UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2019

¨ 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)

_________________________________Korth Direct Mortgage LLC___________________________________

(Former name, former address and formal fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

x Yes   ¨ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).

x Yes   ¨ No

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.

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

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

As of September 30, 2019, there were 5,000,000 shares of Common Stock, Korth Direct Mortgage Inc. outstanding.

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

KORTH DIRECT MORTGAGE INC

UNAUDITED STATEMENTS OF FINANCIAL CONDITION

See accompanying notes to the unaudited financial statements.

KORTH DIRECT MORTGAGE INC

UNAUDITED STATEMENTS OF OPERATIONS

FOR THE PERIOD FROM JANUARY 1 THROUGH SEPTEMBER 30

See Accompanying notes to the unaudited financial statements.

KORTH DIRECT MORTGAGE INC

UNAUDITED STATEMENTS OF CASH FLOWS

See accompanying notes to the unaudited financial statements.

KORTH DIRECT MORTGAGE INC

NOTES TO UNAUDITED FINANCIAL STATEMENTS

Korth Direct Mortgage Inc. (the “Company” or “KDM”) is a Florida corporation. In June 2019, the Company converted to a corporation from a limited liability company formerly known as Korth Direct Mortgage, LLC. The Company is a wholly-owned subsidiary of J. W. Korth & Company, L.P. (“J. W. Korth”), an SEC and FINRA registered broker dealer. The Company originates and funds loans made to commercial real estate borrowers. The loans are held by KDM as lender. KDM also services its loans, though it may use a sub-servicer for some loans. KDM funds its 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 that are generally a single-purpose entity that owns the underlying property that KDM finances.

Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with US generally accepted accounting principles (“GAAP”) have been condensed or omitted. These unaudited financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s 2018 Annual Report on Form 10-K filed with the Securities and Exchange Commission.

PRINCIPLES OF CONSOLIDATION

The accompanying financial statements are solely for the Company. The financial statements of the parent company, J. W. Korth, have these accounts consolidated within them.

BASIS OF ACCOUNTING

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

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 Unaudited Statements of Financial Condition, and is recognized on the Unaudited Statements of Operations as an unrealized gain on mortgages owned.

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 the date of these financial statements, the Company has funded loans totaling $45,956,402 and it issued MSNs secured by those loans, in the amount of $41,798,402. 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. In August 2019, the Company made a bridge loan to a customer to assist in getting the loan closed which it planned to be repaid upon that customer’s next loan funding. This $460,000 loan was funded by the Company as well as affiliates, and was paid off in October 2019.

REVENUE RECOGNITION

The Company has three primary sources of revenue: origination fees, servicing fees, and processing fees.

Origination Fees

Loan origination fees represent revenue earned from originating mortgage loans, net of any credits given to the borrower. Origination fees may be on loans where KDM or another party is lender and KDM has acted as a broker in the transaction. Loan origination fees generally represent flat, per-loan fee amounts and are recognized as revenue at the time the loans are funded.

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 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.

Unrealized Gain on Mortgages Owned

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 a short operating history and a small number of loans outstanding, we have a limited basis to predict prepayment rates and default rates.

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.

DUE TO PARENT AND PAYABLES

Items due to parent are operating expenses due to the parent company, J. W. Korth, pursuant to the support agreement. On At September 30, 2019, the Company owed J.W Korth $84,495. On May 2, 2019, and as of March 31, 2019, J. W. Korth forgave its receivable of $548,802 that was on the Company’s balance sheet as Due to Parent in order to assist the Company in strengthening its balance sheet and Stockholder’s Equity.

INCOME TAXES

The Company converted to a corporation from a limited liability company in June of this year. The Company was previously a limited liability company and disregarded entity. As of June 4, 2019, the company has estimated income taxes at 21%.

In accordance with Financial Accounting Standards Board Accounting Standards Codification (“ASC”) 740 – Income Taxes, management has evaluated uncertain tax positions taken or expected to be taken in the Company’s tax returns. In order for a benefit to be recognized, a tax position must be more-likely-than-not to be sustained when challenged or examined by the applicable taxing authority. For the nine months ended September 30, 2019, the Company has no material uncertain tax positions to be accounted for in the financial statements.

The Company maintains two 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. This account corresponds to the Escrow Payable liability. As of September 30, 2019, this account has a balance of $391,780.

The “In Trust for 2” account receives payments from borrowers, distributes payments to investors, and pays the servicing fee to the Company. This account corresponds to the Due to Investors liability. As of September 30, 2019, this account has a balance of $4,264,305 (commitment fees/accrued interest), which includes a balance of $4,158,000 pending closing of a loan.

The Company relies partially on its parent, J. W. Korth, to provide office space, internet connectivity, phone service, and incidentals through the end of 2019.

 
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.

As of September 30, 2019, the Company has ten customers excluding the $460K portfolio loan. 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. Currently, 22% of loans, by unpaid balance, are geographically concentrated in the state of Ohio and 23% are concentrated in the state of New Jersey.

The Due to Parent account is used to account for bills and expenses paid by J. W. Korth on behalf of the Company. The Company was previously largely supported by its parent company, J. W. Korth. The Company owed J. W. Korth $548,802 on March 30, 2019; however, this debt was forgiven as of March 31, 2019 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 Unaudited Statements of Operations for the nine months ended September 30, 2019. The Company owed J.W. Korth $84,495 and $494,122 as of September 30, 2019 and December 31, 2018, respectively. The support agreement between the Company and J. W. Korth remains in place to facilitate accounting and payables.

On September 27, 2019, the Company issued 200,000 shares of its Series A 6% Cumulative Perpetual Convertible Preferred Stock. The Company paid $250,000 in expenses related to the 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.

GAAP 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.

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:

All of the loans on the balance sheet as of September 30, 2019 are carried at principal value, as are the corresponding Mortgage Secured Notes Payable. The Company has determined that the fair values were determined by the market at the time of sale and should be classified as Level II of the fair value hierarchy. The carrying amounts for these items approximate the fair value. For amortizing loans, the Company discounts those to remaining principal value.

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.”

Fair Value Disclosure

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

Fair Value Measurements

Changes in Fair Value Measurements for the nine months ended September 30, 2019

The following table presents a reconciliation of changes in Level 3 assets and liabilities reported in the Statements of Financial Condition for the nine months ended September 30, 2019:

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 nine months ended September 30, 2019, 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 September 30, 2019:

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

The following is a discussion of our historical consolidated financial condition and results of operations, and should be read in conjunction with (i) our historical consolidated financial statements and accompanying notes thereto included elsewhere in this Quarterly Report on Form 10-Q; (ii) our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the Securities and Exchange Commission (the “SEC”) on March 28, 2019; and (iii) our management’s discussion and analysis of financial condition and results of operations included in our 2018 Form 10-K. This discussion includes forward-looking statements that are subject to risk and uncertainties. Actual results may differ substantially from the statements we make in this section due to a number of factors that are discussed in “Forward-Looking Statements” herein and “Part I – Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2018.

Overview

Korth Direct Mortgage Inc. (“KDM,” the “Company”, “we,” or “us”) was organized in Florida on July 24, 2009, under the name HCMK Consulting LLC. We changed our name to Korth Direct Mortgage, LLC, on August 24, 2016.  On June 3, 2019, we converted from a limited liability company to a corporation, Korth Direct Mortgage Inc. Concurrently with our conversion into a corporation, James W. Korth was named Chief Executive Officer, Holly MacDonald-Korth was named President and Chief Financial Officer, and we appointed a board of directors.

Our principal executive offices are located at 2937 SW 27^th Avenue Suite 307, Miami, Florida 33133, and our telephone number is (305) 668-8485. Our website address is www.korthdirect.com.

KDM began its formal operations in October of 2016 when we engaged our Chief Lending Officer. We are a licensed in Florida as a Mortgage Lender Servicer. Our NMLS License Number is 1579547. Our operating history is limited. As of September 30, 2019, we were wholly owned by J. W. Korth & Company, L.P. (“J.W. Korth & Company”), a FINRA and SEC registered broker-dealer founded in 1982. We believe we will become independent from our parent company by the end of 2019. We do not anticipate incurring any research and development expenses nor expenses for plant and equipment, and that office space will continue to be shared with our parent company during calendar year 2019. We anticipate renting office space in 2020 and adding support staff by the end of that year as our lending and servicing activities require.

The total support we have received from J. W. Korth & Company through March 31, 2019, was $752,302. In November 2018, $203,500 was repaid to J.W. Korth & Company, and subsequently, as of March 31, 2019, J.W. Korth & Company forgave the remaining receivable from KDM of $548,802. For the quarter ended September 30, 2019, KDM owed J W Korth & Company $84,495, as part of inter-company receivables. The Support Agreement remains in place.

Results of Operations for the Nine Months ended September 30, 2019

The Company had net income of $1,754,400 for the nine months ended September 30, 2019, substantially attributable to a one-time gain from the cancelation of a payable to J.W. Korth & Company of $548,802. The Company had revenues of $1,118,275 during the nine-month period, 87% of which was attributable to origination revenue, and for the period we had servicing and processing revenue of $119,791 and $9,420, respectively. Servicing revenue was reduced by the sale of approximately $200,000 of servicing rights for 18 months which began in January 2019. Costs were dominated by mortgage broker and brokerage underwriting expenses of $231,720 and $457,275, respectively, which together accounted for approximately 60% of direct costs. Gross profits grew to $342,514, an 866% increase over the same period in 2018, when the Company had gross profits of $35,458. Operating expenses rose as well, but at a slower pace of 52% ($363,064 for the current period compared to $238,619 for the same period in 2018) as we shift more salaries and expenses to KDM that were previously being paid by J. W. Korth.

Higher expenses and costs were offset by the unrealized gain on mortgages owned, which was $1,232,433 at September 30, 2019, an increase of $634,072 over the prior quarter due to new lending. A discussion of the assumptions underlying the valuation can be found in Note 8 of the Notes to our Unaudited Financial Statements.

Financial Condition for the nine Months Ended September 30, 2019

As of September 30, 2019, we had eleven loans including the 460K portfolio loan on our balance sheet for a total of $42,258,402 ($41,798,402 without $460K) at fair value. The original loan amounts totaled $42,300,250 ($41,840,250, without $460K); however, two loans are amortizing and are carried at their remaining principal balances. We have recognized an unrealized gain of $1,232,433, which is the change in 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 will be recalculated quarterly. The current value was provided by a third-party consulting firm and uses 15.0% for the discount rate and includes a 10.76% constant prepayment rate (“CPR”), along with other assumptions customary to the industry.

When J. W. Korth & Company forgave its receivable from the Company, we realized a large one-time gain as well as a decline in our Due to Parent liability, resulting in a corresponding substantial increase in Stockholder’s Equity of $548,802.

On September 27, 2019, we completed our first round of equity funding by an issuance of $5,000,000 Series A 6% Cumulative Perpetual Convertible Preferred Stock. The proceeds of sale of this preferred equity allow us to have a reserve for advancing payments to noteholders, providing additional funding to our borrowers, and capital needed for accelerating growth of the Company.

We have grown our origination team to 4 members and have a goal to close an additional $50M of loans in 2019.

Capital and Liquidity Needs

The Company completed a $5,000,000 (less issue costs of $250,000) Series A 6% Cumulative Perpetual Convertible Preferred Stock in September 2019. We expect to raise additional preferred capital, as necessary, in 2019 and succeeding years.

Status of KDM Loans

We include our annual reviews of CM Loans as exhibits to our quarterly reports on SEC Form 10-Q. Loans that are held by outside investors or securitized and reach the anniversary of their inception in a current reporting quarter are included as an exhibit to each report.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We have no instruments subject to market risk.

Item 4. Controls and Procedures.

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 Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our internal control over financial reporting as of June 30, 2019, 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 September 30, 2019.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

The Company is not subject to any material legal proceeding. The Company is a defendant in a suit regarding a mortgage brokerage fee dispute. The Company is fully indemnified for the suit by the borrower in the transaction which is the subject of the suit. We do not believe that the proceeding is material under Item 103 of SEC Regulation S-K.

Item 1A. Risk Factors.

There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018, as amended. Please refer to the “Risks Factors” section in our Annual Report for a discussion of risks to which our business, financial condition, results of operations and cash flows are subject.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

See Item 3.01 of our Current Report on Form 8-K filed on June 12, 2019, for a description of the issuance of equity securities to our parent company pursuant to our conversion from a limited liability company to a corporation.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not Applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

*Filed herewith.

SIGNATURES

Pursuant to the requirements 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.

14