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VRTB > SEC Filings for VRTB > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for VESTIN REALTY MORTGAGE II, INC

Form 10-Q for VESTIN REALTY MORTGAGE II, INC


14-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is a financial review and analysis of our financial condition and results of operations for the three and nine months ended September 30, 2012 and 2011. This discussion should be read in conjunction with our consolidated financial statements and accompanying notes and other detailed information regarding us appearing elsewhere in this report on Form 10-Q and our report on Form 10-K, Part II, Item 7 Management's Discussion and Analysis of Financial Conditions and Results of Operations for the year ended December 31, 2011.

FORWARD-LOOKING STATEMENTS

Certain statements in this report, including, without limitation, matters discussed under this Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations, should be read in conjunction with the consolidated financial statements, related notes, and other detailed information included elsewhere in this report on Form 10-Q. We are including this cautionary statement to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Statements that are not historical fact are forward-looking statements. Certain of these forward-looking statements can be identified by the use of words such as "believes," "anticipates," "expects," "intends," "plans," "projects," "estimates," "assumes," "may," "should," "will," or other similar expressions. Such forward-looking statements involve known and unknown risks, uncertainties and other important factors, which could cause actual results, performance or achievements to differ materially from future results, performance or achievements. These forward-looking statements are based on our current beliefs, intentions and expectations. These statements are not guarantees or indicative of future performance. Important assumptions and other important factors that could cause actual results to differ materially from those forward-looking statements include, but are not limited to, those factors, risks and uncertainties of this Quarterly Report on Form 10-Q and in our other securities filings with the Securities and Exchange Commission ("SEC"). Our future financial condition and results of operations, as well as any forward-looking statements, are subject to change and involve inherent risks and uncertainties. Our estimates of the value of collateral securing our loans may change, or the value of the underlying property could decline subsequent to the date of our evaluation. As a result, such estimates are not guarantees of the future value of the collateral. The forward-looking statements contained in this report are made only as of the date hereof. We undertake no obligation to update or revise information contained herein to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

RESULTS OF OPERATIONS

OVERVIEW

Our primary business objective is to generate income while preserving principal by investing in real estate loans. We believe there is a significant market opportunity to make real estate loans to owners and developers of real property whose financing needs are not met by other real estate lenders. The loan underwriting standards utilized by our manager and the mortgage brokers we utilize are less strict than those used by many institutional real estate lenders. In addition, one of our competitive advantages is our ability to approve loan applications more quickly than many institutional lenders. As a result, in certain cases, we may make real estate loans that are riskier than real estate loans made by many institutional lenders such as commercial banks. However, in return, we seek a higher interest rate and our manager takes steps to mitigate the lending risks such as imposing a lower loan-to-value ratio. While we may assume more risk than many institutional real estate lenders, in return, we seek to generate higher yields from our real estate loans.

Our operating results are affected primarily by: (i) the amount of capital we have to invest in real estate loans, (ii) the level of real estate lending activity in the markets we service, (iii) our ability to identify and work with suitable borrowers, (iv) the interest rates we are able to charge on our loans and (v) the level of non-performing assets, foreclosures and related loan losses which we may experience.

Our operating results have been adversely affected by increases in allowances for loan losses and increases in non-performing assets. This negative trend accelerated sharply during the year ended December 31, 2008 and continues to affect our operations. See Note F - Real Estate Held for Sale and "Non-performing Loans" in Note D - Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part I, Item I Consolidated Financial Statements of this Quarterly Report on Form 10-Q.

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We believe that the current level of our non-performing assets is a direct result of the deterioration of the economy and credit markets several years ago. As the economy weakened and credit became more difficult to obtain, many of our borrowers who develop and sell commercial real estate projects were unable to complete their projects, obtain takeout financing or were otherwise adversely impacted. While the general economy has improved, the commercial real estate markets in many of the areas where we make loans continue to suffer from depressed conditions. Our exposure to the negative developments in the credit markets and general economy has likely been increased by our business strategy, which entails more lenient underwriting standards and expedited loan approval procedures. Moreover, declining real estate values in the principal markets in which we operate has in many cases eroded the current value of the security underlying our loans.

Continued weakness in the commercial real estate markets and the weakness in lending may continue to have an adverse impact upon our markets. This may result in further defaults on our loans, and we might be required to record additional reserves based on decreases in market values, or we may be required to restructure additional loans. This increase in loan defaults has materially affected our operating results and led to the suspension of dividends to our stockholders. For additional information regarding our non-performing loans see "Non-Performing Loans" in Note D - Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part I, Item I Consolidated Financial Statements of this Quarterly Report on Form 10-Q.

During the nine months ended September 30, 2012, we funded 13 loans totaling approximately $22.9 million. During the nine months ended September 30, 2011, we funded five loans totaling approximately $3.7 million. As of September 30, 2012, our loan-to-value ratio was 62.0%, net of allowances for loan losses, on a weighted average basis generally using updated appraisals. Additional increases in loan defaults accompanied by additional declines in real estate values, as evidenced by updated appraisals generally prepared on an "as-is-basis," will have a material adverse effect on our financial condition and operating results.

As of September 30, 2012, we have provided a specific reserve allowance for one non-performing loan and three performing loans based on updated appraisals of the underlying collateral and our evaluation of the borrower for these loans, obtained by our manager. For further information regarding allowance for loan losses, refer to "Specific Reserve Allowance" in Note D - Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in

Part I, Item I Consolidated Financial Statements of this Quarterly Report on
Form 10-Q.

As of September 30, 2012, our loans were in the following states: California, Michigan, Nevada, Ohio, Texas and Utah.

At our annual meeting held on December 15, 2011, a majority of the shareholders voted to amend our Bylaws to expand our investment policy to include investments in and acquisition, management and sale of real property or the acquisition of entities involved in the ownership or management of real property. A majority of the shareholders also voted to amend our charter to change the terms of our existence from its expiration date of December 31, 2020 to perpetual existence. As a result, we will begin to acquire, manage, renovate, reposition, sell or otherwise invest in real property or acquire entities involved in the ownership or management of real property.

We, along with VRM Merger Sub, Inc. (a subsidiary we wholly own) and VRM I announced on May 30, 2012 that we have entered into a definitive merger agreement pursuant to which VRM Merger Sub will merge with and into VRM I in a stock-for-stock merger, with VRM I surviving the transaction as our wholly owned subsidiary. Under the terms of the transaction, which has been approved by the boards of directors of both companies, stockholders of VRM I (other than us) will receive a fixed ratio of 0.82 share of our common stock for each share of VRM I common stock they own. If the transaction is approved by our shareholders and the shareholders of VRM I, upon closing, VRM I stockholders will own approximately 30% of our common stock. Pursuant to the terms of the agreement, one member of the VRM I Board of Directors will replace an existing Director on our Board of Directors. A registration statement relating to the stock to be issued by us in the proposed transaction has been filed with the SEC and is pending a declaration of effectiveness by the SEC. The transaction is subject to customary approvals and closing conditions and requires the approval of the VRM I stockholders (with respect to the merger) and our stockholders (with respect to the issuance of our common stock).

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Our board of directors has recommended that we change our manager by appointing VRM Management LLC as its new manager. VRM Management is a newly formed Nevada limited liability company which is 90% owned by our Chairman and Chief Executive Officer, Michael Shustek and 10% owned by Craig Burr. Mr. Burr is an attorney who has been engaged in the private practice of law in Las Vegas, Nevada for more than 19 years. The current employees and officers of Vestin Mortgage would join VRM Management and would continue to render services to us through this new entity.

The terms of the proposed management agreement with VRM Management are identical to our current Management Agreement with Vestin Mortgage. In addition, VRM Management will be subject to the continuing oversight of our board of directors to be the same extent as Vestin Mortgage.

SUMMARY OF FINANCIAL RESULTS

Comparison of operating results for the three months ended September 30, 2012,
to the three months ended September 30, 2011.

Total Revenue:                               2012          2011        $ Change       % Change
Interest income from investment in real
estate loans                               $ 427,000     $ 259,000     $ 168,000             65 %
Gain related to pay off of real estate
loan, including recovery of allowance
for loan loss                                 31,000       100,000       (69,000 )          (69 %)
Gain related to pay off of notes
receivable, including recovery of
allowance for notes receivable                79,000            --        79,000            100 %
Other income                                      --        42,000       (42,000 )         (100 %)
      Total                                $ 537,000     $ 401,000     $ 136,000             34 %

Our revenue from interest income is dependent upon the balance of our investment in real estate loans and the interest earned on these loans. Interest income was adversely affected by the level of modified loans and the reduction in new lending activity during the first three quarters of 2011. We experienced an increase in new lending activity in the second half of 2011and first half of 2012, which has produced an overall increase in interest income for third quarter 2012. It is premature at this time to predict whether or not the increase in lending activity in the second half of 2011 and first three quarters of 2012 will be sustained in the future. Scheduled payments on fully reserved notes receivable and loans resulted in an increase in gain related to payoff of real estate loan.

For additional information see Note D - Investments in Real Estate Loans and Note J - Notes Receivable of the Notes to the Consolidated Financial Statements included in Part I, Item 1 Consolidated Financial Statements of this Quarterly Report on Form 10-Q.

Operating Expenses:                 2012           2011           $ Change       % Change
Management fees - related party   $ 242,000     $   274,000     $    (32,000 )         (12 %)
Provision for loan loss              50,000         955,000         (905,000 )         (95 %)
Interest expense                      2,000          60,000          (58,000 )         (97 %)
Professional fees                   166,000         247,000          (81,000 )         (33 %)
Insurance                            49,000          63,000          (14,000 )         (22 %)
Consulting                           73,000          73,000               --            --
Other                                26,000          92,000          (66,000 )         (72 %)
      Total                       $ 608,000     $ 1,764,000     $ (1,156,000 )         (66 %)

Operating expenses were 66% lower during the three months ended September 30, 2012 than during the same three months in 2011. Provision for loan loss expense change is due to what appears to be a more stabilized real estate market. Interest expense decreased during the three months ended September 30, 2012 due to the decreased balance of secured borrowings which were paid off in 2011. Professional fees have decreased due to a significant decrease in pending litigation.

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Non-operating Income (Loss):                     2012          2011        $ Change       % Change
Interest income from banking institutions      $      --     $   1,000     $  (1,000 )         (100 %)
Settlement income                                 90,000            --        90,000            100 %
Recovery from settlement with loan guarantor     203,000            --       203,000            100 %
      Total                                    $ 293,000     $   1,000     $ 292,000            292 %

During January 2011, we, VRM I and Fund III were awarded unsecured claims up to $3.6 million from a bankruptcy settlement with a guarantor of certain loans. Pursuant to the terms of the settlement, we received payment of approximately $203,000 during July 2012. In July, 2012, we along with our Manager, VRM II, Vestin Group, Vestin Originations and Michael Shustek entered into a Settlement Agreement and Mutual Release with the State of Hawaii and The Huntington National Bank as successor trustee to the Rightstar Trusts. Under the Settelement Agreement, we and VRM I were entitled to receive a portion of certain net proceeds from certain claims from third parties through litigation, settlement or otherwise. The agreement resulted in payments to claimants of $145,000, of which our portion was approximately $90,000.

See Note N - Legal Matters involving the Company of the Notes to the Financial Statements included in Part I, Item I Consolidated Financial Statements of this Quarterly Report on Form 10-Q.

Discontinued Operations, net of income
taxes:                                        2012           2011         $ Change       % Change
Net gain on sale of real estate held for
sale                                       $       --     $   64,000     $  (64,000 )         (100 %)
Expenses related to real estate held for
sale                                         (252,000 )     (258,000 )        6,000              2 %
Write down on real estate held for sale            --       (708,000 )      708,000            100 %
Income from assets held for sale, net of
income taxes                                   95,000        862,000       (767,000 )          (89 %)
      Total                                $ (157,000 )   $  (40,000 )   $ (117,000 )         (293 )%

Discontinued operations were 293% lower during the three months ended September 30, 2012 than during the same three months in 2011. We received income from assets held for sale during the three months ended September 30, 2012 for a different asset held for sale than in the same period 2011. During the three months ended September 30, 2011, we recorded net gains on sale of real estate held for sale for properties sold in prior periods due to payments on settlement agreements. There was no such income during the same period in 2012. No write-down on real estate was necessary for the three months ended September 30, 2012 compared to write-downs in of $708,000 during the same period in 2011.

See Note F - Real Estate Held For Sale of the Notes to the Financial Statements included in Part I, Item I Consolidated Financial Statements of this Quarterly Report on Form 10-Q.

Comparison of operating results for the nine months ended September 30, 2012, to the nine months ended September 30, 2011.

Total Revenue:                                2012            2011          $ Change        % Change
Interest income from investment in real
estate loans                               $ 1,008,000     $ 1,016,000     $    (8,000 )           (1 %)
Gain related to pay off of real estate
loan, including recovery of allowance
for loan loss                                1,268,000         133,000       1,135,000            848 %
Gain related to pay off of notes
receivable, including recovery of
allowance for notes receivable                 226,000              --         226,000            100 %
Other income                                        --         100,000        (100,000 )         (100 %)
      Total                                $ 2,502,000     $ 1,249,000     $ 1,253,000            100 %

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Our revenue from interest income is dependent upon the balance of our investment in real estate loans and the interest earned on these loans. Interest income has been adversely affected by the level of modified loans and the reduction in new lending activity during the first three quarters of 2011. We experienced an increase in new lending activity in the second half of 2011 and first three quarters of 2012 and we anticipate that the activity in our loan portfolio will produce an overall increase in interest income for 2012. It is premature at this time to predict whether or not the increase in lending activity in the second half of 2011 and first three quarters of 2012 will be sustained in the future. Scheduled payments on fully reserved notes receivable and loans resulted in an increase in gain related to payoff of real estate loan and other income. During May 2012, we, VRM I and Fund III sold our portions of a fully reserved loan of $14.0 million, of which our portion was $12.6 million to a third party. We received a payment of approximately $1.0 million.

For additional information see Note D - Investments in Real Estate Loans and Note J - Notes Receivable of the Notes to the Consolidated Financial Statements included in Part I, Item 1 Consolidated Financial Statements of this Quarterly Report on Form 10-Q.

Operating Expenses:                  2012            2011          $ Change      % Change
Management fees - related party   $   791,000     $   823,000     $  (32,000 )          (4 %)
Provision for loan loss               815,000         955,000       (140,000 )          15 %
Interest expense                        2,000         178,000       (176,000 )         (99 %)
Professional fees                     753,000         927,000       (174,000 )         (19 %)
Consulting fees                       161,000         134,000         27,000            20 %
Insurance                             219,000         230,000        (11,000 )          (5 %)
Other                                 143,000         225,000        (82,000 )         (36 %)
      Total                       $ 2,884,000     $ 3,472,000     $ (588,000 )         (17 %)

Operating expenses were 17% lower during the nine months ended September 30, 2012 partially as a result of a decrease in provision for loan losses compared to the nine months ended September 30, 2011. Interest expense decreased during the nine months ended September 30, 2012 due to the decreased balance of secured borrowings which were paid off in 2011. Professional fees have decreased due to a significant decrease in pending litigation. Consulting fees have increased due to credit review by a third party.

See "Specific Loan Allowance" in Note D - Investments in Real Estate Loans and Note N - Legal Matters Involving The Company of the Notes to the Consolidated Financial Statements included in Part I, Item 1 Consolidated Financial Statements of this Quarterly Report on Form 10-Q.

Non-operating Income (Loss):                     2012           2011           $ Change        % Change
Interest income from banking institutions      $   1,000     $     6,000     $     (5,000 )          (83 %)
Settlement income                                 90,000              --           90,000            100 %
Recovery from settlement with loan guarantor     746,000              --          746,000            100 %
Gain on sale of marketable securities             15,000              --           15,000            100 %
Discounted professional fees                          --       1,620,000       (1,620,000 )         (100 %)
Settlement expense                               (66,000 )            --          (66,000 )         (100 %)
      Total                                    $ 786,000     $ 1,626,000     $   (840,000 )          (52 %)

During the nine months ended September 30, 2012 we settled two lawsuits which resulted in an expense of approximately $66,000. In addition, we received from the plaintiff 14,374 shares of the company's stock that was held as treasury stock, but since retired. The purchase and subsequent sale of marketable securities occurred during the nine months ended September 30, 2012, resulting in a gain of approximately $15,000. No such transactions occurred in the nine months ended September 30, 2011. During the nine months ended September 30, 2011 we received approximately $1.6 million in discounts related to past legal bills. There was no similar discount received in 2012. In addition, during January 2011, we, VRM I and Fund III were awarded unsecured claims up to $3.6 million from a bankruptcy settlement with a guarantor of certain loans. Pursuant to the terms of the settlement, we received payment of approximately $543,000 during April 2012 and $203,000 in July 2012. In July, 2012, we along with our Manager, VRM II, Vestin Group, Vestin Originations and Michael Shustek entered into a Settlement Agreement and Mutual Release with the State of Hawaii and The Huntington National Bank as successor trustee to the Rightstar Trusts. Under the Settlement Agreement, we and VRM II were entitled to receive a portion of certain net proceeds from certain claims from third parties through litigation, settlement or otherwise. The agreement resulted in payments to claimants of $145,000, with our portion was approximately $90,000.

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See Note N - Legal Matters involving the Company of the Notes to the Financial Statements included in Part I, Item I Consolidated Financial Statements of this Quarterly Report on Form 10-Q.

Discontinued Operations, net of income
taxes: 2012 2011 $ Change % Change Net gain on sale of real estate held for sale $ 12,000 $ 74,000 $ (62,000 ) (84 %) Expenses related to real estate held for sale (1,094,000 ) (657,000 ) (437,000 ) (67 %) Write-downs on real estate held for sale (1,420,000 ) (1,321,000 ) (99,000 ) (7 %) Income from assets held for sale, net of income taxes 95,000 1,739,000 (1,644,000 ) (95 %) Total $ (2,407,000 ) $ (165,000 ) $ (2,242,000 ) (1359 %)

Expenses related to discontinued operations increased by approximately $2.2 million during the nine months ended September 30, 2012 compared to the same three months in 2011. This variance is primarily due to receiving income from two different assets held for sale during the three months ended September 30, 2012 and 2011. Expenses related to real estate held for sale increased due to acquiring two properties during 2012. The increase in expenses related to real estate held for sale is due to attorney fees for the bankruptcy and other operating expenses for 1701 Commerce. During the nine months ended September 30, 2011 we recorded net gains on sale of real estate held for sale for properties sold in prior periods due to payments on settlement agreements, with gains higher than during the same time period in 2012. Write downs on real estate held for sale were higher during the nine months ended September 30, 2012 than they were during the same time period in 2011.

See Note F - Real Estate Held For Sale and Note G - Assets Held for Sale of the Notes to the Financial Statements included in Part I, Item I Consolidated Financial Statements of this Quarterly Report on Form 10-Q.

CAPITAL AND LIQUIDITY

Liquidity is a measure of a company's ability to meet potential cash requirements, including ongoing commitments to fund lending activities and general operating purposes. Subject to a 3% reserve, we generally seek to use all of our available funds to invest in real estate assets. Distributable cash flow generated from such loans is paid out to our stockholders, in the form of a dividend. We do not anticipate the need for hiring any employees, acquiring fixed assets such as office equipment or furniture, or incurring material office expenses during the next twelve months. We may pay our manager an annual management fee of up to 0.25% of the aggregate capital received by Fund II and us from the sale of shares or membership units.

During the nine months ended September 30, 2012, net cash flows used in operating activities were approximately $2.3 million. Operating cash flows were used for the payment of normal operating expenses such as management fees, accounting fees, legal bills and expenses related to real estate held for sale. Cash flows related to investing activities consisted of cash used by loan investments in new real estate loans of approximately $22.9 million and an investment in MVP Realty Advisors of approximately $0.5 million. In addition, cash flows related to investing activities consisted of cash provided by loan payoffs and sale of investments in real estate loans to third parties of approximately $18.4 million, proceeds from the sale of REO and nonrefundable . . .

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