State the aggregate
market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the
common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s
most recently completed second fiscal quarter.
Indicate by check
mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company,
or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller
reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
If an emerging growth
company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any
new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate the number of shares outstanding of
each of the issuer’s classes of common stock, as of the latest practicable date.
Portions of the Company’s Proxy Statement
to be delivered to its stockholders in connection with the Company’s 2019 Annual Meeting of Stockholders, which the Company
plans to file with the Securities and Exchange Commission within 120 days of the end of the fiscal year covered by this report,
are incorporated by reference in Part III of this report (Items 10, 11, 12, 13 and 14).
PART I
In connection with
the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, readers of this document and
any document incorporated by reference herein, are advised that this document and documents incorporated by reference into this
document contain both statements of historical facts and forward-looking statements. Forward looking statements are subject to
certain risks and uncertainties, which could cause actual results to differ materially from those indicated by the forward-looking
statements. Examples of forward looking statements include, but are not limited to (i) projections of revenues, income or loss,
earning or loss per share, capital expenditures, dividends, capital structure and other financial items; (ii) statements of plans
and objectives of ours or our management or Board of Directors, including any public sale of our securities, or estimates or predictions
of actions by borrowers, competitors or regulatory authorities; (iii) statements of future economic performance; and (iv) statements
of assumptions underlying other statements and statements about our business.
This document and
documents incorporated by reference herein also identify important factors which could cause actual results to differ materially
from those indicated by forward looking statements. These risks and uncertainties include, among other things, interest rate fluctuations
as they affect the relative yield of our loan portfolio and our ability to compete in making loans to borrowers; payment default
on loans made or bonds purchased by us, which could adversely affect our ability to make distributions to our stockholders or payments
due on our secured investor certificates; the actions of competitors; the effects of government regulation; and other factors which
are described herein and/or in documents incorporated by reference herein, including the risks described in Item 1A.
The cautionary statements
made pursuant to the Private Litigation Securities Reform Act of 1995 above and elsewhere by us should not be construed as exhaustive
or as any admission regarding the adequacy of disclosures made by us prior to the effective date of such Act. Matters which are
the subject of forward-looking statements are beyond our ability to control and in many cases we cannot predict what factors would
cause results to differ materially from those indicated by the forward looking statements.
General
We are a Minnesota
corporation incorporated on May 27, 1994. We operate as a Real Estate Investment Trust (“REIT”) and are engaged in
the business of making mortgage loans to churches and other non-profit religious organizations throughout the United States. The
principal amount of loans we offer ranges from $100,000 to $2,000,000. We may also invest up to 30% of our Average Invested Assets
in mortgage secured debt securities (bonds) issued by churches and other non-profit religious organizations. Between the date upon
which we began active business operations (April 15, 1996) and December 31, 2018, we have made 196 loans to 166 churches approximating
$103,652,503, with the average principal amount of such loans being $529,000. Of the 196 loans we have made, 111 loans totaling
$63,377,737 have been repaid early by the borrowing churches. We also own, as of December 31, 2018, approximately $15,848,000 principal
amount of Church Bonds (hereinafter defined). At no time have we paid a premium for any of the bonds in our portfolio. Subject
to the supervision of our Board of Directors, our day to day business operations are managed by Church Loan Advisors, Inc. (the
“Advisor”), which provides investment advisory and administrative services to us. The principals of the Advisor include
principals of American Investors Group, Inc., (“American”) a FINRA member broker-dealer, which has served as underwriter
of the public offerings of our common stock, as well as our public offerings of secured investor certificates.
The Company’s Business Activities
Our business is managed
by the Advisor. We have no employees but we do have two executive officers. The Advisor's affiliate, American has been engaged
since 1987 in the business of underwriting first mortgage bonds for churches throughout the United States. In underwriting church
bonds, American reviews financing proposals, analyzes prospective borrowers’ financial capability, and structures, markets
and sells, mortgage-backed securities which are debt obligations (bonds) of such borrowers to the investing general public. Since
its inception, American has underwritten approximately 294 church bond financings, in which approximately $555,670,000 in first
mortgage bonds have been sold to public investors. The average size of single church bond financings underwritten by American since
its inception is approximately $1,890,000.
In the course of its
business, American identified a demand from potential borrowers for smaller loans of $100,000 to $2,000,000. Because of the regulatory,
administrative expenses and complexity normally associated with the bond financing business, American determined that the economic
feasibility of bond financing diminished for financings under $1,000,000. As a result, we believe that many churches are forced
to either forego the project for which their financing request was made, fund their project from cash flow over a period of time
and at greater expense, or seek bank financing at terms that are not always favorable or available to them, due to the historic
reluctance of banks to lend to churches for other than economic reasons. Our objective is to provide a lending source to this segment
of the industry by capitalizing on the human resources and experience available at American and the Advisor, and taking advantage
of the marketing, advertising and general goodwill of American.
Financing Business
Our primary business
is to make first mortgage loans in amounts ranging from $100,000 to $2,000,000, to churches and other non-profit religious organizations,
and selecting and investing in mortgage-secured debt instruments ("Church Bonds") issued by churches and other non-profit
religious organizations throughout the United States. All of our loans belong to one portfolio segment. We attempt to apply our
working capital (after adequate reserves determined by the Advisor) toward making mortgage loans and investing in Church Bonds.
We seek to enhance returns on investments on such loans by:
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offering terms of up to 30 years, generating the highest yields possible
under current market conditions;
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seeking origination fees (i.e. "points") from the borrower
at the outset of a loan and upon any renewal of a loan;
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making a limited amount of higher-interest rate second mortgage loans
to qualified borrowers; and
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purchasing mortgage-secured debt securities having various maturities
issued by churches and other non-profit religious organizations.
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Our policies limit
the amount of second mortgage loans to 20% of the Company's Average Invested Assets (hereinafter defined) on the date any second
mortgage loan is closed and limit the amount of mortgage-secured debt securities to 30% of Average Invested Assets on the date
of their purchase.
“Average Invested
Assets” for any period is defined as the average of the aggregated book value of the assets of the corporation invested,
directly or indirectly, in loans (or interests in loans) secured by real estate, and first mortgage bonds, before reserves for
depreciation or bad debts or other similar non-cash reserves computed by taking the average of such values at the end of each calendar
month during such period.
All other mortgage
loans made by us (or Church Bonds purchased for investment) will be secured by a first mortgage (or deed of trust) lien in favor
of us. Although we attempt to make mortgage loans for various terms typically ranging from one to thirty years, we may determine
to emphasize longer-term fixed-rate loans in our discretion, in order to reduce the risk to us of downward interest rate fluctuations.
Our lending and investing
operations, including determination of a prospective borrower's or church bond issuer's financial credit worthiness, are made on
our behalf by the Advisor. Employees and agents of the Advisor conduct all aspects of our business, including (i) marketing and
advertising; (ii) communication with prospective borrowers; (iii) processing loan applications; (iv) closing the loans; (v) servicing
the loans; (vi) enforcing the terms of our loans; (vii) shareholder relations and (viii) administering our day-to-day business.
For its services, the Advisor is entitled to receive a management fee equal to 1.25% annually of the Company's Average Invested
Assets, plus one-half of any origination fee charged to borrowers on mortgage loans we make. The management fee is reduced to 1%
on assets from $35 million to $50 million and to .75% on assets over $50 million. The Advisor’s management fees are computed
and payable monthly.
Current First Mortgage Loan Terms
We offer prospective borrowers
a selection of loan types, which include a choice of fixed or variable rates of interest indexed to the prime rate, the U.S. Treasury
10-Year Notes, or another generally recognized reference index, and having various terms to maturity, origination fees and other
terms and conditions. The terms of loans we offer may be changed by our Advisor as a result of such factors as (i) the credit quality
and experience of the borrowers; (ii) the terms of loans in our portfolio; (iii) competition from other lenders; (iv) anticipated
need to increase the overall yield on our mortgage loan portfolio; (v) local and national economic factors; and (vi) actual experience
in borrowers’ demand for the loans. We currently offer the loan types described in the table below. This table describes
certain material terms of loans available from us. The table does not purport to identify all possible terms, rates, and fees we
may offer. We may modify the terms identified below or offer loan terms different than those identified below at any time. Many
loans are individually negotiated and differ from the terms described below.
Loan Type
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Interest Rate (1)
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Origination Fee (2)
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25/30 Year Term (3)
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Fixed @ 8.75%/8.95% respectively
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3.5%
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20 Year Term (3)
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Variable Annually @ Prime + 2.50%
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3.5%
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3 Year Renewable Term (4)
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Fixed @ 8.25%
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3.0%
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Construction 1 Year Term
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Fixed @ 9.00%
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2.0%
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(1)
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“Prime” means the prime rate of interest charged to preferred customers, as published
by a federally chartered bank chosen by us. We may also tie our offered interest rates to other indices.
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(2)
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These are “target” fees and negotiation of these fees with borrowers can occur. Origination
fees are generally based on the original principal amount of the loan and are collected from the borrower at the origination and
renewal of loans, one-half of which is payable directly to our Advisor.
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(3)
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Fully amortized repayment term. Amortization terms may vary, as may other loan terms, depending
on individual loan negotiations and competitive forces.
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(4)
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Renewable term loans are repaid based on a 25-year amortization schedule, and are renewable at
the conclusion of their initial term for additional like terms up to an aggregated maximum of 25 years. We charge a fee of 1% upon
the date of each renewal. If renewed by the borrower, the interest rate is adjusted upon renewal to Prime plus a specified percentage
“spread.”
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Mortgage Loan Processing and Underwriting
Mortgage loan applications
are prepared and verified by our Advisor's personnel in our Loan Origination and Underwriting Department. Verification procedures
are designed to assure a borrower's qualification under our Financing Policies which are specifically identified herein and include,
among other things, obtaining:
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applications containing key information concerning the prospective
borrowers;
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financial statements in accordance with our Financing Policies;
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corporate records and other organizational documents of the borrower;
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preliminary title report or commitment for mortgagee title insurance;
and
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a real estate appraisal in accordance with the Financing Policies.
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All appraisals are prepared
by independent third-party professionals who we approve based on their experience, reputation and education. All financial statements
are prepared by independent third-party professionals or a qualified accountant that we hire that is independent of the borrower.
Completed loan applications, together with a written summary are then presented to our Underwriting Committee. Our loan Underwriting
Committee is comprised of the Advisor's President and Chief Financial Officer and Treasurer and certain members of its staff. Our
Advisor may arrange for the provision of mortgage title insurance and for the services of professional independent third-party
accountants and appraisers on behalf of borrowers in order to achieve pricing efficiencies on their behalf and to assure the efficient
delivery of title commitments, preliminary title reports and title policies, and financial statements and appraisals that meet
our underwriting criteria. Our Advisor may arrange for the direct payment for such professional services and for the direct reimbursement
to it of such expenditures by borrowers and prospective borrowers. Upon closing and funding of mortgage loans, an origination fee
based on the original principal amount of each loan may be charged, of which one-half is payable by the borrower to our Advisor,
and the other one-half to us.
Loan Commitments
Subsequent to approval
by our Underwriting Committee, and prior to funding a loan, we may issue a loan commitment to qualified applicants. A loan commitment
deposit may be required from the borrowing church to commence the loan preparation procedure. These deposits are directly applied
by the Advisor to engage accountants and appraisers to prepare their respective reports on the church. Commitments may indicate,
among other things, the loan amount, origination fees, closing costs, underwriting expenses (if any), funding conditions, approval
expiration dates and interest rate and other terms. Commitments generally set forth a "prevailing" interest rate that
is subject to change in accordance with market interest rate fluctuations until the final loan closing documents are prepared,
at which time we commit to a stated interest rate. In certain cases we may establish ("lock in") interest rate commitments
up to sixty (60) days from the commitment to closing; however, interest rate commitments beyond sixty days will not normally be
issued unless we receive an appropriate fee premium based upon our assessment of the risk associated with a longer period.
Loan Portfolio Management
Our portfolio of mortgage
loans and Church Bonds is managed and serviced by our Advisor in accordance with the Advisory Agreement. The Advisor is responsible
for all aspects of our mortgage loan business, including closing and recording of mortgage loans; collecting payments of principal
and interest regularly and upon the maturity of a loan; enforcing loan payments and other lender's requirements; periodic review
of each mortgage loan file and determination of its reserve classification; and exercising our remedies in connection with any
defaulted or non-performing loans. Fees and costs of attorneys, insurance, bonds and other direct expenses incurred in connection
with the exercise of such remedies are our responsibility. We may, however, recoup these expenses from the borrower in the process
of pursuing our remedies. The Advisor will not receive any additional compensation for services rendered in connection with loan
portfolio management or exercising remedies on our behalf in the event of a loan default.
Loan Funding and Bank Borrowing
Our mortgage loans (and
our purchases of Church Bonds) are funded with available cash.
Currently, we have no
borrowings with a commercial lender or bank. However, we have established a $4 million dollar line of credit with a local bank.
In addition, we may borrow up to 300% of our stockholders’ equity (in the absence of a satisfactory showing that a higher
level of borrowing is appropriate; any excess in borrowing over such 300% level must be approved by a majority of the Independent
Directors and disclosed to stockholders in the next quarterly report along with justification for such excess) to make loans regardless
of our capacity to (i) sell our securities on a continuing basis, or to (ii) reposition assets from the maturity or early repayment
of mortgage loans in our secured investor certificates, minus reserves for operating expenses, and bad-debt reserves, as determined
by the Advisor. Cash resources available to us for lending purposes include, in addition to the net proceeds from any future sales
of our common stock, secured investor certificates (if any) or other debt securities, (i) principal repayments from borrowers on
loans made by us and (ii) funds borrowed under any line of credit arrangement.
Public Offerings - Secured Investor Certificates
In September 2017, we filed
a registration statement with the Securities and Exchange Commission to offer $10,000,000 worth of Series E secured investor certificates.
The offering was declared effective by the SEC on November 6, 2017. The certificates are being offered in multiples of $1,000 with
interest rates ranging from 4.00% to 6.50%, subject to changing market rates, and maturities from 5 to 15 years. The certificates
are collateralized by certain mortgage loans receivable and church bonds of approximately the same value. At December 31, 2018,
we sold 2,786 Series E Secured Investor Certificates totaling $2,786,000.
In July 2014, we filed
a registration statement with the Securities and Exchange Commission to offer $10,000,000 worth of Series D secured investor certificates.
The offering was declared effective by the SEC on August 12, 2014. The offering was renewed with an effective date of September
23, 2016. The certificates were offered in multiples of $1,000 with interest rates ranging from 4.00% to 6.50%, subject to changing
market rates, and maturities from 5 and 7 to 15 years. The certificates are collateralized by certain mortgage loans receivable
and church bonds of approximately the same value. At December 31, 2018, approximately 8,234 Series D certificates had been issued
and were outstanding for $8,234,000. The offering terminated in August 2017.
Previously, we offered
Series A, Series B and Series C secured investor certificates, at various maturities and interest rates. The weighted average interest
rate on all outstanding certificates was 6.33% and 6.45% at December 31, 2018 and 2017, respectively. Holders of the secured investor
certificates may renew certificates at the current rates and terms upon maturity at the Company’s discretion. Renewals upon
maturity are considered neither proceeds from nor issuance of secured investor certificates. Renewals of secured investor certificates
totaled approximately $1,671,000 and $1,282,000 for the years ended December 31, 2018 and 2017, respectively. There were no Series
A secured investor certificates outstanding as of December 31, 2018 and 2017. There were $9,880,000 and $12,442,000 representing
9,880 and 12,442 in outstanding Series B secured investor certificates as of December 31, 2018 and 2017, respectively and there
were $6,464,000 and $6,647,000 representing 6,647 and 6,647 in outstanding Series C secured investor certificates at December 31,
2018 and 2017, respectively. All secured investor certificates are collateralized by certain mortgage loans receivable or secured
church bonds of approximately the same stated value as the certificates. In addition, the secured investor certificates have certain
financial and non-financial covenants, as set forth in each Series’ respective trust indenture.
The Advisory Agreement
We have entered into a
contract with the Advisor (the “Advisory Agreement”) under which the Advisor furnishes advice and recommendations concerning
our business affairs, provides administrative services to us and manages our day-to-day operations. We have no employees but we
do have two executive officers. All our personnel needs are met through the personnel and expertise of the Advisor and its affiliates.
Among other things, the Advisor:
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serves as our mortgage loan underwriter and advisor in connection with our primary business
of making loans to churches;
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advises and selects Church Bonds to be purchased and held for investment
by us;
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services all mortgage loans we make;
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provides marketing and advertising and generates loan leads directly
and through its affiliates;
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deals with regulatory agencies, borrowers, lenders, banks, consultants,
accountants, brokers, attorneys, appraisers, insurers and others;
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supervises the preparation, filing and distribution of tax returns
and reports to governmental agencies and to stockholders and acts on our behalf in connection with shareholder relations;
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provides office space and personnel as required for the performance
of the foregoing services; and
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as requested by us, makes reports to us of its performance of the
foregoing services and furnishes advice and recommendations with respect to other aspects of our business.
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In performing its services
under the Advisory Agreement, the Advisor may use facilities, personnel and support services of its affiliates. Expenses such as
legal and accounting fees, stock transfer agent, registrar and paying agent fees and proxy solicitation expenses are direct expenses
of ours and are not provided for by the Advisor as part of its services.
The Advisory Agreement
is renewable annually by us for one-year periods, subject to our determination, including a majority of the Independent Directors,
that the Advisor's performance has been satisfactory and that the compensation paid the Advisor has been reasonable. The Advisory
Agreement was last approved by the Board of Directors (including a majority of the Independent Directors) as of April 18, 2018.
We may terminate the Advisory Agreement with or without cause upon 60 days written notice to the Advisor. Upon termination of the
Advisory Agreement by either party, the Advisor may require us to change our name to a name that does not contain the word "American,"
"America" or the name of the Advisor or any approximation or abbreviation thereof, and that is sufficiently dissimilar
to the word "America" or "American" or the name of the Advisor as to be unlikely to cause confusion or identification
with either the Advisor or any person or entity using the word "American" or "America" in its name. Our Board
of Directors shall determine that any successor Advisor possesses sufficient qualifications to perform the advisory function for
us and justify the compensation provided for in its contract with us.
Pursuant to the Advisory
Agreement, the Advisor is required to pay all of the expenses it incurs in providing services to us, including, but not limited
to, personnel expenses, rental and other office expenses, expenses of officers and employees of the Advisor, including travel and
all of its overhead and miscellaneous administrative expenses relating to performance of its functions under the Advisory Agreement.
We are required to pay all other expenses we incur in the daily operations of our business–such as the costs and expenses
of reporting to various governmental agencies and stockholders; the general conduct of our operations as a mortgage lender; fees
and expenses of appraisers, directors, auditors, outside legal counsel and transfer agents; directors and officers liability insurance
premiums; unreimbursed costs directly relating to closing of loan transactions; and costs relating to the enforcement of loan agreements
and/or foreclosure proceedings.
In the event that our
Total Operating Expenses exceed in any calendar year the greater of (a) 2% of our Average Invested Assets or (b) 25% of our net
income, the Advisor is obligated to reimburse us, to the extent of its fees for such calendar year, for the amount by which the
aggregate annual operating expenses paid or incurred by us exceed the limitation. Total operating expenses as defined in the Advisory
Agreement exclude expenses of raising capital, interest payments, taxes, non-cash expenditures (including, but not limited to,
depreciation, amortization and bad debt reserves), incentive fees and property operation and disposition costs. The Independent
Directors may, upon a finding of unusual and non-recurring factors which they deem sufficient, determine that a higher level of
expenses is justified in any given year.
Our bylaws provide that
the Independent Directors are to determine at least annually the reasonableness of the compensation we pay to our Advisor. The
Advisory Agreement was renewed for a one-year period as of April 18, 2018, and the reasonableness of our Advisor’s compensation
was reviewed as of this date as well. Factors to be considered in reviewing the Advisory Fee include the size of the fees of the
Advisor in relation to the size, composition and profitability of our loan portfolio, the rates charged by other advisors performing
comparable services, the success of the Advisor in generating opportunities that meet our investment objectives, the amount of
additional revenues realized by the Advisor for other services performed for us, the quality and extent of service and advice furnished
by the Advisor, the quality of our investments in relation to investments generated by the Advisor for its own account, if any,
and the performance of our investments.
The Advisory Agreement
provides for indemnification by us of the Advisor and each of its directors, officers and employees against expense or liability
arising out of such person's activities in rendering services to us, provided that the conduct against which the claim is made
was determined by such person, in good faith, to be in our best interests and was not the result of negligence or misconduct.
Financing Policies
Our business of mortgage
lending to churches and other non-profit religious organizations is managed in accordance with and subject to the policies, guidelines,
restrictions and limitations identified herein (collectively, the "Financing Policy"). The intent of the Financing Policy
is to identify for our stockholders not only the general business in which we are involved, but the parameters of our lending business.
These policies may not be changed (except in certain immaterial respects by majority approval of the Board of Directors) without
the approval of a majority of the Independent Directors, and the holders of a majority of our outstanding shares at a duly held
meeting for that purpose:
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(i)
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Loans made by us will be limited to churches and other non-profit religious organizations, and
will be secured by mortgages. The total principal amount of all second mortgage loans that we fund is limited to 20% of Average
Invested Assets. All other loans will be first mortgage loans.
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(ii)
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The total principal amount of mortgage-secured debt securities we purchase from churches and other
non-profit religious organizations is limited to 30% of our Average Invested Assets.
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(iii)
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The loan amount cannot exceed 75% of the value of the real estate and improvements securing each
loan, such value being determined based on a written appraisal prepared by an appraiser acceptable to the Advisor. On all loans,
we will require a written appraisal certified by a member of the Appraisal Institute ("MAI"), or a state-certified appraiser.
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(iv)
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An ALTA (American Land Title Association) or equivalent Mortgage Title Policy must be furnished
to us by the borrower insuring our mortgage interest.
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(v)
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The borrower's long-term debt (including the proposed loan) cannot exceed four times their gross
income for the previous twelve (12) months.
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(vi)
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The borrower must furnish us with financial statements (balance sheet and income and expense statement)
for its last three (3) complete fiscal years and current financial statements for the period within ninety (90) days of the loan
closing date. A borrower must have the last complete fiscal year financial statements reviewed by a certified public accountant
(CPA) engaged by the borrower and who is independent of the borrower. On loans in excess of $500,000 our Advisor may require the
last complete fiscal year be audited by a CPA engaged by the borrower and who is independent of the borrower. In lieu of the above
requirement, we or our Advisor may employ a qualified accountant. The qualified accountant we employ would be required to be independent
of the borrower. Our employed qualified accountant would not be independent of us. Compiled financial statements of the borrower
are acceptable from our employed qualified accountant. Along with the compiled financial statements of the borrower, our employed
qualified accountant would perform partial and targeted review examination procedures for borrowers. On loans in excess of $500,000,
the Advisor may require partial and targeted audit examination procedures for borrowers.
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(vii)
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Borrowers in existence for less than three (3) fiscal years must provide financial statements since
their inception. No loan will be extended to a borrower in operation less than two (2) calendar years absent express approval by
our Board of Directors
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(viii)
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The Advisor typically requires the borrower to arrange for automatic electronic payment or drafting
of monthly payments.
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(ix)
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The Advisor may require (i) key-man life insurance on the life of the senior pastor of a church;
(ii) personal guarantees of church members and/or affiliates; and (iii) other security enhancements for our benefit.
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(x)
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The borrower must agree to provide to us annual reports (including financial statements) within
120 days of each fiscal year end beginning with the fiscal year end next following the funding of the loan.
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(xi)
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The Advisor may require the borrower to grant to us a security interest in all personal property
located and to be located upon the mortgaged premises (excluding property leased by the borrower).
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(xii)
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We require borrowers to maintain a general perils and liability coverage insurance policy naming
us as the loss-payee in connection with damage or destruction to the property of the borrower which typically includes weather-related
damage, fire, vandalism and theft. Our Advisor may require the borrower to provide flood, earthquake and/or other special coverage.
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These Financing Policies are in addition to
the prohibited investments and activities identified below and which are set forth in our Bylaws.
Prohibited Investments and Activities
Our Bylaws impose certain
prohibitions and restrictions on our investment practices and lending activities, including prohibitions against:
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(i)
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Investing more than 10% of our total assets in unimproved real property or mortgage loans on unimproved
real property;
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(ii)
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Investing in commodities or commodity futures contracts other than "interest rate futures"
contracts intended only for hedging purposes;
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(iii)
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Investing in mortgage loans (including construction loans) on any one property which in the aggregate
with all other mortgage loans on the property would exceed 75% of the appraised value of the property unless substantial justification
exists because of the presence of other underwriting criteria;
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(iv)
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Investing in mortgage loans that are subordinate to any mortgage or equity interest of the Advisor
or the Directors or any of their affiliates;
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(v) Investing
in equity securities;
(vi) Engaging
in any short sales of securities or in trading, as distinguished from investment activities;
(vii) Issuing
redeemable equity securities;
(viii) Engaging
in underwriting or the agency distribution of securities issued by others;
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(ix)
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Issuing options or warrants to purchase our shares at an exercise price less than the fair market
value of the shares on the date of the issuance or if the issuance thereof would exceed 10% in the aggregate of our outstanding
shares;
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(x)
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The aggregate borrowings of the corporation, secured and unsecured, must be reasonable in relation
to the Stockholders’ Equity of the corporation and must be reviewed by the Independent Directors at least quarterly. The
maximum amount of such borrowings cannot exceed 300% of stockholders’ equity. Any excess in borrowing over such 300% level
must be approved by a majority of Independent Directors and disclosed to stockholders in the next quarterly report along with justification
for such excess;
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(xi)
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Investing in real estate contracts of sale unless such contracts are in recordable form and are
appropriately recorded in the chain of title;
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(xii)
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Selling or leasing to the Advisor, a Director or any affiliate thereof unless approved by a majority
of our Directors (including a majority of our Independent Directors), who are not otherwise interested in such transaction, as
being fair and reasonable to us;
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(xiii)
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Acquiring property from any Advisor or Director, or any affiliate thereof, unless a majority of
our Directors (including a majority of our Independent Directors) who are not otherwise interested in such transaction approve
the transaction as being fair and reasonable and at a price to us which is no greater than the cost of the asset to such Advisor,
Director or any affiliate thereof, or if the price to us is in excess of such cost, that substantial justification for such excess
exists and such excess is reasonable. In no event shall the cost of such asset exceed its current appraised value;
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(xiv)
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Investing or making mortgage loans unless a mortgagee's or owner's title insurance policy or commitment
as to the priority of the mortgage or condition of title is obtained; or
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(xv)
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Issuing shares on a deferred payment basis or other similar arrangement.
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We do not invest in the
securities of other issuers for the purpose of exercising control, engage in the purchase and sale of investments other than as
described in this Report, offer securities in exchange for property unless deemed prudent by a majority of the Directors, or make
loans to other persons except in the ordinary course of our business as described herein.
We will not make loans
to or borrow from, or enter into any contract, joint venture or transaction with, any of our Directors or officers, the Advisor
or any affiliate of any of the foregoing unless a majority of our Directors, including a majority of our Independent Directors,
approves the transaction as fair and reasonable to us and the transaction is on terms and conditions no less favorable to us than
those available from unaffiliated third parties. Any investment by us in any property, mortgage or other real estate interest pursuant
to a transaction with the Advisor or any Directors or officers thereof will be based upon an appraisal of the underlying property
from an independent qualified appraiser selected by the Independent Directors and will not be made at a price greater than fair
market value as determined by such appraisal.
Under Performing and Non-Performing Loans
As of December 31, 2018,
we had eleven first mortgage loans totaling approximately $4,351,000 that are three or more monthly payments in arrears. We may
incur a loss if these borrowers are unable to bring their payments current and we are compelled to foreclose on their properties.
We may be unable to dispose of the foreclosed properties on terms that enable us to recoup our expenses and outstanding balances.
As of December 31, 2018,
we had acquired on property located in Bethel, Ohio through the foreclosure process with an outstanding balance of $112,515. We
are preparing the property to list for sale through a local realtor. We acquired another property located in Pine Bluff, Arkansas
via deed in lieu of foreclosure, with an outstanding loan balance totaling $225,872. The Church is still occupying this property
and paying rent while trying to either sell the building or obtain refinancing.
We have initiated foreclosure
proceedings on two loans and expect to take possession of these two churches and list their property for sale in 2019. The fair
value of these two properties, which represents the carrying value, was approximately $688,000 at December 31, 2018 after an impairment
reserve of approximately $308,000.
As of December 31, 2017,
we had fourteen first mortgage loans totaling approximately $5,408,000 that were three or more monthly payments in arrears. In
addition, we took possession of the Pine Bluff, Arkansas property via deed in lieu of foreclosure, with a loan balance outstanding
totaling $225,872.
Competition
The business of making
loans to churches and other non-profit religious organizations is highly competitive. We compete with a wide variety of investors
and other lenders, including banks, insurance companies, pension funds and fraternal organizations which may have investment objectives
similar to our own. A number of these competitors have greater financial resources, larger staffs and longer operating histories
than we do. We compete principally by limiting our business "niche" to lending to churches and other non-profit religious
organizations, offering loans with competitive and flexible terms,
and
emphasizing our expertise in the specialized industry segment of lending to churches and other religious organizations. Our competitive
“specialty” is in offering fixed-rate, long-term loans, which few of our competitors make available to churches.
Employees
We have no employees but
we have two executive officers: Philip J. Myers, our Chief Executive Officer and President, and Scott J. Marquis, our Chief Financial
Officer and Treasurer. Our daily operations and other material aspects of our business are managed by Church Loan Advisors, Inc.
(the “Advisor”) on a “turn-key” basis using employees of the Advisor and/or its Affiliates. At present,
certain officers and directors of the Advisor are providing services to us at no charge and which will not be reimbursed to them.
These services include, among others, legal and analytic services relating to the execution of our business plan, development and
preparation of reports to be filed under the Securities Exchange Act, and utilization of proprietary forms and documents utilized
by the Advisor in connection with our business operations.
Subject to the supervision
of the Board of Directors, our business is managed by the Advisor, which provides us investment advisory and administrative services.
Philip J. Myers, our Chief Executive Officer, President and a Director, is President of the Advisor and President of American Investors
Group, Inc., the underwriter of our past public offerings. The Company utilizes two employees of the Advisor on a full-time basis
and one member of its staff on a part-time or other basis. The Company does not presently expect to directly employ anyone in the
foreseeable future, since all of our administrative functions and operations are contracted through the Advisor. However, legal,
accounting and certain other services are provided to us by outside professionals and paid by us directly.
Operations
Our operations currently
are located in the 1,500 square foot offices of the Advisor’s affiliate, American Investors Group, Inc., 10400 Yellow Circle
Drive, Ste. 102, Minnetonka, Minnesota 55343. These facilities are being leased by American Investors Group, Inc. The lease expires
November 30, 2020. We are not separately charged any rent for our use of these facilities, or for our use of computers, copying
services, telephones, facsimile machines, postage service, office supplies or employee services, since these costs are covered
by the advisory fee paid to the Advisor. However, we do pay postage service for costs associated with the distribution of dividends
and proxy materials to our stockholders.
Item 1A. Risk Factors.
Risks Related to Mortgage Lending
We Are Subject to the
Risks Generally Associated with Mortgage Lending.
Mortgage lending involves various risks, many of which are unpredictable
and beyond our control and foresight. It is not possible to identify all potential risks associated with mortgage lending. Some
of the more common risks encountered may be summarized as follows:
·
low demand for mortgage loans
·
interest rate and real estate valuation fluctuations
·
changes in the level of consumer confidence
·
availability of credit-worthy borrowers
·
national and local economic conditions
·
demographic and population patterns
·
zoning regulations
·
taxes and tax law changes
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·
availability of alternative financing and competitive conditions
·
factors affecting specific borrowers
·
losses associated with default, foreclosure of a mortgage, and sale of the mortgaged property
·
state and federal laws and regulations
·
bankruptcy or insolvency of a borrower
·
borrower’s misrepresentation(s) and/or fraud
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Losses Associated with
Default, Foreclosure of a Mortgage and Sale of Mortgaged Property Pose Additional Risks
. We have experienced losses associated
with default, foreclosure of mortgages, and sales of mortgaged properties. The time frame to foreclose on a property varies from
state to state, and delays can occur due to backlog in court dockets; we have experienced delays from 12 to 48 months. Such delays
have and can cause the value of the mortgaged property to further deteriorate due to lack of maintenance. Theft and vandalism have
also occurred on certain of our foreclosed properties. Some borrowers have removed fixtures and furnishings including sound systems,
chairs, pulpits, appliances, mechanical and electrical systems prior to vacating the facility which further reduces the value of
our collateral. The properties also incur operating expenses pending their
sale
(resale marketing, property insurance, security, repairs and maintenance) and these expenses could be substantial if we cannot
readily dispose of the property. Expenses related to the foregoing and diminution in value could prevent us from recovering the
full value of a loan in the event of foreclosure, which shortfall would decrease the value of assets held by the Company and could
negatively impact the Company’s ability to pay interest on its outstanding secured investor certificates or dividends to
stockholders.
Real Estate Taxes Resulting
from a Foreclosure May Prevent Us from Recovering the Full Value of a Loan
. If we foreclose on a mortgage and take legal title
to a church’s real estate, real estate taxes could be levied and assessed against the property since the property would no
longer be owned by a non-profit entity. These expenses would be our financial responsibility, and could be substantial in relation
to our prior loan if we cannot readily dispose of the property. Such expenses could prevent us from recovering the full value of
a loan in the event of foreclosure, which shortfall would decrease the value of assets held by the Company.
Second Mortgage Loans
Pose Additional Risks
. Our financing policies allow us to make second mortgage loans. The principal amount of such loans may
not exceed 20% of our Average Invested Assets. Second mortgage loans entail more risk than first mortgage loans, as foreclosure
of senior indebtedness or liens could require us to pay the senior debt or risk losing our mortgage, or reduced collateral value
may reduce or eliminate our security.
Fixed and Variable-Rate
Debt Can Result in Yield Fluctuations
. Fixed and variable-rate debt obligations carry certain risks. A general rise in interest
rates could make the yield on a particular mortgage loan lower than prevailing rates. This could negatively affect our value and
consequently the value of our shares and certificates. Neither we nor our Advisor can predict changes in interest rates. We will
attempt to reduce this risk by maintaining medium and longer-term mortgage loans and through offering adjustable rate loans to
borrowers. We do not intend to borrow funds or sell certificates if the cost of such borrowing exceeds the income we believe we
can earn from lending the funds. The current average holding period of our debt is approximately seven and a half years, which
has mitigated this risk in yield fluctuations.
The Mortgage Banking
Industry Is Highly Competitive
. We compete with a wide variety of lenders, including banks, credit unions, insurance companies,
pension funds and fraternal organizations for mortgage loans. Many competitors have greater financial resources, larger staffs
and longer operating histories than we have, and thus may be a more attractive lender to potential borrowers. We intend to compete
by limiting our business “niche” to lending to churches and other non-profit religious organizations, offering loans
with competitive and flexible terms, and emphasizing our expertise in the specialized industry segment of lending to churches and
other non-profit religious organizations.
Fluctuations in Interest
Rates May Affect Our Ability to Generate New Loans
. Prevailing market interest rates impact borrower decisions to obtain new
loans or to refinance existing loans, possibly having a negative effect upon our ability to originate mortgage loans. If interest
rates decrease and the economic advantages of refinancing mortgage loans increase, then prepayments of higher interest mortgage
loans in our portfolio would likely reduce our portfolio’s overall rate of return (yield).
We Are Subject to the
Risks Associated with Fluctuations in National and Local Economic Conditions
. The mortgage lending industry is subject to increased
credit risks and foreclosure rates during economic downturns. In addition, because we provide mortgages to churches and other religious
organizations who generally receive financing through charitable contributions, our financial results are subject to fluctuations
based on a lack of consumer confidence or a severe or prolonged national or regional recession. As a result of these and other
circumstances, our potential borrowers may decide to defer or terminate plans for financing their properties. In addition, during
such economic times we may be unable to locate as many credit-worthy borrowers. In addition, we believe the risks associated with
our business are more severe during periods of economic slowdown or recession if these periods are accompanied by declining values
in real estate. For example, declining real estate values would likely reduce the level of new loan originations, since borrowers
often use increases in the value of their existing properties to support the purchase of or investment in additional properties.
Borrowers may also be less able to pay principal and interest on our loans if the real estate economy is weak, which could result
in higher default rates. Higher default rates could adversely affect the Company’s results of operations, which could negatively
impact the Company’s ability to pay interest on the certificates and dividends to stockholders. Further, declining real estate
values significantly increase the likelihood that we will incur losses in the event of default because the value of our collateral
may be insufficient to cover our basis in the investment.
The Company Faces Certain
Risks and Uncertainties Related to Financing and Liquidity, and These Volatilities Could Have an Impact on Its Operations and Its
Ability to Maintain its Long-term Capital Needs and/or Secure Additional Financing.
The Company faces certain risks and uncertainties,
particularly during volatile market conditions. In addition, liquidity, during such time periods, can be tight in all financial
markets, including the debt and equity markets. These volatilities could have an impact
on
operations to the extent that the Company experiences slower maturities or repayment of mortgage loans, illiquid markets for our
bond portfolio, or a higher redemption rate on our secured investor certificates than has been the case historically.
Our Business May Be
Adversely Affected if Our Borrowers Become Insolvent or Bankrupt
. If any of our borrowers become insolvent or bankrupt, the
borrower’s mortgage payments will be delayed and may cease entirely. Because our borrowers are churches and other religious
organizations who generally receive financing through charitable contributions, if their members experience a decrease in pay or
lose their jobs and are unable to secure new ones, they may make fewer or no contributions to our borrowers, which could result
in the borrower’s inability to make mortgage payments or make them on time. In those situations, we may be forced to foreclose
on the mortgage and take legal title to the real estate and incur expenses related to the foreclosure and disposition of the property.
Such increased expenses paired with possible lower real estate values (having been reduced by the foregoing expenses) could adversely
affect the Company’s results of operations.
We Have Fluctuating
Earnings.
As a mortgage lender, we make provision for losses relating to our loan portfolio and sometimes take impairment charges
due to our borrowers defaulting or declaring bankruptcy. Increases in the occurrence of such events resulted in greater fluctuation
of our earnings, which reduced our net income. Our earnings are also impacted by non-performing assets and the carrying cost of
maintaining such assets (taxes, insurance and maintenance). Inconsistent earnings could adversely affect the Company’s financial
condition and results of operations.
Risks Related to Mortgage Lending to Churches
Churches Rely on Member
Contributions to Repay Our Loans.
Churches typically rely on member contributions for their primary source of income. As such,
member contributions are the primary source used to repay our loans. The membership of a church or the per capita contributions
of its members may not increase or remain constant after a loan is funded. A decrease in a church’s income could result in
its temporary or continued inability to pay its obligation to us, which may affect our ability to pay dividends on our common stock
or pay interest or principal due on certificates. We have no control over the financial performance of a borrowing church after
a loan is funded.
Churches Depend Upon
Their Senior Pastors.
A church’s senior pastor usually plays an important role in the management, leadership and continued
viability of that church. A senior pastor’s absence, resignation or death could have a negative impact on a church’s
operations, and thus its continued ability to generate revenues sufficient to service its obligations to us.
The Limited Use Nature
of Church Facilities Can Limit the Resale Value of Our Mortgage Collateral
. Our loans are secured principally by first mortgages
upon the real estate and improvements owned or to be owned by borrowing churches. Although we will require an appraisal of the
premises as a pre-condition to making a loan, the appraised value of the premises cannot be relied upon as being the actual amount
which might be obtained in the event we need to foreclose after a default by the borrower. The actual liquidation value of a church,
school or other institutional premises could be adversely affected by, among other factors: (i) its limited use nature; (ii) the
availability on the market of similar properties; (iii) the availability and cost of financing, rehabilitation or renovation to
prospective buyers; (iv) the length of time the seller is willing to hold the property on the market; or (v) the availability in
the area of the mortgaged property of congregations or other buyers willing to pay the fair value for a church facility. These
factors may influence our decision to restructure the terms of a non-performing loan rather than foreclose on a church property
which may decrease the amount of the loan we recover.
Expenses of Foreclosure
May Prevent Us From Recovering the Full Value of a Loan
. If we foreclose on a mortgage and take legal title to a church’s
real estate, real estate taxes could be levied and assessed against the property until sold since the property would no longer
be owned by a non-profit entity. The property may also incur operating expenses pending its sale, such as resale marketing, property
insurance, utilities, security, repairs and maintenance. These expenses would be our financial responsibility, and could be substantial
in relation to our prior loan if we cannot readily dispose of the property. Such expenses could prevent us from recovering the
full value of a loan in the event of foreclosure.
Risks Related to Us
Our Failure to Qualify
as a Real Estate Investment Trust Could Reduce the Funds We Have Available For Investment
. We operate as a real estate investment
trust (“REIT”). As a REIT, we are allowed a deduction for dividends paid to our stockholders in computing our taxable
income. Thus, only our stockholders are taxed on our taxable income that we distribute.
This
treatment substantially eliminates the “double taxation” of earnings to which most corporations and their stockholders
are subject. Qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions.
To qualify and maintain
our status as a REIT, we must meet certain share ownership, income, asset and distribution tests on a continuing basis. No assurance
can be given that we will satisfy these tests at all times. Further, the requirements for a REIT may substantially affect day-to-day
decision-making by our Advisor. Our Advisor may be forced to take action it would not otherwise take or refrain from action which
might otherwise be desirable in order to maintain our REIT status.
If we fail to qualify
as a REIT in any taxable year, then we would be subject to federal income tax on our taxable income at regular corporate rates
and not be allowed a deduction for distributions to stockholders. We would be disqualified from treatment as a REIT for the four
taxable years following the year of losing our REIT status. We intend to continue to operate as a REIT. However, future economic,
market, legal, tax or other consequences may cause our Board of Directors to revoke the REIT election. The payment of taxes resulting
from our disqualification as a REIT or revocation of REIT status would reduce the funds available for distribution to stockholders
or for investment.
Consistent with our qualification
as a REIT for federal income tax purposes, we do not file state income tax returns in all states in which the collateral securing
our loans is located. Since our inception, no state has ever asserted a claim for income taxes on any amount of our earnings or
any aspect of our operations. Although we believe our position as it relates to state income taxes is appropriate, there can be
no assurance that in the future any state tax jurisdiction will not pursue payment of some amount of state income taxes.
Conflicts of Interest
Arise From Our Relationship with Our Advisor
. The terms of transactions involving our formation and the formation of our Advisor,
and our contractual relationship with our Advisor, were not negotiated at arm’s-length. Our non-independent directors and
officers may have conflicts of interest in enforcing agreements between us and our Advisor. Future business arrangements and agreements
between us and our Advisor and their affiliates must be approved by our Board of Directors, including a majority of our Independent
Directors.
Risks Related to the Shares
Lack of Liquidity and
Inconsistent Public Market Price.
Our common stock is not currently listed or traded on any exchange. “Pink Sheet”
price quotations for our stock under the symbol “ACMC” were made at certain isolated times during 2018 by other broker-dealers
at prices as low as $2.00 per share and as high as $2.94 per share. In addition, the market for REIT securities historically has
been less liquid than non-real estate types of publicly-traded equity securities. Because of such illiquidity and the fact that
the shares would be valued by market-makers (if a material market develops) based on market forces which consider various factors
beyond our control, there can be no assurance that the market value of the shares at any given time would be the same or higher
than the public purchase price of our shares. In addition, the market price, if a material market develops, could decline if the
yields from other competitive investments exceed the actual dividends paid by us on our shares.
There Are Restrictions
on Certain Transfers of Our Shares.
Our Articles of Incorporation and Bylaws prohibit a transfer of shares to any person who,
as a result, would beneficially own shares in excess of 9.8% of the outstanding capital stock and allow us to redeem shares held
by any person in excess of 9.8% of the outstanding capital stock. These provisions may reduce market activity for the shares and
the opportunity for stockholders to receive a premium for their shares.
Fluctuations in Interest
Rates May Cause the Value of Our Shares to Fluctuate.
Prevailing market interest rates impact borrower decisions to obtain
new loans or to refinance existing loans, possibly having a negative effect upon our ability to originate mortgage loans. Fluctuations
in interest rates may cause the value of the shares to fluctuate unpredictably. If interest rates increase and we are unable to
deploy funds into higher yielding mortgage loans, the dividends we pay may be less than other organizations which may have investment
objectives similar to our own.
Interest Payments to
Certificate Holders May Reduce Dividend Payments on Our Shares.
We attempt to deploy our capital into new loans at rates that
provide a positive interest rate spread. This spread, however, may be materially and adversely affected by changes in prevailing
interest rates which would reduce our net income. If this occurs, we may not have sufficient net income after paying interest on
the certificates to maintain dividends to stockholders at the levels paid in the past or even to pay dividends at all. In addition,
because dividends are directly affected by the yields generated on the Company’s portfolio of loans and bonds, stockholders
dividends can be expected to fluctuate significantly with interest rates generally.
Risks Related to the Indebtedness/Certificates
We May Be Unable to
Generate Sufficient Cash Flow to Service Our Debt Obligations.
Our ability to make payments on our indebtedness and to fund
our operations depends on our ability to generate cash in the future. Our ability to generate future cash is subject to general
economic, industry, financial, competitive, operating, legislative, regulatory and other factors that are beyond our control. As
such, we cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will
be available to us under a credit arrangement in an amount sufficient to enable us to pay amounts due on our indebtedness or to
fund our other liquidity needs.
Our ability to obtain
additional financing, if needed, will depend on, among other things: (i) our financial condition at the time; (ii) restrictions
on outstanding indebtedness; and (iii) other factors, including the condition of the financial markets or the real estate and real
estate lending markets. If we do not generate sufficient cash flow from operations, and additional borrowings or proceeds of asset
sales are not available to us, we may not have sufficient cash to enable us to meet all of our obligations, which could affect
our tax status as a REIT.
We May Incur More Indebtedness.
We may incur additional indebtedness in the future. We may assign or pledge some of our mortgage-secured promissory notes
or other collateral in connection with incurring any additional indebtedness. Under our Bylaws, as amended, we may incur indebtedness
up to 300% of our shareholder’s equity, the level permitted under North American Securities Administrators Association (“NASAA”)
guidelines, in the absence of a satisfactory showing that a higher level of borrowing is appropriate; any excess in borrowing over
such 300% level must be approved by a majority of the Independent Directors and disclosed to stockholders in the next quarterly
report along with justification for such excess.
There Are Potential
Adverse Effects Associated with Lending Borrowed Funds.
In the past, we have deployed the proceeds from the sale of secured
investor certificates into loans to, and bonds issued by, churches and other non-profit religious organizations. We have also used
a credit facility from time to time to fund loans and purchase bonds. Lending borrowed funds is subject to greater risks than in
unleveraged lending. The profit we realize from lending borrowed funds is largely determined by the difference, or “spread,”
between the interest rates we pay on the borrowed funds and the interest rates that our borrowers pay us. Our spread may be materially
and adversely affected by changes in prevailing interest rates. Furthermore, the financing costs associated with lending borrowed
funds could decrease the effective spread in lending borrowed funds, which could adversely affect our ability to pay interest on
and repay the certificates as they mature.
There Is No Public
Market for the Secured Investor Certificates
. There is no market for the secured investor certificates. It is unlikely that
a market will develop. There are no current plans to list the secured investor certificates on any exchange or for a broker-dealer
to make a market in the secured investor certificates. In addition, the market for REIT securities historically has been less liquid
than the markets for other types of publicly-traded securities.
There Is No Sinking
Fund, Insurance or Guarantee Associated With the Secured Investor Certificates.
We do not contribute funds to a separate account,
commonly known as a sinking fund, to repay principal or interest on the secured investor certificates upon maturity or default.
Our secured investor certificates are not certificates of deposit or similar obligations of, or guaranteed by, any depository institution.
Further, no governmental or other entity insures or guarantees payment on the secured investor certificates if we do not have enough
funds to make principal or interest payments. Therefore, holders of our secured investor certificates have to rely on our revenue
from operations, along with the security provided by the collateral for the secured investor certificates, for repayment of principal
and interest on them.
The Collateral for
the Secured Investor Certificates May Not Be Adequate If We Default
. The secured investor certificates must at all times be
secured by mortgage-secured promissory notes and church bonds having an outstanding principal balance equal to at least 100% of
the outstanding principal balance of the secured investor certificates. If we default in the repayment of the secured investor
certificates, or another event of default occurs, the trustee will not be able to foreclose on the mortgages securing the promissory
notes and bonds in order to obtain funds to repay certificate holders. Rather, the trustee will need to look to the revenue stream
associated with our borrowers’ payments on or repayment of the promissory notes and bonds or revenue derived from sale of
the promissory notes or bonds to repay certificate holders. If the trustee chooses to rely on revenues received from our borrowers,
certificate holders may face a delay in payment on certificates in the event of default, as borrowers will repay their obligations
to us in accordance with amortization schedules associated with their promissory notes or bonds. If the trustee chooses to sell
promissory notes or bonds in the event of our default, the proceeds from the sales may not be sufficient to repay our obligations
on all outstanding or defaulted secured investor certificates.
The Secured Investor
Certificates Are Not Negotiable Instruments and Are Subject to Restrictions on Transfer.
The secured investor certificates
are not negotiable debt instruments. Rights of record ownership of the secured investor certificates may be
transferred
only with our Advisor’s prior written consent. Certificate holders are not able to freely transfer the secured investor
certificates.
We Are Obligated To
Redeem Secured Investor Certificates Only In Limited Circumstances.
Certificate holders have no right to require us to prepay
or redeem any certificate prior to its maturity date, except in the case of death or if we replace our current Advisor. Further,
even in the event of death, we will not be required to redeem secured investor certificates if we have redeemed at least $25,000
of principal amount of certificates for the benefit of estates during the calendar quarter. There is no present intention to redeem
secured investor certificates prior to maturity except in the case of death of a certificate holder.
We May Not Have Sufficient
Available Cash to Redeem Secured Investor Certificates If We Terminate Our Advisory Agreement with Our Current Advisor.
We
will be required to offer to redeem all outstanding secured investor certificates if we terminate our advisory agreement with Church
Loan Advisors, Inc., our Advisor, for any reason. If the holders of a significant principal amount of secured investor certificates
request that we redeem their certificates, we may be required to sell a portion of our mortgage loan and church bond portfolio
to satisfy the redemption requests. Any such sale could be at a discount to the recorded value of the mortgage loans and bonds
being sold. Further, if we are unable to sell loans or church bonds in our portfolio, we may be unable to satisfy the redemption
obligations.
The Indenture Contains
Limited Protection For Holders of Secured Investor Certificates
. The indenture governing the secured investor certificates
contains only limited events of default other than our failure to pay principal and interest on the certificates on time. Further,
the indenture provides for only limited protection for holders of certificates upon a consolidation or merger between us and another
entity or the sale or transfer of all or substantially all of our assets. If we default in the repayment of the secured investor
certificates under the indenture, certificate holders will have to rely on the trustee to exercise any remedies on their behalf.
Certificate holders will not be able to seek remedies against us directly.
Risks Related to Management
We Are Dependent Upon
Our Advisor
. Our Advisor, Church Loan Advisors, Inc., has managed us since commencement of active business operations in 1996
and selects our investments subject to general supervision by our Board of Directors and compliance with our lending policies.
We depend upon our Advisor and its personnel for most aspects of our business operations. Our success depends on the success of
our Advisor in locating borrowers and negotiating loans upon terms favorable to us. Among others, our Advisor performs the following
services for us:
·
mortgage loan marketing and procurement
·
bond portfolio selection and investment
·
mortgage loan underwriting
·
mortgage loan servicing
·
money management
·
developing and maintaining business relationships
·
maintaining “goodwill”
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·
managing relationships with our accountants and attorneys
·
corporate management
·
bookkeeping
·
reporting to state, federal, tax and other regulatory authorities
·
reports to stockholders and shareholder relations
·
loan enforcement and collections
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Our stockholders’
right to participate in management is generally limited to the election of directors. Certificate holders have no right to participate
in our management or the election of directors. Certificate holders must be willing to entrust our management to our Advisor and
our Board of Directors.
We Have Conflicts of
Interest with Our Advisor and Affiliates.
Affiliations and conflicts of interests exist among our officers and directors and
the owner and officers and directors of our Advisor and affiliates. Our Advisor and affiliates are controlled by our Chief Executive
Officer and President, Philip J. Myers. Our President and the officers and directors of our Advisor are involved in the church
financing business through their affiliations with American Investors Group, Inc. (“American”). American originates,
offers and sells first mortgage bonds for churches. We may purchase first mortgage bonds issued by churches through American in
its capacity as underwriter for the issuing church, or as broker or dealer on the secondary market. In such event, American would
receive commissions (paid by the issuing church) on original issue bonds, or “mark-ups” in connection with any secondary
transactions. If we sell church bonds in our portfolio, the bonds will be sold through American. We would pay American commissions
in connection with such transactions, but in no event, in excess of those normally charged to customers.
Our Bylaws limit the amount
of all commissions, mark-downs or mark-ups paid to American. Our business dealings with our Advisor and its affiliates outside
of the ordinary course of our activities are subject to approval by a majority of our Board of Directors, including a majority
of our Independent Directors.
Generally, mortgage loans
we originate are smaller than the bond financings originated by American. However, there may be circumstances where our Advisor
and American could recommend either type of financing to a prospective borrower. The decisions of our Advisor and American could
affect the credit quality of our portfolio.
Redemption Obligations
Relating to the Secured Investor Certificates May Affect Our Ability to Replace Our Advisor.
We will be required to offer to
redeem all outstanding secured investor certificates if we terminate our Advisory Agreement with Church Loan Advisors, Inc. Our
Independent Directors are required to review and approve the advisory agreement with our Advisor on an annual basis. The redemption
provision relating to the secured investor certificates may have the effect of reducing our ability to replace our current Advisor.
Risks Related to Environmental Laws
We May Face Liability
Under Environmental Laws.
Under federal, state and local laws and regulations, a secured lender (like us) may be liable, under
certain limited circumstances, for the costs of removal or remediation of certain hazardous or toxic substances and other costs
(including government fines and injuries to persons and adjacent property). Liability may be imposed whether or not the owner or
lender knew of, or was responsible for, the presence of hazardous or toxic substances. The costs of remediation or removal of hazardous
or toxic substances, or of fines for personal or property damages, may be substantial and material to our business operations.
The presence of hazardous or toxic substances, or the failure to promptly remediate such substances, may adversely affect our ability
to resell real estate collateral after foreclosure or could cause us to forego foreclosure. This is a changing area of the law.
The courts have found both in favor and against lender liability in this area under various factual scenarios.
The Collateral For
Our Loans and Our Lenders May Be Subject to Environmental Claims.
If there are environmental problems associated with the real
estate securing any of our loans, the associated remediation or removal requirements imposed by federal, state and local laws could
affect our ability to realize value on our collateral or our borrowers’ ability to repay their loans.
Item 1B. Unresolved Staff Comments.
Not applicable.
Item 2. Properties.
Our operations are located
in the leased offices of American Investors Group, Inc., in Minnetonka, Minnesota. It is expected that for the foreseeable future
our operations will continue to be housed in these or similar leased premises along with American's operations and those of the
Advisor. We are not directly charged for rent, nor do we incur other costs relating to such leased space, because our Advisor includes
these expenses in the Advisory Fee.
Real Estate Held for Sale/Description of
Properties Acquired through Foreclosure
As of December 31, 2018,
we acquired one property through the foreclosure process, with an outstanding loan balance of approximately $125,248 and acquired
one property via deed in lieu of foreclosure, with outstanding loan balance totaling approximately $226,000. The property acquired
through foreclosure is being prepared for sale through a local realtor. The property acquired via deed in lieu of foreclosure is
available for sale, however it is currently not listed as we have allowed the church to either obtain financing from another source
or list the property for sale. The Church is paying rent while trying to either sell the building or obtain refinancing. This property
is being carried at the fair value. The fair value of our real estate held for sale, which represents the carrying value, is approximately
$341,000 as of December 31, 2018 after an impairment reserve of approximately $22,000. Once a property is acquired by us, comparable
sales information is obtained and a local realtor is engaged to determine demand for our properties. The situation with respect
to each property is reviewed periodically with our realtors. The general competitive conditions surrounding the potential sale
of our properties are tied, in large part, to the fact that they are special-use properties with variable zoning restrictions.
We principally lend to churches, which are commonly exempt from zoning restrictions. However, while a church property may be exempt
from zoning restrictions, if it is located in a residential area, it still may only be used as a church, thereby limiting the pool
of potential buyers. On the other hand, a church or other property that is zoned for commercial use generally experiences higher
demand, as potential buyers can convert the property to their own business use. As such, our properties that are located in residential
areas typically experience less demand than those zoned for commercial use. Description of the property owned by us is listed below:
In 2008, we received a
deed in lieu of foreclosure on a church located in Pine Bluff, Arkansas and have recorded the deed in the county where the church
is located. Due to the value of the property $360,000 versus the amount owed to us $238,000, we have allowed the church to either
obtain financing from another source or list the property for sale in hopes of recovering some of its equity. The church is paying
us monthly rent until the property is refinanced or sold. We have included this property in Real Estate Held for Sale at $226,000
at December 31, 2018. This property is located in a residential area.
In 2018, we acquired a
church through the foreclosure process. The Church is located in Bethel, Ohio. We have included this property in Real Estate Held
for Sale at $125,249 at December 31, 2018. We are in the process of determining the current value of the property. This property
is located in a rural area and not subject to typical zoning requirements.
Item 3. Legal Proceedings.
There are presently no
legal actions against us, pending or threatened.
Item 4. Mine Safety Disclosures
Not applicable.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
American Church Mortgage Company, a Minnesota
corporation, was incorporated on May 27, 1994. The Company was organized to engage primarily in the business of making mortgage
loans to churches and other nonprofit religious organizations throughout the United States, on terms established for individual
organizations.
Accounting Estimates
Management uses estimates and assumptions in
preparing these financial statements in accordance with accounting principles generally accepted in the United States of America.
Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and
liabilities, and the reported revenues and expenses. Actual results could differ from those estimates. The most sensitive estimates
relate to the realizability of the mortgage loans receivable, the valuation of the bond portfolio and the valuation of real estate
held for sale. It is at least reasonably possible that these estimates could change in the near term and that the effect of the
change, if any, may be material to the financial statements.
Concentration of Credit Risk
The Company's loans have been granted to churches and other non-profit
religious organizations. The ability of the Company’s debtors to honor their contracts is dependent on member contributions
and the involvement in the church or organization of its senior pastor.
Cash and Cash Equivalents
The Company considers all highly liquid debt
instruments purchased with maturities of three months or less to be cash equivalents.
The Company maintains accounts primarily at
two financial institutions. At times throughout the year, the Company’s cash and equivalents balances may exceed amounts
insured by the Federal Deposit Insurance Corporation. Cash in money market funds is not federally insured. The Company had $974,346
and $15,428 in a money market fund account at December 31, 2018 and 2017, respectively. The Company has not experienced any losses
in such accounts.
Bond Portfolio
The Company accounts for the bond portfolio
under the Accounting Standards Codification (ASC) 320, Investments-Debt and Equity Securities. The Company classifies the bond
portfolio as “available-for sale” and measures the portfolio at fair value. While the bonds are generally held until
contractual maturity, the Company classifies them as available for sale as the bonds may be used to repay secured investor certificates
or provide additional liquidity or working capital in the short term. The Company has classified $167,000 and $139,000 in bonds
as current assets as of December 31,
2018 and 2017, respectively, based on management’s estimates for liquidity requirements
and contractual maturities of certain bonds maturing in 2019 and 2018, respectively.
Allowance for Loan Losses on Mortgage
Loans Receivable
The Company records mortgage loans receivable
at estimated net realizable value, which is the unpaid principal balances of the mortgage loans receivable, less the allowance
for loan losses on mortgage loans receivable and less deferred loan origination fees. The Company’s loan policy provides
an allowance for estimated uncollectible loans based on an evaluation of the current status of the loan portfolio with application
of reserve percentages to specific loans based on payment status. This policy reserves for principal amounts outstanding on a specific
loan if cumulative interruptions occur in the normal payment schedule of the loan, therefore, the Company recognizes a provision
for losses and an allowance for the outstanding principal amount of the loan in the Company’s portfolio if the amount is
in doubt of collection. Additionally, no interest income is recognized on impaired loans that are declared to be in default and
are in the foreclosure process. At December 31, 2018, the Company reserved $1,672,003 for seventeen mortgage loans. Eleven of these
loans are three or more mortgage payments in arrears of which three are declared to be in default and two are in the foreclosure
process. The total principal amount of these seventeen loans totals approximately $6,893
,000
at December 31, 2018. At December 31, 2017, the Company reserved $1,428,155 for nineteen mortgage loans. Fourteen of these loans
are three or more mortgage payments in arrears of which five are declared to be in default and two loans are in the foreclosure
process. The total principal amount of these nineteen loans totals approximately $5,408,000 at December 31, 2017.
A summary of transactions in the allowance
for mortgage loans for the years ended December 31 is as follows:
|
2018
|
2017
|
Balance at beginning of year
|
$ 1,428,155
|
$ 1,311,983
|
Provision for losses on mortgage loans receivable
|
254,310
|
116,172
|
Reclassified to real estate held for sale
|
(10,462)
|
-
|
Balance at end of year
|
$ 1,672,003
|
$ 1,428,155
|
The total impaired loans, which are loans that
are in the foreclosure process or are declared to be in default, were approximately $1,498,000 and $2,044,000 at December 31, 2018
and 2017, respectively, which the Company believes are adequately secured by the underlying collateral and the allowance for mortgage
loans. Approximately $833,000 of the Company’s allowance for mortgage loans was allocated to these loans at December 31,
2018. Approximately $723,000 of the Company’s allowance for mortgage loans was allocated to impaired loans at December 31,
2017.
The Company will declare a loan to be in default
and will place the loan on non-accrual status when the following thresholds have been met: (i) the borrower has missed three consecutive
mortgage payments; (ii) the borrower has not communicated to the Company any legitimate reason for delinquency in its payments
to the Company and has not arranged for the re-continuance of payments;
(iii) lines of communication to the borrower have broken
down such that any reasonable prospect of rehabilitating the loan and return of regular payments is gone.
The Company’s policies on payments received
and interest accrued on non-accrual loans are as follows: (i) The Company will accept payments on loans that are currently on non-accrual
status when a borrower has communicated to us that they intend to meet their mortgage obligations. A payment made on a non-accrual
loan is considered a good faith deposit as to the intent to resume their mortgage payment obligation. This good faith deposit is
credited back to interest first then principal as stated in the mortgage loan documentation. (ii) A letter outlining the re-payment
terms or the restructure terms (if any) of the loan is provided to the borrower. This letter will be signed by the Senior Pastor
and either officers or board members of the borrower. This letter resumes the obligation to make payments on non-accrual loans.
(iii) The borrower must meet all its payment obligations for the next 120 days without interruption in order to be removed from
non-accrual status. No interest income was recognized on non-accrual loans for the years ended December 31, 2018 and 2017.
When a loan is declared in default according
to the Company’s policy or deemed to be doubtful of collection, the loan committee of the Advisor to the Company will direct
the staff to charge-off the uncollectable receivables.
Loans totaling approximately $2,853,000 and
$3,364,000 exceeded 90 days past due but continued to accrue interest as of December 31, 2018 and 2017, respectively. The Company
believes that continued interest accruals are appropriate because the loans are well secured, not deemed to be in technical default
and the Company is actively pursuing collection of past due payments.
Real Estate Held for Sale
As of December 31, 2018, the Company had acquired
one property located in Bethel, Ohio through the foreclosure process with an outstanding balance of $112,515. The Company is preparing
to list the property for sale through a local realtor.
As of December 31, 2018, the Company has one
property located in Pine Bluff, Arkansas acquired via deed in lieu of foreclosure with an outstanding balance totaling balance
totaling $225,872. The Church is still occupying this property and paying rent while trying to either sell the building or obtain
refinancing. The Company records real estate held for sale at the estimated fair value, which is net of the expected expenses related
to the sale of the real estate. The fair value of our real estate held for sale, which represents the carrying value, is $340,659
as of December 31, 2018.
The Company sold one property and disposed
of a second property during the year ended December 31, 2017. The first property was sold to an unrelated third party for approximately
$48,000. The second property was disposed by way of a “Quit-Claim Deed” to an unrelated third party. The disposed property
had no carrying value. The Company realized an additional loss of approximately $67,000 on property that was sold as of December
31, 2017.
Carrying Value of Long-Lived Assets
The Company tests long-lived assets or asset
groups for recoverability when events or changes in circumstances indicate that the carrying amount may not be recoverable. Circumstances
which could trigger a review include, but are not limited to: significant decreases in the market price of the asset; significant
adverse changes in the business climate or legal factors; accumulation of costs significantly in excess of the amount originally
expected for the acquisition or construction of the asset; current period cash flow or operating losses combined with a history
of losses or a forecast of continuing losses associated with the use of the asset; and current expectation that the asset will
more likely than not be sold or disposed of significantly before the end of the estimated useful life.
Recoverability is assessed based on the carrying
amount of the asset compared to the sum of the undiscounted cash flows expected to result from the use and the eventual disposal
of the asset, as well as specific appraisal in certain instances. An impairment loss is recognized when the carrying amount is
deemed not recoverable and exceeds fair value as determined through various valuation techniques including, but not limited to,
discounted cash flow models, quoted market values, and third party independent appraisals.
Revenue Recognition
Interest income on mortgage loans receivable
and the bond portfolio is recognized as earned per the terms of the specific asset. Other income included with interest represents
cash received for loan origination fees, which are recognized over the life of the loan as an adjustment to the yield on the loan.
As of January 1, 2018, the Company adopted
ASU 2014-09
Revenue from Contracts with Customers - Topic 606
and all subsequent ASUs that modified ASC 606. The Company
has elected to apply the ASU and all related ASUs using the modified retrospective implementation method. The implementation of
the guidance had no material impact on the measurement or recognition of revenue of prior periods.
The Company generally fully satisfies its performance
obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either
on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction
prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount
and timing of revenue from contracts with customers. The main types of revenue contracts included in non-interest income within
the consolidated statements of operations are as follows:
Gain Losses on Sale of OREO
The Company records a gain or loss from the
sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When
the Company finances the
sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations
under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset
is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determine
the gain or loss on the sale, the Company adjusts the transaction prices and related gain (loss) on sale if a significant financing
component is present.
Deferred Financing Costs
The Company defers the costs related to obtaining
financing. These costs are amortized over the life of the financing using the straight line method, which approximates the effective
interest method.
Income (Loss) Per Common Share
No adjustments were made to income (loss) for
the purpose of calculating earnings per share, as there were no potential dilutive shares outstanding.
Recent Accounting Pronouncements
In June, 2016 the FASB issued ASU 2016-13,
“Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments.” ASU 2016-13
is intended to provide financial statement users with more decision-useful information about the expected credit losses on financial
instruments and other commitments to extend credit. For public entities, ASU 2016-13 is effective for fiscal years beginning after
December 15, 2019, including interim periods within those fiscal years. The Company has not yet fully evaluated the potential effects
of adopting ASU 2016-13 on the Company’s results of operations, financial position or cash flows.
Recent Accounting Pronouncements –
Adopted
In the first quarter of 2018, the Company adopted
Accounting Standards Update (ASU) 2014-09,
Revenue from Contracts with Customers (Topic 606).
Under the ASU, revenue
is recognized when a customer obtains control of promised services in an amount that reflects the consideration the entity expects
to receive in exchange for those services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty
of revenue and cash flows arising from contracts with customers. The Company applied the five-step method outlined in
the ASU to all revenue streams scoped-in by the ASU and elected the modified retrospective implementation method. Substantially
all of the Company’s interest income and certain non-interest income were not impacted by the adoption of this ASU because
either the revenue from those contracts with customers is covered by other guidance in U.S. GAAP or the revenue recognition outcomes
were similar to our current revenue recognition practices. We reviewed non-interest sources of income and related contracts to
document the impact of the new standard on our service offerings that are in the scope of the ASU including gains (losses) on sale
of OREOs. Upon our analysis we concluded that the adoption of the ASC 606 did not change the timing and pattern of revenue recognition
related to scoped in non-interest income source and only required additional disclosures. In addition, we reviewed, and where necessary,
enhanced our business processes, systems and controls to support recognition and disclosures under the new standard. The additional
disclosures required by the ASU have been included above.
Income Taxes
The Company elected to be taxed as a Real Estate
Investment Trust (REIT). Accordingly, the Company is not subject to Federal income tax to the extent of distributions to its shareholders
if the Company meets all the requirements under the REIT provisions of the Internal Revenue Code.
The Company evaluated its recognition of income
tax benefits using a two-step approach to recognizing and measuring tax benefits when realization of the benefits is uncertain.
The first step is to determine whether the benefit meets the more-likely-than-not condition for recognition and the second step
is to determine the amount to be recognized based on the cumulative probability that exceeds 50%. Primarily due to the Company’s
tax status as a REIT, the Company does not have any significant tax uncertainties that would require recognition or disclosure.
Subsequent Events
The Company has evaluated events and transactions
through the date the financial statements were available to be issued. No material events or transactions occurred in the time
period referenced above requiring adjustment to or disclosure in the December 31, 2018 financial statements.
2. FAIR VALUE MEASUREMENT
The Company measures certain financial instruments
at fair value in our balance sheets. The fair value of these instruments is based on valuations that include inputs that can be
classified within one of the three levels of a hierarchy. Level 1 inputs include quoted market prices in an active market for identical
assets or liabilities. Level 2 inputs are market data, other than Level 1, that are observable either directly or indirectly. Level
2 inputs include quoted market prices for similar assets or liabilities, quoted market prices in an inactive market, and other
observable information that can be corroborated by market data. Level 3 inputs are unobservable and corroborated by little or no
market data.
Except for the bond portfolio, which is required
by authoritative accounting guidance to be recorded at fair value in our balance sheets, the Company elected not to record any
other financial assets or liabilities at fair value on a recurring basis. We recorded an aggregate other than temporary impairment
for losses on our Agape bonds (Note 3), which totaled $458,000 for both the years ended December 31, 2018 and 2017.
The following table summarizes the Company’s financial
instruments that were measured at fair value on a recurring basis:
|
|
Fair Value Measurement
|
December 31, 2018
|
Fair Value
|
Level 3
|
|
|
|
Bond portfolio
|
$
15,389,807
|
$
15,389,807
|
|
|
Fair Value Measurement
|
December 31, 2017
|
Fair Value
|
Level 3
|
|
|
|
Bond portfolio
|
$
14,229,755
|
$
14,229,755
|
We determine the fair value of the bond portfolio
shown in the table above by comparing it with similar instruments in inactive markets. The analysis reflects the contractual terms
of the bonds, which are callable at par by the issuer at any time, and the anticipated cash flows of the bonds and uses observable
and unobservable market-based inputs. Unobservable inputs include our internal credit rating and selection of similar bonds for
valuation.
The change in Level 3 assets measured at fair value
on a recurring basis is summarized as follows:
|
2018
|
2017
|
Balance at beginning of year
|
$14,229,755
|
$11,482,616
|
Purchases
|
1,883,052
|
2,964,000
|
Proceeds
|
(723,000
)
|
(216,861
)
|
Balance at end of year
|
$15,389,807
|
$14,229,755
|
Real estate held for sale and impaired loans
are recorded at fair value on a nonrecurring basis. The fair value of real estate held for sale was based upon the listed sales
price less expected selling costs, which is a Level 3 input. The resulting impairment charges were $114,787 and $0 for the years
ended December 31, 2018 and 2017, respectively.
The following table summarizes the Company’s financial
instruments that were measured at fair value on a nonrecurring basis:
|
December 31, 2018
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Fair Value at December 31,
2018
|
Impaired Loans
|
$ -
|
|
$ -
|
|
$665,267
|
|
$665,267
|
Real estate held for resale
|
-
|
|
-
|
|
340,659
|
|
340,659
|
|
$ -
|
|
$ -
|
|
$1,005,926
|
|
$1,005,926
|
|
December 31, 2017
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Fair Value at December 31,
2017
|
Impaired Loans
|
$ -
|
|
$ -
|
|
$1,321,500
|
|
$1,321,500
|
Real estate held for resale
|
-
|
|
-
|
|
225,872
|
|
225,872
|
|
$ -
|
|
$ -
|
|
$1,547,372
|
|
$1,547,372
|
The change in Level 3 assets measured at fair value
on a nonrecurring basis is summarized as follows:
|
Impaired Loans
|
Real Estate Held for Sale
|
|
|
|
Balance at December 31, 2016
|
$1,189,873
|
$340,872
|
Additions/Acquisitions
|
197,034
|
-
|
Dispositions/Proceeds
|
(5,465)
|
(115,000)
|
Impairment
|
( 59,942
)
|
-
|
Balance at December 31, 2017
|
$
1,321,500
|
$
225,872
|
Additions/Acquisitions
|
-
|
125,249
|
Dispositions/Proceeds
|
(546,406)
|
-
|
Impairment
|
(109,827
)
|
(10,462)
|
Balance at December 31, 2018
|
$
665,267
|
$
340,659
|
The fair value of impaired loans referenced
above was determine by obtaining independent third party appraisals and/or internally developed collateral valuations to support
the Company’s estimates and judgements in determining the fair value of the underlying collateral supporting impaired loans.
The fair value of real estate held for resale
referenced above was determined by obtaining market price valuations from independent third parties wherever such quotes were available
for the other collateral owned. The company utilized independent third party appraisal to support the Company’s estimates
and judgements in determining fair value for other real estate owned.
3. MORTGAGE LOANS RECEIVABLE AND BOND PORTFOLIO
At December 31, 2018, the Company had first
mortgage loans receivable totaling $23,607,655. The loans bear interest ranging from 0% to 10.25% with a weighted average of approximately
8.15% at December 31, 2018. The Company had first mortgage loans receivable totaling $24,158,787 that bore interest ranging from
0% to 10.25% with a weighted average of approximately 8.19% at December 31, 2017.
The Company has a portfolio of secured church
bonds at December 31, 2018 and December 31, 2017, which are carried at fair value. The bonds pay either semi-annual or quarterly
interest ranging from 3.50% to 9.75%. The aggregate par value of secured church bonds equaled approximately $15,847,807 at December
31, 2018 with a weighted average interest rate of 6.80% and approximately $14,687,755 at December 31, 2017 with a weighted average
interest rate of 6.82%. These bonds are due at various maturity dates through May 2046. The Company has recorded an aggregate other
than temporary impairment of $458,000 for both December 31, 2018 and 2017 for the First Mortgage Bonds issued by Agape Assembly
Baptist Church. This bond series in the aggregate constitute approximately 6.47% and 6.98% of the bond portfolio at December 31,
2018 and 2017, respectively. The Company had maturities and redemptions of bonds of approximately $723,000 and $217,000 in 2018
and 2017, respectively.
The contractual
maturity schedule for mortgage loans receivable and the bond portfolio as of December 31, 2018, is as follows:
|
Mortgage Loans
|
Bond Portfolio
|
|
|
|
2019
|
$ 2,435,321
|
$ 167,000
|
2020
|
963,625
|
240,000
|
2021
|
756,395
|
266,000
|
2022
|
1,554,461
|
188,000
|
2023
|
924,931
|
289,000
|
Thereafter
|
16,972,922
|
14,697,807
|
|
23,607,655
|
15,847,807
|
Less loan loss and other than temporary impairment on bonds allowance
|
(1,672,003)
|
(458,000)
|
Less deferred origination income
|
(271,913
)
|
___-____
|
Totals
|
$
21,663,739
|
$
15,389,807
|
The Company currently owns $529,000 First Mortgage
Bonds and $497,000 Second Mortgage Bonds issued by Agape Assembly Baptist Church located in Orlando, Florida. The total principal
amount of First Mortgage Bonds issued by Agape is $7,200,000, and the total principal amount of Second Mortgage Bonds issued is
$715,000. Agape defaulted on its payment obligations to bondholders in September 2010. The church subsequently commenced a Chapter
11 bankruptcy reorganization proceeding regarding the property that secures the First Mortgage Bonds in December 2010. In October
2014, a minimum of 80% of the bondholders of Agape agreed to a modification in the terms of their bonds which resulted in the temporary
resumption of both principal and interest payments to both the first and second mortgage bond holders. Both the First Mortgage
Bonds and Second Mortgage Bonds were modified to a fully amortized fixed rate, quarterly interest payment of 6.25% with a new maturity
date of September 2037 for all the issued and outstanding bonds. The Company, along with all other bondholders, has a superior
lien over all other creditors. The Church subsequently defaulted on their modification agreement in 2016 and no interest payments
were made to bondholders during the year ended December 31, 2018. However, the trustee made a distribution to bondholders during
2017 of $18.75 per $1,000 bond as a repayment of principal only, effectively reducing the outstanding balance of each $1,000 bond
to approximately $826. The Company has an aggregate other than temporary impairment of $458,000 for the First and Second Mortgage
Bonds at both at December 31, 2018 and 2017, which effectively reduces the bonds to the fair value amount management believes will
be recovered.
The Company restructured two mortgage loans
during the year ended December 31, 2018. The first restructured loan was a $669,544 first mortgage loan located in Indianapolis,
Indiana. The Church was unable to meet its monthly debt obligations. The Company reduced the Church’s monthly mortgage obligation
to interest only payments for a period of three years. After the initial three-year period, the Church will resume its regular
monthly mortgage payments. The Church accepted the restructured loan terms. The modification had no effect on the Company’s
financial statements.
The second restructured loan was a $470,000
first mortgage loan located in Cincinnati, Ohio. The Church was unable to meet its monthly debt obligations. The Company reduced
the Church’s monthly mortgage obligation to interest only for a period of three years which included a reduction in their
interest rate. After the initial three-year term, the rate of interest will increase for an additional three-year period. At the
end of the sixth year, the Church will resume its regular monthly mortgage payments at the original rate of interest. The Church
accepted the restructured loan terms. The modification had no effect on the Company’s financial statements.
A summary of loans re-structured or modified
for the years ended December 31, 2018 and 2017 are shown below. All of the loans shown are currently performing under the terms
of the modifications for their mortgage obligations.
|
December 31, 2018
|
|
|
|
|
|
|
Type of Loan
|
Number of Loans
|
Original Principal Balance
|
Original Average Interest Rate
|
Unpaid Principal Balance
|
Modified Average Interest Rate
|
First Mortgage Loan
|
7
|
$4,415,544
|
8.014%
|
$3,838,819
|
6.03%
|
|
|
|
|
|
|
|
December 31, 2017
|
|
|
|
|
|
|
Type of Loan
|
Number of Loans
|
Original Principal Balance
|
Original Average Interest Rate
|
Unpaid Principal Balance
|
Modified Average Interest Rate
|
First Mortgage Loan
|
5
|
$3,276,000
|
8.67%
|
$2,762,309
|
6.64%
|
|
|
|
|
|
|
4. SECURED INVESTOR CERTIFICATES
Secured investor certificates are collateralized
by certain mortgage loans receivable or secured church bonds of approximately the same value as the certificates. The weighted
average interest rate on the certificates was 6.35% and 6.45% at December 31, 2018 and 2017, respectively. Holders of the secured
investor certificates may renew certificates at the current rates and terms upon maturity at the
Company’s discretion. Renewals
upon maturity are considered neither proceeds from nor issuance of secured investor certificates. Renewals totaled approximately
$1,671,000 and $1,282,000 during 2018 and 2017, respectively. The secured investor certificates have certain financial and non-financial
covenants identified in the respective series’ trust indentures.
The estimated maturity schedule for the secured
investor certificates at December 31, 2018 is as follows:
2019
|
$ 4,105,000
|
|
2020
|
4,117,000
|
|
2021
|
2,168,000
|
|
2022
|
1,316,000
|
|
2023
|
3,217,000
|
|
Thereafter
|
14,463,000
|
|
|
$29,386,000
|
|
Less deferred offering costs
|
(886,411)
|
|
Totals
|
$
28,499,589
|
|
In July 2014, the Company filed a registration
statement with the Securities and Exchange Commission to offer $10,000,000 worth of Series D secured investor certificates. The
offering was declared effective by the SEC on August 12, 2014. The offering was renewed with an effective date of September 23,
2016. The certificates were offered in multiples of $1,000 with interest rates ranging from 4.00% to 6.50%, subject to changing
market rates, and maturities from 5 and 7 to 15 years. The certificates are collateralized by certain mortgage loans receivable
and church bonds of approximately the same value. At December 31, 2018, approximately 8,234 Series D certificates had been issued
and were outstanding for $8,234,000. The offering terminated in August 2017.
In September 2017, the Company filed a registration
statement with the Securities and Exchange Commission to offer $10,000,000 worth of Series E secured investor certificates. The
offering was declared effective by the SEC on November 6, 2017. The certificates are being offered in multiples of $1,000 with
interest rates ranging from 4.00% to 6.50%, subject to changing market rates, and maturities from 5 to 15 years. The certificates
are collateralized by certain mortgage loan receivables and church bonds of approximately the same value. At December 31, 2018,
approximately 2,786 Series E certificates had been issued and were outstanding for $2,786,000.
5. TRANSACTIONS WITH AFFILIATES
The Company has an Advisory Agreement with
Church Loan Advisors, Inc. (the “Advisor”). The Advisor is responsible for the day-to-day operations of the Company
and provides office space and administrative services. The Advisor and the Company are related through common ownership and common
management. For its services, the Advisor is entitled to receive a management fee equal to 1.25% annually of the Company's Average
Invested Assets, plus one-half of any origination fee charged to borrowers on mortgage loans made by the Company. A majority of
the independent board members approve the Advisory Agreement on an annual basis. The Company paid the Advisor
management and origination
fees of approximately $322,000 and $333,000 during the years ended December 31, 2018 and 2017, respectively.
6. LINE OF CREDIT
On April 9, 2018, the Company entered into
a Loan and Security Agreement (the “Loan Agreement”) with Alerus Financial, N.A., as lender (the “Lender”),
and a Revolving Note (the “Note”) evidencing a $4,000,000 revolving loan (the “Revolving Loan”). The Lender
agrees to make loans to the Company from time to time and after the date of the loan agreement and the Company may repay and reborrow
pursuant to the terms and conditions of the Revolving Loan as long as no borrowing causes that dollar limit to be exceeded and
the Company is not otherwise in default on the Revolving Loan. The Revolving Loan is secured by a first priority security interest
in substantially all of the Company’s assets other than collateral pledged to secure the Company’s secured investor
certificates, both those currently issued and any potentially issued in the future. The Company has not yet borrowed against the
line of credit as of December 31, 2018. The maturity date of the Note is April 9, 2019 and the interest rate is the prevailing
London Interbank Offering Rate (LIBOR) plus 2.70% adjusted monthly.
7. INCOME TAXES
As discussed in Note 1, a REIT is subject to
taxation to the extent that taxable income exceeds dividend distributions to shareholders. In order to maintain status as a REIT,
the Company is required to distribute at least 90% of its taxable income. In 2018, the Company had pretax loss of $(50,182) and
distributions to shareholders in the form of dividends during the tax year of $360,727. In 2017, the Company had pretax income
of $152,221 and distributions to shareholders in the form of dividends during the tax year of $469,783. The Company paid out 100%
of taxable income in dividends in 2018 and 2017.
The Company has federal and Minnesota net operating
loss carryforwards of $2,600,000. The federal losses start to expire in 2034 and the Minnesota losses start to expire in 2029.
The carrying amounts of some assets differ for tax basis than book basis. At December 31, 2018 and 2017, the cumulative tax basis
in the Company’s assets and liabilities exceeded book basis by $1,966,000 and $1,725,000, respectively. The Company has no
deferred tax assets or liabilities on its balance sheet.
The Tax Cuts and Jobs Act, signed into law
on December 22, 2017, represents sweeping changes to the Internal Revenue Code, including the reduction of the corporate tax rate
to a flat 21 percent. This rate was effective January 1, 2018, ASC 740-10-30-8 and requires deferred tax assets and liabilities
to be measured based on the enacted rates expected to apply when the deferred tax assets or liabilities are settled. We do
not have any deferred tax assets, and therefore did not incur a charge or benefit with regards to the rate change. We continue
to work with our advisors to evaluate the new law and its application to ASC 740.
8. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company is required to disclose the fair
value information about financial instruments, where it is practicable to estimate that value. Because assumptions used in these
valuation techniques are inherently subjective in nature, the estimated fair values cannot always be substantiated by comparison
to independent market quotes and, in many cases, the estimated fair values could not necessarily be realized in an immediate sale
or settlement of the instrument.
The fair value estimates presented herein are
based on relevant information available to management as of December 31, 2018 and 2017, respectively. Management is not aware of
any factors that would significantly affect these estimated fair value amounts. As these reporting requirements exclude certain
financial instruments and all non-financial instruments, the aggregate fair value amounts presented herein do not represent management’s
estimate of the underlying value of the Company.
The estimated fair values of the Company’s
financial instruments, none of which are held for trading purposes, are as follows:
|
|
December 31, 2018
|
|
December 31, 2017
|
|
|
Carrying
|
|
Fair
|
|
Carrying
|
|
Fair
|
|
|
Amount
|
|
Value
|
|
Amount
|
|
Value
|
|
|
|
|
|
|
|
|
|
Cash and equivalents
|
|
$
|
2,183,441
|
|
|
$
|
2,183,441
|
|
|
$
|
502,490
|
|
|
$
|
502,490
|
|
Accounts receivable
|
|
|
251,535
|
|
|
|
251,535
|
|
|
|
260,785
|
|
|
|
260,785
|
|
Interest receivable
|
|
|
184,869
|
|
|
|
184,869
|
|
|
|
176,365
|
|
|
|
176,365
|
|
Mortgage loans receivable
|
|
|
23,607,655
|
|
|
|
23,905,564
|
|
|
|
24,158,787
|
|
|
|
25,353,731
|
|
Bond portfolio
|
|
|
15,847,807
|
|
|
|
15,389,807
|
|
|
|
14,687,775
|
|
|
|
14,687,775
|
|
Secured investor certificates
|
|
|
29,386,000
|
|
|
|
34,099,540
|
|
|
|
27,323,000
|
|
|
|
34,811,519
|
|
The following methods and assumptions were
used by the Company to estimate the fair value of each class of financial instrument for which it is practicable to estimate that
value:
Cash and equivalents
Due to their short-term nature, the carrying
amount of cash and cash equivalents approximates fair value and represents a level 1 measurement.
Accounts receivable
Due to the short term nature, the carrying
amount of accounts receivable approximates fair value and represents a level 1 measurement.
Interest receivable
Due to the short term nature, the carrying
amount of interest receivable approximates fair value and represents a level 1 measurement.
Mortgage loans receivable
The fair value of the mortgage loans receivable
is currently greater than the carrying value as the portfolio is currently yielding a higher rate than similar mortgages with similar
terms for borrowers with similar credit quality. The credit markets in which the Company conducts business have experienced an
increase in interest rates resulting in the fair value of the mortgage loans falling during the fiscal year ended December 31,
2018. The fair value of loans is considered a level 3 measurement.
Bond portfolio
We determine the fair value of the bond portfolio
shown in the table above by comparing with similar instruments in inactive markets. The analysis reflects the contractual terms
of the bonds, which are callable at par by the issuer at any time, and the anticipated cash flows of the bonds and uses observable
and unobservable market-based inputs. Unobservable inputs include our internal credit rating and selection of similar bonds for
valuation. The fair value of bonds is considered a level 3 measurement.
Secured investor certificates
The fair value of the secured investor certificates
is currently greater than the carrying value due to higher interest rates than current market rates. The fair value of secured
investor certificates is considered a level 3 measurement.