualified options may be granted by the Board of Directors
to participating directors, officers, other key employees, agents and
consultants that are linked directly to increases in stockholder value. Fair
market value is determined periodically by the Board of Directors.
25% of the shares subject to such stock option shall become exercisable on
the first anniversary of the date of grant of the stock option, and an
additional 25% shall become exercisable on each of the next three anniversaries
of the date of grant. In general, vested options must be exercised within three
months after an employee leaves the Company.
The Company has adopted SFAS No. 123, Accounting for Stock-Based
Compensation, which calls for companies to measure non-employee stock
compensation expense based upon the fair value method of accounting. The Company
also adopted SFAS 123 for directors.
Presented below is a summary of the Company's stock options and the related
transactions for the year ended December 31, 1999 and 1998.
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
------- --------
<S> <C> <C>
BALANCE AT JANUARY 1, 1998............................... 75,000 $ .01
Granted.................................................. 30,000 1.08
Exercised................................................ -- --
Forfeited/expired........................................ -- --
------- -----
BALANCE AT DECEMBER 31, 1998............................. 105,000 .32
Granted.................................................. 20,000 5.00
Exercised................................................ (20,200) .05
Forfeited/expired........................................ -- --
------- -----
BALANCE AT DECEMBER 31, 1999............................. 104,800 $1.26
======= =====
</TABLE>
F-9
<PAGE> 63
SPECIALTY MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
(DATA RELATED TO JUNE 30, 2000 AND 1999 IS UNAUDITED)
NOTE G -- STOCK OPTIONS (CONTINUED)
<TABLE>
<CAPTION>
STOCK OPTIONS STOCK OPTIONS
OUTSTANDING EXERCISABLE
----------------------- ------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
CONTRACTUAL EXERCISE EXERCISE
RANGE OF EXERCISE PRICES SHARES LIFE PRICE SHARES PRICE
------------------------ ------- ----------- -------- ------ --------
<S> <C> <C> <C> <C> <C>
DECEMBER 31, 1998:
$ .01.................................. 75,000 8.82 $ .01 18,750 $ .01
.05.................................. 20,000 9.09 .05 -- --
3.15.................................. 10,000 9.58 3.15 -- --
------- ------
Totals.............................. 105,000 18,750
======= ======
DECEMBER 31, 1999:
$ .01.................................. 60,000 7.82 $ .01 22,500 $ .01
.05.................................. 15,000 8.09 .05 -- --
3.15.................................. 9,800 8.58 3.15 2,300 3.15
5.00.................................. 20,000 9.81 5.00 -- --
------- ------
Totals.............................. 104,800 24,800
======= ======
</TABLE>
The fair value of the Company's stock options was estimated as of the grant
date using the Black-Scholes Option Pricing Model with the following weighted
average assumptions for the years ended December 31, 1999 and 1998: Dividend
yield of 0.0%, expected volatility of 0.0%, weighted average risk free interest
rate of 5.98% and 5.4%, respectively, and an expected holding period of four
years. Based on these assumptions, compensation expense was immaterial for the
years ended December 31, 1999 and 1998.
NOTE H -- CAPITAL TRANSACTIONS
The Company was incorporated in the State of Maryland in October 1997 and
was capitalized by its founder purchasing 300,000 shares of Common Stock at $.01
per share. The Company began operations in January 1998. The Common Stock of the
Company is not entitled to any dividends as long as Preferred Stock is
outstanding.
In March 1998, the Company completed its initial private placement of
2,169,588 shares of Class A Convertible Preferred Stock, $.01 par value, for
cash of $11,604,669 and mortgage loans at fair value of $10,091,211. The
mortgage loans were originated by the Manager prior to 1998. Mortgage loans in
the fair value of $1,186,367 were contributed by the Manager or officers of the
Company.
On April 1, 1999, the Company completed a private placement of 1,084,794
shares at $10 per share of its Class A Convertible Preferred Stock, par value
$0.01 per share.
On July 1, 1999, the Company completed a private placement of 520,690
shares at $10 per share of its Class A Convertible Preferred Stock, par value
$0.01 per share.
In October 1999 the Company issued 24,628 shares of Preferred Stock under a
dividend reinvestment plan at $10 per share.
F-10
<PAGE> 64
SPECIALTY MORTGAGE TRUST, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1999 AND 1998
(DATA RELATED TO JUNE 30, 2000 AND 1999 IS UNAUDITED)
NOTE I -- RELATED PARTY
Pursuant to the management agreement, the Manager will receive a management
fee consisting of mortgage placement fees or points, usually charged to the
borrower for and upon origination, extension or refinancing of loans, up to 2.5%
of the loan balance with any additional fees or points paid to the Company. The
Manager will also receive a fee for loan servicing equal to one-half of one
percent of the total mortgage loan serviced and any late payment charges. In
addition, the Manager will receive, as incentive compensation for each fiscal
quarter, an amount equal to 50% of the taxable net income before the dividend
deduction of the Company in excess of the annualized return to the Company equal
to 12%. For the year ended December 31, 1999 and 1998, the Manager earned
$148,252 and $73,251, respectively, in fees for loan servicing. The Manager also
received an incentive compensation bonus of $18,480 and $22,468 for the years
ended December 31, 1999 and 1998, respectively.
NOTE J -- SUBSEQUENT EVENT
On July 1, 2000, the Company issued 689,320 additional shares of Preferred
Stock at $10 per share for total cash proceeds of $6,893,200. As of June 30,
2000, $5,184,800 is included on the balance sheet in deposits for this issuance.
F-11
<PAGE> 65
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SCHEDULES
Board of Directors
Specialty Mortgage Trust, Inc.
In connection with our audit of the financial statements of Specialty
Mortgage Trust, Inc. referred to in our report dated January 21, 2000, which is
included in the S-11 filing, we have also audited Schedule II and Schedule IV
for each of the two years ended December 31, 1999 and 1998. In our opinion,
these schedules present fairly, in all material respects, the information
required to be set forth herein.
/s/ GRANT THORNTON LLP
Reno, Nevada
January 21, 2000
F-12
<PAGE> 66
SCHEDULE II
SPECIALTY MORTGAGE TRUST, INC.
VALUATION AND QUALIFYING ACCOUNTS
PROVISION FOR LOAN LOSSES ROLLFORWARD
<TABLE>
<S> <C>
BALANCE JANUARY 1, 1998..................................... $ --
Charges to costs and expenses............................. 100,000
Deductions................................................ --
--------
BALANCE AT DECEMBER 31, 1998................................ 100,000
Charges to costs and expenses............................. 100,000
Deductions................................................ --
--------
BALANCE AT JUNE 30, 1999.................................... 200,000
Charges to costs and expenses............................. 150,000
Deductions................................................ --
--------
BALANCE AT DECEMBER 31, 1999................................ 350,000
Charges to costs and expenses (unaudited)................. 150,000
Deductions (unaudited).................................... --
--------
BALANCE AT JUNE 30, 2000 (UNAUDITED)........................ $500,000
========
</TABLE>
F-13
<PAGE> 67
SCHEDULE IV
SPECIALTY MORTGAGE TRUST, INC.
MORTGAGE LOANS ON REAL ESTATE
MORTGAGE LOAN ROLLFORWARD
<TABLE>
<S> <C>
BALANCE JANUARY 1, 1998..................................... $ --
-----------
Additions during the period
New mortgage loans..................................... 22,548,000
Mortgage loans exchanged for issuance of preferred
stock................................................. 10,091,211
-----------
32,639,211
-----------
Deductions during the period
Collections of principal............................... 3,038,810
-----------
BALANCE AT DECEMBER 31, 1998................................ 29,600,401
-----------
Additions during the period
New mortgage loans..................................... 13,757,200
Mortgage loans exchanged for issuance of preferred
stock................................................. 1,330,000
-----------
15,087,200
-----------
Deductions during the period
Collections of principal............................... 6,543,019
-----------
BALANCE AT JUNE 30, 1999.................................... 38,144,582
-----------
Additions during the period
New mortgage loans..................................... 9,210,957
Mortgage loans exchanged for issuance of preferred
stock................................................. 168,884
-----------
9,379,841
-----------
Deductions during the period
Collections of principal............................... 11,418,753
-----------
BALANCE AT DECEMBER 31, 1999................................ 36,105,670
Additions during the period
New mortgage loans (unaudited)......................... 23,825,891
Deductions during the period
Collections of principal (unaudited)................... 9,042,051
-----------
BALANCE AT JUNE 30, 2000 (UNAUDITED)........................ $50,889,510
===========
</TABLE>
F-14
<PAGE> 68
SCHEDULE IV
SPECIALTY MORTGAGE TRUST, INC.
MORTGAGE LOANS ON REAL ESTATE
MORTGAGE LOANS BY TYPE OF PROPERTY
DECEMBER 31, 1999
<TABLE>
<CAPTION>
CARRYING AMOUNT
INTEREST FACE AMOUNT AMOUNT MATURITY SUBJECT TO
TYPE OF PROPERTY RATE OF MORTGAGE OF MORTGAGE DATE DELINQUENCY
---------------- ------------- ----------- ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
Commercial income.... 8.5% - 13.5% $ 5,447,000 $ 3,835,668 04/00 - 05/03 $ --
Land only............ 12% - 13% 63,944,500 29,185,839 08/99 - 04/03 5,756,000
Residential income... 12% - 12.5% 1,270,000 1,116,500 09/99 - 04/00 706,000
Residential.......... 12% - 13% 4,412,500 1,967,663 11/99 - 12/06 --
</TABLE>
F-15
<PAGE> 69
SCHEDULE IV
SPECIALTY MORTGAGE TRUST, INC.
MORTGAGE LOANS ON REAL ESTATE
MORTGAGE LOANS BY LIEN POSITION
DECEMBER 31, 1999
<TABLE>
<CAPTION>
FACE AMOUNT INTEREST CARRYING AMOUNT MATURITY AMOUNT SUBJECT
LIEN POSITION OF MORTGAGE RATE OF MORTGAGE DATE TO DELINQUENCY
------------- ----------- ----------- --------------- ------------- --------------
<S> <C> <C> <C> <C> <C>
1st.................. $68,830,000 8.5% - 13% $30,618,677 08/99 - 04/03 $2,806,000
1st and 3rd.......... 365,000 12.50% 365,000 11/99 --
2nd.................. 2,479,000 12% - 13.5% 2,335,993 04/00 - 12/06 870,000
3rd.................. 3,400,000 12% 2,786,000 12/99 2,786,000
</TABLE>
F-16
<PAGE> 70
SCHEDULE IV
SPECIALTY MORTGAGE TRUST, INC.
MORTGAGE LOANS ON REAL ESTATE
MORTGAGE LOANS THAT EXCEED THREE PERCENT
OF THE PORTFOLIO
DECEMBER 31, 1999
<TABLE>
<CAPTION>
FACE CARRYING AMOUNT
INTEREST MATURITY LIEN AMOUNT OF AMOUNT OF SUBJECT TO
DESCRIPTION OF LOAN RATE DATE POSITION MORTGAGE MORTGAGE DELINQUENCY
------------------- -------- -------- -------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Residential land
dev./infrastructure... 12.00% 4/1/03 1st $1,100,000 1,100,000 $ --
Residential
subdivision/land
only.................. 12.25% 8/1/01 1st 2,000,000 1,200,000 --
Residential land
dev./infrastructure... 12.00% 7/1/00 1st 2,540,000 1,286,689 --
Commercial land......... 12.25% 4/1/00 1st 6,000,000 1,377,791 --
Commercial land......... 12.00% 11/1/00 1st 1,500,000 1,500,000 --
Motels/weekly rentals... 12.00% 4/1/03 1st 1,570,000 1,570,000 --
Residential land
dev./infrastructure... 12.00% 6/1/02 1st 6,500,000 1,625,704 --
Commercial/residential
land.................. 12.25% 4/1/01 1st 4,400,000 1,694,934 --
Residential land
dev./infrastructure... 12.00% 6/1/00 1st 2,260,200 1,700,000 1,700,000
Residential land
dev./infrastructure... 12.00% 12/1/99 3rd 3,400,000 2,786,000 2,786,000
Commercial land......... 12.50% 6/1/01 1st 3,500,000 300,000 --
Commercial land......... 13.00% 7/1/00 1st 5,625,000 3,125,000 --
Residential land
dev./infrastructure... 12.50% 8/1/01 1st 7,000,000 4,485,000 --
</TABLE>
F-17
<PAGE> 71
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YOU SHOULD RELY ON THE INFORMATION CONTAINED OR INCORPORATED BY REFERENCE
IN THIS PROSPECTUS. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH DIFFERENT
INFORMATION.
WE ARE NOT OFFERING THE SECURITIES IN ANY STATE WHERE THE OFFER IS NOT
PERMITTED.
WE DO NOT CLAIM THAT THE INFORMATION IN THIS PROSPECTUS IS ACCURATE AS OF
ANY DATE OTHER THAN THE DATE STATED ON THE COVER.
Up to $250,000,000
SPECIALTY MORTGAGE TRUST, INC.
Collateralized Investment Notes
[SPECIALTY LOGO]
PROSPECTUS
AUGUST , 2000
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<PAGE> 72
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 31. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The expenses to be incurred in connection with the issuance and
distribution of the securities being registered are as set forth below. All such
expenses, except for the SEC registration and filing fees, are estimated:
<TABLE>
<S> <C>
SEC Registration............................................ $
Legal Fees and Expenses..................................... $
Accounting Fees and Expenses................................ $
Blue Sky Qualification Fees and Expenses (including counsel
fees)..................................................... $
Printing Fees............................................... $
Transfer Agent and Registrar Fees........................... $
Miscellaneous............................................... $
--------
Total............................................. $
========
</TABLE>
ITEM 32. SALES TO SPECIAL PARTIES.
Not applicable.
ITEM 33. RECENT SALES OF UNREGISTERED SECURITIES.
On October 23, 1997, we sold and issued 300,000 "founder's shares" of
common stock to Nello Gonfiantini III at a price of $0.01 per share or an
aggregate of $3000.
On March 31, 1998, we completed our initial private placement of 2,169,588
shares of Class A Convertible Preferred Stock, par value $0.01 per share, for
approximately $21.7 million. Purchasers were primarily investors in notes and
deeds of trust managed by our manager Gonzo Financial who invested in those
trust deeds before our formation and exchanged their beneficial interests
aggregating to approximately $10.1 million for our stock on a dollar for dollar
basis. Those investors and new investors also purchased shares for cash at
$10.00 per share, which cash purchases aggregated to approximately $11.5
million. There were 146 investors, of which 122 were accredited pursuant to
Regulation D.
On April 1, 1999, we completed a private placement of 1,084,794 shares of
Class A Convertible Preferred Stock at $10.00 per share for approximately $10.8
million to existing shareholders only, 24 of whom were unaccredited. Assignments
of an investor's interest in notes and deeds of trust aggregated to
approximately $1.3 million in this placement.
On July 1, 1999, we completed a private placement of 520,690 shares of
Class A convertible preferred stock at $10.00 per share for approximately $5.2
million to new and existing investors, 9 of whom were unaccredited. Assignments
of an investor's interest in notes and deeds of trust aggregated to
approximately $169,000 in this placement.
On July 1, 2000, we completed a private placement of 689,320 shares of
Class A Convertible Preferred Stock at $10.00 per share for approximately $6.9
million to new and existing investors, 14 of whom were unaccredited.
In October 1998, we began to offer to accredited investors on a monthly
basis our Class A Collateralized Mortgage Notes secured by our mortgage loans
for terms that may range from one month to twelve months. The maximum principal
amount outstanding at any time could not exceed $20 million. As of June 30,
2000, $4,973,731 million of these Notes were outstanding, bearing interest at
rates of 6.25% to 8.50%. The Notes were sold only to accredited investors, as
defined in Regulation D, Rule 501(a)(4), (5) or (6) under the 1933 Securities
Act. Sales of such Notes were terminated as of August 21, 2000.
Each investor in our stock or notes signed a subscription agreement which
included representations that they had sufficient knowledge and experience in
financial and business matters to be capable of evaluating the merits and risks
of investments generally, and of their investment in our stock and Notes,
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<PAGE> 73
and that they were able to bear the economic risk of the investment. Each
investor further acknowledged they understood they could lose their entire
investment.
The sales of stock and issuance of Notes were exempt from the registration
requirements of the Securities Act of 1933 pursuant to Regulation D. Appropriate
legends were placed on each stock certificate and promissory note. No
underwriters were involved and no underwriting commissions were paid in any of
the transactions.
Options to acquire 135,000 shares of common stock have been granted under
Specialty Mortgage Trust's stock option plan. Of these options, 10,000 have been
granted to each of the five independent directors and an additional 85,000 have
been granted to six current employees (excluding the founder) of the manager.
The options were granted without dividend equivalent rights and become
exercisable in annual increments over a four-year period. The options were
granted at prices ranging from $0.01 to $5.00 per share. As of June 30, 2000,
options to purchase 20,200 shares of common stock had been exercised, and shares
of common stock issued, for an aggregate consideration of $1,030.
ITEM 34. INDEMNIFICATION OF OFFICERS AND DIRECTORS.
Section 2-418 of the Corporations and Associations Article of the Annotated
Code of Maryland provides that a Maryland corporation may indemnify any director
of the corporation and any person who, while a director of the corporation, is
or was serving at the request of the corporation as a director, officer,
partner, trustee, employee, or agent of another foreign or domestic corporation,
partnership, joint venture, trust, or other enterprise or employee benefit plan,
is made a party to any proceeding by reason of service in that capacity unless
it is established that the act or omission of the director was material to the
matter giving rise to the proceeding and was committed in bad faith or was the
result of active and deliberate dishonesty; or the director actually received an
improper personal benefit in money, property or services; or, in the case of any
criminal proceeding, the director had reasonable cause to believe that the act
or omission was unlawful. Indemnification may be against judgments, penalties,
fines, settlements, and reasonable expenses actually incurred by the director in
connection with the proceeding, but if the proceeding was one by or in the right
of the corporation, indemnification may not be made in respect of any proceeding
in which the director shall have been adjudged to be liable to the corporation.
Such indemnification may not be made unless authorized for a specific proceeding
after a determination has been made, in the manner prescribed by law, that
indemnification is permissible in the circumstances because the director has met
the applicable standard of conduct. On the other hand, the director must be
indemnified for expenses if he has been successful in the defense of the
proceeding or as otherwise ordered by a court. The law prescribes the
circumstances under which the corporation may advance expenses to, or obtain
insurance or similar protection for, directors.
The law also provides for comparable indemnification for corporate officers
and agents.
The Registrant's Articles of Incorporation provide that our directors and
officers shall, and our agents in the discretion of the Board of Directors may,
be indemnified to the fullest extent required or permitted from time to time by
the laws of Maryland.
The Maryland GCL permits the charter of a Maryland corporation to include a
provision limiting the liability of our directors and officers to the
corporation and our stockholders for money damages except to the extent that (1)
it is proved that the person actually received an improper benefit or profit in
money, property or services for the amount of the benefit or profit in money,
property or services actually received, or (2) a judgment or other final
adjudication is entered in a proceeding based on a finding that the person's
action, or failure to act, was the result of active and deliberate dishonesty
and was material to the cause of action adjudicated in the proceeding. Our
Articles of Incorporation contain a provision providing for elimination of the
liability of our directors and officers or our stockholders for money damages to
the maximum extent permitted by Maryland law from time to time.
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<PAGE> 74
ITEM 35. TREATMENT OF PROCEEDS FROM NOTES BEING REGISTERED.
Not applicable.
ITEM 36. FINANCIAL STATEMENTS AND EXHIBITS.
(a)Financial Statements:
Balance Sheets
Statement of Operations
Statement of Shareholder's Equity
Statement of Cash Flows
(b) Exhibits
<TABLE>
<S> <C>
3.1 Articles of Incorporation
3.2 Articles Supplementary
3.3 Bylaws
3.3.1 Amendment to Bylaws
4.1* Indenture
4.2* Form of Note Purchase Agreement
4.3* Form of Note
5.1* Opinion of Tobin & Tobin, a professional corporation, as to
legality (including consent of such firm)
8.1* Opinion of Gnazzo Thill, a Professional Corporation, as to
certain tax matter (including consent of such firm)
10.1 Amended and Restated Management Agreement
10.2 Master Loan Participation and Servicing Agreement
12.1 Statement regarding Computation of Ratios
23.1* Consent of Tobin & Tobin (see Item 5.1 above)
23.2* Consent of GnazzoThill (see Item 8.1 above)
23.3 Consent of Grant Thornton LLP
24.1 Power of Attorney (set forth on signature page)
25.1* Form T-1, Statement of Eligibility and Qualification Under
the Trust Indenture Act of 1939 of Bankers Trust of
California, N.A., Designated to Act as Trustee
27.1 Financial Data Schedule
</TABLE>
-------------------------
* To be filed by amendment.
ITEM 37. UNDERTAKINGS.
(a) The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of the securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20% change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement;
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<PAGE> 75
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration statement
or any material change to such information in the registration
statement;
provided, however, that the undertakings set forth in clauses (i) and (ii)
of this paragraph do not apply if the registration statement is on Form
S-3, Form S-8 or Form F-3, and the information required to be included in a
post-effective amendment is contained in periodic reports filed by the
registrant pursuant to Section 13 or Section 15(d) of the Exchange Act that
are incorporated by reference in this registration statement.
(2) That, for the purpose of determining any liability under the
securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
(b) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling persons of
Registrant, pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission,
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities, other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding, is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of our counsel the matter
has been settled by controlling precedent, submit to court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
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<PAGE> 76
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-11 and has duly caused this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Reno, County of Washoe, State of Nevada, on August
29, 2000.
SPECIALTY MORTGAGE TRUST, INC.
By: /s/ NELLO GONFIANTINI III
------------------------------------
Nello Gonfiantini III
Chairman, President and Chief
Financial Officer
and Principal Accounting Officer
POWER OF ATTORNEY
We, the undersigned Directors and Officers of Specialty Mortgage Trust,
Inc., do hereby constitute and appoint Nello Gonfiantini III , Stacy Asteriadis,
and Grace C. Caudill, our true and lawful attorney[s] and agent[s], to do any
and all acts and things in our name and behalf in our capacities as directors,
officers and to execute any and all instruments for us and in our names in the
capacities indicated below, which said attorney[s] and agent[s] may deem
necessary or advisable to enable said corporation to comply with the Securities
Act of 1933, as amended, and any rules, regulations and requirements of the
Securities and Exchange Commission, in connection with this Registration
Statement, including specifically, but without limitation, power and authority
to sign for us or any of us in our names and in the capacities indicated below,
any and all amendments (including post-effective amendments) hereof; and we do
hereby ratify and confirm all that the said attorneys and agents shall do or
cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this Form S-11
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE POSITION DATE
--------- -------- ----
<C> <C> <S>
/s/ NELLO GONFIANTINI III Chairman of the Board, President and August 29, 2000
------------------------------------- Chief Financial Officer
Nello Gonfiantini III and Principal Accounting Officer
/s/ GEORGE E. BULL Director August 29, 2000
-------------------------------------
George E. Bull
/s/ ROGER M. PELTYN Director August 29, 2000
-------------------------------------
Roger M. Peltyn
/s/ STEPHEN V. NOVACEK Director August 29, 2000
-------------------------------------
Stephen V. Novacek
/s/ ERNEST MARTINELLI Director August 29, 2000
-------------------------------------
Ernest Martinelli
/s/ HARVEY C. FENNELL Director August 29, 2000
-------------------------------------
Harvey C. Fennell
</TABLE>
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<PAGE> 77
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
3.1 Articles of Incorporation
3.2 Articles Supplementary
3.3 Bylaws
3.3.1 Amendment to Bylaws
4.1* Indenture
4.2* Form of Note Purchase Agreement
4.3* Form of Note
5.1* Opinion of Tobin & Tobin, a professional corporation, as to
legality (including consent of such firm)
8.1* Opinion of Gnazzo Thill, a Professional Corporation, as to
certain tax matter (including consent of such firm)
10.1 Amended and Restated Management Agreement
10.2 Master Loan Participation and Servicing Agreement
12.1 Statement regarding Computation of Ratios
23.1* Consent of Tobin & Tobin (see Item 5.1 above)
23.2* Consent of GnazzoThill (see Item 8.1 above)
23.3 Consent of Grant Thornton LLP
24.1 Power of Attorney (set forth on signature page)
25.1* Form T-1, Statement of Eligibility and Qualification Under
the Trust Indenture Act of 1939 of Bankers Trust of
California, N.A., Designated to Act as Trustee
27.1 Financial Data Schedule
</TABLE>
-------------------------
* To be filed by amendment.
