UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

 

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

For the fiscal year ended December 31, 2020.

 

or

 

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

 

For the transition period from ________ to ________

 

Commission File Number: 000-1695962

 

KORTH DIRECT MORTGAGE INC.

(Exact name of registrant as specified in its charter)

 

Florida		27-0644172
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

 

135 San Lorenzo Avenue, Suite 600, Coral Gables, FL 33146

(Address of principal executive offices)

(305) 668-8485

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:         None

 

Securities registered pursuant to Section 12(g) of the Act:         None

 

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

 

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

 

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 þ No o

 

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

 

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

 

Large accelerated filer	o	Accelerated filer	o
Non-accelerated filer	o	Smaller Reporting company	þ
		Emerging growth company	þ

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.o

 

 

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. Yes ¨ No þ

 

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. Yes ¨ No þ

 

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

 

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.

 

There is no market for the common equity of Korth Direct Mortgage Inc. As of December 31, 2020, there were 5,000,000 common shares of KDM outstanding.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

No documents are incorporated in this Form 10-K by reference.

 

 

 

KORTH DIRECT MORTGAGE, Inc.

 

TABLE OF CONTENTS

 

PART I
Item 1.	Business	4
Item 1A.	Risk Factors	9
Item 1B.	Unresolved Staff Comments	13
Item 2.	Properties	13
Item 3.	Legal Proceedings	13
Item 4.	Mine Safety Disclosures	14
PART II
Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	15
Item 6.	Selected Financial Data	15
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	20
Item 8.	Consolidated Financial Statements	20
Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	21
Item 9A.	Controls and Procedures	21
Item 9B.	Other Information	21
PART III
Item 10.	Directors, Executive Officers and Corporate Governance	22
Item 11.	Executive Compensation	23
Item 12.	Security Ownership of Certain Beneficial Ownership and Management and Related Stockholder Matters	25
Item 13.	Certain Relationships and Related Transactions, and Director Independence	26
Item 14.	Principal Accountant Fees and Services	26
PART IV
Item 15.	Exhibits and Financial Statement Schedules	27

 

 

FORWARD-LOOKING STATEMENTS

 

Some of the information contained in this Report constitutes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may include current expectations of future events based on certain assumptions and statements that do not directly relate to any historical or current fact. When used in this Annual Report, in future filings by the Company with the Securities and Exchange Commission, in the Company’s press releases or other public or shareholder communications, on the Company’s website, or in oral statements made with the approval of an authorized executive officer, the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” “plans,” “believes,” or similar expressions are intended to identify forward-looking statements. The Company’s forward-looking statements are based on management’s current expectation and assumption regarding the Company’s business and performance, the economy, and other future conditions and forecasts of future events, circumstances and results. As with any projection statement or forecast, forward-looking statements are inherently susceptible to uncertainty and changes in circumstances. The Company’s actual results may vary materially from those expressed or implied in its forward-looking statements. Important factors that could cause the Company’s actual results to differ materially from those in its forward-looking statements include, among other things, our inability to predict the extent to which the COVID-19 pandemic and related impacts may adversely impact our business operations, financial performance, results of operations, financial position, and the achievement of our strategic objectives; the status of borrowers; the ability of borrowers to repay CM Loans, as defined below; the plans of borrowers; expected rates of return and interest rates; mortgage default rates; property values; the commercial real estate market; the attractiveness of our CM Loans and Notes; our financial performance; the availability of a secondary market for our Notes; our ability to retain and hire competent employees and appropriately staff our operation; government regulation; regional and national economic conditions, substantial changes in levels of market interest rates; and competitive and regulatory factors.

 

The Company does not undertake and specifically disclaims any obligation to update any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

 

 

PART I

 

Item 1. Business

 

Throughout this Report we use the terms “KDM,” “we,” “Company,” and “us” to refer to Korth Direct Mortgage Inc.

 

Our principal executive offices are located at 135 San Lorenzo Avenue Suite 600, Coral Gables, Florida 33146, and our telephone number is (305) 668-8485. Our website address is korthdirect.com.

 

Korth Direct Mortgage Inc., began its formal operations in October of 2016 when we engaged our Chief Lending Officer. KDM is a licensed Mortgage Lender Servicer with the State of Florida. Our NMLS License Number is 1579547. KDM converted from a Florida limited liability company to a Florida corporation effective June 6, 2019. On July 31, 2020 KDM’s ownership was reorganized, and its former sole shareholder, J. W. Korth & Company Limited Partnership (“J. W. Korth”), a FINRA and SEC registered broker-dealer founded in 1982, is now a wholly owned subsidiary of the Company.

 

Overview

 

KDM originates and funds CM Loans, as herein defined, to borrowers The CM Loans are held by KDM as lender. KDM also services its CM Loans, though it may use a sub-servicer for some loans. KDM funds its CM Loans directly in the capital markets through issuance of Mortgage Secured Notes (“MSNs” or “Notes”). The MSNs are special obligations of KDM, payable to the extent that the underlying mortgage is paid by the borrower. MSNs are secured by KDM’s interest in the underlying Corresponding Mortgage Loan (“CM Loan”). CM Loans are secured obligations of the borrowers, which are generally a single-purpose entity formed or existing that owns the underlying property that is financed.

 

Our loan origination team is comprised of employees and a network of brokers that have joined the KDM Broker Network to submit loans to us via our website and email. We have created software that integrates with our customer relationship management (“CRM”) software to optimize our digital marketing campaigns and streamline our origination program. We also engage in traditional email, internet, trade show, and telephone marketing as well as leveraging our broker network to source new deals.

 

We have positioned ourselves in the lending market as a source for commercial real estate loans of higher quality borrowers, and borrowers that may not qualify or may not want to go through the process for bank loans, but whose loans have strong property and mortgage-related metrics. We fill the gap between traditional lenders and hard money lenders, which we call Middle-Money^.. Property metrics depend on the type of CM Loan being offered and are described below.

 

 

KDM is currently focused on the market for loans secured by mortgages on commercial-tenanted properties, including multi-family housing, offices, industrial, and warehouses, but may fund other types of commercial real estate.

 

KDM funds its loans by securitizing them in the capital markets as MSNs. J. W. Korth & Company acts as underwriter of the Notes and distributes them to institutional investors. The cash from the closing of each MSN issuances is used to complete the funding of the CM Loan or CM Loans underlying each MSN.

 

The KDM Process

 

When KDM identifies a property proposed for financing, it is screened by KDM’s origination underwriting team. If the proposed financing passes underwriting, KDM creates a summary sheet and an estimated KDM Rating which it sends to the underwriter to gauge an indication of interest. When the underwriter believes it has sufficient interest to move forward, it will notify KDM and KDM will complete the loan underwriting and prepare the loan for closing and funding. The underwriter or initial purchaser will execute orders and funds will transfer on the settlement date to one of KDM’s segregated accounts. KDM will then fund the CM Loan and issue the MSNs.

 

KDM receives monthly interest and principal payments from CM Loan borrowers. KDM collects its service fee from the interest portion of the payment and then disburses the remaining interest and principal via wire transfer to DTC for credit to investors’ accounts at their respective DTC member or those brokerage firms corresponding with DTC members.

 

We make CM Loans to borrowers throughout the United States. As of the date of this Report, we were not dependent on any single party for a material amount of our revenue.

 

Borrowers who use us must identify their intended use of CM Loan proceeds in their initial CM Loan request. We do not verify or monitor a borrower’s actual use of funds following the funding of a CM Loan unless otherwise specified in the offering memorandum for the MSN.

 

The KDM Ratings System

 

In order to assist us with pricing and underwriting CM Loans, KDM has created an internal CM Loan ratings system.

 

The scoring matrix consists of seven factors, each weighted according to its relative importance in how we view the loans we choose to make. The seven factors are: loan to value, debt service coverage ratio, property type, property/improvement age, property demand/metropolitan statistical area, building condition, and sponsor experience.

 

We grade each CM Loan on these factors when it is presented to us, which results in a numerical figure that we then translate to a traditional AAA-BBB scale with + and – gradation. We publish our KDM Rating along with each note term sheet and offering memorandum and update it annually in our annual reviews in the quarterly or annual report that corresponds with the anniversary of the CM Loan issuance.

 

The KDM Loan Committee meets annually to review the KDM Ratings System. We review the performance, the factors, and how well those factors are weighted. The KDM Loan Rating Committee met on February 9, 2021 to review the KDM Rating Methodology. The methodology considers seven key criteria and is then subject to adjustment on a deal-by-deal basis. The seven criteria are: LTV, DSCR, Property Type, Property Age, MSA Population Growth, Building Condition and Sponsor Experience. After our discussions, we decided to a) double the importance of LTV, b) add more property types. c) replace Property Age with Lease Quality, d) replace MSA Population Growth with Location (Primary, Secondary, Tertiary) and e) slightly adjusted Sponsor Experience points.

 

KDM UNDERWRITING PROCESS

 

Step One: Identify Loan Parameters

Through market research, KDM identifies CM Loan parameters and related investor parameters that it expects will be of value to both borrowers and investors. It then uses its network of mortgage brokers, real estate agents, and lending platforms to identify properties that potentially meet these parameters. The parameters identified will include the loan type, expected interest rate, maturity, pre-payment terms, loan-to-value, minimum debt service coverage ratio, and basic loan structure.

 

Step Two: Identify and Screen Property

 

The KDM origination team works to bring in leads on new properties on which KDM can potentially lend. The team has a network of mortgage brokers, real estate agents, lending platforms, as well as lead generation databases that it uses on a daily basis to identify potential loans. Once the team finds a potential property it creates a deal scorecard that identifies critical preliminary underwriting information, including potential loan value-to-cost ratio, debt service coverage of the proposed loan, real estate comparison prices, last appraised value, and estimated current value, along with information about the property and location, including city, neighborhood, number of units, rent roll, vacancy rate, and use of proceeds.

 

 

Step Three: Create a Summary Sheet

 

KDM creates a deal summary sheet for our underwriter or initial purchaser, J. W. Korth & Company (the “Underwriter”), to use to gauge interest from selling group members. The Underwriter uses its network of selling group members to assess whether there is adequate investor appetite for the terms of a proposed note, which will be issued pursuant to an offering memorandum. The notes to be offered and sold pursuant to an offering memorandum are referred to herein as the “MSN” or the “Note(s).” If there appears to be sufficient interest, then the Underwriter will communicate that to KDM.

 

Step Four: Complete Underwriting and Due Diligence

 

Once KDM believes that the CM loan can be funded by the proceeds of a note, it executes a commitment letter with a borrower (subject to funding). When the borrower executes the commitment letter, it pays KDM a processing fee, and KDM then orders an appraisal and a subsequent appraisal review. Simultaneously, we complete the underwriting and due diligence on the property and create the offering summary and offering memorandum for the MSN.

 

Step Five: Underwriter and Sales Process

 

The Underwriter takes “when, as and if issued” orders for a series of our Notes. Once the MSN offering is fully subscribed, the Underwriter distributes the final offering memorandum and confirms final orders with other dealers and clients. The Underwriter then execute orders according to a mutually agreed upon trade date with KDM.

 

Step Six: Funding the Note, Closing the CM Loan

KDM will schedule closing for the CM Loan on or before the trade date of the Notes. The CM Loan is closed awaiting final funding. Documents and title are reviewed by both KDM and its attorneys. Upon approval of closing documents, and within one business day of the settlement date, funds, net of selling concession, are wired by the Underwriter to KDM’s segregated account for loan funding. KDM wires funds for the CM Loan closing as soon as practicable after receipt.

 

Once funds are collected, the CM Loan is closed and documents are filed in the proper jurisdiction showing KDM as mortgagee. Concurrently, KDM creates and executes a physical note for issuance to Cede & Company, or its nominee, and delivery to Depository Trust Company (“DTC”), or its agent. DTC credits each participating dealer with the appropriate face amount of the Note for further credit to each of its participating client accounts. Also, as soon as possible, but in no case more than five business days, documents will be filed with the Trustee.

 

How KDM operates if KDM Acquires Existing CM Loans and Issues Corresponding Notes 

 

When KDM acquires an existing CM Loan or group of loans and issues corresponding Notes, the Notes sale and CM Loan closing process is the same as for loans that we originate, except that KDM will purchase the CM Loan from a third party. Information about the borrower of an existing loan may be more limited and appraisals may be less current than for a loan originated by KDM. In such instances, an estimate of value from a local expert may be required to supplement an existing appraisal. A history of CM Loan payments will be included in the offering memorandum for the notes to be issued to purchase an existing CM Loan.

 

CM Loans may also be acquired by purchasing a participation in CM Loans from another lending institution. In these cases, the pricing of the participation and the net mark-up or down of the CM Loan in the form of the corresponding Note will be fully described to investors as well as a detailed description of the financial institution selling the participation interest(s).

 

How KDM Prices CM Loans and Corresponding Notes

 

Note maturities and yields to investors must be competitive with other options they have for secured investments. Notes are not guaranteed by any federal agency, so they must be competitively priced when compared with other types of lower-risk debt, such as lower investment grade corporate bonds or other mortgage loans. Borrowers may have other options for acquiring new mortgage funding. KDM must be competitive with these options in order to acquire new CM Loans. The dynamic between these two marketplaces is a principal factor in the determination of the terms of KDM Notes.

 

 

How our Servicing Fee Applies

 

KDM services the underlying CM Loans and manages the distribution and payment of interest and principal on the corresponding Notes. For these services it charges an annual servicing fee (“Servicing Fee”) targeted at 1.00%. The Servicing Fee could be lower or higher for a given CM Loan based on that CM Loan and the corresponding Note’s terms, as disclosed in the offering material for each Note. The Servicing Fee accrues to KDM and is paid by the borrower from the borrower’s CM Loan interest payments. The Servicing Fee is the difference between the rate paid by the borrower and the rate paid to investors on the MSN. However, the Servicing Fee may sometimes be shared with other parties, and not accrue directly to KDM. The Servicing Fee is applied to every interest payment received on the underlying CM Loan. Therefore, if we receive 7.00% interest annually from the underlying CM Loan and the Servicing Fee is 1%, the Note payments will be 6.00% annually, barring any other expenses. For 2020, the average Servicing Fee collected was 1.01%,

 

 

CM Loan Servicing

 

KDM is responsible for servicing all the loans it makes to mortgage borrowers and collecting payments from those borrowers and delivering payments to investors on its Notes. KDM also manages the tax and insurance escrow accounts of the borrowers and their annual tax and insurance payments. KDM has staff with extensive back office and accounting experience and uses loan servicing software to assist with the accounting and operations of the servicing process. Currently, KDM services 100% of its loans itself; we may engage a third-party servicer in the future.

 

KDM makes advances of funds from time-to-time as it believes necessary. KDM may advance payments to Noteholders if it believes a borrower will return to current status promptly. KDM also may advance payments to local tax authorities and insurance carriers as it believes necessary.

 

KDM has custodial responsibility for the CM Loans and pursuant to the Trust Indenture for the Notes. There are no limitations in KDM’s liability as servicer of its loans.

 

KDM retains a Servicing Fee for each CM Loan. See “How our Servicing Fee Applies,” above. Currently there are no specific arrangements for a back-up servicer. If KDM chooses a back-up servicer for any CM Loan or series of Notes, it will be identified in the offering documents for the Notes.

 

CM Loan payments are deposited or transmitted via ACH to the KDM In Trust For 2 Segregated Account. This segregated account collects payments from all CM Loans, and is segregated from the KDM operating funds. This account is managed as an omnibus account and funds received are disbursed for their respective payment on the Notes to DTC for credit to each participating broker dealer’s account. Broker-dealer participants then make further credit to customer accounts of Noteholders. We also debit this account for our Servicing Fee as described above.

 

CM Loans may also have retention of an impound or escrow amount for taxes and insurance and a replacement reserve for roof repairs, tenant improvements, leasing commissions, debt service, or other items necessary to the proper functioning of the property. Such escrowed funds are currently in the KDM In Trust For 1 Segregated account.

 

In the event it becomes necessary to expend funds for the collection or protection of a CM Loan, or for the preservation or protection of a CM Loan property, including the institution of foreclosure proceedings, such expenses will initially be covered by KDM and recouped at disposition of the property. Ultimately, all costs and expenses will be funded (or reimbursed to us) from the proceeds of any foreclosure or settlement, including reimbursement to us of any expenses we have disbursed toward collection of a CM Loan. These expenses may reduce interest or principal payments on a Note. See “Risk Factors.”

 

On our website www.korthdirect.com, we disclose borrowers’ payment performance on our CM Loans at least annually. We have made arrangements for collection procedures in the event of borrower default. When a CM Loan is past due and payment has not been received, we contact the borrower to request payment. After a 10-day grace period, we may, in our discretion, assess a late payment fee. This fee may be charged only once per late payment. Amounts equal to any late payment fees we receive are paid to holders of the Notes if and only if a payment on the Notes is also late. We may waive a late payment fee when a borrower promises to return a delinquent CM Loan to current status and fulfills that promise. Each time a payment request is denied due to insufficient funds in the borrower’s account or for any other reason, we may assess an unsuccessful payment fee to the borrower in an amount of $35.00 per unsuccessful payment, or such lesser amount as may be provided by applicable law. We retain 100% of this unsuccessful payment fee to cover our costs incurred due to the denial of the payment.

 

 

If the CM Loan becomes 31 days overdue (see “Certain Definitions,” below), we will identify the CM Loan as “Late (31-120),” and we may refer the CM Loan to a real estate attorney for foreclosure proceedings. However, we may pursue other remedies to bring the loan back to performance before foreclosure. In these cases, the interest rate on the CM Loan is increased to the highest legal rate in the state in which the property is located. The costs from a foreclosure and resale of a defaulted CM Loan and mortgaged property are applied against the proceeds payable to Noteholders. If funds remain after a property is resold and all expenses are paid, they would be distributed to Noteholders on a pro-rata basis.

 

Certain Definitions

 

We define delinquent accounts as accounts that are more than 31 days overdue with no immediate plan to repair the delinquency. Charge offs are defined as the unpaid principal balance of a specific CM Loan minus the expected recovery based on current market conditions for the foreclosed property. Uncollectable accounts are defined as those CM Loans where no recovery is expected to be made. These definitions are regardless of any grace period, re-aging, restructure, or partial payments received. A CM Loan that is categorized as a delinquent account could be re-categorized as current if the borrower brought all payments up to date. Charge-offs would be adjusted for properties in foreclosure based on an annual review of the current market conditions for the geography of the property. Uncollectible accounts will be reviewed quarterly and could be reclassified as collectible if market conditions change for the property subject to the mortgage and foreclosure. As of the date of this Report on Form 10-K, we have no delinquent CM Loans.

 

Summary of How KDM Fees Affect Return Sales, Marketing and Customer Service

 

Our marketing efforts are designed to attract borrowers to contact us and to enroll them as clients, and to close transactions with them. Our origination team primarily does this through the substantial network of commercial mortgage brokers we have assembled. We employ primarily email correspondence to mortgage brokers, banks, real estate agents, and commercial property owners to encourage them to present CM Loans to us for possible funding through the issuance of corresponding Notes. We attend trade shows, subscribe to lead generation databases, and loan and property platforms to find loans. We contact other financial institutions, directly and through brokers, that may own commercial mortgages, and may attempt to purchase mortgages for KDM.

 

Fraud detection

 

We consider fraud detection to be of utmost importance to the successful operation of our business. We employ a combination of proprietary technologies and commercially available licensed technologies and solutions to prevent and detect fraud. We use services from third-party vendors for user identification and OFAC compliance.

 

Notwithstanding KDM’s due diligence examination of the information provided to KDM by a borrower, there can be no assurance that the information provided to us, and on which we rely, is true and accurate.

 

Competition

 

The market for mortgage lending is competitive and rapidly evolving. We believe the following are the principal competitive factors in the lending market:

 

·

pricing and fees;

·

experience, including borrower full funding rates and investor returns;

·

branding; and

·

ease of use.

 

We face competition from major banking institutions, credit unions, and other consumer finance companies as well as smaller private lenders.

 

We may also face future competition from new companies entering our market. These companies may have significantly greater financial, technical, marketing and other resources than we do and may be able to devote greater resources to the development, promotion, sale and support of their consumer lending programs. These potential competitors may be in a stronger position to respond quickly to new technologies and may be able to undertake more extensive marketing campaigns. These potential competitors may have more extensive potential borrower bases than we do. In addition, these potential competitors may have longer operating histories and greater name recognition than we do. Moreover, if one or more of our competitors were to merge or partner with another of our competitors or a new market entrant, the change in competitive landscape could adversely affect our ability to compete effectively.

 

Our success depends on further developing our network of transaction referral sources and working with an underwriter to build a ready market for our Notes to finance our lending. We believe both the mortgage broker network and the distribution network for Notes is accessible through email and direct contacts and advertising in key spots. We have ascertained that there is a large niche for the types of Notes that KDM is issuing.

 

 

It is highly likely that another brokerage firm or mortgage company may use our program as a model and attempt to execute it in a similar fashion. The market for commercial loans like our CM Loans is more than $5 trillion and the market for retail securities is estimated by us to be about three times that. This makes room for competitors. We, as a first mover, can be expected to benefit as others enter the marketplace and market saturation can be expected to be several years in the future.

 

Intellectual Property

 

We have intellectual property that is our brand, our process, our ratings system, our KDM Broker Network, and our internal applications and systems. We have applied for a trade mark for the term “Middle-Money.”

 

Employees

 

As of the date of this Report, we employ twenty two full-time people and one part-time person. Five J. W. Korth & Company employees devote partial time to KDM.

 

Facilities

 

We maintain offices at 135 San Lorenzo Avenue, Suite 600, Coral Gables, Florida 33146.

 

Subsidiaries

 

As of the date of this report, KDM has one subsidiary, J. W. Korth, a FINRA and SEC registered broker-dealer founded in 1982 by James W. Korth, our CEO. J. W. Korth was previously the parent company of KDM. The companies were reorganized as of July 31, 2020, when KDM acquired a majority of the equity of J. W. Korth.

 

Item 1A. Risk Factors

 

The following discussion of risk factors contains “forward-looking statements,” as discussed in the forward-looking statements Section of this Form 10-K Report. These risk factors may be important to understanding any statement in this Annual Report on Form 10-K or elsewhere. The following information should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations section and the Financial Statements and related notes of this Report on Form 10-K. Any of these factors, or others, many of which are beyond the Company’s control, could negatively affect the Company’s revenues, profitability or cash flows in the future. These factors include:

 

Certain Risks Related to COVID-19 Pandemic.

 

The spread of COVID-19 has had a material adverse impact on the United States economy. We cannot now anticipate whether, or to what extent, the pandemic may affect our business. Risks of the pandemic include those associated with economic conditions, increased volatility in financial markets, and the possibility of prolonged adverse economic conditions. These risks also include decreases in market value of loans and securities, borrower defaults resulting from tenants’ failures to pay rent, interruption of our growth and other strategic plans, and financial and other risks of government programs addressing the impacts of COVID-19 proving to be ineffective. Governmental regulators have required lenders to suspend foreclosures on certain mortgage loans.

 

In addition to the actions described above, there is risk that COVID-19 will continue to significantly affect the U.S. commercial real estate markets, resulting in reduced U.S. mortgage rates, decreased property values (which, among other effects, may both increase the risk of defaults and reduce the value of real estate collateral, thereby diminishing recovery in the event of default), and reduce demand for commercial and multifamily real estate and increase vacancies if businesses fail or close locations. We note that although the COVID-19 pandemic appears to have an end on the horizon, it is unknown whether further variants could cause additional outbreaks or lockdowns and that there is a potential for additional waves of COVID-19 or new strains of coronavirus even after COVID-19 appears contained in an area.

 

As a result of the COVID-19 outbreak in the United States, financial and operational challenges have arisen in many industries. The Company has been able to enact procedures to abate the financial and operational effects of the outbreak without a reduction in its workforce. Although the Company has been able to adapt sufficiently so far, there is no certainty that this will remain the case going forward.

 

 

Investors in our Notes may lose some or all of their investment in the Notes.

The regular payment of the Notes depends entirely on payments to KDM of a borrower’s CM Loan. The Notes are special, limited obligations of KDM payable only from KDM’s receipts of CM Loan proceeds, net of KDM’s servicing Fee and cost of collection. If the borrower defaults on the CM Loan, Noteholders will be dependent on proceeds from the Assignment of Rents held by KDM and on the proceeds if any, from foreclosure of the CM Loan mortgage for payments on the Notes. The failure of the borrower to repay the CM Loan is not an event of default by KDM. Notes are suitable purchases only for investors of adequate financial means who, in the event of a default on the underlying CM Loan, may have to wait for a foreclosure to recover some or all of the principal invested in their Note.

 

We rely on third-party appraisals to value the property securing the CM Loan, and information from the borrower on cash flow and profitability of the income property.

While we make every effort to engage responsible licensed third-party appraisers, we cannot be certain that the information and presentations they make are reliable. Appraisals are subject to mistakes that could affect the value of a property. Further, appraisers may make judgments of value based on cash flow presented by borrowers. If a borrower were to falsify its cash flow, it could affect the value shown in the appraisal. To verify cash flows, we receive bank statements from borrowers. KDM is not responsible for mistakes or fraudulent activities of borrowers or appraisers.

 

We rely on industry default and recovery rates for underwriting our CM Loans. Our default rates are untested against industry rates and may be higher.

Due to our limited operational and origination history, we do not have significant historical performance data regarding borrower performance and we do not yet know what our long-term CM Loan loss experience may be. It is possible that our default rates may be higher than the industry averages and our recovery rates may be lower than the industry averages.

 

If we believe it is in the best interest of the Noteholders, we have the right to adjust the terms of a CM Loan.

It is possible that due to natural disasters, local disruption of services, political unrest, changes in local laws, market competition or disruptions and other unforeseen events that affect the property pledged under a CM Loan or affect the borrower’s ability to make its CM Loan payments, it might be in the best interest of the Noteholders to provide a borrower with an accommodation regarding loan terms rather than be forced to foreclose on a loan. If we adjust a CM Loan, it may reduce interest payments, suspend interest payments, lengthen the time when principal may be received or change other terms of the CM Loan which could reduce the expected benefits of the CM Loan to the Noteholders.

 

There may be a default on a CM Loan.

CM Loan default rates may be significantly affected by general economic conditions beyond our control and beyond the control of the individual borrower. Default on a CM Loan is subject to many factors, such as prevailing interest rates, the rate of unemployment, the level of consumer confidence, residential or commercial real estate values, the value of the U.S. dollar, energy prices, changes in consumer spending, the number of personal bankruptcies, disruptions in the credit markets, and other factors, none of which can be predicted with certainty.

 

Information supplied by the borrower could be inaccurate or intentionally false.

While we perform due diligence on each borrower, including verifying property ownership, rent collections, property values, coverage ratios and other appropriate due diligence materials, a borrower could present us with false information which we may not discover during our due diligence process.

 

We do not monitor our borrowers’ use of funds.

It is possible the borrower may not use the funds for the purposes it has asserted, for example, to improve the property. Additionally, the borrower could potentially misuse the proceeds it receives from the loan in a way that negatively impacts their ability to make timely payments on the CM Loan, their credit, or the value of the underlying property.

 

CM Loan Guarantees May Not Be Collectable

Some CM Loans may have a personal guarantee. We may ask for guarantees from the owners, or the owners of the owner, if the owner is not an individual. Because we primarily focus our underwriting on the value of the mortgaged property, the loan to value ratio, and the debt service coverage ratio, we generally do not investigate the net worth of the borrowers, and therefore, the ultimate value of the guarantee on a CM Loan, if any. In the event a CM Loan goes into foreclosure and the money realized in the foreclosure does not pay off the entire principal owed on the CM Loan, investors should not count on the guarantee being collectible. Should such a situation arise, investors may not see repayment of the entire principal amount of their Notes.

 

If payments on a CM are not paid when due, Noteholders may not receive the full principal and interest payments that they expect to receive on Notes.

Payment to holders of Notes is completely dependent on payments received from corresponding CM Loans. If the borrower fails to make a required payment on a CM Loan within 30 days of a due date, we will pursue collection. Referral of a delinquent CM Loan to an attorney on the 31st day of its delinquency will be considered reasonable collection efforts. If we refer a CM Loan to an attorney, we will monitor that CM Loan until either the CM Loan is paid or the property is foreclosed and resold and investors are paid. We may also pursue collection of a delinquent CM Loan directly. In the case of collection efforts, the cost of attorney’s fees will be charged against the CM Loan and will reduce the net payments on a Note.

 

 

The CM Loans underlying the Notes are typically payable on an interest-only basis until maturity, at which time the entire principal balance is due. Therefore, borrowers may have to refinance to pay off a balloon payment on the CM Loan.

If a borrower must refinance to pay off a CM Loan, such refinancing could be impossible due to market conditions or other factors. In such a case, the CM Loan would default. Such a default could reduce or eliminate principal payment of the Notes.

 

A CM Loan may be prepaid at any time.  Borrower CM Loan prepayments will reduce payments of interest on the Notes.

 

The borrower may prepay some or all of the principal amount of a CM Loan. A borrower may decide to prepay all, or a portion of, the remaining principal at any time. Notwithstanding the prepayment of all or a portion of the CM Loan, the borrower must pay all of the interest that would be due on the principal amount of the CM Loan until the expiration of borrower’s interest guarantee, typically a guarantee of from two to three years interest. Noteholders will receive such prepayment, net of our servicing fee. Interest will not accrue after the date on which the CM Loan is paid in full. If the borrower prepays a portion of the remaining unpaid principal balance on the CM Loan, we will reduce the outstanding principal amount and interest will cease to accrue on the prepaid portion. On an amortizing loan, we will require the borrower to pay the same amount on the CM Loan as the borrower paid prior to any partial repayment of principal. As a result of the combination of the reduced principal amount and the unchanged monthly payment, the effective term of the CM Loan will decrease. On an interest only CM Loan, the monthly payment Noteholders receive will be reduced proportionally by the amount of principal repaid. If the borrower prepays the CM Loan in full or in part, Noteholders will in all probability not receive all the interest payments that they expected to receive on their Notes.

 

Prevailing interest rates may change during the term of the CM Loan on which a Note is dependent.

If a CM Loan is prepaid, Noteholders may be unable to invest prepaid Note proceeds at a rate comparable to the interest payable on the Notes. Further, if interest rates rise, there is a market for the Notes, and a Noteholder decides to sell a Note prior to maturity, the Noteholder may receive a discounted return on the Note.

 

Investor funds in a KDM segregated account do not earn interest.

Proceeds of the sale of the Notes are held in a non-interest bearing segregated account pending completion of the Note Offering pursuant to an effective registration statement and investment in the Notes. Further, we place borrower loan payments in a segregated account under our control and pay all loan payments collected from the prior payment date at least four business days prior to the payment date on the twenty-fifth day of each month, with an extension to the next business day if required. Funds held in segregated accounts do not earn interest. These segregated accounts are held at Bank United and are managed by KDM. There is no escrow agreement with the bank.

 

The Notes will not be listed on any securities exchange, and it is unlikely that a trading market for the Notes will develop. An underwriter of the Notes may make a market in the Notes, but is not obligated to do so.

 

There can be no assurance that a market for Notes will develop or that there will be a buyer for any particular Notes offered for resale. Therefore, investors must be prepared to hold their Notes to maturity.

 

 

We may have to limit our business to avoid being deemed an investment company under the Investment Company Act.

In general, a company that is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities may be deemed to be an investment company under the Investment Company Act of 1940, as amended (Investment Company Act). The Investment Company Act contains substantive legal requirements that regulate the manner in which “investment companies” are permitted to conduct their business activities. We believe we are excluded from registration by Section 3(c)(5)(c) of the Investment Company Act and have conducted, and we intend to continue to conduct, our business in a manner that does not result in our company being characterized as an investment company. This section of the Investment Company Act contains an exemption for companies that make mortgages and do not issue redeemable shares. To avoid being deemed an investment company, we may not be able to broaden our offerings, which could require us to forego attractive opportunities. If we are ever deemed to be an investment company under the Investment Company Act, we may be required to institute burdensome compliance requirements and our activities may be restricted, which could materially adversely affect our business, financial condition, and results of operations.

 

Funds Received for all CM Loans are commingled in a Segregated Account.

We hold all funds received from CM Loans in a segregated account title In-Trust For 2 at Bank United bank. We then use our internal accounting system to determine which funds are applied to which Note investors. While our internal accounting system is backed up into separate record keeping systems managed by service providers, should our systems fail and the back-up systems fail for any reason we may have difficulty determining which payments are to be applied to which Noteholder and your payments could be delayed until such a determination is made. We also could make an accounting error that would send too much money to one Noteholder and leave other Noteholders short of funds until we could recover the erroneous payments through the payment systems we utilize to distribute funds to investors. In such a case, recovery of over payments may not be achieved and it would leave the account permanently short for investors who did not receive the over payments.

 

 

KDM deposits all interest and principal payments which it receives on CM Loans in a single segregated bank account, and payments on real tax and insurance escrows in another segregated account, which accounts and the funds deposited in them may be subject to claims of general creditors of KDM in the event of a KDM bankruptcy.

 

In the event of a KDM bankruptcy, general creditors of KDM may assert a claim that funds on deposit in the segregated account maintained by KDM for the benefit of Noteholders, and the separate segregated account maintained by KDM for real estate tax and insurance payments, are subject to the claims of general creditors. Principal and interest payments on CM Loans are deposited in a segregated bank account, and payments of real estate taxes and insurance on mortgaged properties are deposited in another segregated account, when and as received by KDM. Receipts deposited in those accounts are disbursed to Noteholders monthly and annually to property insurers and taxing authorities. KDM performs all accounting for these accounts, including sub-accounts for each Noteholder and property, and maintains all accounting records at its principal office. Under the Trust Indenture, the Trustee will have a first lien on the principal and interest account for the benefit of Noteholders. If the bankruptcy court were to determine that the funds in the account were subject to claims of creditors other than Noteholders or the Trustee acting on their behalf, the amount that Noteholders would receive from the account could be adversely affected. Further, amounts on deposit to pay real estate taxes and insurance could be reduced or entirely eliminated if paid to general creditors of KDM in the bankruptcy proceeding. The bankruptcy court could temporarily stay disbursements to Noteholders, taxing authorities and insurers even if the court were ultimately to determine that the funds in the account should be distributed to the Noteholders, the Trustee acting on their behalf, and, also, as appropriate, to taxing authorities and property insurers, resulting in delays to Noteholders in the receipt of payments on their Notes and penalties imposed by insurers and taxing authorities.

 

The market in which we participate is competitive and, if we do not compete effectively, our operating results could be harmed.

The commercial mortgage market is competitive and rapidly changing. We expect competition to persist and intensify in the future, which could harm our ability to increase volume.

 

Our principal competitors include major banking institutions, credit unions, credit card issuers and other consumer finance companies. It is possible that one or more of these companies decide to compete directly with us. The results of such competition could harm our operating results and, in that event, our ability to continue to service the CM Loan and Notes could be adversely affected.

 

We rely on third-party banks to disburse CM Loan proceeds and process CM Loan payments, and we rely on third-party computer hardware and software. If we are unable to continue utilizing these services, our business and ability to service the CM Loans on which the Notes are dependent may be adversely affected.

We rely on a third-party bank to disburse CM Loan amounts. Additionally, because we are not a bank, we cannot belong to and directly access the ACH payment network, and we must rely on an FDIC-insured depository institution to process our transactions, including CM Loan payments and remittances to holders of the Notes. We currently use Bank United for these purposes. We also rely on computer hardware purchased and software licensed from third parties. This purchased or licensed hardware and software may not continue to be available on commercially reasonable terms, or at all. If we cannot continue to obtain such services from this institution or elsewhere, or if we cannot transition to another processor quickly, our ability to process payments will suffer and your ability to receive principal and interest payments on the Notes will be delayed or impaired.

 

Competition for our employees is intense, and we may not be able to attract and retain the highly skilled employees who we need to support our business.

Competition for highly skilled technical and financial personnel is extremely intense. We may not be able to hire and retain these personnel at compensation levels consistent with our existing compensation and salary structure. Many of the companies with which we compete for experienced employees have greater resources than we have and may be able to offer more attractive terms of employment.

 

In addition, we invest significant time and expense in training our employees, which increases their value to competitors that may seek to recruit them. If we fail to retain our employees, we could incur significant expenses in hiring and training their replacements and the quality of our services and our ability to service the CM Loans could diminish, resulting in a material adverse effect on our business and our ability to service the Notes.

 

If we fail to retain our key personnel, we may not be able to achieve our anticipated level of growth and our business could suffer.

Our future depends, in part, on our ability to attract and retain key personnel. Our future also depends on the continued contributions of our executive officers and other key technical personnel, each of whom would be difficult to replace. The loss of the services of any of the executive officers or key personnel, and the process to replace any of our key personnel would involve significant time and expense and may significantly delay or prevent the achievement of our business objectives.

 

 

Purchasers of Notes will have no control over KDM and will not be able to influence KDM corporate matters.

Our Notes grant no equity interest in KDM to the purchaser nor grant the purchaser the ability to vote on or influence our management decisions, including forbearance or foreclosure. As a result, our parent company, J.W. Korth & Company, exercises voting control over all our company operations, including the election of managers and officers and the approval of significant transactions, such as a merger or other sale of our Company or its assets. Any such actions which we take may adversely affect our business and our ability to service the CM Loan and Notes.

 

Unforeseeable Adverse Events.

Events beyond our control may damage our ability to maintain adequate records, or perform our servicing obligations. If such events result in a system failure, Noteholders’ ability to receive principal and interest payments on Notes could be substantially harmed.

 

If a catastrophic event resulted in an outage and physical data loss, our ability to perform our servicing obligations would be materially and adversely affected. Such events include, but are not limited to, fires, earthquakes, hurricanes, terrorist attacks, natural disasters, computer viruses and telecommunications failures. We store back-up records via cloud storage services via several different companies. If our electronic data storage and backup storage system are affected by such events, we cannot guarantee that Noteholders would be able to recoup their investment in the Notes.

 

Federal and State regulatory bodies may create new rules and regulations that could adversely affect our business.

In the wake of the last financial crisis, banking and finance regulation continues to evolve, and increasing regulation by federal and state governments may become more likely. Our business could be negatively affected by the application of existing laws and regulations or the enactment of new laws applicable to lending, mortgages, mortgage servicing, or securities distribution. The cost to comply with such laws or regulations could be significant and would increase our operating expenses, and we may be unable to pass along those costs to our investors in the form of increased fees.

 

If we discover a material weakness in our internal control over financial reporting which we are unable to remedy, or otherwise fail to maintain effective internal control over financial reporting, our ability to report our financial results on a timely and accurate basis may be adversely affected.

Should our auditors discover a material weakness in our internal controls, our ability to report our financial results on a timely and accurate basis may be adversely affected.

 

New Government Regulation may limit our ability to make CM Loans

We do not believe that we are subject to Risk Retention under RR (17 CFR 246), as our entity type is not within scope of the rule according to 12 CFR 244.1(c). However, if we become subject to risk retention rules, we could be required to raise significant capital in order to continue doing business.

 

Our Proprietary Ratings System is untested and based on broad assumptions for which we have no statistical basis

We created the KDM Ratings System internally, and based it on very broad assumptions and experience of staff members. Our staff members have no experience in creating a ratings system. We are not affiliated with nor do we have experience in creating ratings of debt or mortgage securities. The Rating System has no track record and has not been tested against any known data set. The Rating System is still evolving, and we add items as we add property types. It should not be relied upon as a predictable measure of performance of the underlying CM Loan at this time. We also have conflicts of interest with respect to our Ratings System. See “Conflicts of Interest Regarding Our Proprietary Ratings System.”

 

Item 1B. Unresolved Staff Comments

 

Not applicable.

 

Item 2. Properties

 

We do not own any real property for use in our operations or otherwise. We lease office space in Coral Gables, Florida and through our subsidiary, J. W. Korth, in Lansing, Michigan.

 

Item 3. Legal Proceedings

 

The Company is not subject to any material legal proceedings.

 

 

The Company’s broker-dealer subsidiary is subject to an investigation of technical aspects of its financial advisory activities by the SEC regarding the reporting and treatment of certain trades and the disclosures made in the subsidiary’s financial advisory brochure. The inquiry involves rule interpretations by the subsidiary of the technical aspects of recording and reporting for purchases and sales of bonds and the relevance of certain disclosures in the brochure. The transactions in question do not involve KDM issued securities. The firm is fully cooperating with the SEC and believes at this time the outcome of the investigation is not expected to have a material effect on KDM or its subsidiary.

 

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market Information

 

There is no market for the Company’s common equity.

 

Holders

 

As of December 31, 2020, the Company had issued and outstanding (i) 5,000,000 shares of its common stock, all which were issued to J.W. Korth & Company Limited Partnership, and (ii) 200,000 shares of its Series A 6% Cumulative Perpetual Convertible Preferred Stock (the “Series A Preferred”), all of which were issued to Cede & Company. The number of holders was determined from the records of our transfer agent and does not include beneficial owners of common or preferred stock whose shares are held in the names of Cede & Company, broker-dealers, or registered clearing agencies. The transfer agent of our common stock and preferred stock is Continental Transfer and Trust Company, One State Street, New York, New York 10004.

 

Dividends

 

The Company has not paid, and has no plans to pay, dividends on its common stock. Holders of the Series A Preferred are entitled to receive, when, as, and if declared by the Board of Directors, cash dividends at a rate of 6% per annum based of the Series A Preferred liquidation preference of $25.00 per share. Holders of the Company’s 200,000 issued shares of Series A Preferred were paid a dividend totaling $1.50 per share over the four quarterly payments for the year ended December 31, 2020.

 

Securities Authorized for Issuance Under Equity Compensation Plans.

 

For information regarding securities authorized for issuance under our 2019 Stock Plan, please refer to the disclosure included below under the caption “Item 11. Executive Compensation—Equity Compensation Plan Information.”

 

Sales of Unregistered Securities

 

There were no sales of unregistered equity securities of the Company during the year ended December 31, 2020.

 

Purchases of Equity Securities.

 

The Company did not purchase any of its equity securities during the year ended December 31, 2020.

 

Item 6. Selected Financial Data

 

Not applicable.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

You should read the following discussion in conjunction with our audited historical financial statements, which are included elsewhere in this Form 10-K. Management’s Discussion and Analysis of Financial Condition and Results of Operations contains statements that are forward-looking. These statements are based on current expectations and assumptions, which are subject to risk, uncertainties and other factors, including, but not limited to, those described in the subsection titled “Risk Factors,” located in Part I, Item 1A, of this Form 10-K. We urge you to review our discussion of Risk Factors relating to our business, including, without limitation, risks related to the impact on our company of the COVID-19 pandemic, which factors individually or as a group could materially affect the discussion which follows.

 

Overview

 

Korth Direct Mortgage, LLC, was organized in Florida on July 24, 2009, under the name HCMK Consulting, LLC. We changed our name to J. W. Korth & Company, LLC, in November 2010, and then to Korth Direct Mortgage, LLC, on August 24, 2016. KDM converted into a Florida corporation, Korth Direct Mortgage Inc., on June 6, 2019. Our principal executive offices are located at 135 San Lorenzo Avenue Suite 600, Coral Gables, Florida 33146, and our telephone number is (305) 668-8485. Our website address is www.korthdirect.com. We also operate under the trade name KDM Financial, and our subsidiary is J W Korth & Company, L.P.

 

 

Korth Direct Mortgage began its formal operations in October of 2016 when we engaged our Chief Lending Officer. KDM is a licensed Mortgage Lender Servicer with the State of Florida. Our NMLS License Number is 1579547.

 

Reorganization

 

Prior to July 31, 2020, we were wholly owned by J. W. Korth & Company, L.P., a FINRA and SEC registered broker-dealer founded in 1982. On July 31, 2020, we acquired substantially all of the equity of J.W. Korth.

 

We originate, fund and service loans which are made to commercial borrowers. The loans are held by KDM as the lender. We fund our loans directly in the capital markets through issuance of Mortgage Secured Notes (“MSNs” or “Notes”), which are sold through J.W. Korth as underwriter through exemptions from registration available under Rule 144A, Regulation D, and other exemptions from registration. The Company and J.W. Korth determined that the we could operate more efficiently if J.W. Korth became a wholly-owned subsidiary of the Company. J.W. Korth submitted its then-proposed sale to FINRA, as required by FINRA rules, and FINRA advised J.W. Korth that it could proceed with the closing.

 

Pursuant to the Purchase Agreement, as a condition of closing J.W. Korth agreed to distribute all of its 5,000,000 shares of common stock in the Company to its partners ratably in accordance with their partnership interests in J.W. Korth pursuant to exemptions from registration available under Section 4(a)(2) of the Securities Act of 1933, as amended, and Rule 506 promulgated under the Securities Act.

 

As post-closing commitments the Company agreed to (i) retain Mr. Korth as the managing partner of J.W. Korth, Ms. MacDonald-Korth as J.W. Korth’s chief financial officer, and all other employees of J.W. Korth who were employed at closing of the Transactions; (ii) operate J.W. Korth as an SEC registered broker-dealer and investment advisor; (iii) pay the J.W. Korth Preferred Capital Interest Partners quarterly dividends concurrently with its payment of the Company’s Series A Preferred Stock dividends at least annually; (iv) in such years as it pays Series A Preferred dividends, redeem 25% annually of the JW Korth Preferred Capital Interest partners through a capital contribution to J.W. Korth; and (v) make a discretionary redemption of all accounts of the limited partners of J.W. Korth under the J.W. Korth partnership agreement. Upon redemption of the limited partners’ accounts and the payment of the other consideration to described above to the JW Korth partners, KDM will own 100% of the voting interests in J.W. Korth.

 

The following table summarizes the consideration paid, or to be paid, for the Acquisitions:

 

		Consideration
Accrued & unpaid dividends to the Preferred Capital Interest partners		$	213,443
JW Korth LLC’s Common Capital Interest account			150,000
Contingent liability to redeem J.W. Korth Preferred Capital Interest Partners			696,253
Disposition of outstanding loan due from J.W. Korth Executive Officer			69,780
Total Consideration Paid		$	1,129,476

 

The following table summarizes the net book value of assets and liabilities acquired as of the closing date, July 31, 2020:

 

		Net Book Value
J.W. Korth Net Book Value		$	889,131
Less: Preferred Interest in J.W. Korth by Company prior to acquisition			(250,000	)
Adjusted Net Book Value acquired		$	639,131

 

Since the acquisition was between related parties, the transaction was recorded at net book value as of the closing date. The difference of $490,345 between the consideration paid and the net book value of the assets and liabilities acquired was recorded as an offset to equity, specifically to Additional Paid-in Capital. Disclosure of supplemental pro forma information for revenue and earnings related to the acquisition, assuming the acquisition was made at the beginning of the earliest period presented, has not been disclosed since the effects of the acquisition would not have been material to the results of operation for the periods presented.

 

 

Results of Operations for Year Ended December 31, 2020

 

The Company generated revenues of $2,772,776 for the year ended December 31, 2020, an increase of $2,182,653 compared with revenues of $590,123 for the year ended December 31, 2019. The increase in revenues generated from origination fees, servicing revenue, and interest income was due to an increase of $89.7 million in mortgages owned and serviced from December 31, 2019, to December 31, 2020. As of December 31, 2020, the Company owned mortgages of $175,370,850 compared with mortgages of $85,692,812 as of December 31, 2019, an increase of 105%.

 

Total Revenue increased by 370% year over year, from $590,123 in 2019 to $2,772,776 for the year ended December 31, 2020. This growth was due to a 300% increase in servicing revenue, to $1,186,743, as well as $922,527 attributable to the acquisition of J.W. Korth. Of this revenue, $309,210 is for Underwriting Income, which, due to the reorganization, allows KDM to re-capture the underwriting fees it pays for distribution of its MSNs. KDM also earned $176,345 in interest income from its balance sheet lending.

 

Gross profits increased by $1,667,384 (561%) to $1,964,355 during the year ended December 31, 2020, compared with gross profits of $296,971 during the year ended December 31, 2019. The increase in gross profits was attributed to the increase in the amount of mortgages serviced during the year ended December 31, 2020, with lower levels of mortgage related costs as a percentage of revenues, which generated higher gross margins. In addition, gross profits increased by $840,348 during the year ended December 31, 2020, as a result of the acquisition of J.W. Korth, primarily generated from trading profits and broker underwriting income.

 

In spite of positive year over year revenues, KDM growth slowed significantly during the second and third quarters of 2020 due to the global pandemic and the pull-back in credit markets. Our sector of the market began to recover in Q3 of 2020 and we were able to complete nearly $62.8M of lending from August through December 2020.

 

Operating expenses were $2,240,436 during the year ended December 31, 2020, which was an increase of $1,330,841 compared with operating expenses of $909,595 during the year ended December 31, 2019. The increase in operating expenses was the result of increases of $1,136,892 in payroll related costs, $118,452 in accounting, professional and legal fees, $66,430 in rent expense, and $70,220 in other operating expenses to support the growth of the overall business. These increases were partially offset by a decrease of $64,544 in non-cash stock compensation expense related to options issued to employees and directors in 2019. Of the $1,330,841 increase in operating expenses, $792,793 (60%) of the increase in operating expenses, primarily payroll related costs, for the year ended December 31, 2020, were generated by J.W. Korth, which was acquired on July 31, 2020.

 

Other income decreased by $1,665,834 to $1,263,455 during the year ended December 31, 2020, compared with other income of $2,929,289 during the year ended December 31, 2019. The decrease in other income was due to the forgiveness of $548,802 of debt due to J. W. Korth, our parent company at the time, during the year ended December 31, 2019. In addition, unrealized gain on mortgages decreased by $1,112,017 during the year ended December 31, 2020, due to lower net margins on new loans generated during the year ended December 31, 2020, compared with the prior year.

 

In June 2019, the Company transitioned from a limited liability company to a C-corporation. Beginning in June 2019, the Company began recording a provision for income taxes. During the year ended December 31, 2020, the Company recorded $260,875 in deferred income tax expense compared with $380,236 of deferred income tax expense from June 2019 through December 31, 2019.

 

Net income decreased $1,209,930 to $726,499 for the year ended December 31, 2020, compared with net income of $1,936,429 during the year ended December 31, 2019. The decrease in 2020 was primarily attributed to the decrease in Other Income of $1,665,834. The Other Income category is dominated by the Unrealized Gain on Mortgages, which is the net present value of the future income expected from each loan. In 2020, we closed several loans with shorter guaranteed prepayment periods, as well as one large loan with slim net margin to the Company, which resulted in a lower total Unrealized Gain than might be expected from the loan volume. This decrease was partially offset by a decrease in net loss from operations of $336,543 (a 55% improvement) and a decrease of $119,361 in deferred income taxes generated during the year ended December 31, 2020, compared with the year ended December 31, 2019.

 

We are pleased with our growth given the difficult year we just completed due to the global pandemic. We have a large and ever-growing pipeline of new loans and actively pursuing additional capital sources to help speed our time to close as well as our net margin at securitization.

 

 

Financial Condition for the year ended December 31, 2020

 

As of December 31, 2020, we had $2,037,177 in cash and loans on forty-three properties across twenty-two securitizations on our balance sheet for a total of $175,370,850 at fair value. The original loan amounts totaled $176,456,054; however, three loans are amortizing and are carried at their remaining principal balances, and one loan was partially redeemed. We have recognized an unrealized gain of $1,268,470, which is the net present value of the future servicing income we receive from the loans made to date. This value is highly subjective and includes such variables as constant prepayment rate (CPR), discount rate, and market pricing data. This value is calculated quarterly. The current value was provided by a third-party consulting firm and uses 15.0% for the discount rate and includes an14.95% CPR, along with other assumptions customary to the industry.

 

Capital and Liquidity Needs

 

 

The Company completed the sales of $5,000,000 (less issue costs of $250,000) in Series A 6% Cumulative Perpetual Convertible Preferred Stock in September 2019. We did not need to access additional capital in 2020. We expect to raise additional capital in 2021and as necessary in succeeding years.

 

The Company is also looking to secure lines of credit and lender financing in forms that will comply with covenants of our trust indentures, but allow us the flexibility to continue to grow the business.

 

Status of our CM Loans

 

All of our CM Loans are currently performing. We report annually in our quarterly or annual reports on the anniversary of the CM Loan, its updated status. Although no late payments have been made to Noteholders, KDM elected to put KDM2019-N001 in lockbox on January 31, 2020. This loan continues to perform with the additional support of the lockbox. The lockbox was put in place after a single payment became over 30 days late.

 

Loan Information as of March 31, 2021

 

 

 

 

Map of Current Loans

 

 

 

 

Sales, Marketing and Customer Service

 

Our marketing efforts are designed to attract borrowers and mortgage brokers to our platform and to close transactions with them. We employ primarily digital marketing and email correspondence to mortgage brokers, banks, real estate agents, and commercial property owners to encourage them to present loan packages to us for possible financing. We subscribe to lead generation databases and loan and property platforms to find loans. We also contact other financial institutions directly and through brokers who may own commercial mortgages, and will attempt to purchase mortgages for KDM.

 

Fraud Detection

 

We consider fraud detection to be of utmost importance to the successful operation of our business. We employ a combination of proprietary technologies and commercially available licensed technologies and solutions to prevent and detect fraud. We use services from third-party vendors for user identification and OFAC compliance.

 

Competition

 

The market for mortgage lending is competitive and rapidly evolving. We believe the following are the principal competitive factors in the lending market:

 

·

pricing and fees;

·

experience, including borrower full funding rates and investor returns;

·

branding; and

·

ease of use.

 

We face competition from major banking institutions, credit unions, credit card issuers and other consumer finance companies as well as smaller private lenders.

 

We may also face future competition from new companies entering our market. These companies may have significantly greater financial, technical, marketing and other resources than we do and may be able to devote greater resources to the development, promotion, sale and support of their consumer lending programs. These potential competitors may be in a stronger position to respond quickly to new technologies and may be able to undertake more extensive marketing campaigns. These potential competitors may have more extensive potential borrower bases than we do. In addition, these potential competitors may have longer operating histories and greater name recognition than we do. Moreover, if one or more of our competitors were to merge or partner with another of our competitors or a new market entrant, the change in competitive landscape could adversely affect our ability to compete effectively. Another brokerage firm or mortgage company may use our program as a model and attempt to execute it in a similar fashion.

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

 

Not required.

 

Item 8. Consolidated Financial Statements

 

The following is an index to the Consolidated Financial Statements of the Company being filed here-with commencing at page F-1 below:

 

Report of Independent Registered Public Accounting Firm		F-2
Consolidated Statements of Financial Condition as of December 31, 2020 and 2019		F-5
Consolidated Statements of Operations for the fiscal years ended December 31, 2020 and 2019		F-6
Consolidated Statements of Changes in Members’ Equity (Deficit) for the fiscal years ended December 31, 2020 and 2019		F-7
Consolidated Statements of Cash Flows for the fiscal years ended December 31, 2020 and 2019		F-8
Notes to the Consolidated Financial Statements		F-9

 

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

We have had no changes in nor disagreements with our independent accountants on accounting and financial disclosure during the fiscal years ended December 2020 and 2019, nor in any subsequent interim period.

 

Item 9A. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

 

We carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e)) as of December 31, 2019. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2020.

 

Management’s Report on Internal Control Over Financial Reporting

 

We are responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined by Securities Exchange Act Rule 13a-15(f). Our internal controls are designed to provide reasonable assurance as to the reliability of our financial statements for external purposes in accordance with accounting principles generally accepted in the United States.

 

Internal control over financial reporting has inherent limitations and may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable, not absolute, assurance with respect to financial statement preparation and presentation. Further, because of changes in conditions, the effectiveness of internal control over financial reporting may vary over time.

 

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.

 

Under the supervision and with the participation of our President and Chief Financial Officer, we have evaluated the effectiveness of our internal control over financial reporting as of December 31, 2020, as required by Securities Exchange Act Rule 13a-15(c). In making our assessment, we have utilized the criteria set forth by the 2013 Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We concluded that based on our evaluation, our internal control over financial reporting was effective as of December 31, 2020.

 

Changes in internal control over financial reporting

 

There have been no changes in our internal control over financial reporting that occurred during the fourth quarter ended December 31, 2020, or subsequent to the date the Company completed its evaluation, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B. Other Information

 

None

 

 

PART III

 

Item 10. Directors, Executive Officers and Corporate Governance

 

As of the date of this Report, the Executive Officers and Directors of the Company were:

 

Name	Age	Office
James W. Korth	70	Chairman of the Board, Chief Executive Officer, and Director
Holly C. MacDonald-Korth	45	President, Chief Financial Officer and Director
Pamela J. Hipp	52	Director of Securities Marketing and Director
Daniel Llorente	41	Chief Lending Officer and Director
Jonathan L. Shepard	77	Secretary and Director

 

James W. Korth has been the Chief Executive Officer of KDM since its organization. He is also the Managing Partner of J W Korth & Company, LP, which he started in 1982.  Mr. Korth has spent his business career as an investment banker in all manner of debt securities, including brokered CDs, and Certificates of Accrual on Treasury Securities (“CATS”), and has advised the US Treasury Department in the creation of the STRIPS program, and corporate General Term Notes, a Medium Term Note program emulated across the industry. Mr. Korth also manages several securities portfolios for clients of J W Korth & Company and holds his Series 4, 7, 24, 53, 66, and 79 licenses. He received his Master of Science from Michigan State University. Mr. Korth was made Chairman of the Board in June 2019.

 

Holly MacDonald-Korth is the Chief Financial Officer of KDM since 2016, and the President since June 2019. Since 2006, she has been the Managing Director and Chief Financial Officer of J W Korth & Company, where she oversees all operations, finance, and business development for the firm. Prior to joining J W Korth, Ms. MacDonald-Korth was Senior Vice President at Overstock.com and a financial systems analyst at the Board of Governors of the Federal Reserve. Ms. MacDonald-Korth is the daughter of James W. Korth. She received a Bachelor of Business Administration with Honors in Finance from University of Miami. She holds her Series 7, 24, 27, and 66 licenses.

 

Daniel Llorente is the Chief Lending Officer of KDM since 2016.  Mr. Llorente has over fourteen years of commercial and residential real estate financing experience at a variety of mortgage banks. Prior to joining KDM, Mr. Llorente was a Mortgage Loan Originator at Lakeview Loan Servicing. In 2013 and 2014 he served as an Associate Portfolio Manager at Bayview Loan Servicing. From 2012 -2013 he served as Assistant Vice President and Portfolio Manager at Intercredit Bank. From 2009 to 2012 he was Senior Loan Analyst at LNR Property LLC. Prior to that time he held positions at Regions Bank, Silver Hill Financial, and Lincoln Road Funding. All positions were in Miami, Florida and related to real estate financing. He is an ABA Certified Credit Analyst.  Mr. Llorente graduated from Florida State University with a degree in finance and received an MBA from Nova Southeastern University.

 

Pamela J. Hipp is Director of Securities Marketing and a Director. Ms. Hipp works for J. W. Korth & Company as Managing Director of Trading. She joined J. W. Korth in 2007 after its purchase of Cambridge Group Investments as regional trader and was promoted to Managing Director of Trading in 2010. Ms. Hipp has been in the securities industry for 23 years, first working at Citistreet Equities serving major corporations retirement account management; she then moved on to Cambridge Group in 2000. A Registered Representative and General Principal, Pam holds FINRA Series 7, 24, 63, 66, and 79 registrations and received her Bachelor of Science degree from Michigan State University. Pam is also a Partner of J. W. Korth and member of its Investment Committee, which guides recommendations and proprietary investment decisions.

 

Jonathan Shepard has served as outside general counsel to KDM since 2007. Mr. Shepard has practiced in New York City, Philadelphia, and Boca Raton, Florida, in law firms, corporations, and the Environmental Protection Agency. He was a partner in Siegel, Lipman, and Shepard, LLP, in Boca Raton from 1994 until December 2017, and in October 2017 formed Shepard PLLC, where he now practices in Boca Raton. He is a graduate of Princeton University and Yale Law School.

 

Board Committees

 

We do not have any Board committees. We anticipate that as we grow our business we may establish formal committees, which may include an audit committee, a compensation committee, and a governance and nominating Committee.

 

 

Code of Ethics

 

We adopted a Code of Conduct and Ethics that applies to all officers, directors, and employees of our Company on February 27, 2019. Any person may, without charge, request a copy of our Code of Ethics by writing info@korthdirect.com. Our code of ethics is also available on our website at http://www.korthdirect.com.

 

 

Item 11. Executive Compensation 

 

Summary Compensation Table

 

The following table provides summary information regarding compensation earned by the named executive officer during the fiscal years ended December 31, 2020 and 2019.

 

														Option				All Other
Name						Salary				Bonus				Awards				Compensation				Total
and Principal Position		Year				($)				($)				($)(1)				($)				($)
Holly MacDonald Korth, President and Chief Financial Officer			2020			$	365,000			$	25,000				0				0			$	390,000
			2019			$	132,430			$	145,500				0				0			$	277,840
James W Korth, Chief Executive Officer			2020				300,000								0				0				300,000
			2019			$	45,000			$	50,000				0				0			$	95,000

 

Of the compensation listed above, Holly MacDonald-Korth earned $75,000 and James Korth earned $87,500 from J. W. Korth prior to the Company’s acquisition of J. W. Korth on July 31, 2020.

 

For the years ended December 31, 2020 and 2019, our Chief Lending Officer, Daniel Llorente, received compensation of $200,000 and $115,000, respectively.

 

The Company does not have a compensation or other committee of its directors.

 

Equity Compensation Plan Information

On June 28, 2019, the Company’s Board of Directors adopted the Korth Direct Mortgage Inc. 2019 Stock Option Plan (the “Stock Plan”). The Stock Plan provides for the grant of both incentive and non-statutory stock options to key employees, directors or other persons having a service relationship with the Company for the purchase of up to an aggregate of 1,000,000 shares of the Company’s common stock, $0.001 par value. The Stock Plan is administered by the Board of Directors or a committee appointed by the Board.

 

The purpose of the Stock Plan is to attract, retain and motivate employees, officers, directors, consultants, agents, advisors and independent contractors of the Company by providing them the opportunity to acquire a proprietary interest in the Company and to link their interests and efforts to the long-term interests of the Company’s shareholders.

 

The following table presents details of the Company’s equity compensation plan as of December 31, 2020:

 

		Number of securities to be issued upon exercise of outstanding options				Weighted-average exercise price of outstanding options				Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
		(a)				(b)				(c)
Equity compensation plans approved by security holders (1)			835,000			$	1.00				165,000
Equity compensation plans not approved by security holders			–				–				–
Total			835,000			$	1.00				165,000

 

⁽¹⁾ Consists of the Company’s Stock Plan.

 

 

Description of the Stock Plan

 

The Stock Plan is administered by the Board of Directors of the Company. The maximum number of shares of common stock available for issuance under the Stock Plan is 1,000,000.

 

The Stock Plan permits awards of incentive stock options, nonqualified stock options, and restricted stock. The Stock Plan provides that the exercise price of any option will not be less than the fair market value of the common stock on the date of grant or, for a 10% shareholder, 110% of fair market value.

 

Eligibility

An award under the Stock Plan can be made to any employee, consultant, or director of the Company, as selected by the Board of Directors.

 

Shares Covered by the Stock Plan

The Stock Plan permits the granting of awards covering an aggregate of 1,000,000 shares of Company common stock. The shares of Company common stock may be either authorized but unissued shares or treasury shares.

 

Any shares that are reserved for options or performance shares that lapse, expire, terminate or are cancelled, or if shares of Company common stock are issued under the plan and are thereafter reacquired by the Company, the shares subject to such awards and the reacquired shares may be available for subsequent awards under the Stock Plan.

 

Stock Options and Rights

Options granted under the Stock Plan may be either non-qualified stock options or incentive stock options qualifying for special tax treatment under Section 422 of the Internal Revenue Code. The exercise price of any stock option may not be less than the fair market value of the shares of common stock on the date of grant and 110% of fair market value for 10% shareholders. The exercise price is payable in cash, shares of common stock previously owned by the optionee or a combination of cash and shares of common stock previously owned by the optionee, or by a recourse or non-recourse note executed by the nominee (subject to Sarbanes-Oxley prohibitions on officer loans). Both non-qualified stock options and incentive stock options will generally expire on the tenth anniversary of the date of grant, unless otherwise specified.

 

Restricted Stock Plan

Under the Stock Plan, the Board of Directors may grant shares of restricted stock on terms and conditions, including performance criteria, repurchase and forfeiture, as determined by the Board. Upon satisfaction of the terms and conditions of the award, shares of restricted stock become transferable.

 

Amendment and Termination of the Stock Plan

The Board may, at any time, amend the Stock Plan or any portion of the plan, provided that to the extent required by law or a stock exchange rule, shareholder approval is required for any amendment to the plan. By its terms, the Stock Plan terminates ten years after its effective date.

 

Recent Grants

In the fiscal year which ended December 31, 2019, the Company granted 835,000 options to its employees pursuant to the Stock Plan. There were no grants made during the year ended December 31, 2020.

 

Grants of Plan-Based Awards

Our named executive officers have not received any grants of plan-based awards pursuant to our 2019 Stock Plan.

 

Director Compensation

No director receives compensation for serving as a director of the Company. However, directors other than James Korth and Holly MacDonald Korth received common stock options for their services as employees or consultants to the Company. See Item 12 Security Ownership of Certain Beneficial Ownership and Management and Related Stockholder Matters.

 

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

The following table sets forth security ownership information pertaining to persons who are officers, directors, or known by us to beneficially own more than 5% of the common stock, which is the sole class of voting stock in the Company, and of all of the directors and executive officers of the Company as a group, as of December 31, 2020.

 

Except as otherwise indicated, each person and each group shown in the table has sole voting and investment power with respect to the shares of common stock indicated. For purposes of the table below, in accordance with Rule 13d-3 under the Securities Exchange Act of 1934, as amended, a person is deemed to be the beneficial owner, of any shares of our common stock over which he or she has or shares, directly or indirectly, voting or investment power or of which he or she has the right to acquire beneficial ownership at any time within 60 days. As used in this prospectus, “voting power” is the power to vote or direct the voting of shares and “investment power” includes the power to dispose or direct the disposition of shares. Common stock beneficially owned and percentage ownership was based on 5,000,000 shares outstanding on May 14, 2020, plus 417,500 shares deemed outstanding pursuant to Rule 13d-3, for a total of 5,417,500 shares outstanding. Unless otherwise indicated, the address of each beneficial owner is c/o Korth Direct Mortgage Inc., 135 San Lorenzo Ave, Coral Gables, FL 33146.

 

 

Name and Address	Number of Shares	Percent
5% Beneficial Owners
Directors and Executive Officers
James W. Korth	3,010,000	55.6%
Chairman of the Board, Chief Executive
Officer, Director
Holly MacDonald-Korth	1,190,000	22.0%
President, Chief Financial Officer,
Director
Pamela Hipp, Director (1)	412,500	7.6%
Daniel Llorente, Director(1)	150,000	*
Jonathan Shepard, Secretary and Director(1)	25,000	*
All directors and executive officers as	4,787,500	88.4%
a group (5 persons) (1)

 

 

* Indicates less than one percent (1%).

 

(1)

Includes pursuant to Rule 13d-3 common stock options exercisable within 60 days of the date of this Report, as follows: Ms Hipp, 62,500 shares; Mr. Llorente, 150,000 shares; Mr, Shepard, 25,000 shares. See Item 11, “Executive Compensation-Equity Compensation Plan Information.”

 

The Company does not have a class of equity securities registered under Section 12 of the Securities Exchange Act of 1934

 

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

 

The principal shareholder of the Company is James Korth. Mr. Korth is, Chairman, Chief Executive Officer and a Director of the Company, and together with his daughter, Holly MacDonald-Korth, the President, Chief Financial Officer, and a Director of the Company, they both control 77.6% of the Company.

 

KDM earns money by making and servicing loans., J. W. Korth, a wholly owned subsidiary of KDM, is a broker-dealer that makes money by selling securities.

 

KDM has a financial incentive to make CM loans and distribute Notes based on CM Loans. This incentive may influence its judgment as to the quality of CM Loans it will make. To help control this conflict, KDM has created a rating system for CM Loans and has written underwriting standards. Further, our subsidiary, J.W. Korth, will distribute KDM Notes to retail customers and other dealers. Accordingly, JWK has a financial incentive which may influence the underwriting and due diligence required for originating CM Loans.

 

Some members of the KDM loan origination team are also registered brokers with J.W. Korth. Such employees may be paid for both origination and sales of a loan and a Note, respectively. We will mitigate these conflicts of interest with compliance oversight and review of such transactions and compensation.

 

We believe we may have certain conflicts arising from our rating system. The same people doing our ratings may also benefit from the sales of Notes and making new CM Loans. Further, J.W. Korth is owned by KDM, and distributes our Notes and may make a market in them. Ratings will be reviewed periodically and changed as necessary for each CM Loan and the corresponding Notes. If a secondary market were to develop, secondary market prices for our Notes may move up or down if the rating is changed. However, no such market currently exists.

 

We may change any of our procedures regarding managing our conflicts of interest at any time. We also may amend our rating procedure at any time.

 

Indemnification Agreement

 

Our Operating Agreement provides that we will indemnify our Members, managers and officers to the fullest extent permitted by Florida law.

 

Item 14. Principal Accountant Fees and Services

 

Richey May & Co., LLP has served as the Company’s independent registered public accounting firm for the fiscal years ended December 31, 2020, 2019, 2018, and 2017.

 

Auditor Fees

 

The following table sets forth fees billed, or expected to be billed, to the Company by the Company’s independent auditors for the years ended December 31, 2020 and 2019 for (i) services rendered for the audit of the Company’s annual financial statements and the review of the Company’s quarterly financial statements; (ii) services rendered that are reasonably related to the performance of the audit or review of the Company’s financial statements that are not reported as Audit Fees; (iii) services rendered in connection with tax preparation, compliance, advice and assistance; and (iv) all other services:

 

		2020				2019
Audit fees		$	75,680			$	42,030
Audit related fees			-				-
Total Fees		$	75,680			$	42,030

 

 

For 2020, the audit fees listed include J. W. Korth’s audit expense of $28,000 as well as KDM’s audit expense of $47,680. 

 

 

PART IV.

 

Item 15. Exhibits and Financial Statement Schedules

 

The following exhibits designated with a footnote reference are incorporated herein by reference to a prior registration statement or a periodic report filed by the Registrant pursuant to Section 13 or 15(d) of the Exchange Act:

 

Exhibit
Number	Description
2.1	Plan of Conversion, dated May 31, 2019 (incorporated by reference to Exhibit to 2.1 to the Registrant’s Report on Form 8-K filed June 12, 2019)
3.1	Operating Agreement of Korth Direct Mortgage, LLC, a Florida limited liability company (incorporated by reference to Exhibit 3.1 to Registrant’s Registration Statement on Form S-1 filed January 27, 2017)
3.2	Articles of Organization for HCMK Consulting LLC (incorporated by reference to Exhibit 3.2 to Registrant’s Registration  Statement on Form S-1 filed January 27, 2017)
3.3	Articles of Amendment to Articles of Organization Changing Name from HCMK Consulting LLC to J W Korth & Company LLC (incorporated by reference to Exhibit 3.3 to Registrant’s Registration Statement on Form S-1 filed January 27, 2017)
3.6	Articles of Conversion, dated May 31, 2019 (incorporated by reference to Exhibit to 3.1 to the Registrant’s Report on Form 8-K filed June 28, 2019)
3.7	Articles of Incorporation of Korth Direct Mortgage Inc., dated May 31, 2019 (incorporated by reference to Exhibit to 3.2 to the Registrant’s Report on Form 8-K filed June 28, 2019)
3.8	Bylaws of Korth Direct Mortgage Inc., dated May 31, 2019 (incorporated by reference to Exhibit to 3.1 to the Registrant’s Report on Form 8-K filed June 28, 2019)
4.1	Trust Indenture and Security Agreement between Korth Direct Mortgage LLC, and Delaware trust Company dated November 17, 2017 (incorporated by reference to Exhibit 3.4 to registrant’s Registration Statement on Form S-1/A filed November 20, 2017)
4.2	Trust Indenture and Security Agreement (Rule 144A Offerings)  between Korth Direct Mortgage LLC, and Delaware Trust Company dated September 20, 2018 (incorporated by reference to Registrant’s Report on Form 10-Q filed November 13, 2018)
4.3	Trust Indenture and Security Agreement Dated September 30, 2020, between Korth Direct Mortgage Inc. and Delaware Trust Company as Trustee
10.1	Korth Direct Mortgage Inc. 2019 Stock Option Plan (incorporated by reference to Exhibit 10.1 to the Registrant’s report on Form 8-K filed June 29, 2019)
10.2	Support Agreement dated October 1, 2016, between J.W. Korth & Company and Korth Direct Mortgage, LLC (incorporated by reference to Exhibit 10 to Registrant’s Report on Form 10-K filed March 28, 2019)
23.1	Consent of Richey May & Co., LLP*
31.1	Section 302 Certificate of Chief Executive Officer*
31.2	Section 302 Certificate of Chief Financial Officer*
32.1	Section 906 Certificate of Chief Executive Officer*
32.2	Section 906 Certificate of Chief Financial Officer*
101	Interactive Data File

  

*Filed herewith.

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	KORTH DIRECT MORTGAGE, INC.
	By:	/s/ James W. Korth
		James W. Korth
		Chief Executive Officer and Chairman

 

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the registrant and in the capacities and on the dates indicated have signed this report below.

 

Signature	Title	Date
/s/ Holly MacDonald-Korth	President and Chief Financial Officer	March 29, 2021
Holly MacDonald-Korth

 

 

KORTH DIRECT MORTGAGE INC.

 

REPORT ON CONSOLIDATED FINANCIAL STATEMENTS

 

YEARS ENDED DECEMBER 31, 2020 AND 2019

 

 

9605 S. Kingston Ct. Suite 200 Englewood, CO 80112 303-721-6131 www.richeymay.com Assurance | Tax | Advisory

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Shareholders and Board of Directors of Korth Direct Mortgage Inc.

 

Opinion on the Consolidated financial statements

We have audited the accompanying consolidated financial statements of Korth Direct Mortgage Inc, (the “Company”), which comprise the consolidated statements of financial condition as of December 31, 2020 and 2019, and the related consolidated statements of operations, changes in consolidated statements in stockholders’ equity, and consolidated statements of cash flows for the years ended December 31, 2020 and 2019, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial condition of Korth Direct Mortgage Inc as of December 31, 2020 and 2019, and the results of its consolidated operations, changes in its consolidated stockholders’ equity and its consolidated cash flows for the years ended December 31, 2020 and 2019 in accordance with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conduct our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting 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.

 

Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.

 

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period of audit of the consolidated financial statements of the Company. As more fully described in footnote 3 to the consolidated financial statements of the Company, on July 31, 2020, the Company, acquired substantially all of the equity of J.W. Korth, a Michigan limited partnership, and its general partner, J.W. Korth, LLC, 

 

 

a Florida limited liability company. J.W. Korth is registered with the Securities and Exchange Commission as a broker-dealer and investment advisor, and with the Financial Industry Regulatory Authority (“FINRA”) as a broker-dealer. The Company’s acquisitions of J.W. Korth and J.W. Korth, LLC are together referred to as the “Acquisitions.” Prior to closing of the Acquisitions, Mr. James W. Korth (the Company’s Chairman and Chief Executive Officer) and Ms. McDonald-Korth (the Company’s President and Chief Financial Officer) together owned approximately 80% of J.W. Korth’s partnership interests and controlled the business and operations of J.W. Korth. J.W. Korth funded the organization and operation of the Company pursuant to a support agreement with the Company from inception until April 2019, at which time the Company became self-sustaining and J.W. Korth forgave a receivable owed to it by the Company. Until closing of the Acquisitions, the Company was controlled by J.W. Korth, which owned all of its voting common stock. The consolidated statement of financial condition as of December 31, 2020 includes the financial conditions of the Company and the Acquisitions. The consolidated statements of operations, changes in consolidated statements in stockholders’ equity, and consolidated statements of cash flows include the accounts of the Company from January 1, 2020 through July 31, 2020, after which the results include the consolidated activities of the Company and the Acquisitions.

 

/s/ Richey May & Co., LLP

 

We have served as the Company’s auditor since 2016.

 

Englewood, Colorado

March 29, 2021

 

 

KORTH DIRECT MORTGAGE INC.

 

 

 

 

 

 

TABLE OF CONTENTS 

CONSOLIDATED FINANCIAL STATEMENTS 

YEARS ENDED DECEMBER 31, 2020 AND 2019

 

 

 

 

 

	PAGE(S)
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	F-2
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Statements of Financial Condition	F-5
Consolidated Statements of Operations	F-6
Consolidated Statements of Changes in Stockholders’ Equity	F-7
Consolidated Statements of Cash Flows	F-8
Notes to Consolidated Financial Statements	F-9

 

 

KORTH DIRECT MORTGAGE, INC.

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

 

		For Year Ended				For Year Ended
		December 31, 2020				December 31, 2019
ASSETS
Cash and Cash Equivalents		$	2,037,177			$	2,378,716
Restricted Cash			6,605,288				1,295,242
Mortgages Owned			175,370,850				85,692,812
Mortgage Servicing Rights, at Fair Value			3,864,416				2,595,946
Portfolio Loans			2,042,414				2,152,835
Securities			329,152				-
ROU Leased Asset			1,031,126				-
Goodwill			110,000				-
Property & equipment, net of depreciation			186,703				-
Deposits			140,359				-
Prepaid Expenses			120,770				10,584
Accounts Receivable			19,577				62,581
TOTAL ASSETS		$	191,857,832			$	94,188,716
LIABILITIES AND  STOCKHOLDER'S EQUITY
LIABILITIES
Due to Parent		$	-			$	12,151
Escrows Payable			6,462,394				1,174,747
Due to Investors			142,894				120,496
Due to clearinghouse brokers			240,942				-
Lease liability			1,037,538				-
Preferred Dividend Payable			12,500				12,500
Deferred Revenue, net			500,130				289,569
Deferred Tax Liability			641,111				380,236
Accrued Expenses			57,197				66,945
Contingent liability, net			773,405				-
PPP loan payable			161,600				-
Mortgage Secured Notes Payable			175,370,850				85,692,812
Accounts Payable			70,279				14,234
Total Liabilities			185,470,840				87,763,690
STOCKHOLDERS' EQUITY
Accumulated Earnings			1,365,653				939,154
Additional Paid-in Capital			5,020,639				5,485,172
Common Stock, $0.0001 par value, 60,000,000 shares authorized
5,000,000 shares issued and outstanding at December 31, 2020 and 2019			500				500
Series A Preferred Stock, $0.001 par value, 40,000,000 shares authorized,
200,000 shares issued and outstanding at December 31, 2020 and 2019			200				200
Total Stockholders' Equity			6,386,992				6,425,026
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY		$	191,857,832			$	94,188,716

 

See accompanying notes to the audited consolidated financial statements.

 

 

KORTH DIRECT MORTGAGE, INC.

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

 

		For the Year Ended				For the Year Ended
		December 31, 2020				December 31, 2019
REVENUES
Origination Revenue, Net		$	440,027			$	233,125
Servicing Revenue			1,186,743				296,884
Processing Revenue			38,919				21,915
Underwriting Income			309,210				-
Trading Profits			602,525				-
Interest Income			176,345				18,183
Commissions			10,116				-
Late Fees			8,891				20,016
Total Revenues			2,772,776				590,123
COST OF REVENUES
Broker Underwriting Expense			215,090				101,301
Mortgage Broker Expense			263,634				77,714
Co-Manager Engagement Fee			3,526				2,108
Bank Transaction Fees			26,891				9,656
Appraisal Costs			22,745				9,535
Marketing			51,442				38,478
License and Registration			50,530				12,707
Insurance Review			1,000				-
Ratings			47,362				33,092
Technology Fees			126,201				8,561
Total Cost of Revenues			808,421				293,152
GROSS PROFIT			1,964,355				296,971
OPERATING EXPENSES
Office Supplies			28,417				5,750
Accounting			81,752				38,975
Salaries & Commissions			1,635,237				598,466
Payroll Taxes			86,433				30,166
Other Payroll Related Costs			43,854				-
Professional & Legal			184,051				108,376
Rent Expense			66,430				-
Utilities			11,486				-
Travel & Entertainment			16,759				34,738
Tradeshow Expense			9,199				-
Business Insurance			47,615				-
Business Development			-				2,768
Depreciation			3,391				-
Stock Compensation			25,812				90,356
Total Expenses			2,240,436				909,595
Net Loss From Operations			(276,081	)			(612,624	)
Other Income / (Expenses/Loss)
Unrealized Gain on Mortgages			1,268,470				2,380,487
Unrealized Loss on Mortgage Secured Notes			(1,103	)			-
Interest Expense			(17,406	)			-
Interest income			3,494				-
Gain from forgiveness of EIDL advance			10,000				-
Gain from Write-Off Due to Parent			-				548,802
Total Other Income			1,263,455				2,929,289
Net income before provision for income taxes			987,374				2,316,665
Provision for income taxes			260,875				380,236
Net Income			726,499				1,936,429
Series A Preferred Dividends			300,000				77,500
Net income attributable to common stockholder		$	426,499			$	1,858,929

 

See accompanying notes to the audited consolidated financial statements.

 

 

 

KORTH DIRECT MORTGAGE, INC.

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

 

		Series A Preferred Stock								Common Stock								Additional Paid				Accumulated
		Shares				Amount				Shares				Amount				in Capital				Earnings				Totals
Balance at January 1, 2019			-			$	-				-			$	-			$	3,522			$	(277,781	)		$	(274,259	)
Issuance of common stock upon transition from LLC to C-Corp			-				-				5,000,000				500				641,494				(641,994	)			-
Options issued to employees and directors			-				-				-				-				90,356				-				90,356
Issuance of Series A Preferred Stock			200,000				200				-				-				4,749,800				-				4,750,000
Series A preferred stock dividends declared			-				-				-				-				-				(77,500	)			(77,500	)
Net income			-				-				-				-				-				1,936,429				1,936,429
Balance at December 31, 2019			200,000			$	200				5,000,000			$	500			$	5,485,172			$	939,154			$	6,425,026
Options issued to employees and directors			-				-				-				-				25,812				-				25,812
Acquisition of related party affiliate (see Note 3)			-				-				-				-				(490,345	)			-				(490,345	)
Series A preferred stock dividends declared			-				-				-				-				-				(300,000	)			(300,000	)
Net income			-				-				-				-				-				726,499				726,499
Balance at December 31, 2020			200,000			$	200				5,000,000			$	500			$	5,020,639			$	1,365,653			$	6,386,992

 

See accompanying notes to the audited consolidated financial statements.

 

 

KORTH DIRECT MORTGAGE, INC.

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		For the Year Ended				For the Year Ended
		December 31, 2020				December 31, 2019
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income		$	726,499			$	1,936,429
Adjustments to Reconcile Net Income to
Net Cash Used In Operating Activities:
Unrealized Gain on Mortgages Owned			(1,268,470	)			(2,380,487	)
Unrealized Loss on Mortgage Secured Notes			1,103				-
Gain from Write-Off of Due to Parent			-				(548,802	)
Gain from forgiveness of EIDL advance			(10,000	)			-
Stock compensation expense			25,812				90,356
Depreciation			3,391				-
Deferred rent expense from operating lease			6,412				-
Deferred income taxes			260,875				380,236
Changes in Operating Assets and Liabilities:
Restricted Cash			(5,310,046	)			(1,133,788	)
Mortgage Secured Notes Issued			89,678,038				72,519,346
Mortgage Secured Notes Purchased			(103,285	)			-
Portfolio Loans			110,421				(2,152,835	)
Accounts Receivable			51,413				(62,581	)
Prepaid Expenses			(59,716	)			-
Deposits			(33,048	)			-
Due to Parent			(45,247	)			66,831
Deferred Revenue, net			210,561				283,066
Escrow Payable			5,287,647				1,049,702
Due to Investors			22,398				84,087
Due to clearinghouse brokers			141,022				-
Interest payable			17,406				-
Accrued Expenses			(117,471	)			51,944
Accounts Payable			(8,711	)			-
Notes Payable			-				14,234
New Mortgage Lending			(89,678,038	)			(72,519,346	)
Total Adjustments			(817,533	)			(4,258,036	)
NET CASH USED IN OPERATING ACTIVITIES			(91,034	)			(2,321,607	)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment			(179,646	)			-
Acquisition of related party affiliate, net of cash acquired			229,141				-
NET CASH PROVIDED BY INVESTING ACTIVITIES			49,495				-
CASH FLOWS FROM FINANCING ACTIVITIES
Net Proceeds from issuance of preferred stock			-				4,750,000
Payment of Series A preferred stock dividends			(300,000	)			(65,000	)
NET CASH (USED IN)/PROVIDED BY FINANCING ACTIVITIES			(300,000	)			4,685,000
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			(341,539	)			2,363,393
CASH AND CASH EQUIVALENTS – Beginning of Year			2,378,716				15,323
CASH AND CASH EQUIVALENTS – End of Year		$	2,037,177			$	2,378,716
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION
Cash paid during the year for interest		$	17,263			$	-

 

See accompanying notes to the consolidated financial statements.

 

 

KORTH DIRECT MORTGAGE, INC

AND SUBSIDIARIES

NOTES TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1 - NATURE OF BUSINESS

 

Korth Direct Mortgage, Inc. (the “Company” or “KDM”) is incorporated in the State of Florida. The Company was created to originate mortgages and fund those mortgages with Notes secured by mortgage loans. KDM was a wholly-owned subsidiary of J.W. Korth & Company Limited Partnership (“J.W. Korth”) until July 31, 2020.

 

On July 31, 2020, the Company acquired substantially all of the equity of J.W. Korth – see Note 3 below for the details.

 

J.W. Korth is a securities broker dealer registered with the Securities Exchange Commission and the states of Michigan, Florida, and various other states and an SEC registered investment adviser under the Investment Advisers Act of 1940. J.W. Korth is a licensed member of the Financial Industry Regulatory Authority (FINRA), the Securities Investor Protection Corporation, as well as a Municipal Securities Rulemaking Board (MSRB) registrant.

 

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements include the accounts of the Company and, beginning on July 31, 2020, the accounts of J.W. Korth, the Company’s wholly-owned subsidiary. Intercompany balances and transactions have been eliminated in consolidation.

 

BASIS OF ACCOUNTING

The accompanying financial statements have been prepared on the accrual basis of accounting, in accordance with GAAP.

 

USE OF ESTIMATES

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the 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

For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.

 

MORTGAGE VALUATION

Mortgages that are current are carried at the principal value owed by the borrower, as of the date of the financial statements, according to the amortization schedule for the loan. All mortgages owned as of the date of these financial statements are current. The net present value of the servicing revenue is recorded as mortgage servicing rights, at fair value on the Audited Statements of Financial Condition, and is recognized on the Audited Statement of Operations as an unrealized gain on mortgages.

 

MORTGAGE SECURED NOTES

The Company funds the mortgage loans that it makes by issuing Mortgage Secured Notes (“MSNs”), which are secured by those same mortgages. As of December 31, 2020, the Company has funded loans totaling $175,370,850, and it issued MSNs secured by those loans, also in the amount of $175,370,850. The deals have been funded in multiple ways, including private placements, SEC registered deals, and 144A offerings.

 

PORTFOLIO LOANS

The Company recognizes loans made with its own capital, or those not securitized, under the caption “Portfolio Loans” on the balance sheet. As of December 31, 2020, the Company had issued Portfolio Loans in the amount of $2,042,414. These loans were funded by the Company, as well as affiliates.

 

 

GOODWILL

Financial Accounting Standards Board Accounting Standards Codification (“FASB ASC”) Section 350 requires an annual assessment of the recoverability of goodwill using a two-step process. The first step of the impairment test involves a comparison of the fair value of the reporting unit to its carrying value. If the carrying value is higher than the fair value or there is an indication that impairment may exist, a second step must be performed to compute the amount of the impairment. Management conducted its annual assessment of goodwill impairment and determined that there were no indicators of goodwill impairment and therefore did not record an impairment loss for the period ending December 31, 2020.

 

REVENUE RECOGNITION

The Company’s primary sources of revenue are generated from origination fees, servicing fees, processing fees, underwriting income, trading profits, and interest income.

 

Origination Fees

Loan origination fees represent revenue earned from originating mortgage loans; net of any credits given to the borrower. Loan origination fees generally represent flat, per-loan fee amounts and are deferred and recognized as revenue over the life of the loan. The associated loan origination costs are also deferred and recognized as expense over the life of the loan. The deferred portion of the loan origination fees is netted against the deferred portion of the loan origination costs, which include mortgage broker expenses, and reported as a net deferred revenue liability on the Company’s Statement of Financial Condition.

 

Servicing Fees

Loan servicing fees represent revenue earned for servicing loans for various investors. Loan servicing fees are a percentage of the outstanding unpaid principal balance and represent the difference between the Corresponding Mortgage Loan (“CM Loan”) interest received and the MSN interest payable. Servicing Fees are recognized as revenue as the related mortgage payments are received; similarly, loan servicing expenses are charged to operations as incurred.

 

Processing Fees

Processing fees are collected from the borrower at the time the commitment letter is signed and cover a variety of expenses during the underwriting process. If the Company cancels the transaction, then unused fees are refunded. If the transaction is unable to proceed for any reason not the fault of the Company, then the Company keeps the full processing fee. Revenues from processing fees are recognized at closing or at the time a transaction is canceled.

 

Underwriting Income

Underwriting income represents revenue earned by J.W. Korth for underwriting and distribution of the Company’s securities. Revenues from underwriting income are recognized on settlement date of the trades.

 

Trading Profits

Trading profits represent revenue generated through J.W. Korth for the trading of securities either for its own account or on behalf of its clients. Revenue from trading profits is recognized upon settlement of the securities transactions.

 

Interest Income

Revenue that falls under this caption is primarily derived from interest earned on Portfolio Loans. Interest earned on cash and securities also falls under this caption.

 

LEASES

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” The standard requires organizations to recognize right-of-use (“ROU”) assets and lease liabilities on the balance sheet and disclose key information about leases that were historically classified as operating leases under previous generally accepted accounting principles. Leases will be classified as financing or operating, with classification affecting the pattern and classification of expense recognition in the income statement. The Company adopted the new lease standard on January 1, 2019, and has chosen to use that date as the effective date of initial application. Consequently, financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods before January 1, 2019. The new lease guidance provides a number of optional practical expedients in transition. The Company has elected the “package of practical expedient,” which permits it to not reassess under the new standard its prior conclusions about lease identification, lease classification, and initial direct costs. As part of the adoption of this standard, the Company recognized lease liabilities with a corresponding ROU leased asset of approximately the same amount based on the present value of the remaining lease payments pursuant to current leasing standards for existing operating leases. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.

 

STOCK-BASED COMPENSATION

The Company estimates the fair values of share-based payments on the date of grant using a Black-Scholes option pricing model. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. The Company’s accounting policy is to recognize forfeitures as they occur.

 

 

The Black-Scholes option pricing model requires assumptions for the expected volatility of the share price of our common stock, the expected dividend yield, and a risk-free interest rate over the expected term of the stock-based award.

 

Since the Company’s common stock is not publicly traded, we do not have sufficient company specific information regarding the volatility of our share price on which to base an estimate of expected volatility. As a result, we use the historical volatilities of similar entities within our industry as the expected volatility of our share price.

 

The expected dividend yield is 0% as the Company has not paid any dividends on its common stock and does not anticipate it will pay any dividends in the foreseeable future on its common stock.

 

The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of the grant date with a remaining term equal to the expected term of the stock-based award.

 

Since the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term, the Company utilizes the simplified method to calculate the expected term of stock-based awards based on the average of the vesting term and contractual term of the award.

 

The assumptions used in calculating the fair value of stock-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.

 

Unrealized Gain on Mortgages

The net present value of the servicing income is recognized at the time the mortgage is initiated. This value uses several inputs that are highly subjective including: discount rate, prepayment rate, the current interest rate environment, and default rate assumptions. Since the Company has limited operating history and a small amount of loans outstanding, we have a limited basis to predict prepayment rates and default rates.

 

DUE TO CLEARINGHOUSE BROKERS

J.W. Korth operates as an SEC and FINRA registered securities broker dealer. The securities transactions are traded through broker clearinghouses and, upon settlement, funds are transferred in and out of the Company’s bank accounts. Unsettled transactions create short-term payables and receivables due to and from the broker clearinghouses. As of December 31, 2020, the Company had a net amount due to the clearinghouse brokers of $240,942.

 

DUE TO PARENT AND PAYABLES

Items due to parent were operating expenses due to the parent company, J.W. Korth, pursuant to a support agreement in place prior to the acquisition of J.W. Korth by the Company on July 31, 2020. As of December 31, 2019, the Company owed J.W. Korth $12,151 for intercompany expenses. Effective July 31, 2020, intercompany balances and transactions were eliminated in consolidation.

 

During the year ended December 31, 2019, J.W. Korth forgave $548,802 of operating expenses that were due from the Company to J.W. Korth, which was recorded as a Gain from Write-off due to Parent during 2019.

 

DEPRECIATION

Depreciation is provided on a straight-line basis using estimated useful lives of three to seven years.

 

INCOME TAXES

Until June 6, 2019, the Company was a limited liability company and was treated as a partnership for federal and state income tax. Accordingly, no provision for federal income taxes was required since the members report their proportionate share of company taxable income or loss on their respective income tax returns. Such income or losses are proportionately allocated to the members based upon their ownership interests.

 

On June 6, 2019, the Company converted into a Florida corporation. Effective with the conversion into a Florida corporation, income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance on deferred tax assets is established when management considers it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

 

Tax benefits from an uncertain tax position are only recognized if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. Interest and penalties related to unrecognized tax benefits are recorded as incurred as a component of income tax expense.

 

NOTE 3 – ACQUISITION OF RELATED PARTY AFFILIATE

 

On July 31, 2020, the Company acquired substantially all of the equity of J.W. Korth, a Michigan limited partnership, and its general partner, J.W. Korth, LLC, a Florida limited liability company. The Company’s acquisitions of J.W. Korth and J.W. Korth, LLC are together referred to as the “Acquisitions.”

 

The Company was founded by J.W. Korth with James W. Korth, its Chairman and Chief Executive Officer, and his daughter, Holly MacDonald-Korth, the Company’s President and Chief Financial Officer. Mr. Korth is the Managing Partner of J.W. Korth and Ms. MacDonald-Korth is J.W. Korth’s Managing Director and Chief Financial Officer. J.W. Korth is registered with the Securities and Exchange Commission as a broker-dealer and investment advisor, and with the Financial Industry Regulatory Authority (“FINRA”) as a broker-dealer. Together, prior to closing of the Acquisitions Mr. Korth and Ms. MacDonald-Korth together owned approximately 80% of J.W. Korth’s partnership interests and controlled the business and operations of J.W. Korth. J.W. Korth funded the organization and operation of the Company pursuant to a support agreement with the Company from inception until April 2019, at which time the Company became self-sustaining and J.W. Korth forgave a receivable owed to it by the Company. Until the closing of the Acquisitions, the Company was controlled by J.W. Korth, which owned all of its voting common stock.

 

The Company originates, funds and services loans which it makes to commercial borrowers. The loans are held by the Company as lender. The Company funds its loans directly in the capital markets through issuance of Mortgage Secured Notes (“MSNs” or “Notes”), which are sold through J.W. Korth as underwriter through exemptions from registration available under Rule 144A, Regulation D, and other exemptions from registration. The Company and J.W. Korth determined that the Company could operate more efficiently if J.W. Korth became a wholly-owned subsidiary of the Company. J.W. Korth submitted its then-proposed sale to FINRA, as required by FINRA rules, and FINRA advised J.W. Korth that it could proceed with the closing.

 

Pursuant to the Purchase Agreement, as a condition of closing J.W. Korth agreed to distribute all of its 5,000,000 shares of common stock in the Company to its partners ratably in accordance with their partnership interests in J.W. Korth pursuant to exemptions from registration available under Section 4(a)(2) of the Securities Act of 1933, as amended, and Rule 506 promulgated under the Securities Act.

 

Prior to the closing, J. W. Korth LLC owned 73.6% of the Common Capital interest of J W Korth and at closing received 3,680,000 shares of the Company. Simultaneously J W Korth LLC distributed the Company shares it received from J.W. Korth to its members James Korth and Holly MacDonald-Korth according to their membership interests which were 80% and 20% respectively.

 

At closing, after the distribution to its members of the Company shares distributed to J W Korth LLC, the Company acquired all of the membership interests in JW Korth LLC from Mr. Korth and Ms. MacDonald-Korth for consideration of the payment to (i) the Preferred Capital Interest partners of J.W. Korth of accrued and unpaid 6% dividends through July 31, 2020, and (ii) James Korth of $150,000 in payment of the value of his JW Korth LLC’s Common Capital Interest account.

 

As post-closing commitments the Company agreed to (i) retain Mr. Korth as the managing partner of J.W. Korth, Ms. MacDonald- 12 Korth as J.W. Korth’s chief financial officer, and all other employees of JW Korth who were employed at closing of the Transactions; (ii) operate J.W. Korth as an SEC registered broker-dealer and investment advisor; (iii) pay the JW Korth Preferred Capital Interest Partners quarterly dividends concurrently with its payment of the Company’s Series A Preferred Stock dividends at least annually; (iv) in such years as it pays Series A Preferred dividends, redeem 25% annually of the JW Korth Preferred Capital Interest partners through a capital contribution to JW Korth; and (v) make a discretionary redemption of all accounts of the limited partners of J.W. Korth under the J.W. Korth partnership agreement. Upon redemption of the limited partners’ accounts and the payment of the other consideration to described above to the JW Korth partners, KDM will own 100% of the voting interests in JW Korth.

 

 

The following table summarizes the consideration paid, or to be paid, for the Acquisitions:

 

		Consideration
Accrued & unpaid dividends to the Preferred Capital Interest partners		$	213,443
JW Korth LLC’s Common Capital Interest account			150,000
Contingent liability to redeem J.W. Korth Preferred Capital Interest Partners			696,253
Disposition of outstanding loan due from J.W. Korth Executive Officer			69,780
Total Consideration Paid		$	1,129,476

 

The following table summarizes the net book value of assets and liabilities acquired as of the closing date, July 31, 2020:

 

		Net Book Value
J.W. Korth Net Book Value		$	889,131
Less: Preferred Interest in J.W. Korth by Company prior to acquisition			(250,000	)
Adjusted Net Book Value acquired		$	639,131

 

Since the acquisition was between related parties, the transaction was recorded at net book value as of the closing date. The difference of $490,345 between the consideration paid and the net book value of the assets and liabilities acquired was recorded as an offset to equity, specifically to Additional Paid-in Capital. Disclosure of supplemental pro forma information for revenue and earnings related to the acquisition, assuming the acquisition was made at the beginning of the earliest period presented, has not been disclosed since the effects of the acquisition would not have been material to the results of operation for the periods presented.

 

NOTE 4 – CONTINGENT LIABILITY

 

As part of the acquisition of related party affiliate discussed above in Note 3, the Company agreed to pay (i) the Preferred Capital Interest partners of J.W. Korth accrued and unpaid 6% dividends through July 31, 2020; (ii) the JW Korth Preferred Capital Interest Partners quarterly dividends concurrently with its payment of the Company’s Series A Preferred Stock dividends at least annually; and (iii) in such years as it pays Series A Preferred dividends, redeem 25% annually of the JW Korth Preferred Capital Interest partners through a capital contribution to JW Korth.

 

The following table summarizes the unpaid Contingent Liability outstanding as of December 31, 2020:

 

Accrued & unpaid dividends through July 31, 2020		$	59,746
Contingent liability to redeem J.W. Korth Preferred Capital Interest Partners			696,253
Accrued quarterly dividends recorded as interest expense through December 31, 2020			17,406
Contingent Liability, net		$	773,405

 

NOTE 5 - RESTRICTED CASH

 

The Company maintains multiple segregated accounts in trust for borrowers and investors. The value of these accounts is carried under the asset “Restricted Cash.”

 

The “In Trust for 1” account holds the monthly tax and insurance payments collected from borrowers and distributes payments annually, on behalf of borrowers, to the appropriate tax authority and insurance companies. As of December 31, 2020, this account has a balance of $6,261,117. This account is included as part of the Escrow Payable liability account.

 

The “In Trust for 2” account receives payments from borrowers and distributes payments to investors, and pays the servicing fee to the Company. As of December 31, 2020, this account has a balance of $142,894 which consists of borrower early payments and commitment fees. This account corresponds to the Due to Investors liability.

 

The Company also maintains multiple lockbox accounts that collect rental payments directly from tenants on the borrowers’ behalf. These accounts typically net out funds monthly. The lockbox account balances as of December 31, 2020, were $201,277. This account is included as part of the Escrow Payable liability account.

 

 

NOTE 6 - COMMITMENTS

 

Prior to the acquisition of J.W. Korth in July 2020, the Company relied entirely on J.W. Korth to provide office space, internet connectivity, phone service, and incidentals. In November 2020, the Company signed a lease for new office space in Miami, Florida, for a term of sixty-two months with the right to extend the term of the lease for two additional, successive periods of two years upon the same terms and conditions of the initial term. In December 2020, the Company entered into a Sublease Agreement to sublet a portion of the office space described above. The subtenant has agreed to cover the proportionate amount of the lease costs associated with the office space based on essentially the same terms as the lease described above, including the rights to extend for two successive two-year periods.

 

As of December 31, 2020, the Company, through its subsidiary J.W. Korth, leased office space in Miami, Florida, and Lansing, Michigan under two operating leases that expire at various times in 2021. The operating lease agreements include provisions for additional payments to cover common areas, direct operating expenses, utilities, parking, and taxes.

 

The net present value of future lease payments pursuant to the operating lease agreements are included in the ROU Leased Asset and the Lease Liability accounts on the Consolidated Statement of Financial Condition. The ROU Leased Asset represents the right to use an underlying asset for the remaining lease term. The Lease Liability represents the obligation to make lease payments pursuant to the terms of the lease agreements.

 

Rental expense for the year ended December 31, 2020 was $66,430, which includes additional expenses for common area, direct operating expense, utilities, parking, and taxes.

 

As of December 31, 2020, the net present value of the future lease liabilities, using the weighted-average discount rate of 4.24%, which is commensurate with the Company’s secured borrowing rate, over the weighted-average remaining life of 4.9 years was $1,037,538.

 

The following is a schedule of the maturities of future lease payments over the remaining life of the operating leases, reconciled to the net present value of as of December 31, 2020:

 

		Future Lease Payments
2021		$	216,115
2022			221,635
2023			227,747
2024			234,043
2025			240,527
2026			20,089
Total Lease Payments			1,160,156
Less: Imputed Interest			(122,618	)
Present Value of  Lease Liabilities		$	1,037,538

 

PPP Loan

 

In April 2020, J. W. Korth, at that time the parent company of KDM, availed itself of a Paycheck Protection Program loan (“PPP Loan”) in the amount of $161,600. While the Company has complied fully with all of the requirements of forgiveness of this loan, it has not been forgiven as of the date of this report and is included in the consolidated statement of financial condition as PPP Loan Payable as of December 31,2020. We have no reason to expect that it will not be forgiven in the future.

 

NOTE 7 - INDEMNIFICATIONS

 

The Company provides representations and warranties to counterparties in connection with a variety of commercial transactions and occasionally indemnifies them against potential losses caused by the breach of those representations and warranties. These indemnifications generally are standard contractual terms and are entered into in the normal course of business. The maximum potential amount of future payments that the Company could be required to make under these indemnifications cannot be estimated. However, the Company believes that it is unlikely it will have to make material payments under these arrangements and has not recorded any contingent liability in the financial statements for these indemnifications.

 

 

NOTE 8 - CUSTOMERS

 

As of December 31, 2020, the Company has approximately thirty customers. The Company defines customers as borrowers that have an active loan with the Company, or are in the midst of the underwriting process and have a commitment fee on deposit with the Company. Further, we have a concentration of customers where two borrowers account for 46% of our total loans outstanding with a total of $80 million in loans.

 

NOTE 9 – RELATED PARTY TRANSACTIONS

 

Prior to the acquisition of J.W. Korth in July 2020, the Due to Parent account was used to account for bills and expenses paid by J.W. Korth on behalf of the Company. The Company was largely supported by its parent company, J.W. Korth, from inception through late 2019. The Company owed J.W. Korth $548,802 on March 30, 2019; however, this debt was forgiven pursuant to an agreement dated May 1, 2019, between J.W. Korth and the Company. The cancellation of this liability resulted in a one-time gain, which is included on the Company’s Statement of Operations for the year ended December 31, 2019.

 

The Company owed J.W. Korth $12,151 as of December 31, 2019. As of December 31, 2020, the intercompany transactions and balances between the Company and J.W. Korth have been eliminated upon consolidation as a result of the acquisition.

 

In March 2020, the Company purchased an MSN in the amount of $100,000 included on the statement of financial condition as Securities.

 

On April 1, 2020, the Company closed a first lien and corresponding MSN, along with a second lien loan of $500,000 on the same property. The funding for the second lien was provided by 110 Capital LLC, an entity controlled by a KDM director and employee. KDM services both notes.

 

On May 13, 2020, the Company executed a preferred partner subscription agreement with J.W. Korth in the amount of $250,000, which was eliminated upon consolidation as a result of the acquisition of J.W. Korth in July 2020 (see Note 3 above).

 

On December 4, 2020 loan KDM2018-L002 was paid off in the amount of $334,541. This loan was made and serviced by KDM to the borrower, but was funded by an entity controlled by a KDM director.

 

Prior to the acquisition of J.W. Korth in July 2020, the Company paid underwriting fees of $158,138 to J.W. Korth in 2020. During the year ended December 31, 2019, the Company paid underwriting fees of $71,353 to J.W. Korth. J. W. Korth has been the initial purchaser of all the MSNs for the year ended December 31, 2020.

 

NOTE 10 – DEFERRED REVENUE, NET

 

Loan origination fees are deferred and recognized as revenue over the life of the respective loan. The associated loan origination costs are also deferred and recognized as expense over the life of the loan. The deferred portion of the loan origination fees is netted against the deferred portion of the loan origination costs and reported as a net deferred revenue liability on the Company’s Statement of Financial Condition.

 

The following is a summary of the loan originating fees and costs deferred and amortized for the years ended December 31, 2020 and 2019:

 

		Deferred Origination Fees				Deferred Origination Costs				Deferred Revenue, net
Deferred Revenue at January 1, 2019		$	182,450			$	(175,947	)		$	6,503
New loan deferrals			1,882,825				(1,568,707	)			314,118
Amortization of deferrals			(216,175	)			185,123				(31,052	)
Deferred Revenue at December 31, 2019			1,849,100				(1,559,531	)			289,569
New loan deferrals			1,208,370				(916,362	)			292,008
Amortization of deferrals			(440,027	)			358,580				(81,447	)
Deferred Revenue at December 31, 2020		$	2,617,443			$	(2,117,313	)		$	500,130

 

NOTE 11 – EMPLOYEE AND DIRECTOR STOCK OPTIONS

 

On June 28, 2019, the Company’s Board of Directors adopted the 2019 Stock Option Plan (the “Incentive Plan”). The Incentive Plan provides for the grant of both incentive and non-statutory stock options to key employees, directors or other persons having a service relationship with the Company for the purchase of up to an aggregate of 1,000,000 shares of the Company’s unissued, or reacquired, common stock, $0.001 par value. The Plan will be administered by the Board of Directors or a committee appointed by the Board.

 

 

During the year ended December 31, 2019, the Company issued options to purchase 835,000 shares of the Company’s common stock at an exercise price or $1.00 per share. The weighted-average grant date fair values of options granted during the fiscal year 2019 was $0.1855 per share. The fair values of the stock-based awards granted during the year ended December 31, 2020, were calculated with the following weighted-average assumptions:

 

		2020
Risk-free interest rate:		1.76%
Expected term:		5.75 years
Expected dividend yield:		0%
Expected volatility:		35.01%

  

For the year ended December 31, 2020, the Company recorded $25,812 of stock-based compensation expense. As of December 31, 2020, there was $38,724 in total unrecognized compensation expense related to non-vested employee stock options granted under the Incentive Plan, which is expected to be recognized over 1.5 years.

 

Stock option activity for the years ended December 31, 2019 and 2020, is summarized as follows:

 

2019 Stock Option Plan:		Shares				Weighted Average Exercise Price				Weighted Remaining Contractual Life (Years)
Options outstanding at January 1, 2019			-
Granted			835,000			$	1.00
Exercised			-
Expired or forfeited			-
Options outstanding at December 31, 2019			835,000			$	1.00				9.5
Granted			-
Exercised			-
Expired or forfeited			-
Options outstanding at December 31, 2020			835,000			$	1.00				8.5
Options exercisable at December 31, 2020			417,500			$	1.00				8.5
Options expected to vest at December 31, 2020			417,500			$	1.00				8.5

 

NOTE 12 – PREFERRED EQUITY

 

On September 27, 2019, the Company issued 200,000 shares of its Series A 6% Cumulative Perpetual Convertible Preferred Stock for net proceeds of $4,750,000. The Company paid $250,000 in expenses related to the preferred stock issuance to J.W. Korth as underwriter and distributor. Each share was sold for $25, and is convertible into common stock at a ratio of 5 shares of common stock for each share of Series A Preferred Stock.

 

NOTE 13 – FAIR VALUE

 

FASB ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), defines fair value as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value should be calculated based on assumptions that market participants would use in pricing the asset or liability, not assumptions specific to the entity.

 

ASC 820 establishes a hierarchy of valuation techniques based on the observability of inputs utilized in measuring financial assets and liabilities at fair value. GAAP establishes market-based or observable inputs as the preferred source of values, followed by valuation models using management assumptions in the absence of market inputs. The three levels of the hierarchy are described below:

 

Level I—Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

 

Level II—Inputs (other than quoted prices included in Level I) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

 

 

Level III—Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

 

ASC 820 requires the use of observable market data, when available, in making fair value measurements. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurements. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.

 

Valuation Process

 

Cash and cash equivalents: 

The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.

 

Mortgages Owned and Mortgage Secured Notes Payable:

Mortgage loans for which the Company has the intention and ability to hold for the foreseeable future, or until maturity or payoff, are reported at their outstanding principal balances, net of any unearned income, premiums or discounts. If a decline in fair value below the carrying balance is other-than-temporary, an unrealized impairment loss is recorded and the loan is recorded at the lower fair value at each reporting period. To-date, the Company has not recorded any impairment losses related to the mortgage loans.

 

Due to the fact that the Company issues notes secured directly by underlying loans, our assets and liabilities in this category have identical values and assets have offsetting balances.

 

Mortgage Servicing

 

The net present value of the servicing income is recognized at the time the mortgage is initiated as an unrealized gain. This value uses several inputs that are highly subjective including: discount rate, constant prepayment rate, the current interest rate environment, and default rate assumptions. Since the Company has limited operating history and a small amount of loans outstanding, we have a limited basis to predict prepayment rates and default rates, but have engaged a third party, MIAC Analytics, to assist us in our valuation of this asset. The amount is included on the Unaudited Statement of Financial Condition as “Mortgage Servicing Rights, at Fair Value.”

 

Securities

 

J. W. Korth held $225,000 of defaulted Banco Cruzeiro del Sur bonds which it reasonably believes it will receive par value for from the receiver handling the liquidation in Brazil. Local counsel has informed us that the bank has sufficient cash to pay off our bonds. We therefore carry them at par value.

 

KDM also holds a small amount of its own MSNs in an account which it may buy from time to time to provide liquidity to clients of J. W. Korth. These bonds are carried at the published statement values.

 

 

Fair Value Disclosure

 

The following tables display the Company’s assets and liabilities measured at fair value on a recurring basis:

 

		December 31, 2020
		Total				Level I				Level II				Level III
Financial Assets
Mortgages Owned		$	175,370,850			$	-			$	175,370,850			$	-
Mortgage Servicing			3,864,416				-				-				3,864,416
Securities			329,152				-				46				329,106
Total Financial Assets		$	179,564,418			$	-			$	175,370,896			$	4,193,522
Financial Liabilities
Mortgage Secured Notes Payable		$	175,370,850			$	-			$	175,370,850			$	-

 

 

		December 31, 2019
Financial Assets
Mortgages Owned		$	85,692,812			$	-			$	85,692,812			$	-
Mortgage Servicing			2,595,946				-				-				2,595,946
Total Financial Assets		$	88,288,758			$	-			$	85,692,812			$	2,595,946
Financial Liabilities
Mortgage Secured Notes Payable		$	85,692,812			$	-			$	85,692,812			$	-

 

 

Fair Value Measurements

 

Changes in Fair Value Measurements for the year ended December 31, 2020

 

The Company has engaged MIAC Analytics to assist in the valuation of the mortgage servicing component of its business. This leads to significant changes in underlying assumptions within the valuation model, which are detailed below.

 

The following table presents a reconciliation of changes in Level 3 assets and liabilities reported in the Audited Statements of Financial Condition for the year ended December 31, 2020:

 

 

Changes in assets:
Year ended December 31, 2020		Mortgage Servicing Value				Securities				Total Value
Beginning balance at January 1, 2020		$	2,595,946			$	225,000			$	2,820,946
Purchases			-				100,000				100,000
Trades			-				-				-
Sales			-				-				-
Issues			-				-				-
Settlements			-				-				-
Net realized gain/loss or Interest income			-				5,209				5,209
Unrealized Gain from newly issued mortgages			1,294,114				-				1,294,114
Fair Value adjustment			(25,644	)			(1,103	)			(26,747	)
Transfers into Level 3			-				-				-
Transfers out of Level 3			-				-				-
Ending balance at December 31, 2020		$	3,864,416			$	329,106			$	4,193,522

 

 

The Company’s policy for recording transfers between levels of the fair value hierarchy is to recognize as of the financial statement date. For the year ended December 31, 2020, there were no transfers between levels.

 

The Company has established valuation processes and policies for its Level 3 investments to ensure that the methods used are fair and consistent in accordance with ASC 820 – Fair Value Measurements and Disclosures. The Company’s valuation committee performs reviews of the Level 3 investments’ valuations, which include reviewing any significant price changes reported from the prior period. When a Level 3 investment has a significant price change, the valuation committee reviews relevant market data to substantiate the price change.

 

The following table presents quantitative information regarding the significant unobservable inputs the Company uses to determine the fair value of Level 3 investments held as of December 31, 2020:

 

Investment type		Fair Value				Valuation technique				Unobservable inputs				Values
Mortgage servicing		$	3,864,416				Net Present Value				Prepayment Discount				14.95	%
											Discount rate				15.00	%
Securities		$	329,106				Net Present Value

 

 

NOTE 14 – INCOME TAXES

 

Deferred income tax expense is detailed as follows:

 

		2020				2019
Deferred income tax expense:
Federal		$	204,263			$	297,723
State			56,612				82,513
Total deferred income tax expense		$	260,875			$	380,236
Total Income tax expense		$	260,875			$	380,236

 

Income tax expense differs from the amounts that would result from applying the federal statutory rate of 21% to the Company’s income before taxes for the years ended December 31, 2020 and 2019, are as follows:

 

		2020				2019
Computed “expected” income tax expense		$	209,542			$	486,500
Income to attributed to LLC (pre-June 2019)			—				(191,048	)
State income taxes, net of federal benefit			44,723				65,185
Non-deductible expenses			6,610				19,599
Total income tax expense		$	260,875			$	380,236

 

Temporary differences that give rise to the components of deferred tax assets and liabilities as of December 31, 2020 and 2019, are as follows: 

 

		2020				2019
Deferred tax assets:
Deferred revenue, net		$	103,778			$	73,391
Deferred rent from operating leases			1,625				—
Unrealized loss on mortgage security notes			280				—
Net operating loss carry-forwards			77,624				48,447
Deferred tax assets — current			183,307				121,838
Less: Valuation allowance			—				—
Net deferred tax assets		$	183,307			$	121,838
Deferred tax liabilities:
Unrealized gain on accrued interest			(849	)			—
Unrealized gain on mortgage			(823,569	)			(502,074	)
Deferred tax liability		$	(824,418	)		$	(502,074	)
Net deferred tax asset (liability)		$	(641,111	)		$	(380,236	)

 

 

As of December 31, 2020, the Company had net operating losses of $306,269 for federal and state income tax purposes that can be carried forward indefinitely until the loss is fully recovered, but limited to 80% of taxable income in any one tax period.

 

As of December 31, 2020, management determined that there should be no valuation allowance against the net deferred tax assets of $183,307. In assessing the ability to realize a portion of the deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of the deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities and projected future taxable income in making the assessment.

 

The Company has not recognized any tax benefits from uncertain tax positions for any of the reporting periods presented. Although it is reasonably possible that certain unrecognized tax benefits may increase or decrease within the next twelve months due to tax examination changes, settlement activities, expirations of statute of limitations, or the impact on recognition and measurement considerations related to the results of published tax cases or other similar activities, the Company does not anticipate any significant changes to unrecognized tax benefits over the next 12 months. During the year ended December 31, 2020, no interest or penalties were required to be recognized relating to unrecognized tax benefits.

 

The Company files U.S. federal and state tax returns, of which the open tax period subject to examination by taxing authorities include the years ended December 31, 2018, 2019 and 2020. The Company is not currently subject to any examinations by any state or federal taxation authority.

 

NOTE 15 – PROPERTY AND EQUIPMENT

 

Property and Equipment are summarized as follows:

 

Equipment		$	57,268
Furniture and fixtures		$	170,232
Total		$	227,500
Accumulated depreciation		$	(40,797	)
Net Property Equipment		$	186,703

 

Depreciation expense for the period ending December 31, 2020 was $3,391.

 

NOTE 16 – SUBSEQUENT EVENTS

 

The Company has evaluated all events or transactions that occurred after December 31, 2020 through the date of these financial statements, which is the date that the financial statements were available to be issued. During this period, there were no material subsequent events requiring disclosure, other than those noted below.

 

From January 1, 2021 through March 29, 2021, the Company closed approximately $30,000,000 of additional loans.

 

On January 13, 2021 J. W. Korth negotiated a five month early termination of its lease for its Miami office.

 

The Company currently has no loans in default.

 

In early 2020, an outbreak of a novel strain of corona virus (COVID-19) emerged globally. As a result, there have been federal, state and local authorities resulting in an overall decline in economic activity. The Company has been able to enact procedures to abate the financial and operational effects of the outbreak without a reduction in its workforce. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

 

 

F-20