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EX-31.1 - Owens Realty Mortgage, Inc.exhibit31-1.htm
EX-31.2 - Owens Realty Mortgage, Inc.exhibit31-2.htm
EX-32 - Owens Realty Mortgage, Inc.exhibit32-1.htm


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 March 31, 2016

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 000-54957

OWENS REALTY MORTGAGE, INC.
(Exact Name of Registrant as Specified in Its Charter)

Maryland
 
46-0778087
(State or Other Jurisdiction
 
(I.R.S. Employer Identification No.)
of Incorporation or Organization)
   
     
2221 Olympic Boulevard
   
Walnut Creek, California
 
94595
(Address of Principal Executive Offices)
 
(Zip Code)
     
(925) 935-3840
Registrant’s Telephone Number, Including Area Code
 
  NOT APPLICABLE  
 (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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 (§232.405 of this chapter) during the preceding 12 months (or such shorter period that the registrant was required to submit and post such files). Yes [X] No [  ]



 
1

 


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. (Check One):

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes [   ] No [X]


Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class                                                                           Outstanding as of May 6, 2016
Common Stock, $.01 par value                                                              10,247,477 shares

 
2

 


TABLE OF CONTENTS


PART I – FINANCIAL INFORMATION
 
 
    Page
     
Item 1. Financial Statements 4
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 31
     
Item 3. Quantitative and Qualitative Disclosures about Market Risk 49
     
Item 4. Controls and Procedures   50
PART II – OTHER INFORMATION
 
Item 1. Legal Proceedings 51
     
Item 1A. Risk Factors 51
     
Item 6. Exhibits 51
     
 
 

 
3

 

Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
OWENS REALTY MORTGAGE, INC.
Consolidated Balance Sheets
 (UNAUDITED)
   
March 31,
 
December 31,
 
   
2016
 
2015
 
ASSETS
             
Cash and cash equivalents
 
$
3,228,089
 
$
1,255,842
 
Restricted cash
   
7,329,421
   
7,225,371
 
Loans, net of allowance for losses of $1,953,521 in 2016 and $1,842,446 in 2015
   
109,725,818
   
104,901,361
 
Interest and other receivables
   
2,107,398
   
1,764,918
 
Other assets, net of accumulated depreciation and amortization of $280,474 in 2016 and $275,277 in 2015
   
843,818
   
741,001
 
Deferred financing costs, net of accumulated amortization of $158,033 in 2016 and $323,325 in 2015
   
327,302
   
126,308
 
Investment in limited liability company
   
2,183,656
   
2,141,032
 
Real estate held for sale
   
109,092,125
   
100,191,166
 
Real estate held for investment, net of accumulated depreciation of $2,561,044 in 2016 and $2,915,596 in 2015
   
49,155,424
   
53,647,246
 
   Total assets
 
$
283,993,051
 
$
271,994,245
 
LIABILITIES AND EQUITY
             
LIABILITIES:
             
Dividends payable
 
$
819,798
 
$
2,133,455
 
Due to Manager
   
318,022
   
408,643
 
Accounts payable and accrued liabilities
   
5,417,000
   
3,359,294
 
Deferred gains on sales of real estate
   
209,662
   
209,662
 
Lines of credit payable
   
26,852,500
   
20,915,500
 
Notes and loans payable on real estate, net of unamortized deferred financing costs of $568,530 in 2016 and $658,194 in 2015
   
46,944,398
   
45,458,844
 
Total liabilities
   
80,561,380
   
72,485,398
 
Commitments and Contingencies (Note 13)
             
EQUITY:
             
Stockholders’ equity:
             
Preferred stock, $.01 par value per share, 5,000,000 shares authorized, no shares issued and outstanding at March 31, 2016 and December 31, 2015
   
   
 
Common stock, $.01 par value per share, 50,000,000 shares authorized, 11,198,119 shares issued, 10,247,477 shares outstanding at March 31, 2016 and December 31, 2015
   
111,981
   
111,981
 
Additional paid-in capital
   
182,437,522
   
182,437,522
 
Treasury stock, at cost – 950,642 shares at March 31, 2016 and December 31, 2015
   
(12,852,058
)
 
(12,852,058
)
Retained earnings
   
29,197,017
   
25,282,553
 
Total stockholders’ equity
   
198,894,462
   
194,979,998
 
Non-controlling interests
   
4,537,209
   
4,528,849
 
   Total equity
   
203,431,671
   
199,508,847
 
   Total liabilities and equity
 
$
283,993,051
 
$
271,994,245
 

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

 
4

 

OWENS REALTY MORTGAGE, INC.
Consolidated Statements of Income
 (UNAUDITED)

   
Three Months Ended March 31,
 
   
2016
 
2015
 
Revenues:
             
Interest income on loans
 
$
2,043,008
 
$
2,823,871
 
Rental and other income from real estate properties
   
2,139,985
   
3,542,899
 
Income from investment in limited liability company
   
42,624
   
43,061
 
Total revenues
   
4,225,617
   
6,409,831
 
Expenses:
             
Management fees to Manager
   
765,515
   
456,389
 
Servicing fees to Manager
   
69,592
   
41,490
 
General and administrative expense
   
553,417
   
378,971
 
Rental and other expenses on real estate properties
   
1,790,379
   
2,190,412
 
Depreciation and amortization
   
343,649
   
602,386
 
Interest expense
   
683,051
   
587,026
 
Provision for loan losses
   
111,075
   
87,566
 
Impairment losses on real estate properties
   
   
1,109,434
 
Total expenses
   
4,316,678
   
5,453,674
 
Operating (loss) income
   
(91,061
)
 
956,157
 
Gain on sales of real estate, net
   
4,838,815
   
205,441
 
Net income
   
4,747,754
   
1,161,598
 
Less: Net income attributable to non-controlling interests
   
(13,492
)
 
(9,878
)
Net income attributable to common stockholders
 
$
4,734,262
 
$
1,151,720
 
               
Per common share data:
             
Basic and diluted earnings per common share
 
$
0.46
 
$
0.11
 
Basic and diluted weighted average number of common shares outstanding
   
10,247,477
   
10,768,001
 
Dividends declared per share of common stock
 
$
0.08
 
$
0.07
 
               

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










 
5

 

OWENS REALTY MORTGAGE, INC.
Consolidated Statements of Stockholders’ Equity
Three Months Ended March 31, 2016 and 2015
 (UNAUDITED)

 
Common Stock
 
Additional
Paid-in
Capital
   
Treasury Stock
         
Total
Stockholders’
Equity
   
Non-
controlling
Interests
     
         
Retained Earnings
         
Total
Equity
 
 
Shares
 
Amount
     
Shares
   
Amount
               
                                                       
Balances, December 31, 2014
 
11,198,119
 
$
111,981
 
$
182,437,522
   
(430,118
)
$
(5,349,156
)
$
7,371,511
 
$
184,571,858
 
$
4,174,753
 
$
 188,746,611
 
                                                       
Net income
 
   
   
   
              —
   
              —
   
1,151,720
   
1,151,720
   
               9,878
   
1,161,598
 
Dividends declared
 
   
   
   
              —
   
              —
   
(753,760
)
 
                (753,760
)
 
               —
   
                (753,760
)
Contribution from non-controlling interest
 
   
   
   
   
   
   
   
279,184
   
279,184
 
Distributions to non-controlling interests
 
   
   
   
              —
   
              —
   
   
                —
   
               (2,618
)
 
                (2,618
)
Balances, March 31, 2015
 
11,198,119
 
$
111,981
 
$
182,437,522
   
(430,118
)
$
(5,349,156
)
$
7,769,471
 
$
184,969,818
 
$
4,461,197
 
$
189,431,015
 
                                                       
Balances, December 31, 2015
 
11,198,119
 
$
111,981
 
$
182,437,522
   
(950,642
)
 
(12,852,058
)
$
25,282,553
 
$
194,979,998
 
$
4,528,849
 
$
 199,508,847
 
                                                       
Net income
 
   
   
   
              —
   
              —
   
4,734,262
   
4,734,262
   
13,492
   
4,747,754
 
Dividends declared
 
   
   
   
              —
   
              —
   
(819,798
)
 
                (819,798
)
 
   
(819,798
)
Distributions to non-controlling interests
 
   
   
   
   
   
   
   
(5,132
)
 
(5,132
)
Balances, March 31, 2016
 
11,198,119
 
$
111,981
 
  $
182,437,522
   
(950,642
)
$
(12,852,058
)
$
29,197,017
 
$
198,894,462
 
$
4,537,209
 
$
203,431,671
 
                                                       
 
 

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

 
6

 

OWENS REALTY MORTGAGE, INC.
Consolidated Statements of Cash Flows
 (UNAUDITED)

   
Three Months Ended March 31,
 
   
2016
 
2015
 
CASH FLOWS FROM OPERATING ACTIVITIES:
             
Net income
 
$
4,747,754
 
$
1,161,598
 
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
             
Gain on sales of real estate, net
   
(4,838,815
)
 
(205,441
)
Income from investment in limited liability company
   
(42,624
)
 
(43,061
)
Provision for loan losses
   
111,075
   
87,566
 
Impairment losses on real estate properties
   
   
1,109,434
 
Depreciation and amortization
   
343,649
   
602,386
 
Amortization of deferred financing costs
   
107,022
   
79,419
 
Accretion of discount on loan
   
   
(536,816
)
Changes in operating assets and liabilities:
             
Interest and other receivables
   
(342,480
)
 
(174,348
)
Other assets
   
(100,645
)
 
(52,972
)
Accounts payable and accrued liabilities
   
(1,445,657
)
 
46,979
 
Due to Manager
   
(90,621
)
 
(94,541
)
Net cash (used in) provided by operating activities
   
(1,551,342
)
 
1,980,203
 
CASH FLOWS FROM INVESTING ACTIVITIES:
             
Principal collected on loans
   
18,028,938
   
21,873,017
 
Investment in loans
   
(22,964,470
)
 
(10,237,269
)
Investment in real estate properties
   
(2,832,188
)
 
(1,743,620
)
Net proceeds from disposition of real estate properties
   
6,478,811
   
1,108,820
 
Purchases of vehicles and equipment
   
(23,173
)
 
(1,507
)
Transfer to restricted cash, net
   
(104,050
)
 
(2,474,836
)
Net cash (used in) provided by investing activities
   
(1,416,132
)
 
8,524,605
 
CASH FLOWS FROM FINANCING ACTIVITIES:
             
Advances on notes payable
   
1,562,861
   
10,342,938
 
Repayments on notes payable
   
(166,971
)
 
(9,860,453
)
Advances on lines of credit
   
32,128,000
   
10,989,000
 
Repayments on lines of credit
   
(26,191,000
)
 
(8,470,000
)
Payment of deferred financing costs
   
(254,582
)
 
 
Distributions to non-controlling interests
   
(5,132
)
 
(2,618
)
Contribution from non-controlling interest
   
   
279,184
 
Dividends paid (including tax payments on behalf of shareholders)
   
(2,133,455
)
 
(1,292,160
)
Net cash provided by financing activities
   
4,939,721
   
1,985,891
 
Net increase in cash and cash equivalents
   
1,972,247
   
12,490,699
 
Cash and cash equivalents at beginning of period
   
1,255,842
   
1,413,545
 
Cash and cash equivalents at end of period
 
$
3,228,089
 
$
13,904,244
 
Supplemental Disclosure of Cash Flow Information
             
Cash paid during the period for interest (excluding amounts capitalized)
 
$
502,649
 
$
487,145
 
Cash paid during the period for interest that was capitalized
   
188,691
   
20,050
 
Supplemental Disclosure of Non-Cash Activity
             
Amortization of deferred financing costs capitalized to construction project
   
(36,230
)
 
(51,837
)
Change in capital expenditures financed through accounts payable
   
(3,503,363
)
 
(2,588,677
)
Dividends declared but not paid
   
(819,798
)
 
(753,760
)
The accompanying notes are an integral part of these consolidated financial statements.

 
7

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



NOTE 1 – ORGANIZATION
 
Owens Realty Mortgage, Inc. (the “Company”) was incorporated on August 9, 2012, under the laws of the State of Maryland. The Company is authorized to issue 50,000,000 shares of its $0.01 par value common stock (“Common Stock”). In addition, the Company is authorized to issue 5,000,000 shares of preferred stock at $0.01 par value per share. The Company was created to effect the merger (the “Merger”) of Owens Mortgage Investment Fund, a California Limited Partnership (“OMIF”) with and into the Company as described in the Registration Statement on Form S-4, as amended, of the Company, declared effective on February 12, 2013 (File No. 333-184392).  The Merger was part of a plan to reorganize the business operations of OMIF so that it could elect to qualify as a real estate investment trust for Federal income tax purposes. The Merger was approved by OMIF limited partners on April 16, 2013 and was completed on May 20, 2013.

The Company has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Code”). As a REIT, the Company is permitted to deduct distributions made to its stockholders, allowing its income and gain represented by such distributions to avoid taxation at the entity level and to be taxed generally only at the stockholder level. The Company currently intends to distribute all of its REIT taxable income, excluding net capital gains. As a REIT, however, the Company is subject to separate, corporate-level tax, including potential 100% penalty taxes under various circumstances, as well as certain state and local taxes. In addition, the Company’s taxable REIT subsidiaries are subject to full corporate income tax. Furthermore, the Company’s ability to continue to qualify as a REIT will depend upon its continuing satisfaction of various requirements, such as those related to the diversity of its stock ownership, the nature of its assets, the sources of its income and the distributions to its stockholders, including a requirement that the Company distribute to its stockholders at least 90% of its REIT taxable income on an annual basis (determined without regard to the dividends paid deduction and by excluding net capital gain).

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

In the opinion of the management of the Company, the accompanying unaudited financial statements contain all adjustments, consisting of normal, recurring adjustments, necessary to present fairly the financial information included therein. Certain information and footnote disclosures presented in the annual consolidated financial statements are not included in these interim financial statements.  These consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Form 10-K of ORM for the fiscal year ended December 31, 2015 filed with the Securities and Exchange Commission (“SEC”). The results of operations for the three months ended March 31, 2016 are not necessarily indicative of the operating results to be expected for the full year ending December 31, 2016. The Company evaluates subsequent events up to the date it files its Form 10-Q with the SEC. 

Basis of Presentation

Principles of Consolidation

The consolidated financial statements include the accounts of the Company, its wholly-owned taxable REIT subsidiary (TRS) and its majority- and wholly-owned limited liability companies. The Company is in the business of providing mortgage lending services and manages its business as one operating segment. Due to foreclosure activity, the Company also owns and manages real estate assets.

Certain reclassifications, not affecting previously reported net income or stockholders’ equity, have been made to the previously issued consolidated financial statements to conform to the current period presentation.

Management Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 financial statements and the reported amounts of revenues and expenses during the reporting periods. Such estimates are inherently imprecise and actual results could differ significantly from such estimates.
 
8

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



Recently Issued Accounting Pronouncements

In March 2016, the FASB issued Accounting Standards Update 2016-07, “Investments – Equity Method and Joint Ventures (Topic 323) – Simplifying the Transition to the Equity Method of Accounting”, or ASU 2016-07. To simplify the accounting for equity method investments, the amendments in ASU 2016-07 eliminate the requirement in Topic 323 that an entity retroactively adopt the equity method of accounting if an investment qualifies for use of the equity method as a result of an increase in the level of ownership or degree of influence. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. This standard is effective for interim and annual reporting beginning after December 15, 2016, with early adoption permitted. The Company is currently evaluating the impact that ASU 2016-07 may have on its consolidated financial statements.

In February 2016, the FASB issued Accounting Standards Update 2016-02, “Leases (Topic 842)” or ASU 2016-02.  ASU 2016-02 amends existing guidance related to leases, primarily by requiring the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under the current accounting guidance. This standard is effective for interim and annual reporting beginning after December 15, 2018, with early adoption permitted.  The Company is currently evaluating the impact that ASU 2016-02 may have on its consolidated financial statements.

In January 2016, the FASB issued Accounting Standards Update 2016-01, “Financial Instruments- Overall (Subtopic 825-10) – Recognition and Measurement of Financial Assets and Financial Liabilities”, or ASU 2016-1.  ASU 2016-01 amends existing guidance related to the disclosure, presentation, recognition and measurement of financial assets and financial liabilities.  This accounting standard primarily amends the accounting for equity method investments, fair value disclosures and presentation of financial assets and financial liabilities. This standard is effective for interim and annual reporting beginning after December 15, 2017, with certain aspects available for early adoption.  The Company is currently evaluating the impact that ASU 2016-01 may have on its consolidated financial statements.

In May 2014, the FASB issued Accounting Standards Update 2014-09, “Revenue from Contracts with Customers (Topic 606),” or ASU 2014-09. ASU 2014-09 broadly amends the accounting guidance for revenue recognition. ASU 2014-09 is effective for the first interim or annual period beginning after December 15, 2017, and is to be applied prospectively. Early adoption is not permitted. The Company is currently evaluating the impact that ASU 2014-09 may have on its consolidated financial statements.

Recently Adopted Accounting Pronouncements

In April 2015, the FASB issued Accounting Standards Update 2015-03, “Interest - Imputation of Interest (Subtopic 835-30) – Simplifying the Presentation of Debt Issuance Costs,” or ASU 2015-03. ASU 2015-03 simplifies the presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct reduction from the carrying amount of that debt liability, consistent with debt discounts. In August 2015, the FASB issued ASU 2015-15 which clarified that the SEC would not object to entities continuing to report debt issuance costs on line of credit arrangements as assets. The recognition and measurement guidance for debt issuance costs are not affected by these ASUs. The Company adopted these ASUs retrospectively during the quarter ended March 31, 2016 and elected to continue to report its deferred financing costs on lines of credit as assets, as allowed by the clarifying guidance issued in ASU 2015-15. Adoption of these standards resulted in net debt issuance costs (deferred financing costs) being presented as a direct offset to the applicable debt on the balance sheet. Thus, both deferred financing costs and notes and loans payable on real estate on the accompanying consolidated balance sheets were decreased by $569,000 and $658,000 as of March 31, 2016 and December 31, 2015, respectively.
 
9

 
OWENS REALTY MORTGAGE, INC.
 
Notes to Consolidated Financial Statements (Unaudited)


Significant Accounting Policies
 
      The significant accounting policies used in the preparation of these interim consolidated financial statements are disclosed in the Company’s consolidated financial statements for the year ended December 31, 2015 included in its 2015 annual report on Form 10-K.  There have been no significant changes to those significant accounting policies other than the adoption of ASU 2015-03 as discussed above.
 
NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES
 
Loans are generally stated at the principal amount outstanding. Advances under the terms of a loan to pay property taxes, insurance, legal and other costs are generally capitalized and reported as interest and other receivables. The Company’s portfolio consists primarily of real estate loans generally collateralized by first, second and third deeds of trust.  Interest income on loans is accrued by the simple interest method. Loans are generally placed on nonaccrual status when the borrowers are past due greater than ninety days or when full payment of principal and interest is not expected. When a loan is classified as nonaccrual, interest accruals discontinue and all past due interest is included in the recorded investment in the impaired loan that is measured as described below. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest. Cash receipts on nonaccrual loans are used to reduce any outstanding accrued interest, and then are recorded as interest income, except when such payments are specifically designated as principal reduction or when management does not believe the Company’s investment in the loan is fully recoverable. The Company does not incur origination costs and does not earn or collect origination fees from borrowers as OFG is entitled to all such fees (see Note 9).

Loans and the related accrued interest and advances are analyzed by management on a periodic basis for ultimate recovery. The allowance for loan losses is management’s estimate of probable credit losses inherent in the Company’s loan portfolio that have been incurred as of the balance sheet date.  The allowance is established through a provision for loan losses which is charged to expense.  Additions to the allowance are expected to maintain the adequacy of the total allowance after credit losses and loan growth.  Credit exposures determined to be uncollectible are charged against the allowance.  Cash received on previously charged off amounts is recorded as a recovery to the allowance.  The overall allowance consists of two primary components: specific reserves related to impaired loans that are individually evaluated for impairment and general reserves for inherent losses related to loans that are not considered impaired and are collectively evaluated for impairment.

Regardless of a loan type, a loan is considered impaired when, based on current information and events, management believes it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the original agreement or when monthly payments are delinquent for more than 90 days on a loan.  All loans determined to be impaired are individually evaluated for impairment.  When a loan is considered impaired, management estimates impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, management may measure impairment based on a loan's observable market price, or the fair value of the collateral if the loan is collateral dependent.  A loan is collateral dependent if the repayment of the loan is expected to be provided solely by the underlying collateral. These valuations are generally updated during the fourth quarter but may be updated during interim periods if deemed appropriate by management.

A restructuring of a debt constitutes a troubled debt restructuring (“TDR”) if the Company for economic or legal reasons related to the debtor's financial difficulties grants a concession to the debtor that it would not otherwise consider.  Restructured loans typically present an elevated level of credit risk as the borrowers are not able to perform according to the original contractual terms.  Loans that are reported as TDR’s are considered impaired and measured for impairment as described above.

The determination of the general reserve for loans that are not considered impaired and are collectively evaluated for impairment is based on estimates made by management, to include, but not limited to, consideration of historical losses by portfolio segment, internal asset classifications, and qualitative factors to include economic trends in the Company’s service areas, industry experience and trends, geographic concentrations, estimated collateral values, the Company’s underwriting policies, the character of the loan portfolio, and probable losses inherent in the portfolio taken as a whole.
 
10

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



The Company maintains a separate allowance for each portfolio segment (loan type).  These portfolio segments include commercial real estate, residential real estate and land loans.   The allowance for loan losses attributable to each portfolio segment, which includes both impaired loans that are individually evaluated for impairment and loans that are not considered impaired and are collectively evaluated for impairment, is combined to determine the Company’s overall allowance, which is included on the consolidated balance sheet. The reserve for loans that are not considered impaired consists of reserve factors that are based on management’s assessment of the following for each portfolio segment: (1) inherent credit risk, (2) historical losses, and (3) other qualitative factors.  These reserve factors are inherently subjective and are driven by the repayment risk associated with each portfolio segment described below.

Land Loans – These loans generally possess a higher inherent risk of loss than other real estate portfolio segments.  A major risk arises from the necessity to complete the projects within the specified costs and time lines. Trends in the construction industry significantly impact the credit quality of these loans as demand drives construction activity. In addition, trends in real estate values significantly impact the credit quality of these loans, as property values generally determine the economic viability of construction projects.

Commercial and Residential Real Estate Loans –Adverse economic developments or an overbuilt market impact commercial and residential real estate projects and may result in troubled loans.  Trends in vacancy rates of properties impact the credit quality of these loans.  High vacancy rates reduce operating revenues and the ability for properties to produce sufficient cash flow to service debt obligations.

Management monitors the credit quality of the Company’s loan portfolio on an ongoing basis using certain credit quality indicators including a loan’s delinquency status and internal asset classification. A loan is considered classified when it meets the definition of impaired as described above.

 
11

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)


The following tables show the changes in the allowance for loan losses by portfolio segment for the three months ended March 31, 2016 and 2015 and the allocation of the allowance for loan losses and loans as of March 31, 2016 and December 31, 2015 by portfolio segment and by impairment methodology:

   
Commercial
 
Residential
 
Land
   
2016
       
Total
                 
Allowance for loan losses:
           
   
Three Months Ended March 31, 2016
 
Beginning balance
 
$
1,140,530
$
455,587
$
246,329
$
1,842,446
 
  Provision (Reversal)
 
            (3
)
48,335
 
62,743
 
111,075
 
Ending balance
 
$
1,140,527
$
503,922
$
309,072
$
1,953,521
                 
   
As of March 31, 2016
 
Ending balance: individually evaluated for impairment
 
$
495,157
$
$
$
495,157
                 
Ending balance: collectively evaluated for impairment
 
645,370
 
503,922
 
309,072
 
1,458,364
                 
Ending balance
$
1,140,527
$
503,922
$
309,072
$
1,953,521
                 
Loans:
               
Ending balance: individually evaluated for impairment
$
2,510,752
$
7,188,203
$
$
9,698,955
                 
Ending balance: collectively evaluated for impairment
 
77,513,439
 
17,836,088
 
6,630,857
 
101,980,384
                 
Ending balance
$
80,024,191
$
25,024,291
$
6,630,857
$
111,679,339

 
12

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



 
   
Commercial
 
Residential
 
Land
   
2015
       
Total
                 
Allowance for loan losses:
           
   
Three Months Ended March 31, 2015
 
Beginning balance
 
$
888,260
$
1,975,112
$
5,983
$
2,869,355
 
   Provision (Reversal)
 
            23,506
 
(2,091
)
66,151
 
87,566
 
Ending balance
 
$
911,766
$
1,973,021
$
72,134
$
2,956,921
                 
   
As of December 31, 2015
 
Ending balance: individually evaluated for impairment
 
$
485,823
$
          —
$
             —
$
 485,823
                 
Ending balance: collectively evaluated for impairment
 
654,707
 
455,587
 
246,329
 
1,356,623
                 
Ending balance
$
1,140,530
$
455,587
$
246,329
$
1,842,446
                 
Loans:
               
Ending balance: individually evaluated for impairment
$
1,078,752
$
      7,615,055
$
           —
$
8,693,807
                 
Ending balance: collectively evaluated for impairment
 
75,721,545
 
17,060,812
 
        5,267,643
 
98,050,000
                 
Ending balance
$
76,800,297
$
24,675,867
$
5,267,643
$
106,743,807


The following tables show an aging analysis of the loan portfolio by the time monthly payments are past due as of March 31, 2016 and December 31, 2015:

   
Loans
30-59 Days
Past Due
 
Loans
60-89 Days
Past Due
 
Loans
90 or More Days
Past Due
           
         
Total Past
Due Loans
 
Current Loans
 
Total Loans
March 31, 2016
           
                         
Commercial
$
          —
$
       1,432,000
$
        1,078,752
$
         2,510,752
$
77,513,439
$
        80,024,191
Residential
 
          1,323,781
 
 
         7,188,203
 
         8,511,984
 
 
16,512,307
 
        25,024,291
                         
Land
 
          —
 
           —
 
         —
 
       —
 
6,630,857
 
6,630,857
                         
 
$
          1,323,781
$
1,432,000
$
8,266,955
$
11,022,736
$
       100,656,603
$
  111,679,339

 
13

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



 
   
Loans
30-59 Days
Past Due
 
Loans
60-89 Days
Past Due
 
Loans
90 or More Days
Past Due
           
         
Total Past
Due Loans
 
Current Loans
 
Total Loans
December 31, 2015
           
                         
Commercial
$
          —
$
          —
$
       1,078,752
$
       1,078,752
$
       75,721,545
$
76,800,297
                         
Residential
 
 
 
        7,615,055
 
        7,615,055
 
       17,060,812
 
24,675,867
                         
Land
 
          —
 
          —
 
        
 
        
 
5,267,643
 
5,267,643
                         
 
$
         —
$
          —
$
   8,693,807
$
   8,693,807
$
      98,050,000
$
   106,743,807

All of the loans that were 90 or more days past due as listed above were on non-accrual status as of March 31, 2016 and December 31, 2015.

The following tables show information related to impaired loans as of and for the three months ended March 31, 2016:

   
As of March 31, 2016
 
Three Months Ended March 31, 2016
 
 
 
Recorded
Investment
 
 
Unpaid
Principal
Balance
 
 
 
Related
Allowance
   
 
Average
Recorded
Investment
 
 
Interest
Income
Recognized
With no related allowance recorded:
                     
 
Commercial
 
$
1,466,096
  $
1,432,000
 
$
 
 
 
$
488,699
 
$
 
Residential
 
7,636,597
 
7,188,203
 
 
   
7,702,080
 
5,247
 
Land
 
 
 
 
 —
   
 
 
$
9,102,693
$
8,620,203
$
   
$
8,190,779
$
5,247
With an allowance recorded:
                     
 
Commercial
$
1,171,957
$
1,078,752
$
495,157
 
$
1,171,207
$
 
Residential
 
 
 
   
 
 
Land
 
 
 
   
 
 
$
1,171,957
 
1,078,752
$
495,157
 
$
1,171,207
$
Total:
                     
 
Commercial
 
$
2,638,053
 
$
2,510,752
  $
495,157
 
 
$
1,659,906
 
$
 
Residential
 
7,636,597
 
 
7,188,203
 
 
 
 
 
7,702,080
 
 
5,247
 
Land
 
 
 
 
 
 
 
 
 
 
 
$
10,274,650
$
9,698,955
$
495,157
 
$
9,361,986
$
5,247

 
14

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



The following tables show information related to impaired loans as of December 31, 2015 and for the three months ended March 31, 2015:

   
As of December 31, 2015
 
Three Months Ended March 31, 2015
 
 
 
Recorded
Investment
 
 
Unpaid
Principal
Balance
 
 
 
Related
Allowance
   
 
Average
Recorded
Investment
 
 
Interest
Income
Recognized
With no related allowance recorded:
                     
 
Commercial
 
$
 
  $
 
 
$
 
 
 
$
 
7,737,656
 
$
 
601,660
 
Residential
 
 
8,063,450
 
 
7,615,055
 
 
   
 
251,780
 
 
5,493
 
Land
 
 
 
 
 
 
 —
   
 
1,240,045
 
 
216,904
 
$
8,063,450
$
7,615,055
$
   
$
9,229,481
$
824,057
With an allowance recorded:
                     
 
Commercial
$
 
1,144,864
$
 
 1,078,752
$
 
485,823
 
$
 
1,079,699
$
 
13,484
 
Residential
 
 
 
 
 
 
   
 
7,983,345
 
 
63,000
 
Land
 
 
 
 
    —
 
 
   
 
 
 
 
$
1,144,864
 
1,078,752
$
485,823
 
$
9,063,044
$
76,484
Total:
                     
 
Commercial
 
$
 
1,144,864
 
$
 
1,078,752
  $
 
485,823
 
 
$
 
8,817,355
 
$
 
 615,144
 
Residential
 
 
8,063,450
 
 
 
7,615,055
 
 
 
 
 
 
 
8,235,125
 
 
 
68,493
 
Land
 
 
 
 
 
 
 
 
 
 
 
 
1,240,045
 
 
 
216,904
 
$
9,208,314
$
8,693,807
$
485,823
 
$
18,292,525
$
900,541

The recorded investment balances presented in the above tables include amounts advanced in addition to principal on impaired loans (such as property taxes, insurance and legal charges) that are reimbursable by borrowers and are included in interest and other receivables in the accompanying consolidated balance sheets. Interest income recognized on a cash basis for impaired loans approximates the interest income recognized as reflected in the tables above.

Troubled Debt Restructurings

The Company had allocated approximately $495,000 and $486,000 of specific reserves on loans totaling approximately $8,809,000 and $9,208,000 (recorded investments before reserves) to borrowers whose loan terms had been modified in troubled debt restructurings as of March 31, 2016 and December 31, 2015, respectively.  The Company has not committed to lend additional amounts to any of these borrowers.

No loans were modified as troubled debt restructurings during the quarters ended March 31, 2016 and 2015.

 
15

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



NOTE 4 – INVESTMENT IN LIMITED LIABILITY COMPANY

During 2008, the Company entered into an operating agreement (the “Operating Agreement”) of 1850 De La Cruz LLC, a California limited liability company (“1850”), with Nanook Ventures LLC (“Nanook”), an unrelated party.  The purpose of the joint venture is to acquire, own and operate certain industrial land and buildings located in Santa Clara, California that were owned by the Company. The property was subject to a Purchase and Sale Agreement dated July 24, 2007 (the “Sale Agreement”), as amended, between the Company, as seller, and Nanook, as buyer.  During the course of due diligence under the Sale Agreement, it was discovered that the property was contaminated and that remediation and monitoring may be required.  The parties agreed to enter into the Operating Agreement to restructure the arrangement as a joint venture.  At the time of closing in July 2008, the two properties were separately contributed to two new limited liability companies, Nanook Ventures One LLC and Nanook Ventures Two LLC that are wholly owned by 1850. The Company and Nanook are the Members of 1850 and NV Manager, LLC is the manager. (See Note 13 for further discussion of the Company’s environmental remediation obligation with respect to the properties owned by 1850.)

The Company received no distributions from 1850 during the three months ended March 31, 2016 and 2015. The net income to the Company from its investment in 1850 De La Cruz was approximately $43,000 and $43,000 during the three months ended March 31, 2016 and 2015, respectively.

NOTE 5 - REAL ESTATE HELD FOR SALE

Real estate properties held for sale as of March 31, 2016 and December 31, 2015 consists of properties acquired through foreclosure classified by property type as follows:

   
March 31,
2016
 
December 31,
2015
 
Residential
 
$
58,709,206
 
$
51,942,601
 
Land (including land under development)
   
45,663,932
   
42,071,143
 
Office
   
4,718,987
   
4,716,487
 
Industrial
   
   
1,460,935
 
   
$
109,092,125
 
$
100,191,166
 

Transfers

During the three months ended March 31, 2016, the Company transferred one condominium property from “Held for investment” to “Held for sale” as the property was listed for sale and a sale was expected within the next year.

During the three months ended March 31, 2015, the Company transferred three properties (one land, one residential and one industrial) from “Held for investment” to “Held for sale” as the properties were listed for sale and sales were expected within the next year.

Impairment Losses

No impairment losses were recorded during the three months ended March 31, 2016. During the three months ended March 31, 2015, the Company recorded an impairment loss of approximately $1,109,000 on the unimproved residential and commercial land located in Gypsum, Colorado due to a decrease in the listing price of the property and a reduction in the fair market value estimated by management.
 
16

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



Sales

During the three months ended March 31, 2016, the Company sold one industrial property and one office building in an office complex for aggregate net sales proceeds of approximately $6,479,000, resulting in total gain on sale of real estate of approximately $4,839,000.

During the three months ended March 31, 2015, the Company sold one retail property for net sales proceeds of approximately $1,109,000, resulting in a gain on sale of real estate of approximately $53,000. In addition, the Company recognized gain of approximately $152,000 during the three months ended March 31, 2015 that had previously been deferred related to the sale of a real estate property in 2012.  The gain on the sale of this property was being accounted for under the installment method.

In March 2016, TOTB North and TOTB Miami entered into a Purchase Agreement and Deposit Receipt (the “Purchase Agreement”) with Interwest Capital Corporation (the “Buyer”) to sell all real estate and related properties owned by the TOTB entities (the “TOTB Sale”) for $82,000,000, subject to potential adjustments as described in the Purchase Agreement. Buyer’s obligation to purchase the TOTB properties is subject to a number of conditions and there is no guarantee when or if the transaction will close. The aggregate book value of the TOTB properties subject to sale was approximately $54,526,000 as of March 31, 2016.

NOTE 6 - REAL ESTATE HELD FOR INVESTMENT

Real estate held for investment as of March 31, 2016 and December 31, 2015 consists of properties acquired through foreclosure classified by property type as follows:


   
March 31,
2016
 
December 31,
2015
 
Retail
 
$
23,063,829
 
$
23,122,714
 
Land
   
8,112,676
   
8,112,676
 
Residential
   
2,441,772
   
6,673,540
 
Assisted care
   
5,431,169
   
5,402,376
 
Office
   
4,111,383
   
4,315,608
 
Marina
   
4,063,948
   
4,079,087
 
Golf course
   
1,930,647
   
1,941,245
 
   
$
49,155,424
 
$
53,647,246
 

The balances of land and the major classes of depreciable property for real estate held for investment as of March 31, 2016 and December 31, 2015 are as follows:
 
   
March 31,
2016
   
December 31,
2015
 
Land and land improvements
 
$
22,374,479
   
$
23,443,676
 
Buildings and improvements
   
29,341,989
     
33,119,166
 
     
51,716,468
     
56,562,842
 
Less: Accumulated depreciation
   
(2,561,044
)
   
(2,915,596
)
   
$
49,155,424
   
$
53,647,246
 

It is the Company’s intent to sell the majority of its real estate properties held for investment, but expected sales are not probable to occur within the next year.

Depreciation expense was approximately $327,000 and $580,000 for the three months ended March 31, 2016 and 2015, respectively.
 
17

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)


Certain of the Company’s real estate properties held for sale and investment are leased to tenants under noncancellable leases with remaining terms ranging from one to eight years. Certain of the leases require the tenant to pay all or some operating expenses of the properties. The future minimum rental income from noncancellable operating leases due within the five years subsequent to March 31, 2016 and thereafter is as follows:

Twelve months ending March 31:
       
2017
 
$
4,138,779
 
2018
   
2,100,465
 
2019
   
1,646,773
 
2020
   
1,129,873
 
2021
   
526,693
 
Thereafter (through 2024)
   
1,280,518
 
   
$
10,823,101
 


NOTE 7 – LINES OF CREDIT PAYABLE
 
The Company borrows funds under the revolving California Bank & Trust (“CB&T”) line of credit and the revolving Opus Bank (“Opus”) line of credit (collectively, the “Funding Agreements”). As of March 31, 2016 and December 31, 2015, the outstanding balances and total commitments under the Funding Agreements consisted of the following:

   
As of March 31, 2016
 
As of December 31, 2015
 
                   
   
Outstanding
Balance
 
Total
Commitment
 
Outstanding
Balance
 
Total
Commitment
 
CB&T Line of Credit
 
$
17,477,500
 
$
19,531,915
 
$
8,289,500
 
$
22,574,753
 
    Opus Bank Line of Credit     9,375,000     9,375,000     12,626,000     12,626,000  
Total
 
$
26,852,500
 
$
28,906,915
 
$
20,915,500
 
$
35,200,753
 
 
The Funding Agreements are generally collateralized by assignments of specific loans or real estate properties owned by the Company.

CB&T Line of Credit

In February 2014, the Company entered into a Credit Agreement and Advance Formula Agreement and related agreements with CB&T as the lender (the “CB&T Credit Facility”).The agreements were amended and restated in April 2015 to add First Bank as an additional lender and to increase the maximum borrowings available (total commitment) under the facility to the lesser of a $30,000,000 maximum or the amount determined pursuant to a borrowing base calculation described in the Advance Formula Agreement. Pursuant to the First Amendment to Amended and Restated Credit Agreement and Loan Documents dated March 1, 2016 (the “First Amendment”), the maximum commitment of the lenders under the facility has been increased from $30,000,000 to $50,000,000, such maximum commitment can be increased (on request of the Company and with the permission of the lenders) in the future to up to $75,000,000, and borrowings under the CB&T Credit Facility now mature on March 1, 2018.
 
        Such borrowings bear interest payable monthly at the prime rate of interest established by CB&T from time-to-time plus one quarter percent (.25%) per annum (3.75% at March 31, 2016). Upon a default such interest rate increases by 2.00%. The original CB&T Credit Facility required the payment of an origination fee of $100,000 and other issuance costs totaling $177,000 that were capitalized to deferred financing costs and were being amortized to interest expense using the straight-line method through the maturity date of the CB&T Credit Facility (fully amortized as of March 31, 2016). The First Amendment required the payment of an origination fee and other costs totaling $255,000 that was capitalized to deferred financing costs and is being amortized to interest expense using the straight-line method through the new maturity date.  The Company is also subject to certain ongoing administrative fees and expenses. Interest expense on the CB&T Credit Facility was approximately $188,000 and $161,000 during the three months ended March 31, 2016 and 2015, respectively (including $34,000 and $23,000, respectively, in amortization of deferred financing costs).
 
18

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



Borrowings are secured by certain assets of the Company. These collateral assets will include the grant to CB&T of first-priority deeds of trust on certain real property assets and trust deeds of the Company to be identified by the parties from time-to-time and all personal property of the Company, which collateral includes the assets described in the Security Agreement and in other customary collateral agreements entered into by the parties from time-to-time. As of March 31, 2016, the carrying amount and classification of loans and real estate properties securing the CB&T Credit Facility were as follows:

Loans:
   
March 31,
2016
 
Commercial
 
$
18,246,915
 
Residential
   
1,285,000
 
      Total
 
$
19,531,915
 

The CB&T Credit Facility agreements contain financial covenants which are customary for a loan of this type. Management is not aware of any breach of these covenants as of March 31, 2016.

Opus Bank Line of Credit

In April 2014, the Company entered into a Secured Revolving Credit Loan Agreement (the “Opus Credit Agreement”) and related agreements with Opus as the lender (the “Opus Credit Facility”).  The maximum borrowings available (total commitment) under the facility is the lesser of $20,000,000 or the Maximum Allowed Advance amount determined pursuant to a borrowing base calculation described in the Opus Credit Agreement.

Advances under the Opus Credit Facility were available from Opus until April 1, 2016.

All borrowings under the Opus Credit Facility bear interest payable monthly as follows: (i) commencing October 1, 2014, and on each successive six month anniversary during the term (the “Rate Change Date”), the rate of interest will be reset to the Six Month LIBOR rate of interest (0.90% at March 31, 2016) as reported on such Rate Change Date plus four percent (4.0%) per annum but in no event will the interest rate be lower than 4.5% per annum. The interest rate as of March 31, 2016 was 4.9%. Upon a default under the Opus Credit Facility such interest rate increases by an additional 5.00%. Commencing on May 1, 2016, in addition to the required interest payments, the Company is required to make mandatory monthly principal payments. All amounts under the Opus Credit Facility are to be repaid not later than April 1, 2017.

The Opus Credit Facility required the payment of an origination fee of $100,000 and other issuance costs totaling $231,000 that were capitalized as deferred financing costs and are being amortized to interest expense using the straight-line method through the maturity date of the Opus Credit Facility. The Company is also subject to certain ongoing administrative fees and expenses. Interest expense on the Opus Credit Facility was approximately $109,000 and $19,000 during the three months ended March 31, 2016 and 2015, respectively (including $19,000 and $19,000, respectively, in amortization of deferred financing costs).

Borrowings under the Opus Credit Facility are secured by certain of the Company's assets. These collateral assets include the following types of assets as identified by the parties and described in Borrowing Base Collateral Certificates  entered into by the parties: (i) the grant to Opus of first-priority deeds of trust on certain of the Company's real property assets that meet related eligibility requirements set forth in the Opus Credit Agreement (as further defined in the Opus Credit Agreement, the “REO Collateral”); and (ii) the grant to Opus of a collateral interest in mortgage loan promissory notes issued by the Company in the ordinary course of business that meet related eligibility requirements set forth in the Opus Credit Agreement (as further defined in the Opus Credit Agreement, the “Note Collateral”). As of March 31, 2016, the carrying amount and classification of loans and real estate properties securing the Opus Credit Facility were as follows:
 
19

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



Loans:
   
March 31,
2016
 
Commercial
 
$
7,000,000
 
Real Estate:
       
Office
 
$
8,247,422
 

The Opus Credit Facility contains financial covenants which are customary for loans of this type. Management is not aware of any breach of these covenants as of March 31, 2016.
 
NOTE 8 - NOTES AND LOANS PAYABLE ON REAL ESTATE

The Company had the following notes and loans payable outstanding as of March 31, 2016 and December 31, 2015:
   
March 31,
2016
 
December 31,
2015
 
Interest Rate
 
Payment Terms/Frequency
 
Maturity Date
Tahoe Stateline Venture, LLC Note #1
 
$
2,900,000
 
$
2,900,000
 
5.00%
 
Interest Only
Semi-annual
 
December 2016
Tahoe Stateline Venture, LLC Note #3
   
500,000
   
500,000
 
5.00%
 
Interest Only
Quarterly
 
August 2017
TOTB North, LLC Construction Loan Payable
   
17,572,767
   
16,009,906
 
4.63%
 
Amortizing
Monthly
 
June 2017
TOTB Miami, LLC Loan Payable
   
12,619,785
   
12,693,231
 
4.63%
 
Amortizing
Monthly
 
November 2017
Tahoe Stateline Venture, LLC Loan Payable
   
13,920,376
   
14,013,901
 
3.47%
 
Amortizing
Monthly
 
January 2021
Principal amount
 
$
47,512,928
 
$
46,117,038
           
Less unamortized deferred financing costs
   
(568,530
)
 
(658,194
)
         
Notes and loans payable, net
 
$
46,944,398
 
$
45,458,844
           

The following table shows maturities by year on these notes and loans payable as of March 31, 2016:
 
Twelve months ending March 31:
       
2017
 
$
3,582,467
 
2018
   
30,788,183
 
2019
   
409,743
 
2020
   
424,190
 
2021
   
12,308,345
 
   
$
47,512,928
 

Tahoe Stateline Venture, LLC Notes Payable

The Company obtained these obligations as a result of the foreclosure or purchase of nine parcels by TSV in 2013 and 2012. The Company paid approximately $6,000 and $6,000 of interest on the notes during the three months ended March 31, 2016 and 2015, respectively. As of March 31, 2016 and December 31, 2015, there was approximately $55,000 and $18,000, respectively, in accrued but unpaid interest on these notes. The interest incurred has been capitalized to the basis of the land under development.
 
20

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)


TOTB North, LLC Construction Loan Payable
 
In June 2014, TOTB North, LLC (“TOTB North”) entered into a Construction Loan Agreement (the “Loan Agreement”) and related documents with Bank of the Ozarks (“Ozarks”) as the lender providing TOTB North with a loan (the “North Loan”) of up to $21,304,000 to renovate and improve the vacant and unimproved “North” apartment building held in TOTB North (the “Project”).  The North Loan is secured by a first mortgage lien on the North building and all improvements and certain other assets, and is cross-defaulted and cross-collateralized with the TOTB Miami, LLC Loan Payable described below.

The initial maturity date (the “Maturity Date”) of the North Loan is June 12, 2017, which may be extended at the option of TOTB North for two additional one year periods, subject to certain conditions.

All outstanding borrowings under the North Loan bear interest equal to the floating daily Three Month LIBOR rate of interest plus four percent (4.0%) per annum (the “Note Rate”), but the Note Rate will not be lower than four and one-half percent (4.5%) per annum. The Note Rate as of March 31, 2016 was 4.63% per annum.  Upon a default under the North Loan documents the Note Rate increases by an additional eight percent (8.00%) per annum. Interest only payments are payable monthly until the “Amortization Commencement Date” which is the earlier to occur of (i) October 1, 2016 or (ii) the first monthly interest payment date occurring after the Project is completed and the North property achieves a DSCR of greater than 1.25:1. Commencing on the Amortization Commencement Date, monthly principal payments are also required with principal amortizing over 300 months and the balance of the North Loan is due on the Maturity Date or at the earlier closing of the proposed sale of the TOTB properties discussed in further detail below.

TOTB North made a required deposit with Ozarks of $1.0 million (the “Bridge Equity”) in 2014 using a capital contribution by TOTB (excess funds held and capital contributions of $453,000 from the Company and $108,000 from OFG).  The Bridge Equity was provided to fund project costs pending satisfaction of additional post-closing conditions under the loan documents, and Ozarks reimbursed the Bridge Equity as part of the loan in February 2015. All post-closing conditions were met in February 2015, and TOTB North was given access to the remaining balance of the North Loan once the Company and OFG contributed an additional $1,170,000 and $279,000, respectively, during the quarter ended March 31, 2015 due to increased construction costs for the Project.

During 2014, TOTB North paid customary closing fees, disbursements and expenses, including an origination fee to Ozarks, which totaled $622,000. The majority of these costs were paid out of proceeds from the North Loan and capitalized to deferred financing costs and are being amortized to the Project using the straight-line method through the Maturity Date. During the three months ended March 31, 2016 and 2015, approximately $36,000 and $52,000, respectively, of deferred financing costs were amortized to the Project. During the three months ended March 31, 2016 and 2015, approximately $197,000 and $14,000, respectively, of interest was incurred of which $134,000 and $14,000, respectively, was capitalized to the Project. The Project was substantially completed at the beginning of March 2016 and, thus, interest and amortization of deferred financing costs totaling approximately $79,000 were expensed during the quarter. The balance of unamortized deferred financing costs was approximately $242,000 and $294,000 as of March 31, 2016 and December 31, 2015, respectively.

In March 2016, TOTB North and TOTB Miami entered into a Purchase Agreement and Deposit Receipt (the “Purchase Agreement”) with Interwest Capital Corporation (the “Buyer”) to sell all real estate and related properties owned by the TOTB entities (the “TOTB Sale”) for $82,000,000, subject to potential adjustments as described in the Purchase Agreement. Buyer’s obligation to purchase the TOTB properties is subject to a number of conditions and there is no guarantee when or if the transaction will close.

The North Loan documents contain financial covenants of TOTB North and the Guarantors which are customary for loans of this type. Management is not aware of any breach of these covenants as of March 31, 2016.
 
21

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



TOTB Miami, LLC Loan Payable
 
In November 2014, TOTB Miami, LLC (“TOTB”) entered into another loan agreement (the “TOTB Loan Agreement”) and related documents with Ozarks providing TOTB a loan (the “TOTB Miami Loan”) of $13,000,000 secured by a first mortgage lien on the 154 leased condominium units owned in the Pointe building and the related parcel and all improvements as well as certain other assets. As a condition of providing the TOTB Miami Loan, Ozarks required that the TOTB Miami Loan and the North Loan be cross-collateralized and cross-defaulted, that excess proceeds from any sale of the North property be used to reduce or pay off the TOTB Miami Loan and that excess proceeds from any sale of the TOTB property be used to pay off the North Loan.

The net cash proceeds from the TOTB Miami Loan were distributed to the members of TOTB in 2014. The initial maturity date (the “Maturity Date”) of the TOTB Miami Loan is November 16, 2017, and the Maturity Date may be extended at the option of TOTB for two additional one year periods if a number of conditions are met.

All outstanding borrowings under the TOTB Miami Loan will bear interest equal to the floating daily Three Month LIBOR rate of interest plus four percent (4.0%) per annum (the “Note Rate”), but in no event will the Note Rate be lower than four and one-quarter percent (4.25%) per annum. The Note Rate as of March 31, 2016 was 4.63% per annum.  Upon a default under the TOTB Miami Loan documents, including any cross-default, the Note Rate increases by an additional eight percent (8.00%) per annum. Principal and interest is payable monthly with principal amortizing over 300 months, and the balance of the loan is due on the Maturity Date or at the earlier closing of the proposed TOTB Sale.

TOTB was obligated to pay customary closing fees, disbursements and expenses, including an origination fee to the Lender, which totaled approximately $323,000. The majority of these costs were paid out of proceeds from the loan and capitalized to deferred financing costs and are being amortized to interest expense using the effective interest method through the Maturity Date. During the three months ended March 31, 2016 and 2015, approximately $177,000 and $166,000, respectively, of interest expense was incurred (including approximately $29,000 and $28,000, respectively, of deferred financing costs amortized to interest expense). The balance of unamortized deferred financing costs was approximately $153,000 and $182,000 as of March 31, 2016 and December 31, 2015, respectively.

The TOTB Miami Loan documents contain financial covenants of TOTB and the Guarantors which are customary for loans of this type. Management is not aware of any breach of these covenants as of March 31, 2016.
 
Tahoe Stateline Venture, LLC Loan Payable
 
In December 2014, Tahoe Stateline Ventures, LLC (“TSV”) entered into a Credit Agreement (the “Credit Agreement”) and related documents with RaboBank, N.A. as the lender (“Lender”) providing TSV with a loan (the “TSV Loan”) of up to $14,500,000. TSV borrowed $10,445,000 at the first closing under the TSV Loan and an additional $3,830,000 was borrowed in September 2015.

The maturity date of the TSV Loan is January 1, 2021 (the “Maturity Date”). All outstanding borrowings under the TSV Loan documents bear interest initially at a rate of 3.47% per annum (the “Long Term Adjustable Rate”), provided that on January 1, 2018 the Long Term Adjustable Rate will be reset to Lender’s then current market rate for three year fixed rate loans from comparable commercial real estate secured transactions, as determined by Lender in its sole discretion. Upon a default under the TSV Loan documents, the interest rate on the outstanding principal balance increases by an additional five percent (5.00%) per annum and the rate on any other outstanding obligations thereunder increases to ten percent (10.00%) per annum. Prepayments under the TSV Loan documents are subject to certain prepayment fees; provided that during the 90 day period immediately prior to January 1, 2018, and the 90 day period immediately prior to the Maturity Date, TSV may prepay the entire unpaid balance of the Loan in full, without any Prepayment Fee or penalty.
 
22

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



During the term of the TSV Loan, TSV will make equal combined payments of principal and accrued interest on the first day of each month in an amount calculated to fully amortize the original principal amount over a period of 300 months, subject to certain adjustments and the balance of the TSV Loan is due on the Maturity Date.

The Credit Agreement required the payment of a closing fee of $108,750 and certain administrative fees totaling approximately $218,000. The majority of these costs were paid out of proceeds from the loan and capitalized to deferred financing costs and are being amortized to interest expense using the effective interest method through the Maturity Date. During the three months ended March 31, 2016 and 2015, approximately $130,000 and $99,000, respectively, of interest expense was incurred (including approximately $9,000 and $9,000, respectively, of deferred financing costs amortized to interest expense). The balance of unamortized deferred financing costs was $173,000 and $182,000 as of March 31, 2016 and December 31, 2015, respectively.

The TSV Loan documents contain financial covenants which are customary for loans of this type. Management is not aware of any breach of these covenants as of March 31, 2016.

NOTE 9 - TRANSACTIONS WITH AFFILIATES

In consideration of the management services rendered to the Company pursuant to the management agreement between the Company and OFG (the “Management Agreement”), OFG is entitled to receive from the Company a management fee payable monthly, subject to a maximum of 2.75% per annum of the average unpaid balance of the Company’s mortgage loans.

All of the Company’s loans are serviced by OFG, in consideration for which OFG receives a monthly fee, which, when added to all other fees paid in connection with the servicing of a particular loan, does not exceed the lesser of the customary, competitive fee paid in the community where the loan is placed for the provision of such mortgage services on that type of loan, or up to 0.25% per annum of the unpaid principal balance of the loans.

OFG, at its sole discretion may, on a monthly basis, adjust the management and servicing fees as long as they do not exceed the allowable limits calculated on an annual basis. Even though the fees for a month may exceed 1/12 of the maximum limits, at the end of the calendar year the sum of the fees collected for each of the 12 months must be equal to or less than the stated limits. Management fees amounted to approximately $766,000 and $456,000 for the three months ended March 31, 2016 and 2015, respectively and are included in the accompanying consolidated statements of operations. Servicing fees amounted to approximately $70,000 and $41,000 for the three months ended March 31, 2016 and 2015, respectively, and are included in the accompanying consolidated statements of operations. As of March 31, 2016 and December 31, 2015, the Company owed management and servicing fees to OFG in the amount of approximately $279,000 and $267,000, respectively.
 
The maximum management and servicing fees were paid to OFG during the three months ended March 31, 2016 and 2015.
 
In determining the management fees to pay to OFG, OFG may consider a number of factors, including current market yields, delinquency experience, un-invested cash and real estate activities. During the three months ended March 31, 2016 and 2015 and the year ended December 31, 2015, OFG elected to take the maximum compensation that it is able to take pursuant to the Company’s charter and will likely continue to take the maximum compensation for the foreseeable future.

Pursuant to the charter, OFG receives all late payment charges from borrowers on loans owned by the Company. The amounts paid to or collected by OFG for such charges totaled approximately $3,000 and $17,000 for the three months ended March 31, 2016 and 2015, respectively. In addition, the Company remits other miscellaneous fees to OFG, which are collected from loan payments, loan payoffs or advances from loan principal (i.e. funding, demand and partial release fees). The amounts paid to or collected by OFG for such fees totaled approximately $4,000 and $2,000 during the three months ended March 31, 2016 and 2015, respectively.
 
23

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)




OFG originates all loans the Company invests in and receives loan origination and extension fees from borrowers. During the three months ended March 31, 2016 and 2015, OFG earned approximately $718,000 and $244,000, respectively, in loan fees on loans originated of $35,150,000 and $10,438,000, respectively.

OFG is reimbursed by the Company for the actual cost of goods, services and materials used for or by the Company and paid by OFG and the salary and related salary expense of OFG’s non-management and non-supervisory personnel performing services for the Company which could be performed by independent parties (subject to certain limitations in the Management Agreement). The amounts reimbursed to OFG by the Company were $114,000 and $131,000 during the three months ended March 31, 2016 and 2015, respectively, and approximately $39,000 and $142,000 were payable to OFG at March 31, 2016 and December 31, 2015, respectively. The Company also reimbursed certain of OFG’s officers for allowed expenses in the total amount of $0 and $1,000 during the three months ended March 31, 2016 and 2015, respectively.

The Company paid Investor’s Yield, Inc. (a wholly owned subsidiary of OFG) approximately $0 and $7,000 in fees primarily related to certain foreclosure proceedings on Company loans during the three months ended March 31, 2016 and 2015, respectively.
 
During the three months ended March 31, 2015, the Company purchased OFG’s full interest in a loan secured by an industrial property located in San Ramon, California with a principal balance of $1,499,000 at face value.
 
NOTE 10 – STOCKHOLDERS’ EQUITY
 
On December 11, 2015, the Board of Directors authorized a new Rule 10b5-1 stock repurchase plan (the “2016 Repurchase Plan”) under which the Company may purchase up to $7.5 million of its Common Stock. Under the 2016 Repurchase Plan, repurchases will be funded from available working capital, and the repurchased shares will return to the status of authorized but unissued shares of Common Stock. The 2016 Repurchase Plan provides for stock repurchases to commence on April 1, 2016 and is subject to certain price, volume and timing constraints specified in the brokerage agreement. There is no guarantee as to the exact number of shares that will be repurchased by the Company. The 2016 Repurchase Plan is set to expire on March 31, 2017, although the Company may terminate the Repurchase Plan at any time.

NOTE 11 – RESTRICTED CASH
 
Contingency Reserves
 
In accordance with the charter, the Company is required to maintain cash, cash equivalents and marketable securities as contingency reserves in an aggregate amount of 1-1/2% of Capital as defined in the charter. Although the Manager believes the contingency reserves are adequate, it could become necessary for the Company to sell or otherwise liquidate certain of its investments or other assets to cover such contingencies on terms which might not be favorable to the Company, which could lead to unanticipated losses upon sale of such assets.
 
The contingency reserves required per the charter as of March 31, 2016 and December 31, 2015 were approximately $3,892,000 and $3,809,000, respectively, and are reported as restricted cash in the accompanying consolidated balance sheets. The $7,000,000 required to be held in non-interest bearing accounts as of March 31, 2016 pursuant to the Company’s two lines of credit agreements satisfy this contingency reserve requirement.
 
Escrow Deposits
 
Restricted cash includes deposits held in third party escrow accounts to pay property taxes and insurance on Company real estate in the amounts of approximately $329,000 and $225,000 as of March 31, 2016 and December 31, 2015, respectively.
 
24

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



NOTE 12 – FAIR VALUE
 
The Company accounts for its financial and nonfinancial assets and liabilities pursuant to ASC 820 – Fair Value Measurements and Disclosures.  ASC 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.
 
Fair value is defined in ASC 820 as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
 
Level 1       Quoted prices in active markets for identical assets or liabilities
 
Level 2       Observable inputs other than Level 1 prices, such as quoted prices for similar assets or
liabilities; quoted prices in active markets that are not active; or other inputs that are
observable or can be corroborated by observable market data for substantially the full
term of the assets or liabilities

Level 3       Unobservable inputs that are supported by little or no market activity, such as the
Company’s own data or assumptions.

Level 3 inputs include unobservable inputs that are used when there is little, if any, market activity for the asset or liability measured at fair value. In certain cases, the inputs used to measure fair value fall into different levels of the fair value hierarchy. In such cases, the level in which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input requires judgment and considers factors specific to the asset or liability being measured.

Management monitors the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another.  In such instances, the transfer is reported at the beginning of the reporting period.

Management evaluates the significance of transfers between levels based upon the nature of the financial instrument and size of the transfer relative to total assets, total liabilities or total earnings.

The following is a description of the Company’s valuation methodologies used to measure and disclose the fair values of its financial and nonfinancial assets and liabilities on a nonrecurring basis. There were no assets or liabilities measured at fair value on a recurring basis.
 
Impaired Loans
 
The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and a specific allowance for loan losses is established.  A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement or when monthly payments are delinquent greater than ninety days. Once a loan is identified as impaired, management measures impairment in accordance with ASC 310-10-35.  The fair value of impaired loans is estimated by either an observable market price (if available) or the fair value of the underlying collateral, if collateral dependent.  The fair value of the loan’s collateral is determined by third party appraisals (by licensed appraisers), broker price opinions, comparable property sales or other indications of value. Those impaired loans not requiring an allowance represent loans for which the fair value of the collateral exceed the recorded investments in such loans. At March 31, 2016 and December 31, 2015, the majority of the total impaired loans were evaluated based on the fair value of the collateral by obtaining third party appraisals that valued the collateral primarily by utilizing an income or market approach or some combination of the two.  In accordance with ASC 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy.  Because appraisals used by management generally include significant unobservable inputs and market data, the Company records the impaired loan as nonrecurring Level 3. Unobservable market data included in appraisals often includes adjustments to comparable property sales for such items as location, size and quality to estimate fair values using a sales comparison approach.  Unobservable market data also includes cash flow assumptions and capitalization rates used to estimate fair values under an income approach.
 
25

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



Real Estate Held for Sale and Investment
 
Real estate held for sale and investment includes properties acquired through foreclosure of the related loans. When property is acquired, any excess of the Company’s recorded investment in the loan and accrued interest income over the estimated fair market value of the property, net of estimated selling costs, is charged against the allowance for loan losses. Subsequently, real estate properties held for sale are carried at the lower of carrying value or fair value less costs to sell. The Company periodically compares the carrying value of real estate held for investment to expected future cash flows as determined by internally or third party generated valuations (including third party appraisals that primarily utilize an income or market approach or some combination of the two) for the purpose of assessing the recoverability of the recorded amounts. If the carrying value exceeds future undiscounted cash flows, the assets are reduced to fair value. The fair value of real estate held for sale and investment is estimated using appraisals in a manner similar to that of collateral dependent impaired loans described above which generally results in a Level 2 or Level 3 classification in the fair value hierarchy.

The following table presents information about the Company’s assets and liabilities measured at fair value on a nonrecurring basis as of March 31, 2016 and December 31, 2015:
 
   
Fair Value Measurements Using
   
Fair Value
 
Quoted Prices In Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
March 31, 2016
               
Nonrecurring:
               
Impaired loans:
         
 
 
 
  Commercial
$
       676,800
$
$
$
       676,800
 
 Total
 
$
    676,800
$
$
 
$
 
676,800
                 
Real estate properties:
     
 
 
 
 
 
  Land
$
4,224,000
$
$
$
    4,224,000
 
Total
 
$
 
   4,224,000
$
$
 
 
$
 
4,224,000
                 
December 31, 2015
               
Nonrecurring:
               
Impaired loans:
               
  Commercial
$
659,041
$
$
$
659,041
 
Total
 
$
 
659,041
$
 
$
 
$
 
   659,041
                 
Real estate properties:
               
  Land
$
4,224,000
$
$
$
4,224,000
 
Total
 
$
 
    4,224,000
$
$
 
      —
$
 
4,224,000
 
 
26

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)


The provision for loan losses based on the fair value of loan collateral less estimated selling costs for the impaired loans above totaled approximately $9,000 and $3,000 during the three months ended March 31, 2016 and 2015, respectively. Impairment losses of approximately $0 and $1,109,000 were recorded on real estate properties during the three months ended March 31, 2016 and 2015, respectively.
 
There were no liabilities measured at fair value on a non-recurring basis at March 31, 2016 and December 31, 2015.
 
The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at March 31, 2016 and December 31, 2015:

At March 31, 2016:

Description
 
Fair Value
 
Valuation Technique
 
Significant Unobservable Inputs
 
Input/Range
 
Weighted Average
                     
Impaired Loans:
                   
Commercial
$
    676,800
 
Appraisal
 
Estimated Cost of Improvements
 
31.9%
 
N/A
           
Capitalization Rate
 
7.0%
 
N/A
           
Comparable Sales Adjustment
 
(20)% to 30%
 
N/A
Real Estate Properties:
                 
Land
$
4,224,000
 
Appraisal
 
Comparable Sales Adjustment
 
(33.4)%
 
N/A

At December 31, 2015:
Description
 
Fair Value
 
Valuation Technique
 
Significant Unobservable Inputs
 
Input/Range
 
Weighted Average
                     
Impaired Loans:
                   
Commercial
$
    659,041
 
Appraisal
 
Estimated Cost of Improvements
 
31.9%
 
N/A
           
Capitalization Rate
 
7.0%
 
N/A
           
Comparable Sales Adjustment
 
(20)% to 30%
 
N/A
Real Estate Properties:
                 
Land
$
  4,224,000
 
Appraisal
 
Comparable Sales Adjustment
 
(33.4)%
 
N/A

Where only one percentage is presented in the above table there was only one unobservable input of that type for one loan or property. Adjustments to comparable sales included items such as market conditions, location, size, condition, access/frontage and intended use. A weighted average of an unobservable input is presented in the table above only to the extent there were multiple impaired loans or real estate properties measured at fair value on a nonrecurring basis.
 
27

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



The approximate carrying amounts and estimated fair values of financial instruments at March 31, 2016 and December 31, 2015 are as follows:
         
Fair Value Measurements at March 31, 2016
     
Carrying Value
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial assets
                   
 
Cash and cash equivalents
$
3,228,000
$
3,228,000
$
$
$
3,228,000
 
   Restricted cash
 
7,329,000
 
7,329,000
 
 
 
7,329,000
 
   Loans, net
 
109,726,000
 
 
 
109,723,000
 
109,723,000
 
   Investment in limited liability company
 
2,184,000
 
 
 
2,352,000
 
2,352,000
 
   Accrued interest and advances receivable
 
1,264,000
 
 
 
1,264,000
 
1,264,000
                       
Financial liabilities
                   
 
   Due to Manager
$
318,000
$
$
318,000
$
$
318,000
 
   Accrued interest payable
 
290,000
 
 
195,000
 
95,000
 
290,000
 
   Lines of credit payable
 
26,853,000
 
 
26,853,000
 
 
26,853,000
 
   Notes payable
 
46,944,000
 
 
29,797,000
 
16,987,000
 
46,784,000

 
         
Fair Value Measurements at December 31, 2015
     
Carrying Value
 
Level 1
 
Level 2
 
Level 3
 
Total
Financial assets
                   
 
   Cash and cash equivalents
$
1,256,000
$
1,256,000
$
$
$
1,256,000
 
   Restricted cash
 
7,225,000
 
7,225,000
 
 
 
7,225,000
 
   Loans, net
 
104,901,000
 
 
 
104,895,000
 
104,895,000
 
   Investment in limited liability company
 
2,141,000
 
 
 
2,352,000
 
2,352,000
 
   Interest and other receivables
 
1,105,000
 
 
 
1,105,000
 
1,105,000
                       
Financial liabilities
                   
 
   Due to Manager
$
409,000
$
$
409,000
$
$
409,000
 
   Accrued interest payable
 
229,000
 
 
170,000
 
59,000
 
229,000
 
   Lines of credit payable
 
20,916,000
   
20,916,000
 
 
20,916,000
 
   Notes payable
 
45,459,000
 
 
28,227,000
 
17,063,000
 
45,290,000

The following methods and assumptions were used by the Company in estimating the fair value of each class of financial instruments:

Cash, cash equivalents and restricted cash: The carrying value of cash and cash equivalents and restricted cash approximate the fair values because of the relatively short maturity and/or liquid nature of these instruments and are classified as Level 1.

Loans, net: Except as it relates to impaired loans measured at fair value on a nonrecurring basis discussed previously, the fair value of loans is estimated using discounted cash flow methodology, using discount rates, which, in the opinion of management, best reflect current market interest rates that would be offered for loans with similar characteristics and credit quality but are often unobservable resulting in a Level 3 classification. Accrued interest and advances receivable relate to loans and are thus classified as Level 3.

 
28

 
Investment in limited liability company: The fair value of the Company’s investment in limited liability company is estimated based on an appraisal obtained and is classified as Level 3 because the appraisal itself and/or adjustments thereto include unobservable data similar to the unobservable data discussed in the disclosures related to assets measured at fair value on a nonrecurring basis.

Lines of credit payable: The fair values of the Company’s lines of credit are estimated based upon a discounted cash flow model using comparable market indicators of current pricing for the same or similar issue or on the current rate offered to the Company for debt of the same remaining maturity and is generally observable resulting in a Level 2 classification. Accrued interest payable associated with the lines of credit is also classified as Level 2.

Notes and loans payable: The fair values of the Company’s notes and loans payable and related accrued interest payable are estimated based upon a discounted cash flow model using comparable market indicators of current pricing for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities resulting in either a Level 2 or Level 3 classification. Generally, Level 2 inputs are used for notes and loans payable with maturities of one year or less or that have been entered into in relatively close proximity to the balance sheet date and Level 3 inputs are used for other notes and loans payable. Accrued interest payable associated with the notes and loans payable is also classified as either Level 2 or Level 3.

Due to Manager: The carrying value of Due to Manager is estimated to approximate fair value due to the short term nature of this instrument and is classified as Level 2.

NOTE 13 - COMMITMENTS AND CONTINGENCIES

Environmental Remediation Obligations

The Company has an obligation to pay all required costs to remediate and monitor contamination of the real properties owned by 1850. As part of the Operating Agreement executed by the Company and its joint venture partner in 1850, Nanook, the Company has indemnified Nanook against all obligations related to the expected costs to monitor and remediate the contamination. In 2008, the Company had accrued an amount that a third party consultant had estimated would be needed to monitor and remediate the site. The majority of clean-up activities were completed during 2012 as part of the tenant’s construction of a new building on the site. As of March 31, 2016 and December 31, 2015, approximately $24,000 and $36,000 of this obligation remains accrued on the Company’s books. In February 2016, the Company obtained a no further action letter from the water board, which effectively relieves the Company of any future remediation responsibility for the site.

During the course of due diligence performed by a potential buyer of TOTB during 2012, a low level of arsenic was found in the ground water of a monitoring well located on the property owned by TOTB. While the level of arsenic exceeds the minimum level acceptable for drinking water standards, the water under this property is subject to tidal influence and is not used for domestic consumption.  TOTB retained an environmental consultant to perform additional testing and analysis with the goal of petitioning the appropriate governmental agency to issue a no further action letter for this property due to the low level of contamination and the low quality of the ground water under the property.  TOTB has submitted a proposed closure letter to the governmental agency and is waiting for final approval. At this time, the costs of any potential remediation and/or monitoring are unknown and cannot be estimated. As of March 31, 2016 and December 31, 2015, approximately $127,000 and $104,000 had been accrued and/or paid for testing and analysis.
 
29

 
OWENS REALTY MORTGAGE, INC.

Notes to Consolidated Financial Statements (Unaudited)



Contractual Obligations

The Company has entered into various contracts for design, architectural, engineering, foundation work and construction for the phase II development of the land owned by Zalanta Resort at the Village, LLC (“Zalanta”). The aggregate amount of these contracts totaled approximately $31,166,000 of which approximately $7,050,000 had been incurred as of March 31, 2016 in addition to other capitalized costs related to the construction project of $2,227,000 (total of $9,277,000). Management expects that all costs for this project will be paid from cash reserves, advances from the lines or credit and/or construction financing to be obtained in the future. It is possible that additional change orders will be submitted and construction costs may be higher than expected.

As of March 31, 2016, the Company has commitments to advance additional funds to borrowers of construction, rehabilitation and other loans in the total amount of approximately $28,224,000 (including approximately $2,963,000 in interest reserves).
 
Legal Proceedings

The Company is involved in various legal actions arising in the normal course of business.  In the opinion of management, such matters will not have a material effect upon the financial position of the Company.


 

 
30

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 

Forward Looking Statements

The following discussion provides information to assist you in understanding our financial condition and results of operations.  This discussion and analysis contains forward-looking statements. These forward-looking statements include information about possible or assumed future results of our business, financial condition, liquidity, results of operations, plans and objectives. When we use the words “may,” “believe,” “expect,” “anticipate,” “estimate,” “plan,” “continue,” “intend,” “should,” “project” or similar expressions, it intends to identify forward-looking statements. These forward-looking statements are subject to risks and uncertainties, as more particularly set forth in our filings with the Securities and Exchange Commission, including those described in the “Forward Looking Statements” and “Risk Factors” sections of our Annual Report on Form 10-K for the year ended December 31, 2015, that could cause actual results to differ materially from those projected in the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date hereof. New risks and uncertainties arise over time and it is not possible to predict those events or how they may affect us. Except as required by law, we are not obligated to, and do not intend to, update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview and Background

We are a specialty finance company that focuses on the origination, investment and management of commercial real estate mortgage loans.  We provide customized, short-term capital to small and middle-market investors and developers who require speed and flexibility. We are organized and conduct our operations to qualify as a real estate investment trust, or REIT, for U.S. federal income tax purposes. We are externally managed and advised by Owens Financial Group, Inc. (“OFG” or the “Manager”), a specialized commercial real estate management company that has originated, serviced and managed alternative commercial real estate investments since 1951.

The Company is a Maryland corporation formed to reorganize the business of its predecessor, OMIF, into a publicly traded REIT. OMIF was a California Limited Partnership registered with the Securities and Exchange Commission that was formed in 1983 for the purposes of funding and servicing short-term commercial real estate loans. Beginning in 2009, OMIF experienced liquidity issues as its borrowers were unable to access credit sources to pay off its loans.  OMIF eventually foreclosed on a substantial portion of its loan portfolio, repositioning many of the properties for investment or eventual sale.  OMIF also experienced a significant increase in capital withdrawal requests that it was unable to honor due to insufficient cash, net of reserves, and restrictions under the terms of its bank line of credit. In addition, OMIF was restricted by provisions within the partnership agreement from making additional investments in mortgage loans while qualified redemption requests remained pending and unpaid. In addition to increasing investor liquidity through public listing of its stock, the Company was created to provide the opportunity for resuming mortgage lending activities, with the goal of increasing income to stockholders.

On May 20, 2013, OMIF merged with and into the Company with the Company as the surviving entity, succeeding to and continuing the operations of OMIF. The Company now, by virtue of the Merger, directly or indirectly owns all of the assets and business formerly owned by OMIF. The Company is a deemed successor issuer to OMIF pursuant to Rule 12g-3(a) under the Exchange Act, and on July 1, 2013, the Company’s Common Stock was listed on the NYSE MKT exchange.  For accounting purposes, the Merger was treated as a transfer of assets and exchange of shares between entities under common control. The accounting basis used to initially record the assets and liabilities in the Company was the carryover basis of OMIF.

Our primary sources of revenue are interest income earned on our loan portfolio and revenues we generate from our operating real estate assets. We have resumed originating loans and believe the Company is well positioned to capitalize on lending opportunities as the economy continues to recover. However, there can be no assurances that we will be able to identify and make loans to suitable commercial real estate borrowers or have adequate liquidity and capital to fund such loans.

Our operating results are affected primarily by:

·  
the level of foreclosures and related loan and real estate losses experienced;
 
 
31

 
 
·  
the income or losses from foreclosed properties prior to the time of disposal;
·  
the amount of cash available to invest in loans;
·  
the amount of borrowing to finance loan investments and our cost of funds on such borrowing;
·  
the level of real estate lending activity in the markets serviced;
·  
the ability to identify and lend to suitable borrowers;
·  
the interest rates we are able to charge on loans; and
·  
the level of delinquencies on loans.

Between 2008 and 2013, we experienced increased delinquent loans and foreclosures which created substantial losses. As a result, we now own significantly more real estate than in the past, which has reduced cash flow and net income. As of March 31, 2016, approximately 9% of our loans are impaired and/or past maturity. As of March 31, 2016, we own approximately $158 million (book value) of real estate held for sale or investment, which is approximately 56% of total assets. During the three month period ended March 31, 2016, we sold two properties for net sales proceeds of $6,479,000 and total gain of $4,839,000. We will continue to attempt to sell certain of our properties but may need to sell them for losses or wait until market values recover. In addition, under the REIT tax rules, we may be subject to a “prohibited transaction” penalty tax on tax gains from the sale of our properties in certain circumstances. In addition, we are also limited in the number and dollar amount of properties we can sell in a given year under the REIT tax rules.

Although management believes that only one of our delinquent loans will result in a loss to the Company (and has caused the Company to record a specific allowance for loan losses on such loans), real estate values could decrease further. Management continues to perform frequent evaluations of such collateral values using internal and external sources, including the use of updated independent appraisals.  As a result of these evaluations, the allowance for loan losses and our investments in real estate could change in the near term, and such changes could be material.

Our website can be found at www.owensmortgage.com. We make available through the website, access to our annual and quarterly financial statements, current reports on Form 8-K, and amendments to those reports, as well as proxy statements and other periodic reports and filings submitted to the SEC. We also provide access to certain Company presentations, fact sheets, press releases and corporate governance information.

Business Strategy

Our primary business objective is to provide our stockholders with attractive risk-adjusted returns by producing consistent and predictable dividends while maintaining a strong balance sheet. We believe we have positioned the Company for future growth and seek to increase funds from operations, or FFO, adjusted funds from operations, or AFFO, and distributions to stockholders through active portfolio management and execution of our business plan which is outlined below:

·  
Capitalize on market lending opportunity by leveraging our existing origination network to expand our commercial real estate loan portfolio.
·     
Enhance and reposition our commercial real estate assets through the investment of capital and strategic management.
·     
Increase liquidity available for lending activities by focusing on opportunities to remove real estate assets from our balance sheet.
·     
Manage leverage to marginally expand sources of liquidity while maintaining a conservative balance sheet.

Current Market Conditions, Risks and Recent Trends

From 2013 through 2015, the global capital and credit markets continued to slowly recover from the economic downturn which began in 2007. Real estate markets also continued to recover, slowly on a national basis and more significantly in major metropolitan areas, and we expect this trend to continue through 2016. Accordingly, as our real estate assets are carried at the lower of carrying value or fair value less costs to sell, it is possible that we have substantial imbedded gains in certain of our real estate properties held for sale and investment that are not reflected in our financial statements or in the value of our stock. However, despite these improvements, the overall market recovery remains uncertain. Should the economy regress, the commercial real estate sector may experience additional losses and operating challenges.

 
32

 
Critical Accounting Policies

Please refer to the section of ORM’s Annual Report on Form 10-K for the year ended December 31, 2015 entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations —Critical Accounting Policies” for a discussion of our critical accounting policies. During the three months ended March 31, 2016, there were no material changes to these policies.

In preparing the consolidated financial statements, management is required to make estimates based on the information available that affect the reported amounts of assets and liabilities as of the balance sheet dates and revenues and expenses for the reporting periods. Such estimates relate principally to the determination of (1) the allowance for loan losses including the accrued interest and advances that are estimated to be unrecoverable based on estimates of amounts to be collected plus estimates of the value of the property as collateral; (2) the valuation of real estate held for sale and investment (at acquisition and subsequently); and (3) the estimate of environmental remediation liabilities. While we believe that these accounting policies and estimates are based on sound measurement criteria, actual future events can and often do result in outcomes that can be materially different from these estimates and forecasts.

Results of Operations

Net income attributable to our common stockholders increased approximately $3,583,000 during the three months ended March 31, 2016, as compared to the same period in 2015. This increase was primarily a result of the following:

·     
An increase in gain on sale real estate of $4,633,000 due to the sale of two properties during the quarter ended March 31, 2016.

·     
A decrease in impairment losses on real estate properties of $1,109,000 due to an impairment loss recorded on the unimproved residential and commercial land located in Gypsum, Colorado during the quarter ended March 31, 2015 due to a decrease in the listing price and a reduction in the fair market value estimated by management. No impairment losses were recorded during 2016.
 
·     
A decrease in rental and other expenses on real estate properties of $400,000 and a decrease in depreciation and amortization expense of $259,000 due to the sale of four operating properties during 2015 and one in the beginning of 2016.

These items that increased net income during the three months ended March 31, 2016 were partially offset by the following:

·     
A decrease in interest income on loans secured by trust deeds of $781,000 due to the accretion of the remaining $512,000 discount on an impaired loan and past due and deferred interest collected on impaired loans totaling approximately $855,000 during the quarter ended March 31, 2015. This decrease was partially offset by an increase in interest income on performing loans as the average balance of performing loans between the quarter ended March 31, 2015 and the quarter ended March 31, 2016 increased approximately 113%. Although there was a decrease in interest income on loans between the quarters ended March 31, 2015 and 2016, there was an increase in interest income of approximately $463,000 or 29% between the quarters ended December 31, 2015 and March 31, 2016 due to an increase in performing loans in our portfolio.
 
·     
A decrease in rental and other income from real estate of $1,403,000 due primarily to the sale of four operating properties during 2015 and one in the beginning of 2016.
 
 
33

 
 
 
·     
An increase in management and service fees of $337,000 due to an increase in the average balance of loans in the Company’s portfolio of 68% between the quarters ended March 31, 2016 and March 31, 2015.
 
We believe, from period to period in the near term, there could be fluctuations in earnings and net income resulting from the lag time between the sale of our real estate assets and deployment of the proceeds into new loan investments.
 
Comparison of Results of Operations for Three Months Ended March 31, 2016 and 2015
 
The following table sets forth our results of operations for the three months ended March 31, 2016 and 2015:
 
   
Three Months Ended March 31,
 
Increase/(Decrease)
   
2016
 
2015
   
                Amount
 
Percent
 
Revenues:
                         
Interest income on loans
 
$
2,043,008
 
$
2,823,871
   
$
(780,863
)
(28)
%
Rental and other income from real estate properties
   
2,139,985
   
3,542,899
     
(1,402,914
)
(40)
%
Income from investment in limited liability company
   
42,624
   
43,061
     
(437
)
(1)
%
   Total revenues
   
4,225,617
   
6,409,831
     
(2,184,214
)
(34)
%
Expenses:
                         
Management fees to Manager
   
765,515
   
456,389
     
309,126
 
68
%
Servicing fees to Manager
   
69,592
   
41,490
     
28,102
 
68
%
General and administrative expense
   
553,417
   
378,971
     
174,446
 
46
%
Rental and other expenses on real estate properties
   
1,790,379
   
2,190,412
     
(400,033
)
(18)
%
Depreciation and amortization
   
343,649
   
602,386
     
(258,737
)
(43)
%
Interest expense
   
683,051
   
587,026
     
96,025
 
16
%
Provision for loan losses
   
111,075
   
87,566
     
23,509
 
27
%
Impairment losses on real estate properties
   
   
1,109,434
     
(1,109,434
)
(100)
%
   Total expenses
   
4,316,678
   
5,453,674
     
(1,136,996
)
(21)
%
   Operating (loss) income
   
(91,061
)
 
956,157
     
(1,047,218
)
(110)
%
Gain on sales of real estate, net
   
4,838,815
   
205,441
     
4,633,374
 
nm
 
   Net income
   
4,747,754
   
1,161,598
     
3,586,156
 
309
%
Net income attributable to noncontrolling interests
   
(13,492
)
 
(9,878
)
   
(3,614
)
37
%
   Net income attributable to common stockholders
 
$
4,734,262
 
$
1,151,720
   
$
3,582,542
 
311
%
nm – not meaningful

Revenues

Interest income on loans decreased $781,000 (28% decrease) during the three months ended March 31, 2016, as compared to the same period in 2015. This decrease was primarily due to the accretion of the remaining $512,000 discount on an impaired loan as the loan was repaid prior to maturity and past due and deferred interest collected on impaired loans totaling approximately $855,000 during the quarter ended March 31, 2015. This decrease was partially offset by an increase in interest income from performing loans as the average balance of performing loans increased between the quarter ended March 31, 2015 and the quarter ended March 31, 2016 by approximately 113%.

Rental and other income from real estate properties decreased $1,403,000 (40% decrease) during the three months ended March 31, 2016, as compared to the same period in 2015, primarily due to the sale of four operating properties during the year ended December 31, 2015 and one at the beginning of 2016. These properties had rental income totaling approximately $1,193,000 during the three months ended March 31, 2015.

 
34

 

Expenses

Management fees increased $310,000 (68% increase) and servicing fees increased $28,000 (68% increase) during the three months ended March 31, 2016 and 2015, respectively. The increase in management and service fees during 2016 was due to an increase in the average balance of loans in the Company’s portfolio of 68% between the quarters ended March 31, 2016 and March 31, 2015.

The maximum management and servicing fees were paid to the Manager during the three months ended March 31, 2016 and 2015. The maximum management fee permitted under the Management Agreement is 2.75% per year of the average unpaid balance of mortgage loans. For the three months ended March 31, 2016 (annualized) and the calendar years 2015, 2014 and 2013, the management fees were 2.75%, 2.75%, 2.75% and 2.74% of the average unpaid balance of mortgage loans, respectively.
 
In determining the management fees, the Manager may consider a number of factors, including current market yields, delinquency experience, un-invested cash and real estate activities. During the quarters ended March 31, 2016 and 2015, the Manager chose to take the maximum compensation that it is able to take pursuant to the charter and will likely continue to take the maximum compensation for the foreseeable future.

General and administrative expense increased $174,000 (46% increase) during the three months ended March 31, 2016, as compared to the same period in 2015, due primarily to higher legal, consulting and appraisal expenses during 2016 as compared to 2015.

Rental and other expenses on real estate properties decreased $400,000 (18% decrease) during the three months ended March 31, 2016, as compared to the same period in 2015, primarily due to the sale of four operating properties during the year ended December 31, 2015 and one at the beginning of 2016. These properties had rental expenses totaling approximately $455,000 during the three months ended March 31, 2015.

Depreciation and amortization expense decreased $259,000 (43% decrease) during the three months ended March 31, 2016, as compared to the same period in 2015, primarily due to the sale of four depreciable properties during the year ended December 31, 2015 and one at the beginning of 2016. These properties had depreciation expense totaling approximately $149,000 during the three months ended March 31, 2015. In addition, certain other properties were moved to Held for Sale during the year ended December 31, 2015 and, thus, depreciation expense was discontinued.

Interest expense increased $96,000 (16% increase) during the three months ended March 31, 2016 as compared to 2015, due to a higher amount of interest incurred on our lines of credit as the balances were higher during the quarter ended March 31, 2016 as compared to 2015, due to an additional $3,830,000 advance taken on the TSV loan during the third quarter of 2015 and due to additional interest expense incurred on the TOTB Miami and TOTB North loans during 2016, net of reduced interest expense as a result of the repayment of the 720 University loan during the second quarter of 2015.

The provision for loan losses of $111,000 during the three months ended March 31, 2016 was the result of an analysis performed on the loan portfolio. The general loan loss allowance increased $102,000 during the three months ended March 31, 2016 primarily due to an increase in the balance of performing loans during the quarter. The specific loan loss allowance increased $9,000 during the three months ended March 31, 2016. We recorded a provision for loan losses of $88,000 during the three months ended March 31, 2015.

The impairment losses on real estate properties of $1,109,000 during the three months ended March 31, 2015 was the result of a decrease in the listing price of the unimproved residential and commercial land located in Gypsum, Colorado and a reduction in the fair market value estimated by management. There were no impairment losses recorded during the three months ended March 31, 2016.

 
35

 

Gain on Sales of Real Estate

Gain on sales of real estate increased $4,663,000 during the three months ended March 31, 2016, as compared to the same period in 2015. During the three months ended March 31, 2016, we sold one industrial property and one office building in an office complex for gains totaling approximately $4,839,000. During the three months ended March 31, 2015, we sold one commercial property located in San Jose, California for gain of approximately $53,000 and recorded $152,000 of deferred gain under the installment method related to the sale of the condominiums located in Santa Barbara, California in 2012 due to the remaining repayment of the carry back loan during the quarter.

Financial Condition

March 31, 2016 and December 31, 2015

Loan Portfolio

During the quarter ended March 31, 2016, we originated six new loans in the aggregate amount of approximately $21,030,000 ($35,150,000 when fully funded) and advanced additional amounts to borrowers on existing loans of approximately $1,934,000 (total of $22,964,000).  Three of the new loans are incrementally funded for construction, renovation and/or interest and have $13,929,000 available to be funded in the future. We also received full or partial payoffs (including principal amortization) on loans totaling $17,999,000.

Our portfolio of loan investments remained the same at 56 loans, and the average loan balance increased from $1,906,000 to $1,994,000, between December 31, 2015 and March 31, 2016.

As of March 31, 2016 and December 31, 2015, we had four and three loans that were impaired totaling approximately $9,699,000 (8.7%) and $8,694,000 (8.1%), respectively.  This included two past maturity loans totaling $8,029,000 (7.2%) and $8,452,000 (7.9%), respectively. In addition, one loan of approximately $200,000 (0.2%) was past maturity but current in monthly payments as of March 31, 2016 (combined total of impaired and past maturity loans of $9,899,000 (8.9%) and $8,694,000 (8.1%), respectively). Of the impaired and past maturity loans, two loans with principal balances totaling $2,511,000 (2.3%) were in the process of foreclosure. No loans were in the process of foreclosure as of December 31, 2015.  No loans involved borrowers who were in bankruptcy as of March 31, 2016 and December 31, 2015.

As of March 31, 2016 and December 31, 2015, approximately $111,441,000 (99.8%) and $106,502,000 (99.8%) of our loans are interest-only and require the borrower to make a “balloon payment” on the principal amount upon maturity of the loan. To the extent that a borrower has an obligation to pay mortgage loan principal in a large lump sum payment, its ability to satisfy this obligation may be dependent upon its ability to sell the property, obtain suitable refinancing or otherwise raise a substantial cash amount. As a result, these loans involve a higher risk of default than fully amortizing loans. Borrowers occasionally are not able to pay the full amount due at the maturity date.  We may allow these borrowers to continue making the regularly scheduled monthly interest payments for certain periods of time to assist the borrower in meeting the balloon payment obligation without formally filing a notice of default.  These loans for which the principal is due and payable, but the borrower has failed to make such payment of principal, are referred to as “past maturity loans”. As of March 31, 2016 and December 31, 2015, we had three and two past maturity loans totaling approximately $8,229,000 and $8,452,000, respectively.

As of March 31, 2016 and December 31, 2015, we held the following types of loans:

   
March 31,
2016
   
December 31, 2015
 
By Property Type:
           
Commercial
 
$
80,024,191
   
$
76,800,297
 
Residential
   
25,024,291
     
24,675,867
 
Land
   
6,630,857
     
5,267,643
 
    $
111,679,339
    $
106,743,807
 
 
 
36

 
 
By Position:
               
Senior loans
 
$
108,868,495
   
$
103,716,010
 
Junior loans
   
2,810,844
     
3,027,797
 
   
$
111,679,339
   
$
106,743,807
 

 
 
The types of property securing the Company’s commercial real estate loans are as follows as of March 31, 2016 and December 31, 2015: