10-K 1 vrtb10k123112.htm VESTIN REALTY MORTGAGE II, INC DECEMBER 31, 2012 10-K vrtb10k123112.htm


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

FORM 10-K

(Mark one)

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

For the fiscal year ended December 31, 2012

Or

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

For the transition period from _________ to _________

Commission File Number: 333-125121
Company Logo
VESTIN REALTY MORTGAGE II, INC.
(Exact name of registrant as specified in its charter)


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


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

Registrant’s telephone number, including area code 702.227.0965

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, $0.0001 Par Value
 
Nasdaq Global Select Market
(Title of each class)
 
(Name of each exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act:

None
(Title of class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [   ] No [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes [   ] No [X]

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes [X] No [   ]




Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Sec. 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [X] No [   ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Sec. 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [   ]

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

Large accelerated filer [   ]
Accelerated filer [   ]
   
Non-accelerated filer [   ]
Smaller reporting company [X]

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

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.

Class
   
Market Value as of
June 30, 2012
Common Stock, $0.0001 Par Value
 
$
14,223,145
       

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

Class
   
Number of Shares Outstanding
As of March 28, 2013
Common Stock, $0.0001 Par Value
   
12,069,805
       




TABLE OF CONTENTS

     
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Note Regarding Forward-Looking Statements

This report may contain forward-looking statements.  Such forward-looking statements may be identified by the use of such words as “expects,” “plans,” “estimates,” “intend,” “might,” “may,” “could,” “will,” “feel,” “forecasts,” “projects,” “anticipates,” “believes” and words of similar expression.  Forward-looking statements are likely to address such matters as our business strategy, future operating results, future sources of funding for real estate loans brokered by us, future economic conditions and pending litigation involving us.  Some of the factors which could affect future results are set forth in the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Factors Affecting Our Operating Results.”

ITEM 1.
BUSINESS

General

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

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

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

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

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




Our consolidated financial statements include the accounts of VRM II, Vestin TRS II, Inc., our wholly owned subsidiary, 1701 Commerce, LLC and Hawaii Funeral Service, LLC, in which we had a controlling interest through December 1, 2011. Our consolidated financial statements also included the accounts of the funeral merchandise and service trusts, cemetery merchandise and service trusts, and cemetery perpetual care trusts (“Trusts”) in which we had a variable interest and HFS was the primary beneficiary through December 1, 2011.  See Note A – Organization of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Report Form 10-K.   Intercompany balances and transactions have been eliminated in consolidation.

During April 2009, we entered into an accounting services agreement with Strategix Solutions, LLC (“Strategix Solutions”), a Nevada limited liability company, for the provision of accounting and financial reporting services.  Strategix Solutions also provides accounting and financial reporting services to VRM I and Fund III.  Our CFO and other members of our accounting staff are employees of Strategix Solutions.  Strategix Solutions is managed by LL Bradford and Company, LLC ("LL Bradford"), a certified public accounting firm that has provided non-audit accounting services to us.  The principal manager of LL Bradford was a former officer of our manager from April 1999 through January 1, 2005.  Strategix Solutions is owned by certain partners of LL Bradford, none of whom are currently or were previously officers of our manager.  On January 14, 2013, Eric Bullinger resigned from his position as Chief Financial Officer of Vestin Realty Mortgage I, Inc. and Vestin Realty Mortgage II, Inc and the equivalent of Chief Financial Officer of Vestin Fund III, LLC (hereafter referred to collectively as the “Vestin Entities”).  On January 14, 2013, the Board of Directors appointed Tracee Gress as the Chief Financial Officer of the Vestin Entities (or the equivalent thereof in the case of Vestin Fund III, LLC).  As used herein, “management” means our manager, its executive officers and the individuals at Strategix Solutions who perform accounting and financial reporting services on our behalf.

Segments

We are currently authorized to operate two reportable segments, investments in real estate loans and investments in real property.  As of December 31, 2012, we had not commenced investing in real property.

Our objective is to invest approximately 97% of our assets in real estate loans and real estate investments, while maintaining approximately 3% as a working capital cash reserve.  Current market conditions have impaired our ability to be fully invested in real estate loans and real estate investments.  As of December 31, 2012, approximately 62% of our assets, net of allowance for loan losses, are classified as investments in real estate loans.

Real Estate Loan Objectives

As of December 31, 2012, our loans were in the following states: California, Michigan, Nevada, Ohio, Utah and Texas.  The loans we invest in are selected for us by our manager from among loans originated by affiliated or non-affiliated mortgage brokers.  When a mortgage broker originates a loan for us, that entity identifies the borrower, processes the loan application, brokers and sells, assigns, transfers or conveys the loan to us.  We believe that our loans are attractive to borrowers because of the expediency of our manager’s loan approval process, which takes about ten to twenty days.

As a commercial real estate lender willing to invest in loans to borrowers who may not meet the credit standards of other financial institutional lenders, the default rate on our loans has been higher than those generally experienced in the mortgage lending industry.  Because of our willingness to fund riskier loans, borrowers are generally willing to pay us an interest rate that is above the rates generally charged by other commercial lenders.  We invest a significant amount of our funds in loans in which the real property, held as collateral, is not generating any income to the borrower.  The loans in which we invest are generally riskier because the borrower’s repayment depends on their ability to refinance the loan or develop the property so they can refinance the loan.

Our principal investment objectives are to maintain and grow stockholder value by:

 
·
Producing revenues from the interest income on our real estate loans;

 
·
Providing cash dividends from the net income generated by our real estate loans; and

 
·
Reinvesting, to the extent permissible, payments of principal and net proceeds from sales of foreclosed properties.



Acquisition and Investment Policies

Generally, the collateral on our real estate loans is the real property that the borrower is purchasing or developing, together with a guarantee from the principal owners of the borrower.  We sometimes refer to these real properties as the security properties.  While we may invest in other types of loans, most of the loans in which we invest have been made to real estate developers.

Our real estate investments are not insured or guaranteed by any governmental agency.

Our manager continuously evaluates prospective investments, selects the loans in which we invest and makes all investment decisions on our behalf.  In evaluating prospective real estate loan investments, our manager considers such factors as the following:

 
·
The ratio of the amount of the investment to the value of the property by which it is secured, or the loan-to-value ratio;

 
·
The potential for capital appreciation or depreciation of the property securing the investment;

 
·
Expected levels of rental and occupancy rates, if applicable;

 
·
Potential for rental increases, if applicable;

 
·
Current and projected revenues from the property, if applicable;

 
·
The status and condition of the record title of the property securing the investment;

 
·
Geographic location of the property securing the investment; and

 
·
The financial condition of the borrowers and their principals, if any, who guarantee the loan.

Our manager may obtain our loans from affiliated or non-affiliated mortgage brokers.  We may purchase existing loans that were originated by third party lenders or brokered by affiliates to facilitate our purchase of the loans.  Our manager or any affiliated mortgage broker will sell, assign, transfer or convey the loans to us without a premium, but may include its service fees and compensation.

When selecting real estate loans for us, our manager generally adheres to the following guidelines, which are intended to control the quality of the collateral given for our loans:

1.  Priority of Loans.  Our policy is to secure most of our loans by first deeds of trust.  First deeds of trust are loans secured by a full or divided interest in a first deed of trust secured by the property.  We will not invest in any loan that is junior to more than one loan.

2.  Loan-to-Value Ratio.  The amount of our loan combined with the outstanding debt secured by a senior loan on a security property generally does not exceed the following percentage of the appraised value of the security property at origination:

Type of Secured Property
Loan-to-Value Ratio
   
Residential
75%
Unimproved Land
60%  (of anticipated as-if developed value)
Acquisition and Development
60%  (of anticipated as-if developed value)
Commercial Property
75%  (of anticipated as-if developed value)
Construction
75%  (of anticipated post- developed value)
Leasehold Interest
75%  (of value of leasehold interest)




We may deviate from these guidelines under certain circumstances.  For example, our manager, in its discretion, may increase any of the above loan-to-value ratios if it believes a given loan is supported by credit adequate to justify a higher loan-to-value ratio, including personal guarantees.  Occasionally, our collateral may include personal property attached to the real property as well as real property.  We do not have specific requirements with respect to the projected income or occupancy levels of a property securing our investment in a particular loan.  These loan-to-value ratios will not apply to financing offered to the purchaser of any real estate acquired through foreclosure or to refinance an existing loan that is in default.  In those cases, our manager, in its sole discretion, may accept financing terms that it believes are reasonable and in our best interest.

Loan-to-value ratios are initially based on appraisals obtained at the time of loan origination.  Such appraisals, which may have been commissioned by the borrower and may precede the placement of the loan with us, are generally dated no greater than 12 months prior to the date of loan origination.  Current loan-to-value ratios are generally based on the most recent appraisals and include allowances for loan losses.  Recognition of allowance for loan losses will result in a maximum loan-to-value ratio of 100% per loan.

Appraisals may not reflect subsequent changes in value and may be for the current estimate of the “as-if developed” value of the property, which approximates the post-construction value of the collateralized property assuming that such property is developed.  “As-if developed” values on raw land loans or acquisition and development loans often dramatically exceed the immediate sales value.  Realization of the “as-if-developed” value depends upon anticipated zoning changes and successful development efforts by the borrower.  Completion of such development efforts may in turn depend upon the availability of additional financing.  As most of the appraisals will be prepared on an “as-if developed” basis, if a loan goes into default prior to development of a project, the market value of the property may be substantially less than the appraised value.  As a result, there may be less security than anticipated at the time the loan was originally made.  If there is less security and a default occurs, we may not recover the outstanding balance of the loan.

We, or the borrower, retain appraisers who are state certified or licensed appraisers and/or hold designations from one or more of the following organizations: the Federal National Mortgage Association, the Federal Home Loan Mortgage Corporation, the National Association of Review Appraisers, the Appraisal Institute, the National Society of Real Estate Appraisers, American Society of Real Estate Appraisers, or from other appraisers with other qualifications acceptable to our manager.  However, appraisals are only estimates of value and cannot be relied on as measures of realizable value.  An employee or agent of our manager will review each appraisal report and will generally conduct a physical inspection for each property.  A physical inspection includes an assessment of the subject property, the adjacent properties and the neighborhood, but generally does not include entering any structures on the property.

3.  Terms of Real Estate Loans.  Our loans as of December 31, 2012, had original terms of 2 months to 120 months, excluding extensions.  Most of our loans are for an initial term of 12 months.  Generally, our original loan agreements permit extensions to the term of the loan by mutual consent.  Such extensions are generally provided on loans where the original term was 12 months or less and where a borrower requires additional time to complete a construction project or negotiate take-out financing.  Our manager generally grants extensions when a borrower is in compliance with the material terms of the loan, including, but not limited to the borrower’s obligation to make interest payments on the loan.  In addition, if circumstances warrant, our manager may extend a loan that is in default as part of a work out plan to collect interest and/or principal.  The weighted average term of outstanding loans, including extensions, at December 31, 2012, was 12 months.

As of December 31, 2012 and 2011, most of our loans provided for payments of interest only, some of which have accrued interest, with a “balloon” payment of principal payable in full at the end of the term.  In addition, we may invest in real estate loans that require borrowers to maintain interest reserves funded from the principal amount of the loan for a period of time.  At December 31, 2012 and 2011, we had no investments in real estate loans that had interest reserves.

4.  Escrow Conditions.  Our loans will often be funded by us through an escrow account held by a title insurance company, subject to the following conditions:

 
·
Borrowers will obtain title insurance coverage for all loans, providing title insurance in an amount at least equal to the principal amount of the loan.  Title insurance insures only the validity and priority of our deed of trust, and does not insure us against loss by other causes, such as diminution in the value of the security property.




 
·
Borrowers will obtain liability insurance coverage for all loans.

 
·
Borrowers will obtain fire and casualty insurance for all loans secured by improved real property, covering us in an amount sufficient to cover the replacement cost of improvements.

 
·
All insurance policies, notes, deeds of trust or loans, escrow agreements, and any other loan documents for a particular transaction will cover us as a beneficiary.

5.  Purchase of Real Estate Investments from Affiliates.  We may acquire real estate loans from our affiliates, including our manager, that are accounted for at the principal balance and no gain or loss is recognized by us or any affiliate.  These purchases may include allowable fees and expenses, but no other compensation for the loans.  Excluding the compensation paid to our manager, all income generated and expense associated with the loans so acquired shall be treated as belonging to us.

6.  Note Hypothecation.  We may also acquire real estate loans secured by assignments of secured promissory notes.  These real estate loans must satisfy our stated investment standards, including our loan-to-value ratios, and may not exceed 80% of the principal amount of the assigned note upon acquisition.  For example, if the property securing a note we acquire is a commercial property, the total amount of outstanding debts secured by the property generally must not exceed 75% of the appraised value of the property, and the real estate loan generally will not exceed 80% of the principal amount of the assigned note.  For real estate loans secured by promissory notes, we will rely on the appraised value of the underlying property, as determined by an independent written appraisal that was conducted within the then-preceding twelve months.  If an appraisal was not conducted within that period, then we will arrange for a new appraisal to be prepared for the property prior to acquisition of the loan.

7.  Participation.  We participate in loans with other lenders by providing funds for or purchasing an undivided interest in a loan meeting our investment guidelines described above.  We participate in loans with our affiliates, subject to our voluntary compliance with the applicable guidelines of the North American Securities Administrators Association (“NASAA Guidelines”).  The independent directors on our Board may authorize a departure from such NASAA Guidelines.  Typically, we participate in loans if:

 
·
We did not have sufficient funds to invest in an entire loan;

 
·
We are seeking to increase the diversification of our loan portfolio; or

 
·
A loan fits within our investment guidelines, however it would constitute more than 20% of our capital or otherwise be disproportionately large given our then existing portfolio.

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

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

As of December 31, 2012, 66% of our loans were loans in which we participated with other lenders, most of whom are our affiliates.



8.  Diversification.  We voluntarily comply with applicable NASAA Guidelines, unless otherwise approved by the independent members of our board of directors, which provide that we neither invest in or make real estate loans on any one property, which would exceed, in the aggregate, an amount equal to 20% of our stockholders’ equity, nor may we invest in or make real estate loans to or from any one borrower, which would exceed, in the aggregate, an amount greater than 20% of our stockholders’ equity.

As of December 31, 2012, we had loans with common guarantors.  For additional information regarding loans with common guarantors see Note C – Financial Instruments and Concentrations of Credit Risk of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Report Form 10-K.

9.  Reserve Fund.  We have established contingency working capital reserves of approximately 3% of our stockholders’ equity to cover our unexpected cash needs.

10.  Credit Evaluations.  When reviewing a loan proposal, our manager determines whether a borrower has sufficient equity in the security property.  An appraisal dated within 12 months of loan origination is required in order to establish the value of the property. Our manager may also consider the income level and creditworthiness of a borrower to determine its ability to repay the real estate loan.  This is accomplished by the review of various financial data, which may include financial statements, tax returns and credit reports.

11.  Sale of Real Estate Loan Investments.  Our manager may sell our real estate loans or interest in our loans to either affiliates or non-affiliated parties when our Manager believes that it is advantageous for us to do so.  However, we do not expect that our loans will be generally marketable or that a secondary market will develop for them.

Real Estate Loans to Affiliates

We will not invest in real estate loans made to our manager, Vestin Group or any of our affiliates.  However, we may acquire an investment in a real estate loan payable by our Manager when our Manager has assumed the obligations of the borrower under that loan through a foreclosure on the property.

Investment of Loans From our Manager and Its Affiliates

In addition to those loans our manager selects for us, we invest in loans that were originated by affiliates as long as the loan(s) otherwise satisfies all of our lending criteria.  However, we will not acquire a loan from or sell a loan to a real estate program in which our manager or an affiliate has an interest except in compliance with applicable NASAA Guidelines or as otherwise approved by the independent members of our board of directors.

Types of Loans We Invest In

We primarily invest in loans that are secured by first or second trust deeds on real property.  Such loans fall into the following categories: raw and unimproved land, acquisition and development, construction, commercial property and residential loans.  The following discussion sets forth certain guidelines our manager generally intends to follow in allocating our investments among the various types of loans.  Our manager, however, may change these guidelines at its discretion, subject to review by our board of directors.  Actual investments will be determined by our manager pursuant to the terms of the Management Agreement.  The actual percentages invested among the various loan categories may vary as a result of changes in the size of our loan portfolio.

Raw and Unimproved Land Loans

Generally, 15% to 25% of the loans invested in by us may be loans made for the purchase or development of raw, unimproved land.  Generally, we determine whether to invest in these loans based upon the appraised value of the property and the borrower’s actual capital investment in the property.  We will generally invest in loans for up to 60% of the initial as-if developed appraised value of the property and we generally require that the borrower has invested in the property actual capital expenditures of at least 25% of the property’s value.  As-if developed values on raw and unimproved land loans often dramatically exceed the immediate sales value and may include anticipated zoning changes, and successful development by the purchaser, upon which development is dependent on availability of financing.



Acquisition and Development Loans

Generally, 10% to 25% of the loans invested in by us may be acquisition and development loans.  Such loans enable borrowers to acquire and/or complete the basic infrastructure and development of their property prior to the construction of buildings or structures.  Such development may include installing utilities, sewers, water pipes, and/or streets, together with the costs associated with obtaining entitlements, including zoning, mapping and other required governmental approvals.  We will generally invest in loans with an initial face value of up to 60% of the appraised value of the property.  Loan-to-value ratios on acquisition and development loans are calculated using as-if developed appraisals.  Such appraisals have the same valuation limitations as raw and unimproved land loans, described above.

Construction Loans

Generally, 10% to 70% of our loans may be construction loans.  Such loans provide funds for the construction of one or more structures on developed land.  Funds under this type of loan will generally not be forwarded to the borrower until work in the previous phase of the project has been completed and an independent inspector has verified certain aspects of the construction and its costs.  We will typically require material and labor lien releases by the borrower per completed phase of the project.  We will review the appraisal of the value of the property and proposed improvements, and will generally finance up to 75% of the initial appraised value of the property and proposed improvements.  Such appraisals have the same valuation limitations as raw and unimproved land loans, described above.

Commercial Property Loans

Generally, 20% to 50% of the loans we invest in may be commercial property loans.  Such loans provide funds to allow borrowers to acquire income-producing property or to make improvements or renovations to the property in order to increase the net operating income of the property so that it may qualify for institutional refinancing.  Generally, we review the initial property appraisal and generally invest in loans for up to 75% of such appraised value of the property.

Residential Loans

A small percentage of the loans invested in by us may be residential loans.  Such loans facilitate the purchase or refinance of one to four family residential property units provided the borrower uses one of the units on the property as such borrower’s principal residence.  We will generally invest in loans for up to 75% of the initial value of the property.

Collateral

Each loan is secured by a lien on either a fee simple or leasehold interest in real property as evidenced by a first deed of trust or a second deed of trust.

First Deed of Trust

Historically, most of our loans were secured by first deeds of trust.  Thus as a lender, we would have rights as a first priority lender of the collateralized property.  As of December 31, 2012, approximately 97% of our loans were secured by first deeds of trust.

Second Deed of Trust

Prior to September 2008, our objective has been that not more than 10% of our loan portfolio would be secured by second deeds of trust; unless our board of directors approves a higher percentage.  During September 2008, the board authorized us to allow loans secured by second deeds of trust to constitute up to 15% of our loans, due to loan restructuring and business opportunities.  In a second priority loan, the rights of the lender (such as the right to receive payment on foreclosure) will be subject to the rights of the first priority lender.  In a wraparound loan, the lender’s rights will be comparably subject to the rights of a first priority lender, but the aggregate indebtedness evidenced by the loan documentation will be the first priority loan plus the new funds the lender invests.  The lender would receive all payments from the borrower and forward to the senior lender its portion of the payments the lender receives.  As of December 31, 2012, approximately 3% of our loans were secured by a second deed of trust.



Prepayment Penalties and Exit Fees

Generally, the loans we invest in will not contain prepayment penalties but may contain exit fees payable when the loan is paid in full, by the borrower, to our manager or its affiliates as part of their compensation.  If interest rates decline, the amount we can charge as interest on our loans will also likely decline.  Moreover, if a borrower should prepay obligations that have a higher interest rate from an earlier period, we will likely not be able to reinvest the funds in real estate loans earning that higher rate of interest.  In the absence of a prepayment fee, we will receive neither the anticipated revenue stream at the higher rate nor any compensation for its loss.  As of December 31, 2012 none of our loans had a prepayment penalty, although one of our loans, totaling approximately $1.0 million, had an exit fee.  This loan is considered performing as of December 31, 2012.  Depending upon the amount by which lower interest rates are available to borrowers, the amount of the exit fees may not be significant in relation to the potential savings borrowers may realize as a result of prepaying their loans.

Extensions to Term of Loan

Our original loan agreements generally permit extensions to the term of the loan by mutual consent.  Such extensions are generally provided on loans where the original term was 12 months or less and where a borrower requires additional time to complete a construction project or negotiate take-out financing.  Our manager generally grants extensions when a borrower is in compliance with the material terms of the loan, including, but not limited to the borrower’s obligation to make interest payments on the loan.  In addition, if circumstances warrant, our manager may extend a loan that is in default as part of a work out plan to collect interest and/or principal.

Interest Reserves

We may invest in loans that include a commitment for an interest reserve, which is usually established at loan closing.  The interest reserve may be advanced by us or other lenders with the amount of the borrower’s indebtedness increased by the amount of such advances.

Balloon Payment

As of December 31, 2012, most of our loans provided for payments of interest only with a “balloon” payment of principal payable in full at the end of the term.  There are no specific criteria used in evaluating the credit quality of borrowers for real estate loans requiring balloon payments.  Furthermore, a substantial period of time may elapse between the review of the financial statements of the borrower and the date when the balloon payment is due.  As a result, there is no assurance that a borrower will have sufficient resources to make a balloon payment when due.  To the extent that a borrower has an obligation to pay real estate loan principal in a large lump sum payment, its ability to repay the loan may be dependent upon its ability to sell the property, obtain suitable refinancing or otherwise raise a substantial amount of cash.  As a result, these loans can involve a higher risk of default than loans where the principal is paid at the same time as the interest payments.

Repayment of Loans on Sale of Properties

We may require a borrower to repay a real estate loan upon the sale of the property rather than allow the buyer to assume the existing loan.  We will generally require repayment if we determine that repayment appears to be advantageous to us based upon then-current interest rates, the length of time that the loan has been held by us, the creditworthiness of the buyer and our objectives.

Variable Rate Loans

Occasionally we may acquire variable rate loans.  Variable rate loans may use as indices the one and five year Treasury Constant Maturity Index, the Prime Rate Index and the Monthly Weighted Average Cost of Funds Index for Eleventh District Savings Institutions (Federal Home Loan Bank Board).

It is possible that the interest rate index used in a variable rate loan will rise (or fall) more slowly than the interest rate of other loan investments available to us.  If we make variable rate loans, our manager, in conjunction with a mortgage broker we may use, will attempt to minimize this interest rate differential by tying variable rate loans to indices that are sensitive to fluctuations in market rates.  Additionally, variable rate loans may contain an interest rate floor.



Variable rate loans generally have interest rate caps.  For these loans, there is the risk that the market rate may exceed the interest cap rate. For additional information see Note D – Investments in Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Consolidated Financial Statements of this Annual Report on Form 10-K.

Real Estate Investment Objectives

As of December 31, 2012, we had not purchased any real estate properties. Investments in commercial properties will be primarily in Nevada, Arizona, California, Oregon and Texas or in other areas of the Southwestern and Western part of the United States. Properties acquired may include, but are not limited to, office buildings, shopping centers, business and industrial parks, manufacturing facilities, multifamily properties, warehouses and distribution facilities, motel and hotel properties and recreation and leisure properties. We will not invest in unimproved land or construction or development of properties. We intend to lease properties owned by us and to hold properties until such time as we believe it is the optimal time to capitalize on the capital appreciation of our properties.

We intend to invest principally in properties that generate current income.  Potential gain on sale of appreciated properties will be a secondary objective.

ACQUISITION AND INVESTMENT STRATEGIES

Capitalizing on Availability of Properties

We believe that excellent opportunities exist in our target markets in the Southwestern United States to acquire quality properties at significant discounts. Some of these properties should exhibit stable cash flow, but are currently underperforming. We intend to generate value by improving cash flows through aggressive leasing, asset management and repositioning of the property.  We will acquire these properties directly from owners, through the foreclosure process, or from financial institutions holding foreclosed real estate.

Maximizing Value of Acquired Properties

We will seek to reposition properties that we acquire through strategic renovation and re-tenanting such properties.  Repositioning of properties may be accomplished by (1) stabilizing occupancy; (2) upgrading and renovating existing structures; and (3) investing significant efforts in recruiting tenants whose goods and services meet the needs of the surrounding neighborhood.  We currently do not intend to engage in significant development or redevelopment of properties as the costs of development and redevelopment may exceed the cost of properties that we acquire.

Southwestern and Western United States Focus

Our acquisition efforts will occur in the Southwestern and Western United States, primarily in Nevada, California and Arizona. These regions have recently experienced severe economic distress, which has in turn led to significant declines in real estate values.  We believe such factors have created a significant pipeline of acquisition opportunities.  Despite the recent downturn, we believe these regions have fundamentally diverse and dynamic economies that hold the potential to recover significantly as the overall economy in the United States improves and that such recovery will in turn improve the real estate markets in these regions.

Focus on Strong Property and Submarket Fundamentals

We will seek to acquire properties that present strong characteristics that we believe are essential for a successful real estate investment. These include:

 
·
an attractive location in established markets;

 
·
desirable physical attributes such as a contemporary design and function, adequate parking, flexible and efficient floor plans and environmentally friendly design; and

 
·
a strong multi-tenant base with limited exposure to significant tenant concentrations.



Apply a Disciplined Underwriting Process

We intend to utilize a disciplined underwriting process in our evaluation of potential property acquisitions. In evaluating a property’s cash flow potential, we intend to use conservative assumptions regarding future cash flow, taking into account not only current rents but future rents that may be negotiated at a discount during the current market downturn, the credit worthiness of tenants and other factors that may affect cash flow, which we believe our management team is well positioned to understand. We also intend to utilize assumptions regarding the timing and level of a market recovery that we believe to be conservative.  We intend to acquire properties that are able to provide returns, regardless of when a market recovery occurs, with potential for cash flow improvement and capital appreciation.

Leasing

The terms and conditions of any lease we enter into with our tenants may vary substantially. However, we expect that our leases will conform with the standard market practices in the geographic area where the property is located. We expect to execute new tenant leases and tenant lease renewals, expansions and extensions with terms that are dictated by the current market conditions. If it is economically practical, we may verify the creditworthiness of each tenant. If we verify the creditworthiness of each tenant, we may use industry credit rating services for any guarantors of each potential tenant. We may also obtain relevant financial data from potential tenants and guarantors, such as income statements, balance sheets and cash flow statements. We may require personal guarantees from shareholders of our corporate tenants. However, there can be no guarantee that the tenants selected will not default on their leases or that we can successfully enforce any guarantees.

Financing Sources

We will seek financing from a variety of sources to fund our potential acquisitions.  Such sources may include cash on hand, cash flow from operating activities and cash proceeds from any public offering or private placement of equity or debt securities.  We may also seek to obtain a revolving credit facility and other secured or unsecured loans to fund acquisitions.  We cannot provide any assurance that we will be successful in obtaining any financing for all or any of our potential acquisitions.

Borrowing

We may incur indebtedness to:

 
·
Finance our investments in real estate loans;

 
·
Prevent a default under real estate loans that are senior to our real estate loans;

 
·
Discharge senior real estate loans if this becomes necessary to protect our investment in real estate loans; or

 
·
Operate or develop a property that we acquired under a defaulted loan.

Our indebtedness should not exceed 70% of the fair market value of our real estate loans.  This indebtedness may be with recourse to our assets.

In addition, we may enter into structured arrangements with other lenders in order to provide them with a senior position in real estate loans that we might jointly fund.  For example, we might establish a wholly owned special purpose corporation that would borrow funds from an institutional lender under an arrangement where the resulting real estate loans would be assigned to a trust, and the trust would issue a senior certificate to the institutional lender and a junior certificate to the special purpose corporation.  This would assure the institutional lender of repayment in full prior to our receipt of any repayment on the jointly funded real estate loans.




Competition

Generally, real estate developers depend upon the timely completion of a project to obtain a competitive advantage when selling their properties.  We have sought to attract real estate developers by offering expedited loan processing, which generally provides quick approval and funding of a loan.  As a result, we have established a market niche as a non-conventional real estate lender.

We consider our direct competitors to be the providers of real estate loans who offer short-term, equity-based loans on an expedited basis for higher fees and rates than those charged by other financial institutional lenders such as commercial banks.  Many of the companies against which we compete have substantially greater financial, technical and other resources than either our company or our manager that may allow them to enjoy significant competitive advantages.  Competition in our market niche depends upon a number of factors, including terms and interest rates of a loan, the price of a property, speed of loan processing and closing escrow on properties, cost of capital, reliability, quality of service and support services.

Regulation

We are managed by Vestin Mortgage, subject to the oversight of our board of directors, pursuant to the terms and conditions of our management agreement.  Advant Mortgage, an affiliate of Vestin Mortgage, operates as a mortgage broker and is subject to extensive regulation by federal, state and local laws and governmental authorities.  Mortgage brokers we may use conduct their real estate loan businesses under a license issued by the State of Nevada Mortgage Lending Division.  Under applicable Nevada law, the division has broad discretionary authority over the mortgage brokers’ activities, including the authority to conduct periodic regulatory audits of all aspects of their operations.

We, our manager, and certain affiliates are also subject to the Equal Credit Opportunity Act of 1974, which prohibits creditors from discriminating against loan applicants on the basis of race, color, sex, age or marital status, and the Fair Credit Reporting Act of 1970, which requires lenders to supply applicants with the name and address of the reporting agency if the applicant is denied credit.  We are also subject to various other federal and state securities laws regulating our activities.  In addition, our manager is subject to the Employee Retirement Income Security Act of 1974.

The NASAA Guidelines have been adopted by various state agencies charged with protecting the interests of investors.  Administrative fees, loan fees, and other compensation paid to our manager and its affiliates would be generally limited by the NASAA Guidelines.  These Guidelines also include certain investment procedures and criteria, which are required for new loan investments.  We are not required to comply with NASAA Guidelines; however, we voluntarily comply with applicable NASAA Guidelines unless a majority of our unaffiliated directors determines that it is in our best interest to diverge from such NASAA Guidelines.

Because our business is regulated, the laws, rules and regulations applicable to us are subject to modification and change.  There can be no assurance that laws, rules or regulations will not be adopted in the future that could make compliance much more difficult or expensive, restrict our ability to invest in or service loans, further limit or restrict the amount of commissions, interest and other charges earned on loans, or otherwise adversely affect our business or prospects.

Employees

We have no employees.  Our manager has provided and will continue to provide most of the employees necessary for our operations, except as described below regarding Strategix Solutions, LLC.  As of December 31, 2012, the Vestin entities had a total of 16 full-time and no part-time employees.  Except as hereinafter noted, all employees are at-will employees and none are covered by collective bargaining agreements.  John Alderfer, our former CFO, is a party to an employment, non-competition, confidentiality and consulting contract with Vestin Group, Inc., the parent company of our manager, through December 31, 2016.




During April 2009, we entered into an accounting services agreement with Strategix Solutions, LLC (“Strategix Solutions”), a Nevada limited liability company, for the provision of accounting and financial reporting services.  Strategix Solutions also provides accounting and financial reporting services to VRM I and Fund III.  Our CFO and other members of our accounting staff are employees of Strategix Solutions.  Strategix Solutions is managed by LL Bradford and Company, LLC ("LL Bradford"), a certified public accounting firm that has provided non-audit accounting services to us.  The principal manager of LL Bradford was a former officer of our manager from April 1999 through January 1, 2005.  Strategix Solutions is owned by certain partners of LL Bradford, none of whom are currently or were previously officers of our manager.  On January 14, 2013, Eric Bullinger resigned from his position as Chief Financial officer of Vestin Realty Mortgage I, Inc. and Vestin Realty Mortgage II, Inc and the equivalent of Chief Financial Officer of Vestin Fund III, LLC (hereafter referred to collectively as the (“Vestin Entities”).  On January 14, 2013, the Board of Directors appointed Tracee Gress as the Chief Financial Officer of the Vestin Entities (or the equivalent thereof in the case of Vestin Fund III. LLC).  As of December 31, 2012, Strategix Solutions dedicates to us a total of three full time employees.

Available Information

Our Internet website address is www.vestinrealtymortgage2.com.  We make available free of charge through http://phx.corporate-ir.net/phoenix.zhtml?c=193758&p=irol-sec our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports as soon as reasonably practical after such material is electronically filed with or furnished, pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, to the United States Securities and Exchange Commission (“SEC”).  Further, a copy of this annual report on Form 10-K is located at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549.  Information on the operations of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330.  The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov.  Information contained on our website does not constitute a part of this Report on Form 10-K.

PROPERTIES

Our manager shares office facilities through a sublease, in Las Vegas, Nevada, with its parent corporation, Vestin Group.  In March 2010, Vestin Group entered into a ten–year lease agreement for office facilities in Las Vegas, Nevada.

LEGAL PROCEEDINGS

Please refer to Note N - Legal Matters Involving The Manager and Note O - Legal Matters Involving The Company in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K for information regarding legal proceedings, which discussion is incorporated herein by reference.

MINE SAFETY DISCLOSURES

None.





ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock is traded on the Nasdaq Global Select Market under the symbol VRTB and began trading on May 1, 2006.  The price per share of common stock presented below represents the highest and lowest sales price for our common stock on the Nasdaq Global Select Market.

2012
 
High
   
Low
 
             
First Quarter
  $ 1.55     $ 1.09  
Second Quarter
  $ 1.73     $ 1.10  
Third Quarter
  $ 1.68     $ 1.10  
Fourth Quarter
  $ 1.58     $ 1.22  

2011
 
High
   
Low
 
             
First Quarter
  $ 1.64     $ 1.01  
Second Quarter
  $ 1.52     $ 1.02  
Third Quarter
  $ 1.65     $ 1.10  
Fourth Quarter
  $ 1.40     $ 1.08  

Holders

As of March 28, 2013, there were approximately 1,158 holders of record of 12,069,805 shares of our common stock.

Dividend Policy

During June 2008, our Board of Directors decided to suspend the payment of dividends.  No dividends were declared during the years ended December 31, 2012 or 2011.  In light of our accumulated loss, we do not expect to pay dividends in the foreseeable future.

Recent Sales of Unregistered Securities

None

Equity Compensation Plan Information

None

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

On March 21, 2007, our board of directors authorized the repurchase of up to $10 million worth of our common stock.  Depending upon market conditions, shares may be repurchased from time to time at prevailing market prices through open market or privately negotiated transactions.  We are not obligated to purchase any shares.  Subject to applicable securities laws, repurchases may be made at such times and in such amounts, as our manager deems appropriate.  As of December 31, 2011 we had a total of 2,276,580 shares of treasury stock of which 189,378 were received as a part of a settlement in the amount of approximately $0.2 million.  On this date we retired 2,087,202 shares leaving a balance of 189,378 at a cost of approximately $0.2 million.  No shares were purchased pursuant to this plan, however, during 2012 we received and purchased 461,600 shares of treasury stock through settlement agreements and retired 650,978.  As of December 31, 2012 we have no treasury stock



The following is a summary of our stock acquisitions during the year ended December 31, 2012, as required by Regulation S-K, Item 703.

Period
 
(a) Total Number of Shares Purchased
   
(b) Average Price Paid per Share
   
(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
   
(d) Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs
 
January 1 – January 31, 2012
    --     $ --       --     $ 2,461,802  
February 1 – February 29, 2012
    --       --       --       2,461,802  
March 1 – March 31, 2012
    --       --       --       2,461,802  
April 1 – April 30, 2012
    --       --       --       2,461,802  
May 1 – May 31, 2012
    14,374       1.53       --       2,447,428  
June 1 – June 30, 2012
    --       --       --       2,447,428  
July 1 – July 31, 2012
    --       --       --       2,447,428  
August 1 – August 31, 2012
    447,226       1.40       --       2,000,202  
September 1 – September 30, 2012
    --       --       --       2,000,202  
October 1 – October 31, 2012
    --       --       --       2,000,202  
November 1 – November 30, 2012
    --       --       --       2,000,202  
December 1 – December 31, 2012
    --       --       --       2,000,202  
                                 
Total
    461,600     $ 1.40       --     $ 2,000,202  

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

The following is a financial review and analysis of our financial condition and results of operations for the years ended December 31, 2012 and 2011. This discussion should be read in conjunction with our financial statements and accompanying notes and other detailed information regarding us appearing elsewhere in this report on Form 10-K.

FORWARD-LOOKING STATEMENTS

Certain statements in this report, including, without limitation, matters discussed under this Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations, should be read in conjunction with the consolidated financial statements, related notes, and other detailed information included elsewhere in this report on Form 10-K.  We are including this cautionary statement to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  Statements that are not historical fact are forward-looking statements.  Certain of these forward-looking statements can be identified by the use of words such as “believes,” “anticipates,” “expects,” “intends,” “plans,” “projects,” “estimates,” “assumes,” “may,” “should,” “will,” or other similar expressions.  Such forward-looking statements involve known and unknown risks, uncertainties and other important factors, which could cause actual results, performance or achievements to differ materially from future results, performance or achievements.  These forward-looking statements are based on our current beliefs, intentions and expectations.  These statements are not guarantees or indicative of future performance.  Important assumptions and other important factors that could cause actual results to differ materially from those forward-looking statements include, but are not limited to, those factors, risks and uncertainties as discussed in this Annual Report on Form 10-K and in our other securities filings with the Securities and Exchange Commission (“SEC”).  Our future financial condition and results of operations, as well as any forward-looking statements, are subject to change and involve inherent risks and uncertainties.  Our estimates of the value of collateral securing our loans may change, or the value of the underlying property could decline subsequent to the date of our evaluation.  As a result, such estimates are not guarantees of the future value of the collateral.  The forward-looking statements contained in this report are made only as of the date hereof.  We undertake no obligation to update or revise information contained herein to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.




RESULTS OF OPERATIONS

OVERVIEW

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

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

Our operating results have been adversely affected by increases in allowances for loan losses and increases in non-performing assets.  This negative trend accelerated sharply during the year ended December 31, 2008 and continues to affect our operations.  See Note F – Real Estate Held for Sale and “Non-performing Loans” in Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.

Non-performing assets, net of allowance for loan losses, totaled approximately $2.9 million or 7% of our total assets as of December 31, 2012, as compared to approximately $20.3 million or 39% of our total assets as of December 31, 2011.  See Note F – Real Estate Held for Sale and Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.

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

Continued weakness in the commercial real estate markets and constraints on commercial lending may continue to have an adverse impact upon our markets.  In addition, even as real estate markets begin to recover, our operating results may be negatively impacted as we work through loans made prior to or during the great recession.  This may result in further defaults on our loans, and we might be required to record additional reserves based on decreases in market values, or we may be required to restructure additional loans.  This increase in loan defaults has materially affected our operating results and led to the suspension of dividends to our stockholders. For additional information regarding our non-performing loans see “Non-Performing Loans” in Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.

During the year ended December 31, 2012, we funded 18 loans totaling approximately $23.1 million.  During the year ended December 31, 2011, we funded 15 loans totaling approximately $14.3 million.  As of December 31, 2012, our loan-to-value ratio was 58.06%, net of allowances for loan losses, on a weighted average basis generally using updated appraisals.  Additional increases in loan defaults accompanied by additional declines in real estate values, as evidenced by updated appraisals generally prepared on an “as-is-basis,” will have a material adverse effect on our financial condition and operating results.



As of December 31, 2012, we have provided a specific reserve allowance for one non-performing loan and one performing loan based on updated appraisals of the underlying collateral and our evaluation of the borrower for these loans, obtained by our manager.  For further information regarding allowance for loan losses, refer to Note D – Investments in Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements and Supplementary Data of this Annual Report on Form 10-K.

Our capital, subject to a 3% reserve, will constitute the bulk of the funds we have available for investment in real estate loans.

As of December 31, 2012, our loans were in the following states: California, Michigan, Nevada, Ohio, Utah and Texas.

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

We announced on May 30, 2012 that we entered into a definitive merger agreement with VRM I pursuant to which our wholly owned subsidiary, VRM Merger Sub would merge with and into VRM I in a stock-for-stock merger, with VRM I surviving the transaction as our wholly owned subsidiary.  The merger agreement expired by its terms on December 31, 2012 and the merger did not occur.  The Board of Directors may reevaluate a potential merger with VRM I in the future.

SUMMARY OF FINANCIAL RESULTS

The Year Ended December 31, 2012

In 2012, we suffered a net loss of $13,050,000, largely as a result of a non-cash charge of nearly $11 million with respect to a secured, second position loan on the Sheraton Forth Worth Hotel in Texas.  We have entered into a contract to sell the property; however, the proposed buyer has sought an extension of time to close the sale and no assurance can be given that the sale will be consummated.  If the sale is completed, the bulk of the sales proceeds will be used to satisfy amounts due the senior lender and we might realize a small gain to the extent there are any remaining funds from the sale.  See the discussion below under “Discontinued Operations” and Note G to our financial statements.

Total Revenue:
 
2012
   
2011
   
$ Change
   
% Change
 
Interest income from investment in real estate loans
  $ 1,390,000     $ 1,244,000     $ 146,000       12 %
Gain related to pay off of real estate loan, including recovery of allowance for loan loss
    2,861,000       249,000       2,612,000       1049 %
Gain related to pay off of notes receivable, including recovery of allowance for notes receivable
    333,000       505,000       (172,000 )     (34 %)
Other income
    --       89,000       (89,000 )     (100 %)
            Total
  $ 4,584,000     $ 2,087,000     $ 2,497,000       120 %

Our revenue from interest income is dependent upon the balance of our investment in real estate loans and the interest earned on these loans.  Interest income has been adversely affected by the level of modified loans and the reduction in new lending activity during the first three quarters of 2011.  We experienced an increase in new lending activity in the second half of 2011 and first three quarters of 2012 which has produced an overall increase in interest income for 2012.  It is premature at this time to predict whether or not the increase in lending activity in the second half of 2011 and first three quarters of 2012 will be sustained in the future.  Payments on fully reserved loans resulted in an increase in gain related to payoff of real estate loan and other income.  During May 2012, we, VRM I and Fund III sold our portions of a fully reserved loan of $14.0 million, of which our portion was $12.6 million to a third party.  We received a payment of approximately $1.0 million. Additionally, we received approximately $1.8 million in recoveries for investments in real estate which previously included allowance for loan loss.  Gain related to recovery of allowance for notes receivable decreased in 2012 due to a reduction in receipts on notes receivable.



For additional information see Note D – Investments in Real Estate Loans and Note J -  Notes Receivable of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.

Operating Expenses:
 
2012
   
2011
   
$ Change
   
% Change
 
Management fees – related party
  $ 1,066,000     $ 1,098,000     $ (32,000 )     (3 %)
Provision for loan loss
    1,264,000       1,028,000       236,000       23 %
Interest expense
    3,000       206,000       (203,000 )     (99 %)
Professional fees
    1,375,000       1,419,000       (44,000 )     (3 %)
Consulting fees
    203,000       217,000       (14,000 )     (6 %)
Insurance
    292,000       304,000       (12,000 )     (4 %)
Other
    165,000       310,000       (145,000 )     (47 %)
            Total
  $ 4,368,000     $ 4,582,000     $ (214,000 )     (5 %)

Operating expenses were 5% lower during the year ended December 31, 2012 than in 2011.  Provision for loan losses were lower during 2012 than in 2011 due to values of the collateral securing our loans remaining constant.  Interest expense decreased during the year ended December 31, 2012 due to the decreased balance of secured borrowings which were paid off in 2011.  Professional fees have modestly decreased due to a decrease in pending litigation due to less non-performing loans and pursuing foreclosures and collections from borrowers.  Consulting fees have decreased due to credit review by a third party. Decrease in other operating expense is primarily due to decrease in directors fees and travel costs.

See “Specific Loan Allowance” in Note D – Investments in Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.


Non-operating Income (Loss):
 
2012
   
2011
   
$ Change
   
% Change
 
Interest income from banking institutions
  $ 1,000     $ 7,000     $ (6,000 )     (86 %)
Settlement income     90,000       --       90,000       100
Recovery from settlement with loan guarantor
    746,000       --       746,000       100 %
Gain on sale of marketable securities
    15,000       --       15,000       100 %
Discounted professional fees
    --       1,580,000       (1,580,000 )     (100 %)
Settlement expense
    (66,000 )     --       (66,000 )     (100 %)
            Total
  $ 786,000     $ 1,587,000     $ (801,000 )     (50 %)

In July, 2012, we along with our Manager, VRM I, Vestin Group, Vestin Originations and Michael Shustek entered into a Settlement Agreement and Mutual Release with the State of Hawaii and The Huntington National Bank as successor trustee to the Rightstar Trusts.  We and VRM I  were entitled to receive a portion of certain net proceeds from certain claims from third parties through litigation, settlement or otherwise.  The agreement resulted in income of $145,000, of which our portion was approximately $90,000. In addition, during January 2011, we, VRM I and Fund III were awarded unsecured claims up to $3.6 million from a bankruptcy settlement with a guarantor of certain loans. Pursuant to the terms of the settlement, we received payment of approximately $543,000 during April 2012 and $203,000 in July 2012.  The purchase and subsequent sale of marketable securities occurred during 2012, resulting in a gain of approximately $15,000.  No such transactions occurred in 2011. During 2011 we received approximately $1.6 million in discounts related to past legal bills.  There was no similar discount received in 2012. During the year ended December 31, 2012 we settled two lawsuits which resulted in an expense of approximately $66,000. In addition, we received from the plaintiff 14,374 shares of the company’s stock that was held as treasury stock, but since retired.

See Note Note O – Legal Matters Involving The Company of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.




Discontinued Operations, net of income taxes:
 
2012
   
2011
   
$ Change
   
% Change
 
Net gain on sale of real estate held for sale
  $ 50,000     $ 1,258,000     $ (1,208,000 )     (96 %)
Expenses related to real estate held for sale
    (1,716,000 )     (867,000 )     (849,000 )     (98 %)
Gain from settlement related to asset held for sale
    --       430,000       (430,000 )     (100 %)
Write-downs on real estate held for sale
    (1,469,000 )     (1,951,000 )     482,000       25 %
Income (loss) from assets held for sale, net of income taxes
    (10,917,000 )     1,889,000       (12,806,000 )     (678 %)
            Total
  $ (14,052,000 )   $ 759,000     $ (14,811,000 )     (1951 %)

Expenses related to discontinued operations increased by approximately $14.8 million during 2012 compared to 2011.  Discontinued operations relate to properties that have been foreclosed on and are recorded as assets held for sale.  This variance is primarily due to the anticipated loss of net assets held for sale based on recent offers of 1701 Commerce.  In addition, during 2011 we recorded net gains on sale of real estate held for sale for properties sold in prior periods due to payments on settlement agreements.  During 2012 we sold two properties held for sale, which resulted in net gain on sale of approximately $50,000. Expenses related to real estate held for sale increased due to acquiring two properties during 2012. The increase in expenses related to real estate held for sale is due to Attorney fees for the bankruptcy and other operating expenses for 1701 Commerce. During December 2011 we sold our controlling interest in Hawaii Funeral Services which resulted in a gain of approximately $0.4 million.  No similar transaction occurred in 2012. Write downs on real estate held for sale were higher during 2011 than they were during 2012. Due to the values of the collateral securing our loans remaining consistent. Income (loss) was received from two different assets held for sale during the years ended 2012 and 2011.

See Note F — Real Estate Held For Sale and Note G – Asset Held For Sale and Discontinued Operations of the Notes to the Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.

CAPITAL AND LIQUIDITY

Liquidity is a measure of a company’s ability to meet potential cash requirements, including ongoing commitments to fund lending activities and general operating purposes.  Subject to a 3% reserve, we generally seek to use all of our available funds to invest in real estate assets.  Distributable cash flow generated from such loans is paid out to our stockholders, in the form of a dividend.  We do not anticipate the need for hiring any employees, acquiring fixed assets such as office equipment or furniture, or incurring material office expenses during the next twelve months.  We may pay our manager an annual management fee of up to 0.25% of the aggregate capital received by Fund II and us from the sale of shares or membership units.

During the year ended December 31, 2012, net cash flows used in operating activities were approximately $3.3 million.  Operating cash flows were used for the payment of normal operating expenses such as management fees, accounting fees, legal bills and expenses related to real estate held for sale.  Cash flows related to investing activities consisted of cash used by loan investments in new real estate loans of approximately $23.0 million, an investment in MVP Realty Advisors of approximately $1.5 million, and investment in assets held for sale of approximately $0.1 million.  In addition, cash flows related to investing activities consisted of cash provided by loan payoffs and sale of investments in real estate loans to third parties of approximately $22.9 million, proceeds from the sale of REO and nonrefundable extension fees on REO of approximately $6.7 million, proceeds of $0.7 million from unsecured claims awarded from settlement with guarantor and proceeds from notes receivable of approximately $0.3 million.  In addition, the Bankruptcy Court issued an order to deny the dismissal of the bankruptcy and required 1701 Commerce to deposit $1 million as additional collateral with the court, of which our portion is $0.9 million.  Cash flows used in financing activities consisted of cash for payments on notes payable of approximately $0.2 million to finance our directors and officers insurance policy and purchase of treasury stock for approximately $0.7 million.

At December 31, 2012, we had approximately $10.0 million in cash, $0.6 million in marketable securities – related party and approximately $40.2 million in total assets.  We intend to meet short-term working capital needs through a combination of proceeds from loan payoffs, loan sales, sales of real estate held for sale and/or borrowings.  We believe we have sufficient working capital to meet our operating needs during the next 12 months.



We have no current plans to sell any new shares.  Although a small percentage of our shareholders have elected to reinvest their dividends, we suspended payment of dividends in June 2008 and at this time are not able to predict when dividend payments will resume.  Accordingly, we do not expect to issue any new shares through our dividend reinvestment program in the foreseeable future.

When economic conditions permit, we may seek to expand our capital resources through borrowings from institutional lenders or through securitization of our loan portfolio or similar arrangements.  No assurance can be given that, if we should seek to borrow additional funds or to securitize our assets, we would be able to do so on commercially attractive terms.  Our ability to expand our capital resources in this manner is subject to many factors, some of which are beyond our control, including the state of the economy, the state of the capital markets and the perceived quality of our loan portfolio.

We are considering various other options to enhance the Company’s capital resources.  We are seeking to raise funds through the private placement of various classes of promissory notes, some of which would be secured by certain of our real estate owned properties.  Our ability to raise any significant funds through such private placements in unknown.

During April 2012, we contributed $1,000 for a 40% interest in MVPRA, the manager of an affiliated REIT.  Mr. Shustek, through a wholly owned company named MVP Capital Partners, LLC (“MVPCP”), contributed $1,500 for a 60% interest in MVPRA.  We and MVPCP anticipate providing additional funds to MVPRA, either in the form of capital contributions or loans.  The amount and nature of such funding arrangements cannot be determined at this time. As of December 31, 2012, we and MVPCP have loaned approximately $1.5 million and approximately $1.6 million, respectively to MVPRA related to MVP REIT, Inc.

We maintain working capital reserves of approximately 3% in cash and cash equivalents, certificates of deposits and short-term investments or liquid marketable securities.  This reserve is available to pay expenses in excess of revenues, satisfy obligations of underlying properties, expend money to satisfy our unforeseen obligations and for other permitted uses of working capital.  As of March 28, 2013, we have met our 3% reserve requirement.

Investments in Real Estate Loans Secured by Real Estate Portfolio

We offer five real estate loan products consisting of commercial property, construction, acquisition and development, land, and residential loans.  The effective interest rates on all product categories range from 6% to 15%.  Revenue by product will fluctuate based upon relative balances during the period.  We had investments in 17 real estate loans, as of December 31, 2012, with a balance of approximately $27.4 million as compared to investments in 24 real estate loans as of December 31, 2011, with a balance of approximately $58.0 million.

For additional information on our investments in real estate loans, refer to Note D – Investments In Real Estate Loans of the Notes to the Consolidated Financial Statements included in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.

Asset Quality and Loan Reserves

As a commercial real estate lender willing to invest in riskier loans, rates of delinquencies, foreclosures or losses on our loans could be higher than those generally experienced in the commercial mortgage lending industry during this period of economic slowdown and recession.  Problems in the sub-prime residential mortgage market have adversely affected the general economy and the availability of funds for commercial real estate developers.  We believe this lack of available funds has led to an increase in defaults on our loans.  Furthermore, problems experienced in U.S. credit markets from 2007 through 2009 reduced the availability of credit for many prospective borrowers.  While credit markets have generally improved, the commercial real estate markets in our principal areas of operation have not recovered, thereby resulting in continuing constraints on the availability of credit in these markets.  These problems have made it more difficult for our borrowers to obtain the anticipated re-financing necessary in many cases to pay back our loans.  Thus, we have had to work with some of our borrowers to either modify, restructure and/or extend their loans in order to keep or restore the loans to performing status.  Our manager will continue to evaluate our loan portfolio in order to minimize risk associated with current market conditions.




OFF-BALANCE SHEET ARRANGEMENTS

As of December 31, 2012 and 2011 we do not have any interests in off-balance sheet special purpose entities nor do we have any interests in non-exchange traded commodity contracts.

RELATED PARTY TRANSACTIONS

From time to time, we may acquire or sell investments in real estate loans from/to our manager or other related parties pursuant to the terms of our Management Agreement without a premium.  No gain or loss is recorded on these transactions, as it is not our intent to make a profit on the purchase or sale of such investments.  The purpose is generally to diversify our portfolio by syndicating loans, thereby providing us with additional capital to make additional loans.  For further information regarding related party transactions, refer to Note H – Related Party Transactions in the Notes to our Consolidated Financial Statements in Part II, Item 8 Financial Statements of this Annual Report on Form 10-K.

CRITICAL ACCOUNTING ESTIMATES

Revenue Recognition

Interest income on loans is accrued by the effective interest method.  We do not accrue interest income from loans once they are determined to be non-performing.  A loan is considered non-performing when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement or when the payment of interest is 90 days past due.

The following table presents a sensitivity analysis, averaging the balance of our loan portfolio at the end of the last six quarters, to show the impact on our financial condition at December 31, 2012, from fluctuations in weighted average interest rate charged on loans as a percentage of the loan portfolio:

Changed Assumption
 
Increase (Decrease) in Interest Income
 
Weighted average interest rate assumption increased by 1.0% or 100 basis points
  $ 419,000  
Weighted average interest rate assumption increased by 5.0% or 500 basis points
  $ 2,091,000  
Weighted average interest rate assumption increased by 10.0% or 1,000 basis points
  $ 4,182,000  
Weighted average interest rate assumption decreased by 1.0% or 100 basis points
  $ (419,000 )
Weighted average interest rate assumption decreased by 5.0% or 500 basis points
  $ (2,091,000 )
Weighted average interest rate assumption decreased by 10.0% or 1,000 basis points
  $ (4,182,000 )

The purpose of this analysis is to provide an indication of the impact that the weighted average interest rate fluctuations would have on our financial results.  It is not intended to imply our expectation of future revenues or to estimate earnings.  We believe that the assumptions used above are appropriate to illustrate the possible material impact on the consolidated financial statements.

Allowance for Loan Losses

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




The following table presents a sensitivity analysis to show the impact on our financial condition at December 31, 2012, from increases and decreases to our allowance for loan losses as a percentage of the loan portfolio:

Changed Assumption
 
Increase (Decrease) in Allowance for Loan Losses
 
Allowance for loan losses assumption increased by 1.0% of loan portfolio
  $ 274,000  
Allowance for loan losses assumption increased by 5.0% of loan portfolio
  $ 1,369,000  
Allowance for loan losses assumption increased by 10.0% of loan portfolio
  $ 2,738,000  
Allowance for loan losses assumption decreased by 1.0% of loan portfolio
  $ (274,000 )
Allowance for loan losses assumption decreased by 5.0% of loan portfolio
  $ (1,369,000 )
Allowance for loan losses assumption decreased by 10.0% of loan portfolio
  $ (2,738,000 )

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

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

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

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

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

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

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

Real Estate Held for Sale

Real estate held for sale includes real estate acquired through foreclosure and will be carried at the lower of the recorded amount, inclusive of any senior indebtedness, or the property's estimated fair value, less estimated costs to sell, with fair value based on appraisals and knowledge of local market conditions.  The carrying values of real estate held for sale are assessed on a regular basis from updated appraisals, comparable sales values or purchase offers.

RECENT ACCOUNTING PRONOUNCEMENTS

No new accounting pronouncements have been defined that would materially impact our financial statements.




FINANCIAL STATEMENTS


INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 
Page
   
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
23
   
CONSOLIDATED FINANCIAL STATEMENTS
 
Consolidated Balance Sheets
24
Consolidated Statements of Operations
25
Consolidated Statements of Other Comprehensive Income (loss)
26
Consolidated Statements of Equity and Other Comprehensive Loss
27
Consolidated Statements of Cash Flows
28
Notes to the Consolidated Financial Statements
30
   








REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Stockholders of
Vestin Realty Mortgage II, Inc.

We have audited the accompanying consolidated balance sheets of Vestin Realty Mortgage II, Inc. (the “Company”) as of December 31, 2012 and 2011 and the related consolidated statements of operations, other comprehensive income (loss) equity and other comprehensive loss, and cash flows for each of the two years in the period ended December 31, 2012. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Vestin Realty Mortgage II, Inc. as of December 31, 2012 and 2011, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.


/s/ JLK Rosenberger, LLP

Irvine, California
March 28, 2013


FINANCIAL STATEMENTS

VESTIN REALTY MORTGAGE II, INC.
 
   
CONSOLIDATED BALANCE SHEETS
 
   
ASSETS
 
   
December 31, 2012
   
December 31, 2011
 
             
Assets
           
Cash
  $ 10,098,000     $ 9,226,000  
Investment in marketable securities - related party
    592,000       592,000  
Interest and other receivables, net of allowance of $2,428,000 at December 31, 2012 and $5,468,000 at December 31, 2011
    22,000       14,000  
Notes receivable, net of allowance of $20,700,000 at December 31, 2012 and $17,250,000 at December 31, 2011
    --       --  
Real estate held for sale
    2,619,000       10,767,000  
Investment in real estate loans, net of allowance for loan losses of $2,500,000 at December 31, 2012 and $26,247,000 at December 31, 2011
    24,880,000       31,777,000  
Due from related parties
    333,000       110,000  
Investment in and note receivable from MVP Realty Advisors, LLC
    1,534,000       --  
Other assets
    127,000       149,000  
Total assets
  $ 40,205,000     $ 52,635,000  
LIABILITIES AND EQUITY
 
Liabilities
               
Accounts payable and accrued liabilities
  $ 1,080,000     $ 753,000  
Notes payable
    25,000       25,000  
Deferred gain on sale of HFS
    6,000       102,000  
Total liabilities
    1,111,000       880,000  
                 
Commitments and contingencies
               
                 
Equity
Stockholders’ equity
               
Preferred stock, $0.0001 par value; 1,000,000 shares authorized; none issued
    --       --  
Treasury stock, at cost, 0 shares at December 31, 2012 and 189,378 at December 31, 2011
    --       (190,000 )
Common stock, $0.0001 par value; 100,000,000 shares authorized; 12,069,805 shares issued and outstanding at December 31, 2012, and 12,720,783 shares issued and 12,531,405 outstanding at December 31, 2011
    1,000       1,000  
Additional paid-in capital
    270,150,000       271,005,000  
Accumulated deficit
    (231,066,000 )     (219,070,000 )
Accumulated other comprehensive income
    9,000       9,000  
Total stockholders’ equity
    39,094,000       51,755,000  
                 
Total liabilities and equity
  $ 40,205,000     $ 52,635,000  



VESTIN REALTY MORTGAGE II, INC.
 
   
CONSOLIDATED STATEMENTS OF OPERATIONS
 
   
For the Year Ended
 
   
12/31/2012
   
12/31/2011
 
             
Revenues
           
Interest income from investment in real estate loans
  $ 1,390,000     $ 1,244,000  
Gain related to pay off of real estate loan, including recovery of allowance for loan loss
    2,861,000       249,000  
Gain related to pay off of notes receivable, including recovery of allowance for notes receivable
    333,000       505,000  
Other income
    --       89,000  
Total revenues
    4,584,000       2,087,000  
Operating expenses
               
Management fees - related party
    1,066,000       1,098,000  
Provision for loan loss
    1,264,000       1,028,000  
Interest expense
    3,000       206,000  
Professional fees
    1,375,000       1,419,000  
Consulting fees
    203,000       217,000  
Insurance
    292,000       304,000  
Other
    165,000       310,000  
Total operating expenses
    4,368,000       4,582,000  
Income (loss) from operations
    216,000       (2,495,000 )
Non-operating income (loss)
               
Interest income from banking institutions
    1,000       7,000  
Recovery from settlement with loan guarantor
    746,000       --  
Gain on sale of marketable securities
    15,000       --  
Settlement income
    90,000       --  
Discounted professional fees
    --       1,580,000  
Settlement expense
    (66,000 )     --  
Total other non-operating income, net
    786,000       1,587,000  
Provision for income taxes
    --       --  
Income (loss) from continuing operations
    1,002,000       (908,000 ))
Discontinued operations, net of income taxes
               
Net gain on sale of real estate held for sale
    50,000       1,258,000  
Expenses related to real estate held for sale
    (1,716,000 )     (867,000 )
Write-downs on real estate held for sale
    (1,469,000 )     (1,951,000 )
Gain related to HFS settlement
    --       430,000  
Income (loss) from assets held for sale, net of income taxes
    (10,917,000 )     1,889,000  
Total income (loss) from discontinued operations
    (14,052,000 )     759,000  
                 
Net loss
    (13,050,000 )     (149,000 )
Allocation to non-controlling interest – related party
    1,054,000       (718,000 )
                 
Net loss attributable to common stockholders
  $ (11,996,000 )   $ (867,000 )
Basic and diluted loss per weighted average common share
               
Continuing operations
  $ 0.08     $ (0.07 )
Discontinued operations
    (1.05 )     0.00  
Total basic and diluted loss per weighted average common share
  $ (0.97 )   $ (0.07 )
Dividends declared per common share
  $ --     $ --  
Weighted average common shares outstanding
    12,354,428       12,984,982  




VESTIN REALTY MORTGAGE II, INC.
 
CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE INCOME (LOSS)
 

   
For The Year Ended
 
   
12/31/2012
   
12/31/2011
 
             
Net loss
  $ (13,050,000 )   $ (149,000 )
                 
Unrealized holding gain on available-for-sale securities – related party
    --       46,000  
                 
Comprehensive loss
    (13,050,000 )     (103,000 )
Net (income) loss attributable to noncontrolling interest
    1,054,000       (718,000 )
                 
Comprehensive loss attributable to Vestin Realty Mortgage II, Inc.
  $ (11,996,000 )   $ (821,000 )
                 




VESTIN REALTY MORTGAGE II, INC.

CONSOLIDATED STATEMENTS OF EQUITY AND OTHER COMPREHENSIVE LOSS

                                                             
   
Treasury Stock
   
Common Stock
                                     
   
Shares
   
Amount
   
Shares
   
Amount
   
Additional
Paid-in-
Capital
   
Accumulated Deficit
   
Accumulated
Other Comprehensive
Loss
   
Common shares held by trusts related to assets held for sale
   
Noncontrolling Interest – Related Party
   
Total
 
Stockholders' Equity at December 31, 2010     1,857,850     $ (6,907,000 )     13,139,513     $ 1,000     $ 278,550,000     $ (218,203,000 )   $ (37,000 )   $ (648,000 )   $ 5,379,000     $ 58,135,000  
Net Income (Loss)
                                            (867,000 )                     718,000       (149,000 )
                                                                                 
Unrealized Gain on Marketable Securities - Related Party
                                                    46,000                       46,000  
                                                                                 
Comprehensive Loss
                                                                            (103,000 )
                                                                                 
Distributions – Related Party
                                                                    (440,000 )     (440,000 )
                                                                                 
Disposition of Assets Held for Sale
                                                            648,000       (5,657,000 )     (5,009,000 )
                                                                                 
Retire Treasury Stock
    (2,276,580 )     7,545,000               --       (7,545,000 )                                     --  
                                                                                 
Purchase of Treasury Stock
    608,108       (828,000 )     (608,108 )                                                     (828,000 )
                                                                                 
Stockholders' Equity at
December 31, 2011
    189,378     $ (190,000 )     12,531,405     $ 1,000     $ 271,005,000     $ (219,070,000 )   $ 9,000     $ --     $ --     $ 51,755,000  
                                                                                 
Net Loss
                                            (11,996,000 )                     (1,054,000 )     (13,050,000 )
                                                                                 
Unrealized Gain on Marketable Securities - Related Party
                                                    --                       --  
Comprehensive loss                                                                             (13,050,000 )
Write-off of Assets Held for Sale
                                                                    1,054,000       1,054,000  
Retire Treasury Stock
    (650,978 )     855,000               --       (855,000 )                                     --  
                                                                                 
Purchase of Treasury Stock
    461,600       (665,000 )     (461,600 )                                                     (665,000 )
                                                                                 
Stockholders' Equity at
December 31, 2012
    --     $ --       12,069,805     $ 1,000     $ 270,150,000     $ (231,066,000 )   $ 9,000     $ --     $ --     $ 39,094,000  


The accompanying notes are an integral part of these consolidated financial statements.
 
-27-



VESTIN REALTY MORTGAGE II, INC.
 
   
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
   
For the Year Ended
 
   
12/31/2012
   
12/31/2011
 
Cash flows from operating activities:
           
Net loss
  $ (13,050,000 )   $ (149,000 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Write-downs on real estate held for sale
    1,469,000       1,951,000  
Gain on sale of real estate held for sale
    (50,000 )     (1,258,000 )
Gain related to recovery from settlement with loan guarantor
    (746,000 )     --  
Gain on proceeds from settlement
    (90,000 )     --  
Gain on sale of marketable securities
    (15,000 )     --  
Loss from assets held for sale
    10,917,000       --  
Recovery of allowance for doubtful notes receivable included in other income
    (333,000 )     (505,000 )
Gain related to recovery of allowance for loan loss
    (2,861,000 )     (249,000 )
Provision for loan loss
    1,264,000       1,028,000  
Amortized interest income
    --       (26,000 )
Change in operating assets and liabilities:
               
Interest and other receivables
    (6,000 )     2,105,000  
Assets held for sale, net of liabilities
    --       (590,000 )
Due to/from related parties, net
    (223,000 )     601,000  
Deferred gain on sale of Hawaii Funeral Services, LLC
    (96,000 )     --  
Other assets
    241,000       220,000  
Accounts payable and accrued liabilities
    325,000       (3,860,000 )
Net cash used in operating activities
  $ (3,254,000 )   $ (732,000 )
                 
Cash flows from investing activities:
               
Investments in real estate loans
  $ (23,069,000 )   $ (14,337,000 )
Purchase of investments in real estate loans from:
               
VRM I
    (370,000 )     --  
Proceeds from loan payoffs
    18,316,000       6,416,000  
Sale of investments in real estate loans to:
               
VRM I
    1,000,000       --  
Other related parties
    --       500,000  
Third parties
    3,622,000       2,743,000  
Proceeds related to real estate held for sale
    6,737,000       479,000  
Proceeds from settlement income
    90,000       --  
Investment in and note receivable from MVP Realty Advisors, LLC
    (1,534,000 )     --  
Investment in assets held for sale
    (900,000 )     --  
Proceeds on nonrefundable extension fees on real estate held for sale
    24,000       89,000  
Proceeds from sale of asset held for sale
    --       9,369,000  
Proceeds from note receivable
    333,000       505,000  
Proceeds from settlement with loan guarantor
    746,000       --  
Sale of marketable securities
    1,026,000       --  
Purchase of marketable securities
    (1,011,000 )     --  
Purchase of marketable securities – related party
    --       (6,000 )
Net cash provided by investing activities
  $ 5,010,000     $ 5,758,000  
Cash flows from financing activities:
               
Principal payments on notes payable
  $ (219,000 )   $ (1,518,000 )
Distributions to holder of noncontrolling interest – related party
    --       (440,000 )
Cash used for pay down on secured borrowings
    --       (1,088,000 )
Purchase of treasury stock at cost
    (665,000 )     (638,000 )
Net cash used in financing activities
  $ (884,000 )   $ (3,684,000 )
                 
NET CHANGE IN CASH
    872,000       1,342,000  
Cash, beginning of period
    9,226,000       7,884,000  
Cash, end of period
  $ 10,098,000     $ 9,226,000  

The accompanying notes are an integral part of these consolidated financial statements.
 
-28-



             
Supplemental disclosures of cash flows information:
           
Interest paid
  $ 3,000     $ 206,000  
                 
Non-cash investing and financing activities:
               
Retirement of treasury stock
  $ 855,000     $ 7,545,000  
Treasury stock acquired through settlement
  $ --     $ (190,000 )
Write-off of notes receivable and related allowance
  $ --     $ 8,090,000  
Note payable relating to prepaid D & O insurance
  $ 219,000     $ 219,000  
Real estate held for sale acquired through foreclosure, net of prior allowance
  $ 32,000     $ 160,000  
Assets held for sale acquired, net of related liabilities and noncontrolling interest –related party
  $ 8,963,000     $ --  
Deferred gain on asset held for sale
  $ --     $ 102,000  
Investment in real estate loans by purchase of secured borrowings
  $ --     $ 1,320,000  
Accrued liabilities related to sale of asset held for sale
  $ --     $ 38,000  
Write-off of interest receivable and related allowance
  $ 810,000     $ 160,000  
Transfer of fully allowed interest receivable to notes receivable
  $ 907,000     $ --  
Adjustment to accrued interest and related allowance
  $ (1,013,000 )   $ --  
Adjustment to note receivable and related allowance for charge offs
  $ --     $ 3,580,000  
Transfer of fully allowed interest receivable and related allowance to real estate held for sale
  $ 2,334,000     $ --  
Investment in real estate loans and related allowances transferred to note receivable
  $ 7,407,000     $ --  
Unrealized gain on marketable securities - related party
  $ --     $ 46,000  



VESTIN REALTY MORTGAGE II, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2012

NOTE A — ORGANIZATION

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

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

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

As discussed in Part I, Item 1, Business of this Annual Report on Form 10-K, we are managed by Vestin Mortgage pursuant to a management agreement.  Vestin Mortgage is also the manager of Vestin Realty Mortgage I, Inc. (“VRM I”), as the successor by merger to Vestin Fund I, LLC (“Fund I”) and Vestin Fund III, LLC (“Fund III”).  These entities were formed to invest in real estate loans.  VRM I has investment objectives similar to ours, and Fund III is in the process of an orderly liquidation of its assets.

The consolidated financial statements include the accounts of VRM II, Vestin TRS II, Inc., our wholly owned subsidiary, 1701 Commerce, LLC and Hawaii Funeral Service, LLC, in which we had a controlling interest through December 1, 2011. Our consolidated financial statements also included the accounts of the funeral merchandise and service trusts, cemetery merchandise and service trusts, and cemetery perpetual care trusts (“Trusts”) in which we had a variable interest and HFS was the primary beneficiary through December 1, 2011.  All significant inter-company transactions and balances have been eliminated in consolidation.




During April 2009, we entered into an accounting services agreement with Strategix Solutions, LLC (“Strategix Solutions”), a Nevada limited liability company, for the provision of accounting and financial reporting services.  Strategix Solutions also provides accounting and financial reporting services to VRM I and Fund III.  Our CFO and other members of our accounting staff are employees of Strategix Solutions.  Strategix Solutions is managed by LL Bradford and Company, LLC ("LL Bradford"), a certified public accounting firm that has provided non-audit accounting services to us.  The principal manager of LL Bradford was a former officer of our manager from April 1999 through January 1, 2005.  Strategix Solutions is owned by certain partners of LL Bradford, none of whom are currently or were previously officers of our manager.  On January 14, 2013, Eric Bullinger resigned his position as Chief Financial Officer of Vestin Realty Mortgage I, Inc. and Vestin Realty Mortgage II, Inc and the equivalent of Chief Financial Officer of Vestin Fund III, LLC (hereafter referred to collectively as the “Vestin Entities”).  On January 14, 2013, the Board of Directors appointed Tracee Gress as the Chief Financial Officer of the Vestin Entities (or the equivalent thereof in the case of Vestin Fund III, LLC).  As used herein, “management” means our manager, its executive officers and the individuals at Strategix Solutions who perform accounting and financial reporting services on our behalf.

NOTE B — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The financial statements of the Company have been prepared in accordance with the accounting principles generally accepted in the United States of America (“GAAP”).  Management has included all normal recurring adjustments considered necessary to give a fair presentation of operating results for the periods presented.

Management Estimates

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

Cash and Cash Equivalents

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

Revenue Recognition

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

Investments in Real Estate Loans

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



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

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

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

Allowance for Loan Losses

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

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

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

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

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

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



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

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

Discontinued Operations

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

Real Estate Held for Sale

Real estate held for sale (“REO”) includes real estate acquired through foreclosure and will be carried at the lower of the recorded amount, inclusive of any senior indebtedness, or the property's estimated fair value, less estimated costs to sell, with fair value based on appraisals and knowledge of local market conditions.  While pursuing foreclosure actions, we seek to identify potential purchasers of such property.  It is not our intent to invest in or to own real estate as a long-term investment.  We generally seek to sell properties acquired through foreclosure as quickly as circumstances permit, taking into account current economic conditions.  The carrying values of REO are assessed on a regular basis from updated appraisals, comparable sales values or purchase offers.

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

 
·
Management commits to a plan to sell the properties;

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

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

 
·
The sale of the property is probable;

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

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

Real Estate Held For Sale – Seller-Financed

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

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




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

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

Secured Borrowings

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

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

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

Investment in Marketable Securities – Related Party

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

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

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

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

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



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

Fair Value Disclosures

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

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

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

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

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

Basic and Diluted Earnings Per Common Share

Basic earnings per share (“EPS”) is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding.  Diluted EPS is similar to basic EPS except that the weighted average number of common shares outstanding is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been exercised.  We had no outstanding common share equivalents during the years ended December 31, 2012 and 2011.

Common Stock Dividends

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

Treasury Stock

On June 7, 2012, our Board of Directors (“Board”) approved the adoption of a prearranged stock repurchase plan intended to qualify for the safe harbor under Rule 10b5-1 under the Securities Exchange Act of 1934, as amended (“10b5-1 Plan”). Due to the postponement of the merger between VRM I and us, the 10b5-1 plan has been terminated.  No shares were purchased pursuant to this plan, however, during 2012 we received and purchased 461,600 shares of treasury stock through settlement agreements and retired 650,978.




Segments

We are currently authorized to operate two reportable segments, investments in real estate loans and investments in real property.  As of December 31, 2012, we had not commenced investing in real property.

Our objective is to invest approximately 97% of our assets in real estate loans and real estate investments, while maintaining approximately 3% as a working capital cash reserve.  Current market conditions have impaired our ability to be fully invested in real estate loans.  As of December 31, 2012, approximately 62% of our assets, net of allowance for loan losses, are classified as investments in real estate loans.

Reclassifications

Certain amounts in the December 31, 2011 consolidated financial statements have been reclassified to conform to the December 31, 2012 presentation.

Principles of Consolidation

Our consolidated financial statements include the accounts of VRM II, Vestin TRS II, Inc., our wholly owned subsidiary, 1701 Commerce, LLC and Hawaii Funeral Service, LLC, in which we had a controlling interest through December 1, 2011. Our consolidated financial statements also included the accounts of the funeral merchandise and service trusts, cemetery merchandise and service trusts, and cemetery perpetual care trusts (“Trusts”) in which we had a variable interest and HFS was the primary beneficiary through December 1, 2011. Intercompany balances and transactions have been eliminated in consolidation.

Business Combinations

 
In December 2007, the Financial Accounting Standards Board (FASB) revised the authoritative guidance for business combinations, establishing principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired (including goodwill), the liabilities assumed, and any noncontrolling interest in the acquiree. Subsequently, on April 1, 2009, the FASB amended and clarified certain aspects of its authoritative guidance on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. We apply the FASB authoritative guidance to all business combinations for which the acquisition date is on or after January 1, 2009, and to certain future income tax effects related to our prior business combinations, should they arise.

Noncontrolling Interests

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

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



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

The Company follows the accounting guidance which provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized initially and in subsequent periods.  Also included is guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As of December 31, 2012, tax years that remain subject to examination by major tax jurisdictions include the years ended December 31, 2009 through 2011.

NOTE C — FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK

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

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

We maintain cash deposit accounts and certificates of deposit which, at times, may exceed federally-insured limits.  To date, we have not experienced any losses.  As of December 31, 2012 and 2011, we had no funds in excess of the federally-insured limits.

As of December 31, 2012, 55% and 24% of our loans were in Nevada and California, respectively, compared to 36%, 28% 19% and 15% of our loans were in Nevada, Arizona, Texas and California, respectively, as of December 31, 2011.  As a result of this geographical concentration of our real estate loans, the downturn in the local real estate markets in these states has had a material adverse effect on us.

At December 31, 2012, the aggregate amount of loans to our three largest borrowers represented approximately 45% of our total investment in real estate loans.  These real estate loans consisted of commercial and land loans, secured by properties located in Nevada and California, with a first lien position.  Their interest rates are between 8% and 11%, and the aggregate outstanding balance is approximately $12.3 million.  As of December 31, 2012, our largest loan, totaling approximately $6.7 million, is secured by property located in California, is a performing loan with an interest rate of 11%.  The other two loans, secured by property in Nevada, each have an interest rate of 8% and are considered performing.  At December 31, 2011, the aggregate amount of loans to our three largest borrowers represented approximately 53% of our total investment in real estate loans.  These real estate loans consisted of commercial and land loans, secured by property located in Arizona, Texas and California, with a first lien position on the California loan and second lien positions on the Arizona and Texas loans.  Their interest rates ranged between 8% and 15%, and the aggregate outstanding balance was approximately $30.7 million.

In prior periods, we had a significant concentration of credit risk with our largest borrowers.  During the year ended December 31, 2011, four of our performing loans totaling approximately $17.9 million, of which our portion was approximately $9.9 million, accounted for approximately 58% of our interest income.  Three of these loans were paid in full as of December 31, 2011.  Loans funded during 2012 have diversified our portfolio.




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

Common Guarantors

As of December 31, 2011, four loans totaling approximately $11.0 million had a common guarantor.  These loans represented approximately 19.0% of our portfolio’s total value as of December 31, 2011.  All four loans were considered performing as of December 31, 2011.  These loans were either paid off or transferred to notes receivable, net of allowances for loan loss during 2012.  For additional information regarding these loans, see Note J — Notes Receivable.

As of December 31 2012 and 2011, four and nine loans totaling approximately $5.8 million and $6.2 million, respectively, representing approximately 21.3% and 10.7%, respectively, of our portfolio’s total value, had a common guarantor.  At December 31, 2012 and 2011 all loans were considered performing.

As of December 31, 2012 four loans totaling approximately $7.9 million representing approximately 28.9% of our portfolio’s total value had a common guarantor.  As of December 31, 2012 all loans were considered performing.

NOTE D — INVESTMENTS IN REAL ESTATE LOANS

As of December 31, 2012 and 2011, most of our loans provided for payments of interest only with a “balloon” payment of principal payable in full at the end of the term.  As of December 31, 2012, three loans had a variable interest rate adjusted quarterly at a rate of prime plus 3.30% (6.55% as of December 31, 2012). The balance on these loans was approximately $0.3 million as of December 31, 2012.  We had not investments with variable interest rates as of December 31, 2011.

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

Loan Portfolio

As of December 31, 2012, we had five available real estate loan products consisting of commercial, construction, acquisition and development, land and residential.  The effective interest rates on all product categories range from 6%  to 15% which includes performing loans that are being fully or partially accrued and will be payable at maturity.  Revenue by product will fluctuate based upon relative balances during the period.

Investments in real estate loans as of December 31, 2012, were as follows:

Loan Type
 
Number of Loans
   
Balance *
   
Weighted Average Interest Rate
   
Portfolio Percentage
   
Current Weighted Average Loan-To-Value, Net of Allowance for Loan Losses
 
                               
Commercial
    15       19,648,000       9.06 %     71.76 %     62.32 %
Land
    2       7,732,000       10.33 %     28.24 %     48.60 %
Total
    17     $ 27,380,000       9.42 %     100.00 %     58.06 %




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

*
Please see Balance Sheet Reconciliation below.

The “Weighted Average Interest Rate” as shown above is based on the contractual terms of the loans for the entire portfolio including non-performing loans.  The weighted average interest rate on performing loans only, as of December 31, 2012 and 2011, was 8.87% and 6.79%, respectively.  Please see “Non-Performing Loans” and “Asset Quality and Loan Reserves” below for further information regarding performing and non-performing loans.

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

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

 
Loan Type
 
Number of Loans
   
December 31, 2012 Balance*
   
Portfolio
Percentage
   
Number of Loans
   
December 31, 2011 Balance*
   
Portfolio
Percentage
 
                                     
First deeds of trust
    16     $ 26,682,000       97.00 %     18     $ 28,684,000       49.43 %
Second deeds of trust
    1       698,000       3.00 %     6       29,340,000       50.57 %
Total
    17     $ 27,380,000       100.00 %     24     $ 58,024,000       100.00 %

*
Please see Balance Sheet Reconciliation below.

The following is a schedule of contractual maturities of investments in real estate loans as of December 31, 2012:

Non-performing and past due loans (a)
  $ 2,450,000  
January 2013 – March 2013(b)
    5,311,000  
April 2013 – June 2013(b)
    9,720,000  
July 2013 – September 2013(b)
    9,578,000  
October 2013 – December 2013
    --  
Thereafter
    321,000  
         
Total
  $ 27,380,000  


 
(a)
Amounts include the balance of non-performing loans.
 
(b)
Amounts include loans that have been or are in the process of being extended subsequent to March 28, 2013.




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

   
December 31, 2012 Balance *
   
Portfolio Percentage
   
December 31, 2011 Balance *
   
Portfolio Percentage
 
                         
Arizona
  $ --       --     $ 16,108,000       27.76 %
California
    6,696,000       24.46 %     8,564,000       14.76 %
Colorado
    --       --       895,000       1.54 %
Michigan
    2,160,000       7.89 %     --       --  
Nevada
    15,151,000       55.34 %     21,114,000       36.39 %
Ohio
    321,000       1.17 %     323,000       0.56 %
Oregon
    --       --       46,000