In connection with the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995, readers of this document and any document
incorporated by reference herein, are advised that this document and documents
incorporated by reference into this document contain both statements of
historical facts and forward looking statements. Forward looking statements are
subject to certain risks and uncertainties, which could cause actual results to
differ materially from those indicated by the forward looking statements.
Examples of forward looking statements include, but are not limited to (i)
projections of revenues, income or loss, earning or loss per share, capital
expenditures, dividends, capital structure and other financial items; (ii)
statements of plans and objectives of ours or our management or Board of
Directors, including any public sale of our securities, or estimates or
predictions of actions by borrowers, competitors or regulatory authorities;
(iii) statements of future economic performance; and (iv) statements of
assumptions underlying other statements and statements about our business.
This document and documents incorporated by reference herein also identify
important factors which could cause actual results to differ materially from
those indicated by forward looking statements. These risks and uncertainties
include, among other things, interest rate fluctuations as they effect the
relative yield of our loan portfolio and our ability to compete in making loans
to borrowers; payment default on loans made by us, which could adversely affect
our ability to make distributions to our shareholders; the actions of
competitors; the effects of government regulation; and other factors which are
described herein and/or in documents incorporated by reference herein, including
the risks described at the end of Item 1.
The cautionary statements made pursuant to the Private Litigation
Securities Reform Act of 1995 above and elsewhere by us should not be construed
as exhaustive or as any admission regarding the adequacy of disclosures made by
us prior to the effective date of such Act. Matters which are the subject of
forward looking statements are beyond our ability to control and in many cases
we cannot predict what factors would cause results to differ materially from
those indicated by the forward looking statements.
Item 1. Description of Business
General
We are a Minnesota corporation incorporated on May 27, 1994. We operate as
a Real Estate Investment Trust ("REIT") and are engaged in the business of
making mortgage loans to churches and other non-profit religious organizations
throughout the United States. The principal amount of loans we offer ranges from
$100,000 to $2,000,000. We may also invest up to 30% of our Average Invested
Assets in mortgage secured debt securities (bonds) issued by churches and other
non-profit religious organizations. Between the date upon which we began active
business operations (April 15, 1996), and February 28, 2008, we have made 166
loans to 139 churches in the aggregate amount of $85,501,427, with the average
principal amount of such loans being $515,069. Of the 166 loans we have made, 76
loans totaling $34,818,158 have been repaid early by the borrowing churches. We
also own, as of February 28, 2008, $11,511,000 principal amount of Church Bonds
(hereinafter defined), which we purchased at a price of par value ($1,000) or
less. At no time have we paid a premium for any of the bonds in our portfolio.
Subject to supervision of our Board of Directors, our day to day business
operations are managed by Church Loan Advisors, Inc. (the "Advisor"), which
provides investment advisory and administrative services to us. The principals
of the Advisor include principals of American Investors Group, Inc., a FINRA
member broker-dealer which has served as underwriter of the public offerings of
our common stock, as well as our public offerings of secured investor
certificates.
Public Offerings
On October 7, 2004 the Securities and Exchange Commission declared
effective our fifth public offering of $23,000,000 worth of secured investor
certificates under SEC file 333-75836. The Company concluded the Offering on
October 7, 2006. The Offering was conducted on a "best-efforts" basis pursuant
to applicable rules of the Securities and Exchange Commission. $14,860,000 worth
of certificates were sold through our advisor's affiliate, American Investors
Group, Inc., to public investors.
The Company's Business Activities
Our business is managed by Church Loan Advisors, Inc., Minnetonka,
Minnesota (the "Advisor"). We have no employees. The Advisor's affiliate,
American Investors Group, Inc., ("American") has been engaged since 1987 in the
business of underwriting first mortgage bonds for churches throughout the United
States. In underwriting church bonds, American reviews financing proposals,
analyzes prospective borrowers' financial capability, and structures, markets
and sells, mortgage-backed securities which are debt obligations (bonds) of such
borrowers to the investing general public. Since its inception, American has
underwritten approximately 228 church bond financings, in which approximately
$469,820,000 in first mortgage bonds have been sold to public investors. The
average size of single church bond financings underwritten by American since its
inception is approximately $2,061,000.
3
In the course of its business, American identified a demand from potential
borrowers for smaller loans of $100,000 to $2,000,000. Because of the
regulatory, administrative expenses and complexity normally associated with the
bond financing business, American determined that the economic feasibility of
bond financing diminished for financings under $1,000,000. As a result, we
believe that many churches are forced to either forego the project for which
their financing request was made, fund their project from cash flow over a
period of time and at greater expense, or seek bank financing at terms that are
not always favorable or available to them, due to the historic reluctance of
banks to lend to churches for other than economic reasons. Our objective is to
provide a lending source to this segment of the industry-by capitalizing on the
human resources and experience available at American and the Advisor, and taking
advantage of the marketing, advertising and general goodwill of American.
Financing Business
Our primary business is to make first mortgage loans in amounts ranging
from $100,000 to $2,000,000, to churches and other non-profit religious
organizations, and selecting and investing in mortgage-secured debt instruments
("Church Bonds") issued by churches and other non-profit religious organizations
throughout the United States. We attempt to apply our working capital (after
adequate reserves determined by the Advisor) toward making mortgage loans and
investing in Church Bonds. We seek to enhance returns on investments on such
loans by:
o offering terms of up to 30 years or more, generating the highest
yields possible under current market conditions;
o seeking origination fees (i.e. "points") from the borrower at the
outset of a loan and upon any renewal of a loan;
o making a limited amount of higher-interest rate second mortgage loans
to qualified borrowers; and
o purchasing a limited amount of mortgage-secured debt securities having
various maturities issued by churches and other non-profit religious
organizations.
Our policies limit the amount of second mortgage loans to 20% of the
Company's Average Invested Assets (hereinafter defined) on the date any second
mortgage loan is closed and limit the amount of mortgage-secured debt securities
to 30% of Average Invested Assets on the date of their purchase.
"Average Invested Assets" for any period is defined as the average of the
aggregated book value of the assets of the corporation invested, directly or
indirectly, in loans (or interests in loans) secured by real estate, and first
mortgage bonds, before reserves for depreciation or bad debts or other similar
non-cash reserves computed by taking the average of such values at the end of
each calendar month during such period.
All other mortgage loans made by us (or Church Bonds purchased for
investment) will be secured by a first mortgage (or deed of trust) lien in favor
of us. Although we attempt to make mortgage loans for various terms typically
ranging from three to twenty-five years, we may determine to emphasize
longer-term fixed-rate loans in our discretion, in order to reduce the risk to
us of downward interest rate fluctuations.
Our lending and investing operations, including determination of a
prospective borrower's or church bond issuer's financial credit worthiness, are
made on our behalf by the Advisor. Employees and agents of the Advisor conduct
all aspects of our business, including (i) marketing and advertising; (ii)
communication with prospective borrowers; (iii) processing loan applications;
(iv) closing the loans; (v) servicing the loans; (vi) enforcing the terms of our
loans; (vii) shareholder relations and (viii) administering our day-to-day
business. For its services, the Advisor is entitled to receive a management fee
equal to 1 1/4% annually of the Company's Average Invested Assets, plus one-half
of any origination fee charged to borrowers on mortgage loans we make. The
management fee is reduced to 1% on assets from $35 million to $50 million and to
.75% on assets over $50 million. The Advisor's management fees are computed and
payable monthly.
Current First Mortgage Loan Terms
We offer prospective borrowers a selection of "Loan Types," which include a
choice of fixed or variable rates of interest indexed to the "prime" rate of
interest or other generally recognized reference index, and having various terms
to maturity, origination fees and other terms and conditions. The Loan Types,
interest rates and fees offered and charged by us may from time-to-time be
limited, changed or otherwise unilaterally amended by the Advisor in its
discretion as a result of such factors (among others) as (i) balance of Loan
Types in our portfolio; (ii) competition from other lenders; (iii) anticipated
need to increase the overall yield to our mortgage loan portfolio; (iv) local
and national economic factors; (v) actual experience in borrowers' demand for
the loans; and (vi) available funds. In addition, we may make mortgage loans on
terms other than those identified in our list of Loan Types. Subject to change,
modification or elimination at our complete discretion, the following is a list
of the currently available Loan Types we may offer to prospective borrowing
institutions:
4
================================== ======================================= =======================
Loan Type Interest Rate (1) Origination Fee (2)
---------------------------------- --------------------------------------- -----------------------
30 Year Term (3) Fixed @ 8.25% 3.5%
---------------------------------- --------------------------------------- -----------------------
30 Year Term (3) Variable Annually @ 10-year T + 400 2.0%
basis points
---------------------------------- --------------------------------------- -----------------------
Renewable Term 5 Year (4) Fixed @: 7.75% 2.5%
================================== ======================================= =======================
|
(1) "10-year T" means the rate of interest paid to investors on the
10-year notes issued by the U.S. Treasury, as published by the Wall
Street Journal, CNBC cable network or other sources deemed reliable by
the Company.
(2) Origination fees are based on the original principal amount of the
loan and are collected from the borrower at the origination and
renewal of loans, one-half of which is payable directly to the
Advisor. Origination fees are often subject to negotiations with
borrowers and thus, may be less than these amounts.
(3) Fully amortized repayment term. Amortization terms may vary, as may
other loan terms, depending on individual loan negotiations and
competitive forces.
(4) Renewable term loans are repaid based on a 30-year amortization
schedule, and are renewable at the conclusion of their initial term
for additional like terms up to an aggregated maximum of 30 years. We
charge a fee of 1/2% to the borrower upon each renewal date. If
renewed by the borrower, the interest rate is adjusted to the 10-year
T plus a specified basis point "spread," i.e., 450 basis points.
The above table describes certain material terms of Loan Types, interest
rates and fees currently offered and charged by us. The table does not, however,
purport to identify all possible Loan Types, terms, rates, and fees that we may
offer from time-to-time. We may determine at any time to modify the terms
identified above and/or offer loan terms different than any of the Loan Types,
interest rates and fees identified above and do, in fact, negotiate these terms
and fees with certain of our borrowers. In practice, loan terms vary widely
depending upon quality of the prospective borrowers, our working capital
situation, presence or absence of competitive influences on specific loans, and
general economic conditions.
Mortgage Loan Processing and Underwriting
Mortgage loan applications are prepared and verified by our Advisor's
personnel in our Loan Origination and Underwriting Department. Verification
procedures are designed to assure a borrower's qualification under our Financing
Policies which are specifically identified herein and include, among other
things, obtaining:
o applications containing key information concerning the prospective
borrowers;
o project description;
o financial statements in accordance with our Financing Policies;
o corporate records and other organizational documents of the borrower;
o preliminary title report or commitment for mortgagee title insurance;
and
o a real estate appraisal in accordance with the Financing Policies.
All appraisals and financial statements are prepared by independent
third-party professionals who we approve based on their experience, reputation
and education. Completed loan applications, together with a written summary are
then presented to our Underwriting Committee. Our loan Underwriting Committee is
comprised of the Advisor's President and Vice-President and certain members of
its staff including staff members of American. Our Advisor may arrange for the
provision of mortgage title insurance and for the services of professional
independent third-party accountants and appraisers on behalf of borrowers in
order to achieve pricing efficiencies on their behalf and to assure the
efficient delivery of title commitments, preliminary title reports and title
policies, and financial statements and appraisals meet our underwriting
criteria. Our Advisor may arrange for the direct payment for such professional
services and for the direct reimbursement to it of such expenditures by
borrowers and prospective borrowers. Upon closing and funding of mortgage loans,
a negotiable origination fee based on the original principal amount of each loan
may be charged, of which one-half is payable by the borrower to our Advisor, and
the other one-half to us.
5
Loan Commitments
Subsequent to approval by our Underwriting Committee, and prior to funding
a loan, we may issue a loan commitment to qualified applicants. A loan
commitment deposit may be required from the borrowing church to commence the
loan preparation procedure. These deposits are directly applied by the Advisor
to engage accountants and appraisers to prepare their respective reports on the
Church. Commitments may indicate, among other things, the loan amount,
origination fees, closing costs, underwriting expenses (if any), funding
conditions, approval expiration dates and interest rate and other terms.
Commitments generally set forth a "prevailing" interest rate that is subject to
change in accordance with market interest rate fluctuations until the final loan
closing documents are prepared, at which time we commit to a stated interest
rate. In certain cases we may establish ("lock in") interest rate commitments up
to sixty (60) days from the commitment to closing; however, interest rate
commitments beyond sixty days will not normally be issued unless we receive an
appropriate fee premium based upon our assessment of the risk associated with a
longer period.
Loan Portfolio Management
Our portfolio of mortgage loans and Church Bonds is managed and serviced by
our Advisor in accordance with the Advisory Agreement. The Advisor is
responsible for all aspects of our mortgage loan business, including closing and
recording of mortgage loans; collecting payments of principal and interest
regularly and upon the maturity of a loan; enforcing loan payments and other
lender's requirements; periodic review of each mortgage loan file and
determination of its reserve classification; and exercising our remedies in
connection with any defaulted or non-performing loans. Fees and costs of
attorneys, insurance, bonds and other direct expenses incurred in connection
with the exercise of such remedies are our responsibility. We may, however,
recoup these expenses from the borrower in the process of pursuing our remedies.
The Advisor will not receive any additional compensation for services rendered
in connection with loan portfolio management or exercising remedies on our
behalf in the event of a loan default.
Loan Funding and Bank Borrowing
Our mortgage loans (and our purchases of Church Bonds) are funded with
available cash resources and, at the discretion of the Advisor, with borrowings
under a line of credit with a commercial lender or bank.
We currently have a $15,000,000 revolving credit facility with KeyBank
National Association, Cleveland, Ohio. As of December 31, 2007, we have an
outstanding balance of $3,350,000 against our line of credit. On July 26, 2007,
we entered into the revolving credit facility and a related promissory note with
KeyBank. Approximately $2,800,000 was drawn on the credit facility at closing.
Of that amount, $1,956,000 was used to redeem certain Series A 2002 secured
investor certificates, and approximately $650,000 was used to pay off and close
our previous line of credit with Beacon Bank. Borrowings under the credit
facility are based upon a borrowing base calculation and are available to us for
use in connection with our working capital and general corporate needs.
Additionally, under certain circumstances, total availability under the credit
facility can be increased to $25 million. The revolving credit facility is
secured by a first priority security interest in substantially all of our assets
other than collateral pledged to secure our Series A and Series B secured
investor certificates.
Advances under the credit facility and related promissory note bear
interest at either KeyBank's base rate plus an applicable margin or at LIBOR
plus an applicable margin, at the Company's option. These rates adjust as
provided in the credit agreement for the credit facility, but at December 31,
2007, the effective rate was 6.56%. The applicable margin is indexed based upon
the Company's financial performance. The Company may prepay loans under certain
circumstances, which include restrictions on notice, timing and amount.
The credit agreement for the credit facility contains customary affirmative
and negative covenants. The financial covenants include borrowing base
restrictions, a maximum indebtedness to assets ratio, a minimum cash flow
coverage ratio, a minimum tangible net worth ratio, and a maximum non-performing
assets ratio. The creation of indebtedness outside the credit facility, creation
of liens, making of certain investments, sale of assets, and incurrence of debt
are all either limited or require prior approval from KeyBank or the lenders
under the credit facility. The credit agreement also contains customary events
of default such as nonpayment, bankruptcy, and change in control, which if they
occur may constitute an event of default.
Currently, we may borrow up to 300% of our shareholder's equity (in the
absence of a satisfactory showing that a higher level of borrowing is
appropriate; any excess in borrowing over such 300% level must be approved by a
majority of the Independent Directors and disclosed to shareholders in the next
quarterly report along with justification for such excess) to make loans
regardless of our capacity to (i) sell our securities on a continuing basis, or
to (ii) reposition assets from the maturity or early repayment of mortgage loans
in our secured investor certificates, minus reserves for operating expenses, and
bad-debt reserves, as determined by the Advisor. Cash resources available to us
for lending purposes include, in addition to the net proceeds from any future
sales of our common stock, secured investor certificates (if any) or other debt
securities, (i) principal repayments from borrowers on loans made by us and (ii)
funds borrowed under any line of credit arrangement.
6
The Advisory Agreement
We have entered into a contract with the Advisor (the "Advisory Agreement")
under which the Advisor furnishes advice and recommendations concerning our
business affairs, provides administrative services to us and manages our
day-to-day operations. We have no employees. All of our personnel needs are met
through the personnel and expertise of the Advisor and its affiliates. Among
other things, the Advisor:
o serves as our mortgage loan underwriter and advisor in connection with
our primary business of making loans to churches;
o advises and selects Church Bonds to be purchased and held for
investment by us;
o services all mortgage loans we make;
o provides marketing and advertising and generates loan leads directly
and through its affiliates;
o deals with regulatory agencies, borrowers, lenders, banks,
consultants, accountants, brokers, attorneys, appraisers, insurers and
others;
o supervises the preparation, filing and distribution of tax returns and
reports to governmental agencies and to shareholders and acts on our
behalf in connection with shareholder relations;
o provides office space and personnel as required for the performance of
the foregoing services; and
o as requested by us, makes reports to us of its performance of the
foregoing services and furnishes advice and recommendations with
respect to other aspects of our business.
In performing its services under the Advisory Agreement, the Advisor may
use facilities, personnel and support services of its affiliates. Expenses such
as legal and accounting fees, stock transfer agent, registrar and paying agent
fees and proxy solicitation expenses are direct expenses of ours and are not
provided for by the Advisor as part of its services.
The Advisory Agreement is renewable annually by us for one-year periods,
subject to our determination, including a majority of the Independent Directors,
that the Advisor's performance has been satisfactory and that the compensation
paid the Advisor has been reasonable. We may terminate the Advisory Agreement
with or without cause upon 60 days written notice to the Advisor. Upon
termination of the Advisory Agreement by either party, the Advisor may require
us to change our name to a name that does not contain the word "American,"
"America" or the name of the Advisor or any approximation or abbreviation
thereof, and that is sufficiently dissimilar to the word "America" or "American"
or the name of the Advisor as to be unlikely to cause confusion or
identification with either the Advisor or any person or entity using the word
"American" or "America" in its name. Our Board of Directors shall determine that
any successor Advisor possess sufficient qualifications to perform the advisory
function for us and justify the compensation provided for in its contract with
us.
Pursuant to the Advisory Agreement, the Advisor is required to pay all of
the expenses it incurs in providing services to us, including, but not limited
to, personnel expenses, rental and other office expenses, expenses of officers
and employees of the Advisor, including travel and all of its overhead and
miscellaneous administrative expenses relating to performance of its functions
under the Advisory Agreement. We are required to pay all other expenses we incur
in the daily operations of our business-such as the costs and expenses of
reporting to various governmental agencies and the shareholders; the general
conduct of our operations as a mortgage lender; fees and expenses of appraisers,
directors, auditors, outside legal counsel and transfer agents, directors and
officers liability insurance premiums, unreimbursed costs directly relating to
closing of loan transactions, and costs relating to the enforcement of loan
agreements and/or foreclosure proceedings.
In the event that our Total Operating Expenses exceed in any calendar year
the greater of (a) 2% of our Average Invested Assets or (b) 25% of our net
income, the Advisor is obligated to reimburse us, to the extent of its fees for
such calendar year, for the amount by which the aggregate annual operating
expenses paid or incurred by us exceed the limitation. Total operating expenses
as defined in the Advisory Agreement exclude expenses of raising capital,
interest payments, taxes, non-cash expenditures (including, but not limited to,
depreciation, amortization and bad debt reserves), incentive fees and property
operation and disposition costs. The Independent Directors may, upon a finding
of unusual and non-recurring factors which they deem sufficient, determine that
a higher level of expenses is justified in any given year.
Our bylaws provide that the Independent Directors are to determine at least
annually the reasonableness of the compensation we pay to our Advisor. On
January 24, 2007, our Directors reviewed and unanimously approved renewal of the
Advisory Agreement for another year. Factors to be considered in reviewing the
Advisory Fee include the size of the fees of the Advisor in relation to the
size, composition and profitability of our loan portfolio, the rates charged by
other investment advisors performing comparable
7
services, the success of the Advisor in generating opportunities that meet our
investment objectives, the amount of additional revenues realized by the Advisor
for other services performed for us, the quality and extent of service and
advice furnished by the Advisor, the quality of our investments in relation to
investments generated by the Advisor for its own account, if any, and the
performance of our investments.
The Advisory Agreement provides for indemnification by us of the Advisor
and each of its directors, officers and employees against expense or liability
arising out of such person's activities in rendering services to us, provided
that the conduct against which the claim is made was determined by such person,
in good faith, to be in our best interests and was not the result of negligence
or misconduct.
Financing Policies
Our business of mortgage lending to churches and other non-profit religious
organizations is managed in accordance with and subject to the policies,
guidelines, restrictions and limitations identified herein (collectively, the
"Financing Policy"). The intent of the Financing Policy is to identify for our
shareholders not only the general business in which we are involved, but the
parameters of our lending business. These policies may not be changed (except in
certain immaterial respects by majority approval of the Board of Directors)
without the approval of a majority of the Independent Directors, and the holders
of a majority of our outstanding shares at a duly held meeting for that purpose:
(i) Loans made by us will be limited to churches and other non-profit
religious organizations, and will be secured by mortgages. The total
principal amount of all second mortgage loans that we fund is limited
to 20% of Average Invested Assets. All other loans will be first
mortgage loans.
(ii) The total principal amount of mortgage-secured debt securities we
purchase from churches and other non-profit religious organizations is
limited to 30% of our Average Invested Assets.
(iii) The loan amount cannot exceed 75% of the value of the real estate and
improvements securing each loan, such value being determined based on
a written appraisal prepared by an appraiser acceptable to the
Advisor. On all loans, we will require a written appraisal certified
by a member of the Appraisal Institute ("MAI"), or a state-certified
appraiser.
(iv) An ALTA (American Land Title Association) or equivalent Mortgage Title
Policy must be furnished to us by the borrower insuring our mortgage
interest.
(v) The borrower's long-term debt (including the proposed loan) cannot
exceed four times their gross income for the previous twelve (12)
months.
(vi) The borrower must furnish us with financial statements (balance sheet
and income and expense statement) for their last three (3) complete
fiscal years and a current financial statement for the period within
ninety days of the loan closing date. On loans of $500,000 or less,
the last complete fiscal year must be reviewed by an independent
accounting firm. On loans in excess of $500,000, the Advisor may
require that the last complete fiscal year financial statements be
audited by an independent auditor. Borrowers in existence for less
than three fiscal years must provide financial statements since their
inception. No loan will be extended to a borrower in operation less
than two years absent express approval by our Board of Directors.
(vii) The Advisor typically requires the borrower to arrange for automatic
electronic payment or drafting of monthly payments.
(viii) The Advisor may require (i) key-man life insurance on the life of
the senior pastor of a church; (ii) personal guarantees of church
members and/or affiliates; and (iii) other security enhancements for
our benefit.
(ix) The borrower must agree to provide to us annual reports (including
financial statements) within 120 days of each fiscal year end
beginning with the fiscal year end next following the funding of the
loan.
(x) The Advisor may require the borrower to grant to us a security
interest in all personal property located and to be located upon the
mortgaged premises (excluding property leased by the borrower).
(xi) We require borrowers to maintain a general perils and liability
coverage insurance policy naming us as the loss-payee in connection
with damage or destruction to the property of the borrower which
typically includes weather-related damage, fire, vandalism and theft.
Our Advisor may require the borrower to provide flood, earthquake
and/or other special coverage.
8
These Financing Policies are in addition to the prohibited investments and
activities identified below and which are set forth in our Bylaws.
Prohibited Investments and Activities
Our Bylaws impose certain prohibitions and restrictions on our investment
practices and lending activities, including prohibitions against:
(i) Investing more than 10% of our total assets in unimproved real
property or mortgage loans on unimproved real property;
(ii) Investing in commodities or commodity futures contracts other than
"interest rate futures" contracts intended only for hedging purposes;
(iii) Investing in mortgage loans (including construction loans) on any one
property which in the aggregate with all other mortgage loans on the
property would exceed 75% of the appraised value of the property
unless substantial justification exists because of the presence of
other underwriting criteria;
(iv) Investing in mortgage loans that are subordinate to any mortgage or
equity interest of the Advisor or the Directors or any of their
Affiliates;
(v) Investing in equity securities;
(vi) Engaging in any short sales of securities or in trading, as
distinguished from investment activities;
(vii) Issuing redeemable equity securities;
(viii) Engaging in underwriting or the agency distribution of securities
issued by others;
(ix) Issuing options or warrants to purchase our shares at an exercise
price less than the fair market value of the shares on the date of the
issuance or if the issuance thereof would exceed 10% in the aggregate
of our outstanding shares;
(x) The aggregate borrowings of the corporation, secured and unsecured,
must be reasonable in relation to the Shareholder's Equity of the
corporation and must be reviewed by the Independent Directors at least
quarterly. The maximum amount of such borrowings can not exceed 300%
of Shareholder's Equity in the absence of a satisfactory showing that
a higher level of borrowing is appropriate. Any excess in borrowing
over such 300% level must be approved by a majority of Independent
Directors and disclosed to shareholders in the next quarterly report
along with justification for such excess;
(xi) Investing in real estate contracts of sale unless such contracts are
in recordable form and are appropriately recorded in the chain of
title;
(xii) Selling or leasing to the Advisor, a Director or any Affiliate
thereof unless approved by a majority of our Directors (including a
majority of our Independent Directors), who are not otherwise
interested in such transaction, as being fair and reasonable to us;
(xiii) Acquiring property from any Advisor or Director, or any Affiliate
thereof, unless a majority of our Directors (including a majority of
our Independent Directors) who are not otherwise interested in such
transaction approve the transaction as being fair and reasonable and
at a price to us which is no greater than the cost of the asset to
such Advisor, Director or any Affiliate thereof, or if the price to us
is in excess of such cost, that substantial justification for such
excess exists and such excess is reasonable. In no event shall the
cost of such asset exceed its current appraised value;
(xiv) Investing or making mortgage loans unless a mortgagee's or owner's
title insurance policy or commitment as to the priority of the
mortgage or condition of title is obtained; or
(xv) Issuing shares on a deferred payment basis or other similar
arrangement.
We do not invest in the securities of other issuers for the purpose of
exercising control, to engage in the purchase and sale of investments other than
as described in this Report, to offer securities in exchange for property unless
deemed prudent by a majority of the Directors, to issue senior securities or to
make loans to other persons except in the ordinary course of our business as
described herein.
9
We will not make loans to or borrow from, or enter into any contract, joint
venture or transaction with, any of our Directors or officers, the Advisor or
any Affiliate of any of the foregoing unless a majority of our Directors,
including a majority of our Independent Directors, approves the transaction as
fair and reasonable to us and the transaction is on terms and conditions no less
favorable to us than those available from unaffiliated third parties. Any
investment by us in any property, mortgage or other real estate interest
pursuant to a transaction with the Advisor or any Directors or officers thereof
will be based upon an appraisal of the underlying property from an independent
qualified appraiser selected by the Independent Directors and will not be made
at a price greater than fair market value as determined by such appraisal.
Under Performing and Non-Performing Loans
As of December 31, 2007, we have four first mortgage loans totaling
approximately $1,156,000 that are three or more monthly payments in arrears. We
may incur a loss if these borrowers are unable to bring their payments current
and we are compelled to foreclose on their properties. We may be unable to
dispose of the foreclosed properties on terms that enable us to recoup our
expenses and outstanding balances. We have initiated foreclosure proceedings on
three of these loans and expect to take possession of these churches and list
their properties for sale. In addition, we have foreclosed and have taken
possession of five properties with total loan balances outstanding totaling
approximately $2,202,000 and have listed four of the properties for sale through
local realtors. We have an earnest money deposit on the fifth property and are
awaiting an updated certificate of occupancy from the city in order to transfer
the property. One of the properties was acquired through foreclosure proceedings
in 2007. The fair value of the properties was $1,566,561 at December 31, 2007.
Competition
The business of making loans to churches and other non-profit religious
organizations is highly competitive. We compete with a wide variety of investors
and other lenders, including banks, savings and loan associations, insurance
companies, pension funds and fraternal organizations which may have investment
objectives similar to our own. A number of these competitors have greater
financial resources, larger staffs and longer operating histories than we do. We
compete principally by limiting our business "niche" to lending to churches and
other non-profit religious organizations, offering loans with competitive and
flexible terms, and emphasizing our expertise in the specialized industry
segment of lending to churches and other religious organizations. Our
competitive "specialty" is in offering fixed-rate, long-term loans, which few of
our competitors make available to churches.
Employees
We have no employees. Our daily operations and other material aspects of
our business are managed by Church Loan Advisors, Inc. (the "Advisor") on a
"turn-key" basis using employees of the Advisor and/or its Affiliates. At
present, certain officers and directors of American and the Advisor are
providing services to us at no charge and which will not be reimbursed to them.
These services include, among others, legal and analytic services relating to
the execution of our business plan, development and preparation of reports to be
filed under the Securities Exchange Act, and utilization of proprietary forms
and documents utilized by the Advisor in connection with our business
operations.
Subject to the supervision of the Board of Directors, our business is
managed by the Advisor, which provides us investment advisory and administrative
services. Philip J. Myers, our Chief Executive Officer, Treasurer and a
Director, is President of the Advisor and President of American Investors Group,
Inc., the underwriter of our past public offerings. The Advisor employs three
people on a part-time or other basis. The Company does not presently expect to
directly employ anyone in the foreseeable future, since all of our
administrative functions and operations are contracted for through the Advisor.
However, legal, accounting and certain other services are provided to us by
outside professionals and paid by us directly.
Operations
Our operations currently are located in the 8,200 square foot offices of
the Advisor's affiliate, American Investors Group, Inc., 10237 Yellow Circle
Drive, Minnetonka, Minnesota 55343. These facilities are owned by Yellow Circle
Partners, L.L.P., a partnership owned in part by Philip J. Myers, our Chief
Executive Officer, Treasurer and a Director. We are not separately charged any
rent for our use of these facilities, or for our use of copying services,
telephones, facsimile machines, postage service, office supplies or employee
services, since these costs are covered by the advisory fee paid to the Advisor.
However, we do pay postage service for costs associated with the distribution of
dividends and proxy materials to our shareholders.
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Risk Factors
Risks Related to Mortgage Lending
We Are Subject to the Risks Generally Associated with Mortgage Lending.
Mortgage lending involves various risks, many of which are unpredictable and
beyond our control and foresight. It is not possible to identify all potential
risks associated with mortgage lending. Some of the more common risks
encountered may be summarized as follows:
o low demand for mortgage loans o availability of alternative financing
and competitive conditions
o interest rate fluctuations
o factors affecting specific borrowers
o changes in the level of consumer confidence
o losses associated with default,
o availability of credit-worthy borrowers foreclosure of a mortgage, and sale of the
mortgaged property
o national and local economic conditions
o state and federal laws and regulations
o demographic and population patterns
o bankruptcy or insolvency of a borrower
o zoning regulations
o financial industry market risk
o taxes and tax law changes
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Second Mortgage Loans Pose Additional Risks. Our financing policies allow
us to make second mortgage loans. The principal amount of such loans may not
exceed 20% of our Average Invested Assets. Second mortgage loans entail more
risk than first mortgage loans, as foreclosure of senior indebtedness or liens
could require us to pay the senior debt or risk losing our mortgage, or reduced
collateral value may reduce or eliminate our security.
Fixed and Variable-Rate Debt Can Result in Yield Fluctuations. Fixed and
variable-rate debt obligations carry certain risks. A general rise in interest
rates could make the yield on a particular mortgage loan lower than prevailing
rates. This could negatively affect our value and consequently the value of our
shares and certificates. Neither we nor our advisor can predict changes in
interest rates. We will attempt to reduce this risk by maintaining medium and
longer-term mortgage loans and through offering adjustable rate loans to
borrowers. We do not intend to borrow funds or sell certificates if the cost of
such borrowing exceeds the income we believe we can earn from lending the funds.
The average holding period of our debt is less than three years which has
mitigated this risk in yield fluctuations.
The Mortgage Banking Industry Is Highly Competitive. We compete with a wide
variety of lenders, including banks, savings and loan associations, insurance
companies, pension funds and fraternal organizations for mortgage loans. Many
competitors have greater financial resources, larger staffs and longer operating
histories than we have, and thus may be a more attractive lender to potential
borrowers. We intend to compete by limiting our business "niche" to lending to
churches and other non-profit religious organizations, offering loans with
competitive and flexible terms, and emphasizing our expertise in the specialized
industry segment of lending to churches and other non-profit religious
organizations.
Fluctuations in Interest Rates May Affect Our Ability to Generate New
Loans. Prevailing market interest rates impact borrower decisions to obtain new
loans or to refinance existing loans, possibly having a negative effect upon our
ability to originate mortgage loans. If interest rates decrease and the economic
advantages of refinancing mortgage loans increase, then prepayments of higher
interest mortgage loans in our portfolio would likely reduce our portfolio's
overall rate of return (yield).
We Are Subject to the Risks Associated with Fluctuations in National and Local
Economic Conditions. The mortgage lending industry is subject to increased
credit risks and rates of foreclosures during economic downturns. In addition,
because we provide mortgages to churches and other religious organizations who
generally receive financing through charitable contributions, our financial
results are subject to fluctuations based on a lack of consumer confidence or a
severe or prolonged national or regional recession. As a result of these and
other circumstances, our potential borrowers may decide to defer or terminate
plans for financing their properties decreasing demand for mortgage loans. In
addition, during such economic times we may be unable to locate credit-worthy
borrowers.
Our Business May Be Adversely Affected If Our Borrowers Become Insolvent or
Bankrupt or Cease Using the Financed Facilities. If any of our borrowers become
insolvent or bankrupt, the borrower's mortgage payments will be delayed and may
cease entirely. We may be forced to foreclose on the mortgage and take legal
title to the real estate and incur expenses related to the foreclosure and
disposition of the property. The sale of church property can take longer than
typical commercial or residential real estate because of its "special use"
nature. We have experienced extended offering periods for properties we hold
through foreclosure. This has, and we expect will, compel us to discount our
asking prices and/or our actual sale prices to liquidate foreclosed properties.
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Risks Related to Mortgage Lending to Churches
Churches Rely on Member Contributions to Repay Our Loans. Churches
typically rely on member contributions for their primary source of income. As
such, member contributions are the primary source used to repay our loans. The
membership of a church or the per capita contributions of its members may not
increase or remain constant after a loan is funded. A decrease in a church's
income could result in its temporary or continued inability to pay its
obligation to us, which may affect our ability to pay dividends on our common
stock or pay interest or principal due on the certificates. We have no control
over the financial performance of a borrowing church after a loan is funded.
Churches Depend Upon Their Senior Pastors. A church's senior pastor usually
plays an important role in the management, leadership and continued viability of
that church. A senior pastor's absence, resignation or death could have a
negative impact on a church's operations, and thus its continued ability to
generate revenues sufficient to service its obligations to us.
The Limited Use Nature of Church Facilities Can Limit the Resale Value of
Our Mortgage Collateral. Our loans are secured principally by first mortgages
upon the real estate and improvements owned or to be owned by borrowing
churches. Although we will require an appraisal of the premises as a
pre-condition to making a loan, the appraised value of the premises cannot be
relied upon as being the actual amount which might be obtained in the event we
need to foreclose after a default by the borrower. The actual liquidation value
of church, school or other institutional premises could be adversely affected
by, among other factors: (i) its limited use nature; (ii) the availability on
the market of similar properties; (iii) the availability and cost of financing,
rehabilitation or renovation to prospective buyers; (iv) the length of time the
seller is willing to hold the property on the market; or (v) the availability in
the area of the mortgaged property of congregations or other buyers willing to
pay the fair value for a church facility. This factor may influence our decision
to restructure the terms of a non-performing loan rather than foreclosing on the
church property.
Expenses of Foreclosure May Prevent Us From Recovering the Full Value of a
Loan. If we foreclose on a mortgage and take legal title to a church's real
estate, real estate taxes could be levied and assessed against the property
until sold since the property would no longer be owned by a non-profit entity.
The property may also incur operating expenses pending its sale, such as
property insurance, utilities, security, repairs and maintenance. These expenses
would be our financial responsibility, and could be substantial in relation to
our prior loan if we cannot readily dispose of the property. Such expenses could
prevent us from recovering the full value of a loan in the event of foreclosure.
Risks Related to Us
Our Failure to Qualify as a Real Estate Investment Trust Could Reduce the
Funds We Have Available For Investment. We operate as a real estate investment
trust ("REIT"). As a REIT, we are allowed a deduction for dividends paid to our
shareholders in computing our taxable income. Thus, only our shareholders are
taxed on our taxable income that we distribute. This treatment substantially
eliminates the "double taxation" of earnings to which most corporations and
their shareholders are subject. Qualification as a REIT involves the application
of highly technical and complex Internal Revenue Code provisions.
To qualify and maintain our status as a REIT, we must meet certain share
ownership, income, asset and distribution tests on a continuing basis. No
assurance can be given that we will satisfy these tests at all times. Further,
the requirements for a REIT may substantially affect day-to-day decision-making
by our advisor. Our advisor may be forced to take action it would not otherwise
take or refrain from action which might otherwise be desirable in order to
maintain our REIT status.
If we fail to qualify as a REIT in any taxable year, then we would be
subject to federal income tax on our taxable income at regular corporate rates
and not be allowed a deduction for distributions to shareholders. We would be
disqualified from treatment as a REIT for the four taxable years following the
year of losing our REIT status. We intend to continue to operate as a REIT.
However, future economic, market, legal, tax or other consequences may cause our
board of directors to revoke the REIT election. The payment of taxes resulting
from our disqualification as a REIT or revocation of REIT status would reduce
the funds available for distribution to shareholders or for investment. Because
interest paid to certificate holders will be a deductible business expense to
us, loss of our REIT status would not necessarily impede our ability to make
interest payments to holders of certificates.
Conflicts of Interest Arise From Our Relationship with Our Advisor. The
terms of transactions involving our formation and the formation of our Advisor,
and our contractual relationship with our Advisor, were not negotiated at
arm's-length. Our non-independent directors and officers may have conflicts of
interest in enforcing agreements between us and our Advisor. Future business
arrangements and agreements between us and our Advisor and their affiliates must
be approved by our board of directors, including a majority of our independent
directors.
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Risks Related to the Shares
There Is No Public Market for Our Shares. There is no market for our
shares. It is unlikely that a market will develop. There are no current plans to
list on any exchange or qualify our shares for quotation on NASDAQ. In addition,
the market for REIT securities historically has been less liquid than other
types of publicly-traded equity securities.
There Are Restrictions on Certain Transfers of Our Shares. Our articles of
incorporation and bylaws prohibit a transfer of shares to any person who, as a
result, would beneficially own shares in excess of 9.8% of the outstanding
capital stock and allow us to redeem shares held by any person in excess of 9.8%
of the outstanding capital stock. These provisions may reduce market activity
for the shares and the opportunity for shareholders to receive a premium for
their shares.
Fluctuations in Interest Rates May Cause the Value of Our Shares to
Fluctuate. Prevailing market interest rates impact borrower decisions to obtain
new loans or to refinance existing loans, possibly having a negative effect upon
our ability to originate mortgage loans. Fluctuations in interest rates may
cause the value of the shares to fluctuate unpredictably. If interest rates
decrease and the economic advantages of refinancing mortgage loans increase,
then prepayments of higher interest mortgage loans in our portfolio would likely
reduce the portfolio's overall rate of return (yield).
Interest Payments to Certificate Holders May Reduce Dividend Payments on
Our Shares. We attempt to deploy our capital into new loans at rates that
provide a positive interest rate spread. This spread, however, may be materially
and adversely affected by changes in prevailing interest rates which would
reduce our net income. If this occurs, we may not have sufficient net income
after paying interest on the certificates to maintain dividends to shareholders
at the levels paid in the past or even to pay dividends at all. In addition,
because dividends are directly affected by the yields generated on the Company's
portfolio of loans and bonds, shareholders dividends can be expected to
fluctuate significantly with interest rates generally.
Risks Related to the Certificates
We May Incur More Indebtedness. We may incur additional indebtedness in the
future. We may assign or pledge some of our mortgage-secured promissory notes or
other collateral in connection with incurring this additional indebtedness.
Under our Bylaws, as amended, we may incur indebtedness up to 300% of our
shareholder's equity, the level permitted under North American Securities
Administrators Association ("NASAA") guidelines, in the absence of a
satisfactory showing that a higher level of borrowing is appropriate; any excess
in borrowing over such 300% level must be approved by a majority of the
Independent Directors and disclosed to shareholders in the next quarterly report
along with justification for such excess.
There Are Potential Adverse Effects Associated With Lending Borrowed Funds.
We have deployed the proceeds from the sale of secured investor certificates
into loans to churches and other non-profit religious organizations. We have
also used our line of credit with KeyBank, Cleveland, Ohio, from time to time,
to fund loans, and intend to use our line of credit in this way in the future.
Lending borrowed funds is subject to greater risks than in unleveraged lending.
The profit we realize from lending borrowed funds is largely determined by the
difference, or "spread," between the interest rates we pay on the borrowed funds
and the interest rates that our borrowers pay us. Our spread may be materially
and adversely affected by changes in prevailing interest rates. Furthermore, the
financing costs associated with lending borrowed funds could decrease the
effective spread in lending borrowed funds, which could adversely affect our
ability to pay interest on and repay the certificates as they mature.
There Is No Public Market for the Certificates. There is no market for the
certificates. It is unlikely that a market will develop. There are no current
plans to list the certificates on any exchange or for a broker-dealer to make a
market in the certificates. In addition, the market for REIT securities
historically has been less liquid than the markets for other types of
publicly-traded securities.
There Is No Sinking Fund, Insurance or Guarantee Associated With the
Certificates. We do not contribute funds to a separate account, commonly known
as a sinking fund, to repay principal or interest on the certificates upon
maturity or default. Our certificates are not certificates of deposit or similar
obligations of, or guaranteed by, any depository institution. Further, no
governmental or other entity insures or guarantees payment on the certificates
if we do not have enough funds to make principal or interest payments.
Therefore, holders of our certificates have to rely on our revenue from
operations, along with the security provided by the collateral for the
certificates, for repayment of principal and interest on the certificates.
The Collateral for the Certificates May Not Be Adequate If We Default. The
certificates must at all times be secured by mortgage-secured promissory notes
and church bonds having an outstanding principal balance equal to at least 100%
of the outstanding principal balance of the certificates. If we default in the
repayment of the certificates, or another event of default occurs, the trustee
will not be able to foreclose on the mortgages securing the promissory notes and
bonds in order to obtain funds to repay certificate holders. Rather, the trustee
will need to look to the revenue stream associated with our borrowers' payments
on or repayment of the promissory notes and bonds or revenue derived from sale
of the promissory notes or bonds to repay certificate holders. If the trustee
chooses to rely on revenues received from our borrowers, certificate holders may
face a delay in payment on certificates in the event of default, as borrowers
will repay their obligations to us in accordance with amortization schedules
associated
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with their promissory notes or bonds. If the trustee chooses to sell promissory
notes or bonds in the event of our default, the proceeds from the sales may not
be sufficient to repay our obligations on all outstanding or defaulted
certificates.
The Certificates Are Not Negotiable Instruments and Are Subject to
Restrictions on Transfer. The certificates are not negotiable debt instruments.
Rights of record ownership of the certificates may be transferred only with our
Advisor's prior written consent. Certificate holders are not able to freely
transfer the certificates.
We Are Obligated To Redeem Certificates Only In Limited Circumstances.
Certificate holders have no right to require us to prepay or redeem any
certificate prior to its maturity date, except in the case of death or if we
replace our current Advisor. Further, even in the event of death, we will not be
required to redeem certificates if we have redeemed at least $25,000 of
principal amount of certificates for the benefit of estates during the calendar
quarter. There is no present intention to redeem certificates prior to maturity
except in the case of death of a certificate holder.
We May Not Have Sufficient Available Cash to Redeem Certificates If We
Terminate Our Advisory Agreement With Our Current Advisor. We will be required
to offer to redeem all outstanding certificates if we terminate our advisory
agreement with Church Loan Advisors, Inc., our current Advisor, for any reason.
If the holders of a significant principal amount of certificates request that we
redeem their certificates, we may be required to sell a portion of our mortgage
loan and church bond portfolio to satisfy the redemption requests. Any such sale
could be at a discount to the recorded value of the mortgage loans and bonds
being sold. Further, if we are unable to sell loans or church bonds in our
portfolio, we may be unable to satisfy the redemption obligations.
The Indenture Contains Limited Protection For Holders of Certificates. The
indenture governing the certificates contains only limited events of default
other than our failure to pay principal and interest on the certificates on
time. Further, the indenture provides for only limited protection for holders of
certificates upon a consolidation or merger between us and another entity or the
sale or transfer of all or substantially all of our assets. If we default in the
repayment of the certificates under the indenture, certificate holders will have
to rely on the trustee to exercise any remedies on their behalf. Certificate
holders will not be able to seek remedies against us directly.
Risks Related to Management
We Are Dependent Upon Our Advisor. Our Advisor, Church Loan Advisors, Inc.,
manages us and selects our investments subject to general supervision by our
Board of Directors and compliance with our lending policies. We depend upon our
Advisor and its personnel for most aspects of our business operations. Our
success depends on the success of our Advisor in locating borrowers and
negotiating loans upon terms favorable to us. Among others, our Advisor performs
the following services for us:
o mortgage loan marketing and procurement o managing relationships with our accountants and attorneys
o bond portfolio selection and investment o corporate management
o mortgage loan underwriting o bookkeeping
o mortgage loan servicing o reporting to state, federal, tax and other
o money management authorities
o developing and maintaining business relationships o reports to shareholders and shareholder relations
o maintaining "goodwill" o loan enforcement and collections
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Our shareholders' right to participate in management is generally limited
to the election of directors. Certificate holders have no right to participate
in our management. Certificate holders must be willing to entrust our management
to our Advisor and our Board of Directors.
We Have Conflicts of Interest with Our Advisor and Affiliates. Affiliations
and conflicts of interests exist among our officers and directors and the owner
and officers and directors of our Advisor and affiliates. Our Advisor and
affiliates are both controlled by our Chief Executive Officer and President,
Philip Myers. Our President and the officers and directors of our Advisor are
involved in the church financing business through their affiliations with
American Investors Group, Inc. ("American"). American originates, offers and
sells first mortgage bonds for churches. We may purchase first mortgage bonds
issued by churches through American in its capacity as underwriter for the
issuing church, or as broker or dealer on the secondary market. In such event,
American would receive commissions (paid by the issuing church) on original
issue bonds, or "mark-ups" in connection with any secondary transactions. If we
sell church bonds in our portfolio, the bonds will be sold through American. We
would pay American commissions in connection with such transactions, but in no
event, in excess of those normally charged to customers.
Our Bylaws limit the amount of all commissions, mark-downs or mark-ups paid
to American. Our business dealings with our Advisor and its affiliates outside
of the ordinary course of our activities are subject to approval by a majority
of our Board of Directors, including a majority of our Independent Directors.
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Generally, mortgage loans we originate are smaller than the bond financings
originated by American. However, there may be circumstances where our Advisor
and American could recommend either type of financing to a prospective borrower.
The decisions of our Advisor and American could affect the credit quality of our
portfolio.
Redemption Obligations Relating to the Certificates May Affect Our Ability
to Replace our Advisor. We will be required to offer to redeem all outstanding
certificates if we terminate our advisory agreement with Church Loan Advisors,
Inc. Our independent directors are required to review and approve the advisory
agreement with our Advisor on an annual basis. The redemption provision relating
to the certificates may have the effect of reducing our ability to replace our
current Advisor.
Risks Related to Environmental Laws
We May Face Liability Under Environmental Laws. Under federal, state and
local laws and regulations, a secured lender (like us) may be liable, under
certain limited circumstances, for the costs of removal or remediation of
certain hazardous or toxic substances and other costs (including government
fines and injuries to persons and adjacent property). Liability may be imposed
whether or not the owner or lender knew of, or was responsible for, the presence
of hazardous or toxic substances. The costs of remediation or removal of
hazardous or toxic substances, or of fines for personal or property damages, may
be substantial and material to our business operations. The presence of
hazardous or toxic substances, or the failure to promptly remediate such
substances, may adversely affect our ability to resell real estate collateral
after foreclosure or could cause us to forego foreclosure. This is a changing
area of the law. The courts have found both in favor and against lender
liability in this area under various factual scenarios.
The Collateral For Our Loans and Our Lenders May Be Subject to
Environmental Claims. If there are environmental problems associated with the
real estate securing any of our loans, the associated remediation or removal
requirements imposed by federal, state and local laws could affect our ability
to realize value on our collateral or our borrowers' ability to repay their
loans.