Korth Direct Mortgage Inc. - 10-K

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 flow in the future. The risks and uncertainties described below are not the only ones we face but do represent those risks and uncertainties that we believe are material to our business, operating results, prospects and financial condition. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also harm our business.

Difficult conditions in the mortgage, residential and commercial real estate markets, or in the financial markets and the economy generally, including market volatility, and geopolitical tensions, may cause us to experience market losses related to our holdings. There is no assurance that these conditions now existing, will improve in the near future.

Our results of operations are materially affected by conditions in the mortgage market, the residential and commercial real estate markets, the financial markets and the economy generally. Difficult market conditions, as well as inflation, energy costs, geopolitical issues, health epidemics, unemployment and the availability and cost of credit, can contribute to increased volatility and diminished expectations for the economy and markets. The U.S. mortgage market has been severely affected by changes in the lending landscape and has experienced defaults, credit losses and significant liquidity concerns, and there is no assurance that these conditions have fully stabilized or that existing conditions will not worsen. Disruptions in mortgage markets negatively impact new demand for real estate. Further, disruptions in the broader financial markets, including the occurrence of unforeseen or catastrophic events such as the  effects of COVID-19 or other widespread health emergencies, geopolitical tensions or terrorist attacks, could adversely affect our business and operations. Any such disruption could  adversely impact our ability to raise capital, cause increases in borrower defaults and decreases in the value of our assets, cause continued interest rate volatility and movements that could make obtaining financing or refinancing our debt obligations more challenging or more expensive, and could lead to operational difficulties that could impair our ability to manage our business.

The market for real estate assets constituting commercial office space have experienced a significant downturn.

The market for commercial office real estate assets has seen a significant downturn due to changes in the workforce practices of many organizations. These changes have seen many office tenants abandoning traditional office footprints and/or downsizing their positions in the same in favor of remote or hybrid working environments. This practice has had a significant effect on the valuation of these assets and nationwide has caused an uptick in defaults by the owners of such assets on their debt service obligations as the revenue from these tenants has disappeared. Many property owners have struggled to relet some of these spaces causing outright maturity defaults, DSCR covenant violations and limited exit options for borrowers through a softer demand for such properties on the real estate market, and reduced leasing activity for vacant spaces. These changes have been exacerbated by continued high interest rates that make it difficult for borrowers to refinance existing debt at rates that generate sufficient DSCR coverage. The result of these factors have created situations where lenders have to foreclose on such loans and manage the assets until they can sell the collateral at a rate sufficient to cover the debt owed, or forcing lenders to extend the terms of the existing debt at interest rates that may not be current market rates. See the Inflation risk factor below.

KDM’s lending of additional subordinated funds to a Borrower may provide the Borrower needed funds to stabilize or complete needed renovations to subject properties but may also cause the property to be leveraged higher than would be acceptable under the current CM Loans underwriting guidelines.

KDM may lend a CM Loan Borrower additional funds through a subordinated real estate mortgage loan. KDM may elect to do so when it seems that the CM Loan Borrower needs such additional funds to complete or stabilize the subject property. This in turn may limit the ability of a CM Loan Borrower to refinance a loan and may over-leverage the subject property if the valuation of the property does not increase as expected, if market conditions change or of the CM Loan Borrower does not properly execute its business plan, which may increase the risk of a maturity or monetary default.

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Inflation in the U.S. is expected to continue at an elevated level in the near- to medium-term, which may have an adverse impact on the valuation of our loans and affect our borrowers’ ability to refinance.

Heightened competition for workers, supply chain issues, the relocation of foreign production and manufacturing businesses to the U.S., and rising energy and commodity prices have contributed to increasing wages and other economic inputs. Inflation can negatively impact the profitability of real estate assets with long-term leases that do not provide for short-term rent increases or that provide for rent increases with a lower annual percentage increase than inflation. Continued inflation, particularly at higher levels, may have an adverse impact on the valuation of the properties underlying the CM Loans as well as the sponsors’ ability to refinance.

CM Investors may lose some or all of their CM Investment.

The regular payment of a CM Investment 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 a borrower defaults on the CM Loan, CM Investors in that CM Loan 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 their Notes. The failure of a borrower to repay a 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 and subsequent sale to recover some or all of the principal invested in their Note. In some cases the property may not be sold quickly and workouts may take years.

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. Although we engage appraisal review firms, some errors may not be caught. KDM is not responsible for mistakes or fraudulent activities of borrowers or appraisers.

As we are highly dependent on information technology. System failures or security breaches could materially disrupt our business.

Our business is highly dependent on information technology and our ability to process, record and monitor many complex transactions and large amounts of data efficiently and accurately. In the ordinary course of our business, we store sensitive data, including our proprietary business information and that of our business partners, and non-public personally identifiable information of mortgage borrowers, on our networks. The secure maintenance and transmission of this information is critical to our operations. Computer malware, viruses, ransomware and phishing attacks remain widespread and are increasingly sophisticated. We are from time to time the target of attempted cyber threats. We continuously monitor and develop our information technology networks and infrastructure to prevent, detect, address and mitigate the risk of unauthorized access, misuse, computer viruses and other events that could have a security impact. Despite these security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee or service provider error, malfeasance or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, regulatory penalties, disruption to our operations, or disruption to our trading activities or damage our reputation, which could have a material adverse effect on our financial results and negatively affect our ability to pay dividends to stockholders.

The resources required to protect our information technology and infrastructure, and to comply with the laws and regulations related to data and privacy protection, are continuously evolving. Even in circumstances where we are able to successfully protect such technology and infrastructure from attacks, we may incur significant expenses in connection with our responses to such attacks. Government and regulatory scrutiny of the measures taken by companies to protect against cybersecurity attacks has resulted in heightened cybersecurity requirements and additional regulatory oversight. Any of the foregoing issues may adversely impact our results of operations and financial condition.

If we believe it is in the best interest of CM Investors, 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 CM Investors 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, that may reduce interest payments, suspend interest payments, lengthen the time when principal may be received or change other terms of the CM Loan, any of which could reduce the expected benefits of the CM Loan to the CM Investors.

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KDM may also choose to extend a performing CM Loan for an additional term due to market conditions, or may modify a loan for a good borrower to extend their period while adjusting their rate to current market level, if we believe such modification will not be detrimental to 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.

Any costs or delays involved in the completion of a foreclosure or liquidation of the underlying property may further reduce proceeds from the property and may increase the loss.

It is possible that we may find it necessary or desirable to foreclose on certain CM Loans we acquire or originate, and the foreclosure process may be lengthy and expensive. Borrowers may resist mortgage foreclosure actions by asserting numerous claims, counterclaims and defenses against us including, without limitation, numerous lender liability claims and defenses, even when such assertions may have no basis in fact, in an effort to prolong the foreclosure action and force us into a modification of the loan or a favorable buy-out of the borrower’s position. In some states, foreclosure actions can sometimes take several years or more to litigate. At any time prior to or during the foreclosure proceedings, the borrower may file for bankruptcy, which would have the effect of staying the foreclosure actions and further delaying the foreclosure process. Foreclosure may create a negative public perception of the related mortgaged property, resulting in a decrease in its value. Even if we are successful in foreclosing on the loan, the liquidation proceeds upon sale of the underlying real estate may not be sufficient to recover our cost basis in the CM Loan, resulting in a loss to CM Investors. Furthermore, any costs or delays involved in the completion of a foreclosure of the CM Loan or a liquidation of the underlying property will further reduce the proceeds and thus increase the loss. Any such reductions could materially and adversely affect the return to the CM Investor.

Real estate properties acquired through foreclosure subject us to additional risks associated with owning real estate.

When a CM Loan defaults, KDM may, on behalf of CM Investors, acquire the property through foreclosure or a deed in lieu of foreclosure. Depending on the market environment at the time, we may need to own the properties for an extended period of time before sale. We have acquired real estate properties through foreclosure, which exposes us to additional risks, including, but not limited to, the following:

facing difficulties in integrating these properties with our existing business operations;

incurring costs to carry, and in some cases make repairs or improvements, which results in additional expenses and requires additional liquidity that could exceed our original estimates and impact our operating results;

being unable to realize sufficient amounts from sales of the properties to avoid losses;

being unable to sell properties, which are not liquid assets, in a timely manner, or at all, when we need to increase liquidity;

maintaining occupancy of the properties;

controlling operating expenses;

coping with general and local market conditions;

complying with changes in laws and regulations pertaining to taxes, use, zoning and environmental protection;

possible liability for injury to persons and property;

possible uninsured losses related to environmental events such as earthquakes, floods or mudslides; and

possible liability for environmental remediation.

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.

In many cases, we do not monitor our borrowers’ use of funds.

Unless specified otherwise, KDM does not monitor 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.

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If payments on a CM Loan are not paid when due, CM Investors 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. 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.

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 subject to any prepayment penalties (if any) listed in the CM Loan. The amount of any prepayment penalty will depend on the type of loan product and the borrower. CM Investors 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 CM Investors receive will be reduced proportionally by the amount of principal repaid. If the borrower prepays the CM Loan in full or in part, CM Investors will in all probability not receive all the interest payments that they expected to receive on their Notes.

The current interest rate environment and/or market volatility may make it difficult for a CM Loan to refinance.

Sharp increases in prevailing interest rates may make it difficult or in some cases, not possible, for some CM Loan borrowers to refinance out of the CM Loan. Sharp increases in prevailing interest rates and or inflationary pressures may negatively impact the profitability of the collateral secured by the CM Loans, causing some assets to lose their ability to be cash flow positive or maintain the debt service covenants of lenders at the time they need to refinance. Similarly, market volatility reduces the amount of lenders in the marketplace when outcomes of the current environment are unpredictable. Accordingly, such changes may make it difficult, or in some cases, not possible for some CM Loan Borrowers to refinance a CM Loan at maturity, affecting the CM Loan Investors’ ability to realize a return of their principal and or interest payments.

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

If a CM Loan is prepaid, CM Investors may be unable to invest prepaid Note proceeds at a rate comparable to the interest payable on the Notes. Further, for our MSNs, if interest rates rise and 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. 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 BankUnited, RBC, or Chase and are managed by KDM. There is no escrow agreement with the bank.

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.

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Funds Received for all CM Loans are held on an omnibus basis in a Segregated Account.

We hold all funds received from CM Loans in a segregated account titled In-Trust For 2 at BankUnited 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.

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 CM Investors, 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 CM Investors monthly and annually to property insurers and taxing authorities. KDM performs all accounting for these accounts, including sub-accounts for each CM Investment and property, and maintains all accounting records at its principal office. Under the Trust Indenture for the MSNs, 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 CM Investors, taxing authorities and insurers even if the court were ultimately to determine that the funds in the account should be distributed to the CM Investors, the Trustee acting on their behalf, and, also, as appropriate, to taxing authorities and property insurers, resulting in delays to CM Investors in the receipt of payments on their Notes and penalties imposed by insurers and taxing authorities.

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 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 CM Investors. 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 the ability to receive principal and interest payments on the Notes will be delayed or impaired.

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

The market for hiring highly skilled technical and financial personnel is competitive. We may not be able to hire and retain 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 key personnel would involve significant time and expense and may significantly delay or prevent the achievement of our business objectives.

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

Our CM Investments 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.

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, CM Investors’ ability to receive principal and interest payments on CM Investments could be substantially harmed.

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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 CM Investors would be able to recoup their investment.

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 we or 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 is based on broad assumptions for which we have little statistical basis

We created the KDM Ratings System internally and based it on very broad assumptions. It should be noted that our staff members have no experience in creating a ratings system. We are not affiliated with any commercial rating agency, nor do we have experience in creating ratings of debt or mortgage securities. The Rating System has a short track record and has not been tested against any known data set. The Rating System is still evolving as we add items and add property types. It is not intended to be and 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.”

Risks Related to the Banking System and Financial Markets

KDM depends on the functioning of the U.S. banking system and bond markets to raise the capital needed to fund CM Loans which are the core of its business. Should the banking system or bond markets enter into a prolonged downturn or suffer a crisis of confidence, KDM’s ability to raise money to originate new CM Loans may be adversely impacted, causing it to reduce the number of loans it originates.

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

You should read the following discussion in conjunction with our 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.

Overview

KDM was organized as a Florida limited liability company 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, as well as via our subsidiary, J. W. Korth & Company Limited Partnership, a Michigan limited partnership.

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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.

We were wholly owned by J. W. Korth until July 31, 2020, when we acquired all of the equity of J.W. Korth, making it a subsidiary.

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 in a variety of ways, including selling loan participations, via a warehouse line, and directly in the capital markets through issuance of Mortgage Secured Notes (“MSNs” or “Notes”), which are sold through J.W. Korth as initial purchaser through exemptions from registration available under Rule 144A, Regulation D, and other exemptions from registration. We also own and operate commercial property acquired via foreclosure or deed in lieu of foreclosure. We may also issue second lien loans using KDM’s own assets, in which case these loans will be junior to the CM Loans where they are secured by the same property, or issue first mortgages with our own funds, which may or may not use additional financing.

KDM also operates its business through a variety of subsidiaries. KDM MFB LLC, a Delaware limited liability company was formed to issue multi-family bridge loans, and KDM Funding I LLC, a Florida limited liability company was formed to issue additional MSNs. These companies are wholly owned by KDM. Our REO portfolio is held in the name of KDM Asset Management LLC, a wholly owned subsidiary of KDM, and each property is held in a special purpose entity owned by KDM Asset Management, LLC.

Results of Operations for Year Ended December 31, 2025

The Company generated revenues of $17,235,522 for the year ended December 31, 2025, an increase of $5,167,865 or 43% compared with revenues of $12,067,657 for the year ended December 31, 2024, due to large increases in Origination and Leasing Revenue of revenues from our Asset Management segment. As of December 31, 2025, the Company owned mortgages of $285,416,050 compared with mortgages of $451,974,989 as of December 31, 2024, a decrease of 36.85%.

Similarly, gross profits increased by $4,704,605, or 55% to $13,220,244 during the year ended December 31, 2025, compared with gross profits of $8,515,639 during the year ended December 31, 2024.

Operating expenses were $10,533,839 during the year ended December 31, 2025, an increase of $1,000,724 compared with operating expenses of $9,533,115 during the year ended December 31, 2024. The increase in operating expenses was primarily the result of an increase of $745,944 in office expenses and an increase of $564,275 in depreciation related to the properties in our REO Portfolio.

The Unrealized (Loss)Gain on Mortgages caption is the net present value of our mortgage servicing rights. The balance sheet caption Mortgage Servicing Rights (“MSRs”) takes our expected future servicing revenues from our entire book of loans and discounts it to present value. Due to approximately $125 million loans being paid off in 2025, Servicing Revenue fell year over year by $914,377, or a decline of 18.10%.

For the year ended December 31, 2025, the Company recorded an income tax provision of $126,363 compared with an income tax benefit of $633,698 for the year ended December 31, 2024.

The Company pared Net Loss from $3,618,907 for the year ended December 31, 2024 to $2,344,108 net loss for the year ended December 31, 2025. Our Net Loss was 49% lower than the prior year, primarily due to a 73% increase in Origination Revenue at $2.918 million and a 94.3% increase in Leasing Revenue due to additional properties added to our REO Properties. See Segment Reporting for more information on our Asset Management segment. Our Operating Profit improved by 364% to $2,686,405 from ($1,017,406).

Although the benchmark interest rates dropped 75 bps in 2025, the commercial real estate landscape continued to present challenges. While growing additional relationships to fund lending for our primary segment of Lending and Servicing, we also made significant progress in our Asset Management division bringing one property back to performing and negotiating additional tenants and possible sale contract on another. With the MSN market stalled for 2025, KDM was unable to add significantly to its servicing portfolio which has resulted in a net decline of approximately $125 million of loans serviced. Additionally new loans closed were at traditional servicing rates, rather than at net interest margin rates, resulting in less unrealized gain added to the balance sheet. We are hopeful that the MSN market investors will return for 2026, as this is a critical piece of our business model as well as the net margin from those loans is the security interest underlying our preferred stock payments. KDM continues to explore additional avenues in its business and expects 2026 to present new opportunities for the Company and its investors.

Financial Condition for the year ended December 31, 2025

As of December 31, 2025, we had $5,354,168 in cash, $5,732,975 in portfolio loans and securities, as well as $285,416,050 of loans securitized or participated out to investors. Total KDM originations stood at $672,267,797 as of December 31, 2025. As of December 31, 2025, our property and equipment net of depreciation is valued at $69,691,129. The Company also has invested approximately $1,084,050 in KDM Capital Partners, LP, which makes bridge loans on multifamily properties.

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The fair value of our Mortgage Servicing Rights fell by 34%, falling proportionally to the MSN loans that have paid off and not been replaced. Our MSRs are the net present value of the future servicing income we receive from loans made to date. This value is highly subjective and includes such variables as constant prepayment rate (CPR), discount rate, and market pricing data. Please see the explanation of this change in value above in “Results of Operations.” The current value was provided by a third-party consulting firm and uses 15.0% for the discount rate and includes a 14.25% CPR, along with other assumptions customary to the industry.

Total assets declined by 27% to $380,854,013 at December 31, 2025 due to $166,558,939 book value of loans paying off or otherwise being disposed. This includes $50,800,000 moved out of the mortgage book and into REO at fair value upon acquisition through foreclosure or deed in lieu of foreclosure.

Capital and Liquidity Needs

W ith the decline in the MSN market, and KDM just beginning to ramp business with some new lending partners at lower net profit to the Company than the MSN program, KDM’s balance sheet and ongoing monthly revenue from servicing has declined significantly. We are optimistic that in 2026 the MSN market will recover and we will add additional assets to our MSRs and recurring revenue streams .

I n the Asset management segment of the business, KDM may need to access financing in order to improve or reposition properties it owns. Including, in particular, a development project on its LA Arts District property to convert it to multi-family .

KDM continues to work to raise capital for its nascent fund, KDM Capital Partners, LP (the “Fund”), currently targeting high net worth investors, RIAs, and family offices. The Company is actively looking to repackage some of its existing loans into an alternative structure or may otherwise access the capital markets or private credit markets as we deem necessary for our business in forms that will allow us the flexibility to grow our business again.

Status of our CM Loans

As of year-end 2025, KDM had 4 loans in payment default and outstanding, for a total of $8,156,973, of which $4,656,977 is KDM’s portfolio capital. Two of these loans are fully funded by KDM and two are partially funded by investors. We believe the outstanding balances on these loans represent an approximate 72% loan to value, and that we are reasonably secured versus stabilized value of the properties, but they will take time to resolve the foreclosure actions.

In total, KDM has had payment defaults on 11 loans out of the 118 loans we have originated on 167 properties, representing a default rate of 9.3% of loans, or 6.6% of properties lent on. Of these, 64% were office defaults, 3 of the 11 were sold at or near par, with investors experiencing only minor losses. However, one office did not have sufficient cash flow to pay its ground lease once it was acquired and investors were unwilling to put in additional capital due to the distressed capital structure, and that loan was a total loss. Of the remaining seven defaults, as of year end 2025, three are in our REO portfolio, and four are in various stages of the foreclosure process.

Of the approximately $673,567,197 in loans originated by the Company, $322,769,453 of principal has been returned to investors, representing approximately 48% of total funds invested. Additionally, the Company has paid out a total of $114,103,957 in MSN interest to investors since inception, representing a 16.9% interest return based on the total amount of loans originated. In aggregate, the Company has returned $463,874,410 to investors through its Mortgage Secured Note program.

CM Loans may from time to time be in a state of technical default. Such defaults arise out of a breach of one or more covenants or obligations of the loan, other than those for the repayment of principal or interest. KDM as the Servicer may elect to trigger default conditions where it feels that the underlying loan agreements provide for such default and that the triggering of default remedies is in the best interest of protecting the value of the underlying collateral and the repayment of the loan. Where KDM believes that a technical default would create a material risk to the CM Investors, KDM will provide notice to the CM Investors of the default and its risks.

Real Estate

In November 2022, KDM acquired a majority interest in a specialty office building in Stafford, Virginia after the borrower defaulted on its second lien mortgage. The first lien mortgage is in KDM2021-N011 and the property continues to cash flow the first lien. KDM is planning a specialty buildout of the third floor for a new tenant and may continue to operate the property or sell it to investors.

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In the beginning of 2024, KDM acquired two properties on behalf of are MSN Noteholders in Acton, MA and St. Louis, MS via foreclosure and deed in lieu of foreclosure, respectively. The properties were currently securitized in KDM2021-N015 and KDM2021-N022, respectively. Both properties had high vacancy at the point of acquisition and the Company is working to stabilize the properties prior to sale in order to maximize recovery for the MSN Noteholders.

After taking the office building in April 2024, in May 2025, KDM Cupples REO LLC defaulted on the ground lease of the property it owned in St. Louis, Missouri. After a meeting with the bondholders, where KDM informed all bondholders that capital would need to be raised to pay the taxes, insurance, and ground rent, in order to not default, with additional funds in order to stabilize the property, the bondholders chose to let the property go. The ground lessor terminated the ground lease and KDM Cupples REO LLC no longer owns the leasehold estate. On June 23, 2025, KDM removed the $9,000,000 asset from its balance sheet and canceled the related outstanding bonds. The transaction is reflected in the consolidated statements of operations as a loss on foreclosures and change in fair value of mortgage secured notes.

In March 2025 and April 2025, via deed in lieu of foreclosure, KDM acquired a mixed use property in Los Angeles, California, a majority-owned via a subsidiary named KDM Seaton Colyton Holdings, LLC and an owner-occupied building in Selma, TX.

We have future expected rents from the above properties of approximately $43,171,046, approximately $14M of which is expected before 2030, and the remaining $29.1M from 2031 and beyond.

Map of Current Loans

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Loan Information as of March 31, 2025

Number

Buildings

Ticker

Property

Property

Type

EJ Rating

Issue Date

Maturity

Date

Status

Original Balance

Original Appraisal

Original LTV

Appraisal Date

Current Balance

KDM2017-N001

Pinellas Park, FL

Multi-family

Paid-in-Full

KDM2017-N002

Miami, FL

Multi-family

Paid-in-Full

KDM2018-N001

Miami, FL

Warehouse

Paid-in-Full

KDM2018-N002

St Petersburg, FL

Multi-family

Paid-in-Full

KDM2018-N003

Perrysburg, OH

Warehouse

Paid-in-Full

KDM2018-N005

Northwood,  Ohio

Warehouse

Paid-in-Full

KDM2018-N007

Vicksburg, MS

Multi-family

Paid-in-Full

KDM2019-N001

Hammonton, NJ

Office

Paid-in-Full

KDM2019-N002

Birmingham & Center Point, AL

Multi-family

Paid-in-Full

KDM2019-N003

Springs Global SC and PA

Industrial

BBB+

Paid-in-Full

KDM2019-N004

Masco Springs - OH, OK, GA

Industrial

Performing

KDM2019-N005

Capitol Heights, MD

Industrial

Paid-In-Full

KDM2019-N008

Cleveland, Ohio

Retail

Paid-in-Full

KDM2020-N001

Woodbridge, VA

Industrial

Performing

KDM2020-N002

Cleveland, OH

Office

Paid-in-Full

KDM2020-N003

Carrollton, GA

Data Center

Paid-In-Full

KDM2020-N007

Stuart, FL

Office

Paid-in-Full

KDM2020-N006

Water's Edge, Trenton, NJ

Skilled Nursing Facility

Paid-In-Full

KDM2020-N009

La Grange, IL

Industrial

Paid-in-Full

KDM2020-N008

Loves Park, IL

Industrial

Paid-in-Full

KDM2020-N010

Multifamily in AL, NY, FL

Multi-family

Performing

KDM2020-N012

Hampton, VA

Office

Performing

KDM2020-N011

Stamford, CT

Office

Performing

KDM2021-N001

Mixed-use

Performing

and 01/21

KDM2021-N002

Bellingham, WA

Office

BBB+

Performing

KDM2021-N004

Ronkonkoma, NY

Warehouse

BBB/BBB+

Performing

KDM2021-N005

Los Angeles, CA

Industrial

REO

KDM2021-N006

FL and SC

Office

Performing

KDM2021-N007

Cheyenne, WY

Industrial

Paid -In-Full

KDM2021-N008

Covina, CA &  Las Cruces, NM

Retail

Paid-in-Full

KDM2021-N011

Stafford, VA

Office

REO

KDM2021-N013

East Orange, NJ

Education Center

Performing

KDM2021-N014

Mount Prospect, IL

Retail

Paid -In-Full

KDM2021-N015

Acton, MA

Office

REO

KDM2021-N018

Columbus, Toledo, Alliance & Mansfield, OH

Skilled Nursing Facility

Paid -In-Full

KDM2021-N020

Washington, PA  & Goreville &  Marion, IL

Funeral Homes & Office

Paid off 89.90%

KDM2021-N021

Kentucky

Office

Performing

KDM2021-N022

St. Louis, Missouri

Office

BBB+

Charge-Off

KDM2022-N001

Allentown, PA

Office

Performing

KDM2022-N002

North Carolina & Virginia

Retail

Performing

KDM2022-N003

Ohio

Skilled Nursing Facility

Paid -In-Full

KDM2022-N006

Honolulu, HI

Special Use

Performing

KDM2022-N007

California and Texas

Retail

Performing

KDM2022-N009

Benton, Washington

Office

Performing

KDM2022-N010

Washington D.C.

Office

BBB+

Performing

KDM2022-N011

Selma, Texas

Warehouse

REO

KDM2022-N014

Coral Gables, Florida

Office

Paid-in-Full

KDM2023-N001

Long Beach, CA

Retail

A/A-/BBB

Paid-in-Full

KDM2023-N002

Homewood, AL

Office

Performing

KDM2023-N003

Murray, Kentucky &  Kingsport, Tennesseee

Multisecuritization

Performing

KDM2023-N006

Worcester, MA

Retail

BBB+

Performing

KDM2023-N008

Ft Myers, FL

SFR

Default

KDM2024-N001

Pembroke Pines, FL

Medical Office

Performing

KDM2024-N002

Miami, FL

Industrial

Performing

KDM2024-N003

San Diego, CA

Mixed-use

Performing

KDM2019-N005

Capitol Heights, MD

Industrial

Performing

KDM2025-N001

San Diego, CA

Multi-Family

Performing

MFB 1

KDM2024-N004

Clute, TX

Multi-family

Performing

MFB 2

KDM2024-N005

Atlanta, GA

Multi-family

Default

MFB 3

KDM2024-N007

San Diego, CA

Multi-family

Performing

* Ratings are the original and current ratings received from Egan-Jones Ratings Agency

** NR means the loan has not been rated and was either sold as a participation or an unrated bond.

*** Non-sequential loan numbers are due to some loans having been issued a file number, but the transaction was not closed, or is waiting to be closed

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Sales, Marketing and Customer Service

Our marketing efforts are designed to attract borrowers and brokers to solicit us for lending opportunities. Our origination team primarily does this through the substantial network of commercial mortgage brokers we have assembled, as well as through correspondent and wholesale relationships. 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 Office of Foreign Assets Control (“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, accurate, and complete.

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, non-bank lenders, local banks, other private credit groups, as well as smaller private lenders.

Our success depends on further developing our network of transaction referral sources and broadening our distribution of our CM Investments.

We may also face future competition from new companies entering our market. 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.