UDF Response To Misleading Anonymous Posts via SEC
On December 10, 2015, United Development Funding III, L.P. (“UDF III”) and United Development Funding IV (“UDF IV”, and together with UDF III, “we” or the “Companies”) and other affiliated funds (together with the Companies, “UDF”) were attacked by a hedge fund or funds. We believe that the hedge fund(s) built a significant short position in UDF IV with the intention of unlawfully manipulating the price of UDF IV shares (a type of securities trading scheme known as “short and distort”). UDF IV short activity reported by Nasdaq.com at November 30, 2015 was in excess of 4.1 million shares, up from approximately 59,000 shares on December 31, 2014. We have communicated our knowledge of the facts and circumstances to the Securities and Exchange Commission (“SEC”). We believe the hedge fund(s) intend to continue to disseminate misleading information. We will defend our funds aggressively.
Consistent with a short and distort scheme, the posts about UDF have appeared on Internet sites and contain misleading statements, speculation and rumors. The statements clearly demonstrate a lack of understanding of the residential development project life cycle, which typically involves multi-phase master planned communities and the related financing structures. Investors who wish to understand our business should review our registration statements and periodic SEC filings, which describe the business model for each fund.
The Companies have been cooperating since April 2014 with a non-public fact-finding investigation being conducted by the SEC. We have provided a broad range of information to the SEC, however, the SEC has not identified to us any specific issues that are the subject of its investigation. The SEC has informed the Companies that this investigation is not an indication that any violations of law have occurred or that the SEC has any negative opinion of any person, entity, or security. UDF has not been accused of any wrongdoing and we believe that the Companies have appropriate policies and procedures in place to ensure accurate financial reporting and compliance with all applicable rules and regulations. The SEC has requested that the details of its fact-finding process be kept confidential and we have followed the advice of our securities counsel with respect to communication with the SEC and disclosure with respect thereto.
The following discussion refutes the misleading statements made in the posts about UDF and addresses additional questions from our investors.
UDF IV Value of Loans and Book Value Per Share
We evaluate each loan and its underlying collateral or business purpose on a quarterly basis. For our secured loans, we prepare detailed cash flow analyses using assumptions such as the land purchase price, projected development costs and expected cash flows from land parcel sales and finished lot sales, many of which are based on executed lot sales contracts between our borrowers and homebuilders. This information is available to our auditors for the quarterly reviews and annual audits of our financial statements. We believe the balances on our balance sheet are properly presented. UDF IV’s shareholder equity at September 30, 2015 totaled $510.2 million, or $16.63 per share.
UDF IV Accrued Interest on Loans
Most of our loans allow for interest accrual, which causes the loan balance to increase. Some projects may start development right away, while others may have various entitlement processes to complete before development begins. The value of collateral securing our loans generally increases as projects gain entitlements and move through the development stages. In addition, many of the projects we finance are multi-phase projects that may extend for several years, with different phases moving into development at different times. Once a project generates cash flows, payments are first applied to accrued but unpaid interest and then to principal. Our underwriting considers the expected asset life and the associated financing costs. We recognize interest income and record accrued interest on the loans where full collectability is considered probable.
Management/Advisory Fee Calculation
Management/Advisory fees are assessed differently from fund to fund. UDF III’s general partner currently receives a promotional and carried interest. UDF IV’s management fee is based on UDF IV’s shareholders’ equity as defined in its advisory agreement, plus an incentive fee based on achievement of a performance hurdle. United Development Funding Income Fund V’s (“UDF V”) advisory fee is based on average invested assets. The management/advisory fees and the basis for the calculations are disclosed in each Company’s Quarterly Reports on Form 10-Q and Annual Reports on Form 10-K.
UDF IV Provision for Loan Losses
UDF IV’s general reserve was approximately $6.8 million at September 30, 2015. The general reserve has not changed significantly in 2015 because the outstanding balance of the portfolio has been relatively static. UDF IV has not had any realized losses in its portfolio. UDF IV reviewed each matured loan and underlying collateral, and determined that its loan balances were either paid in full subsequent to the quarter end, or are fully supported by the related collateral as of September 30, 2015.
We are primarily an asset-based lender and as such, our loans are underwritten based on collateral value. By design, we concentrate our lending to seasoned and accomplished builders and developers. Our largest group of related borrowers represents one of the largest single-family developers in North Texas. This developer does business with many of the largest homebuilders in the Texas markets. Our transactions with this group are on arms-length terms, and our loan terms with this group are generally the same as loan terms with our other borrowers. Many of the projects we have financed have related borrowers. At September 30, 2015, UDF IV has invested 62% of its portfolio in 69 loans to its largest group of related borrowers. In addition, as of September 30, 2015, UDF IV is participating in 5 loans originated by its affiliates to the same group of related borrowers, representing an additional 5% of the outstanding balance of UDF IV’s loan portfolio. As of September 30, 2015, UDF III has invested 43% of its portfolio in 11 loans to its largest group of related borrowers. Each fund discloses its concentration of credit risk.
In the ordinary course of our business, as with other lenders, consistent with multi-phase residential development financing, the expected life of some projects is anticipated to exceed the original term of the loan. Because extensions are a normal part of our business, we generally do not charge an extension fee. When this occurs, as provided for in our business model, we evaluate the performance of the underlying collateral and determine whether to extend the maturity date of the loan. As of September 30, 2015, management has assessed all UDF IV matured loans and determined that collectability is probable. As of September 30, 2015, management has assessed all UDF III matured loans and of these 6 loans, full collectability is considered probable for 2 loans with an aggregate unpaid principal balance of approximately $109.6 million, full collectability is considered more likely than not, but not probable, for 3 loans with an aggregate unpaid principal balance of approximately $25.0 million, and 1 note receivable with an aggregate unpaid principal balance of approximately $5.3 million was deemed as probable that we will be unable to collect all amounts due. In addition to the 6 loans considered impaired due to the loans remaining