XNAS:VRTB Vestin Realty Mortgage II Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark one)

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2012

Or

[    ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to _________

Commission File Number: 333-125121
 

Company Logo
VESTIN REALTY MORTGAGE II, INC.
(Exact name of registrant as specified in its charter)


MARYLAND
 
61-1502451
(State or Other Jurisdiction of
 
(I.R.S. Employer
Incorporation or Organization)
 
Identification No.)

8880 W. SUNSET ROAD, SUITE 200, LAS VEGAS, NEVADA 89148
(Address of Principal Executive Offices)  (Zip Code)

Registrant’s Telephone Number: 702.227.0965

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  [X]    No   [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  [   ]    No   [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [   ]
Accelerated filer [   ]
Non-accelerated filer [   ]
(Do not check if a smaller reporting company)
Smaller reporting company [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  [   ]    No   [X]

As of August 14, 2012, there were 12,531,405 shares of the Company’s Common Stock outstanding.



TABLE OF CONTENTS

   
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PART I - FINANCIAL INFORMATION

ITEM 1.
CONSOLIDATED FINANCIAL STATEMENTS

VESTIN REALTY MORTGAGE II, INC.
 
   
CONSOLIDATED BALANCE SHEETS
 
   
ASSETS
 
   
   
June 30, 2012
   
December 31, 2011
 
   
(Unaudited)
       
Assets
           
Cash and cash equivalents
  $ 3,271,000     $ 9,226,000  
Investment in marketable securities - related party
    501,000       592,000  
Interest and other receivables, net of allowance of $2,505,000 at June 30, 2012 and $5,468,000 at December 31, 2011
    20,000       14,000  
Notes receivable, net of allowance of $24,465,000 at June 30, 2012 and $17,250,000 at December 31, 2011
    --       --  
Real estate held for sale
    9,171,000       10,767,000  
Other real estate owned
    8,963,000       --  
Investment in real estate loans, net of allowance for loan losses of $6,804,000 at June 30, 2012 and $26,247,000 at December 31, 2011
    28,132,000       31,777,000  
Due from related parties
    89,000       110,000  
Investment in MVP Realty Advisors
    32,000       --  
Other assets
    288,000       149,000  
                 
Total assets
  $ 50,467,000     $ 52,635,000  
                 
LIABILITIES AND EQUITY
 
                 
Liabilities
               
Accounts payable and accrued liabilities
  $ 661,000     $ 753,000  
Note payable
    171,000       25,000  
Deferred gain on sale of HFS
    38,000       102,000  
                 
Total liabilities
    870,000       880,000  
                 
Commitments and contingencies
               
                 
Stockholders’ equity
               
Preferred stock, $0.0001 par value; 1,000,000 shares authorized; none issued
    --       --  
Treasury stock, at cost, 189,378 shares at June 30, 2012 and 189,378 shares at December 31, 2011
    (190,000 )     (190,000 )
Common stock, $0.0001 par value; 100,000,000 shares authorized; 12,720,783 shares issued and 12,531,405 outstanding at June 30, 2012 and 12,720,783 shares issued and 12,531,405 outstanding at December 31, 2011
    1,000       1,000  
Additional paid-in capital
    270,983,000       271,005,000  
Accumulated deficit
    (221,115,000 )     (219,070,000 )
Accumulated other comprehensive income
    (82,000 )     9,000  
Total stockholders’ equity
    49,597,000       51,755,000  
                 
Total equity
    49,597,000       51,755,000  
                 
Total liabilities and equity
  $ 50,467,000     $ 52,635,000  


The accompanying notes are an integral part of these consolidated statements.
 
-1-



VESTIN REALTY MORTGAGE II, INC.
   
     
CONSOLIDATED STATEMENTS OF OPERATIONS
 
(UNAUDITED)
   
   
For The
Three Months Ended
   
For The
Six Months Ended
   
6/30/2012
   
6/30/2011
   
6/30/2012
 
6/30/2011
                     
Revenues
                   
Interest income from investment in real estate loans
  $ 313,000     $ 258,000     $ 581,000   $ 757,000  
Gain related to pay off of real estate loan, including recovery of allowance for loan loss
    1,099,000       35,000       1,236,000     35,000  
Gain related to pay off of notes receivable, including recovery of allowance for notes receivable
    85,000       92,000       148,000     98,000  
Total revenues
    1,497,000       385,000       1,965,000     890,000  
                                 
Operating expenses
                               
Management fees - related party
    274,000       274,000       549,000     549,000  
Provision for loan loss
    --       --       765,000     --  
Interest expense
    --       50,000       --     119,000  
Professional fees
    335,000       394,000       587,000     699,000  
Consulting
    58,000       35,000       112,000     66,000  
Insurance
    73,000       82,000       146,000     157,000  
Other
    50,000       51,000       116,000     140,000  
Total operating expenses
    790,000       886,000       2,275,000     1,730,000  
                                 
Income (loss) from operations
    707,000       (501,000 )     (310,000 )   (840,000 )
                                 
Non-operating income (loss)
                               
Interest income from banking institutions
    --       2,000       1,000     5,000  
Recovery from settlement with loan guarantor
    543,000       --       543,000     --  
Gain on sale of marketable securities
    --       --       15,000     --  
Discounted professional fees
    --       1,600,000       --     1,600,000  
Settlement expense
    (22,000 )     --       (44,000 )   --  
Total non-operating income, net
    521,000       1,602,000       515,000     1,605,000  
                                 
Provision for income taxes
    --       --       --     --  
                                 
Income from continuing operations
    1,228,000       1,101,000       205,000     765,000  
                                 
Discontinued operations, net of income taxes
                               
Net gain on sale of real estate held for sale
    2,000       10,000       12,000     10,000  
Expenses related to real estate held for sale
    (289,000 )     (127,000 )     (842,000 )   (399,000 )
Write-downs on real estate held for sale
    (1,420,000 )     (612,000 )     (1,420,000 )   (612,000 )
Income from Hawaiian cemeteries and mortuaries, net of income taxes
    --       591,000       --     877,000  
Total loss from discontinued operations
    (1,707,000 )     (138,000 )     (2,250,000 )   (124,000 )
                                 
Net income (loss)
    (479,000 )     963,000       (2,045,000 )   641,000  
Allocation to noncontrolling interest – related party
    --       225,000       --     333,000  
Net income (loss) attributable to common stockholders
  $ (479,000 )   $ 738,000     $ (2,045,000 ) $ 308,000  
                                 
Basic and diluted income (loss) per weighted average common share
                               
  Continuing operations
    0.10       0.08       0.01     0.06  
  Discontinued operations
    (0.14 )     (0.02 )     (0.17 )   (0.04 )
   Total basic and diluted income (loss) per weighted
                               
    average common share
  $ (0.04 )   $ 0.06     $ (0.16 ) $ 0.02  
                                 
Dividends declared per common share
  $ --     $ --     $ --   $ --  
                                 
Weighted average common shares outstanding
    12,531,405       13,139,513       12,531,405     13,139,513  


The accompanying notes are an integral part of these consolidated statements.
 
-2-



VESTIN REALTY MORTGAGE II, INC.
 
CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME (LOSS)
 
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2012 AND 2011
 
(UNAUDITED)
   
For The
Three Months Ended
   
For The
Six Months Ended
 
   
6/30/2012
   
6/30/2011
   
6/30/2012
   
6/30/2011
 
                         
Net income (loss)
  $ (479,000 )   $ 963,000     $ (2,045,000 )   $ 641,000  
                                 
Unrealized holding loss on available-for-sale securities – related party
    (97,000 )     361,000       (91,000 )     128,000  
Unrealized gain on marketable securities on assets held for sale
    --       --       --       1,058,000  
                                 
Comprehensive income (loss)
    (576,000 )     1,324,000       (2,136,000 )     1,827,000  
Net (income) loss attributable to noncontrolling interest
    --       (225,000 )     --       (333,000 )
                                 
Comprehensive income (loss) attributable to Vestin Realty Mortgage II, Inc.
  $ (576,000 )   $ 1,099,000     $ (2,136,000 )   $ 1,494,000  
                                 



The accompanying notes are an integral part of these consolidated statements.
 
-3-



  VESTIN REALTY MORTGAGE II, INC.
 
  CONSOLIDATED STATEMENT OF EQUITY
 
  FOR THE SIX MONTHS ENDED JUNE 30, 2012
 
  (UNAUDITED)  
   
Treasury Stock
 
Common Stock
                         
   
Shares
 
Amount
 
Shares
 
Amount
 
Additional
Paid-in
Capital
 
Accumulated Deficit
 
Accumulated
Other Comprehensive
Income (Loss)
 
Total
     
                                       
Stockholders' Equity at
December 31, 2011
 
189,378
$
(190,000)
 
12,531,405
$
1,000
$
271,005,000
$
(219,070,000)
$
9,000
  $
51,755,000     
   
                                     
Net Loss
                     
(2,045,000)
     
(2,045,000)
     
                                       
Unrealized Loss on Marketable Securities – Related Party
                         
(91,000)
 
(91,000)
     
                                       
Comprehensive Loss
                             
(2,136,000)
     
                                       
Purchase treasury stock
     
 
 
 
        (22,000 )        
(22,000
)    
                                       
Stockholders' Equity at
June 30, 2012 (Unaudited)
 
189,378
$
(190,000)
 
12,531,405
$
1,000
$
270,983,000
$
(221,115,000)
$
(82,000)
$
49,597,000
     
         


The accompanying notes are an integral part of these consolidated statements.
 
-4-


VESTIN REALTY MORTGAGE II, INC.
 
   
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
(UNAUDITED)
 
   
For the
Six Months Ended
 
   
06/30/2012
   
06/30/2011
 
Cash flows from operating activities:
           
Net income (loss)
  $ (2,045,000 )   $ 308,000  
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Recovery of allowance for doubtful notes receivable
    (148,000 )     (91,000 )
Gain related to recovery of allowance for loan loss
    (1,236,000 )     (35,000 )
Gain related to recovery from settlement with loan guarantor
    (543,000 )     --  
Provision for loan loss
    765,000       --  
Gain on sale of real estate held for sale
    (12,000 )     --  
Gain on sale of marketable securities
    (15,000 )     --  
Amortized interest income
    --       (26,000 )
Provision for doubtful accounts related to receivable included in other expense
    --       559,000  
Write-downs on real estate held for sale
    1,420,000       612,000  
Change in operating assets and liabilities:
               
Interest and other receivables
    (6,000 )     1,498,000  
Assets held for sale, net of liabilities
    --       156,000  
Due to/from related parties
    21,000       639,000  
Deferred gain on sale of HFS
    (64,000 )     --  
Other assets
    153,000       106,000  
Accounts payable and accrued liabilities
    (93,000 )     (3,519,000 )
Net cash provided by (used in) operating activities
    (1,803,000 )     207,000  
                 
Cash flows from investing activities:
               
Investments in real estate loans
    (19,881,000 )     (1,453,000 )
Proceeds from loan payoffs
    12,697,000       71,000  
Sale of investments in real estate loans to
               
    related parties
    --       100,000  
    third parties
    2,307,000       600,000  
Proceeds from notes receivable
    148,000       91,000  
Proceeds from settlement from loan guarantor
    543,000       --  
Investment in MVP Realty Advisors
    (32,000 )     --  
Proceeds from sale of real estate held for sale
    207,000       --  
Proceeds on nonrefundable extension fees on real estate held for sale
    12,000       --  
Purchase of marketable securities
    (1,011,000 )     --  
Purchase of marketable securities – related party
    --       (6,000 )
Sale of marketable securities
    1,026,000       --  
Net cash used in investing activities
    (3,984,000 )     (597,000 )
                 
Cash flows from financing activities:
               
Principal payments on notes payable
    (146,000 )     (76,000 )
Purchase of treasury stock
    (22,000 )     --  
Distributions to holder of noncontrolling interest – related party
    --       (213,000 )
Net cash used in financing activities
    (168,000 )     (289,000 )
                 
NET CHANGE IN CASH
    (5,955,000 )     (679,000 )
                 
Cash and cash equivalents, beginning of period
    9,226,000       7,884,000  
                 
Cash and cash equivalents, end of period
  $ 3,271,000     $ 7,205,000  

The accompanying notes are an integral part of these consolidated statements.
 
-5-



VESTIN REALTY MORTGAGE II, INC.
 
   
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
 
   
(UNAUDITED)
 
   
For the
Six Months Ended
 
   
06/30/2012
   
06/30/2011
 
             
Supplemental disclosures of cash flows information:
           
Interest paid
  $ --     $ 119,000  
                 
Non-cash investing and financing activities:
               
Transfer of  fully allowed interest receivable and related allowance to real estate held for sale
  $ 2,334,000     $ --  
Transfer of fully allowed interest receivable to notes receivable
  $ 907,000     $ --  
Investments in real estate loans  and related allowances transferred to note receivable
  $ 6,642,000     $ --  
Real estate held for sale acquired through foreclosure, net of prior allowance
  $ 32,000     $ 160,000  
Note payable relating to prepaid D & O insurance
  $ 219,000     $ 219,000  
Unrealized gain on marketable securities of assets held for sale
  $ --     $ 1,058,000  
Other real estate owned acquired through deed in lieu, net of prior allowance
  $ 8,963,000     $ --  
    Retirement of treasury stock   $ 22,000      $ --   
Unrealized gain (loss) on marketable securities - related party
  $ (91,000 )   $ 128,000  


The accompanying notes are an integral part of these consolidated statements.
 
-6-



VESTIN REALTY MORTGAGE II, INC

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2012

(UNAUDITED)

NOTE A — ORGANIZATION

Vestin Realty Mortgage II, Inc. (“VRM II”) formerly Vestin Fund II, LLC (“Fund II”) invests in loans secured by real estate through deeds of trust or mortgages (hereafter referred to collectively as “deeds of trust” and as defined in our management agreement (“Management Agreement”) as “Mortgage Assets”).  In addition we may invest in, acquire, manage or sell real property or acquire entities involved in the ownership or management of real property.  We commenced operations in June 2001.  References in this report to the “Company,”“we,”“us,” or “our” refer to Fund II with respect to the period prior to April 1, 2006 and to VRM II with respect to the period commencing on April 1, 2006.

We operated as a real estate investment trust (“REIT”) through December 31, 2011.  We are not a mutual fund or an investment company within the meaning of the Investment Company Act of 1940, nor are we subject to any regulation thereunder.  As a REIT, we were required to have a December 31 fiscal year end.  We announced on March 28, 2012 that we have terminated our election to be treated as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”), effective for the tax year ending December 31, 2012.  Under the Code, we will not be able to make a new election to be taxed as a REIT during the four years following December 31, 2012.  Pursuant to our charter, upon the determination by the Board of Directors that we should no longer qualify as a REIT, the restrictions on transfer and ownership of shares set forth in Article VII of our charter ceased to be in effect and, accordingly, shares of the Company’s stock will no longer be subject to such restrictions.

Vestin Group, Inc. (“Vestin Group”), a Delaware corporation, owns a significant majority of Vestin Mortgage, LLC, a Nevada limited liability company, which is our manager (the “manager” or “Vestin Mortgage”). On January 7, 2011, Vestin Mortgage converted from a corporation to a limited liability company.  Michael Shustek, the CEO and managing member of our manager and CEO, President and a director of us, wholly owns Vestin Group, which is engaged in asset management, real estate lending and other financial services through its subsidiaries.  Our manager, prior to June 30, 2006, also operated as a licensed Nevada mortgage broker and was generally engaged in the business of brokerage, placement and servicing of commercial loans secured by real property.  On July 1, 2006, a mortgage broker license was issued to an affiliated company, Vestin Originations, Inc. (“Vestin Originations”), which is majority-owned by Vestin Group.  Vestin Originations continued the business of brokerage, placement and servicing of real estate loans.  Since February 14, 2011, the business of brokerage and placement of real estate loans have been performed by affiliated or non-affiliated mortgage brokers, including Vestin Originations and Advant Mortgage, LLC (“Advant”), both licensed Nevada mortgage brokers, which are indirectly majority owned by Mr. Shustek.

Pursuant to a management agreement, our manager is responsible for managing our operations and implementing our business strategies on a day-to-day basis.  Consequently, our operating results are dependent to a significant extent upon our manager’s ability and performance in managing our operations and servicing our loans.

Vestin Mortgage is also the manager of Vestin Realty Mortgage I, Inc. (“VRM I”), as the successor by merger to Vestin Fund I, LLC (“Fund I”) and Vestin Fund III, LLC (“Fund III”).  VRM I has investment objectives similar to ours, and Fund III is in the process of an orderly liquidation of its assets.




During April 2009, we entered into an accounting services agreement with Strategix Solutions, LLC (“Strategix Solutions”), a Nevada limited liability company, for the provision of accounting and financial reporting services.  Strategix Solutions also provides accounting and financial reporting services to VRM I and Fund III.  Our CFO and other members of our accounting staff are employees of Strategix Solutions.  Strategix Solutions is managed by LL Bradford and Company, LLC ("LL Bradford"), a certified public accounting firm that has provided non-audit accounting services to us.  The principal manager of LL Bradford was a former officer of our manager from April 1999 through January 1, 2005.  Strategix Solutions is owned by certain partners of LL Bradford, none of whom are currently or were previously officers of our manager.  As used herein, “management” means our manager, its manager, its executive officers and the individuals at Strategix Solutions who perform accounting and financial reporting services on our behalf.

NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The financial statements of the Company have been prepared in accordance with the accounting principles generally accepted in the United States of America (“GAAP”).  In the opinion of management, all normal recurring adjustments considered necessary to give a fair presentation of operating results for the periods presented have been included.  Interim results are not necessarily indicative of results for a full year.  The information included in this Form 10-Q should be read in conjunction with information included in the 2011 annual report filed on Form 10-K.

Management Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Cash and Cash Equivalents

Cash and cash equivalents include interest-bearing and non-interest-bearing bank deposits, money market accounts, short-term certificates of deposit with original maturities of three months or less, and short-term instruments with a liquidation provision of one month or less.

Revenue Recognition

Interest is recognized as revenue on performing loans when earned according to the terms of the loans, using the effective interest method.  We do not accrue interest income on loans once they are determined to be non-performing.  A loan is non-performing when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due.  Cash receipts will be allocated to interest income, except when such payments are specifically designated by the terms of the loan as principal reduction.  Interest is fully allowed for on impaired loans and is recognized on a cash basis method.

Investments in Real Estate Loans

We may, from time to time, acquire or sell investments in real estate loans from or to our manager or other related parties pursuant to the terms of our Management Agreement without a premium.  The primary purpose is to either free up capital to provide liquidity for various reasons, such as loan diversification, or place excess capital in investments to maximize the use of our capital.  Selling or buying loans allows us to diversify our loan portfolio within these parameters.  Due to the short-term nature of the loans we make and the similarity of interest rates in loans we normally would invest in, the fair value of a loan typically approximates its carrying value.  Accordingly, discounts or premiums typically do not apply upon sales of loans and therefore, generally no gain or loss is recorded on these transactions, regardless of whether to a related or unrelated party.



Investments in real estate loans are secured by deeds of trust or mortgages.  Generally, our real estate loans require interest only payments with a balloon payment of the principal at maturity.  We have both the intent and ability to hold real estate loans until maturity and therefore, real estate loans are classified and accounted for as held for investment and are carried at amortized cost.  Loans sold to or purchased from affiliates are accounted for at the principal balance and no gain or loss is recognized by us or any affiliate.  Loan-to-value ratios are initially based on appraisals obtained at the time of loan origination and are updated, when new appraisals are received or when management’s assessment of the value has changed, to reflect subsequent changes in value estimates.  Such appraisals are generally dated within 12 months of the date of loan origination and may be commissioned by the borrower.

The Company considers a loan to be impaired when, based upon current information and events, it believes it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.  The Company’s impaired loans include troubled debt restructuring, and performing and non-performing loans in which full payment of principal or interest is not expected.  The Company calculates an allowance required for impaired loans based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or at the loan’s observable market price or the fair value of its collateral.

Loans that have been modified from their original terms are evaluated to determine if the loan meets the definition of a Troubled Debt Restructuring (“TDR”) as defined by ASC 310-40.  When the Company modifies the terms of an existing loan that is considered a TDR, it is considered performing as long as it is in compliance with the modified terms of the loan agreement.  If the modification calls for deferred interest, it is recorded as interest income as cash is collected.

Allowance for Loan Losses

We maintain an allowance for loan losses on our investments in real estate loans for estimated credit impairment.  Our manager’s estimate of losses is based on a number of factors including the types and dollar amounts of loans in the portfolio, adverse situations that may affect the borrower’s ability to repay, prevailing economic conditions and the underlying collateral securing the loan.  Additions to the allowance are provided through a charge to earnings and are based on an assessment of certain factors, which may indicate estimated losses on the loans.  Actual losses on loans are recorded first as a reduction to the allowance for loan losses.  Generally, subsequent recoveries of amounts previously charged off are recognized as income.

Estimating allowances for loan losses requires significant judgment about the underlying collateral, including liquidation value, condition of the collateral, competency and cooperation of the related borrower and specific legal issues that affect loan collections or taking possession of the property.  As a commercial real estate lender willing to invest in loans to borrowers who may not meet the credit standards of other financial institutional lenders, the default rate on our loans could be higher than those generally experienced in the real estate lending industry.  We and our manager generally approve loans more quickly than other real estate lenders and, due to our expedited underwriting process; there is a risk that the credit inquiry we perform will not reveal all material facts pertaining to a borrower and the security.

Additional facts and circumstances may be discovered as we continue our efforts in the collection and foreclosure processes.  This additional information often causes management to reassess its estimates.  In recent years, we have revised estimates of our allowance for loan losses.  Circumstances that have and may continue to cause significant changes in our estimated allowance include, but are not limited to:

 
·
Declines in real estate market conditions, which can cause a decrease in expected market value;

 
·
Discovery of undisclosed liens for community improvement bonds, easements and delinquent property taxes;

 
·
Lack of progress on real estate developments after we advance funds.  We customarily utilize disbursement agents to monitor the progress of real estate developments and approve loan advances.  After further inspection of the related property, progress on construction occasionally does not substantiate an increase in value to support the related loan advances;



 
·
Unanticipated legal or business issues that may arise subsequent to loan origination or upon the sale of foreclosed property; and

 
·
Appraisals, which are only opinions of value at the time of the appraisal, may not accurately reflect the value of the property.

Discontinued Operations

We have reclassified for all periods presented in the accompanying consolidated statements of operations, the amounts related to discontinued operations and real estate held for sale, in accordance with the applicable accounting criteria.  In addition, the assets and liabilities related to the discontinued operations are reported separately in the accompanying consolidated balance sheets as real estate held for sale, assets held for sale, and liabilities related to assets held for sale.

Real Estate Held for Sale

Real estate held for sale (“REO”) includes real estate acquired through foreclosure and will be carried at the lower of the recorded amount, inclusive of any senior indebtedness, or the property's estimated fair value, less estimated costs to sell, with fair value based on appraisals and knowledge of local market conditions.  While pursuing foreclosure actions, we seek to identify potential purchasers of such property.  We generally seek to sell properties acquired through foreclosure as quickly as circumstances permit, taking into account current economic conditions.  The carrying values of REO are assessed on a regular basis from updated appraisals, comparable sales values or purchase offers.

Management classifies real estate as REO when the following criteria are met:

 
·
Management commits to a plan to sell the properties;

 
·
The property is available for immediate sale in its present condition subject only to terms that are usual and customary;

 
·
An active program to locate a buyer and other actions required to complete a sale have been initiated;

 
·
The sale of the property is probable;

 
·
The property is being actively marketed for sale at a reasonable price; and

 
·
Withdrawal or significant modification of the sale is not likely.

Real Estate Held For Sale – Seller-Financed

We occasionally finance sales of foreclosed properties (“seller-financed REO”) to third parties.  In order to record a sale of real estate when we provide financing, the buyer of the real estate is required to make minimum initial and continuing investments.  Minimum initial investments range from 10% to 25% based on the type of real estate sold.  In addition, there are limits on commitments and contingent obligations incurred by a seller in order to record a sale.

Because we occasionally foreclose on loans with raw land or developments in progress, available financing for such properties is often limited and we frequently provide financing up to 100% of the selling price on these properties.  In addition, we may make additional loans to the buyer to continue development of a property.  Although sale agreements are consummated at closing, they lack adequate initial investment by the buyer to qualify as a sale transaction.  These sale agreements are not recorded as a sale until the minimum requirements are met.




These sale agreements are recorded under the deposit method or cost recovery method. Under the deposit method, no profit is recognized and any cash received from the buyer is reported as a deposit liability on the balance sheet.  Under the cost recovery method, no profit is recognized until payments by the buyer exceed the carrying basis of the property sold.  Principal payments received will reduce the related receivable, and interest collections will be recorded as unrecognized gross profit on the balance sheet.  The carrying values of these properties would be included in real estate held for sale – seller financed on the consolidated balance sheets, when applicable.

In cases where the investment by the buyer is significant (generally 20% or more) and the buyer has an adequate continuing investment, the purchase money debt is not subject to future subordination, and a full transfer of risks and rewards has occurred, we will use the full accrual method.  Under the full accrual method, a sale is recorded and the balance remaining to be paid is recorded as a normal note.  Interest is recorded as income when received.

Secured Borrowings

Secured borrowings provide an additional source of capital for our lending activity.  Secured borrowings allow us to increase the diversification of our loan portfolio and to invest in loans that we might not otherwise invest in.  We do not receive any fees for entering into secured borrowing arrangements; however, we may receive revenue for any differential of the interest spread, if applicable.  Loans in which unaffiliated investors have participated through inter-creditor agreements (“Inter-creditor Agreements”) are accounted for as secured borrowings.

The Inter-creditor Agreements provide us additional funding sources for real estate loans whereby an unaffiliated investor (the “Investor”) may participate on a non-paripassu basis in certain real estate loans with us and/or VRM I (collectively, the “Lead Lenders”).  In the event of borrower non-performance, the Inter-creditor Agreements generally provide that the Lead Lenders must repay the Investor’s loan amount either by (i) continuing to remit to the Investor the interest due on the participated loan amount; (ii) substituting an alternative loan acceptable to the Investor; or (iii) repurchasing the participation from the Investor for the outstanding balance plus accrued interest.

Additionally, an Investor may participate in certain loans with the Lead Lenders through Participation Agreements.  In the event of borrower non-performance, the Participation Agreement may allow the Investor to be repaid up to the amount of the Investor’s investment prior to the Lead Lender being repaid.  Real estate loan financing under the Participation Agreements are also accounted for as a secured borrowing.  We do not receive any revenues for entering into secured borrowing arrangements.

Investment in Marketable Securities – Related Party

Investment in marketable securities – related party consists of stock in VRM I.  The securities are stated at fair value as determined by the closing market prices as of June 30, 2012 and December 31, 2011.  All securities are classified as available-for-sale.

We are required to evaluate our available-for-sale investment for other-than-temporary impairment charges.  We will determine when an investment is considered impaired (i.e., decline in fair value below its amortized cost), and evaluate whether the impairment is other than temporary (i.e., investment value will not be recovered over its remaining life).  If the impairment is considered other than temporary, we will recognize an impairment loss equal to the difference between the investment’s cost and its fair value.

According to the SEC Staff Accounting Bulletin, Topic 5: Miscellaneous Accounting, M - Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities, there are numerous factors to be considered in such an evaluation and their relative significance will vary from case to case.  The following are a few examples of the factors that individually or in combination, indicate that a decline is other than temporary and that a write-down of the carrying value is required:

 
·
The length of the time and the extent to which the market value has been less than cost;




 
·
The financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology that may impair the earnings potential of the investment or the discontinuance of a segment of the business that may affect the future earnings potential; or

 
·
The intent and ability of the holder to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value.

Fair Value Disclosures

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e. “the exit price”) in an orderly transaction between market participants at the measurement date.  In determining fair value, the Company uses various valuation approaches, including quoted market prices and discounted cash flows.  The established hierarchy for inputs used, in measuring fair value, maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available.  Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from independent sources.  Unobservable inputs are inputs that reflect a company’s judgment concerning the assumptions that market participants would use in pricing the asset or liability developed based on the best information available under the circumstances.  The fair value hierarchy is broken down into three levels based on the reliability of inputs as follows:

 
·
Level 1 – Valuations based on quoted prices in active markets for identical instruments that the Company is able to access.  Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

 
·
Level 2 – Valuations based on quoted prices in active markets for instruments that are similar, or quoted prices in markets that are not active for identical or similar instruments, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

 
·
Level 3 – Valuations based on inputs that are unobservable and significant to the overall fair value measurement, which utilize the Company’s estimates and assumptions.

If the volume and level of activity for an asset or liability have significantly decreased, we will still evaluate our fair value estimate as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions.  In addition, since we are a publicly traded company, we are required to make our fair value disclosures for interim reporting periods.

Basic and Diluted Earnings Per Common Share

Basic earnings per share (“EPS”) is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding.  Diluted EPS is similar to basic EPS except that the weighted average number of common shares outstanding is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been exercised.  We had no outstanding common share equivalents during the three months ended June 30, 2012 and 2011.

Common Stock Dividends

During June 2008, our Board of Directors decided to suspend the payment of dividends.  Our Board of Directors will closely monitor our operating results in order to determine when dividends should be reinstated; however, we do not expect them to be reinstating dividends in the foreseeable future.




Treasury Stock

On June 7, 2012, the our Board of Directors (“Board”) approved the adoption of a prearranged stock repurchase plan intended to qualify for the safe harbor under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (“10b5-1 Plan”). The 10b5-1 Plan will become effective on the third business day following the earlier of (i) completion of the proposed acquisition by the Company of VRM I in a stock for stock merger pursuant to a definitive merger agreement dated May 30, 2012 (the “Merger Agreement”), (ii) a vote by our shareholders or VRM I to reject the proposed Merger or (iii) termination of the Merger Agreement by VRM I.  The 10b5-1 Plan will terminate twelve months after its effective date, unless terminated sooner in accordance with its terms. Purchases may be made in the open market or through privately negotiated transactions in support of the Company’s stock repurchase plan. Purchases in the open market will be made in compliance with Rule 10b-18 under the Securities Exchange Act of 1934. The Company is authorized to purchase up to $5,200,000 of its common stock pursuant to the 10b5-1 Plan.

Segments

We are currently authorized to operate two reportable segments, investments in real estate loans and investments in real property.  As of June 30, 2012, we had not commenced investing in real property.

Our objective is to invest approximately 97% of our assets in real estate loans and real estate investments, while maintaining approximately 3% as a working capital cash reserve.  Current market conditions have impaired our ability to be fully invested in real estate loans and real estate investments.  As of June 30, 2012, approximately 55% of our assets, net of allowance for loan losses, are classified as investments in real estate loans.

Reclassifications

Certain amounts in the June 30, 2011 consolidated financial statements have been reclassified to conform to the June 30, 2012 presentation.

Principles of Consolidation

Our consolidated financial statements include the accounts of VRM II, TRS II, our wholly owned subsidiary, and HFS, in which we had a controlling interest through December 1, 2011. Our consolidated financial statements also included the accounts of the funeral merchandise and service trusts, cemetery merchandise and service trusts, and cemetery perpetual care trusts (“Trusts”) in which we had a variable interest and HFS was the primary beneficiary through December 1, 2011. Intercompany balances and transactions have been eliminated in consolidation.
 
Noncontrolling Interests

The FASB issued authoritative guidance for noncontrolling interests in December 2007, which establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The guidance clarifies that a noncontrolling interest in a subsidiary, which is sometimes referred to as an unconsolidated investment, is an ownership interest in the consolidated entity that should be reported as a component of equity in the consolidated financial statements. Among other requirements, the guidance requires consolidated net income to be reported at amounts attributable to both the parent and the noncontrolling interest. It also requires disclosure, on the face of the consolidated income statement, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest.
 
Income Taxes

The Company accounts for its income taxes under the assets and liabilities method, which requires recognition of deferred tax assets and liabilities for future tax consequences of events that have been included in the financial statements.  Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.  The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.



The Company records net deferred tax assets to the extent the Company believes these assets will more likely than not be realized.  In making such determination, the Company considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations.  A valuation allowance is established against deferred tax assets that do not meet the criteria for recognition.  In the event the Company were to determine that it would be able to realize deferred income tax assets in the future in excess of their net recorded amount, they would make an adjustment to the valuation allowance which would reduce the provision for income taxes.

The Company follows the accounting guidance which provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized initially and in subsequent periods.  Also included is guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

NOTE C — FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK

Financial instruments consist of cash, interest and other receivables, notes receivable, accounts payable and accrued liabilities, due to/from related parties and notes payable.  The carrying values of these instruments approximate their fair values due to their short-term nature.  Marketable securities – related party and investment in real estate loans are further described in Note K – Fair Value.

Financial instruments with concentration of credit and market risk include cash, interest and other receivables, marketable securities - related party, notes receivable, accounts payable and accrued liabilities, due to/from related parties, notes payable, and loans secured by deeds of trust.

We maintain cash deposit accounts and certificates of deposit that, at times, may exceed federally-insured limits.  To date, we have not experienced any losses.  As of June 30, 2012 and December 31, 2011, we had no funds in excess of the federally-insured limits.  Additionally as of December 31, 2011, the assets held for sale included no cash deposits held in excess of federally insured limits.

As of June 30, 2012, 56% and 23% of our loans were in Nevada and California respectively, compared to 36%, 28%, 19%, and 15% in Nevada, Arizona, Texas, and California, at December 31, 2011, respectively.  As a result of this geographical concentration of our real estate loans, the downturn in the local real estate markets in these states has had a material adverse effect on us.

At June 30, 2012, the aggregate amount of loans to our three largest borrowers represented approximately 38% of our total investment in real estate loans.  These real estate loans consisted of commercial and land loans, secured by properties located in Nevada and California, with a first lien position on the California loan and one of the Nevada loans, and a second lien position on the second Nevada loan.  Their interest rates are between 8% and 15%, and the aggregate outstanding balance is approximately $13.2 million.  As of June 30, 2012, our largest loan, totaling approximately $7.2 million, is secured by property located in California, is a non-performing loan with an interest rate of 11%, and is a result of troubled debt restructuring.  Through March 25, 2011, interest was being paid monthly at 6% and deferred at 5%.  Effective March 25, 2011, the total interest was being fully deferred until March 2012. As of August 14, 2012 the loan has matured however the balance due continues to be outstanding.  Our manager is in negotiations to attempt to remediate the non-performing status of this loan.   See “Troubled Debt Restructuring” and “Non-Performing Loans” in Note D – Investments in Real Estate Loans. One of the loans secured by property located in Nevada has an interest rate of 15%, was considered non-performing, and has been fully reserved.  The second loan secured by property in Nevada has an interest rate of 8% and is considered performing.    At December 31, 2011, the aggregate amount of loans to our three largest borrowers represented approximately 53% of our total investment in real estate loans.  These real estate loans consisted of commercial and land loans, secured by property located in Arizona, Texas and California, with a first lien position on the California loan and second lien positions on the Arizona and Texas loans.  Their interest rates ranged between 8% and 15%, and the aggregate outstanding balance was approximately $30.7 million.



The success of a borrower’s ability to repay its real estate loan obligation in a large lump-sum payment may be dependent upon the borrower’s ability to refinance the obligation or otherwise raise a substantial amount of cash.  With the weakened economy, credit continues to be difficult to obtain and as such, many of our borrowers who develop and sell commercial real estate projects have been unable to complete their projects, obtain takeout financing or have been otherwise adversely impacted.  In addition, an increase in interest rates over the loan rate applicable at origination of the loan may have an adverse effect on our borrower’s ability to refinance.

Common Guarantors

As of June 30, 2012 and December 31, 2011, two and four loans, respectively, totaling approximately $3.5 and $11.0 million, respectively, had a common guarantor.  These loans represented approximately 10.0% and 19.0%, respectively, of our portfolio’s total value as of June 30, 2012 and December 31, 2011.  All two and four loans, respectively, were considered performing as of June 30, 2012 and December 31, 2011.

As of June 30, 2012 and December 31 2011, six and nine loans totaling approximately $7.6 million and $6.2 million, respectively, representing approximately 21.9% and 10.7%, respectively, of our portfolio’s total value, had a common guarantor.  At June 30, 2012 and December 31, 2011 all loans were considered performing.

As of June 30, 2012 three loans totaling approximately $5.8 million representing approximately 16.5% of our portfolio’s total value had a common guarantor.  As of June 30, 2012 all three loans were considered performing.

For additional information regarding non-performing loans discussed above, see “Non-Performing Loans” in Note D – Investments In Real Estate Loans.

NOTE D — INVESTMENTS IN REAL ESTATE LOANS

As of June 30, 2012 and December 31, 2011, most of our loans provided for interest only payments with a “balloon” payment of principal payable and any accrued interest payable in full at the end of the term.

In addition, we may invest in real estate loans that require borrowers to maintain interest reserves funded from the principal amount of the loan for a period of time.  At June 30, 2012 and December 31, 2011, we had two and no investments in real estate loans, respectively, that had interest reserves.

Loan Portfolio

As of June 30, 2012, we had five available real estate loan products consisting of commercial, construction, acquisition and development, land and residential.  The effective interest rates on all product categories range from 4.5% to 15% which includes performing loans that are being fully or partially accrued and will be payable at maturity.  Revenue by product will fluctuate based upon relative balances during the period.

Investments in real estate loans as of June 30, 2012, were as follows:
 
Loan Type
 
Number of Loans
   
Balance *
   
Weighted Average Interest Rate
   
Portfolio Percentage
   
Current Weighted Average Loan-To-Value, Net of Allowance for Loan Losses
 
Commercial
    18     $ 24,254,000       9.75 %     69.42 %     70.90 %
Land
    3       10,682,000       10.74 %     30.58 %     58.13 %
Total
    21     $ 34,936,000       10.06 %     100.00 %     66.45 %




Investments in real estate loans as of December 31, 2011, were as follows:
Loan Type
 
Number of Loans
   
Balance *
   
Weighted Average Interest Rate
   
Portfolio Percentage
   
Current Weighted Average Loan-To-Value, Net of Allowance for Loan Losses
 
                               
Residential
    1     $ 385,000       8.00 %     0.66 %     61.41 %
Commercial
    19       40,050,000       10.97 %     69.02 %     71.43 %
Construction
    1       6,656,000       8.00 %     11.47 %     89.49 %
Land
    3       10,933,000       10.75 %     18.85 %     64.15 %
Total
    24     $ 58,024,000       10.57 %     100.00 %     71.10 %

*
Please see Balance Sheet Reconciliation below.

The “Weighted Average Interest Rate” as shown above is based on the contractual terms of the loans for the entire portfolio including non-performing loans.  The weighted average interest rate on performing loans only, as of June 30, 2012 and December 31, 2011, was 10.06% and 6.79%, respectively.  Please see “Non-Performing Loans” and “Asset Quality and Loan Reserves” below for further information regarding performing and non-performing loans.

Loan-to-value ratios are generally based on the most recent appraisals and may not reflect subsequent changes in value and include allowances for loan losses.  Recognition of allowance for loan losses will result in a maximum loan-to-value ratio of 100% per loan.

The following is a schedule of priority of real estate loans as of June 30, 2012, and December 31, 2011:

 Loan Type  
Number of Loans
   
June 30, 2012
Balance*
   
Portfolio
Percentage
   
Number of Loans
   
December 31, 2011 Balance*
   
Portfolio
Percentage
 
First deeds of trust
    19     $ 31,017,000       88.78 %     18     $ 28,684,000       49.43 %
Second deeds of trust
    2       3,919,000       11.22 %     6       29,340,000       50.57 %
Total
    21     $ 34,936,000       100.00 %     24     $ 58,024,000       100.00 %

*
Please see Balance Sheet Reconciliation below.

The following is a schedule of contractual maturities of investments in real estate loans as of June 30, 2012:

Non-performing and past due loans
  $ 12,900,000  
July 2012 – September 2012
    6,176,000  
October 2012 – December 2012
    3,161,000  
January 2013 – March 2013
    1,842,000  
April 2013 – June 2013
    9,615,000  
Thereafter
    1,242,000  
         
Total
  $ 34,936,000  




The following is a schedule by geographic location of investments in real estate loans as of June 30, 2012 and December 31, 2011:

   
June 30, 2012 Balance *
   
Portfolio Percentage
   
December 31, 2011 Balance *
   
Portfolio Percentage
 
                         
Arizona
  $ 1,343,000       3.84 %   $ 16,108,000       27.76 %
California
    7,869,000       22.52 %     8,564,000       14.76 %
Colorado
    --       --       895,000       1.54 %
Michigan
    2,159,000       6.18 %     --       --  
Nevada
    19,605,000       56.12 %     21,114,000       36.39 %
New York
    250,000       0.72 %     --       --  
Ohio
    323,000       0.92 %     323,000       0.56 %
Oregon
    --       --       46,000       0.08 %
Texas
    1,307,000       3.74 %     10,974,000       18.91 %
Utah
    2,080,000       5.96 %     --       --  
Total
  $ 34,936,000       100.00 %   $ 58,024,000       100.00 %

*
Please see Balance Sheet Reconciliation below.

Balance Sheet Reconciliation

The following table reconciles the balance of the loan portfolio to the amount shown on the accompanying Consolidated Balance Sheets.

   
June 30, 2012 Balance
   
December 31, 2011 Balance
 
Balance per loan portfolio
  $ 34,936,000     $ 58,024,000  
Less:
               
Allowance for loan losses (a)
    (6,804,000 )     (26,247,000 )
Balance per consolidated balance sheets
  $ 28,132,000     $ 31,777,000  

 
(a)
Please refer to Specific Reserve Allowance below.

Non-Performing Loans

As of June 30, 2012, we had three loans considered non-performing (i.e., based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due).  These loans are currently carried on our books at a value of approximately $7.7 million, net of allowance for loan losses of approximately $5.3 million, which does not include the allowances of approximately $1.6 million relating to performing loans as of June 30, 2012.  Except as otherwise provided below, these loans have been placed on non-accrual of interest status and may be the subject of pending foreclosure proceedings.  Our manager has commenced foreclosure proceedings on a majority of these loans, and has proceeded with legal action to enforce the personal guarantees as our manager deems appropriate.  As of August 15, 2012, these loan balances have not been charged off.




At June 30, 2012, the following loan types were non-performing:

Loan Type
 
Number Of Non-Performing Loans
   
Balance at
June 30, 2012
   
Allowance for Loan Losses
   
Net Balance at
June 30, 2012
 
Commercial
    2     $ 5,700,000     $ (5,250,000 )   $ 450,000  
Land
    1       7,200,000       --       7,200,000  
Total
    3     $ 12,900,000     $ (5,250,000 )   $ 7,650,000  

At December 31, 2011, the following loan types were non-performing:

Loan Type
 
Number Of Non-Performing Loans
   
Balance at
December 31, 2011
   
Allowance for Loan Losses
   
Net Balance at
December 31, 2011
 
Commercial
    4     $ 22,114,000     $ (19,570,000 )   $ 2,544,000  
Land
    1       7,450,000       --       7,450,000  
Total
    5     $ 29,564,000     $ (19,570,000 )   $ 9,994,000  

Asset Quality and Loan Reserves

Losses may occur from investing in real estate loans.  The amount of losses will vary as the loan portfolio is affected by changing economic conditions and the financial condition of borrowers.

The conclusion that a real estate loan is uncollectible or that collectability is doubtful is a matter of judgment.  On a quarterly basis, our manager evaluates our real estate loan portfolio for impairment.  The fact that a loan is temporarily past due does not necessarily mean that the loan is non-performing.  Rather, all relevant circumstances are considered by our manager to determine impairment and the need for specific reserves.  Such evaluation, which includes a review of all loans on which full collectability may not be reasonably assured, considers among other matters:

 
·
Prevailing economic conditions;

 
·
Historical experience;

 
·
The nature and volume of the loan portfolio;

 
·
The borrowers’ financial condition and adverse situations that may affect the borrowers’ ability to pay;

 
·
Evaluation of industry trends; and

 
·
Estimated net realizable value of any underlying collateral in relation to the loan amount.

Based upon this evaluation, a determination is made as to whether the allowance for loan losses is adequate to cover any potential losses on an individual loan basis; we do not have a general allowance for loan losses.  Additions to the allowance for loan losses are made by charges to the provision for loan loss.  Our ratio of total allowance for loan losses to total loans with an allowance for loan loss is 77%.




The following is a breakdown of allowance for loan losses related to performing loans and non-performing loans as of June 30, 2012 and December 31, 2011:

   
As of June 30, 2012
 
   
Balance
   
Allowance for loan losses **
   
Balance, net of allowance
 
Non-performing loans – no related allowance
  $ 7,200,000     $ --     $ 7,200,000  
Non-performing loans – related allowance
    5,700,000       (5,250,000 )     450,000  
Subtotal non-performing loans
    12,900,000       (5,250,000 )     7,650,000  
                         
Performing loans – no related allowance
    18,919,000       --     $ 18,919,000  
Performing loans – related allowance
    3,117,000       (1,554,000 )     1,563,000  
Subtotal performing loans
    22,036,000       (1,554,000 )     20,482,000  
                         
 
Total
  $ 34,936,000     $ (6,804,000 )   $ 28,132,000  
                         

   
As of December 31, 2011
 
   
Balance
   
Allowance for loan losses **
   
Balance, net of allowance
 
Non-performing loans – no related allowance
  $ --     $ --     $ --  
Non-performing loans – related allowance
    29,564,000       (19,570,000 )     9,994,000  
Subtotal non-performing loans
    29,564,000       (19,570,000 )     9,994,000  
                         
Performing loans – no related allowance
    17,064,000       --       17,064,000  
Performing loans – related allowance
    11,396,000       (6,677,000 )     4,719,000  
Subtotal performing loans
    28,460,000       (6,677,000 )     21,783,000  
                         
Total
  $ 58,024,000     $ (26,247,000 )   $ 31,777,000  

**
Please refer to Specific Reserve Allowances below.

Our manager evaluated our loans and, based on current estimates with respect to the value of the underlying collateral, believes that such collateral is sufficient to protect us against further losses of principal.  However, such estimates could change or the value of the underlying real estate could decline.  Our manager will continue to evaluate our loans in order to determine if any other allowance for loan losses should be recorded.
 
Specific Reserve Allowances
As of June 30, 2012, we have provided a specific reserve allowance for two non-performing loans and two performing loans based on updated appraisals of the underlying collateral and/or our evaluation of the borrower.  The following table is a roll-forward of the allowance for loan losses for the six months ended June 30, 2012 and 2011 by loan type.  We will continue to evaluate our position in these loans.

 
 
Loan Type
 
Balance at
12/31/2011
   
Specific Reserve Allocation
   
Loan Pay Downs
   
Settlements
   
Transfers to REO or Notes Receivable
   
Balance at
6/30/2012
 
Commercial
  $ 22,392,000     $ 765,000     $ (13,567,000 )   $ --     $ (3,670,000 )   $ 5,920,000  
Construction
    2,971,000       --       --       --       (2,971,000 )     --  
Land
    884,000       --       --       --       --       884,000  
Total
  $ 26,247,000     $ 765,000     $ (13,567,000 )   $ --     $ (6,641,000 )   $ 6,804,000  






Loan Type
 
Balance at
12/31/2010
   
Specific Reserve Allocation *
   
Sales, Loan Pay Downs and Write Downs
   
Settlements
   
Transfers to REO or Notes Receivable
   
Balance at
6/30/2011
 
Commercial
  $ 27,487,000     $ --     $ (33,000 )   $ (1,414,000 )   $ (3,940,000 )   $ 22,100,000  
Construction
    5,646,000       --       --       --       (2,736,000 )     2,910,000  
Land
    424,000       --       --       --       --       424,000  
Total
  $ 33,557,000     $ --     $ (33,000 )   $ (1,414,000 )   $ (6,676,000 )   $ 25,434,000  

Troubled Debt Restructuring

As of June 30, 2012 and December 31, 2011, we had three and seven loans, totaling approximately $11.1 million and $30.8 million, respectively, which met the definition of a Troubled Debt Restructuring or TDR.  When the Company modifies the terms of an existing loan that is considered TDR, it is considered performing as long as it is in compliance with the modified terms of the loan agreement.  If the modification calls for deferred interest, it is recorded as interest income as cash is collected.  Impairment on these loans is generally determined by the lesser of the value of the underlying collateral or the present value of expected future cash flows.  During the previous 12 months there have been four loans that became TDR loans and all remain performing.  The following is a breakdown of our TDR loans that were considered performing and non-performing as of June 30, 2012 and December 31, 2011:

As of June 30, 2012
                                   
   
Total
   
Performing
   
Non-Performing
 
Loan Type
 
Number of Loans
   
Fund Balance
   
Number of Loans
   
Fund Balance
   
Number of Loans
   
Fund Balance
 
Commercial
    2     $ 3,919,000       1     $ 669,000       1     $ 3,250,000  
Land
    1       7,200,000       --       --       1       7,200,000  
Total
    3     $ 11,119,000       1     $ 669,000       2     $ 10,450,000  

As of December 31, 2011
                                   
   
Total
   
Performing
   
Non-Performing
 
Loan Type
 
Number of Loans
   
Fund Balance
   
Number of Loans
   
Fund Balance
   
Number of Loans
   
Fund Balance
 
Commercial
    5     $ 16,740,000       3     $ 2,821,000       2     $ 13,919,000  
Construction
    1       6,655,000       1       6,655,000       --       --  
Land
    1       7,450,000       1       7,450,000       --       --  
Total
    7     $ 30,845,000       5     $ 16,926,000       2     $ 13,919,000  

 
·
Commercial – As of June 30, 2012 and December 31, 2011, we had 18 and 19 commercial loans, respectively, three and five of which, respectively, were modified pursuant to TDR.  During January 2012, our one TDR construction loan was modified into a new loan which reduced the principal balance from approximately $7.3 million, of which our portion was approximately $6.7 to the carrying value of approximately $4.0 million in total, of which our portion is approximately $3.7 million.  Subsequent to the loan modification we sold approximately $1.6 million of our loan to third parties.  The interest rate was changed from 3% paid and 5% accruing monthly to 7% paid monthly.  The accrued interest balance of approximately $1.0 million, of which our portion is approximately $1.0 million, was reclassified as a notes receivable.  During April 2012 this loan was paid in full and the second deed of trust, which was another TDR loan, was reclassified as a notes receivable   For additional information, see “Non-Performing” of this Note D – Investments in Real Estate Loans and Note J – “Notes Receivable”.




 
·
Construction – As of December 31, 2011, we had one construction loan modified pursuant to TDR.  During January 2012, we restructured the loan into a new loan which is a commercial loan.

 
·
Land – As of June 30, 2012 and December 31, 2011, we had one land loan modified pursuant to TDR.  Through March 25, 2011, interest payment was being paid monthly at 6% and deferred at 5% on this loan.  Effective March 25, 2011, the total interest was being fully deferred until June 30. As of March 25, 2012 the loan has matured, however the balance due continues to be outstanding.  Our manager is in negotiations to attempt to remediate the non-performing status of this loan.  See “Non-Performing Loans” in Note D – Investments in Real Estate Loans.

Extensions

As of June 30, 2012, our manager had granted extensions on seven outstanding loans totaling approximately $20.5 million of which our portion was approximately $17.4 million, pursuant to the terms of the original loan agreements, which permit extensions by mutual consent, or as part of a TDR.  Such extensions are generally provided on loans where the original term was 12 months or less and where a borrower requires additional time to complete a construction project or negotiate take-out financing.  Our manager generally grants extensions when a borrower is in compliance with the material terms of the loan, including, but not limited to the borrower’s obligation to make interest payments on the loan.  In addition, if circumstances warrant, our manager may extend a loan that is in default as part of a work out plan to collect interest and/or principal.  Subsequent to their extension, three of the eight loans had become non-performing.  The loans, which became non-performing after their extension, had a total principal amount at June 30, 2012, of $13.9 million, of which our portion is $12.9 million.

NOTE E — INVESTMENT IN MARKETABLE SECURITIES

As of June 30, 2012 and December 31, 2011, we owned 538,178 shares of VRM I’s common stock, representing approximately 8.50% of the total outstanding shares. The closing price of VRM I’s common stock on June 30, 2012, was $0.93 per share.

During the three months ended June 30, 2012, the trading price for VRM I’s common stock ranged from $0.90 to $1.49 per share.  We will continue to evaluate our investment in marketable securities on a quarterly basis.

During January 2012, we purchased 60,000 shares of Annaly Capital Management Inc. This company is a publicly traded REIT and the shares were deemed to be part of our 3% working capital reserve.  During February 2012, we sold all of our shares for a gain of $15,000.

NOTE F — REAL ESTATE HELD FOR SALE

At June 30, 2012, we held seven properties with a total carrying value of approximately $10.3 million, which were acquired through foreclosure and recorded as investments in REO.  Our REO are accounted for at the lower of cost or fair value less costs to sell with fair value based on appraisals and knowledge of local market conditions.

During May 2012, we, VRM I and Fund III foreclosed on a loan with a balance of approximately $6.0 million, of which our portion was approximately $46,000. The property includes 23 cottage units in a retirement community located in Eugene, Oregon.

During April 2012, we, VRM I and Fund III sold a property to an unrelated third party for approximately $0.5 million, of which our portion was approximately $0.2 million.  This transaction resulted in a net gain for us of approximately $2,000.  A consultation fee of approximately $17,000 was paid to our manager.

We seek to sell properties acquired through foreclosure as quickly as circumstances permit taking into account current economic conditions.




NOTE G — OTHER REAL ESTATE OWNED

On February 7, 2012, we, VRM I and Fund III entered into a Deed in Lieu Agreement with a borrower resolving the foreclosure of our secured loan which had matured on December 31, 2011, with a balance of approximately $11.8 million, of which our portion was approximately $10.7 million.  Our subsidiary, 1701 Commerce, LLC, pursuant to the Deed in Lieu Agreement received a deed to the property which had secured the loan.  The property, which is being operated as the Sheraton – Forth Worth, Texas, is the subject of litigation relating to the validity, priority, nature, and extent of liens claimed by other parties that may secure claims ranging from approximately $39 million to $43 million. We dispute both the validity of the claimed liens and the amount of the claimed secured debt in whole or in part and as of this time intend to pursue our objections and disputes as to such matters.  On March 26, 2012, 1701 Commerce filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court for the Northern District of Texas, Ft. Worth Division, to reorganize its financial affairs and to avoid a potential foreclosure of the property that had been scheduled by the lien claimants and to preserve and protect 1701 Commerce’s equity in the and the interests of the other creditors of the property.  Due to the uncertainty and dispute involving this property, we have recorded this investment as Other Real Estate Owned on the balance sheet. We will continue to pursue and protect our equity in this property and have formulated and proposed a plan of reorganization for the Debtor and the property. Such plan has not been confirmed or approved by the Bankruptcy Court as of this time and we anticipate that revisions to the plan will be required to confirm the plan. If the Bankruptcy Court confirms a plan of reorganization in which our equity in the Debtor is preserved or retained, we expect to include the operations through consolidation into our financial statements from that date. If we are not able to confirm such a plan or if the Bankruptcy Court confirms a reorganization plan that does not retain or preserve 100% of the loan, we will determine the appropriate accounting treatment as of the date of such event, if any.  We hold an interest of approximately 90%, VRM I holds an interest of approximately 8% and Fund III holds an interest of approximately 2% in 1701 Commerce.

NOTE H — RELATED PARTY TRANSACTIONS

From time to time, we may acquire or sell investments in real estate loans from/to our manager or other related parties.  Pursuant to the terms of our Management Agreement, such acquisitions and sales are made without any mark up or mark down.  No gain or loss is recorded on these transactions, as it is not our intent to make a profit on the purchase or sale of such investments.  The purpose is generally to diversify our portfolio by syndicating loans, thereby providing us with additional capital to make additional loans.

Transactions with the Manager

Our manager is entitled to receive from us an annual management fee of up to 0.25% of our aggregate capital contributions received by us and Fund II from the sale of shares or membership units, paid monthly.  The amount of management fees paid to our manager for the six months ended June 30, 2012 and 2011 were $0.5 million, during each period.

As of June 30, 2012 and December 31, 2011, our manager owned 92,699 of our common shares, representing approximately 0.74% of our total outstanding common stock for both periods.

As of June 30, 2012 and December 31, 2011, we had receivables from our manager of approximately $19,000.

During January 2012, we paid our manager approximately $550,000 of management fees for services to be performed from January through June 2012.  As of June 30, 2012 there is no prepaid balance.  A discount of 7% will be applied to the July 2012 payment.




Integrated Financial Associates, Inc. (“IFA”) entered into an Intercreditor Agreement (“Intercreditor Agreement”) with us in connection with a note of $23.1 million (the “Note”) of which our portion was $3.0 million. Pursuant to the Intercreditor Agreement, in the event that our interest in the Note was not repaid in full, IFA would be responsible to pay a monthly fee equal to one percent of the unpaid amount plus interest at the rate of 15% per annum. We are to receive the 15% interest per annum and our Manager has a claim to the monthly fee equal to one percent of the unpaid amount which is $3.0 million. IFA breached the Intercreditor Agreement and we obtained, on November 9, 2010, a judgment against IFA in the amount of approximately $4.0 million, plus, among other things, additional monthly fees and default interest. During March 2011, IFA filed a Chapter 11 bankruptcy petition. During May 2012, we entered into a Purchase and Sale Agreement (“Sale Agreement”) with TPKT, LLC (“TPKT”), owned by certain principals of IFA, whereby we agreed to assign our interest in the claim and judgment in exchange for $1,050,000 and the first $1,250,000 plus certain other amounts received on our portion of the Note. Currently the loan is in default and there is pending litigation between the borrower and the borrower's seller KB Homes where in teh borrower seeks a recission of its purchase of the property from KB Homes.  During May 2012, the outstanding fee due to our Manager was approximately $1.6 million. In order to resolve our Manager’s claim, our Manager received $500,000 in connection with the purchase by TPKT and waived any right to receive any amounts paid on our portion of the Note.

During May 2012, our manager received total consultation fee of approximately $17,000, related to the sale of a VRM I, Fund III and our REO property.

Transactions with Other Related Parties

As of June 30, 2012 and December 31, 2011, we owned 538,178 common shares of VRM I, representing approximately 8.5% of their total outstanding common stock for both periods.

As of June 30, 2012 and December 31, 2011, VRM I owned 537,078 of our common shares, representing approximately 4.3% of our total outstanding common stock for both periods.

As of June 30, 2012 and December 31, 2011, we had receivables from VRM I of approximately $20,000 and $0.1 million, primarily related to legal fees.

As of December 31, 2011, Fund III owned 114,117 of our common shares, representing approximately 0.9% of our total outstanding common stock.  On June 11, 2012, our Chairman and Chief Executive Officer, Michael Shustek purchased these shares from Fund III.

As of June 30, 2012, we had receivables from Fund III of approximately $12,000.  As of December 31, 2011, we had a payable to Fund III of approximately $13,000.

NOTE I — INVESTMENT IN MVP REALTY ADVISORS

Together with MVP Capital Partners LLC which is owned by our Chairman and Chief Executive Officer, Michael Shustek, we have formed a Nevada limited liability company, MVP Realty Advisors, LLC (“MVPRA”).  MVPRA intends to act as the advisor to MVP REIT, Inc., a recently formed Maryland corporation which was organized to invest in real estate and loans secured by real estate (“MVP Realty Trust “).  On April 16, 2012, MVP Realty Trust made its initial filing of a registration statement with the Securities and Exchange Commission and has subsequently filed amendments in connection with a proposed public offering of its common stock.  MVP Realty Trust will seek to qualify as a real estate investment trust (“REIT”).  Under the terms of a proposed Advisory Agreement between MVPRA and MVP Realty Trust, MVPRA will be entitled to certain fees for advisory and other management services rendered to MVP Realty Trust.

During April 2012, we contributed $1,000 for a 40% interest in MVPRA.  Mr. Shustek, through a wholly owned company named MVP Capital Partners, LLC (“MVPCP”), contributed $1,500 for a 60% interest in MVPRA.  We and MVPCP anticipate providing additional funds to MVPRA, either in the form of capital contributions or loans.  The amount and nature of such funding arrangements cannot be determined at this time. As of June 30, 2012, we and MVPCP have loaned approximately $31,000 and approximately $0.6 million, respectively to MVPRA related to MVP REIT, Inc.



Under the terms of the Operating Agreement which will govern MVPRA, any loans we may make to MVPRA must be paid in full and we shall have received distributions of profits equal to our capital contributions prior to MVPCP receiving any distributions from MVPRA.

Our participation in MVPRA was approved by the independent members of our Board of Directors.

NOTE J — NOTES RECEIVABLE

During January 2012 we, VRM I and Fund III rewrote one of our existing loans.  The interest rate of this loan was changed from 3% paying monthly with 5% accruing to 7% paid monthly.  The amount of the loan allowance of approximately $3.0 million and the interest currently accrued on the existing loan, which was fully allowed for, of approximately $1.0 million was moved to notes receivable.  In April 2012, we received a payment on the new loan which was less than the amount owed.  The difference of approximately $0.8 million was recorded as a loan allowance as of June 30, 2012 and was reclassified to note receivable during April, 2012.

During April 2012, we, VRM I and Fund III received a payment in full satisfaction of an investment in real estate loan secured by a first deed of trust.  The remaining balance due on the second deed of trust was previously fully allowed for, of approximately $0.7 million was moved to notes receivable and remains fully allowed for.  We receive monthly payments of approximately $33,000.  As of June 30, 2012 the balance is approximately $0.6 million.

During February 2012, we, VRM I and Fund III received a payment in full satisfaction of an investment in real estate loan secured by a first deed of trust and a partial payment of an investment in real estate loan secured by a second deed of trust on the same real estate.  The remaining balance due on the second deed of trust was previously fully allowed for, of approximately $1.3 million was moved to notes receivable and remains fully allowed for.  During March 2012 a payment of approximately $50,000 was received and recognized as gain related to pay off of notes receivable, including recovery of allowance for notes receivable.  Additionally, we receive monthly payments of approximately $3,000.  As of June 30, 2012 the balance is approximately $1.2 million.

On February 29, 2012, we made a loan to TNP Strategic Retail Operating Partnership, LP, a Delaware limited-partnership, in the amount of $1,040,000 evidenced by a promissory note (“Note”) and secured by the separate and unconditional guaranty (“Guaranty”) of TNP Strategic Retail Trust, Inc., a Maryland corporation (“TNP Trust”).  The unpaid principal balance on the Note bore interest at a rate of 9.00% per annum until May 31, 2012, at which time the loan matured.  The Guaranty was secured by an absolute assignment to VRM II of all of TNP Trust’s right, title and interest in and to 25% of all net proceeds received by TNP Trust in connection with TNP Trust’s public offering of stock after payment of sales commission, fees and expenses payable in connection therewith.  This loan was paid in full on May 17, 2012.

NOTE K — FAIR VALUE

As of June 30, 2012, financial assets and liabilities utilizing Level 1 inputs included investment in marketable securities - related party.  We had no assets or liabilities utilizing Level 2 inputs, and assets and liabilities utilizing Level 3 inputs included investments in real estate loans.

To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment.  Accordingly, our degree of judgment exercised in determining fair value is greatest for instruments categorized in Level 3.  In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy.  In such cases, an asset or liability will be classified in its entirety based on the lowest level of input that is significant to the measurement of fair value.




Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure.  Therefore, even when market assumptions are not readily available, our own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date.  We use prices and inputs that are current as of the measurement date, including during periods of market dislocation, such as the recent illiquidity in the auction rate securities market.  In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments.  This condition may cause our financial instruments to be reclassified from Level 1 to Level 2 or Level 3 and/or vice versa.

Our valuation techniques will be consistent with at least one of the three possible approaches: the market approach, income approach and/or cost approach.  Our Level 1 inputs are based on the market approach and consist primarily of quoted prices for identical items on active securities exchanges.  Our Level 2 inputs are primarily based on the market approach of quoted prices in active markets or current transactions in inactive markets for the same or similar collateral that do not require significant adjustment based on unobservable inputs.  Our Level 3 inputs are primarily based on the income and cost approaches, specifically, discounted cash flow analyses, which utilize significant inputs based on our estimates and assumptions.

The following table presents the valuation of our financial assets and liabilities as of June 30, 2012 and December 31, 2011, measured at fair value on a recurring basis by input levels:

   
Fair Value Measurements at Reporting Date Using
       
   
Quoted Prices in Active Markets For Identical Assets (Level 1)
   
Significant Other Observable Inputs (Level 2)
   
Significant Unobservable Inputs (Level 3)
   
Balance at 06/30/2012
   
Carrying Value on Balance Sheet at 06/30/2012
 
Assets
                             
Investment in marketable securities - related party
  $ 501,000     $ --     $ --     $ 501,000     $ 501,000  
Investment in real estate loans
  $ --     $ --     $ 27,976,000     $ 27,976,000     $ 28,132,000  

   
Fair Value Measurements at Reporting Date Using
       
   
Quoted Prices in Active Markets For Identical Assets (Level 1)
   
Significant Other Observable Inputs (Level 2)
   
Significant Unobservable Inputs (Level 3)
   
Balance at 12/31/2011
   
Carrying Value on Balance Sheet at 12/31/2011
 
Assets
                             
Investment in marketable securities - related party
  $ 592,000     $ --     $ --     $ 592,000     $ 592,000  
Investment in real estate loans
  $ --     $ --     $ 30,646,000     $ 30,646,000     $ 31,777,000  




The following table presents the changes in our financial assets and liabilities that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) from January 1, 2012 to June 30, 2012:

   
Investment in
real estate loans
 
       
Balance on January 1, 2012
  $ 30,646,000  
Change in temporary valuation adjustment included in net income (loss)
       
Increase in allowance for loan losses
    (765,000 )
Purchase and additions of assets
       
Transfer of allowance on real estate loans to real estate held for sale
    1,720,000  
Reduction of allowance on real estate loans due to loan payments
    1,238,000  
Reduction of allowance on real estate loans following settlement of loan
    11,565,000  
New mortgage loans and mortgage loans acquired
    23,566,000  
Transfer of allowance on real estate loans converted to unsecured notes receivable
    5,685,000  
Sales, pay downs and reduction of assets
       
Transfer of real estate loans to real estate held for sale
    (10,715,000 )
Collections and settlements of principal and sales of investment in real estate loans
    (15,004,000 )
Reduction of loan balance following settlement of loan
    (11,565,000 )
Conversion of real estate loans to unsecured notes receivable
    (9,370,000 )
Temporary change in estimated fair value based on future cash flows
    975,000  
         
Balance on June 30, 2012, net of temporary valuation adjustment
  $ 27,976,000  




The following table presents the changes in our financial assets and liabilities that are measured at fair value on a recurring basis using significant unobservable inputs (Level 3) from January 1, 2011 to June 30, 2011:
   
Assets
 
   
Investment in
real estate loans
   
Assets under secured borrowings
 
             
Balance on January 1, 2011
  $ 26,624,000     $ 1,320,000  
Purchase and additions of assets
               
Transfer of allowance on real estate loans to real estate held for sale
    2,736,000       --  
New mortgage loans and mortgage loans acquired
    1,453,000       --  
Transfer of allowance on real estate loans converted to unsecured notes receivable
    3,940,000       --  
Sales, pay downs and reduction of assets
               
Collections and settlements of principal and sales of investment in real estate loans
    (771,000 )     --  
Conversion of real estate loans to unsecured notes receivable
    (3,940,000 )     --  
Transfer of real estate loans to real estate held for sale
    (2,896,000 )     --  
Temporary change in estimated fair value based on future cash flows
    (10,000 )     --  
Transfer to Level 1
    --       --  
Transfer to Level 2
    --       --  
                 
Balance on June 30, 2011, net of temporary valuation adjustment
  $ 27,136,000     $ 1,320,000  

   
Liabilities
 
   
Secured borrowings
 
       
Balance on January 1, 2011
  $ 1,088,000  
Payment on secured borrowings
    --  
         
Balance on June 30, 2011
  $ 1,088,000  

NOTE L — RECENT ACCOUNTING PRONOUNCEMENTS

Adopted

On January 1, 2012, VRM II adopted changes issued by the Financial Accounting Standards Board (FASB) to conform to existing guidance regarding fair value measurement and disclosure between GAAP and International Financial Reporting Standards. These changes both clarify the FASB’s intent about the application of existing fair value measurement and disclosure requirements and amend certain principles or requirements for measuring fair value or for disclosing information about fair value measurements. The clarifying changes relate to the application of the highest and best use and valuation premise concepts, measuring the fair value of an instrument classified in a reporting entity’s shareholders’ equity, and disclosure of quantitative information about unobservable inputs used for Level 3 fair value measurements. The amendments relate to measuring the fair value of financial instruments that are managed within a portfolio; application of premiums and discounts in a fair value measurement; and additional disclosures concerning the valuation processes used and sensitivity of the fair value measurement to changes in unobservable inputs for those items categorized as Level 3, a reporting entity’s use of a nonfinancial asset in a way that differs from the asset’s highest and best use, and the categorization by level in the fair value hierarchy for items required to be measured at fair value for disclosure purposes only. Other than the additional disclosure requirements, the adoption of these changes had no impact on the Consolidated Financial Statements.



On January 1, 2012, VRM II adopted changes issued by the FASB to the presentation of comprehensive income. These changes give an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements; the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. The items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income were not changed. Additionally, no changes were made to the calculation and presentation of earnings per share. Management elected to present the two-statement option. Other than the change in presentation, the adoption of these changes had no impact on the Consolidated Financial Statements.

Issued

In December 2011, the Financial Accounting Standards Board (“FASB”) released Accounting Standards Update No. 2011-10 (“ASU 2011-10”), Property, Plant and Equipment (Topic 360): Derecognition of in Substance Real Estate—a Scope Clarification (a consensus of the FASB Emerging Issues Task Force). ASU 2011-10 clarifies when a parent (reporting entity) ceases to have a controlling financial interest in a subsidiary that is in substance real estate as a result of default on the subsidiary’s nonrecourse debt, the reporting entity should apply the guidance for Real Estate Sale (Subtopic 360-20). The provisions of ASU 2011-10 are effective for public companies for fiscal years and interim periods within those years, beginning on or after June 15, 2012. When adopted, ASU 2011-10 is not expected to materially impact our consolidated financial statements.

NOTE M — LEGAL MATTERS INVOLVING THE MANAGER

The United States Securities and Exchange Commission (the “Commission”), conducted an investigation of certain matters related to us, our manager, Vestin Capital, VRM I, and Fund III.  We fully cooperated during the course of the investigation.  On September 27, 2006, the investigation was resolved through the entry of an Administrative Order by the Commission (the “Order”).  Our manager, Vestin Mortgage and its Chief Executive Officer, Michael Shustek, as well as Vestin Capital (collectively, the “Respondents”), consented to the entry of the Order without admitting or denying the findings therein.

In the Order, the Commission found that the Respondents violated Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 through the use of certain slide presentations in connection with the sale of units in Fund III and in our predecessor, Vestin Fund II, LLC.  The Respondents consented to the entry of a cease and desist order, the payment by Mr. Shustek of a fine of $100,000 and Mr. Shustek’s suspension from association with any broker or dealer for a period of six months, which expired in March 2007.  In addition, the Respondents agreed to implement certain undertakings with respect to future sales of securities.  We are not a party to the Order.

The Vestin Group and Fund III were defendants in a civil action filed by Birkeland Family, LLC III and Birkeland Family, LLC V (“Plaintiffs”) in District Court for Clark County, Nevada.  The Plaintiffs alleged as causes of action against Vestin Group and Fund III:  Breach of Contract and Breach of the Implied Covenant of Good Faith and Fair Dealing regarding the sale of the office building commonly described as 8379 W. Sunset Road, Las Vegas, Nevada.  The action sought monetary, punitive and exemplary damages.  On January 18, 2011, summary judgment was granted in favor of Fund III, with the Court finding that Fund III was not part of the lease and, therefore, could not be held liable for damages.  The Manager is still involved in this civil action. Fund III is attempting to recover legal fees associated with this matter.  A judgment has been entered against Vestin Group in the amount of approximately $4.2 million.  Vestin Group has appealed this judgment.

VRM II, Vestin Mortgage and Michael V. Shustek (“Defendants”) were defendants in a civil action filed by 88 sets of plaintiffs representing approximately 138 individuals (“Plaintiffs”), in District Court for Clark County, Nevada (the “Nevada Lawsuit”).  The Plaintiffs alleged, among other things, that Defendants: breached certain alleged contractual obligations owed to Plaintiffs; breached fiduciary duties supposedly owed to Plaintiffs; and misrepresented or omitted material facts regarding the conversion of Fund II into VRM II.  The action sought monetary and punitive damages.  The court dismissed the claim for punitive damages.  On September 8, 2010, the parties agreed to settle the case.  The Settlement Agreement provides for the settlement and complete release of all claims against the Defendants.  The settlement was made without admission of liability by Defendants.



For additional information, see Note N – Legal Matters Involving the Company

In addition to the matters described above, our manager is involved in a number of other legal proceedings concerning matters arising in connection with the conduct of its business activities.  Our manager believes it has meritorious defenses to each of these actions and intends to defend them vigorously.  Other than the matters described above, our manager believes that it is not a party to any pending legal or arbitration proceedings that would have a material adverse effect on our manager’s financial condition or results of operations or cash flows, although it is possible that the outcome of any such proceedings could have a material impact on our manager’s net income in any particular period.

NOTE N — LEGAL MATTERS INVOLVING THE COMPANY

We, VRM I and Vestin Mortgage (“Defendants”) were defendants in a breach of contract class action filed in San Diego Superior Court by certain plaintiffs who alleged, among other things, that they were wrongfully denied roll-up rights in connection with the merger of Fund I into VRM I and Fund II into VRM II.  The court certified a class of all former Fund I unit holders and Fund II unit holders who voted against the mergers of Fund I into VRM I and Fund II into VRM II.  The trial began in December 2009 and concluded in January 2010.  On February 11, 2010, the Defendants were notified of a Tentative Statement of Decision, in their favor issued by the Superior Court for the State of California in San Diego following a trial.  In the Tentative Statement, the Court found that there was no roll-up and therefore no breach of contract.  The Court entered final judgment for the Defendants on March 18, 2010.  Defendants and Plaintiffs agreed to a post-judgment settlement by which Plaintiffs agreed not to appeal the judgment in consideration of a waiver by the Defendants of any claim to recover actual court costs from the Plaintiffs.  The Court granted final approval of this settlement of post-judgment rights on July 9, 2010.

We, Vestin Mortgage and Michael V. Shustek (“Defendants”) were defendants in a civil action filed by 88 sets of plaintiffs representing approximately 138 individuals (“Plaintiffs”), in District Court for Clark County, Nevada (the “Nevada Lawsuit”).  The Plaintiffs alleged, among other things, that Defendants: breached certain alleged contractual obligations owed to Plaintiffs; breached fiduciary duties supposedly owed to Plaintiffs; and misrepresented or omitted material facts regarding the conversion of Fund II into VRM II.  The action sought monetary and punitive damages.  The court dismissed the claim for punitive damages.  On September 8, 2010, the parties agreed to settle the case.  The Settlement Agreement provides for the settlement and complete release of all claims against the Defendants.  The settlement was made without admission of liability by Defendants.

In addition to the matters described above, we are involved in a number of other legal proceedings concerning matters arising in the ordinary course of our business activities.  We believe we have meritorious defenses to each of these actions and intend to defend them vigorously.  Other than the matters described above, we believe that we are not a party to any pending legal or arbitration proceedings that would have a material adverse effect on our financial condition or results of operations or cash flows, although it is possible that the outcome of any such proceedings could have a material impact on our operations in any particular period.

In July, 2012, we along with our Manager, VRMI, Vestin Group, Vestin Originations and Michael Shustek entered into a Settlement Agreement and Mutual Release with the State of Hawaii and The Huntington National Bank as successor trustee to the Rightstar Trusts.  Under the ARRA, Vestin was entitled to receive a portion of certain net proceeds from certain claims from third parties through litigation, settlement or otherwise. The parties agreed that to mutually release each other from any claims and in lieu of such amounts due under the ARRA, within ten (10) business days after the later of (a) the Successor Trustee Huntington's receipt of the First Tranche of certain trust recovery proceeds or (b) entry of a final and non-appealable decision or order approving settlement with each of certain other persons, of approximately $0.1 million shall be disbursed from the First Tranche of TRM Proceeds to Vestin.  All other amounts payable under the ARRA were assigned to the Rightstar Trusts and the Successor Trustee Huntington all rights, obligations and claims Vestin has or ever can, shall or may have or claim to have arising out of or related to the Rightstar Trusts, or which were asserted or which could have been asserted in such cases.  Vestin also released any and all interest in the amounts set aside from the sale of the property at 485 Waiale Street, Wailuku, Hawai'i (the "Maui Property Proceeds"). Finally Vestin agreed to purchase all 447,226 shares in Vestin Fund II, LLC currently owned by the Rightstar trusts for $1.40 per share , which purchase is to be consummated within seven (7) days following Court approval of the settlement.  The settlement was approved by the Court on August 3, 2012.



On February 7, 2012, we, VRM I and Fund III entered into a Deed in Lieu Agreement with a borrower resolving the foreclosure of our secured loan which had matured on December 31, 2011, with a balance of approximately $11.8 million, of which our portion was approximately $10.7 million.  Our subsidiary, 1701 Commerce, LLC, pursuant to the Deed in Lieu Agreement received a deed to the property which had secured the loan.  The property, which is being operated as the Sheraton – Forth Worth, Texas, is the subject of litigation relating to the validity, priority, nature, and extent of liens claimed by other parties that may secure claims ranging from approximately $39 million to $43 million. We dispute both the validity of the claimed liens and the amount of the claimed secured debt in whole or in part and as of this time intend to pursue our objections and disputes as to such matters.  On March 26, 2012, 1701 Commerce filed for Chapter 11 bankruptcy protection in the United States Bankruptcy Court for the Northern District of Texas, Ft. Worth Division, to reorganize its financial affairs and to avoid a potential foreclosure of the property that had been scheduled by the lien claimants and to preserve and protect 1701 Commerce’s equity in the and the interests of the other creditors of the property.  Due to the uncertainty and dispute involving this property, we have recorded this investment as Other Real Estate Owned on the balance sheet. We will continue to pursue and protect our equity in this property and have formulated and proposed a plan of reorganization for the Debtor and the property. Such plan has not been confirmed or approved by the Bankruptcy Court as of this time and we anticipate that revisions to the plan will be required to confirm the plan. If the Bankruptcy Court confirms a plan of reorganization in which our equity in the Debtor is preserved or retained, we expect to include the operations through consolidation into our financial statements from that date. If we are not able to confirm such a plan or if the Bankruptcy Court confirms a reorganization plan that does not retain or preserve 100% of the loan, we will determine the appropriate accounting treatment as of the date of such event, if any.  We hold an interest of approximately 90%, VRM I holds an interest of approximately 8% and Fund III holds an interest of approximately 2% in 1701 Commerce.
 
NOTE O — INCOME TAXES

We operated as a REIT through December 31, 2011. We announced on March 28, 2012 that we have terminated our election to be treated as a REIT under the Internal Revenue Code of 1986, as amended (the “Code”), effective for the tax year ending December 31, 2012.

The components of the provision for income tax benefit are as follows for the six months ended:

   
6/30/2012
   
6/30/2011
 
Current taxes
           
    Federal
    --       --  
    State
    --       --  
    Total current taxes
    --       --  
Change in deferred taxes
    762,000       --  
Change in valuation allowance
    (762,000 )     --  
                 
Provision for income tax expense (benefit)
    --       --  

The following is a summary of the significant components of the Company’s deferred tax assets and liabilities at June 30, 2012:

Deferred tax assets:
     
   Provision for loan losses
  $ 2,313,000  
   Write down on real estate held for sale
    3,852,000  
   Recovery of allowance for doubtful notes receivable
    5,332,000  
   Unrealized (gain) loss on marketable securities - related party
    998,000  
   Net operating loss carry forward
    63,033,000  
   Total deferred tax assets
    75,528,000  
   Valuation allowance
  $ (75,528,00 )
   Deferred tax assets, net of valuation allowance
    --  




The effective tax rate used for calculation of the deferred taxes as of June 30, 2012 was 34%.  The Company has established a valuation allowance against deferred tax assets of $75,528,000 due to the uncertainty regarding realization, comprised primarily of a reserve against the deferred tax assets attributable to the net operating loss carry forward timing differences.

As of December 31, 2011 we were organized and conducted our operations to qualify as a REIT under Sections 856 to 860 of the Internal Revenue Code of 1986, as amended (the “Code”) and to comply with the provisions of the Internal Revenue Code with respect thereto.  A REIT is generally not subject to federal income tax on that portion of its REIT taxable income (“Taxable Income”) which is distributed to its stockholders, provided that at least 90% of Taxable Income is distributed and provided that certain other requirements are met.  Our Taxable Income may substantially exceed or be less than our net income as determined based on GAAP, because, differences in GAAP and taxable net income consist primarily of allowances for loan losses or doubtful account, write-downs on real estate held for sale, amortization of deferred financing cost, capital gains and losses, and deferred income.

NOTE P— SUBSEQUENT EVENTS

In July, 2012, we along with our Manager, VRMI, Vestin Group, Vestin Originations and Michael Shustek entered into a Settlement Agreement and Mutual Release with the State of Hawaii and The Huntington National Bank as successor trustee to the Rightstar Trusts.  Under the ARRA, Vestin was entitled to receive a portion of certain net proceeds from certain claims from third parties through litigation, settlement or otherwise. The parties agreed that to mutually release each other from any claims and in lieu of such amounts due under the ARRA, within ten (10) business days after the later of (a) the Successor Trustee Huntington's receipt of the First Tranche of certain trust recovery proceeds or (b) entry of a final and non-appealable decision or order approving settlement with each of certain other persons, of approximately $0.1 million shall be disbursed from the First Tranche of TRM Proceeds to Vestin.  All other amounts payable under the ARRA were assigned to the Rightstar Trusts and the Successor Trustee Huntington all rights, obligations and claims Vestin has or ever can, shall or may have or claim to have arising out of or related to the Rightstar Trusts, or which were asserted or which could have been asserted in such cases.  Vestin also released any and all interest in the amounts set aside from the sale of the property at 485 Waiale Street, Wailuku, Hawai'i (the "Maui Property Proceeds"). Finally Vestin agreed to purchase all 447,226 shares in Vestin Fund II, LLC currently owned by the Rightstar trusts for $1.40 per share, which purchase is to be consummated within seven (7) days following Court approval of the settlement.  The settlement was approved by the Court on August 3, 2012.




MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

FORWARD-LOOKING STATEMENTS

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

RESULTS OF OPERATIONS

OVERVIEW

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

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

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



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

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

During the six months ended June 30, 2012, we funded twelve loans totaling approximately $19.9 million.  During the six months ended June 30, 2011, we funded one loan totaling approximately $1.5 million.  As of June 30, 2012, our loan-to-value ratio was 66.45%, net of allowances for loan losses, on a weighted average basis generally using updated appraisals.  Additional increases in loan defaults accompanied by additional declines in real estate values, as evidenced by updated appraisals generally prepared on an “as-is-basis,” will have a material adverse effect on our financial condition and operating results.

As of June 30, 2012, we have provided a specific reserve allowance for two non-performing loans and two performing loans based on updated appraisals of the underlying collateral and our evaluation of the borrower for these loans, obtained by our manager.  For further information regarding allowance for loan losses, refer to “Specific Reserve Allowance” in Note D –  Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part I, Item I Consolidated Financial Statements of this Quarterly Report on Form 10-Q.

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

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

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




SUMMARY OF FINANCIAL RESULTS

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

Total Revenue:
 
2012
   
2011
   
$ Change
   
% Change
 
Interest income from investment in real estate loans
  $ 313,000     $ 258,000     $ 55,000       21 %
Gain related to pay off of real estate loan, including recovery of allowance for loan loss
    1,099,000       35,000       1,064,000       3040 %
Gain related to pay off of notes receivable, including recovery of allowance for notes receivable
    85,000       92,000       (7,000 )     (8 %)
            Total
  $ 1,497,000     $ 385,000     $ 1,112,000       289 %

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

For additional information