Item
1. Business
General
We
are a New York-based real estate finance company that specializes in originating, servicing and managing a portfolio of first
mortgage loans. We offer short-term, secured, non-banking loans (sometimes referred to as “hard money” loans), which
we may renew or extend on, before or after their initial term expires, to real estate investors to fund their acquisition, renovation,
rehabilitation or improvement of properties located in the New York metropolitan area. We are organized and conduct our operations
to qualify as a real estate investment trust for federal income tax purposes (“REIT”). We have qualified for taxation
as a REIT beginning with our taxable year ended December 31, 2014.
We
are organized as a New York corporation and operated as a fully-taxable C-corporation for federal and state income tax purposes
through the end of our 2013 tax year. As a result, we were able to re-invest most of our net after-tax profits back into our business.
In 2014, we concluded that it would be in the best interests of our shareholders if we operated as a REIT for U.S. federal income
tax purposes. In July 2014, we completed a public offering of 1,754,386 common shares at a price to the public of $2.85 per share.
As a result of that offering, we met all the requirements to qualify as a REIT and elected REIT status starting with that year.
In
order to maintain our qualification for taxation as a REIT, we are required to distribute at least 90% of our taxable income to
our shareholders each year. To the extent we distribute less than 100% of our taxable income to our shareholders (but more than
90%) we will maintain our qualification for taxation as a REIT but the undistributed portion will be subject to regular corporate
income taxes. As a REIT, we may also be subject to federal excise taxes and minimum state taxes. We also intend to operate our
business in a manner that will permit us to maintain our exemption from registration under the Investment Company Act of 1940,
as amended (the “Investment Company Act”). In addition, in order for us to qualify for taxation as a REIT, not more
than 50% in value of our outstanding common shares may be owned, directly or indirectly, by five or fewer individuals (as defined
in the Internal Revenue Code of 1986, as amended (the “Code”) to include certain entities) at any time during the
last half of each taxable year, and at least 100 persons must beneficially own our stock during at least 335 days of a taxable
year of 12 months, or during a proportionate portion of a shorter taxable year. To help ensure that we meet the tests, our restated
certificate of incorporation restricts the acquisition and ownership of our capital stock. The ownership limitation is fixed at
4.0% of our outstanding shares of capital stock, by value or number of shares, whichever is more restrictive.
The
properties securing the loans are generally classified as residential or commercial real estate and, typically, are not income
producing. Each loan is secured by a first mortgage lien on real estate. In addition, each loan is personally guaranteed by the
principal(s) of the borrower, which guarantee may be collaterally secured by a pledge of the guarantor’s interest in the
borrower. The face amount of the loans we originate historically ranged from $14,000 to a maximum of $2 million. Our lending policy
limits the maximum amount of any loan to the lower of (i) 9.9% of the aggregate amount of our loan portfolio (not including the
loan under consideration) and (ii) $2 million. Our loans typically have a maximum initial term of 12 months and bear interest
at a fixed rate of 12% to 14% per year. In addition, we usually receive origination fees or “points” ranging from
0% to 3% of the original principal amount of the loan as well as other fees relating to underwriting and funding the loan. Interest
is always payable monthly, in arrears. In the case of acquisition financing, the principal amount of the loan usually does not
exceed 75% of the value of the property (as determined by an independent appraiser) and in the case of construction financing,
it is typically up to 80% of construction costs.
Since
commencing our business in 2007, we have never foreclosed on a property and none of our loans have ever gone into default, although
sometimes we have renewed or extended the term of a loan to enable the borrower to avoid premature sale or refinancing of the
property. When we renew or extend a loan we generally receive additional “points” and other fees.
Our
executive officers are experienced in hard money lending under various economic and market conditions. Loans are originated, underwritten
and structured by our chief executive officer, assisted by our chief financial officer and controller, and then managed and serviced
principally by our chief financial officer. A principal source of new transactions has been repeat business from prior customers
and their referral of new business. We also receive leads for new business from real estate brokers and mortgage brokers and a
limited amount of advertising.
Our
primary business objective is to grow our loan portfolio while protecting and preserving capital in a manner that provides for
attractive risk-adjusted returns to our shareholders over the long term through dividends. We intend to achieve this objective
by continuing to selectively originate, fund loans secured by first mortgages on residential real estate held for investment located
in the New York metropolitan area and to carefully manage and service our portfolio in a manner designed to generate attractive
risk-adjusted returns across a variety of market conditions and economic cycles. We believe that current market dynamics specifically
the demand/supply imbalance for relatively small real estate loans, presents significant opportunities for us to selectively originate
high-quality first mortgage loans on attractive terms and we believe that these market conditions should persist for a number
of years. We have built our business on a foundation of intimate knowledge of the New York metropolitan area real estate market
combined with a disciplined credit and due diligence culture that is designed to protect and preserve capital. We believe that
our flexibility and ability to structure loans that address the needs of our borrowers without compromising our standards on credit
risk, our expertise, our intimate knowledge of the New York metropolitan area real estate market and our focus on newly originated
first mortgage loans, has defined our success until now and should enable us to continue to achieve our objectives.
The
Market Opportunity
Real
estate investment is a capital-intensive business that relies heavily on debt capital to acquire, develop, improve, construct,
renovate and maintain properties. We believe that the demand for relatively small loans to acquire, renovate or improve residential
real estate held in the New York metropolitan market presents a compelling opportunity to generate attractive returns for an established,
well-financed, non-bank lender like us. We have competed successfully in this market notwithstanding the fact that many traditional
lenders, such as banks and other institutional lenders, also service this market. Our primary competitive advantage is our ability
to approve and fund loans quickly and efficiently. In this environment, characterized by a supply-demand imbalance for financing
and increasing asset values, we believe we are well positioned to capitalize and profit from these industry trends.
We
believe there is a significant market opportunity for a well-capitalized “hard money” real estate finance company
to originate attractively priced loans with strong credit fundamentals. Particularly in the New York metropolitan area, where
real estate values are relatively stable and substandard properties are being improved, rehabilitated and renovated, we believe
there are many opportunities for a “hard money” lender providing capital for these purposes to small scale developers.
We further believe that our flexibility to structure loans to suit the particular needs of our borrowers and our ability to close
quickly make us an attractive alternative to banks and other large institutional lenders for small real estate developers and
investors.
Our
Business and Growth Strategies
Our
objective is to protect and preserve capital in a manner that provides for attractive risk-adjusted returns to our shareholders
over the long term, principally through dividends. We intend to achieve this objective by continuing to focus exclusively on selectively
originating, servicing and managing a portfolio of short-term real estate loans secured by first mortgages on real estate located
in the New York metropolitan area that are designed to generate attractive risk-adjusted returns across a variety of market conditions
and economic cycles. We believe that our ability to react quickly to the needs of borrowers, our flexibility in terms of structuring
loans to meet the needs of borrowers, our intimate knowledge of the New York metropolitan area real estate market, our expertise
in “hard money” lending and our focus on newly originated first mortgage loans, should enable us to achieve this objective.
Nevertheless, we will remain flexible in order to take advantage of other real estate related opportunities that may arise from
time to time, whether they relate to the mortgage market or, if we determine that it is in our best interest, to direct or indirect
investments in real estate.
Our
strategy to achieve our objective includes the following:
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capitalize
on opportunities created by the long-term structural changes in the real estate lending market and the continuing demand for
liquidity in the real estate market;
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take
advantage of the prevailing economic environment as well as economic, political and social trends that may impact real estate
lending currently and in the future as well as the outlook for real estate in general and particular asset classes;
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remain
flexible in order to capitalize on changing sets of investment opportunities that may be present in the various points of
an economic cycle; and
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operate
so as to qualify for taxation as a REIT and for an exemption from registration under the Investment Company Act.
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In
furtherance of these strategies, on February 27, 2015, we obtained a three-year $14 million revolving line of credit with Webster
Business Credit Corporation (“Webster”) to replace our existing $7.7 million credit facility with Sterling National
Bank. Mr. Ran, has personally guaranteed all of our obligations to Webster.
Our
Competitive Strengths
We
believe our competitive strengths include:
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Experienced
management team. Our management team has successfully originated and serviced a portfolio of real estate mortgage loans generating
attractive annual returns under varying economic and real estate market conditions. We expect that the experience of our management
team will provide us with the ability to effectively deploy our capital in a manner that we believe will provide for attractive
risk-adjusted returns but with a focus on capital preservation and protection.
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Long-standing
relationships. A significant portion of our business comes from repeat customers with whom we have long-standing relationships.
These customers are also a referral source for new borrowers. As long as these customers remain active real estate investors
they provide us with an advantage in securing new business and help us maintain a pipeline to attractive new opportunities
that may not be available to many of our competitors or to the general market.
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Knowledge
of the market. Our intimate knowledge of the New York metropolitan area real estate market enhances our ability to identify
attractive opportunities and helps distinguish us from many of our competitors.
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Disciplined
lending. We seek to maximize our risk-adjusted returns, and preserve and protect capital, through our disciplined and credit-based
approach. We utilize rigorous underwriting and loan closing procedures that include numerous checks and balances to evaluate
the risks and merits of each potential transaction. We seek to protect and preserve capital by carefully evaluating the condition
of the property, the location of the property, the creditworthiness of the guarantors and the availability of other forms
of collateral.
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Vertically-integrated
loan origination platform. We manage and control the loan process from origination through closing with our own personnel
or independent legal counsel and appraisers, with whom we have long relationships, who together constitute a highly experienced
team in credit evaluation, underwriting and loan structuring. We also believe that our procedures and experience allow us
to quickly and efficiently execute opportunities we deem desirable.
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Structuring
flexibility. As a relatively small, non-bank real estate lender, we can move quickly and have much more flexibility than traditional
lenders to structure loans to suit the needs of our clients. Our ability to customize financing structures to meet borrowers’
needs is one of our key business strengths.
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No
legacy issues. Unlike many of our competitors, we are not burdened by distressed legacy real estate assets. We do not have
a legacy portfolio of lower-return or problem loans that could potentially dilute the attractive returns we believe are available
in the current liquidity-challenged environment and/or distract and monopolize our management team’s time and attention.
We do not have any adverse credit exposure to, and we do not anticipate that our performance will be negatively impacted by,
previously purchased assets.
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Our
Real Estate Lending Activities
Our
real estate lending activities involve originating, funding, servicing and managing short-term loans (i.e.: loans with an initial
term of not more than one year), secured by first mortgage liens on real estate property in the New York metropolitan area held
for investment or resale. Generally, borrowers use the proceeds from our loans for one of three purposes: (i) to acquire and renovate
existing residential (single, one or two family) real estate properties; (ii) to acquire vacant real estate and construct residential
real properties; and (iii) to purchase and hold income producing properties. Our mortgage loans are structured to fit the needs
and business plans of the borrowers. Revenue is generated primarily from the interest borrowers pay on our loans and, to a lesser
extent, loan fee income generated on the origination and extension of loans.
Most
of our loans are funded in full at the closing. However, our loan portfolio includes a number of construction loans, which are
only partially funded at closing. At December 31, 2015, our unfunded commitment was approximately $2.16 million. At December 31,
2016, our unfunded commitment was approximately $4.10 million. Advances under construction loans are funded against requests supported
by all required documentation as and when needed to pay contractors and other costs of construction. In the case of construction
loans, the borrower will either deliver multiple notes or one global note for the entire commitment. In either case, interest
only accrues on the funded portion of the loan.
In
general, our strategy is to service and manage the loans we originate until they are paid. However, there have been a few instances
where we have either used loans as collateral, or sold participating interests in loans. All of our loans are secured by properties
located in the New York metropolitan area, which is where we are based. We have no intention at this time to attempt to expand
into any other geographic market. Most of the properties we finance are residential, although on occasion they are classified
as commercial. However, in all instances the properties are held only for investment by the borrowers. Most of these properties
do not generate any cash flow.
The
typical terms of our loans are as follows:
Principal
amount
- Historically, a minimum of $14,000 to a maximum of $2 million. Our lending policy limits the maximum loan amount
to the lower of (i) 9.9% of the aggregate amount of our loan portfolio (not including the loan under consideration) and (ii) $2
million.
Loan-to-Value
Ratio
- Up to 75%, and/or up to 80% of construction costs.
Interest
rate
- Most of the loans in our portfolio have a fixed rate of typically 12% to 14%.
Term
- Generally, one year with early termination in the event of a sale of the property or a refinancing. We entertain requests
for granting extensions under certain conditions.
Prepayments
- Borrower may prepay the loan at any time beginning three months after the funding date.
Covenants
- To timely pay all interest on the loan and to maintain hazard insurance with respect to the property.
Events
of default
- Include: (i) failure to make a payment when due; (ii) breach of a covenant.
Payment
terms
- Interest only is payable monthly in arrears. Principal is due in a “balloon” payment at the maturity date.
Escrow
- None.
Reserves
- None.
Security
- The loan is evidenced by a promissory note, which is secured by a first mortgage lien on the real property owned by the
borrower. In addition, each loan is guaranteed by the principals of the borrower, which may be collaterally secured by a pledge
of the guarantor’s interest in the borrower.
Fees
and Expenses
- Borrowers generally pay an origination fee equal to 0% to 3% of the loan amount. If we agree to extend the
term of the loan, we usually collect the same origination fee we charged on the initial funding of the loan. In addition, borrowers
also pay a processing fee, wire fee, bounced check fee and, in the case of construction loans, check requisition fee for each
draw from the loan. Finally, the borrower pays all expenses relating to obtaining the loan including the cost of a property appraisal,
the cost of a credit report and all title, recording fees and legal fees.
Operating
Data
Our
lending activities increased each year since 2007, the first year we started making real estate loans. We believe our business
will continue to grow given the strength of the New York real estate market and our reputation among real estate investors as
a reliable and reasonable financing source.
Our
loan portfolio
The
following table highlights certain information regarding our real estate lending activities for the periods indicated:
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Year
Ended December 31,
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($
in thousands)
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2016
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2015
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Loans originated
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$
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36,657
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$
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21,609
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Loans repaid
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$
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32,806
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$
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14,737
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Mortgage lending revenues
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$
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4,649
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$
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4,001
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Mortgage lending expenses
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$
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789
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$
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694
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Number of loans outstanding
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97
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97
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Principal amount of loans earning interest
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$
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34,755
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$
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30,904
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Average outstanding loan balance
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$
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358
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$
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319
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Percent of loans secured
by New York area properties
(1)
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100.0
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100.0
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%
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Weighted average contractual interest rate
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12.5
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%
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12.3
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%
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Weighted average term to maturity (in months)
(2)
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6.73
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%
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5.40
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(1)
Calculated based on the number of loans.
(2)
Without giving effect to extension options.
At
December 31, 2016 and 2015, no single loan, borrower or group of affiliated borrowers accounted for more than 10% of our loan
portfolio.
The
following table sets forth information regarding the types of properties securing our mortgage loans outstanding at December 31,
2016 and 2015, and the interest earned in each category (dollars in thousands):
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2016
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2015
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Number
of
Loans
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Interest
Earned
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Percentage
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Number
of
Loans
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Interest
Earned
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Percentage
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Residential
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89
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$
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1,927
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91
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%
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93
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$
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2,289
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93
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%
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Commercial
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1
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26
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1
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%
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1
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120
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5
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%
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Mixed Use
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7
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163
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8
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%
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3
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46
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2
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%
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Total
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97
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$
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2,116
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100
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%
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97
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$
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2,455
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100
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%
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Our
Origination Process and Underwriting Criteria
We
primarily rely on our relationships with existing and former borrowers, real estate investors, real estate brokers and mortgage
brokers to originate loans. Many of our borrowers are “repeat customers.” When underwriting a loan, the primary focus
of our analysis is the value of a property and the credit worthiness of the borrower and its principals. Prior to making a final
decision on a loan application we conduct extensive due diligence of the borrower and its principals. In terms of the property,
we usually require a third party appraisal and a third party assessment report. We also order title, lien and judgment searches.
In most cases, we will also make an on-site visit to evaluate not only the property but the neighborhood in which it is located.
Finally, we analyze and assess financial and operational data provided by the borrower relating to its operation and maintenance
of the property. In terms of the borrower and its principals, we usually obtain third party credit reports from one of the major
credit reporting services as well as personal financial information provided by the borrower and its principals. We analyze all
this information carefully prior to making a final determination. Ultimately, our decision is based on our conclusions regarding
the value of the property, which takes into account factors such as the neighborhood in which the property is located, the current
use and potential alternative use of the property, current and potential net income from the property, the local market, sales
information of comparable properties, existing zoning regulations, the creditworthiness of the borrower and its principles and
their experience in real estate ownership, construction, development and management. In conducting our due diligence we rely,
in part, on third party professionals and experts including appraisers, engineers, title insurers and attorneys.
Before
a loan commitment is issued, the loan must be reviewed and approved by our chief executive officer. Our loan commitments are generally
issued subject to receipt by us of title documentation and title report, in a form satisfactory to us, for the underlying property.
We require a personal guarantee from the principal or principals of the borrower.
Our
Current Financing Strategies
Our
financing strategies are critical to the success and growth of our business. Our financing strategies at this time are limited
to equity and debt offerings. Our principal capital raising transactions have consisted of the following:
Credit
line
. On February 27, 2015, we repaid and terminated the Sterling Credit Line, as described in “Liquidity and Capital
Resources” below, and simultaneously entered into a Line of Credit Agreement with Webster pursuant to which we may borrow
up to $14 million during the next three years (the “Webster Credit Line”). The Webster Credit Line provides for an
interest rate equal to (i) LIBOR plus 4.75% or (ii) Webster’s base commercial lending rate plus 3.25%, as chosen by us for
each drawdown, and expires on February 27, 2018. The credit line is secured by assignment of mortgages and other collateral and
is guaranteed by Assaf Ran, our chief executive officer. (See Note 7 to the financial statements included elsewhere in this report.)
Short-term
loans
. Over the last seven years we have raised approximately $8.7 million through the sale of short and medium-term promissory
notes to private investors. As of April 2016, all of the short-term loans were repaid in full. Senior secured notes having an
aggregate principal amount of $500,000 were repaid in full in 2013.
Public
offerings
. In July 2014, we sold 1,754,386 common shares in a registered public offering for an aggregate of $5.0 million,
or approximately $4.3 million after deducting our underwriting discounts and commissions and offering expenses.
On
May 29, 2015, we completed another public offering of 1,015,000 common shares. In June 2015, the underwriter partially exercised
its over-allotment option for an additional 105,000 common shares. The gross proceeds from the offering, including the partial
exercise of the over-allotment option, were approximately $4.9 million and the net proceeds were approximately $4.2 million, after
deducting our underwriting discounts and commissions and offering expenses.
On
April 25, 2016, MBC Funding II Corp., a New York corporation (“MBC Funding II”), our wholly owned subsidiary, completed
a firm commitment underwritten public offering of 6% senior secured notes due April 22, 2026 (the “Notes”). We guaranteed
MBC Funding II’s obligations under the Notes, which are secured by our pledge of 100% of the outstanding common shares of
MBC Funding II we own. The gross proceeds to MBC Funding II from this offering were $6.0 million, and the net proceeds were approximately
$5.2 million, after deducting the underwriting discounts and commissions and other offering expenses. MBC Funding II utilized
the proceeds to purchase a pool of mortgage loans from us, which we in turn used to pay down the Webster Credit Line.
On
August 15, 2016, we completed another public offering of 672,269 common shares. In addition, the underwriter fully exercised its
over-allotment option for an additional 100,840 common shares. The gross proceeds from the offering, including the exercise of
the over-allotment option, were approximately $4.6 million and the net proceeds were approximately $4.2 million, after deducting
our underwriting discounts and commissions and offering expenses.
The
following table shows our sources of capital, including our financing arrangements, and our loan portfolio as of December 31,
2016:
Sources
of Capital ($ in thousands):
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Debt:
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Line of credit
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$
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6,483
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Senior secured
notes (net of deferred financing costs of $698)
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5,302
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Total debt
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$
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11,785
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Other liabilities
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1,235
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Capital (equity)
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22,314
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Total sources
of capital
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$
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35,334
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Assets:
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Loans:
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Short-term loans
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$
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27,495
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Long-term loans
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7,260
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Total loans
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$
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34,755
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Other assets
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579
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Total assets
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$
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35,334
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Competition
The
real estate finance market in the New York metropolitan area is highly competitive. We face competition for lending and investment
opportunities from a variety of institutional lenders and investors and many other market participants, including specialty finance
companies, mortgage/other REITs, commercial banks and thrift institutions, investment banks, insurance companies, hedge funds
and other financial institutions as well as private equity funds, family offices and high net worth individuals. Many of these
competitors enjoy competitive advantages over us, including greater name recognition, established lending relationships with customers,
financial resources, and access to capital.
Notwithstanding
the intense competition and some of our competitive disadvantages, we believe we have carved a niche for ourselves among small
real estate developers, owners and contractors throughout the New York metropolitan area because of our ability to structure each
loan to suit the needs of each individual borrower and our ability to act quickly. In addition, we believe we have developed a
reputation among these borrowers as offering reasonable terms and providing outstanding customer service. We believe our future
success will depend on our ability to maintain and capitalize on our existing relationships with borrowers and brokers and to
expand our borrower base by continuing to offer attractive loan products, remain competitive in pricing and terms, and provide
superior service.
Sales
and Marketing
We
do not engage any third parties for sales and marketing. Rather, we rely on our internal team to generate lending opportunities
as well as referrals from existing or former borrowers, brokers and bankers and advertising to generate lending opportunities.
A principal source of new transactions has been repeat business from prior customers and their referral of new leads.
Intellectual
Property
Our
business does not depend on exploiting or leveraging any intellectual property rights. To the extent we own any rights to intellectual
property, we rely on a combination of federal, state and common law trademarks, service marks and trade names, copyrights and
trade secret protection. We have registered some of our trademarks and service marks in the United States Patent and Trademark
Office (USPTO) including “Manhattan Bridge Capital” and “DAG Funding Solutions”.
The
protective steps we have taken may not deter misappropriation of our proprietary information. These claims, if meritorious, could
require us to license other rights or subject us to damages and, even if not meritorious, could result in the expenditure of significant
financial and managerial resources on our part.
Employees
As
of December 31, 2016, we employed four employees (three full-time and one part-time). In addition, during 2016 we used outside
lawyers and other independent professionals to verify titles and ownership, to file liens and to consummate the transactions.
Outside appraisers were used to assist management in evaluating the worth of collateral, when deemed necessary by management.
We also used construction inspectors as well as mortgage brokers and deal initiators.
Regulation
Our
operations are subject, in certain instances, to supervision and regulation by state and federal governmental authorities and
may be subject to various laws and judicial and administrative decisions imposing various requirements and restrictions. In addition,
we may rely on exemptions from various requirements of the Securities Act of 1933, as amended (the “Securities Act”),
the Exchange Act, the Investment Company Act and ERISA. These exemptions are sometimes highly complex and may in certain circumstances
depend on compliance by third-parties who we do not control.
Regulatory
Reform
The
Dodd-Frank Act, which went into effect on July 21, 2010, was intended to make significant structural reforms to the financial
services industry. For example, pursuant to the Dodd-Frank Act, various federal agencies have promulgated, or are in the process
of promulgating, regulations with respect to various issues that may affect us. Certain regulations have already been adopted
and others remain under consideration by various governmental agencies, in some cases past the deadlines set in the Dodd-Frank
Act for adoption. At the present time, we do not believe any regulations adopted under the Dodd-Frank Act apply to us. However,
it is possible that regulations that will be adopted in the future will apply to us or that existing regulations will apply to
us as our business evolves.
Regulation
of Commercial Real Estate Lending Activities
Although
most states do not regulate commercial finance, certain states impose limitations on interest rates and other charges and on certain
collection practices and creditor remedies, and require licensing of lenders and financiers and adequate disclosure of certain
contract terms. We also are required to comply with certain provisions of, among other statutes and regulations, certain provisions
of the Equal Credit Opportunity Act that are applicable to commercial loans, The USA PATRIOT Act, regulations promulgated by the
Office of Foreign Asset Control and federal and state securities laws and regulations.
Investment
Company Act Exemption
Although
we reserve the right to modify our business methods at any time, we are not currently required to register as an investment company
under the Investment Company Act. However, we cannot assure you that our business strategy will not evolve over time in a manner
that could subject us to the registration requirements of the Investment Company Act.
Section
3(a)(1)(A) of the Investment Company Act defines an investment company as any issuer that is or holds itself out as being engaged
primarily in the business of investing, reinvesting or trading in securities. Section 3(a)(1)(C) of the Investment Company Act
defines an investment company as any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning,
holding or trading in securities and owns or proposes to acquire investment securities having a value exceeding 40% of the value
of the issuer’s total assets (exclusive of U.S. Government securities and cash items) on an unconsolidated basis, which
we refer to as the 40% test. Real estate mortgages are excluded from the term “investment securities.”
We
rely on the exception set forth in Section 3(c)(5)(C) of the Investment Company Act which excludes from the definition of investment
company “[a]ny person who is not engaged in the business of issuing redeemable securities, face-amount certificates of the
installment type or periodic payment plan certificates, and who is primarily engaged in one or more of the following businesses...
(C) purchasing or otherwise acquiring mortgages and other liens on and interests in real estate.” The U.S. Securities and
Exchange Commission (the “SEC”) generally requires that, for the exception provided by Section 3(c)(5)(C) to be available,
at least 55% of an entity’s assets be comprised of mortgages and other liens on and interests in real estate, also known
as “qualifying interests,” and at least another 25% of the entity’s assets must be comprised of additional qualifying
interests or real estate-type interests (with no more than 20% of the entity’s assets comprised of miscellaneous assets).
At the present time, we qualify for the exemption under this section and our current intention is to continue to focus on originating
short term loans secured by first mortgages on real property. However, if, in the future, we do acquire non-real estate assets
without the acquisition of substantial real estate assets, we may qualify as an “investment company” and be required
to register as such under the Investment Company Act, which could have a material adverse effect on us.
If
we were required to register as an investment company under the Investment Company Act, we would become subject to substantial
regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions
with affiliated persons (as defined in the Investment Company Act), portfolio composition, including restrictions with respect
to diversification and industry concentration, and other matters.
Qualification
for exclusion from the definition of an investment company under the Investment Company Act will limit our ability to make certain
investments. In addition, complying with the tests for such exclusion could restrict the time at which we can acquire and sell
assets.
Environmental
Laws
Our
borrowers, who own properties, may be subject to various environmental laws of federal, state and local governments. To the extent
that an owner of a property underlying one of our debt instruments becomes liable for removal costs, the ability of the owner
to make payments to us may be reduced, which in turn may adversely affect the value of the relevant mortgage asset held by us
and our ability to make distributions to our shareholders. To date, our borrowers compliance with existing laws has not had a
material adverse effect on our earnings and we do not have reason to believe it will have such an impact in the future. However,
we cannot predict the impact of unforeseen environmental contingencies or new or changed laws or regulations on the properties
owned by our borrowers.
Item
1A. Risk Factors
The
following risk factors, among others, could affect our actual results of operations and could cause our actual results to differ
materially from those expressed in forward-looking statements made by us. These forward-looking statements are based on current
expectations and except as required by law we assume no obligation to update this information. You should carefully consider the
risks described below and elsewhere in this Report before making an investment decision. Our business, financial condition or
results of operations could be materially adversely affected by any of these risks. Our common stock is considered speculative
and the trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment.
The following risk factors are not the only risk factors facing our Company. Additional risks and uncertainties not presently
known to us or that we currently deem immaterial may also affect our business.
Risks
Related to Our Business
Our
loan origination activities, revenues and profits are limited by available funds. If we do not increase our working capital, we
will not be able to grow our business.
As
a real estate finance company, our revenue and net income is limited to interest received or accrued on our loan portfolio. Our
ability to originate real estate loans is limited by the funds at our disposal. In February 2015, we replaced the Sterling Credit
Line with the Webster Credit Line. As of December 31, 2016, we had approximately $7.5 million of borrowing availability under
the Webster Credit Line. We intend to use the proceeds from the repayment of loans outstanding and the additional borrowing capacity
under the Webster Credit Line to originate real estate loans. Nevertheless, if demand for our mortgage loans increases, we cannot
assure you that we will be able to capitalize on this demand given the limited funds available to us to originate loans.
We
operate in a highly competitive market and competition may limit our ability to originate loans with favorable interest rates.
We
operate in a highly competitive market and we believe these conditions will persist for the foreseeable future as the financial
services industry continues to consolidate, producing larger, better capitalized and more geographically diverse companies with
broad product and service offerings. Thus, our profitability depends, in large part, on our ability to compete effectively. Our
competition includes mortgage/other REITs, specialty finance companies, savings and loan associations, banks, mortgage banks,
insurance companies, mutual funds, pension funds, private equity funds, hedge funds, institutional investors, investment banking
firms, non-bank financial institutions, governmental bodies, family offices and high net worth individuals. We may also compete
with companies that partner with and/or receive financing from the U.S. Government. Many of our competitors are substantially
larger and have considerably greater financial, technical, marketing and other resources than we do. In addition, larger and more
established competitors may enjoy significant competitive advantages, including enhanced operating efficiencies, more extensive
referral networks, greater and more favorable access to investment capital and more desirable lending opportunities. Several of
these competitors, including mortgage REITs, have recently raised or are expected to raise, significant amounts of capital, which
enables them to make larger loans or a greater number of loans. Some competitors may also have a lower cost of funds and access
to funding sources that may not be available to us, such as funding from various governmental agencies or under various governmental
programs for which we are not eligible. In addition, some of our competitors may have higher risk tolerances or different risk
assessments, which could allow them to consider a wider variety of possible loan transactions or to offer more favorable financing
terms than we would. Finally, as a REIT and because we operate in a manner so as to be exempt from the requirements of the Investment
Company Act, we may face further restrictions to which some of our competitors may not be subject. As a result, we may find that
the pool of potential borrowers available to us is limited. We cannot assure you that the competitive pressures we face will not
have a material adverse effect on our business, financial condition and results of operations.
We
may change our investment, leverage, financing and operating strategies, policies or procedures without shareholder consent, which
may adversely affect the market value of our common shares and our ability to make distributions to shareholders.
We
may amend or revise our policies, including our policies with respect to growth strategy, operations, indebtedness, capitalization,
financing alternatives and underwriting criteria and guidelines, or approve transactions that deviate from our existing policies
at any time, without a vote of, or notice to, our shareholders. For example, we may decide that in order to compete effectively,
we should relax our underwriting guidelines and make riskier loans, which could result in a higher default rate on our portfolio.
We may also decide to expand our business focus to other targeted asset classes, such as participation interests in mortgage loans,
mezzanine loans and subordinate interests in mortgage loans. We could also decide to adopt investment strategies that include
securitizing our portfolio, hedging transactions and swaps. We may even decide to broaden our business to include acquisitions
of real estate assets, which we may or may not operate. Finally, as the market evolves, we may determine that the residential
and commercial real estate markets do not offer the potential for attractive risk-adjusted returns for an investment strategy
that is consistent with our intention to qualify for taxation as a REIT and to operate in a manner to remain exempt from registration
under the Investment Company Act. If we believe it would be advisable for us to be a more active seller of loans and/or interests
thereon, we may determine that we should conduct such business through a taxable REIT subsidiary or that we should cease to maintain
our qualification for taxation as a REIT. These changes may increase our exposure to interest rate risk, default risk, financing
risk and real estate market fluctuations, which could adversely affect our business, operations and financial conditions as well
as the value of our securities and our ability to make distributions to our shareholders.
Management
has broad authority to make lending decisions. If management fails to generate attractive risk-adjusted loans on a consistent
basis, our revenue and income could be materially and adversely affected and the market price of a share of our common shares
is likely to decrease.
Our
board of directors has given management broad authority to make decisions to originate loans. The only limitation imposed by the
board of directors is that no single loan may exceed the lower of (i) 9.9% of our loan portfolio (without taking into account
the loan under consideration) and (ii) $2 million. Within these broad guidelines, our chief executive officer has the absolute
authority to make all lending decisions. Thus, management could authorize transactions that may be costly and/or risky, which
could result in returns that are substantially below expectations or that result in losses, which would materially and adversely
affect our business operations and results. Further, management’s decisions may not fully reflect the best interests of
our shareholders. Our board of directors may periodically review our underwriting guidelines but will not, and will not be required
to, review all of our proposed loans. In conducting periodic reviews, our board of directors will rely primarily on information
provided to them by management.
Our
chief executive officer and chief financial officer are each critical to our business and our future success may depend on our
ability to retain them. In addition, as our business grows we will need to hire additional personnel.
Our
future success depends to a significant extent on the continued efforts of our founder, president and chief executive officer,
Assaf Ran, and our chief financial officer, Vanessa Kao. Mr. Ran generates most, if not all, of our loan applications, supervises
all aspects of the underwriting and due diligence process in connection with each loan, structures each loan and has absolute
authority (subject only to the maximum amount of the loan) as to whether or not to approve the loan. Ms. Kao services all loans
in our portfolio. If Mr. Ran is unable to continue to serve as our chief executive officer on a full-time basis, we might not
be able to generate sufficient loan applications and our business and operations would be adversely affected. In addition, in
the future we may need to attract and retain qualified senior management and other key personnel, particularly individuals who
are experienced in the real estate finance business and people with experience in managing a mortgage REIT. If we are unable to
recruit and retain qualified personnel in the future, our ability to continue to operate and to grow our business will be impaired.
Terrorist
attacks and other acts of violence or war may affect the real estate industry generally and our business, financial condition
and results of operations.
The
risk of terrorist attacks by extremist groups has risen dramatically over the last few years. Any future terrorist attacks, the
anticipation of any such attacks, and the consequences of any military or other response by the United States and its allies may
have an adverse impact on the U.S. financial markets and the economy in general. In addition, a significant terrorist attack in
New York City, such as those recently perpetrated in Paris, France and San Bernardino, California could have a material adverse
impact on the New York real estate market, which, in turn, could make it more difficult for our borrowers to repay their loans.
We cannot predict the severity of the effect that any such future events would have on the U.S. financial markets, including the
real estate capital markets, the economy or our business. Any future terrorist attacks could adversely affect the credit quality
of some of our loan portfolio. We may suffer losses as a result of the adverse impact of any future terrorist attacks and these
losses may adversely impact our results of operations.
The
enactment of the Terrorism Risk Insurance Act of 2002, or the TRIA, and the subsequent enactment of the Terrorism Risk Insurance
Program Reauthorization Act of 2007, which extended TRIA through the end of 2020, requires insurers to make terrorism insurance
available under their property and casualty insurance policies in order to receive federal compensation under TRIA for insured
losses. However, this legislation does not regulate the pricing of such insurance. The absence of affordable insurance coverage
may adversely affect the general real estate lending market, lending volume and the market’s overall liquidity and may reduce
the number of suitable financing opportunities available to us and the pace at which we are able to make loans. If property owners
are unable to obtain affordable insurance coverage, the value of their properties could decline and in the event of an uninsured
loss, we could lose all or a portion of our investment.
Security
breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and
reputation to suffer.
In
the ordinary course of our business, we may acquire and store sensitive data on our network, such as our proprietary business
information and personally identifiable information of our prospective and current borrowers. The secure processing and maintenance
of this information is critical to our business strategy. Despite our security measures, our information technology and infrastructure
may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. Any such breach could
compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access,
disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy
of personal information, regulatory penalties, disruption to our operations and the services we provide to customers or damage
our reputation, which could materially and adversely affect us.
Our
existing credit line has numerous covenants. If we are unable to comply with these covenants, the outstanding amount of the loan
could become due and payable.
The
Webster Credit Line contains various covenants and restrictions that are typical for these kinds of credit facilities, including
limiting the amount that we can borrow relative to the value of the underlying collateral, maintaining various financial ratios
and limitations on the terms of loans we make to our customers. If we fail to meet or satisfy any of these covenants, we would
be in default under our agreement with Webster, and Webster could elect to declare outstanding amounts due and payable, terminate
its commitments to us, require us to post additional collateral and/or enforce their interests against existing collateral. Acceleration
of our debt to Webster could significantly reduce our liquidity or require us to sell our assets to repay amounts due and outstanding.
This would significantly harm our business, financial condition, results of operations and ability to make distributions and could
result in the foreclosure of our assets which secure our obligations, which could cause the value of our outstanding securities
to decline. A default could also significantly limit our financing alternatives such that we would be unable to pursue our leverage
strategy, which could adversely affect our returns.
Our
indebtedness could adversely affect our financial flexibility and our competitive position.
We
have, and expect that we will continue to have a significant amount of indebtedness. As of December 31, 2016, we had approximately
$12.5 million of debt outstanding, consisting of the amounts outstanding under the Webster Credit Line and the balance of senior
secured notes. Another $7.5 million was available under the Webster Credit Line as of that date. This level of indebtedness increases
the risk that we may be unable to generate cash sufficient to pay amounts due in respect of the indebtedness. Our indebtedness
could have other important consequences to you and significantly impact our business. For example, it could:
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make
it more difficult for us to satisfy our obligations;
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increase
our vulnerability to adverse changes in general economic, industry and competitive conditions;
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require
us to dedicate a substantial portion of our cash flow from operations to make payments on our indebtedness, thereby reducing
the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes;
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limit
our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
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limit
our ability to make material acquisitions or take advantage of business opportunities that may arise;
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expose
us to fluctuations in interest rates, to the extent our borrowings bear variable rates of interest;
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place
us at a competitive disadvantage compared to our competitors that have less debt;
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limit
our ability to borrow additional funds for working capital, capital expenditures, acquisitions, debt service requirements,
execution of our business plan or other general corporate purposes on reasonable terms or at all;
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reduce
the amount of surplus funds distributable by our subsidiaries to us for use in our business, such as for the payment of indebtedness
and dividends to our shareholders; and
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lead
us to elect to make additional investments in our subsidiaries if their cash flow from operations is insufficient for them
to make payments on their indebtedness.
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We
may incur additional debt, which could exacerbate the risks associated with our leverage.
We
and our subsidiaries may incur substantial additional indebtedness in the future. The covenants in the agreement governing the
Webster Credit Line may limit our ability and the ability of our subsidiaries to incur additional indebtedness. To the extent
that we are nevertheless able to incur additional indebtedness or such other obligations, the risks associated with our indebtedness
described above, including our possible inability to service our debt, will increase.
Our
financial statements may be materially affected if our estimates prove to be inaccurate.
Financial
statements prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP) require the use of estimates, judgments
and assumptions that affect the reported amounts. Different estimates, judgments and assumptions reasonably could be used that
would have a material effect on the financial statements, and changes in these estimates, judgments and assumptions are likely
to occur from period to period in the future. Significant areas of accounting requiring the application of management’s
judgment include, but are not limited to, assessing the adequacy of the allowance for loan losses. These estimates, judgments
and assumptions are inherently uncertain, and, if they prove to be wrong, then we face the risk that charges to income will be
required. For example, currently, we do not carry any loan loss reserves. However, a decline in economic condition could negatively
impact the credit quality of our loan portfolio and require us to establish loan loss reserves, which could have an adverse impact
on our net income. In addition, because we have limited operating history as a REIT and limited experience in making these estimates,
judgments and assumptions, the risk of future charges to income may be greater than if we had more experience in these areas.
Any such charges could significantly harm our business, financial condition, results of operations and the price of our securities.
Risks
Related to Our Portfolio
If
we overestimate the yields on our loans or incorrectly value the collateral securing the loan, we may experience losses.
Loan
decisions are typically made based on the credit-worthiness of the borrower and the value of the collateral securing the loan.
We cannot assure you that our assessments will always be accurate or the circumstances relating to a borrower or the collateral
will not change during the loan term, which could lead to losses and write-offs. Losses and write-offs could materially and adversely
affect our business, operations and financial condition and the market price of our securities.
Difficult
conditions in the markets for mortgages and mortgage-related assets as well as the broader financial markets have resulted in
a significant contraction in liquidity for mortgages and mortgage-related assets, which may adversely affect the value of the
assets that we intend to originate.
Our
results of operations will be materially affected by conditions in the markets for mortgages and mortgage-related assets as well
as the broader financial markets and the economy generally. Significant adverse changes in financial market conditions may result
in a decline in real estate values, jeopardizing the performance and viability of many real estate loans. As a result, many traditional
mortgage lenders may suffer severe losses and even fail. This situation may negatively affect both the terms and availability
of financing for small non-bank real estate finance companies. This could have an adverse impact on our financial condition, business
and operations.
Short-term
loans and loans on which the maturity date has been extended may involve a greater risk of loss than traditional mortgage loans.
Borrowers
usually use the proceeds of a long-term mortgage loan or sale to repay our loans. We may therefore depend on a borrower’s
ability to obtain permanent financing or sell the property to repay our loan, which could depend on market conditions and other
factors. On our balance sheet we make a distinction between short- and long-term loans receivable. Long-term loans receivable
are loans that are extended beyond their original maturity dates unless it is clear that the loan will be repaid within one year
of the balance sheet date. At December 31, 2016, our long-term loans receivable was $7.3 million compared to $10.7 million at
December 31, 2015. At December 31, 2016, our long-term loans receivable represented approximately 20.9% of total loans receivable
compared to 34.6% at December 31, 2015. Our loans are also subject to risks of borrower defaults, bankruptcies, fraud, losses
and special hazard losses that are not covered by standard hazard insurance. In the event of a default, we bear the risk of loss
of principal and non-payment of interest and fees to the extent of any deficiency between the value of the mortgage collateral
and the principal amount and unpaid interest of the loan. To the extent we suffer such losses with respect to our loans, our enterprise
value and the price of our securities may be adversely affected.
We
may be subject to “lender liability” claims. Our financial condition could be materially and adversely impacted if
we were to be found liable and required to pay damages.
In
recent years, a number of judicial decisions have upheld the right of borrowers to sue lenders on the basis of various evolving
legal theories, collectively termed “lender liability.” Generally, lender liability is founded on the premise that
a lender has either violated a duty, whether implied or contractual, of good faith and fair dealing owed to the borrower or has
assumed a degree of control over the borrower resulting in the creation of a fiduciary duty owed to the borrower or its other
creditors or shareholders. We cannot assure you that such claims will not arise or that we will not be subject to significant
liability if a claim of this type did arise.
An
increase in the rate of prepayment of outstanding loans may have an adverse impact on the value of our portfolio as well as our
revenue and income.
The
value of our loan portfolio may be affected by prepayment rates and a significant increase in the rate of prepayments could have
an adverse impact on our operating results. Prepayment rates cannot be predicted with certainty and no strategy can completely
insulate us from prepayment or other such risks. In periods of declining interest rates, prepayment rates on mortgage and other
real estate-related loans generally increase. Proceeds of prepayments received during such periods are likely to be reinvested
by us in new loans yielding less than the yields on the loans that were prepaid, resulting in lower revenues and possibly, lower
profits. A portion of our loan portfolio requires prepayment fees if a loan is prepaid. However, there can be no assurance that
these fees will make us whole for the detriment incurred by virtue of the prepayment.
The
lack of liquidity in our portfolio may adversely affect our business.
The
illiquidity of our loan portfolio may make it difficult for us to sell such assets if the need or desire arises. As a result,
if we are required to liquidate all or a portion of our portfolio quickly, we may realize significantly less than the outstanding
loan balance.
The
geographic concentration of our loan portfolio may make our revenues and the values of the mortgages and real estate securing
our portfolio vulnerable to adverse changes in economic conditions in the New York metropolitan area.
Under
our current business model, we have one asset class — mortgage loans that we originate, service and manage — and we
have no current plans to diversify. Moreover, most of our collateral is located in a limited geographic area. At December 31,
2016, all of our outstanding loans are secured by properties located in the New York metropolitan area. A lack of geographical
diversification makes our mortgage portfolio more sensitive to local and regional economic conditions. A significant decline in
the New York metropolitan area economy could result in a greater risk of default compared with the default rate for loans secured
by properties in other geographic locations. This could result in a reduction of our revenues and provision for loan loss allowances,
which might not be as acute if our loan portfolio were more geographically diverse. Therefore, our loan portfolio is subject to
greater risk than other real estate finance companies that have a more diversified asset base and broader geographic footprint.
To the extent that our portfolio is concentrated in one region and/or one type of asset, downturns relating generally to such
region or type of asset may result in defaults on a number of our assets within a short time period, which may reduce our net
income and the value of our securities and accordingly reduce our ability to make distributions to our shareholders.
A
prolonged economic slowdown, a lengthy or severe recession or declining real estate values could impair our investments and harm
our operations.
A
prolonged economic slowdown, a recession or declining real estate values could impair the performance of our assets and harm our
financial condition and results of operations, increase our funding costs, limit our access to the capital markets or result in
a decision by lenders not to extend credit to us. Thus, we believe the risks associated with our business will be more severe
during periods of economic slowdown or recession because these periods are likely to be accompanied by declining real estate values.
Declining real estate values are likely to have one or more of the following adverse consequences:
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reduce
the level of new mortgage and other real estate-related loan originations since borrowers often use appreciation in the value
of their existing properties to support the purchase or investment in additional properties;
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make
it more difficult for existing borrowers to remain current on their payment obligations; and
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significantly
increase the likelihood that we will incur losses on our loans in the event of default because the value of our collateral
may be insufficient to cover our cost on the loan.
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Any
sustained period of increased payment delinquencies, foreclosures or losses could adversely affect both our net interest income
from loans in our portfolio as well as our ability to originate new loans, which would materially and adversely affect our results
of operations, financial condition, liquidity and business and our ability to make distributions to our shareholders.
We
do not carry any loan loss reserves. If we are required to write-off all or a portion of any loan in our portfolio, our net income
will be adversely impacted. Loan loss reserves are particularly difficult to estimate in a turbulent economic environment.
Based
on our experience and our periodic evaluation of our loan portfolio, we have not deemed it necessary to create any loan loss reserves.
Thus, a loss with respect to all or a portion of a loan in our portfolio will have an immediate and adverse impact on our net
income. The valuation process of our loan portfolio requires us to make certain estimates and judgments, which are particularly
difficult to determine during a period in which the availability of real estate credit is limited and real estate transactions
have decreased. These estimates and judgments are based on a number of factors, including projected cash flows from the collateral
securing our mortgage loans, if any, loan structure, including the availability of reserves and recourse guarantees, likelihood
of repayment in full at the maturity of a loan, the relative strength or weakness of the refinancing market and expected market
discount rates for varying property types. If our estimates and judgments are not correct, our results of operations and financial
condition could be severely impacted.
Our
due diligence may not reveal all of a borrower’s liabilities and may not reveal other weaknesses in its business.
Before
making a loan to a borrower, we assess the strength and skills of such entity’s management and other factors that we believe
are material to the performance of the loan. In making the assessment and otherwise conducting customary due diligence, we rely
on the resources available to us and, in some cases, services provided by third parties. This process is particularly important
and subjective with respect to newly organized entities because there may be little or no information publicly available about
the entities. There can be no assurance that our due diligence processes will uncover all relevant facts or that the borrower’s
circumstances will not change after the loan is funded. In either case, this could adversely impact the performance of the loan
and our operating results.
Our
loans are usually made to entities to enable them to acquire, develop or renovate residential or commercial property, which may
involve a greater risk of loss than loans to individual owners of residential real estate.
We
make loans to corporations, partnerships and limited liability companies that are looking to purchase, renovate and/or improve
residential or commercial real estate held for resale or investment. More often than not, the property is under-utilized, poorly
managed, or located in a recovering neighborhood. These loans may have a higher degree of risk than loans to individual property
owners with respect to their primary residence or to owners of commercial operating properties because of a variety of factors.
For instance, our borrowers usually do not have the need to occupy the property, or an emotional attachment to the property as
borrowers of owner-occupied residential properties typically have, and therefore they do not always have the same incentive to
avoid foreclosure. Similarly, in the case of non-residential property, a majority of the properties securing our loans have little
or no cash flow. If the neighborhood in which the asset is located fails to recover according to the borrower’s projections,
or if the borrower fails to improve the quality of the property’s performance and/or the value of the property, the borrower
may not receive a sufficient return on the property to satisfy the loan, and we bear the risk that we may not recover some or
all of our principal. Finally, there are difficulties associated with collecting debts from entities that may be judgment proof.
While we try to mitigate these risks in various ways, including by getting personal guarantees from the principals of the borrower,
we cannot assure you that these lending and credit enhancement strategies will be successful.
Volatility
of values of residential and commercial properties may adversely affect our loans and investments.
Residential
and commercial property values are subject to volatility and may be affected adversely by a number of factors, including, but
not limited to, events such as natural disasters, including hurricanes and earthquakes, acts of war and/or terrorism and others
that may cause unanticipated and uninsured performance declines and/or losses to us or the owners and operators of the real estate
securing our investment; national, regional and local economic conditions, such as what we have experienced in recent years (which
may be adversely affected by industry slowdowns and other factors); local real estate conditions (such as an oversupply of housing,
retail, industrial, office or other commercial space); changes or continued weakness in specific industry segments; construction
quality, construction cost, age and design; demographic factors; retroactive changes to building or similar codes; and increases
in operating expenses (such as energy costs). In the event of a decline in the value of a property securing one of our loans,
the borrower may have difficulty repaying our loan, which could result in losses to us. In addition, decreases in property values
reduce the value of the collateral and the potential proceeds available to a borrower to repay our loans, which could also cause
us to suffer losses.
Our
inability to promptly foreclose on defaulted loans could increase our costs and/or losses.
The
performance of first mortgage loans may depend on the performance of the underlying real estate collateral. In particular, mortgage
loans secured by property held for investment or resale are subject to risks of delinquency and foreclosure, and risks of loss
that are greater than similar risks associated with loans secured by owner-occupied residential properties. The ability of a borrower
under a first mortgage loan to repay a loan secured by an income-producing property typically depends primarily on the successful
operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating
income of the property is reduced, the borrower’s ability to repay the loan is impaired and the borrower defaults, we may
lose all or substantially all of our investment. If the property is not income producing, as is the case with most of our loans,
the risks are even greater. While we have certain rights with respect to the real estate collateral underlying a first mortgage
loan, and rights against the borrower and guarantor(s), in the event of a default there are a variety of factors that may inhibit
our ability to enforce our rights to collect the loan, whether through a non-payment action against the borrower, a foreclosure
proceeding against the underlying property or a collection or enforcement proceeding against the guarantor. These factors include,
without limitation, state foreclosure timelines and deferrals associated therewith (including with respect to litigation); unauthorized
occupants living in the property; federal, state or local legislative action or initiatives designed to provide residential property
owners with assistance in avoiding foreclosures and that serve to delay the foreclosure process; government programs that require
specific procedures to be followed to explore the refinancing of a residential mortgage loan prior to the commencement of a foreclosure
proceeding; and continued declines in real estate values and sustained high levels of unemployment that increase the number of
foreclosures and place additional pressure on the already overburdened judicial and administrative systems.
None
of our loans are funded with interest reserves and our borrowers may be unable to pay the interest accruing on the loans when
due, which could have a material adverse impact on our financial condition.
Our
loans are not funded with an interest reserve. Thus, we rely on the borrowers to make interest payments as and when due from other
sources of cash. Given the fact that most of the properties securing our loans are not income producing or even cash producing
and most of the borrowers are entities with no assets other than the single property that is the subject of the loan, some of
our borrowers have considerable difficulty servicing our loans and the risk of a non-payment of default is considerable. We depend
on the borrower’s ability to refinance the loan at maturity or sell the property for repayment. If the borrower is unable
to repay the loan, together with all the accrued interest, at maturity, our operating results and cash flows would be materially
and adversely affected. Foreclosure of a mortgage loan can be an expensive and lengthy process that could have a substantial negative
effect on our anticipated return on the foreclosed mortgage loan. In addition, in the event of the bankruptcy of the borrower,
we may not have full recourse to the assets of the borrower, or the assets of the borrower or the guarantor may not be sufficient
to satisfy the debt.
Interest
rate fluctuations could reduce our ability to generate income and may cause losses.
Our
primary interest rate exposures relate to the yield on our loan portfolio and the financing cost of our debt. Our operating results
depend, in part, on differences between the interest income generated by our loan portfolio net of credit losses and our financing
costs. Thus, changes in interest rates will affect our revenue and net income in one or more of the following ways:
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our
operating expenses may increase;
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our
ability to originate loans may be adversely impacted;
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to
the extent we use our credit line or other forms of debt financing to originate loans, our borrowing costs would rise, reducing
the “spread” between our cost of funds and the yield on our outstanding mortgage loans, which tend to be fixed
rate obligations;
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a
rise in interest rates may discourage potential borrowers from refinancing existing loans or defer plans to renovate or improve
their properties;
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borrower
default rates may increase;
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property
values may be negatively impacted, making our existing loans riskier and new loans that we originate smaller; and
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rising
interest rates could also result in reduced turnover of properties which may reduce the demand for new mortgage loans.
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Liability
relating to environmental matters may impact the value of properties that we may acquire or the properties underlying our investments.
Under
various U.S. federal, state and local laws, an owner or operator of real property may become liable for the costs of removal of
certain hazardous substances released on its property. These laws often impose liability without regard to whether the owner or
operator knew of, or was responsible for, the release of such hazardous substances. The presence of hazardous substances may adversely
affect an owner’s ability to sell real estate or borrow using real estate as collateral. To the extent that an owner of
a property underlying one of our debt instruments becomes liable for removal costs, the ability of the owner to make payments
to us may be reduced, which in turn may adversely affect the value of the relevant mortgage asset held by us and our ability to
make distributions to our shareholders. If we acquire any properties by foreclosure or otherwise, the presence of hazardous substances
on a property may adversely affect our ability to sell the property and we may incur substantial remediation costs, thus harming
our financial condition. The discovery of material environmental liabilities attached to such properties could have a material
adverse effect on our results of operations and financial condition and our ability to make distributions to shareholders.
Defaults
on our loans may cause declines in revenues and net income.
Defaults
by borrowers could result in one or more of the following adverse consequences:
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a
decrease in interest income, profitability and cash flow;
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the
establishment of or an increase in loan loss reserves;
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write-offs
and losses;
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an
increase in legal and enforcement costs, as we seek to protect our rights and recover the amounts owed;
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default
under our credit facilities; and
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an
increase in legal and enforcement costs, as we seek to protect our rights and recover the amounts owed.
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As
a result, we will have less cash available for paying our other operating expenses and for making distributions to our shareholders.
This would have a material adverse effect on the market value of our securities.
Our
revenues and the value of our portfolio may be negatively affected by casualty events occurring on properties securing our loans.
We
require our borrowers to obtain, for our benefit, all risk property insurance covering the property and any improvements to the
property collateralizing our loan in an amount intended to be sufficient to provide for the cost of replacement in the event of
casualty. However, the amount of insurance coverage maintained for any property may not be sufficient to pay the full replacement
cost following a casualty event. Furthermore, there are certain types of losses, such as those arising from earthquakes, floods,
hurricanes and terrorist attacks, that may be uninsurable or that may not be economically feasible to insure. Changes in zoning,
building codes and ordinances, environmental considerations and other factors may make it impossible for our borrowers to use
insurance proceeds to replace damaged or destroyed improvements at a property. If any of these or similar events occur, the amount
of coverage may not be sufficient to replace a damaged or destroyed property and/or to repay in full the amount due on loans collateralized
by such property. As a result, our returns and the value of our investment may be reduced.
Borrower
concentration could lead to significant losses, which could have a material adverse impact on our operating results and financial
condition.
A
single borrower or a group of affiliated borrowers may account for more than 10% of our loan portfolio. A default by one borrower
in a group is likely to result in a default by the other borrowers in the group. Concentration of loans to one borrower or a group
of affiliated borrowers poses a significant risk, as default would have a material adverse impact on our operating results, cash
flow, the Webster Credit Line, financial condition and our ability to service our debt.
Risks
Related to Financing Transactions
Our
existing credit line has numerous covenants with which we must comply. If we are unable to comply with these covenants, the outstanding
amount of the loan could become due and payable and we may have to sell off a portion of our loan portfolio to pay off the debt.
We
have a $14.0 million credit line with Webster that expires on February 27, 2018. The Webster Credit Line contains various covenants
and restrictions that are typical for these kinds of credit facilities, including limiting the amount that we can borrow relative
to the value of the underlying collateral, maintaining various financial ratios and limitations on the terms of loans we make
to our customers. The Webster Credit Line imposes certain restrictions which may adversely impact our ability to grow and/or maintain
our qualification for taxation as a REIT. These limitations include the following:
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limit
our ability to pay dividends under certain circumstances;
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limit
our ability to make certain investments or acquisitions;
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limit
our ability to reduce liquidity below certain levels;
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limit
our ability to redeem debt or equity securities;
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limit
our ability to determine our operating policies and investment strategies; and
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limit
our ability to repurchase our common shares, sell assets, engage in mergers or consolidations, grant liens and enter into
transactions with affiliates.
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If
we fail to meet or satisfy any of these covenants, we would be in default under our agreement with Webster, and Webster could
elect to declare outstanding amounts due and payable, terminate its commitments to us, require us to post additional collateral
and/or enforce their interests against existing collateral. Acceleration of our debt to Webster, could also make it difficult
for us to satisfy the requirements necessary to maintain our qualification for taxation as a REIT, significantly reduce our liquidity
or require us to sell our assets to repay amounts due and outstanding. This would significantly harm our business, financial condition,
results of operations and ability to make distributions and could result in the foreclosure of our assets which secure our obligations,
which could cause the value of our outstanding securities to decline. A default could also significantly limit our financing alternatives
such that we would be unable to pursue our leverage strategy, which could adversely affect our returns.
Under
the terms of the agreement governing the Webster Credit Line, our borrowing capacity is limited to 70% of Eligible Mortgage Loans
(as defined). Moreover, Webster, in its discretion, may reduce this percentage. This borrowing limitation is determined, in part,
by the value of the real estate securing the loans in our portfolio. Thus, a general decline in real estate values or a change
in the percentage will adversely impact our ability to borrow under the Webster Line of Credit and could even result in a situation
where any amount in excess of the borrowing limitation will become immediately due and payable. If we default and Webster accelerates
the loan we would have to repay the debt immediately with our working capital (
i.e.,
proceeds from loan repayments), sell
a portion of our loan portfolio and use the proceeds to repay the debt or refinance with another lender. We cannot assure you
that we would be able to replace the Webster Credit Line on similar terms or on any terms. If we have to sell a portion of our
loan portfolio, the amount we realize may be less than the face amount of the loans sold, resulting in a loss. If we sell a portion
of our portfolio or use proceeds from loan repayments to pay the Webster debt, our opportunities to grow our business will be
negatively impacted.
Our
access to financing may be limited and, thus, our ability to maximize our returns may be adversely affected.
Our
ability to grow and compete may also depend on our ability to borrow money to leverage our loan portfolio and to build and manage
the cost of expanding our infrastructure to manage and service a larger loan portfolio. In general, the amount, type and cost
of any financing that we obtain from another financial institution will have a direct impact on our revenue and expenses and,
therefore, can positively or negatively affect our financial results. The percentage of leverage we employ will vary depending
on our assessment of a variety of factors, which may include the anticipated liquidity and price volatility of our existing portfolio,
the potential for losses and extension risk in our portfolio, the gap between the duration of our assets and liabilities, the
availability and cost of financing, our opinion as to the creditworthiness of our financing counterparties, the health of the
U.S. economy and commercial mortgage markets, our outlook for the level, slope, and volatility of interest rates, the credit quality
of our borrowers and the collateral underlying our assets.
Our
access to financing will depend upon a number of factors, over which we have little or no control, including:
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general
market conditions;
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the
market’s view of the quality of our assets;
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the
market’s perception of our growth potential;
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our
eligibility to participate in and access capital from programs established by the U.S. Government;
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our
current and potential future earnings and cash distributions; and
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the
market price of our common shares.
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Continuing
weakness in the capital and credit markets could adversely affect our ability to secure financing on favorable terms or at all.
In general, this could potentially increase our financing costs and reduce our liquidity or require us to sell loans at an inopportune
time or price.
We
cannot assure you that we will always have access to structured financing arrangements when needed. If structured financing arrangements
are not available to us we may have to rely on equity issuances, which may be dilutive to our shareholders, or on less efficient
forms of debt financing that require a larger portion of our cash flow from operations, thereby reducing funds available for our
operations, future business opportunities, cash distributions to our shareholders and other purposes. We cannot assure you that
we will have access to such equity or debt capital on favorable terms (including, without limitation, cost and term) at the desired
times, or at all, which may cause us to curtail our lending activities and/or dispose of loans in our portfolio, which could negatively
affect our results of operations.
Our
use of leverage may adversely affect the return on our assets and may reduce cash available for distribution to our shareholders,
as well as increase losses when economic conditions are unfavorable.
We
do not have a formal policy limiting the amount of debt we incur and our governing documents contain no limitation on the amount
of leverage we may use. We may significantly increase the amount of leverage we utilize at any time without approval of our board
of directors. In addition, we may leverage individual assets at substantially higher levels. Incurring substantial debt could
subject us to many risks that, if realized, would materially and adversely affect us, including the risk that:
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our
cash flow from operations may be insufficient to make required payments of principal and interest on our outstanding indebtedness
or we may fail to comply with all of the other covenants contained in the debt, which is likely to result in (i) acceleration
of such debt (and any other debt containing a cross-default or cross-acceleration provision) that we may be unable to repay
from internal funds or to refinance on favorable terms, or at all, (ii) our inability to borrow unused amounts under our financing
arrangements, even if we are current in payments on borrowings under those arrangements and/or (iii) the loss of some or all
of our assets pledged or liened to secure our indebtedness to foreclosure or sale;
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our
debt may increase our vulnerability to adverse economic and industry conditions with no assurance that yields will increase
with higher financing costs;
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we
may be required to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing
funds available for operations, future business opportunities, shareholder distributions or other purposes; and
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we
are not able to refinance debt that matures prior to the asset it was used to finance on favorable terms, or at all.
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Our
board of directors may adopt leverage policies at any time without the consent of our shareholders, which could result in a portfolio
with a different risk profile.
Risks
Related to REIT Status and Investment Company Act Exemption
We
have limited experience operating as a REIT or managing a portfolio of assets in the manner necessary to maintain an exemption
under the Investment Company Act, which may hinder our ability to achieve our business objectives or result in the loss of our
qualification as a REIT.
Until
2014, we operated as a taxable C-corporation subject to federal corporate income taxes. While we have been profitable in every
year since we started our lending business, we cannot assure you that we will be able to continue to operate our business successfully
in conformity with REIT requirements. As a result, we are subject to all of the customary business risks and uncertainties associated
with any new business, including the risk that we will not achieve our objectives and, as a result, the value of our common shares
could decline substantially.
The
rules and regulations applicable to REITs under the Code, are highly technical and complex and the failure to comply with these
rules and regulations in a timely manner could prevent us from qualifying for taxation as a REIT or could force us to pay unexpected
taxes and penalties. Our executive officers have limited experience managing a portfolio of assets under these complex rules and
regulations or operating a business in compliance with the numerous technical restrictions and limitations set forth in the Code
applicable to REITs. In addition, in order to maintain our exemption from registration under the Investment Company Act, the assets
in our portfolio are subject to certain restrictions, which limits our operations meaningfully. Our executive officers have limited
experience managing a portfolio in the manner necessary to maintain our exemption from registration under the Investment Company
Act, and limited experience managing a public company under the constraints imposed by the Investment Company Act.
Complying
with REIT requirements may hinder our ability to maximize profits, which would reduce the amount of cash available to be distributed
to our shareholders. This could have a negative impact on the value of our securities.
In
order to maintain our qualification for taxation as a REIT, we must continually satisfy tests concerning among other things, the
composition of our assets, our sources of income, the amounts we distribute to our shareholders and the ownership of our capital
stock. Specifically, we must ensure that at the end of each calendar quarter at least 75% of the value of our assets consists
of cash, cash items, government securities and qualified REIT real estate assets. The remainder of our investment in securities
of any issuer (excluding those of our taxable REIT subsidiaries and our qualified REIT subsidiaries) cannot include more than
10% of the outstanding voting securities of such issuer, more than 10% of the total value of the outstanding securities of such
issuer, or exceed more than 5% of the value of our assets. If we fail to comply with these requirements, we must dispose of the
portion of our assets in excess of such amounts within 30 days after the end of the calendar quarter in order to maintain our
qualification for taxation as a REIT and to avoid suffering other adverse tax consequences. In such event, we may be forced to
sell non-qualifying assets at less than their fair market value. In addition, we may also be required to make distributions to
shareholders at times when we do not have funds readily available for distribution or are otherwise not optional for us. Accordingly,
compliance with REIT requirements may hinder our ability to operate solely on the basis of maximizing profits.
Our
failure to remain qualified for taxation as a REIT would subject us to U.S. federal income tax and applicable state and local
taxes, which would reduce the amount of cash available for distribution to our shareholders.
We
intend to continue to operate in a manner that will enable us to continue to qualify for taxation as a REIT as long as we believe
it is in the best interests of our shareholders. While we believe that we qualified for taxation as a REIT for the taxable year
ended December 31, 2016, we have not requested and do not intend to request a ruling from the Internal Revenue Service(the “IRS”),
that we so qualified in 2016 or that we will qualify in future years. The U.S. federal income tax laws and the Treasury Regulations
promulgated thereunder governing REITs are complex. In addition, judicial and administrative interpretations of the U.S. federal
income tax laws governing REIT qualification are limited. To qualify for taxation as a REIT, we must meet, on an ongoing basis,
various tests regarding the nature of our assets and our income, the ownership of our outstanding shares, and the amount of our
distributions. Our ability to satisfy the asset tests depends on our analysis of the characterization and fair market values of
our assets, some of which are not susceptible to a precise determination, and for which we will not obtain independent appraisals.
Our compliance with the REIT income and quarterly asset requirements also depends on our ability to successfully manage the composition
of our income and assets on an ongoing basis. Moreover, new legislation, court decisions or administrative guidance, in each case
possibly with retroactive effect, may make it more difficult or impossible for us to qualify for taxation as a REIT. Thus, while
we intend to operate so that we will continue to qualify for taxation as a REIT, given the highly complex nature of the rules
governing REITs, the ongoing importance of factual determinations, and the possibility of future changes in our circumstances,
no assurance can be given that we will so qualify for any particular year. These considerations also might restrict the types
of assets that we can acquire in the future.
If
we fail to qualify for taxation as a REIT in any taxable year, and we do not qualify for certain statutory relief provisions,
we would be required to pay U.S. federal income tax on our taxable income, and distributions to our shareholders would not be
deductible by us in determining our taxable income. In such a case, we might need to borrow money or sell assets in order to pay
our taxes. Our payment of income tax would decrease the amount of our income available for distribution to our shareholders. Furthermore,
if we fail to maintain our qualification for taxation as a REIT, we no longer would be required to distribute substantially all
of our taxable income to our shareholders. In addition, unless we were eligible for certain statutory relief provisions, we could
not re-elect to qualify for taxation as a REIT until the fifth calendar year following the year in which we failed to qualify.
REIT
distribution requirements could adversely affect our ability to execute our business plan and may require us to incur debt or
sell assets to make such distributions.
In
order to qualify as a REIT, we must distribute to our shareholders, each calendar year, at least 90% of our REIT taxable income
(including certain items of non-cash income), determined without regard to the deduction for dividends paid and excluding net
capital gain. To the extent that we satisfy the 90% distribution requirement, but distribute less than 100% of our taxable income,
we are subject to U.S. federal corporate income tax on our undistributed income. In addition, we will incur a 4% nondeductible
excise tax on the amount, if any, by which our distributions in any calendar year are less than a minimum amount specified under
U.S. federal income tax laws. We intend to distribute our net income to our shareholders in a manner that will satisfy the REIT
90% distribution requirement and avoid the 4% nondeductible excise tax.
Under
the terms of the agreement governing the Webster Line of Credit, we are prohibited from paying dividends with respect to our common
shares if at the time during the 90-day period before the payment of the dividend and the 90-day period following the payment
of the dividend we are within $500,000 of our maximum borrowing ability under the facility. Under these circumstances, we would
have to choose to either pay the dividend putting us in default under the Webster Credit Line and maintain our qualification for
taxation as a REIT or not pay the dividend and jeopardize our REIT status. In either case, there would be material adverse consequences
to us and our shareholders.
Our
taxable income may substantially exceed our net income as determined by U.S. GAAP and differences in timing between the recognition
of taxable income and the actual receipt of cash may occur. For example, we may be required to accrue interest and discount income
on mortgage loans before we receive any payments of interest or principal on such assets. We may be required under the terms of
the indebtedness that we incur, to use cash received from interest payments to make principal payment on that indebtedness, with
the effect that we will recognize income but will not have a corresponding amount of cash available for distribution to our shareholders.
As
a result of the foregoing, we may generate less cash flow than taxable income in a particular year and find it difficult or impossible
to meet the REIT distribution requirements in certain circumstances. In such circumstances, we may be required to: (i) sell assets
in adverse market conditions, (ii) borrow on unfavorable terms, (iii) distribute amounts that would otherwise be invested in future
acquisitions, capital expenditures or repayment of debt, (iv) make a taxable distribution of our shares as part of a distribution
in which shareholders may elect to receive shares or (subject to a limit measured as a percentage of the total distribution) cash
or (v) use cash reserves, in order to comply with the REIT distribution requirements and to avoid corporate income tax and the
4% nondeductible excise tax. Thus, compliance with the REIT distribution requirements may hinder our ability to grow, which could
adversely affect the value of our securities.
Even
if we qualify for taxation as a REIT, we may face tax liabilities that reduce our cash flow.
As
a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including taxes on any undistributed
income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, franchise, property
and transfer taxes, including mortgage recording taxes. In addition, in order to meet the REIT qualification requirements, or
to avoid the imposition of a 100% tax that applies to certain gains derived by a REIT from sales of inventory or property held
primarily for sale to customers in the ordinary course of business, we may create “taxable REIT subsidiaries” to hold
some of our assets. Any taxes paid by such subsidiary corporations would decrease the cash available for distribution to our shareholders.
Our
qualification for taxation as a REIT may depend on the accuracy of legal opinions or advice rendered or given and the inaccuracy
of any such opinions, advice or statements may adversely affect our REIT qualification and result in significant corporate-level
tax.
In
determining whether we qualify for taxation as a REIT, we may rely on opinions or advice of counsel as to whether certain types
of assets that we hold or acquire are deemed REIT real estate assets for purposes of the REIT asset tests and produce income which
qualifies under the gross income tests. The inaccuracy of any such opinions, advice or statements may adversely affect our qualification
for taxation as a REIT and result in significant corporate-level tax.
We
may choose to make distributions in shares of our capital stock, in which case you may be required to pay income taxes in excess
of the cash dividends you receive.
We
may distribute taxable dividends that are payable in cash and/or common shares at the election of each shareholder. Shareholders
receiving such dividends will be required to include the full amount of the dividend as ordinary income. As a result, shareholders
may be required to pay income taxes with respect to such dividends in excess of the cash portion of the dividend. Accordingly,
shareholders receiving a distribution of common shares may be required to sell those shares or may be required to sell other assets
they own at a time that may be disadvantageous in order to satisfy any tax imposed on the distribution they receive from us. If
a shareholder sells the common shares that he or she receives as a dividend in order to pay this tax, the sales proceeds may be
less than the amount included in income with respect to the dividend, depending on the market price of our common shares at the
time of the sale. Furthermore, with respect to certain non-U.S. shareholders, we may be required to withhold U.S. tax with respect
to such dividends, including in respect of all or a portion of such dividend that is payable in common shares, by withholding
or disposing of some of the common shares in the distribution and using the proceeds of such disposition to satisfy the withholding
tax imposed. In addition, if a significant number of our shareholders determine to sell our common shares in order to pay taxes
owed on dividends, such sales may put downward pressure on the trading price of our common shares.
Dividends
payable by REITs do not qualify for the reduced tax rates on dividend income from regular corporations, which could adversely
affect the value of our common shares.
Dividends
payable by REITs are not generally eligible for reduced rates applicable to dividends paid by other corporations, but are taxed
at the same rate as ordinary income. Although the reduced U.S. federal income tax rate applicable to dividend income from regular
corporate dividends does not adversely affect the taxation of REITs or dividends paid by REITs, the more favorable rates applicable
to regular corporate dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs
to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends. This could have an
adverse impact on the market price of our common shares.
Liquidation
of our assets may jeopardize our qualification for taxation as a REIT.
To
qualify for taxation as a REIT, we must comply with requirements regarding our assets and our sources of income. If we are compelled
to liquidate our assets to repay obligations to our lenders, we may be unable to comply with these requirements, thereby jeopardizing
our qualification for taxation as a REIT. In addition, we may be subject to a 100% tax on any gain realized from the sale of assets
that are treated as inventory or property held primarily for sale to customers in the ordinary course of business.
The
ownership restrictions set forth in our restated certificate of incorporation may not prevent five or fewer shareholders from
owning 50% or more of our outstanding shares of capital stock causing us to lose our status as a REIT, which may inhibit market
activity in our common shares and restrict our business combination opportunities.
In
order for us to qualify for taxation as a REIT, not more than 50% in value of our outstanding common shares may be owned, directly
or indirectly, by five or fewer individuals (as defined in the Code to include certain entities) at any time during the last half
of each taxable year, and at least 100 persons must beneficially own our stock during at least 335 days of a taxable year of 12
months, or during a proportionate portion of a shorter taxable year. To help ensure that we meet the tests, our restated certificate
of incorporation restricts the acquisition and ownership of our capital stock. The ownership limitation is fixed at 4.0% of our
outstanding shares of capital stock, by value or number of shares, whichever is more restrictive. Assaf Ran, our chief executive
officer, is exempt from this restriction. As of December 31, 2016, Mr. Ran owns 30.93% of our outstanding common shares. In addition,
our board of directors may grant such an exemption to such limitations in its sole discretion, subject to such conditions, representations
and undertakings as it may determine. These ownership limits could delay or prevent a transaction or a change in control of our
company that might involve a premium price for shares of our common shares or otherwise be in the best interest of our shareholders.
We
may be subject to adverse legislative or regulatory tax changes that could reduce the market price of our common shares.
At
any time, the U.S. federal income tax laws or regulations governing REITs or the administrative interpretations of those laws
or regulations may be changed, possibly with retroactive effect. We cannot predict if or when any new U.S. federal income tax
law, regulation or administrative interpretation, or any amendment to any existing U.S. federal income tax law, regulation or
administrative interpretation, will be adopted, promulgated or become effective or whether any such law, regulation or interpretation
may take effect retroactively. We and our shareholders could be adversely affected by any such change in, or any new, U.S. federal
income tax law, regulation or administrative interpretation.
We
may be unable to generate sufficient cash flows from our operations to make distributions to our shareholders at any time in the
future.
As
a REIT, we are required to distribute to our shareholders at least 90% of our taxable income each year. We intend to satisfy this
requirement through quarterly distributions of all or substantially all of our REIT taxable income in such year, subject to certain
adjustments. Our ability to make distributions may be adversely affected by a number of factors, including the risk factors described
in this report. If we distribute proceeds from the sale of securities, which would generally be considered to be a return of capital
for tax purposes, our future earnings and cash available for distribution may be reduced from what they otherwise would have been.
All distributions will be made at the discretion of our board of directors and will depend on various factors, including our earnings,
our financial condition, our liquidity, our debt and preferred stock covenants, maintenance of our REIT qualification, applicable
provisions of the New York Business Corporation Law (NYBCL), and other factors as our board of directors may deem relevant from
time to time. We believe that a change in any one of the following factors could adversely affect our results of operations and
impair our ability to pay distributions to our shareholders:
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how
we deploy the net proceeds from the sale of securities;
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our
ability to make loans at favorable interest rates;
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expenses
that reduce our cash flow;
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defaults
in our asset portfolio or decreases in the value of our portfolio; and
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the
fact that anticipated operating expense levels may not prove accurate, as actual results may vary from estimates.
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A
change in any of these factors could affect our ability to make distributions. As a result, we cannot assure you that we will
be able to make distributions to our shareholders at any time in the future or that the level of any distributions we do make
to our shareholders will achieve a market yield or increase or even be maintained over time, any of which could materially and
adversely affect us.
In
addition, distributions that we make to our shareholders will generally be taxable to our shareholders as ordinary income. However,
a portion of our distributions may be designated by us as long-term capital gains to the extent that they are attributable to
capital gain income recognized by us or may constitute a return of capital to the extent that they exceed our earnings and profits
as determined for tax purposes. A return of capital is not taxable, but has the effect of reducing the basis of a shareholder’s
investment in our shares of common shares.
We
could be materially and adversely affected if we are deemed to be an investment company under the Investment Company Act.
We
intend to conduct our business in a manner that will qualify for the exception from the Investment Company Act set forth in Section
3(c)(5)(C) of the Investment Company Act. The SEC generally requires that, for the exception provided by Section 3(c)(5)(C) to
be available, at least 55% of an entity’s assets be comprised of mortgages and other liens on and interests in real estate,
also known as “qualifying interests,” and at least another 25% of the entity’s assets must be comprised of additional
qualifying interests or real estate-type interests (with no more than 20% of the entity’s assets comprised of miscellaneous
assets). Any significant acquisition by us of non-real estate assets without the acquisition of substantial real estate assets
could cause us to meet the definitions of an “investment company.” If we are deemed to be an investment company, we
could be required to dispose of non-real estate assets or a portion thereof, potentially at a loss, in order to qualify for the
3(c)(5)(C) exception. We may also be required to register as an investment company if we are unable to dispose of the disqualifying
assets, which could have a material adverse effect on us.
Registration
under the Investment Company Act would require us to comply with a variety of substantive requirements that impose, among other
things:
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limitations
on capital structure;
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restrictions
on specified investments;
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restrictions
on leverage or senior securities;
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restrictions
on unsecured borrowings;
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prohibitions
on transactions with affiliates; and
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compliance
with reporting, record keeping, voting, proxy disclosure and other rules and regulations that would significantly increase
our operating expenses.
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If
we were required to register as an investment company but failed to do so, we could be prohibited from engaging in our business,
and criminal and civil actions could be brought against us.
Registration
with the SEC as an investment company would be costly, would subject us to a host of complex regulations and would divert attention
from the conduct of our business, which could materially and adversely affect us. In addition, if we purchase or sell any real
estate assets to avoid becoming an investment company under the Investment Company Act, our net asset value, the amount of funds
available for investment and our ability to pay distributions to our shareholders could be materially adversely affected.
Risks Related to Our Common Shares
We
are effectively controlled by our largest shareholder whose interests may not always be aligned with the interests of our other
shareholders.
As
of December 31, 2016, Assaf Ran, our chief executive officer, beneficially owns 30.93% of our outstanding shares. Thus, Mr. Ran
currently has and will continue to exercise effective control over all corporate actions. This concentration of ownership could
have an adverse impact on the market price of our common shares.
There
is limited trading in our common shares, which could make it difficult for you to sell your common shares.
Our
common shares are listed on The NASDAQ Capital Market. Average daily trading volume in our common shares was approximately 39,000
shares in 2015 and approximately 40,000 shares in 2016. The lack of liquidity may make it more difficult for you to sell your
common shares when you wish to do so. Even if an active trading market develops, the market price of our common shares may be
highly volatile and could be subject to wide fluctuations.
The
market prices of our common shares may be adversely affected by future events.
Market
factors unrelated to our performance could also negatively impact the value of our securities, including the market price of our
common shares. One of the factors that investors may consider in deciding whether to buy or sell our common shares is our distribution
rate as a percentage of our share price relative to market interest rates. If market interest rates increase, prospective investors
may demand a higher distribution rate or seek alternative investments paying higher dividends or interest. As a result, interest
rate fluctuations and conditions in the capital markets can affect the market value of our common shares. For instance, if interest
rates rise, it is likely that the market price of our common shares will decrease as market rates on interest-bearing securities
increase. Other factors that could negatively affect the market price of our common shares include:
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our
actual or projected operating results, financial condition, cash flows and liquidity, or changes in business strategy or prospects;
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actual
or perceived conflicts of interest with individuals, including our executive officers;
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equity
issuances by us, or share resales by our shareholders, or the perception that such issuances or resales may occur;
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actual
or anticipated accounting problems;
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changes
in our earnings estimates or publication of research reports about us or the real estate industry;
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changes
in market valuations of similar companies;
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adverse
market reaction to any increased indebtedness we incur in the future;
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additions
to or departures of our key personnel;
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speculation
in the press or investment community;
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our
failure to meet, or the lowering of, our earnings’ estimates or those of any securities analysts;
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increases
in market interest rates, which may lead investors to demand a higher distribution yield for our common shares, would result
in increased interest expenses on our debt;
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changes
in the credit markets;
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failure
to maintain our qualification for taxation as a REIT or exemption from the Investment Company Act;
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actions
by our shareholders;
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price
and volume fluctuations in the stock market generally;
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general
market and economic conditions, including the current state of the credit and capital markets;
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sales
of large blocks of our common shares;
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sales
of our common shares by our executive officers, directors and significant shareholders; and
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restatements
of our financial results and/or material weaknesses in our internal controls.
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The
price of our common shares is volatile, and purchasers of our common shares could incur substantial losses.
Historically,
the price at which our common shares trade on The NASDAQ Capital Market has been extremely volatile and seemingly unrelated to
our operating performance. In 2015, the price of our common shares on NASDAQ ranged from $2.98 to $4.78. In 2016, the range was
$3.80 to $7.60. These broad market fluctuations may adversely affect the trading price of our common shares. Class action litigation
has often been instituted against companies whose securities have experienced periods of volatility in market price. Any such
litigation brought against us could result in substantial costs, which would hurt our financial condition and results of operations,
divert management’s attention and resources.
Common
shares eligible for future sale may have adverse effects on our share price.
At
December 31, 2016, we have outstanding options to purchase 28,000 common shares with exercise prices range from $1.02 to $2.92
per share, outstanding warrants to purchase 4,000 shares at a price of $3.5625 per share, outstanding warrants to purchase 19,031
shares at a price of $5.4875 per share, and outstanding warrants to purchase 33,612 shares at a price of $7.4375 per share (exercisable
after August 9, 2017). Upon issuance, the common shares underlying these options and warrants would be immediately saleable. We
cannot predict the effect, if any, the exercise of these options and/or warrants or the future sale of the common shares issuable
upon the exercise of these options and/or warrants would have on the market price of our common shares. The market price of our
common shares may decline significantly when the restrictions on resale or lock up agreements by certain of our shareholders lapse.
Sales of substantial amounts of common shares or the perception that such sales could occur may adversely affect the prevailing
market price for our common shares.
We
may, from time-to-time, issue common shares and securities convertible into, or exchangeable or exercisable for, common shares
to attract or retain key employees or in public offerings or private placements to raise capital. We are not required to offer
any such shares or securities to existing shareholders on a preemptive basis. Therefore, it may not be possible for existing shareholders
to participate in such future share or security issuances, which may dilute the existing shareholders’ interests in us.
Future
offerings of debt or equity securities, which would rank senior to our common shares, may adversely affect the market price of
our common shares.
If
we decide to issue debt or equity securities in the future, which would rank senior to our common shares, it is likely that they
will be governed by an indenture or other instrument containing covenants restricting our operating flexibility. Additionally,
any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable
than those of our common shares and may result in dilution to owners of our common shares. We and, indirectly, our shareholders,
will bear the cost of issuing and servicing such securities. Because our decision to issue debt or equity securities in any future
offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing
or nature of our future offerings. Thus, holders of our common shares will bear the risk of our future offerings reducing the
market price of our common shares and diluting the value of their stock holdings in us.
Risks
Related to Our Organization and Structure
Certain
provisions of New York law could inhibit changes in control.
Various
provisions of the NYBCL may have the effect of deterring a third party from making a proposal to acquire us or of impeding a change
in control under circumstances that otherwise could provide the holders of our common shares with the opportunity to realize a
premium over the then-prevailing market price of our common shares. For example, we are subject to the “business combination”
provisions of the NYBCL that, subject to limitations, prohibit certain business combinations (including a merger, consolidation,
share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities)
between us and an “interested shareholder” (defined generally as any person who beneficially owns 20% or more of our
then outstanding voting capital stock or an affiliate thereof for five years after the most recent date on which the shareholder
becomes an interested shareholder.) After the five-year prohibition, any business combination between us and an interested shareholder
generally must be recommended by our board of directors and approved by the affirmative vote of a majority of the votes entitled
to be cast by holders of outstanding shares of our voting capital stock other than shares held by the interested shareholder with
whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested
shareholder. These provisions do not apply if holders of our common shares receive a minimum price, as defined under the NYCBL,
for their shares in the form of cash or other consideration in the same form as previously paid by the interested shareholder
for its common shares. They also do not apply to business combinations that are approved or exempted by a board of directors prior
to the time that the interested shareholder becomes an interested shareholder.
Our
authorized but unissued common and preferred shares may prevent a change in our control.
Our
restated certificate of incorporation authorizes us to issue up to 25,000,000 common shares and 5,000,000 preferred shares. Currently,
we have 8,312,036 common shares issued and 8,135,036 common shares outstanding and no preferred shares issued or outstanding.
Our board of directors has the power and authority to create classes of common or preferred shares, with such rights and designations
as it deems appropriate or advisable, which rights and designations may be senior to or have a priority over the rights and designations
of any existing class of common or preferred shares. For example, our board of directors may establish a series of common or preferred
shares that could delay or prevent a transaction or a change in control that might involve a premium price for our common shares
or otherwise be in the best interest of our shareholders.
Our
rights and the rights of our shareholders to take action against our directors and officers are limited, which could limit your
recourse in the event of actions not in your best interests.
Our
restated certificate of incorporation limits the liability of our present and former directors to us and our shareholders for
money damages due to any breach of duty in such capacity, if a judgment or other final adjudication adverse to a present or former
officer or director establishes that his or her acts or omissions were in bad faith or involved intentional misconduct or a knowing
violation of law or that he or she personally gained in fact a financial profit or other advantage to which he or she was not
legally entitled or that his or her acts violated Section 719 of the NYBCL. Section 719 of the NYBCL limits director liability
to the following four instances:
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declarations
of dividends in violation of the NYBCL;
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a
purchase or redemption by a corporation of its own shares in violation of the NYBCL;
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distributions
of assets to shareholders following dissolution of the corporation without paying or providing for all known liabilities;
and
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making
any loans to directors in violation of the NYBCL.
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Our
restated certificate of incorporation and bylaws authorize us to indemnify our directors and officers for actions taken by them
in those capacities to the maximum extent permitted by the NYBCL. In addition, we may be obligated to pay or reimburse the defense
costs incurred by our present and former directors and officers without requiring a preliminary determination of their ultimate
entitlement to indemnification.
Our
bylaws contain provisions that make removal of our directors difficult, which could make it difficult for our shareholders to
effect changes to our management.
Our
bylaws provide that a director may be removed by either the board of directors or by shareholders for cause. Vacancies may be
filled only by a majority of the remaining directors in office, even if less than a quorum, unless the vacancy occurred as a result
of shareholder action, in which case the vacancy must be filled by a vote of shareholders at a special meeting of shareholders
duly called for that purpose. These requirements make it more difficult to change our management by removing and replacing directors
and may prevent a change in control of our company that is in the best interests of our shareholders.
Risks
Related to the Notes issued by MBC Funding II
We
are controlled by our largest shareholder whose interests may not always be aligned with the interests of the Noteholders.
Noteholders
will not have any voting rights with respect to us or MBC Funding II (other than as set forth in the Indenture) or the right to
influence management or day-to-day operations of MBC Funding II or of us. The interests of shareholders who do vote may be different
or even in opposition of those of creditors such as the Noteholders. For example, shareholders may place a higher priority on
the long-term, as opposed to short-term, performance of a company. Shareholders also tend to focus on building value and increasing
stock price while creditors are more interested in cash flow. As of the date of this Report, Mr. Ran beneficially owns 34.57%,
of our outstanding common shares. Mr. Ran is also the chief executive officer and sole director of MBC Funding II. Thus, Mr. Ran
currently has and will continue to exercise effective control over all corporate actions of us and MBC Funding II.
The
Indenture contains restrictive covenants that may limit MBC Funding II’s operating flexibility and could adversely affect
its financial condition.
The
Indenture contains restrictive covenants that could adversely affect MBC Funding II’s operating flexibility as well as its
financial condition. For example, the Indenture requires MBC Funding II to maintain a specific debt coverage ratio at all times,
specifically providing that the aggregate outstanding principal balance of the mortgage loans held by us, together with our cash
on hand, must always equal at least 120% of the aggregate outstanding principal amount of the Notes at all times, as well as limits
or prohibits its ability to:
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acquire
or dispose of assets;
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merge
with another corporation; and
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incur
additional secured and unsecured indebtedness.
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MBC
Funding II’s failure to comply with those covenants could result in an event of default which, if not cured or waived, could
result in the acceleration of the indebtedness evidenced by the Notes. In addition, a default by MBC Funding could serve as a
default under our existing Webster Credit Line. For example, defaults under the mortgage loans held by MBC Funding II could result
in a violation of the debt coverage ratio covenant. In that case, MBC Funding II is required to make monthly payments of principal
on the Notes until such debt coverage ratio covenant is in compliance. We cannot assure you that in that event MBC Funding II
will be able to repay all the Notes in full, or at all.
The
limited covenants in the Indenture and the terms of the Notes will not provide protection against significant events that could
adversely impact MBC Funding II’s obligations under the Notes.
Neither
the Indenture nor the Notes require MBC Funding II to maintain any financial ratios or specific levels of net worth, revenues,
income, cash flow or liquidity and, accordingly, do not protect the Noteholders in the event that MBC Funding II experiences significant
adverse changes in its financial condition or results of operations or protect your interest as a Noteholder. For example, during
the term of the Notes, the true value of the mortgage loans held by MBC Funding II may fluctuate based on a number of factors
including interest rates on the loans relative to prevailing market rates, as well as the solvency and credit-worthiness of the
borrower. However, as long as the borrowers are not in default of their obligations, MBC Funding II will not be deemed to be in
default of the debt coverage ratio covenant in the Indenture.
As
the controlling shareholder of MBC Funding II, we have an inherent conflict of interest and we may not always act in the best
interests of the Noteholders.
We
have absolute control over MBC Funding II. We own all of its stock and its chief executive officer and sole director is our controlling
shareholder, chief executive officer and chairman of our board of directors. Subject to the requirements set forth in the Indenture,
we will determine which mortgage loans MBC Funding II will purchase from us and any additional mortgage loans that we will transfer
to MBC Funding II in order to meet the debt coverage ratio requirement set forth in the Indenture. In addition, we will decide
whether MBC Funding II should extend the term of any mortgage loan in its portfolio that becomes due. Finally, we will decide
how MBC Funding II should reinvest the principal payments on existing loans and the terms of any new mortgage loans that MBC Funding
II will make. In making these decisions we may be conflicted by our obligations to our shareholders and our obligations to the
Noteholders. We cannot assure you that the decisions we ultimately make will be in the best interest of the Noteholders.
Various
provisions in the Indenture restrict the ability of the Indenture Trustee and the Noteholders to enforce their rights against
us in the event MBC Funding II defaults on its obligations under the Notes.
We
have guaranteed MBC Funding II’s obligations under the Notes and we have secured that guaranty with a pledge of 100% of
the issued and outstanding shares of MBC Funding II. However, if MBC Funding II is in default of its obligations to the Noteholders,
the value of MBC Funding II may be less than the amount due to the Noteholders. Under the Indenture, if an event of default occurs,
the Indenture Trustee, at the written direction of the holders of at least 50% of the principal amount of the Notes then outstanding,
must declare the unpaid principal and all accrued but unpaid interest on the Notes to be immediately due and payable. In addition,
pursuant to the terms of an Inter-creditor Agreement entered into by the Indenture Trustee and Webster, neither the Indenture
Trustee nor the Noteholders can exercise their rights under the guaranty until the Webster Credit Line has been paid in full except
in connection with their exercise of remedies under the Pledge Agreement. Furthermore, under our agreement with Webster, we are
prohibited from making any payment, direct or indirect (whether for interest, principal, as a result of any redemption or repayment
at maturity, on default, or otherwise), on the Notes so long as there are any unpaid balances on the Webster Credit Line. Although
the Webster Credit Line matures and is fully payable in February 2018, we are not prohibited from renewing, extending or increasing
the amount of the Webster Credit Line or replacing it with a new credit facility provided by a different lender, which may insist
on the same restriction. Thus, upon a default by MBC Funding II, the Noteholders may never have full recourse to us under our
guaranty.
If
a bankruptcy petition were filed by or against us or MBC Funding II, Noteholders may receive less than the outstanding balance
on the Notes.
If
a bankruptcy case were filed by or against us or MBC Funding II under the U.S. Bankruptcy Code after the issuance of the Notes,
the Noteholders may receive, on account of their claims related to the Notes, less than they would be entitled to under the terms
of the Indenture.